Economics gets a reputation as the “dismal science” as coined first by Victorian Historian Thomas Carlye. I for one don’t believe it’s dismal nor really a science. It’s a social science which basically means it’s an examination of human behavior through a scientific lens. While I think it’s easy to know what economics is, it’s actually somewhat harder to define. Technically, Economics is the study of the production, distribution and consumption of goods and services. It’s an awfully big category. I didn’t know anything about Economics before the first course I took my freshman year. Even though I ended up majoring in the subject, my first course, Introduction toMicroeconomics , hardly inspired me. However, there’s no question that today, studying Economics has ultimately shaped how I view the world. Economics because it often assumes perfect competition,symmetric knowledge, and perfectly rational participants is far from infallible, but none the less provides a great framework to understand business, and policy decisions.  Everyone would do well to have a basic understanding of Economics.

I want to devote some time in the next couple weeks getting back to Economic basics. While I don’t think my blog is particularly full of Economic jargon (though I do think it’s full of financial jargon), I realize I do take it for granted that my readers have some basic background in economics (at least some of the terms and concepts).   Economics usually breaks down into Microeconomics, and Macroeconomics. Microeconomics deals with the behavior of individual entity such as a person or a corporation. Macroeconomics centers around broad measures of the economy such as total employment, and trade. So company’s decision to import products from China is a microeconomic decision while the impact on the trade balance is a macroeconomic effect.

Everyone starts with Microeconomics, and one the first concepts taught is supply and demand curves, where quantity consumed or supplied is determined by price.

Demand curves are almost always downward sloping, i.e. consumers choose to consume more at lower the prices. Supply curves are upward sloping, i.e. a producer will supply more at higher price. Where the supply and demand curve meet is the market clearing price, and is the price than ensures that supply meets demand. Often times the term elastic (and inelastic) will be used as an adjective to describe either the supply or demand curve. An elastic curve implies that the quantity can vary widely with price, a flatter curve.  A small change in price may have a large impact and quantity demanded or supplied. An inelastic curve implies that quantity supplied or demanded will not vary despite what the price might be. A perfectly inelastic curve would be vertical line. Some people consider the demand for cigarettes relatively inelastic. Despite the increase in price, smokers will still have their smokes. The fundamental argument against increasing minimum wage is based on the simple application of supply and demand curves. A minimum wage create an artificial price above the market clearing price. Because the minimum wage price is higher than the market price, the supply of jobs is lower than the demand for jobs at that price.

In the graph above, the number of jobs is reduced from Nc to Nm with a minimum wage Wm that is higher than the market clearing wage Wc. In this simple model the higher the minimum wage, the greater the reduction in employment. In actuality it’s much harder to say how much of an effect raising the minimum wage has and if those reduction in jobs are more than outweighed by the benefit of higher wages for employees. However even the simple model does demonstrate conceptually that having a minimum wage may have unintended consequences such as job losses.

The other primary lesson to be taken away from supply and demand is the role of price. Price is the signal that consumers and supplier respond, and why it’s so important to have pricing transparency. Inaccurate pricing leads to the wrong behavior. For example high oil prices are signal for suppliers such Exxon to go and find more oil, just as its signal for a driver like myself to drive less.   Without the proper price signal consumers and suppliers would do the wrong thing.  I wouldn’t drive less, and Exxon wouldn’t try hard to find new sources of energy.