Economics is all about humanity’s struggle to achieve happiness in a world full of constraints. There’s never enough time or money to do everything people want, and things like curing cancer are still impossible because the necessary technologies haven’t been developed yet. But people are clever. They tinker and invent, ponder and innovate. They look at what they have and what they can do with it and take steps to make sure that if they can’t have everything, they’ll at least have as much as possible.

Having to choose is a fundamental part of everyday life. The science that studies how people choose — economics — is indispensable if you really want to understand human beings both as individuals and as members of larger organizations. Sadly, though, economics has typically been explained so badly that people either dismiss it as impenetrable gobbledygook or stand falsely in awe of it — after all, if it’s hard to understand, it must be important, right?

I wrote this book so you can quickly and easily understand economics for what it is — a serious science that studies a serious subject and has developed some seriously good ways of explaining human behavior out in the (very serious) real world. Economics touches on nearly everything, so the returns on reading this book are huge. You’ll understand much more about people, the government, international relations, business, and even environmental issues.

About This Book

The Scottish historian Thomas Carlyle called economics the “dismal science,” but I’m going to do my best to make sure that you don’t come to agree with him. I’ve organized this book to try to get as much economics into you as quickly and effortlessly as possible. I’ve also done my best to keep it lively and fun.

In this book, you find the most important economic theories, hypotheses, and discoveries without a zillion obscure details, outdated examples, or complicated mathematical “proofs.” Among the topics covered are

• How the government fights recessions and unemployment
• How and why international trade is good for both individuals and nations
• Why poorly designed property rights are responsible for environmental problems such as global warming, pollution, and species extinctions
• How profits guide businesses to produce the goods and services you take for granted
• How economic incentives affect healthcare costs, prices, and efficiency
• Why competitive firms are almost always better for society than monopolies
• How the Federal Reserve controls the money supply, interest rates, and inflation all at the same time
• Why government policies such as price controls and subsidies often cause much more harm than good
• How the simple supply and demand model can explain the prices of everything from comic books to open-heart surgeries

You can read the chapters in any order, and you can immediately jump to what you need to know without having to read a bunch of stuff that you couldn’t care less about.

Economists like competition, so you shouldn’t be surprised that there are a lot of competing views. Indeed, it’s only through vigorous debate and careful review of the evidence that the profession improves its understanding of how the world works. This book contains core ideas and concepts that economists agree are true and important — I try to steer clear of fads or ideas that foster a lot of disagreement. (If you want to be subjected to my opinions and pet theories, you’ll have to buy me a drink.)

Note: Economics is full of two things you may not find very appealing: jargon and algebra. To minimize confusion, whenever I introduce a new term, I put it in italics and follow it closely with an easy-to-understand definition. Also, whenever I bring algebra into the discussion, I use those handy italics again to let you know that I’m referring to a mathematical variable. For instance, I is the abbreviation for investment, so you may see a sentence like this one: I think that I is too big.

I try to keep equations to a minimum, but sometimes they help make things clearer. In such instances, I sometimes have to use several equations one after another. To avoid confusion about which equation I’m referring to at any given time, I give each equation a number, which I put in parentheses. For example,

(1)

(2)

Foolish Assumptions

I wrote this book assuming some things about you:

• You’re sharp, thoughtful, and interested in how the world works.
• You’re a high school or college student trying to flesh out what you’re learning in class, or you’re a citizen of the world who realizes that a good grounding in economics will help you understand everything from business and politics to social issues like poverty and environmental degradation.
• You want to know some economics, but you’re also busy leading a very full life. Consequently, although you want the crucial facts, you don’t want to have to read through a bunch of minutiae to find them.
• You’re not totally intimidated by numbers, facts, and figures. Indeed, you welcome them because you like to have things proven to you instead of taking them on faith because some pinhead with a PhD says so.
• You like learning why as well as what. That is, you want to know why things happen and how they work instead of just memorizing factoids.

Icons Used in This Book

To make this book easier to read and simpler to use, I include a few icons that can help you find and fathom key ideas and information.

This icon alerts you that I’m explaining a fundamental economic concept or fact that you would do well to stash away in your memory for later. It saves you the time and effort of marking the book with a highlighter.

This icon tells you that the ideas and information that it accompanies are a bit more technical or mathematical than other sections of the book. This information can be interesting and informative, but I’ve designed the book so that you don’t need to understand it to get the big picture about what’s going on. Feel free to skip this stuff.

This icon points out time and energy savers. I place this icon next to suggestions for ways to do or think about things that can save you some effort.

This icon discusses any troublesome areas in economics you need to know. Keep an eye open for them to alert you of potential pitfalls.

Beyond the Book

To view this book’s Cheat Sheet, simply go to www.dummies.com and search for “Economics For Dummies Cheat Sheet” for a handy reference guide that answers common questions about economics.

To gain access to the online practice, all you have to do is register. Just follow these simple steps:

1. Register your book or ebook at Dummies.com to get your PIN. Go to www.dummies.com/go/getaccess.
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3. Follow the prompts to validate your product, and then check your email for a confirmation message that includes your PIN and instructions for logging in.

If you do not receive this email within two hours, please check your spam folder before contacting us through our Technical Support website at http://support.wiley.com or by phone at 877-762-2974.

Now you’re ready to go! You can come back to the practice material as often as you want — simply log on with the username and password you created during your initial login. No need to enter the access code a second time.

Your registration is good for one year from the day you activate your PIN.

Where to Go from Here

This book is set up so that you can understand what’s going on even if you skip around. The book is also divided into independent parts so that you can, for instance, read all about microeconomics without having to read anything about macroeconomics. The table of contents and index can help you find specific topics easily. But, hey, if you don’t know where to begin, just do the old-fashioned thing and start at the beginning.

Framing Economics as the Science of Scarcity

Scarcity is the fundamental and unavoidable phenomenon that creates a need for the science of economics: There isn’t nearly enough time or stuff to satisfy all desires, so people have to make hard choices about what to produce and consume so that if they can’t have everything, they at least have the best that was possible under the circumstances. Without scarcity of time, scarcity of resources, scarcity of information, scarcity of consumable goods, and scarcity of peace and goodwill on Earth, human beings would lack for nothing. Chapter 2 gets deep into scarcity and the tradeoffs that it forces people to make.

Economists analyze the decisions people make about how to best maximize human happiness in a world of scarcity. That process turns out to be intimately connected with a phenomenon known as diminishing returns, which describes the sad fact that each additional amount of a resource that’s thrown at a production process brings forth successively smaller amounts of output.

Like scarcity, diminishing returns is unavoidable, and in Chapter 3, I explain how people very cleverly deal with this phenomenon in order to get the most out of humanity’s limited pool of resources.

Sending Microeconomics and Macroeconomics to Separate Corners

The main organizing principle I use in this book is to divide economics into its two broad pieces, macroeconomics and microeconomics:

• Microeconomics focuses on individual people and individual businesses. For individuals, it explains how they behave when faced with decisions about where to spend their money or how to invest their savings. For businesses, it explains how profit-maximizing firms behave individually, as well as when competing against each other in markets.
• Macroeconomics looks at the economy as an organic whole, concentrating on factors such as interest rates, inflation, and unemployment. It also encompasses the study of economic growth and the methods governments use to try to moderate the harm caused by recessions.

Underlying both microeconomics and macroeconomics are some basic principles such as scarcity and diminishing returns. Consequently, I spend the rest of Part I explaining these fundamentals before diving in to microeconomics in Part II and macroeconomics in Part III. But first, this section gives you an overview of microeconomics and macroeconomics.

Understanding How Economists Use Models and Graphs

Economists like to be logical and precise, which is why they use a lot of algebra and other math. But they also like to present their ideas in easy-to-understand and highly intuitive ways, which is why they use so many graphs.

The graphs economists use are almost always visual representations of economic models. An economic model is a mathematical simplification of reality that allows you to focus on what’s really important by ignoring lots of irrelevant details. For instance, the economist’s model of consumer demand focuses on how prices affect the amounts of goods and services that people want to buy. Obviously, other things, such as changing styles and tastes, affect consumer demand as well, but price is key.

To avoid a graph-induced panic as you flip through the pages of this book, I spend a few pages helping you get acquainted with what you encounter in other chapters. Take a deep breath; I promise this won’t hurt.

Introducing your first model: The demand curve

When economists look at demand, they simplify by concentrating on prices. Consider orange juice, for example. The price of orange juice is the major thing that affects how much orange juice people are going to buy. (I don’t care which dietary trend is in vogue — if orange juice cost $50 a gallon, you’d probably find another diet.) Therefore, it’s helpful to abstract from those other things and concentrate solely on how the price of orange juice affects the quantity of orange juice that people want to buy.

Suppose that economists go out and survey consumers, asking them how many gallons of orange juice they would buy each month at three hypothetical prices: $10 per gallon, $5 per gallon, and $1 per gallon. The results are summarized in the following table:

Gallons of Orange Juice That Consumers Want to Buy
Price	Gallons
$10	1
$5	6
$1	10

Economists refer to the quantities that people would be willing to purchase at various prices as the quantity demanded at those prices. What you find if you look at the data in the preceding table is that the price of orange juice and the quantity demanded of orange juice have an inverse relationship with each other — meaning that when one goes up, the other goes down.

Because this inverse relationship between price and quantity demanded holds true for nearly all goods and services, economists refer to it as the law of demand. But quite frankly, the law of demand becomes much more immediate and interesting if you can see it rather than just think about it.

Creating a demand curve by plotting out the data

The best way to see the quantity demanded at various prices is to plot it out on a graph. In the standard demand graph, the horizontal axis represents quantity, and the vertical axis represents price.

In Figure 1-1, I’ve graphed the orange juice data in the preceding table and marked three points and labeled them A, B, and C. The horizontal axis of Figure 1-1 measures the number of gallons of orange juice that people demand each month at various prices per gallon. The vertical axis measures the prices.

Point A is the visual representation of the data in the top row of the preceding orange juice table. It tells you that at a price of $10 per gallon, people want to purchase only 1 gallon per month of orange juice. Similarly, Point B tells you that they demand 6 gallons per month at a price of $5, and Point C tells you that they demand 10 gallons per month at a price of $1 per gallon.

Notice that I’ve connected the Points A, B, and C with a line. I’ve done this to make up for the fact that the economists who conducted the survey asked about what people would do at only three prices. If they’d had a big enough budget to ask consumers about every possible price ($8.46 per gallon, $2.23 per gallon, and so on), there’d be an infinite number of dots on the graph. But because they didn’t do that, I draw a straight line passing through the data points, which should do a pretty good job of estimating what people’s demands are for prices that the economists didn’t survey.

The straight line connecting the points in Figure 1-1 is a demand curve. I know it doesn’t curve at all, but for simplicity, economists use the term demand curve to refer to all plotted relationships between price and quantity demanded, regardless of whether they’re straight or curvy lines. (This is consistent with the fact that economists are both eggheads and squares.)

Straight or curvy, you can visualize the fact that price and quantity demanded have an inverse relationship: When price goes up, quantity demanded goes down. The inverse relationship implies that demand curves slope downward.

Generalizing a bit, you can also see that the slope of a demand curve gives quick intuition about the sensitivity of the inverse relationship between price and quantity demanded. If a demand curve is very steep, then you know that it would take a large change in price to cause a small change in quantity demanded. By contrast, a very flat demand curve tells you that a small change in price would result in a large change in quantity demanded.

Extending that reasoning even further, you can see that demand curves with changing slopes (that is, demand curves that aren’t perfectly straight lines) tell you that the relationship between price and quantity demanded varies. On the steeper parts of such curves, a change in price causes a relatively small change in quantity demanded. On the flatter part of such curves, a change in price causes a relatively large change in quantity demanded.

Using the demand curve to make predictions

Graphing out a demand curve allows for a much greater ability to make quick predictions. For instance, you can use the straight line I’ve drawn in Figure 1-1 to estimate that at a price of $9 per gallon, people would want to buy about 2 gallons of orange juice per month. I’ve labeled this Point E on the graph.

Suppose that you can see only the data in the preceding orange juice table and can’t look at Figure 1-1. Can you quickly estimate for me how many gallons per month people are likely to demand if the price of orange juice is $3 per gallon? Looking at the second and third rows of this table you have to conclude that people will demand somewhere between 6 and 10 gallons per month. But figuring out exactly how many gallons will be demanded would take some time and require some annoying calculations.

By contrast, if you look at Figure 1-1, it’s easy to figure out how many gallons per month people would demand at $3 per gallon. You start at $3 on the vertical axis, move sideways to the right until you hit the demand curve at Point F, and drop down vertically until you get to the horizontal axis, where you discover that you’re at 8 gallons per month. (To clarify, I’ve drawn in a dotted line that follows this path.) As you can see, using a figure rather than a table makes coming up with model-based predictions much, much simpler.