Economics can be understood as a study of how, when and why economic agents indulge in economic actions in respect of economic goods. Economic goods, by definition, are those goods and services that make a human being better off. Though there are actually a large variety of economic actions that an economic agent can undertake in respect of such goods, almost all of them can be grouped within four broad categories of consumption, production, exchange and transfer.
In earlier articles, we have discussed as to how economics differs from finance, and that unlike finance, economics relates primarily to human behavior in respect of economic goods. Economic ‘goods’, by their very definition, as those goods (including intangibles) and services that are likely to make a human being having access to their use and consumption better off. Thus, economic behavior of human beings can be understood as an intelligent attempt to improve their welfare by indulging in various economic actions dealing with these economic goods.
Before we move forward, it is important to understand an important caveat in this theory related to economic goods. The term ‘economic good’ is conceptualized in a way that excludes certain very subjective and unquantifiable goods, even though they may be of immense value for human welfare. These include love, affection, relationships, happiness and similar goods which we want in our lives, but which are often not subject of economic actions. Certain natural goods like the Sun and the Moon are also not considered economic goods.
One reason why they are not included in the definition of economic goods is because none of these goods can be subjected to economic actions.
All economic actions undertaken by human beings can be grouped in four broad categories of consumption, production, exchange and transfer. Most complex actions in the real world today also consist of these four forms. Most goods that we consider economic goods can be subjected to these actions.
Let us elaborate each one in a little more detail.
Consumption is the primary economic action, because all other actions like production, exchange and transfer are actually oriented to facilitate it or make it possible. The simplest examples of consumption are eating food, drinking water or burning fuel for cooking, where the economic good is immediately consumed and thereby ceases to exist. An analogous immediate consumption in the digital world would be surfing internet to consume the data limit of your telecom service. In such cases, the good once consumed is lost forever for everyone. All disposable goods belong to this category. Other examples of instant consumption include services.
However, consumption need not always be instantaneous, and instead, can be a prolonged event like in case of wearing clothes or using a durable like a washing machine or a mobile handset. Clothes undergo wear and tear, and gradually get destroyed over a period. In case of such durable goods, the use of that durable is a form of its consumption spread over a longer period of time. Nevertheless, their use makes the users better off.
There are very few categories of goods that can be used forever, without the good getting destroyed in the process. Land is such a good. While the construction made over land is a durable which gets consumed over a period of time, the land does not disappear. Data, information and knowledge are similar goods that can be used without destroying the good itself. It is because technology – a term used broadly for all scientific and management knowledge and skills – does not get destroyed by its use, that it has been the most important factor in making human lives better. Unlike land, which is fixed, new technology can be produced by human effort. The use of such goods, nevertheless makes its users better off and can therefore be treated as consumption.
The consumer indulges in the act of consumption because it makes him better off. It would be logical to presume that unless an individual becomes better off by consuming a good, he would not be willing to opt for such consumption.
Production means assimilation and modification of factors of production to create a new economic good. In earliest primitive societies, production activities of pre-civilized human beings were limited to collection of natural goods and hunting of prey. As civilization began to take shape, the primary production that humans indulged in was cooking food, which actually preceded agriculture by several thousand years. Once agricultural revolution set in, growing crops was the main production activity, but simultaneously a number of other non-agricultural productions also became a part of human life, including making clothes from wool and cotton and building dwellings to live in. In modern world, manufacturing of goods is the main form of production.
Services are also economic goods, and when they are provided, it also amounts to production. Today, one of the most important form of goods produced are digital goods and services. This article is also such a good. Development of technology is also production. The Gross Domestic Production or GDP is an estimate of total goods produced by all economic agents in a country.
Exchange means giving away some economic goods and receiving other economic goods in lieu of them. Exchange is an economic activity that has existed even in pre-civilized societies, but was not something as common as was consumption. However, in modern economies today, exchange forms the bulk of modern economic activity, where every good is traded, not only in its original form, but also by way of its derivatives – rights to exchange economic goods in a predetermined manner- which are treated as a good itself and undergo trading in huge volumes.
Historically, exchange of goods began as barter, and was limited to a few goods. In agricultural world, artisans exchanged man made goods for agricultural products. Gradually markets came into existence and it became easier to exchange goods. With markets in existence, incentives were created for surplus production, which in turn also gave an impetus for exchange of goods (like grains and fruits) for services (work in farm).
In the modern world, exchange of goods is undertaken by mediating it through money, so that a person having surplus goods can exchange it for money immediately and later exchange with another person to obtain some other goods. Existence of money brings great flexibility in exchange of goods. The bulk of exchange transactions in modern economy involve money or financial products.
Transfer means that certain goods belonging to one person are given by him to another without anything in return. It is different from exchange since it involves one way movement of goods, and lack a quid pro quo as is there in exchange. Since economic goods are supposed to make a person better off, as a corollary, he would be likely to become worse off by giving away those goods. This is the reason why transfer is the least common of all economic activities.
Transfer can be either voluntary or enforced. Voluntary transfer is exemplified by gift of goods for the purpose of love and affection, or donations made to needy people out of piety or on humanitarian grounds. Enforced transfers, in its simplest form is property stolen away or forcibly snatched away by criminals. However, the most common form of transfer in the modern world are transfer of resources by the Government from the richer to the poorer for the purpose of promoting equity. This can be either by way of progressive taxes or by way of subsidies to the poor.
In case of economic goods, there are four basic actions that form part of human behavior related to economic goods. These are the primary actions an economic agent can take in respect of them. She can consume them, produce them, exchange them for some other goods or transfer them to someone else without anything in return. Whether she does that or not; when she does that and when she does not; up to what extent does she keep doing it; what makes her do so and what prevents her from doing it – all these are the factors that one would need to understand to be able to predict the economic behavior of human beings. To a large extent, the principles that govern these actions lie at the core of economics.
Public memory is awfully short, and one of the reasons why financial crisis tend to recur as soon as the horrifying memories of the last crisis have died down. As we complete a decade of what was one of the worst and most wide spread financial crisis of last century, perhaps it is time to remind ourselves of the man-made follies that led to it, and try to ensure that they are repeated in near future. .
The modern human beings are so engrossed in economic activities that the human species can now be named as Homo Sapiens Economicus. In this economic universe, Governments have a huge responsibility to regulate economic activities of the people in a way that maximizes the welfare of the people.
Most of us opt for insurance, but only few realize how it works, what its benefits are and how it helps in preserving our welfare. Such an important decision deserves better understanding.