The D-I-Y University: Week 3 Day 4 Economics

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The Independent Online
When the monthly inflation (or unemployment, or output, or countless other economic) statistics are released, all ears turn to the pin-striped City economists for analysis. Inflation down, interest rates up, the pound down, the markets buoyant, unemployment falling, consumption rising; such is the stuff of the economics we see on television or read in the paper.

Faced with such mysterious jargon, the only alternatives seem to be to give up on economics altogether or to invest several years studying it, as plenty of teenagers are about to do this autumn. But the DIY economist need not give up. There is a pathway between the extremes, which starts from the economic decisions we each make, and the economic consequences that flow from them.

Every day we make trade-offs, choosing to spend our limited time and money in different ways. Firms decide to make rollerblades rather than computer games, to set the same price as their competitors or to under- cut them. Individuals decide to buy tomatoes or lettuce, to work or to study. Economics is the study of these decisions: what the textbooks call "the allocation of scarce resources".

Of course, our decisions are not just affected by financial costs and benefits. Our interests, talents, expectations, morality, class background - even government policy - all have an impact on the choices we make. Good economics - stretching its talons into sociology, politics, and occasionally psychology, too - should be able to take these things into account.

Economists also try to explain the overall outcomes of these many individual decisions - using models to simplify the complex interactions that are taking place. And the one model they use more than anything else is that of supply and demand.

Take those rollerblades. If rollerblades suddenly become fashionable, demand goes up. Suppose that the firms can't produce them fast enough to keep up; new blades are scarce, and prices rise. In the short term, only those who are rich enough or determined enough will be prepared to pay such extortionate prices, and in economists' language, "the market will clear".

However, since making rollerblades has become profitable, firms will compete to produce more, supply will go up too, and prices will fall again - and moderate enthusiasts will be able to afford blades after all. The knees and elbows of the nation will be bloodier; but for economists, the market has worked by responding to consumer demand.

In practice of course, many markets aren't as smooth and simple as this. If companies have monopolies of a market they behave very differently. In fact, wherever access to information is limited or unbalanced, the rollerblade example starts to come unstuck. Take insurance companies. They invented no-claims bonuses, exactly because they can't keep tabs on us out on the road, and they fear that insurance cover will encourage us to be reckless (since we don't have to foot the bill for damages). Much of modern micro economics explores everyday situations like these, which don't fit inside the traditional model.

Macro economics isn't far removed from our normal lives either, for all the confusing language. For example, as most home-owners know, house prices are starting to rise again. Interest rates are low, so borrowing is cheap; all in all it looks like a good time to buy. But suppose we all get too cheerful and confident, start borrowing money and spending it fast on new houses and consumer goods, so that house builders and firms can't keep up (just as the rollerblade manufacturers couldn't): prices across the economy will start to rise.

Unlike the prices of the rollerblade manufacturer, rising prices across the economy (inflation) can become self-perpetuating. As workers and managers expect prices to go up across the board, they put wages up, too - rather than simply producing more. Inflation starts to escalate out of control. Raising interest rates - as the Bank of England is now recommending - increases the cost of borrowing (and of mortgage repayments) and stops consumer demand growing faster than the economy can cope with.

So economics is accessible without investing all those years acquiring an economics qualification. For some, taking the degree will still be a sensible economic decision. Fascinated by the subject, keen to work out where real economic power lies, they may see the debts incurred studying, or the missed opportunity to study James Joyce, as a small sacrifice compared to the long-term gains.

But those for whom money matters might do well to think again. Most professional economists (bar a few pundits in the City) work in the public sector or in universities - hardly lucrative fields. A better economic decision might be to glean your economics from newspapers and books, and invest your time studying law.

Tomorrow: Neuroscience