The so called Economic Environment

Much of the early-on Undergrad-ECON classes focus on recognizing in what consists and Economic Environment and how it affect consumer’s willingness to pay for a certain good and/or supplier’s willingness to exchange his good for a certain monetary value. Sometimes the way in which those introductory courses introduce this subject is disguised by the distinction between change in demand (or supply) and change in quantity demanded (supplied). But what exactly is an Economic Environment, and why understanding it is fundamental for the Economic Science?

The broader definition of Economics is: The study of how Economic Agents allocate scarce resources.

The key here is understanding the role Economic Environment plays on our definition. On the moment of the decision-making process, our Economic Agents find themselves inserted in an Economic Environment. As Economists, we seek to translate such Environment in a series of Economic Variables, which ultimately compound the information set available for the agent. Perhaps this definition is a bit too intangible for you, reader. I shall illustrate with some examples.

  • The Consumer’s problem is to choose among all affordable bundles of goods, the one which he/she prefers (in other words, choose the utility-maximizing bundle within the budget set). The role of the Economic Environment here is precisely to determine affordability of different bundles of goods. We could choose to represent it through many different Economic Variables. In Walrasian demand (or Utility Maximizing Problem in Microeconomic Theory), we choose to represent Economic Environment as the Price System for this Economy, as well as available wealth for the consumer.
  • The Producer’s problem  would be to choose among all feasible goods, the one which maximizes profit. The role of Economic Environment here would be to establish which combinations of inputs and outputs are in fact feasible (this may be reported as available technology to the firms), as well as which profit each of those bundles can generate (which may be reported as a price system).
  • The Social Planner’s Problem is to maximize social welfare given preferences (utility) and feasible bundles (available technology to transform inputs into outputs). Notice that since the Social Planner allocates inputs and outputs among all Economic Agents using available technology, no price system is necessary (the market structure isn’t used as the allocation mechanism).

Scarcity, constraints, limitations is the whole reason choices matter, and why we think about them. When things are unlimited, there is no choice to be made because there are no trade-offs involved. The Economic Environment helps us understand which are the constraints we are facing on our daily lives and have sever implications on what our best choice is. I encourage you to think about all the constraints you are currently facing, and instead of resent them, think in how meaningful they make all your daily choices.