What is Economics?
- Why Should I Care?
Environmental destruction, poverty, literacy, democracy, exploration, cultural exchanges, health, leisure, arts, sports… Many social phenomena can be directly influenced by what we produce, how much we produce, who produces it, and where it is produced.
- This Chapter Has 4 Parts
- Economic Systems
- Economics is a Social Science
- Economic Models
- Empirical Verification
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Many economists define Economics is more than that.
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- What is Economics?
The word economy comes from two Greek words: οἴκος (oikos: "home") and νέμω (nomos: “system of rules”). Therefore, the economy is a system of management for the home, where much production takes place.
This word was coined by Xenophon, a Greek philosopher whose views often criticized those of Socrates. His book Oeconomicus is a manual on what today would be called “Good Housekeeping”. A retired military man, Xenophon appreciated efficiency and order, and felt his peers would appreciate his advice on how to run a household rationally. The word was also used by Aristotle in a three-book series on economic themes.
Economics was originally seen as the study of the system of rules that govern our homes. Historically, a home was a place where many goods and services were produced, such as shelter, meals, clothes, teaching, cleaning, etc. Today, economics is defined in many ways. One definition would be as an academic discipline focussed on material culture, financial institutions and the measurement of wealth and well-being. Another definition would be to see it as a discipline interested in problems of optimization, where individuals and groups of people try to make the most out of their resources. Finally, another definition would be to see economics as a study of systems of production of goods and services.
We will be using all three of these approaches in this text, with a stronger leaning on the third definition.
- Economic Systems
Analyzing systems is an important aspect of this book. So, let’s define what we mean by that. First, what is a system?
A system is a set of components and relationships that operate together to make something. Their operations may also react to other components, or other systems, from the outside. The study of systems is called Systems Analysis or Industrial Dynamics., and it has been developed mostly in the fields of engineering. We believe it is very useful as a basic frame of thought to build an economics course, especially to discuss environmental issues.
An economic system is a social institution which deals with the extraction and transformation of resources to produce goods and services for consumers in a particular society.
The economic system is composed of people, social customs, ways of communication, and institutions, with their relationships to natural resources, knowledge, tools, machines and technology.
A system is made of seven components: Inputs, Processors, Outputs, Control, Feedback, Environment, and Boundaries.
- Inputs: Objects that go into production.
- Natural Resources, such as light, water, and minerals.
- Transformed inputs, such as lumber, food ingredients, petroleum, and metals.
- Intangibles, such as information, art.
- Processors: What transform inputs into output.
- Human Labour, such as hourly-paid workers, family labour, or non-paid labour.
- Machines and Equipment, such as appliances, vehicles, manufacturing, computers, and software.
- Instruments and Tools, including kitchen utensils, construction tools, and scientific instruments.
- Outputs: Products that are the outcome of inputs being
- Goods are useful transformed objects produced by a system
- Bads are unintended secondary productions that are harmful to humans
- Services are intangible products meant for consumption
- Intermediate Goods and Services are meant to be used as inputs or processors in other production systems.
- Final Goods and Services are meant to be consumed by humans
- Control: People who decide which inputs and processors to use, and which outputs to produce.
- Private sector leadership, including non-profits, small businesses, large corporations. CEOs and managers.
- Public sector leadership, including Prime Minister and Cabinet, CEOs and managers of government-owned institutions, city Mayors.
- Families and Households who produce inputs and outputs.
- Feedback: Information relayed to the control function about production quantities, qualities, and other factors
- Non-verbal feedback includes lineups at storefronts, empty shelves, excess inventory, rapid wear and tear (ex: road use), congestion, etc.
- Informal feedback can be comments made to producers/controllers, word-of-mouth, and social media.
- Institutionalized feedback includes surveys, town hall meetings, and focus groups.
- Price feedback includes price bubbles, rebates, and liquidation strategies.
- Environment: Objects outside the system that can affect it
- Physical environment includes landscape, climate, weather, and availability of natural resources.
- Political environment includes legal regime, political institutions, tax levels,
- Social environment includes cultural institutions such as family, religion, language, moral constructs, sports, arts, and culinary habits.
- Boundaries: Limitations of the system
- Demographics are defined as population, which grows with
natality,births, increased life expectancy and immigration. - Technology includes knowledge, competencies, skills, machines, computers, robots, buildings, roads, railways, ports, and other infrastructure.
- Demographics are defined as population, which grows with
Summary Table
Component Role Example
Economic systems What produces Factories, Farms, and Office Towers
Inputs What goes in Natural Resources
Processors What transform inputs Workers and machines
Control Who decides CEOs, Civil Servants, and Politicians
Outputs What comes out Goods and Bads
Feedback What people want Comments, Prices, and Lineups
Environment What surrounds you Landscape, Laws, Taxes, and Culture
Boundaries What limits you Number of workers and Technology
Exercise: Pizza Dinner
IMPORT IMAGE???
INPUTS PROCESSORS OUTPUTS OTHER SYSTEM
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Flour Cook Pizza
Hot _________
Cheese Oven
_________ _________ Dishes
Dirty ________
Electricity
Pepperoni __________
_________
FEEDBACK
Pepperoni
More Pizza, Please! But not so much ___________!
This example shows us how pizza is produced, simple enough. That's what happens in one location, by one producer. But an economy is a more complex system, since it is the intertwined flow of objects between these individual systems. For example, inputs into pizza makingmaking, like flour and cheese, are usually the outputoutputs of anotherother system,systems, such as thea wheat mill, and a dairy industry.farm. Same for ovens: they were produced by a machine plant, where steel and glass were used as inputs.
On the other end, pizza is an input for other activities. Humans need to eat for energy and biological needs. The human body is a system, where food and air are inputs. Human output includes producing intangibles such as art, singing, talking, screaming, running, walking, writing, building things, baking, cooking, punching, moving objects... Human output also includes physical matter (tangibles): exuding heat, exhaling CO2, transpiring sweat, shedding hair, and releasing urine and stool.
What makes the overall system even more complex is that there often is not any finality to the flow of these objects. Everything we produce ends up as an input, in some way. Humans eat to live, but they also are part of the production process. Humans are also important as labour, in the process of making objects. FoodSince food is thereforeinput bothfor labour, the pizza could very well be an output of the pizza restaurant, and an input for labour in that restaurant. If we were to draw the entire web of these flows, the result would probably be very complicated to actually model everything into thea flow chart.
In economics, there are many types of systems we can look at: the producer, the industry, and the regional economy.
The producer, whether it’s a plant that manufactures chairs, or an office where legal services are offered, is the first-level system. Sometimes economists refer to this as the ‘firm’.
Next, you can look at certain sections of the economy, which we call industries. You can look at the banking sector, for example, as a system that operates within a larger context, such as other industries, a political regime, and cultural institutions. The field of micro-economics usually focusses producers and industries.
Finally, you can look at economic systems from a geographical perspective, such as the city-region, the province, or state level. Economies in this regard have inputs and outputs, such as imports and exports, as well as all the other components of a system. The field of macro-economics usually focusses on national-level economies.
What about waste?
An important thing here is that we don’t lose track of both the primary and the secondary productions, both the GOODS and the BADS. Many times, an industrial facility will find a way to reuse,reuse a secondary production, especially if it can resell it, a secondary production.it. For example, one important waste in the process of making chocolate is called cocoa butter. The famous Swiss company Nestlé was the first to try to make a product with mostly cocoa butter: they invented white chocolate. Instead of throwing the butter out, it becomes an input for another, new product. In this case, a BAD was turned into a GOOD.
And in this case, reducing waste has added lots of zeros to Nestlé's bottom line (and maybe a few inches to many peoples waistline).
In economics, we are always studying some kind of system. We can narrow the focus of the analysis, depending on the scope we are trying to achieve. Usually we will look at three types of systems : the agent, the industry, and the aggregated economy.
Agent
The economic agent, whether it’s a consumer buying dinner, a company that manufactures chairs, or an office where legal services are offered, is the some kind of individual actor. This is the first-level system. Sometimes economists refer to the producer as the ‘firm’. Some companies or organizations have many plants, and many offices so economists need to be precise about the scope of their outlook when defining their research problem. When analyzing a single producer's activities, one is also considering the role of buyers, also called consumers.
The sub-field of behavioural economics studies human behaviour, using insights from psychology, to better understand patterns in consumption, choices, and well-being.
Industries
Next, you can look at certain sections of the economy, which we call industries. These are groups of producers who are in the same type of business. Their products are similar, or they are part of the chain of production. Examples include the banking industry, the aerospace industry, or the food transformation industry. When you study an industry, you tend to focus on the level of competition between producers, and the overall output of the system. You also have to consider the industry as a system that operates within a larger context, such as other industries, the level of taxes, the political regime, and cultural institutions.
The sub-field of micro-economics focuses on agents, and on industries, analyzing issues such as competition levels, optimal regulations, profits, and consumer welfare. The role of freely adjusted (or fixed) prices is often the principal feedback mechanism discussed by micro-economists at this level of analysis. There are many specialized sub-fields, which concentrate on specific industries, or topics, such as financial economics, labour economics, innovation economics, development economics, welfare economics, and international economics, to name a few.
The sub-fields of environmental and ecological economics focus on the policies and regulations needed to reduce pollution, encourage the re-using of waste, and stem the degradation of natural environments.
Aggregates
Finally, you can look at economic systems from an aggregated perspective, usually with a geographical definition, such as the city-region, the province, or the national/state level. Economies in this regard have inputs, processors, and outputs, but their variables will be measured and analyzed in aggregates, such as total imports, total employment, total physical capital, total domestic consumption, total exports, and total inventory.
The sub-field of economic geography (also called urban and regional economics) are interested in the spatial relationships associated to income, wealth, production, trade and consumption. Cities, in particular, are a main object of discussion, since they are important physical manifestations of economic activity.
The sub-field of macro-economics usually focuses on provincial, state, and national-level economies. It discusses the role of controlling institutions such as legislative assemblies, elected parliaments, the office of the Prime Minister and Cabinet, and the central bank. An emerging sub-sub-field is ecological macro-economics, which analyzes the relationship between the aggregate economy and the earth's capacity to sustain human life.
Table. Economics and its sub-fields
| Type of System |
Agent |
Industry |
Aggregate |
| behavioural |
x |
x |
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| micro-economics | x |
x |
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| environmental & ecological |
x |
x |
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| economic geography |
x |
x |
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| macro-economics |
x |
- In-class Exercise
Think of a company that makes chairs.
Identify 2 examples for each component. List 2 items per component.
Use a dollar sign to identify the output that is sold on a market.
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Component |
Item 1 |
Item 2 |
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Inputs
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Wood |
Leather |
|
Processor |
Bandsaw |
Labour |
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Outputs |
Chair |
Air pollution |
|
Control |
Manager |
Stockholders |
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External Environment |
Local tree varieties |
Local climate for indoor/outdoor needs |
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Feedback |
Client comments |
Trade Magazine Reviews |
|
Boundaries |
Size of the bandsaw |
Quantity of available materials, labour |
- Economics is a Social Science
Economics is a social science. This means economists are interested in the study of human behaviour. This also implies that economists use the scientific method to generate knowledge.
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The scientific method is a widely used research convention that is built on two foundations: theory,the hypothesis, and the empirical verification of theorythe (p. 11).
hypothesis.
The focus of economics is particular: it is the study of systems of production of goods and services.
So economists will ask questions about people, how the consume, how they produce, and why? Those questions become hypotheses. Then economists use data about people, their habits, their decisions. That data will either confirm, or infirm, the hypothesis. Whatever the result, economists gain a better understanding of our economy, and how it works. This method is used in any of the sciences, whether natural sciences like biology, ecology, physics, and chemistry, or the social sciences listed below.
If you compare economics to other social sciences, you will notice that economists study many similar variables that come up in the work of other disciplines, such as personal characteristics (age, gender, education level), demographic characteristics (religion, language, ethnicity), behaviours, skills, competencies, and many more. However, each discipline has a unique focus.
Psychology is the study of individual behaviourbehaviour, and sometimes they get really interested in emotions, relationships, and personal struggles. You might think that this has nothing to do with investments, and making airplanes. And that's ok, sometimes psychologists get interested in things that economists don't care about. But sometimes there are overlaps, and hopefully economists and psychologists can work together to better understand humans.
Sociology is the study of groups of peoplepeople. This is obviously a very simple definition, but it serves an important point. There are patterns in society that indicate important problems. For example, there might be an issue with education levels in certain groups of the population. Defining those groups and identifying their issues is important, if sociologists want to help them out. Of course an issue like education can have economic consequences, so its very possible that economists work with sociologists to study the issue.
Political Science is the study of institutions of powergovernance, and power, in our societies. Political scientists will learn every detail about political systems, such as elected parliaments, or totalitarian regimes. They get really interested about the political game as well, for its own sake. There is obviously an overlap here in many instances with economics, because the state is an important actor in the economy, and political institutions are key players in terms of feedback, and control, of the economy.
History is the study of humans over timetime, but mostly in the past (we can't really study the future). Historians usually acquire an enormous amount of knowledge about past events, specializing on periods, and places in particular. Sometimes they focus on military history, political history, or social history, which chronicles important changes in society such as the end of child labour, or the role of women in society. There is such a discipline as economic history, which is the study of economic issues in the past, including famous depressions, or industrial revolutions.
Geography is the study of humans over spacespace, over areas (not outer space!). Geographers are the experts in making maps. Of course they need to study physical and natural geography, including oceans, lakes, mountains and rivers. But they also study social geography, which answers questions like 'Where do rich people live?', and 'How far will people drive to work?'. Many of these social issues overlap with the study of the economy, which explains the development of the sub-field of economic geography.
Anthropology is the study of ancienthuman culturesculture. Anthropologists are famously known for studying traditional societies such as Indigenous groups, but they also are very much interested in long-gone civilizations. Anthropologists can bring many disciplines together, such as geography, sociology, psychology, and history, to understand a society. They also will describe the material culture of a society, including tools, and other objects, which is another way of saying its economy. Anthropologists are notorious for conducting field work to collect their data.
EconomicsUniversities are organized in fields, and disciplines. Many of them don't abide by the strict nature of the scientific method. In many cases, this is because the studydiscipline ofis productionfocussed systemson applying the most advanced knowledge in a technologically useful way. There is absolutely nothing wrong with this and in no way are scientists more worthy or intelligent than technologists. For example, Medicine, Business Administration, Law, and Engineering are technological fields, whose knowledge mostly comes from the sciences, like biology, chemistry, psychology, and economics.
WhatOther disciplines are notacademic sciences?fields of study, who chose to focus on a particular aspect of human activity. Examples include Humanities, Philosophy, Literature, Religion Studies, Literature,Cultural Music,Studies, Law,Gender Medicine,Studies, Engineering,African andStudies, Business.Canadian InStudies, mostetc. cases,These these fields apply scientific knowledge to solve real-life issues, such as technological fields (medicine, engineering). Some fields refer to professional services (law, accounting, business).
Yet other fieldsdisciplines concentrate on erudition, analysis, interpretation, and the use of logic, without using the full scientific methodlogic to develop their insights (philosophy, music, literature, religion studies).insights.
Keep in mind that academics are sensitive folk, and some won't appreciate these categorizations, which are constantly up to debate. Also, many disciplines are torn between categories, since some of their research is more fundamental (scientific), and some of the research is more applied (technological). This is the case in economics. Sometimes economists are trying to figure out how the world works (science), but sometimes they are applying their knowledge to help institutions such as banks or the government (application).
- Economic Models
One of the unique features of economics is the use of simplifiedmathematical models to help predict what is going to happen in the economy. Sometimes, economists can run experiments in a laboratory with real humans. But most of the time, especially when you are thinking in terms of the aggregate economy, it is impossible to set up experiments.
So economists use models, which are sometimes called thought experiments,experiments. whichA wemodel callis somewhat similar to a laboratory, but there are no humans directly involved. Much like laboratories, models (p.are 12).an artificial, and controlled, environment. This enables the economist to run simulations.
For example, when the war in Ukraine broke out in 2022, business leaders, union leaders, and politicians started asking all sorts of questions about how this war was going to affect the economy of their country.
- How will it affect food prices?
- Will it change the rate of exchange of the national currency? Will it generate bottlenecks in transportation? Will the government need to finance its operations? Will Russia go broke?
These models are based on more complex theories, and often rely on deductive logic to help us sort out the complex relationships between economic variables.
Models have 4 parts:
Definitions Define variables and objects
Assumptions Assume certain behaviours, preferences
Hypotheses Guess relationships between variables,
IF THEN
Predictions Simulate a change to see its effect on the system
Models are usually presented as flow charts, as graphs, or as equation sets.
A model is somewhat similar to a laboratory, but there are no humans directly involved. Models are an artificial, and controlled, environment. This enables the economist to run simulations.
“How does variable D react to a change in variable X?”
Some economists thus liken the modelling technique to testing theory. But the modelling environment remains artificial. The predictions made by models can be very useful, and their logic may seem implacable. But the predictions from models may or may not be confirmed with real-life empirical observations.
- Empirical Verification
Once models are written, they should be tested with real-life observations. This step of the scientific method is called empirical verification. Research methods used by economists include surveys, and available data disclosed by taxpayers to their state.
For example, unemployment data is collected by a monthly telephone survey on a relatively small sample of the population. Another example, income data (GDP) is collected through monthly income tax declarations to the government by citizens and corporations.
As most economic activity can be measured with money, economists are trained at length to analyze quantitative data. This kind of data has its advantages and disadvantages. On one hand, there is lots of data on consumers, investors, institutions, and all sorts of actors in the economy. So, there is lots of data to analyze. On the other hand, keep in mind that most human phenomena may be difficult to quantify, which might give an incomplete picture of the situation. Variables like motivations, personalities, cultural preferences, and cognitive functions, just to cite a few examples, are difficult to include in economics.
Sadly, economists most often cannot use the more powerful research methods such as experiments. We cannot ask the government to slash or raise taxes just to “see what happens”. We cannot trust findings from a laboratory because it is an artificial setting. People would likely act differently with real money in the real world. Also, it would be very expensive to compensate participants of an experiment over long periods of time, to study their behaviour more closely. This said, economists do take advantage of the occurrence of major events, such as a recession, which are said to be natural experiments. There are also subfields of economics which use small scale experiments, or pilot-projects, which does make for some very interesting science.
Also, economists are generally shy to use fieldwork and other more qualitative research methods. The data would be considered anecdotal and difficult to generalize to the whole population.
The most frustrating aspect of all this is that many models actually don’t hold up to the test of real-life data. However, they can still be useful for students to understand basic ideas, and where further research should be conducted.
- Think Piece
When you take a plane, or a car, to get somewhere, how important is it to you that you produced carbon dioxide and global warming?
Submit 1 page essay
- Green Policy
This first lesson on economic systems is the cornerstone of changing our economy. Most of our BADS are toxic to humans. Scientists call this pollution. In an ideal world, all of these secondary productions would be either banned, or used as an input to make something else.
This is exactly how nature works. Nature is an economic system. Everything in nature is producing something. Trees produce energy-rich carbon material (wood) and oxygen. The beautiful aspect of nature is that there are no wastes, no BADS. Carbon is biodegradable, so if a tree dies, the carbon goes back to the atmosphere, and the earth, and then probably back to another tree which will grow in its place.
About the air, trees use carbon dioxide (CO2) in the air and turn it into oxygen. That becomes an input for other living mammals, such as humans. When we breathe, our oxygen is transformed into CO2, an output, which is an input for trees.
In nature, any living organism that does not create outputs that are beneficial to its environment, as inputs for other organisms, will die. The most successful organisms are those that produce outputs which are perfect inputs for its neighbors. This view of production is part of a more recent branch of study in engineering and science called Biomimicry.
One easy way to implement this in your household is to purchase products where all the waste is both bio-degradable and compostable. Of course, this will eliminate all the waste in your garbage pail, and the plastics in your recycling bin.
Compost is an input for horticulturalists, gardeners, and landscapers. These tradespeople actually pay money for compost, when our cities could (and many do) be providing it for free, by picking up brown bins every week and producing compost in municipal facilities.
Humans should look into these solutions more carefully if they wish to keep growing their population on earth. If we wish to keep having babies, living longer lives, and to keep growing our quality of life, we have to adapt!
- Climate Change Solution
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CO2 for sale! Anybody need Anybody? |
Reducing our BADS across the board is important. However, there is a specific type of production that scientists don’t always designate as pollution because it’s not that toxic to humans. Theses gases actually allow us to exist on Earth.
Nonetheless, the overproduction of greenhouse gases could lead to the demise of the human species. The greenhouse gases (GHG) that keep the earth warm are primarily water vapor (H2O), carbon dioxide (CO2), methane (CH4), nitrous oxide (N2O), and ozone (O3). As you know already, our cars and trucks run on fuel, which emit carbon dioxide. Our meat comes from cattle that emit methane. We don’t emit these gases on purpose. They are secondary, and quite useless, productions.
To solve Climate Change, one must take a deep look at the economic systems that produce these particular BADS to either stem their emissions, or to divert them back to the economy as INPUTS. This latter solution is called the Circular Economy.
If we don’t solve Climate Change, a cascade of events will eventually affect many sectors of the economy. If one system is made of seven components, an economy can be seen as an eco-system: a collection of systems that interact and mostly depend on each other. Using Systems Analysis, it is possible to chart and predict the effects of unmitigated climate change on our societies. In the US, the advent of more heatwaves and hurricanes will have a damaging effect on farming, oil refining, electricity grids, and water treatment. A critical report from the US government outlines the sector interactions using a complex systems analysis, to help understand the effects of global warming over the next century (USGCRP, 2018, Ch. 17).
- Democracy Booster
Any political system rests on some type of popular support. Whether it’s a community-based non-profit association, a town, a small country, a federation, or a military regime, anyone who controls the system must be weary of his or her allies, and his or her foes. Support is the key.
When you study the economic system, some parts may seem to be mechanical, and they rightly are, such as the flow of inputs into processors, transforming raw materials into final products. True. However, any change made to the system is guided by feedback, and control mechanisms.
To improve the democratic process, one needs to keep the controllers – the people in charge – accountable to everyone else. You need to design the system so that the controllers have to listen; they need to take feedback into account. One way is to have open, free, elections to choose the people in charge. Another way, may be to have the possibility of changing the people in charge. This is why an organization may have a board of directors, who can replace the Chief Executive Officer (CEO). Still, another way, may be to create incentives that will guide the people in charge to respond to the wants and needs of the many.
Most of our political systems have advantages and disadvantages. It’s up to us to improve these systems so that feedback is not ignored in economic decision making.
- Wrap-Up
Economics is a social science that attempts to understand systems of production of output (goods and services). Those systems produce using inputs, and processors, are subject to feedback and control, and must comply with their environment and boundaries.
Economics uses the scientific method of theory and empirical verification to generate knowledge about what, and how, we produce.
Economics uses a particular kind of theory, called models. These are simplifications of reality and help to isolate specific variables.
These models must be confronted to empirical data to validate their usefulness.
- Cheat Sheet with Memory Helper
System: A set of objects that work together to process inputs into outputs, in a given environment and within boundaries.
Resources: Objects and services used as inputs to produce final products.
Products: Goods and Services.
Goods: Physical, or tangible, outputs of production used as final consumption by people.
Bads: Outputs that are not meant for final consumption, but can either be waste, or a reusable input for other productions. Also: externality.
Services: Intangible, or non-physical, outputs of production used as final consumption.
Model: An artificial, and controlled, environment, allowing the economist to run simulations. The model thus predicts relationships between variables.
- References and Further Reading
Benyus, J. (2005). Biomimicry’s surprising lessons from nature’s engineers. Ted Talks. https://www.ted.com/talks/janine_benyus_shares_nature_s_designs
USGCRP. (2018). Chapter 17: Sector Interactions, Multiple Stressors, And Complex Systems. In Impacts, Risks, and Adaptation in the United States: Fourth National Climate Assessment, Volume II [Reidmiller, D.R., C.W. Avery, D.R. Easterling, K.E. Kunkel, K.L.M. Lewis, T.K. Maycock, and B.C. Stewart (eds.)]. U.S. Global Change Research Program, Washington, DC, USA, 1515 pp.
Forrester, J. W. (1961). Industrial Dynamics. Martino Fine Books; Illustrated edition (Reprinted 2013).
Xenophon. (2012). Oeconomicus. Hardpress Publishing. Available on Amazon.ca.