economics basic notes - topic one

8/11/2019 Economics Basic Notes - Topic One

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Topic 1Introduction to Economics


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The Central EconomicProblem

Scarcity is the central economicproblem Our inability to satisfy all our wants (from

your textbook) Scarcity is a result of unlimited wants but

limited resources to satisfy these wants

Limited resources (factors of production)Unlimited wants (goods & services)


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Scarce ResourcesFactors of production - the basic categories ofinputs used to produce goods and services.Land & Raw Materials (Natural Resources) A shorthand expression for any natural resource

provided by nature

Labour (Human Resources) The mental and physical capacity of workers to

produce goods and servicesCapital (Manufactured Resources) The physical tools, machinery, equipment and

buildings used to produce other goods Not to be confused with financial capitalEntrepreneurship The creative ability of individuals to seek profits by

combining resources to produce innovative products


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Scarcity and Choice

Scarcity forces us to make choices Rational Choices refers to choices that

involve weighing up the benefit of any activityagainst its opportunity cost

Opportunity cost The highest-valued alternative that is given

up to get something.

Sacrifice

Next best thing forgone Can be in monetary or non-monetary terms


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Scarcity

Choice

OpportunityCost


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What is EconomicsEconomics: The study of choices that individuals,

businesses, governments and societies make tocope with scarcity and the incentives thatinfluence and reconcile those choices.

Macroeconomics Studies the performance of the national economy

and global economy Studies decision-making for the economy as a

wholeMicroeconomics Studies the choices that individuals and

businesses make, the way these choices interactin markets, and the influence of governments (onspecific markets)

Studies decision-making by a single individual,household, firm, industry


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Microeconomic Issues

Individual parts (economic agents)

Individual units such as households,

firms and industries Demand and supply of particular goods

and services

Market structure


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Methodology of Economics

The purpose of an economic model isto forecast or predict the results ofvarious changes in variables

A model is a simplified description ofreality used to understand and predictthe relationship between variables.

Three basic steps in the model-building process


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Identify the problem

Develop a model basedon simplified assumptions

Collect data andtest the model


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Hazards to Economic Way ofThinking

Two pitfalls (reasoning mistakes): Failing to understand the ceteris paribus

assumptionWhen testing a model we often use the assumption

of ceteris paribusMeans that while certain variables can change, allother things remain unchanged

Confusing association (correlation) with

causation Association - two events can occur together but oneevent is not the cause of the other

Cannot always assume that when one event followsanother, the first caused the second


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Choosing at the Margin People make choices at the margin they

evaluate the consequences of makingincremental changes .

Marginal benefit (MB) the benefit that arises frompursuing an incremental increase in an activity.Marginal cost (MC) the opportunity cost of pursuing anincremental increase in an activity.

Marginal benefit and marginal cost act as

incentivesWhen MB > MC, people have an incentive to do more ofthat activity.When MC > MB, people have an incentive to do less ofthat activity.


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Three Fundamental Economic Questions

Wh at , h o w and f o r w h o m

What type & what quantities of goods & services

How to produce these goods & services

what mix of resources is needed for production

For whom to produce for

basically who gets what

All societies and nations need to answer thesethree questions


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Economic Systems

Economic systems The organization and methods used to

determine what goods and services are

produced, how they are produced, and forwhom they are produced

All economic systems answers the three

fundamental economic questions Command economy, Market economy,

Mixed economy


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Totallyplanned

economy

Totallyfree-market

economy

N. Korea

N. Korea

Cuba

China

Poland

Poland France

France

UK

UKUSA

USA

Early 1980s

Early 2000s

Classifying economic systems

China HongKong

CubaChina

(HongKong)


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Command Economy

Command Economy (also known asCentrally Planned & similar to communism) A system that answers the What, How, and For

Whom questions by central authority(i.e.

government)The three fundamental economic questions areanswered through central planning

Plans what will be produced and in what quantities

Decides which resources will be used for the productionof various goods and services

Decides on the distribution of the goods and servicesproduced

All economic decisions are taken by the central

authorities


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Command Economy Advantages of a command economy

High focus on investment goods bygovernment will lead to high economicgrowth

Stable growth if properly overseen bycentral planning prevents extremefluctuations in economic growth

Low unemployment if there is accurate

matching of labour needs Social goals can be pursued (e.g. income

equality, basic needs met) Government can prevent the destruction of

the environment (e.g. control pollution)


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Command EconomyProblems of a command economy

Problems of gathering information for centralplanning due to complexity of economies (veryexpensive to administer)

Inefficient use of resources as there are no pricesignals, price arbitrarily decided by government

Inappropriate incentives for producers (not profitdriven) and workers may lead to poor quality andlow variety of goods

Loss of individual liberty Shortages and surpluses can occur with poor

planning (for the case of shortages, this may leadto a black market where buyers pay much higherprices)


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Market Economy

Market Economy (also similar toCapitalism) An economic system that answers the What,

How, and For Whom questions using pricesdetermined by the interaction of the forces ofsupply and demand

The price mechanism (demand and supply) willanswer the three fundamental economic questions

Firms will decide what goods and services to produce andhouseholds will decide what goods and service to buyFirms will decide what resources to use and householdswill decide what resources to supply

All economic decisions are taken by individualhouseholds and firms with no government


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Market Economy

Adam Smiths Invisible Hand A phrase that expresses the belief that the bestinterests of a society are served whenindividual consumers and producers competeto achieve their own private interests


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Market Economy

Advantages of a free-market economy Price mechanism transmits information

between buyers and sellers leading to widerange of products - no need for costlybureaucracy

Competitive markets (with many sellers andbuyers) leads to lower prices

Quicker response time to market changesby reacting to changes in demand andsupply

Incentives to be efficient and produce quality


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Market Economy

Problems of a free-market economy Competition may be limited which leads to theproblem of market power (where a monopolywill sell goods a high prices)

Social goals may not be met (e.g. incomeinequality and unequal distribution of wealthand power)

Environment / social problems may be ignoredNegative externalities such as pollution

Lack of desirable public goods (e.g. street lights)Poor ethics / values (selfishness)

There may be macroeconomic instability (highfluctuations in economic growth and highunemployment)


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Mixed Economy

The mixed economy An economic system that answers the What, How,

and For Whom questions through a mixture ofcommand and market systems

Both government and private sector (individuals and firms)make economic decisions

Some examples of government intervention:relative prices of goods & services (taxes, price controls)

relative incomes (taxes, welfare payments, legislations)

pattern of production & consumption (taxes, legislations,state-owned companies)

macroeconomic problems (fiscal & monetary policies)

economics basic notes - topic one

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