INTRODUCTION TO ECONOMICS

THE ECONOMIC PROBLEM

- Economics - the study of the production, distribution and exchange of goods and services in an economic system
 Involves the study of the problem of scarcity of resources in relation to human needs and wants

The economic problem flow chart

Wants and Needs

- Basic wants
 Needs that all individuals must satisfy to some degree to survive e.g. food, water, clothing, shelter
 Without these individuals may not survive in their environment, experience a very low standard of
living or live in poverty
- Recurring wants
 Wants that must be continually satisfied at regular intervals e.g. food, water, clothing, shelter
- Substitute wants
 Interchangeable wants e.g. second hand car instead of new because of budget/ income
- Luxury wants
 Desires for goods and services to satisfy needs in excess of survival wants e.g. holidays,
entertainment
- Complementary wants
 Wants which are derived from other wants e.g. petrol, knives and forks, computers
- Individual wants
 Wants of each person according to preferences and income e.g. types of food
- Collective wants
 Wants demanded by a community/ group e.g. health care, education, transport, emergency services
- Some consumer goods and services are single use, once they are consumed they don't exist and have to be
produced or supplied again e.g. food, water, petrol
- Capital goods: used to produce more consumer and capital goods in the future and are durable
Resources or the factors of production
1. Land refers to all natural resources (land and everything that comes with it) e.g. minerals, agriculture.
2. Labour refers to the human effort used in the production of goods and services.
3. Capital refers to the goods used to produce more goods and services in the future
4. Enterprise refers to the risks entrepreneurs are willing to take
OPPORTUNITY COSTS AND PRODUCTION POSSIBILITY CURVES
 Opportunity cost - the cost of not taking an alternative opportunity
 Marginal rate of substitution (MRS) - the opportunity cost co-efficient
Four simplifying assumptions:
1. Only two goods, can be produced with limited or finite resources available.
2. All resources are fully employed
3. The level of technology in the economy is assumed to be constant or fixed.
4. Resources are fixed or finite but can be be switched from one type of production to another.
Production Possibilities, Increased Resources and Technological Progress
 When resources are not perfectly substitutable in production, the production possibility curve for
consumer and capital goods is concave to the origin
The Future Implications of Current Choices
 Allocative efficiency, where resources are allocated according to the preferences of consumers and
society for certain goods and services
Consumers
 Current spending decisions reflect an individual's desire to maximise their satisfaction of needs and wants
by buying goods and services in the present which maximise a consumer's utility (satisfaction)
Businesses
 Firms are also faced with present and future choices
Governments
 Governments mainly source their income from taxes, fees and charges from the privatisation and profits
of PTEs (public trading enterprises)
 Choices are made by local, state, territory and federal governments

ECONOMIC FACTORS UNDERLYING DECISION MAKING

Consumers
- Spending and saving
 C (consumption)
 S (savings)
 Y (income)
 Y=C+S
 People SAVE for security against unforeseen future events
 Three main motives for saving:
 Transactionary motive of consumers for saving was to finance cash purchases of
goods and services
 Precautionary motive of consumers was to save for precautionary income or
purchases
 Speculative motive of consumers was to save to invest in shares, bonds, real estate
or cash in order to earn a rate of return on the money invested
- Work
 The higher income earnt, higher the potential levels of consumption and saving which can
lead to higher standards of living
- Education
 The higher the level of education an individual has, the higher the capacity of a person's
income in the future
- Retirement
 Retirement influences decision making since employers must contribute 9.5% of employees'
gross wager to superannuation
Business
- Primarily run for the maximisation of profits
 - Profit = the total revenue – total costs of production
- Total revenue = price × quantity sold
- Price = costs + mark up (profit margin)

Government
Four main ways governments influence the decisions of individuals and businesses:
1. Allocate resources through their spending decisions for infrastructure and collective services
2. Federal government tries to stabilise economic activity through economic policies (monetary & fiscal)
3. Redistribute through implementing a progressive system of taxation)
4. Government regulates economic behaviour and attempts to protect individual consumer rights and
increase competition in markets to raise efficiency and lower prices.
Examples of government regulation that affect the decision making of individuals and firm include:
 Price control, price regulation and price surveillance
 The provision of a framework of law and order
 The application of a national competition policy (Competition and Consumer Act 2010)
 Minimum wage legislation
 Legislation to control environmental externalities through regulation

THE OPERATION OF AN ECONOMY

WHAT, HOW MUCH AND HOW TO PRODUCE, TO WHOM TO DISTRIBUTE
Production
 What to produce – economic system responding to society's scale of preferences for certain goods and
services over others.
 How much to produce –involves determining the quantities of goods and services to be produced,
depending on the level and pattern of consumer demand, and the availability of resources.
 How to produce involves the method of production to be used. E.g. capital, labour
Distribution and exchange
 To whom to distribute - the distribution of the output of goods and services depends on individual
incomes. Each individual's income in society is determined by their employment

RESOURCES AND THE PROVISION OF INCOME

 Saving --> Investment --> Capital accumulation
 Real Interest Rate = Nominal Interest Rate - Inflationary Expectations

The factors of production and factor income returns

Factor of production Factor income return
Land (natural or environmental resources) Rent
Labour (the human effort in production) Wages
Capital (plant, machinery, tools and equipment) Interest
Enterprise (risk taking behaviour by entrepreneurs) Profit

 Profit - the return to enterprise. Profit = total revenue – costs of production

 Normal profit - rate of profit sufficient to keep the entrepreneur in business or the industry
 Supernormal profit - profit over and above what is necessary to keep the entrepreneur in business or the
industry in which a firm operates and is usually earnt by businesses with a large degree of market power
 Gross income - subject to income taxation by the federal government.
 Disposable income - equal to gross income minus taxation
 Final income - cash and non-cash benefits paid
PROVISION OF EMPLOYMENT AND THE QUALITY OF LIFE
- High level of specialisation in an economy leads to independence between households, firms and
governments
- 3 main industry sectors
 Primary industry - collection of natural resources
 Secondary industry - processing of natural resources
 Tertiary industry - services performed
- Quality of life – depends on quantity and quality of both material and non-material goods and services in
the economy and community
- Business Cycle
 Upswing/recovery phase – expenditure, output, income and employment levels rise
 Peak – expenditure, output, income and employment levels reach its peak
 Downswing/recession - expenditure, output, income and employment levels decelerate
 Trough - expenditure, output, income and employment levels reach minimum point

CIRCULAR FLOW OF INCOME

- Circular flow of income – shows the relationship between inputs, outputs, income and expenditure in an
economy
- Closed economy – one where there is no overseas sector and therefore no international trade
- Open economy – one that is characterised by the inclusion of an overseas sector and international trade and
money flows
- Equilibrium
 Equilibrium condition – S + T + M = I + G + X
 Recession – S + T + M > I + G + X
 Peak – S + T + M < I + G + X
- Household Sector
 All individuals in the economy who earn income by selling productive resources to the firms
sector
 With the money earnt, households purchase products from firms sector to satisfy needs and wants
- Firms Sector
 All private business enterprises in the economy which produce and distribute goods and services to
consumers
 Buy productive resources from the household sector
 Attempt to maximise profits by minimising production costs
- Finance Sector
 All financial institutions who engage in borrowing/lending money and sale/purchase of financial
assets and services to household and firms sector
 Attempt to maximise profits by charging a higher rate of interest to borrowers than they pay to the
public for depositing funds
- Government Sector
 Economic activities of local, state, territory and federal governments in Australia
 Raise revenues through taxes, rates, fees and charges and the profits of Public Trading Enterprises
- Overseas Sector
 Consists of firms who are the exporters and importers of goods and services to and from the rest of
the world
 Trade flow – the exports of goods/services sold by Australian firms to foreigners and imports and
the imports of goods/services purchased by Australian residents from foreigners

ECONOMIES: THEIR SIMILARITIES AND DIFFERENCES

- Three main criteria used to classify economies include:

 Whether productive resources are owned by private individuals or the government and the
allocation of property rights over the use of resources
 The role of markets and the market forces of demand and supply in allocating resources
determining prices and distributing incomes in the economy
 The role of the government in economic life, including the production of goods and services and
the provision of infrastructure and social welfare services to the community

TYPES OF ECONOMIC SYSTEMS

MARKET ECONOMY
- Some key characteristics of a market economy include:
 Private ownership of property through the existence and enforcement of private property rights
 Freedom of enterprise for individuals to establish, run and own businesses and freedom of choice
in spending and employment
 Motivation of individual behaviour through self-interest and profit motives
 Consumer sovereignty in the market
 Price mechanisms for resource allocation
 Competition between consumers in product markets and between producers in factor markets
 Limited role of government in economic life by providing infrastructure and social welfare
- E.g. Australia, USA, Japan, Canada, UK
NEWLY INDUSTRIALISING ECONOMIES
- A key characteristic in this type of economy includes:
 Being a formerly developing economy but have industrialised rapidly
- E.g. Singapore, Taiwan, Hong Kong, South Korea

PLANNED E CONOMY
- Some key characteristics of a planned economy include:
 Public ownership of property and resources
 Limited personal economic and political freedom and a low material standard of living
 Motivation of individual behaviour through coercion, state propaganda and national goals
 Absence of freely operating product and factor markets and market determined prices
 Central planning is the main allocative mechanism in product and factor markets
 Production is largely carried out by state owned and operated enterprises
 Dominant role is played by the government in economic, political, military and cultural life