Lecture 1

Introduction to Economics,
The Economic Problem, and
Economic Systems
Economics as a social
science
Models
• Because real-life situations are often complex, economists use models
to understand and analyze them.
• The findings from using models will have economists make statements
that we can classify as either positive economics, or negative
economics.
Positive vs normative economics
• Because real-life situations are often complex, economists use models to
understand and analyze them.
• The findings from using models will have economists make statements that
we can classify as either positive economics, or negative economics.
• If statements made by economists can be proven – true/false – we say these
are positive statements.
• Positive statements can be supported or refuted by evidence. They are
objective, fact-based.
• Positive economics describes the way the economy actually works.
• E.g. The UK economy is currently operating on its production possibility
frontier.
Positive vs normative economics
• Statements that cannot be supported or refuted – we say these are
negative statements. They are subjective, value-based, opinion-based
so cannot be proven.
• Negative economics prescribes how the economy should work.
• E.g. Manufacturing companies should invest more.
The economic problem
The economic problem
• Society has infinite (unlimited) wants, but society’s resources are
limited. Society faces scarcity.
• Here’s the problem: because of scarcity, we have to make choices. We
have to decide how to allocate these resources efficiently.
• Thus, economics is the study of this allocation of resources.
• E.g. should the government spend $10m in tax revenues on military
ammunition, better schools, or greater care for the elderly? It has to
make a choice.
The economic problem
• Making a choice has a cost – because you have to give up all alternatives –
in economics, what we call a trade-off.
• Making a choice involves comparing or weighing of benefits and costs of
each alternative.
• The benefit lost from next best alternative – is what we call opportunity
cost. What you must give up in order to get the item you want.
• E.g. choosing between your two favourite courses: economics and math.
• So, we can say, the opportunity cost of taking economics course, is the
benefit you would have derived from taking the math course.
The economic problem
• Is opportunity cost in monetary terms? No, and yes.
• No – as in the above example.
• Yes – e.g. if economics course costs $750, and math course is free. So,
the opportunity cost of taking economics course, is the benefit you
would have derived from taking the math course, and the $750 you
could have spent on other things.
Solution to the economic
problem
Solution to the economic problem
• To solve this economic problem, there ought to exist a system, or an
economy.
• Society decides which economic system to use, that will best allocate
those resources to society.
• In deciding which economic system to use, these questions are asked –
and so answers provided: what goods and services to produce, how
many to produce, how they should be produced, how much they cost
to produce.
Solution to the economic problem
• At this point, it is crucial first to talk about resources, and goods and services.
• Resource – anything that can be used to produce something else
• Examples of resources:
• Land – natural resources you can get e.g. rainwater, natural forests, oil, coal, gold.
• Labour – the workforce of an economy – people who make goods and services.
• Capital – money and tools invested into business to produce goods and services.
• Human capital (or entrepreneurship or enterprise) – skills and knowledge acquired
through education and experience e.g. entrepreneur or manager.
• Resources are also known as factors of production.
Solution to the economic problem
• Factors of production gain you rewards. Specifically,
• Land – owners of land get rent or lease payments. If land refers to oil,
copper, gold, owners receive royalties (share of the money from sales
of the resource).
• Labour – workers get wages (paid by the hour) or salaries (fixed
amount per pay period).
• Capital – owners who rent or invest capital get income.
• Human capital / entrepreneurs – they earn profit.
Solution to the economic problem
• When we say goods and services, we can typically classify them into
two types.
• Goods we directly consume – we call them consumer goods.
• E.g. cakes
• Goods we indirectly consume – we call them capital goods.
• E.g. whisk machines, ovens, knives – goods used to make consumer
goods.
Economic systems
Economic systems
• Recap: how resources are allocated efficiently, and how goods and
services are produced and distributed – we look at which economic
system society is structured upon.
• 3 economic systems we will look at – free-market economy,
centrally-planned economy, mixed economy.
Economic systems – free market economy
• When economic decisions are made by individuals and businesses.
• They decide what to produce, how to produce, how much to produce,
for whom to produce.
• The state/government plays no-to-limited role in the economy, or
when necessary.
• Free market economy also commonly known as lasseiz-faire (“leave it
alone”) – government does not interfere.
Economic systems – free market economy
• Resources are distributed using forces of demand and supply. If
consumers want a good, producers are willing to supply, consumers
can (will) get what they want.
• Because individuals in the free market economy make decisions for
self-interest, their actions ultimately benefit society as a whole, even
though those actions were not the initial intent.
• We say that “the invisible hand” is at play. (Adam Smith, An Inquiry
into the Nature and Causes of the Wealth of Nations, 1776).
Economic systems – free market economy
• Forces of demand and supply also determine the price at which goods
and services are to be bought and sold (neoclassical economics). It
used to be when price is largely based upon cost of production
(classical economics).
• What’s good about this economic system?
• Creates competition.
• Competition among producers.
• Encourages flourishing of ideas, innovation.
• Prices can be kept low. Consumers have more choices, more opportunities to
obtain wealth.
Economic systems – free market economy
• What’s bad about this economic system?
• Creates inequalities in wealth distribution.
• Some are able to obtain wealth, others at ‘disadvantaged end’.
• E.g. owners of production exploiting proletariat in capitalist economies
• Lack of government control helps the rich become richer, while the poor
becomes poorer.
• Privatization of public services à private companies are profit-driven à
services become increasingly difficulty for the poor to access and afford.
• Nations that adopt free market economics: US, Singapore, Hong Kong,
China (markedly from 1970s – Deng’s era)
Economic systems – centrally-planned
economy
• Also, referred to as ‘command economy’.
• When economic decisions are made by state/government.
• The state/government decides what to produce, how to produce, how
much to produce, for whom to produce.
• Inequalities not as high as in free markets, as resources produced by
government tend to be distributed more equally.
Economic systems – centrally-planned
economy
• Resources are distributed not by forces of demand and supply, but by
top-down planning, or central planning (closely associated with
Marxist-Leninist theory).
• Nations that adopt this economic system: Soviet Union, China,
Vietnam, Cuba
Economic systems – mixed economy
• Also, referred to as ‘hybrid economy’.
• Economic decisions made by both individuals and businesses, and the
government.
• Rarely are economies free or planned, most are hybrid. Decisions are
shared between private and public sectors, and within different levels
of control by governments.
• Nations that adopt this economic system: US, UK, France. Also,
Singapore, China.
Economic systems
Economic systems
• How goods and services are produced and distributed, we look at
which economic system society uses.
• To decide which one, society asks: what should be produced? How
should these goods and services be produced? Who consumes these
goods and services?
• 3 economic systems we will look at: free-market economy,
centrally-planned economy, and mixed economy.
Economic systems – free market economy
• When economic decisions are made by individuals and businesses.
• They decide what to produce, how to produce, how much to produce,
and for whom to produce.
• The state/government plays no-to-limited role in the economy, or
when necessary.
• Free-market economy also commonly known as lasseiz-faire (“leave it
alone”) – government does not interfere.
• Resources are distributed using forces of demand and supply. If
consumers want a good, there will be producers willing to supply.
Economic systems – free market economy
• What’s good about this economic system?
• Creates competition.
• Competition among producers.
• Encourages flourishing of ideas, innovation
• Prices can be kept low – consumers have more choices, more opportunities to
obtain wealth.
• Proponents argue that government interference should be minimized.
Economic systems – free market economy
• What’s bad?
• Creates inequalities in wealth distribution.
• Some are able to obtain wealth, others at ‘disadvantaged end’
• E.g. owners of production exploiting proletariat in capitalist economy
• Lack of government control helps rich becomes richer, while the poor
becomes poorer.
• Privatization of public services à private companies are profit-driven
à become increasing difficult for the poor to access and afford.
• Nations that adopt this economic system: Singapore, Hong Kong,
China (markedly from 1970s, Deng’s era)
Economic systems – centrally-planned
economy
• Also known as ‘command economy’.
• Someone commands on what to produce, how to produce, how much
to produce, for whom to produce: the government (public sector)
makes these economic decisions.
• Resources are distribution not by demand and supply, but by top-down
planning, or central planning (closely associated with Marxist-Leninist
theory).
• Nations that adopt this economic system: Soviet Union, China,
Vietnam, Cuba
Economic systems – mixed economy
• Also known as ‘hybrid economy’ – economic decisions made by both
individuals and businesses, and the government.
• Rarely are economies free or planned; most are hybrid. Decisions are
made about allocation of resources shared between private and public
ownership, and different levels of control by governments.
• Nations that adopt this economic system: US, UK, France. Also,
Singapore, China.
In summary,
• We looked at the characteristics of different market economies
(economic systems) - free market/capitalist, centrally-
planned/command, mixed/hybrid.
• We briefly touched on the four different resources (factors of
production): land, labor, capital, human capital (entrepreneurship)
Readings – essential
• Please read Chapters 1, 3 and 6 of textbook.
• Anderton, Alain. (2015). Chapter 1: Economics as a social science. In
Economics (6th ed.), pp.2-4. UK: Anderton Press Ltd.
• Ibid. Chapter 3: The economic problem. In Economics (6th ed.), pp.12-15. UK:
Anderton Press Ltd.
• Ibid. Chapter 6: Types of economy. In Economics (6th ed.), pp.26-29. UK:
Anderton Press Ltd.
Readings – supplementary
(uploaded on easyclass.com)
• Fulcher, James (2004). What is capitalism? Capitalism: A Short
Introduction, pp.1-18. USA: Oxford University Press.
• Wheelan, Charles (2010). The Power of Markets: Who feed Paris?. Naked
Economics: Undressing the Dismal Science. New York, London: W. W.
Norton & Company.
• Wheelan, Charles (2010). Government and the Economy. Naked
Economics: Undressing the Dismal Science. New York, London: W. W.
Norton & Company.
• Marron, Donald (2010). The Invisible Hand. 30-Second Economics, pp.172.
Ivy Press.
• Investopia (2019, June 25). What does the term ‘Invisible Hand’ refer to in
the economy?. Retrieved from
https://www.investopedia.com/ask/answers/011915/what-does-term-
invisible-hand-refer-economy.asp