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Chapter 1 What is economics?

What is economics?
What is economics?

The study of how humans attempt to solve the problem of unlimited wants
with scarce resources

Science of choice, resting on various assumptions

What are the assumptions made in economics?

💡 Assumptions are a set of statements which are assumed to be true

to explain human behaviour

We assume people are selfish and are wealth maximizers (people maximize
their wealth subject to constraints), the assumption of constrained
maximization

What are the 2 branches of economics?

Microeconomics: analyze the behavior of individual and firms

Chapter 1 What is economics? 1

 Macroeconomics: analyze the operation of the economy as a whole ( how
society makes economic decisions and how they affect individual and firms

Positive statements vs Normative

statements
What are the differences between positive statements and normative
statements?
Positive statements: NO personal preference or value judgement, is refutable
by facts (what is)
Normative statement: Subjective opinions or value judgement, not testable
with facts (what should)

Wants, scarcity, Choices, (Opportunity)

Cost
Wants
Human desires for things, unlimited, not necessarily supported by buying
power

Scarcity
Limited resources available are insufficient to satisfy unlimited wants

Scarcity is a universal phenomenon. It CANNOT be solved

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Choice and cost

Because of scarcity, we have to make choices.

Whenever there is a choice, there is a cost

Cost is the highest-valued option forgone.

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 Scarcity, Competition, Discrimination
Competition
Exists when 2 or more ppl compete for the same goods

There is no competition in a one-man economy (eg. Robinson)

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Types of competition

Price: people paying the market price to get the thing they want
Non-price: all forms competitions other than price.

How scarcity and competition are related

Scarcity implies competition IN SOCIETY, existence of competition implies
scarcity

Discrimination

Due to competition, some criteria must be used to discriminated winners and

losers
All forms of competition are discriminatory in nature

Price competition⟶ Poor

First come first serve NP)⟶higher time cost

More About Cost

 Cost will change only when the highest-valued option forgone

 When there is no choice, there is no cost

 Time itself is NOT a cost

Why?

The value of time varies between individuals

Chapter 1 What is economics? 3

 Definition of time cost
The loss of alternative use of time, and the forsaken productivity it represents,
(which determines the cost of an individual.)

4. Higher cost does not mean that one is worse-off

e.g doctor vs nurse

5. Historical (sunk) cost

Cost considers only options available at the moment of decision

Sunk cost

The cost incurred by a past action and is no longer an option available now

6. Full cost=Explicit cost+Implicit cost (monetary cost+non-monetary cost)

Explicit cost=involve actual transaction or transfer of fund

Implicit cost=involve no actual transaction

Goods
What is a good?

Include tangible goods and intangible goods

Anything that can satisfy human goods

Good vs bad

Good is something we prefer more to none, bad is something we prefer less to

more

Free good and economic good IMPORTANT

Free good
A good whose supply is so abundant that it can satisfy all human wants at
one time and no one is willing to incur a cost for obtaining free goods.
Thus, it is a good of which more is not preferred
eg. air at your home

Economic good

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 A good whose supply is insufficient to satisfy all human wants at one time
and costs are incurred in obtaining economic goods. It is a good of which
more is preferred to less.

Are the following free goods?

12-year free education in HK

No. Free good is a good whose supply is so abundant that it can satisfy all
human wants at one time and no one is willing to incur a cost for obtaining free
goods. Thus, it is a good of which more is not preferred. As 12-year education
is a good of which more is preferred. Its supply cannot satisfy all human
wants. People always want a longer period of education. And scarce resources
are used in providing 12-year free education. There is a cost incurred in
providing education. The resources spent on education can be used in other
aspects such as medical health. Therefore, 12-year free education is a scarce
good

⚠ A good which is free of charge does not mean it is a free good

Fireworks display in Disneyland

Free good is a good whose supply is so abundant that it can satisfy all human
wants at one time and no one is willing to incur a cost for obtaining free
goods. Thus, it is a good of which more is not preferred. As fireworks display is
a good of which more is preferred. People always want to enjoy a longer
period of fireworks. Its supply cannot satisfy all human wants. A cost is
incurred in displaying fireworks, money is used to buy fireworks however the
money can be used in other areas such as building new facilities. Therefore,
fireworks display in Disneyland is a scarce good.

Production and Consumption

Production

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 The process of turning inputs, or factors of production into goods and services

Factors of production
CELL

Labor

Land=natural resources

Capital=manmade resources

Entrepreneurship

Consumption

The process of using goods and services to satisfy human wants directly.

Present consumption and future consumption are economic goods

There is a tradeoff （取捨） between present and future consumption

Interest as a cost of earlier consumption IMPORTANT

To borrower ( 問⼈借野)
Interest is the cost of earlier availability of goods and resources. The
borrower pays interest to obtain the goods earlier

To lender ( 借野⽐⼈)
Interest is the compensation for deferring consumption of goods

💡 Higher interest rate⟶higher cost of present consumption⟶less

present consumption⟶more saving for future consumption

🔑 Interest exists even w/o money eg. barter economy

Circular flows of economic activities

Circular flow model

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 A simple economic model showing the relationship between two basic
economic units: the firm and the household. Their economic activities are
inter-related

Firms

Basic unit of product, employ factor of production, supply final goods and
service to the household for consumption

Household
Basic unit of consumption, buys final goods and services, provides factors of
production to the firm

The 2 flows

Real flow
Flow of good and services

Household supplies factors of production to the firm in the factor market

Household buys final goods and products from the firm in the product
market

Money flow

Flow of monetary resources

Firm pays household for factors of production (wages of labour)

Household spends income to buy goods and services

🔑 We assume that there is no saving

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