Economics

• A social science concerned with the allocation of

scarce/limited resources between unlimited and
often competing needs and wants.
– Scarcity: The situation in which unlimited wants
exceed the limited resources available to fulfill
The nature of them.
– Trade-off: The idea that because of scarcity,
economics producing more of one good or service means
producing less of another good or service.

Check Your Understanding Check Your Understanding

We study economics because of What does the adage ‘There is no such thing
a. resources. as a free lunch’ mean?
b. money. a. To get something we like, we usually have
c. scarcity. to give up another thing we like.
d. economists have convinced universities it is a
b. Even people on welfare have to pay for
necessary field of study.
food these days.
c. The cost of living is always increasing.
d. All costs are measured in dollars.

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Basic Economic Questions

Limited resources Unlimited needs and wants

What does scarcity force us to Scarcity

It forces us to make choices

do? => Choices must be made about:

• What to produce?
• How many to produce?
• For whom to produce?
• At what price to sell?

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Slide 6

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Resources:
- Land
- Labour
- Capital (ie. investment goods such as plant, machinery, storage, transport and distributions facilities
etc. Not money or financial capital).
- Entrepreneurship
v00076, 6/3/2004
 Factors of production
Labour
Land Capital
– Land: natural resource
– Labour: human resource
– Capital: man-made resource
– Entrepreneurship: The creative ability of
Entrepreneurship organizes
individuals to seek profits by combining
resources to produce goods
resources to produce innovative products and services

Economic Models Check Your Understanding

• Models are simplified representations of the real

world. Economic models are usually composed of:
– A hypothesis in an economic model: A a. plastic.
statement about an economic variable that may
b. beautiful people.
be either correct or incorrect.
c. assumptions only.
– Economic variable: Something measurable that
relates to resources that can have different d. diagrams and equations.
values.

Check Your Understanding

Opportunity cost
Economists understand that people respond
a crucial concept in economic analysis
to:
the quantity of other goods that must be
a. the wishes of policymakers. sacrificed to obtain another unit of a
b. Incentives. good
c. threats more than rewards.
d. tax breaks, but not tax hikes.

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 Check Your Understanding
Opportunity cost
Assume a firm can produce a combination of 60
units of X together with 80 units of Y but to produce
 At the individual level: tomato/ carrot/
70 units of X, the firm can only produce 60 units of Y.
coriander/ English Spinach
What is the opportunity cost to produce 10 more
 At the level of the firm: milk chocolate/ plain
chocolate units of X?
 At government level: four new schools/ a a. Two units of Y
new hospital b. 10 units of X
c. One-half a unit of X
d. 20 units of Y

• Trade-offs and disaster relief The production possibility frontier (PPF)

More funds for one

 The PPF shows the alternative combinations
disaster relief means
of the two products that the country can
less funds for other
produce if it fully uses all of its resources.
charities.
 Negatively sloped: to have more of one good,
we must give up some of other goods.
 Curve gets steeper as production of goods
measured on y axis increases
 PPF is concave to the origin

A production possibility curve A production possibility curve

8 8
a
7 7

6 6
Units of food (millions)

Units of food (millions)

5 Units of food Units of clothing 5 Units of food Units of clothing

(millions) (millions) (millions) (millions)

4 8m 0.0 4 a 8m 0.0
7m 2.2m 7m 2.2m
3 6m 4.0m 3 6m 4.0m
5m 5.0m 5m 5.0m
4m 5.6m 4m 5.6m
2 3m 6.0m 2 3m 6.0m
2m 6.4m 2m 6.4m
1m 6.7m 1m 6.7m
1 1
0 7.0m 0 7.0m

0 0
0 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8
Units of clothing (millions) Units of clothing (millions)

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 A production possibility curve A production possibility curve
8 8

7
b 7

c
6 6

Units of food (millions)

Units of food (millions)

5 Units of food Units of clothing 5 Units of food Units of clothing

(millions) (millions) (millions) (millions)

4 8m 0.0 4 8m 0.0
b 7m 2.2m 7m 2.2m
3 6m 4.0m 3 c 6m 4.0m
5m 5.0m 5m 5.0m
4m 5.6m 4m 5.6m
2 3m 6.0m 2 3m 6.0m
2m 6.4m 2m 6.4m
1m 6.7m 1m 6.7m
1 1
0 7.0m 0 7.0m

0 0
0 1 2 3 4 5 6 7 8 0 1 2 3 4 5 6 7 8
Units of clothing (millions) Units of clothing (millions)

A production possibility curve

8
A production possibility curve
7 w
x – microeconomics and the p.p. curve:
6
Units of food (millions)

• choices and opportunity cost

5

4
• increasing opportunity cost

0
0 1 2 3 4 5 6 7 8
Units of clothing (millions)

Increasing opportunity costs Making a fuller use of resources

8

7
x
6 x
Units of food (millions)

1 y
5 Production inside
Food

1 the production y
2 possibility curve
4

3
z
1 v
2

0 O
0 1 2 3 4 5 6 7 8 Clothing
Units of clothing (millions)

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 Growth in potential output The circular flow of goods and incomes
Goods and services

£
5 years’ time Consumer
expenditure
Food

Now

Wages, rent
dividends, etc.
£
O
Clothing
Services of factors of production (labour, etc)

Economic systems The market economy

• In a ‘pure’ free market economy: no

• Market economy: allocate resources through
government intervention
the forces of demand and supply with prices
being determined by the market. • price mechanism/ market mechanism.
• Planned economy: allocate resources through
administrative decision.
• Mixed economy: contains features of both the
market and planned economic system.

The market economy The market economy

 Disadvantages:
• Advantages:
– The market mechanism is based on the
– Market mechanism: without government ‘ability to pay’ and not on need.
intervention. – Monopolies
– ‘money vote’: – Externality: a cost or benefit that arises from
an economic transaction and that falls on
– Producers are motivated by profit.
people who do not participate in that
transaction.
– Public goods and merit goods may be under-
provided or not provided at all. ‘free rider’

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 Check Your Understanding
The planned economy
A market economy rewards people
according to: The government makes all the decisions about:
– What is produced
a. their need for goods and services.
– How resources are allocated
b. how willing they are to work.
– How the finished products are distributed.
c. their ability to produce things of cultural
importance.
d. their ability to produce things that other
people are willing to pay for.

The planned economy The planned economy

Disadvantages:
• Advantages:
Any wasteful competition is avoided.
Dealing with the externalities, such as
pollution.
More equal distribution of income and
wealth.
Administering the prices of products:
effectively control inflation
The planning authority may misjudge the
preferences of the consumers  over-production
of certain products or under-production of others.
 Lack of motivation among managers and workers.
 State monopoly  lack of competition between
companies  lack of variety and quality of
products
 Misused of resources

Positive versus Normative

The mixed economy
• Positive: Claims that attempt to describe the
aims to combine the merits of both the market world as it is. Statements of facts. Can be tested
and the planned economy.
empirically.
• Normative: Claims that attempt to prescribe how
the world should be. Opinions. Cannot be tested
empirically.

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 Check Your Understanding Micro and macroeconomics
Which of the following is a positive economic statement?

a. The government should close income tax loopholes

• Microeconomics deals with the decision
that enable people to avoid paying tax. making of individuals and firms, and how
b. We should redistribute income to reduce poverty. particular markets work.
• Macroeconomics studies the operation of the
c. Everyone should live at the same standard of living.
economy as a whole, covering areas such as
d. If the price of petrol rises, a smaller quantity of it will be unemployment, inflation and aggregate
bought. demand.

Check Your Understanding

State whether the following issues are

microeconomic or macroeconomic.
a. The overall unemployment rate
b. A tax that affects workers in the automobile industry.
c. The inflation rate
d. Prices of electronic goods
e. Real GDP