Chapter 1: Basic Economic Ideas & resource allocation

1.1
The fundamental economic problem = Unlimited wants & limited
resources

Factors of production:
1. Capital: man-made products that is used to produce goods and services
2. Enterprise (entrepreneur): organizes the capital, land and labour together
or takes the risk of production.
3. Land: natural resource
4. Labour: human resource from population

Reward of FOP:
❋ Capital: Interest
❋ Enterprise: profit
❋ Land: Rent
❋ Labour: Wages/Salary

Economic agents:
 Households (individuals in some cases)
 Firms (businesses)
 Governments (known as the state in some countries)
Opportunity cost: next alternati ve choice is forgone when the choice
has been made.

Basic economic questions:

What to produce?
How to produce?
For whom to produce?
Ceteris paribus: “other things remain equal”.

Marginal: additional
Ex: marginal product of labor is 12 => you can get 12 more products for one
additional hour of work.

The time dimension

 Short run: only labor change
 Long run: all FOP can change
 Very long run: all FOP and all other key variables can change (ex:
technology, government regulation, change in thinking,…)

1.2
Normative and Positive statements:
Positive: facts and can be proven
Normative: opinion and cannot be proven

1.3
Specialization
Specialization is when an employee, firm, region or nation concentrate on
producing some goods rather than others.

Division of labor
Each worker has a specific task which they are specialized in to achieve the
highest quality possible while still being efficient.

1.4
Economic structure:
1. Primary sector: using natural resource. Ex: mining, fishing,..
2. Secondary sector: producing products by raw materials. Ex: clothing, food
processing,…
 3. Tertiary sector: providing service. Ex: transportation, banking, education,…
4. Quaternary sector: providing information and knowledge. Ex: scientific
research, ICT, computing,…

Industrialization & de-industrialization

Industrialization: change main focus from primary sector to secondary sector.
Deindustrialization: change main focus from secondary sector to the tertiary
sector.

Resource allocation systems

There are 3 distinct types of economic system:
1. Market economy
2. Command economy (AKA planned economy)
3. Mixed economy

Economic impact of the transition between planned to mixed

economy
 Huge job losses in the transition of ownership between the relatively
inefficient public sector to the efficient private sector. Unemployment at
first and employment later. Possibly leading to more welfare needed in
short term.
 The mindset of the population also needs to change towards a more
entrepreneurial thought.
 People have to be willing to take the risks to open these new firms and
potentially fail in the process. Possibly leading to inflation. In the long long
term could lead to increased exports.

1.5
Production Possibility Curve (AKA PPF)
A PPC diagram is used to show how a country allocates its resources and are
referred to as the production possibility of the country.
Causes and consequences of movements on the PPC:
 All resources must be used – There can not be any unemployment of the
factors of production.
 The use of the resources must be efficient – the factors of production are
allocated to their best use/purpose.

PPC increase:
 The PPC of a country can either shift inward or outward. For an outward
shift to happen, there must be economic growth.
 An increase can happen when the productivity of the industries of the
country increase.
 This can happen through advancements in technology or increasing the
amount of skilled labor.

PPC decrease:
 A decrease can happen if some sort of disaster (ex: war, natural disasters,
…) happens that interrupts production.

1.6
Money: medium of exchange that is widely accepted for purchasing
goods and services.

Near Money:
 Foreign currency
 Savings accounts – Some have time limits where the money cannot be
touched without a penalty.
 Bonds - A bond is a fixed income instrument that represents a loan made by
an investor to a borrower (typically corporate or governmental).
 Certificates of deposit – Similar to a savings account but the interest rate is
fixed, and the money cannot be taken out before the time limit is finished
without huge penalties.
Liquidity:
Liquidity talks about how easily an asset
can be turned into cash.
Stocks, bonds, foreign currency, and gold
are very liquid (change easily)
CDs, savings accounts and debentures are
less liquid (doesn’t change easily)

Liability:
A liability is a promise to pay money back to someone, can be known as debt.

4 functions of money:
1. A medium of exchange –acceptable to trade for a good/service.
2. A unit of account – Helps to put a price on different things.
3. A standard of deferred payment – This function allows for payments to be
made at a later date. (debt)
4. A store of wealth – This allows people to store wealth over time. (put in
bank)

1.7
Private goods:
Private goods are goods that are bought and consumed by individual consumers
or firms for their own benefit.
There are 2 main characteristics of a private good:
1. Excludability :Not all people can afford to buy these items, therefore some
people will be excluded from their use.
2. Rivalry: When one person consumes a private good, there are less available
for other people.
Free goods:
 These goods have no opportunity cost or price.
 No factors of production are necessary for their production.

Public goods:
Public goods are goods that are provided for everyone that are hard to charge a
price for.
There are 2 main characteristics of a public good:
1. Non-excludable: It is not possible to stop people from benefiting from
consumption
2. Non-rival: When people consume these goods, it does not reduce the
amount of other people that can also consume them

Quasi-public goods:
Some goods meet one of the requirements of being a public good but not the
other and if that is the case, they fall under the category of quasi-public.
Ex: You go to the beach and there is many people so you cannot enjoy the peace
and quiet.

Problems caused by public goods:

“Free rider” problem: someone who plans on benefiting from a public good
without being the one to pay for it. Ex: People who drive on the street and use
the roads and streetlights but do not pay taxes

Merit VS Demerit goods:

 A merit good is one that has positive side effects from consuming it.
 A demerit good is one that has negative side effects from consuming it.

Information failure (a type of market failure):

This refers to the lack of full or complete information on how good or bad goods
are.
Moral Hazards:
Moral hazard describes a situation where a person is willing to take risks because
they have insurance. This can be health insurance, car insurance, homeowner
insurance, etc.

Adverse selection:
Unequal information between buyers and sellers leading to market failure.