Lecture Notes, Lectures 1-10

11/30/23, 10:52 AM Lecture notes, lectures 1-10
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BSB 113 – ECONOMICS NOTES
LECTURE 1: THE BARE BONES OF ECONOMICS
LECTURE NOTES
At the heart of economics lies the problem of scarcity!
What is economics?
 The application of rigorous, often mathematical thinking to understand how scarce resources are best
used
 Tries to understand how scarce resources are used in the real world
 Positive vs. normative theory: how are resources used and what is the best way to use resources in the
economy
 Theory of how to run a business ie. how to improve efficiency by making better use of resources and to
make a profit without incurring extra costs.
The basic economic problem

 All decision-makers (consumers, firms and gov) want more than is possible ie. demand is larger than
what is possible to produce/supply
 Issue of scarcity (Insufficiency of amount or supply; shortage)
All of the groups have infinite needs and only finite resources
 Demand vs. supply

 People are concerned only for their own interests ie. they look after themselves/their own needs or
wants etc.
 People always care about their material welfare – all strive to increase it.
Economics: how to best use limited resources in a way which is beneficial for the people (a majority?)
Economists: claim everyone is selfish
A short history of economic thought

Basic Stance
“What government should care about is the combined welfare of all inhabitants” – Adam Smith
The role of economists
“To find out what is in the best interests of all and to relay this information to the benevolent decision maker.”
This implies
 Economics is implicitly idealistic ie. it is for the common good
But … whose welfare should be maximised
 The welfare of the poor? Or the welfare of the average?
 ‘Average’ is found through GDP or the average income which is often seen as a measure of a successful
country.
Economics contains a lot of idealisms and therefore doesn’t tell you want to do immediately. Therefore, it is not
practical in some situations.
Eight Basic Ideas of Economics

* Scarcity
1. Competition
2. Functioning Markets
3. Benevolent Markets
Jessica King BSB113 - Economics Semester 1, 2009
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4. Homo Economicus
5. Equilibrium
6. Money Circulation
7. Creative Destruction
1. Competition
 Prices ensure that individuals specialise in what they do relatively best
 Business want to sell goods to make profit but increasing competition limits prices and ensures
consumers get the lowest possible price.
 Stores therefore have an incentive to provide goods to ensure customers return to their store
 Specialise: reduces costs, produce more and arguably goods of better quality (occurs as a result of
competition)
 The use of scarce resources efficiently ensures a business will earn an optimum profit
 Economics of scale eg. car makers merge which allows them to cut production costs and therefore
increase efficiency
2. Functioning Markets
 Competition only works when a situation of many sellers exists
 Only 1 seller (monopoly or no competition) means prices rise
 Functioning market – where competition can occur
 Buyers have access to price from all sellers and can purchase from anyone ie. they can chose the best
product for their needs
 Ownership is honoured.
3. Who sets market rules?

 Believe that the rule setter is interested
 In the common good (not always!) eg. the government, rule setters: competition boards (eg. ACCC),
courts with impartial judges, government or those with independent power ie. a king
4. Homo Economicus
 People maximise their own individual material gain and act highly rational in doing so
 Eg. Cultural inhibitions against eating cows in India – the standard explanation from economists is that
this prevents people when times are bad from eating their productive future capacity ie. keep food
resources under control
 People behave the way Homo Economicus predicts
 Homo Economicus presumes pure selfishness
 Eg. Experience with socialism
5. Equilibrium
 An economic situation is said to be in equilibrium when it is not possible for anyone to improve their
outcome by changing their current behaviour
 A system should always be moving towards this but should never reach it
 Occurs only in a stable market situation
6. Money circulation
Main functions of money
 allows trade in small quantities with little transaction costs – allows specialisation
 a store of value: allows for pensions over weeks, years or decades
 a unit of calculation – gives a price or a value
Bottom line: allows/is needed for cheap trade of the result of time investments with others and oneself
 critical for trade
 needed in a functioning market
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Money Circulation
 Keeps control of money in the market – if not it leads to money problems eg. inflation
 people use money to store value
Inflation
 more money for the same amount of goods, increases the number of notes (value) per good
 ie. money loses its value
 hyper-inflation – wipes out the value of savings and leads to fluctuations in relative prices,
undermining specialisation (eg. Germany 1930’s)
 loss of confidence in money leads to alternative means of exchange eg. barter or people trading
goods and reduced specialisation
7. Creative Destruction
 How do we progress?
 A continuous stream of shocks and discoveries constantly creates new opportunities and closes down
ways of doing things
 Always new ideas/opportunities coming up.
 Links are need to work in an economy but new opportunities often break existing links
 A firm faced with new technological possibilities must attain expertise of incorporating the new
technology and has to ditch the old technology ie. Job loss as technology increases the issue of human
vs capital labor will become more significant especially in certain manufacturing industries
Policy implications of the bones of economics

 Individuals must have an incentive to invest and innovate. Therefore, good rules are need to ensure one
receives rewards for their efforts
 Equilibrium requests everybody can do what he/she wants and everyone has a much information as
possible
 Market systems allow everybody to participate and as such, barriers to entering the market should be
lower
 Allow as much trade as possible
TEXTBOOK NOTES – Chapter 1: The Bare Bones of Economic Thought

Definitions
Home economicus: someone who rationally maximises his or her own material welfare
Economics: how and why a society produces things and how governments should manage things for the best in
a calm and rational way
Utilitarianism: what a government should care about is the combined welfare of all inhabitants.
Inflation: More money without extra production in an economy is going to put upward pressure on prices
because there would be more bank notes buying the same amount of goods
Equilibrium: An economic system is said to be in equilibrium when it is not possible for anyone to improve on
their outcome by changing their current behaviour.
Economics by moral philosophy

 Economists’ view f the rest of humanity is that they are almost solely interested in having as many
possessions as possible ie. materialism
Functioning markets: the advantage of specialisation

 Not everyone has equal abilities in terms of production and it is therefore efficient to specialise.
 Through specialisation everyone will gain from trade as, all will benefit from the fact that they do not
have to make all products individually but can specialise in what they do best
 Trade allows specialisation into fields of relative excellence (also known as comparative advantage)
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The immutability of Homo economicus

 Two related big ideas in economics: A large part of the behaviour of individuals is dictated by their
material interest and that it is not possible to have a continuously growing economy without appealing
to material motivations
Equilibrium and rationality

 An economic system is said to be in equilibrium when it is not possible for anyone to improve on their
outcome by changing their current behaviour
 When individuals have all available information as to all possible opportunities for improvements and
can freely contract with others, that the whole system will move towards a situation where all
opportunities from improvement gradually disappear
 The relation between the notion of equilibrium and rationality is clear: if expectations are roughly right
then the economy should always be moving towards equilibrium
Economies of Scale
 Increasing economies of scale occur when the average cost of producing something goes down if the
scale of production goes up.
 Decreasing economies of scale also know as diseconomies of scale, occur when the average cost of
production goes up if the sale of production goes up.
 Eg. The cheapest way to produce billions of cares and computer chips is believed to involve very large
plants with lots of automated processes rather than many small backyard production facilities.
 However, when companies become too big they may begin to suffer from disadvantage eg. Law firms
made up from merely a couple of lawyers are for instance believed to operate at lower average costs
than huge law firms.
Money and Money Circulation

 The main role of money was as a means of exchange and a storage of value
 Money allows people to trade the equivalent goods for the value of the notes/coins
 Money allows individuals with different talents to trade the result of their time without even meeting
each other and to allow any individual to trade with himself over time.
 More money without extra production in an economy is going to put upward pressure on prices because
there would be more bank notes buying the same amount of goods, which is known as inflation.
Creative destruction and growth

 Creative destruction believes that the world around us is constantly changing in a million different ways,
opening new business opportunities and closing old ones.
 Continuous search for new opportunities via experimentation with organisations, technology and trading
partners
 Within the market place, flexibility in terms of who does what and well-established property right such
that individuals have incentives to take opportunities that present themselves (ie. enterprise) is needed.
 In order for individuals to take opportunities there must be something in it for them, hence patent laws
and business ownership
 The fact that changes are so massive and multiply all the time means a large slice of the population
needs to be on the lookout for these new opportunities
 Recognition of opportunities needs as much useful information as possible
 More barriers to changes = the less new opportunities that can be taken up quickly.
Summary Table of Basic Ideas and their Relevance

Basic Concept Intuitive Content of Basic Concept Policy Relevance of Basic Concept
Scarcity Everyone wants more than is possible There is always a trade-off implicit in any
choice
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Competition The fear of losing business to another will Social production costs can be lowered by
make me demand no more than my costs competition
for a service
Functioning Markets Competition arises when the fear of losing Close down all options of avoiding
cannot be taken away except by efficient competition or making money by defrauding
specialisation consumers in other ways
Benevolent rue setters The state can count on a loyalty to overall The state can somewhat impartially set the
good from some of its employees rules for overall good.
Homo economicus All individuals and their organisations are Do not design policies that go heavily against
to a large degree consciously looking for material motives for long periods of time
material gain
Economic rationality Homo econmicus is a fairly good Take account of the fact that people
calculator anticipate and adapt to policies
Equilibrium The situation where all opportunities for Thinking of all the opportunities that open up
gain are exhausted towards which we after a policy change
forever move
Money circulation All exchange is paid for in money, linking Increasing the money supply without
the prices of the supply of money producing more goods means more money
per good ie. inflation
Creative Destruction A continuous stream of shocks and 1. Allow incentives to search and take the
discoveries constantly creates new new opportunities
opportunities and closes down old ones 2. Aid the exchange of information
3. Allow old ways to die in order to make
room for the new.
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LECTURE 2: BASIC MICROECONOMICS – SCARCITY AND CHOICE
LECTURE NOTES
Key Concepts
1. Scarcity
2. Free goods
3. Production
4. Transfers
5. Choice
6. Opportunity cost
7. QuALY
8. Tax rates
9. Poverty trap
Unlimited Wants
 Everyone has many different types of wants and needs
 4 key reasons why wants and needs are virtually unlimited:
- goods eventually wear out and need to be replaced
- new or improved products become available
- people got fed up with what they already own
- the more you have, the more you want
What is actually scarce?

 Commodities are produced by using resources
 Resources/factors of production:
Type Description Reward
Land* All natural resources RENT
Labour* All physical and mental work of people WAGES
Capital All human-made tools/machines INTEREST
Enterprise All managers and organisers PROFIT
*limited and are the only ones which are actually scarce
 All resources are eventually reducible to labour (time) and natural resources (restricted in the amount).
Physical and other capital can be seen as the conserved result of previous production. Entrepreneurship
effort is actually another form of labour and therefore, time.
Types of (scarce) goods

 Free good: available without the use of resources eg. air
 Economic good: limited in supply eg. water or oil
 Expenditure on capital goods is called a cost or an investment
 Capital (good) is a productive asset eg. a machine, building
Terminology of economics
 Production: transforming the combination of production factors into something consumable – it
contributes to GDP
 Home production: untaxed production in households
 Transfer: a change/swap in ownership of a resource or good eg. trade for trade or a good for money
Economists often look at things from different perspectives. The difference between cost, a transfer, a return on
an asset and production depends on the judge/their perspective.
The economic problem
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 Refers to the scarcity of commodities – only a limited amount of resources available to produce the
unlimited amount of goods and services desired by society
Choice implies to choose one thing and forego another
 Opportunity cost principle – the cost (or value) of one good in terms of the next best alternative
 Implicitly or explicitly a choice for X limits the other options – there are tradeoffs inherent in any choice
 The set of possible choices is called the opportunity set, the feasibility set or the budget constraint ie.
something’s are just not possible.
 There is not necessarily always a ‘best’ decision – but some decisions are worse than others
Quality Adjusted Life Year (QuALY)

 The estimated costs for various medical procedures, environmental regulation and safety measures
 Policies implicitly set the value of a year of decent life and not all get an equal amount
 Try to cease the more ineffective measures (less QuALY/dollar spent) in favour of more effective ones
Managing People: Policies and the work place

Taxation is the policy which most affects people’s behaviour
Basic Terms
Suppose pre-tax revenue = Y and tax bill = T
 Average tax is total bill divided by pre-tax revenue ie. T/Y
 Marginal tax is the percentage of the last dollar of revenue that gets paid in tax ie. dT/dY
 Progressive tax – average tax increases with pre-tax revenue
 Regressive tax – average tax decreases with pre-tax revenue ie. a lump sum tax is set for the whole
population of eg. $1000. For a person on a high salary this amount would be small, but for a person on a
low salary, this amount could be significant
 Effective marginal tax rate – percentage of the last dollar in Y that is paid in tax or reduces the slide
payments. Where transfers from the government which depend on income = W, (d(T-W)/dY).
Taxation and Choice

 The effect of taxes on people’s choices particular their decision to work, is significant
 In example 1 (slide 28), tax system has high EMTR, in area where marginal taxes kick in and welfare
payments are reduced.
 High EMTR makes it less attractive to seek work
 This situation can be changed by decreasing welfare payments or avoiding areas where the reduction of
welfare payments coincide with marginal tax
 Poverty trap: situation whereby a person with generally few marketable skills earns less in work than
out of work. Occurs when EMTR goes over 100%.
Retirement/Pension Schemes
Defined contributions compared to defined benefits and the effect on taxes
 When does one stop working?
- EMTR is the percentage of a year’s income somebody close to retirement loses due to taxes and
changes in pension payments
 Two possible systems:
1. Defined contributions – save 12% of income. Sum of savings defines your pension
2. Defined benefits – pay 12% into a pension fund and get a fixed percentage of average income for
the last 3 years you work.
 With the potential income situation, it can be seen that the average drops compared to the last year and
never reaches that high again
 Defined contributions – save less in last years of working life but overall, you will have more money
 Therefore, pensions systems which are based on last=earned incomes can give rise to very high EMTR
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TEXTBOOK NOTES – Chapter 2: Scarcity
Definitions
 Goods and services: physical items and non-physical items that satisfy wants and needs
 Factors of production: the items of value used in the production of goods and services
 Transfer: a change in ownership of a resource of a consumption good
 Scarcity: there is only a limited amount of resources available to produce the unlimited amount of goods
and services that we desire. Scarcity requires making choices
 Opportunity cost of a choice x: best available alternative for the resources involved in choosing X (value
of the next best use)
 Tradeoffs: exchange of one thing is return for another due to alternative key objectives that cannot be
attained together
 Budget constraint: the set of possible choices (eg. set of bundles that a consumer can afford)
 Quality Adjusted Life Year (QuALY): equals a year of normal living of a person in good health and
average happiness
 Cost-effective policy: policy that minimises the cost of obtaining a given desirable outcome
 Cost-benefit analysis: an analysis of all the benefits of a choice as well as the (opportunity) costs
involved in making that choice.
 Effective marginal tax rate (EMRT): the increase in taxes and the decrease in side-payments due to the
last additional dollar of pre-tax revenue
 Progressive tax: when the average tax increases with pre-tax revenue, the tax is progressive
 Regressive tax: when average tax decreases with pre-tax revenue
 Poverty trap: when earning more income in the formal economy reduces the material welfare of a
relatively low skilled person
 Defined contribution system: a superannuation system whereby the sum you get at the end is determined
by how much you contributed
 Benefit system: a superannuation system whereby the sum you get at the end is determined by an
administrative rule not determined by your total contribution
Unlimited Wants
 Everyone has many different types of wants and needs
 There are four reasons why wants and needs are virtually unlimited:
1. goods eventually wear out and need to be replaced
2. new or improved products become available
3. people get fed up with what they already own
4. the more you have, the more you want
Factors of Production
 Physical capital and natural resources are relatively easy to measure
 Capital is something that eventually comes from time investments and natural resources spent in the
previous period
 Hence, from a long-term perspective, the only two ultimate production factors are natural resources and
human time investments
Types of Commodities
 A free good is available without the use of priced resources
 An economic good is a commodity in limited supply
 Expenditure on producer or capital goods is called a cost or an investment
Opportunity costs
 The set of possible choices we can make is called the opportunity set, the feasibility set or the budget
constraint
 Principle states the cost (or value) of one good in terms of the next best alternative
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Scarcity and the value of life

 The essential task is to make problems comparable by expressing the value of different activities in the
same way
QuALY
 Scarcity of resources forces you to think hard about what you fund and what you don’t fund
 It forces you to think of who loses when someone else wins
 Completely reverses what it means to be kind: eg. You are not being kind if you refuse to value life and
simply willy-nilly choose medicine and policies to find
How the government affects choice by changing opportunity costs

 Government policy affects the choices of individuals by changing the trade-offs between alternatives –
seen in the taxation and retirement examples
 Taxation promotes the thing untaxed and discourages the thing taxed ie. taxation changes the
opportunity costs and therefore will change individual choices.
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LECTURE 3: DEMAND AND SUPPLY
LECTURE NOTES
What determines the demand, supply and prices in a market?
Price taking behaviour

 Price taking: you can only decide whether to buy or not. You cannot determine the price.
 Is this the same for a seller? No, he/she can set the price … BUT if many shops sell the same (similar)
goods, then a higher price in one shop implies that all customers would buy from another shop. We
assume that (at least in the long run) sellers are also price takers, i.e. can only decide whether to sell at a
price or not.
Perfect Competition
 What do we think that buyers know when they make their decision?
• All prices that are offered by some sellers
• All the sellers (and where their shops are)
• The exact quality/design of products offered
• Buyers know how much a good is worth to them
• Sellers know their costs to produce/supply a good
If buyers and sellers are price takers and all of the five assumptions are holding we speak of Perfect
Competition.
Willingness to pay
 One way to express the opportunity cost is to give the foregone opportunities a monetary value. This is
called the willingness to pay.
 The amount of money willing to give up (opportunity cost)/spend on one item
 Is influenced by other opportunities
Demand curve
 A demand curve depicts the quantity of a good that an individual demands (wants to buy) at a given
price.
 Demand curves are (almost always) downwards sloping because for most goods the additional benefit
we get out of consuming more of the same is decreasing. This is called diminishing marginal* utility or
diminishing marginal propensity to consume. This fact is so pervasive that we speak of it as the LAW
OF DEMAND
 Higher price = less likely to consume
 The more you have consumed the less willing you are to pay
What affects demand for a (normal) good?

 Besides the price (as shown by the demand curve – low price = high demand), the budget, prices of
other goods (opportunity costs) and the taste for something affect the demand and the demand curve
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11/30/23, 10:52 AM Lecture notes, lectures 1-10

LECTURE 1: THE BARE BONES OF ECONOMICS

At the heart of economics lies the problem of scarcity!

The basic economic problem

 Demand vs. supply

A short history of economic thought

Eight Basic Ideas of Economics

Jessica King BSB113 - Economics Semester 1, 2009

3. Who sets market rules?

Jessica King BSB113 - Economics Semester 1, 2009

Policy implications of the bones of economics

TEXTBOOK NOTES – Chapter 1: The Bare Bones of Economic Thought

Economics by moral philosophy

Functioning markets: the advantage of specialisation

Jessica King BSB113 - Economics Semester 1, 2009

The immutability of Homo economicus

Equilibrium and rationality

Money and Money Circulation

Creative destruction and growth

Summary Table of Basic Ideas and their Relevance

Jessica King BSB113 - Economics Semester 1, 2009

Jessica King BSB113 - Economics Semester 1, 2009

What is actually scarce?

Types of (scarce) goods

The economic problem

Jessica King BSB113 - Economics Semester 1, 2009

Quality Adjusted Life Year (QuALY)

Managing People: Policies and the work place

Taxation and Choice

Jessica King BSB113 - Economics Semester 1, 2009

Jessica King BSB113 - Economics Semester 1, 2009

Scarcity and the value of life

How the government affects choice by changing opportunity costs

Jessica King BSB113 - Economics Semester 1, 2009

Price taking behaviour

What affects demand for a (normal) good?

Jessica King BSB113 - Economics Semester 1, 2009

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