Chapter 1

• Economics


  The study of choices people and societies make to attain their unlimited wants, given their scarce resources.
• Market


  A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade.
• Scarcity


  The situation in which unlimited wants exceed the limited resources available to fulfil those wants.
• Resources

  Inputs used to produce goods and services, including natural resources (such as land, water and minerals), labour, capital, and entrepreneurial ability. These are also referred to as the factors of production.
• Economic Models

  Simplified versions of reality used to analyse real-world economic situations. Economists use this to understand how different parts of an economy interact. They’re like maps that help us understand and predict economic behaviour
• Three key economic ideas

  1. People are rational
  2. People respond to economic incentives
  3. Optimal decisions are made at the margin.

  • Marginal analysis: Analysis that involves comparing benefits and marginal costs
• 1. People are rational

  • Rational means based on clear thought and reason

  Economists generally assume that people are rational. Meaning that they assume consumers and firms use as much of the available information as they can to achieve their goals.
• 2. People respond to economic incentives

  Individuals, firms and organisations tend to change their behaviour based on incentives they face (motives). Economic incentives influence decision-making by shaping the costs and benefits associated with different choices.
• 3. Optimal decisions are made at the margin


  Some decisions are ‘all or nothing’. For example, an entrepreneur decides whether or not to open a new cafe -they either do it or not. However, most decisions in life are not all or nothing and instead they involve doing a little more or a little less. For example, should you watch another hour of TV or spend that hour studying? Economists use the term marginal to mean an extra or additional benefit or a cost of a decision.

  • Marginal analysis: Analysis that involves comparing marginal benefits (MB) and marginal costs (MC)
• Scarcity, trade-offs and the economic problem that every society must solve

  We have already noted the important fact that we live in a world of scarcity. As a result, any society faces the economic problem that it only has limited amount of economic resources -workers, machines and natural resources- and therefore produces a limited amount of goods and services. Therefore, society faces trade-offs.
• Trade-offs


  The idea that, because of scarcity, producing more of one good or service means producing less of another good or service. E.g. A person might face a trade-off between spending money on vacation and saving for retirement. Choosing to spend on vacation means sacrificing some potential savings for retirement.
• Trade-offs forces society to make choices, particularly answering:

  1. What goods and services will be produced?
  2. How will the goods and services be produced?
  3. Who will receive the goods and services produced?
• 1. What goods and services will be produced?

  What will be produced is determined by the choices made by consumers, firms and governments. Every day you help to decide which goods and services will be produced when you choose to buy, for e.g. an iPhone rather than a Blu-ray player. Similarly, Apple must choose whether to devote its scarce resources to making more iPhones or more iPads.

  • When choosing between alternative options, economists use the concept of opportunity cost.

  Opportunity cost:

  The highest-valued alternative that must be given up to engage in an activity.
• 2. How will the goods and services be produced?

  Firms choose how to produce the goods and services they sell. In many cases, firms face a trade-off between using more workers and using more machines.
• 3. Who will receive the goods and services produced?

  This largely depends on how income is distributed. Those with highest income have the ability to buy most goods and services.
• Centrally planned economics VS market economics

  To answer the 3 questions -what, how and who- societies organise their economies in 2 main ways. A society can have a centrally planned economy or it can have a market economy.
• Centrally planned economy


  An economy in which the government decides how economic resources will be allocated
• Market economy


  An economy in which the decisions of households and firms interacting in markets allocate economic resources.

  Consumer sovereignty

  The concept that in a market economy it is ultimately consumers who decide what goods and services will be produced. This occurs because firms must produce goods and services that meet the wants of consumers or the firms will go out of business.
• The modern ‘mixed’ economy

  Mixed economy:

  An economy in which most economic decisions results from the interaction of buyers and sellers in markets, but in which the government plays a significant role in the allocation.
• Efficiency and equity


  Market economies tend to be more efficient than centrally planned economies. There are 3 types of efficiency:

  1. Productive efficiency
  2. Allocative efficiency
  3. Dynamic efficiency
• 1. Productive efficiency 


  Occurs when a good or service is produced using the least amount of resources
• 2. Allocative efficiency


  Occurs when production reflects consumer preferences and resources are allocated throughout the economy to produce what consumers demand. Meaning that resources are allocated in a way that maximises society’s satisfaction or utility.
• 3. Dynamic efficiency


  When new technology and innovation are adopted over time. Refers to how well an economy adapts and innovates over time to improve its productivity and meet changing needs and wants.
• Voluntary exchange


  Markets tend to be efficient because they promote competition and facilitate voluntary exchange. Voluntary exchange refers to the situation in which both the buyer and seller of a good or service are made better off by the transaction.
• Equity


  The fair distribution of economic benefits between individuals and between societies

  • An efficient outcome may or may not be considered by society to be equitable
• Economic Models


  Economics rely on economic theories or models (the word ‘theories’ and ‘models’ are used interchangeable) to analyse real-world issues.

  Economic models:

  simplified versions of reality used to analyse real-world economic issues.

  Economic models make behavioural assumptions about the motives of consumers and firms.
• To develop a model, economists generally follow these steps:

  1. Decide on the assumptions to be used in developing the model.
  2. Formulate a testable hypothesis
  3. Use economic data to test the hypothesis
  4. Revise the model if it fails to explain the economic data
  5. Retain the revised model to help answer similar economic questions in the future
• Forming and testing hypotheses in economic models

  A hypothesis in an economic model is a statement that may be either correct or incorrect about an economic variable

  Economic variable:

  Something measurable that relates to resources that can have different values, for example, wages, prices or hours worked.

  • in testing hypotheses, economics distinguish between correlation and causality.
• Positive analysis


  Analysis concerned with what is and involves value-free statements that can be checked by using the facts. For example, ‘a reduction in taxation rates will lead to an increase up spending by individuals’ is a positive statement and can be confirmed or negated by factual data.
• Normative analysis


  Analysis concerned with what ought to be and involves making value judgements, which cannot be tested. For example, ‘individuals should receive deductions in taxations as they are able to decide how to spend money to maximise their satisfaction better than the government can’ is a normative statement as it cannot be tested.
• Economics as a social science

  Because economics studies the actions of individuals, it is a social science. Economics is therefore similar to other social science disciplines, such as psychology, political science and sociology.

  As a social science, economics considers human behaviour -particularly decision-making behaviour -in every context, not just in the context of business.
• Microeconomics and macroeconomics


  Economic models can be used to analyse decision making in many areas. We group some of these areas together as microeconomics and others macroeconomics.
• Microeconomics


  The study of how households and firms make choices, how they interact in markets and how the government attempts to influence their choices.
• Macroeconomics


  The study of economy as a whole, including topics such as inflation, unemployment and economic growth
• Economic skills and economics as a career

  Economic principles are useful in the world of economics and business and in your everyday life.

  Examples of careers as economists:

  • Forecasting the demand for electric cars for Mercedes=Benz
  • Working for the government to forecast the types of skills, education and training required for jobs in the future
  • Working for McDonalds to assess whether additional stores should be opened, and in which countries
  • An analyst for the World Bank to assess the effectiveness of policies to reduce poverty and increase economic growth in low-income countries