Micro economics Year 1

• Economics


  A social science which studies society and relationships between people
• Economics


  • Is about the decisions that we take in our everyday life
  • For every choice we make as individuals or as a society, there is a cost and a benefit
• Models in Economics


  Economists develop models and theories to help explain the many choices we make in our daily lives
• Assumptions


  Initial or prior conditions made before a micro or macroeconomic analysis is built
• Ceteris paribus


  Economists isolate the relationship between two variables by assuming all other influencing factors are held constant
• Positive statements

  Objective statements that can be tested, amended or rejected by referring to the available evidence
• Normative statements

  Subjective statements that carry value judgments
• Microeconomics


  Considers the economics of everyday life such as the decisions that we as households take and the impact of businesses in different and related industries
• Economic problem


  Limited resources unlimited needs and wants
• Decisions to be made due to scarcity

  • What goods and services to produce
  • How best to produce goods and services
  • Who is to receive goods and services
• Scarcity


  we usually have limited resources available to meet our objectives
• Factors of production

  • Land
  • Labour
  • Capital
  • Enterprise
• Automation


  Production technique that uses capital machinery & new technology to replace or enhance human labour
• Non-renewable resources


  Finite in supply, no mechanisms exist to replenish them
• Renewable resources

  Replaceable if the rate of extraction is less than the natural rate at which a resource renews
• Opportunity cost

  The next best alternative foregone when a choice is made
• Opportunity cost examples


  • Work-leisure choices
  • Government spending priorities
  • Investing today for consumption tomorrow
  • Relationships
• Opportunity cost


  The cost of a choice measured by the next best alternative foregone (i.e. given up)
• Opportunity cost


  • Work-leisure choices: The opportunity cost of deciding not to work an extra 10 hours is the lost wages foregone
  • Government spending priorities: The opportunity cost of the government spending nearly £10 billion on investment in National Health Service might be that £10 billion less is available for spending on education or improvements to the road and rail transport network
  • Investing today for consumption tomorrow: The opportunity cost of an economy investing resources in capital goods is the production of consumer goods given up for today
  • Relationships: The opportunity cost of continuing in a relationship might be expressed as sacrificing the opportunity to go on a date with someone else
• Assume you run a hospital with a monthly healthcare budget of £200,000. Opportunity cost would be expressed in terms of other treatments that might have to be foregone. For example, the opportunity cost of one hip replacement is sacrificing the funds to provide cataract surgery for six people.
• Production Possibility Frontier (PPF)

  Shows the maximum potential output combinations of two goods or services that an economy can achieve when all its resources are fully and efficiently employed

  
• Production Possibility Frontier (PPF)


  • Normally drawn as concave to the origin i.e. when we move down along the PPF, as more resources are allocated towards Good Y, then the extra output gets smaller
  • This is explained by the law of diminishing marginal returns. It occurs because not all factor inputs (such as land, labour and capital) are equally suited to producing different goods leading to lower productivity

  
• A micro PPF would look at two specific products such as smartphones and smartwatches. A business might reallocate their available inputs towards one product i.e. it is specialising in supplying these. This decision involves an opportunity cost because some output of the alternative good has to be sacrificed.
• A macro PPF looks at the choices an economy might have between producing capital goods such as factories and technology versus supplying consumer goods and services.

  
• Efficient allocation of resources


  Any point lying on the PPF is an efficient allocation of scarce resources whereas a point inside the PPF is an inefficient allocation of resources since it is possible to produce more of one good without sacrificing any of the other
• Pareto efficiency


  In neoclassical economics, a Pareto efficient outcome is an action that harms no one and helps at least one person. A situation is Pareto efficient if the only way to make one person better off is to make another person worse off.
• Pareto efficiency will occur on points that lie on a production possibility frontier / curve

  
• When an economy is operating on a production possibility frontier, it is not possible to increase output of goods without reducing output of services
• When an economy lies well within the PPF boundary, there is an inefficient use of resources or under-utilization of resources
• An outcome may be a Pareto improvement, but it doesn't always mean this is a satisfactory outcome or fair. There could still be inequality after a Pareto improvement.
• Opportunity cost on the PPF


  Reallocating scarce resources from one product to another involves an opportunity cost. If we increase our output of cotton (i.e. we move along the PPF from point A to point B) then fewer factor resources are available to produce wheat, therefore total output of wheat will decline.

  
• If the law of diminishing returns holds true, the opportunity cost of expanding output of cotton measured in terms of lost units of wheat must be increasing.

  
• Causes of an outward shift of a country's production possibility frontier

  • Higher productivity / efficiency of factor inputs
  • Better management of factor inputs
  • Increase in the stock of capital and labour supply
  • Innovation and invention of new products and resources
  • Discovery / extraction of new natural resources (land)

  
• Public health measures brought in to control the coronavirus have had the effect of greatly restricting consumption and production in many countries including the UK. The result has been a sharp fall in demand for goods and services and a severe contraction of GDP. In the short-term, this means that we move away from the production possibility frontier which implies a higher level of spare capacity.
• There are some fears that the downturn may turn out to be longer-lasting, especially if there is a second wave of infections and an effective vaccine is delayed. In this case, there might be some 'economic scarring' effects which could lead to an inward shift of the production possibility frontier.
• Causes of an inward shift of a country's production possibility frontier


  • The damaging effects of severe natural disasters
  • The destruction caused by war and other types of conflict
  • Large scale net migration of people out of a country
  • A long-term fall in productivity of labour
• Resource depletion


  A decline in the total stock of resources available, for example arising from the effects of de-population, climate change and low rates of investment in new capital goods
• Resource depreciation


  When the efficiency of resources diminishes with age and with repeated use during production
• Deforestation causes significant economic and social/human costs, and this is one of the most critical environmental issues of the age.
• Key causes / drivers of deforestation

  • Expansion of industrial cattle / soy / palm oil farming
  • Expansion of (often illegal) gold mining
  • Expansion of hydro-electric dams requiring land clearance
  • Urban development / urban sprawl
  • Illegal logging / land grabbing alongside weak legal / institutional protections