Theme 1

• Basic Economic Problem

  There are infinite wants and finite resources. Resources are scarce in relation to wants.
• Opportunity Cost


  The value of the next best alternative foregone (given up) when a choice is made
• Choices need to be made about how to allocate resources among competing uses


  1. What to produce?

  2. How to produce?

  3. For whom to produce?
• Resources (Factors of Production)

  • Land - natural physical resources
  • Labour - human input
  • Capital - man-made resources, eg machinery
  • Enterprise/Entrepreneurship - the ability and willingness to organize, coordinate, and take risks in the production process
• Rewards to Factors of Production

  • Land = rent
  • Labour = wages
  • Capital = interest
  • Enterprise = profit
• Microeconomics

  A branch of economics that studies the behaviour of individuals and firms in the market
• Macroeconomics

  Considers the economy as a whole
• Need

  Something you must have to survive or to do something
• Want

  Something you desire but it is not essential
• What rational economic agents aim to maximise

  • Consumers: total utility
  • Workers: wages and benefits from work
  • Producers: profit
  • Government: social welfare
• Capital Goods


  Goods used in the production of other goods
• Consumer Goods


  Goods used for final consumption
• Moving from point A to point B on the production possibility frontier


  The opportunity cost of producing C1-C2 more consumer goods is the K1-K2 capital goods foregone
• Positive Statements


  Describe the world as it is, without making any value judgements. They are based on objective facts, and they can be proven or disproven.
• Normative Statements


  Express an opinion about what ought to be. They are subjective statements - i.e. they carry value judgements.
• Production Possibility Frontier (PPF)


  Shows the maximum possible output combinations of two goods or services an economy can achieve when all resources are fully and efficiently employed
• What causes an outward shift in the PPF?


  • An increase in the quantity of the factors of production
  • An increase in the quality of the factors of production
  • An advance in technology
• What causes an inward shift in the PPF?


  • A decrease in the quantity of the factors of production
  • A decrease in the quality of the factors of production

  
• PPFs are usually curved because of the Law of Diminishing Returns – the marginal (extra) output of consumers goods diminishes as more factor resources are allocated to it.

  
• Using the PPF diagram


  • Point A - inefficient, some resources unemployed
  • Points B, C & D - efficient, all resources fully employed
  • Point E - unattainable with current resources and state of technology
• Moving along the PPF


  The opportunity cost increases as more consumers goods are produced
• A straight line PPF indicates resources are equally efficient at producing both goods shown on the PPF axes – opportunity cost is constant
• A non-parallel shift in the PPF indicates a technological advance in the production of one good only
• Geographical immobility of labour


  Labour may not be fully mobile because of regional house price variation, family & social ties, children in school etc.
• Occupational immobility of labour


  Can occur because of insufficient education and training, a lack of transferable skills, inability to afford training etc.
• Advantages of specialisation and division of labour


  • Increased Productivity
  • Lower Costs
  • Economies of Scale
• Disadvantages of specialisation and division of labour


  • Higher staff turnover
  • Dependency
  • Structural unemployment
  • Lack of variety
• Factor mobility


  When factors of production can easily be moved from one use to another
• Geographical mobility


  Resources can move easily between regions / areas / countries
• Occupational mobility


  Resources can move easily between different types of work
• Money


  Anything generally accepted in payment of a debt; removes the needs to barter, avoiding the double coincidence of wants
• Characteristics of money


  • Acceptable to all
  • Portable
  • Durable
  • Easily divisible
  • Uncounterfeitable
  • Scarce in supply
• The Four Functions of Money


  • Medium of exchange
  • Unit of account
  • Store of Value
  • Standard for deferred payment
• Free Market Economy


  Also known as a laissez-faire, market or capitalist economy
• Characteristics of a free market economy


  • Private ownership of resources
  • Owners of resources and producers are free to buy/sell
  • Economic agents are motivated by self-interest
  • Consumers have sovereignty
  • Income depends on the market value of an individual's work
  • Resources are allocated by the price mechanism
• Disadvantages of a free market economy


  • Income/wealth inequality, and poverty
  • Market failure can reduce social welfare
  • Lack of provision of public goods
  • Over-provision of goods with negative externalities
  • Under-provision of goods with positive externalities
  • Information gaps may cause market failure
  • Unemployment/worker exploitation/low pay for some
  • Environmental depletion/degradation
  • Resources may be wasted on advertising and marketing
  • Firms may develop monopoly power and push up prices
  • Macroeconomic instability
• Advantages of free market economy


  • Resources can be bought and sold
  • Consumer sovereignty
  • Freedom of choice
  • Profit-motive and self-interest incentivises
  • Incentive to worker harder for higher wages; productivity rises
  • Firms face competitive forces driving down prices
  • Incentive to innovate and invest in new ideas (dynamic efficiency)
• Adam Smith's 'invisible hand'


  If economic agents act in their own best interests, the forces of demand and supply in the market can promote an efficient allocation of scarce resources for society
• The price mechanism in action


  • If consumers exercise their sovereignty and are willing and able to buy more of a good, the market demand curve shifts right
  • Suppliers are incentivised to extend supply to meet the demand and can increase price to reduce the excess demand
  • This causes the market price and quantity to increase
  • The market has allocated more scarce resources to the production of this good – the quantity has increased.
• Command Economy


  Resources are allocated by the government to maximise social welfare