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
• Negative externalities


  A third party or spillover external cost arising from the production or consumption of a good for which no compensation is paid
• 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
• Types of negative externalities


  • Negative production externality
  • Negative consumption externality
• 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
• Negative production externality


  A third party or spillover external cost arising from the production of a good for which no compensation is paid (e.g. pollution)
• Moving along the PPF

  The opportunity cost increases as more consumers goods are produced
• Negative consumption externality


  A third party or spillover external cost arising from the consumption of a good for which no compensation is paid (e.g. tobacco consumption causing passive smoking, often called demerit goods)
• A straight line PPF indicates resources are equally efficient at producing both goods shown on the PPF axes – opportunity cost is constant
• Social benefit


  Private benefit + external benefit
• A non-parallel shift in the PPF indicates a technological advance in the production of one good only
• Social cost


  Private cost + external cost
• Geographical immobility of labour

  Labour may not be fully mobile because of regional house price variation, family & social ties, children in school etc.
• Marginal private cost (MPC)


  All the costs of producing one more unit of the good to the producer
• Occupational immobility of labour


  Can occur because of insufficient education and training, a lack of transferable skills, inability to afford training etc.
• Marginal social cost (MSC)


  All the costs of producing one more unit of the good to society
• Advantages of specialisation and division of labour


  • Increased Productivity
  • Lower Costs
  • Economies of Scale
• Marginal private benefit (MPB)


  All the benefits of consuming one more unit of the good to the consumer
• Disadvantages of specialisation and division of labour

  • Higher staff turnover
  • Dependency
  • Structural unemployment
  • Lack of variety
• Marginal social benefit (MSB)


  All the benefits of consuming one more unit to society
• Factor mobility


  When factors of production can easily be moved from one use to another
• In a perfect market, allocative efficiency is achieved when P = MC, but if externalities exist, then the social optimum is achieved when MSC = MSB

  
• Policies to address negative externalities


  • Banning/restricting output
  • Legislation/regulations
  • 'Nudge' policies
  • Indirect tax
  • Pollution permit trading schemes