Notesale: Turn your study into money

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ECONONIMC NOTES: BASIC ECONOMIC PROBEM

Topic 1: Basic Economic Problem
Economics is not all about money
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Economics is more than just a study of money and it studies:
The production of commodities: How much an economy produces, both in
total and of individual items, how much each firm produces or person produces,
what techniques are used to produce and how many people are employed
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It studies how people make choices to allocate resources in order to satisfy their needs
and wants
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Problem of Scarcity: The excess of human wants over what can actually be
produced or fulfil these wants
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Means of fulfilling wants is limited because the world has a limited amount of
resources
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How to produce?

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1
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This labour force is limited in numbers and come
in different skills
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(ex
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(ex
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(ex
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Land (Natural resources): Refers to the land area, upon which firms
operate as well as the raw materials extracted from that land
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Oil)

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3
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Refers to factories, machines, cranes and other equipment
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4
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The entrepreneur brings together the other
factors of production, organises and manages them and bears the risk
of the enterprise not being successful
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What to produce?

Consumer goods – Goods which are consumed in order to satisfy peoples’ immediate
wants
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Goods – tangible

Goods & Services = Commodities

Services - intangible
Choice involves sacrifice
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Opportunity Cost: It is the next best that could have been an alternative
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With this we are recognising that we face trade-offs
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We therefore have to make decisions between alternatives
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In
Economics this is known as ‘rational decision making’ or ‘rational choices’
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For a firm this may mean by choosing whatever will maximise their
profits
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Marginal costs: The additional costs of doing a little bit more of an activity
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Change in Y/
Change in X

Economic efficiency: A situation where each good is produced at the minimum
cost and where individual people and firms get the maximum benefit from their
resources
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Allocative efficiency: A situation where the current combination of goods
produced and sold gives the maximum satisfaction for each consumer at their current
levels of income
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a
b

c

Production Possibility Curve (PPC): A curve showing all the possible
combinations of two goods that a country can produce within a specified time period
with all its resources fully and efficiently employed
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Point A: All resources are used in the production of food
Point B: - Within productive capacity of the economy
- Production of food and clothing can increase without opportunity cost
- Some factors of production are not being used
- Productive inefficiency
- Unemployment
Point C: All resources are used in the production of clothing

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ECONONIMC NOTES: BASIC ECONOMIC PROBEM

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Point X: Productive efficiency where the given amount of resources available
are being used and is impossible to produce more of a commodity without
opportunity cost
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Point W: Outside productive capacity of the economy
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The more we produce of either commodity, opportunity
cost will gradually increase because of the Law of Diminishing Returns
...

2
...

4
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oil)
Land reclamation (man-made land)
Investment in new plant and machinery

Investment: With this investment in capital, new resources may be found,
technological advances
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Increase in quality of factors of production:
 Technological advances (Capital investment)
 Education and training leading to more skilled labour force
 Increase in factory mobility*

*Mobility
Geographical mobility – The ease that people can move from
one region to another
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Occupational mobility – The ease at which people can switch
jobs
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2
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4
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6
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For whom to produce?
We allocate resources to the production of goods that will satisfy needs and wants
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Allocative efficiency
All resources are being allocated in a way that will maximise satisfaction for each
customer at their current levels of income
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So equity: where income is distributed in a way that is considered to be fair or just
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Consumers are free to buy whatever that will it satisfy them the most with their current
income
...
In other words firms
are free to choose what to supply and people are free to choose what to demand
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Equilibrium price: The price where quantity demanded is equal to quantity
supplied
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Section Summary:
The central economic problem is that of scarcity
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Potential demands exceed potential supplies
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Macroeconomics deals with aggregates such as the overall levels of unemployment,
output, growth and prices in the economy
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Because resources are scarce, people have
to make choices
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Microeconomics studies these choices
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If the marginal benefits exceed the marginal costs, it
is rational to choose to do more of that activity
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Assuming that the country is already
producing on the curve, the production of more of one good will involve producing
less of the other
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If the
economy is producing within the curve as a result of idle resources or inefficiency, it
can produce more of both goods by taking up this slack
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The circular flow of goods and incomes shows the interrelationships between firms
and households in a money economy
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In goods markets, firms supply goods and households demand goods
...
In factor markets, firms demand factors of production
and households supply them
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ECONONIMC NOTES: BASIC ECONOMIC PROBEM

Free Market economy – Private property (factors of production owned by the
people) An economy where all economic decisions are taken by individual
households and firms and with no government intervention
...
national security)
 Can respond quickly to changing conditions of demand and supply
Free Market economy leads firms to be more efficient by combining their factors of
production resulting in a higher profit
...


Critique of the Free Market:
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Income and wealth inequality
Monopolies
lack of information
persuasion rather than responding to customers’ needs and wants
no public goods
under-provision and under-consumption of merit goods
over-provision and over-consumption of demerit goods
negative externalities example pollution
economic instability
Power and property may be unequally distributed
Lack of competition and high profits resulting in efficiency
Consumers and firms may not have full information about the costs and
benefits

Planned economy - communism where all economic decisions are taken by the
government
...
Land and capital are
collectively owned
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It plans the output of each industry and firm, the
techniques that will be used, and the labour and other resources required by each
industry and firm
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2
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4
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In practice all economies
are mixed
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Relative incomes, by the use of income taxes, welfare payments or direct controls
over wages, profits, rents, etc
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g
...
g
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Positive economics - related to objective facts or factual facts
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‘Unemployment is
rising’, ‘Inflation will be over 6 per cent by next year’ and ‘If the government cuts
taxes, imports will rise’ are all examples of positive statements
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Statement about what ought or ought not to be, about whether something is good or
bad, desirable or undesirable
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They cannot be proved or disproved by a
simple appeal to the facts
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At the one extreme, in a command economy, the state makes all the economic
decisions
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It plans the output of each industry, the
methods of production it will use and the amount of resources it will be allocated
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A command economy has the advantage of being able to address directly various
national economic goals, such as rapid growth and the avoidance of unemployment
and inequality
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At the other extreme is the free-market economy
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Price changes act as the mechanism
whereby demand and supply are balanced
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If there is a surplus, price will fall until that is eliminated
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In practice,
however, competition may be limited; there may be great inequality; there may be
adverse social and environmental consequences; there may be macroeconomic
instability
...
It is the degree and form of government intervention that distinguishes
one type of economy from another

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