e c

q

e c

q

4 10

4 10

Lecture 1The

Economic Problem

Key Points

ScarcityChoice

Rational DecisionsOpportunity Cost

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q

e c

q

4 10

4 10 The Problem….

How to organise Production and Consumption of goods

and services?

Scarcity

e c

q

e c

q

4 10

4 10 Choice

A consequence of scarcityCompare

Costs Benefits

Rational choice maximises benefit relative to cost

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q

e c

q

4 10

4 10 Microeconomic Problems

• Choices• Rational economic decision

making• Opportunity cost

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q

e c

q

4 10

4 10 Macroeconomic Problems

• Growth• Unemployment• Inflation• International Trade - Balance of

Payments problems

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Imagine that you won millions of pounds on the National Lottery. Would your `economic problem' be solved?

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Imagine that you won millions of pounds on the National Lottery. Would your `economic problem' be solved?

It would not be solved. Many things would still be scarce. For example, you would still have only a finite amount of time to enjoy what the money could buy: there are only 24 hours in a day, and we do not live for ever.

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Assume that you are looking for a job and are offered two. One is unpleasant to do but pays more. How would you make a RATIONAL choice between the two?

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

You should weigh up whether the extra pay (benefit) from the better paid job is worth the extra hardship (cost) involved in doing it..

Assume that you are looking for a job and are offered two. One is unpleasant to do but pays more. How would you make a RATIONAL choice between the two?

e c

q

e c

q

4 10

4 10

Opportunity Cost

The cost of any activity measured in terms of the best alternative forgone

e c

q

e c

q

4 10

4 10 Illustrating choice &

opportunity cost

The Production Possibility Curve

0

Rice

Peas

e c

q

e c

q

4 10

4 10 Illustrating choice &

opportunity cost

Rice

Peas0

Production possible

y

x

not all resources

used

e c

q

e c

q

4 10

4 10 Illustrating choice &

opportunity cost

0 x

Production boundary

y1

x

All resources are used

Rice

Peas

e c

q

e c

q

4 10

4 10 Illustrating choice &

opportunity cost

0

Possible choicesy1

y2

x2x1

Rice

Peas

e c

q

e c

q

4 10

4 10 Illustrating choice &

opportunity cost

0

Impossible choices

y1

y2

x2

Rice

Peas

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Suppose you have a choice of spending Saturday afternoon studying economics or working for £20.00 or watching television. What is the opportunity cost of choosing to study?

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

The £20.00 wages foregone (probably)…The difficulty here is the VALUATION of the ‘watching television’.

Suppose you have a choice of spending Saturday afternoon studying economics or working for £20.00 or watching television. What is the opportunity cost of choosing to study?

e c

q

e c

q

4 10

4 10 Economic reasoning

Economic methodology constructs theories or models

Compare with natural sciences

(physics)

Used to explain or

predict

Problems of a Social ScienceControlled experiments not possibleHuman behaviour unpredictable

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q

e c

q

4 10

4 10 Statements about the

economy

Statement of fact

Statement of what is desirable, ought to be or what is good or bad

Positive Normative

either

Statement of factMay be tested

Statement of factMay be testedThe statement may be true or false

Statement of what is desirable, ought to be or what is good or badNot testable

e c

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e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Is the statement below Positive, or Normative or could it be either?

“It is wrong that inflation should be reduced if this means that there will be higher unemployment.”.

1

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Is the statement below Positive, or Normative or could it be either?

“Current Government policies should reduce unemployment”.

2

e c

q

e c

q

4 10

4 10 Workshop ActivityWorkshop Activityecqecq1 101 10

Is the statement below Positive, or Normative or could it be either?

“Cutting the higher rate of income tax will redistribute incomes from the poor to the rich”.

3

e c

q

e c

q

4 10

4 10 Summary

Finite resources

Scarcity

Choices

Opportunity Cost

Subjective -difficult to value

Costs

Benefits compar

e