As unit 1 tes

Unit 1

BASIC ECONOMICS PROBLEM

• Scarcity, choice (opportunity cost) and resource allocation – Hence the BASIC ECONOMIC problem

• Factors of Production• Production possibility curves – shapes and shifts• Decision making at the margin • Specialization and exchange• Division of labour

• Different allocative mechanisms – Planned, Market & free and Problems of transition

• Ceteris Paribus, Positive and normative statements

• Money: functions and characteristics

ECONOMICS – “OIKONOMOUS”

oikos – householdnomous– law/ rules; to manage

resources

“Management of Resources”

* MicroEconomics - deals with individual units or groups

* MacroEconomics - deals with nation or economy as a whole

This is a need!

A Want

Economics is the

Science of CHOICE(decisions made by you and me, firms,

government )

• Hence scarcity forces us to make choice

• And so Allocation of Resources

Decision on allocation of resources, Leads to 3 major

economic problem/ questions:

•What to produce•How to produce•Whom to produce

• WHAT TO PRODUCE

• Food or Clothes• Cars or hospitals• ipods or Cosmetics or military strength

Basic Economic Problem- 3 decisions

techniques used. least cost method of production labour intensive or capital intensive


HOW TO PRODUCE

Will everyone get an equal share of what is produced ?

Would the income be distributed equally?


for WHOM TO PRODUCE

• Production: Creating goods and services

• Consumption: Using the goods and services to satisfy want

Basic Economic Problem Factors of Production (FOP)

Labour

The Enterpreneur:- Organizes the 3 factors and production process- Takes the risk (Profit and Loss)

Enhancement of Production….

• Specialization• Exchange (Trade)• Division of Labour

Specialization

• Firms or Individuals or Regions or Countries producing some goods and services which they are best producing at

Exchange• No economy can be self dependent

but they have to be interdependent

• Trade and exchange of goods and services helps to resolve the problem of scarcity to a certain extent

Division of labour

• Adam Smith – division of labour represents a qualitative increase in productivity

Production Possibility Curve (PPC)• Every decision has an opportunity cost

– the cost in foregone opportunities.• The production possibilities curve

shows the trade-offs among choices we make.

• A production possibility curve is used to illustrate opportunity cost.

• Opportunity Cost is the highest-valued option forgone

Eg 1

Going to Hong Kong Disneyland• Ticket : Free of charge• Money spent on food, transport =$200• Income forgone = $500

• Full cost of going for Disneyland (HK) =$700

Eg 2 • Option 1 going to a 1 hour concert and pays $200

for a ticket• Option 2 working in Park’n as a salesman earning

$30 per hour• Option 3 working as a tutor earning $100 per hour

• Full cost of attending the concert = price of ticket + income forgone (highest-valued option forgone)

• Full cost of attending the concert = $200 + $100 = $300

Slide 27

A = 24 lbs of coffeeB = 16 lbs of cofee & 4 units of computersC = 8 lbs of cofee and 8 ComputersD = 12 units of Computer

Coffee(lb/day)

Computers(unit/day)

A

B

C

D

24

0

16

8

4 8 12

Cost of 4 computers= ?Another 4 Computers= ?Another 4 Computers = ?Hence Opportunity cost is same

In our choices of production,the opportunity cost may

Remain ConstantIncrease Decrease

Depending on our choices of Production,

the opportunity cost may

Remain ConstantIncrease Decrease

Unit 1 : MacroeconomicsNational Council on Economic Education

Constant O.C Decreasing O.C

Increasing O.C

PPC is also called:• Production Possibility Frontier (PPF)

– What you can and cannot produce

• Product Transformation Curve–What will it cost you to produce the other

good–When you produce something else, you have to

reallocate resources – “Reallocation of Resources”

–How easily you can reallocate – Factor Mobility

A Typical PPF & PTC ………….Unattainable

Inefficient

Opportunity cost of is increasing…

Shift in PPC

Economic Growth

0

B

A

Butter

Guns

C

Availibility of resources (Quantity and Quality)Increased Labour forceImproved Technology

Shift in PPC

Economic Growth due to:

Economic Decline…..

Butter

A

B Guns0

C

D

Due toDecline in resourcesWorking population falls

Shift in PPC

Decision making at the margin

• Consumer GoodsProducts purchased by consumers for personal or household use.

• Capital GoodsProducers’ goods or means of production (Eg: Machines)

Creating Captial goods Investment

• More Consumer goods Higher standard of living

• But if we do not have sufficient capital goods to produce consumer goods In the future Standard of living may fall

• So a decision has to be made: “Whether to produce Consumer Goods or

Capital Goods?”

Decision making at the margin

K

100 200 300 400 500 600 700 800 900

• If Capital goods are less than K Economics Decline

• If we produce more capital goods In the future Economic Growth

• Developing Countries–They have to increase their capital

goods so more resources are allocated capital goods Low standard of living.

–A minimum amount of resources allocated for comsumer goods survival of population

–“Subsistence Level of Consumption”

• In under-developed countries or poorly developing countries………

–Most of resources are allocated for consumer goods for survival of population

Economic structure• The Various Sectors in an Economy

• Primary sector - agriculture, fishing and mining & oil extraction

• Secondary sector– All Manufacturing activities. Eg: Food processing, textiles and clothing, iron and steel production, vehicle manufacturing and electronics.

• Tertiary sector – service sector. Eg: retailing, transport, financial services, education, call centre services & information technology.

Economic System • Economic system is used to describe the means

or allocative mechanism by which its people, businesses and government make choices

– The (free) market economy

– The command/planned economy

– Mixed economy

The Characteristics of Market Economy• Freedom to buy what they want and sell what they make.

• Private property

• Changes in supply and demand control the prices (and hence what is made and sold) Adam Smith-invisible hand (the price system)

• Self-interest

• Little government interference (control national defence, act against monopolies, issue money, raise taxes and protect the rights of the private sector)

• Market economy is an ideal which does not exist in today’s economy.

Strengths of Strengths of (Free) Market Economy(Free) Market Economy

• Freedom exists for everyone involvedFreedom exists for everyone involved

• Relatively small degree of governmental Relatively small degree of governmental influenceinfluence

• Variety of goods and services are producedVariety of goods and services are produced

• High degree of consumer satisfactionHigh degree of consumer satisfaction

Weaknesses of (Free) Market EconomyWeaknesses of (Free) Market Economy

• The primary weakness is deciding for whom to The primary weakness is deciding for whom to produceproduce

• The young, sick and old would have difficulty The young, sick and old would have difficulty in a free market environmentin a free market environment

• Markets sometimes fails (some goods are Markets sometimes fails (some goods are overproduction and underproduction or fail overproduction and underproduction or fail production)production)

The The Characteristics of Command (planned) Command (planned) EconomyEconomy

• The government makes all the key decisions and has The government makes all the key decisions and has complete control over all the resources of the country:complete control over all the resources of the country:

• Public ownership of all propertyPublic ownership of all property

• Centrally planned productionCentrally planned production

• government dictates prices government dictates prices

• Profit is not a factor Profit is not a factor –– the government produces what it the government produces what it feels is in the national interestfeels is in the national interest

The The Characteristics of Mixed Economy Mixed Economy

• The government makes some general policy The government makes some general policy decisionsdecisions

• Mostly private but some public ownership of Mostly private but some public ownership of property. Govt also produces Merit Goods.property. Govt also produces Merit Goods.

• In private industry profit is the driverIn private industry profit is the driver

• Government intervention to solve the problem Government intervention to solve the problem caused by market failure.caused by market failure.

Problems of transition when central planning in an economy is reduced

• Law and order

• Merit goods

• Public goods

• Quality and standards

• Inflation

Positive economics/statement• Positive statement is about “ what the

world is.” Has a logic or reason…….

• May be wrong!!

• For example:• Inflation will increases the prices

Normative economics/statement• “Is what you think the world should be”.

• Involves your judgment or opinions, personal views, political beliefs and ethics

• For example:• The government ought to introduce a ban on

smoking in public places.

Money • A simple definition is that money is

anything that is regularly used to buy goods and services.

• Normally, this is coins and notes but the definition also includes cheques, debit cards and credit cards. Oil/ Platinum/Gold

Barter• The direct exchange of one good or

service for another in this way is known as Barter.

Coincidence of wants• For Barter to happen, both parties in a

transaction must have goods/ services that each other wants….. coincidence of wants

• So money is “one such commodity” that everyone would be willing to accept in exchange for all other goods and services.

The functions of money

• a medium of exchange

• a unit of account

• a standard for deferred payment

• a store of wealth

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Medium of exchange

• use it to buy and sell things

Unit of account– The ‘account’ aspect allows

the sum of money to be recorded and for different values to be added or compared.

– it measures the value of a good and allows you to compare the value of one good to another good

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Standard of Deferred Payment

–Not all payments we make are immediate.

–Payments can be made in the future once terms have been agreed between the parties involved.

I shouldn’t have told him I can’t pay him back.

Store of Wealth

–Money can be held or ‘stored’ for a period of time, usually with a bank or other financial institution, before it is used.

The characteristics of money

• Acceptability • Durability• Portability • Divisibility• Scarcity

Ceteris paribus • This Latin phrase translates to –

“with other things the same” or “all other things being equal or held constant.”

• If the price of beef increases —ceteris paribus—the quantity of beef demanded by buyers will decrease.

Intrinsic Value of Coins and Notes

• Intrinsic Value - The market value of the constituent metal within a coin/ paper of a currency.

• Intrinsic Value of Coins and Notes is very less or No Value at all…..