AS 9708 » Section 1
1.1 Scarcity, choice and opportunity cost
1.1.1 fundamental economic problem of scarcity
The fundamental economic problem is scarcity.
definition
Scarcity — when wants and needs are greater than the resources available, due to the fact that wants are unlimited but resources are limited.
1.1.2 need to make choices at all levels (individuals, firms, governments)
All levels (individuals, firms, and governments) need to make choices due to scarcity.
1.1.3 nature and definition of opportunity cost, arising from choices
definition
Opportunity cost — the value of the best alternative forgone.
Opportunity cost applies to all economic agents in an economy. It arises from choices.
note
Scarcity → choices → opportunity cost.
1.1.4 basic questions of resource allocation
- What to produce: the problem of product mix
- How to produce: the problem of factor combination
- For whom to produce: the problem of distribution
1.2 Economic methodology
1.2.1 economics as a social science
definition
Economics — the study of the allocation of limited resources to satisfy unlimited wants (scarcity).
Economics
- Microeconomics: study of markets for individual items
- Macroeconomics: study of the whole economy
1.2.2 positive and normative statements
Positive statements are based on facts, and can be factually proven.
Normative statements are based on opinions and personal value judgement.
warning
Either kind of statement can be false.
1.2.3 meaning of the term ceteris paribus
definition
Ceteris paribus (latin) — other things remain equal.
When analyzing relationship between two variables, we assume all other variables are held constant, i.e. ceteris paribus.
1.2.4 importance of the time period
definition
Short run — the period in which at least one factor of production is fixed.
Long run — the period in which all factors of production is variable.
Very long run — the period in which all factors of production is variable, and technical progression is taking place.
1.3 Factors of production
1.3.1 nature and definition of factors of production
definition
Land — natural resources in an economy.
Labor — human resources available in an economy.
Capital — physical resources made by humans that aids the production of goods and services.
Enterprise — the FoP that involves organizing production and taking risks.
note
Quality is often more important than quantity in terms of FoPs.
1.3.2 difference between human capital and physical capital
definition
Human capital — the value of labor to the productive potential (future growth) of an economy. (labor)
Physical capital — factors of production such as machinery, buildings, and infrastructure. (capital)
1.3.3 rewards to the factors of production
- Land: the rent its owners receive
- Labor: the wages paid to owners
- Capital: the interest generated
- Enterprise: the profit generated
1.3.4 division of labor and specialization
definition
Division of labor — the process by which a manufacturing process is split into a sequence of individual tasks.
Specialization — the process by which individuals, firms, regions or economies can concentrate on producing those products in which they have an advantage.
Division of labor works best when there are a large number of people and the product is standardized.
Advantages of specialization for individuals
- increase productivity
- increase skill & experience
- saves time
- can utilize specialized tools
- potential higher wages
Disadvantages of specialization for individuals
- boredom
- dependency on others
- unemployment
- loss of other skills
Advantages of specialization for firms/economy
- lower unemployment
- economic growth
- increase living standards
- more variety & quantity of goods
- lower prices
Disadvantages of specialization for firms/economy
- inter-dependence is a danger to a country
- structural unemployment
1.4 Resource allocation in difference economic systems
1.4.1 decision-making in market, planned and mixed economies
1.4.2 resource allocation in these economic systems
definition
Free market economy — an economic system where most resource allocation decisions are taken through the market mechanism.
Allocation mechanism — the way in which scarce resources are allocated in an economy.
Features of market economy
- resources are privately owned
- prices are determined by demand and supply
- prices are information that signals consumer preference
- main aim is for consumers to maximize their own utility
- little government intervention
Roles of government in a free market
- ensure essential goods and services are produced and available
- provide public and merit goods; prohibit demerit goods
- regulate economic activities to protect consumers' interests and workers' interests
- help the disadvantaged
- help domestic producers
Advantages of market economy
- efficient allocation
- profit motive encourages firms to be innovative and cost-efficient
- more choices, lower prices, higher quality
- there is incentive to work
Disadvantages of market economy
- market failure
- no public goods provided
- large inequalities
definition
Planned economy — an economy that has no private sector with the state owning and controlling all the resources in the economy.
Features of planned economy
- the state makes all the decisions
- the state owns all economic resources
- prices and wages are set by the state
- no competition so consumers and firms have little choice
- main aim is to maximize social welfare
Advantages of planned economy
- decisions taken in interest of whole economy
- allows long-term planning
- goods and services are affordable
Disadvantages of planned economy
- resources are allocated inefficiently
- slow and bureaucratic
- low motivation
definition
Mixed economy — an economic system in which decisions about the allocation of resources are taken both in public and private sector.
Features of mixed economy
- has both private and public sector
- private sector driven by self-interest; public sector driven by public interest
- private sector has competitions; public sector intervenes when there is market failure
- AoR will be taken by market mechanism in private sector; it will be determined by the government in public sector
Advantages of mixed economy
- competition promotes efficiency
- government can intervene when there is market failure
- provides essential services
Disadvantages of mixed economy
- government failure may occur
- excessive control adds costs and discourage enterprise
- too little regulation can cause monopoly
- politicians may not act in the interest of the citizens
1.5 Production possibility curves
1.5.1 nature and meaning of a production possibility curve (PPC)
definition
Production possibility curve — a curve that shows the maximum output of two types of products and the different combinations of those products that can be produced with a given amount of resources.
1.5.2 shape of the PPC
- PPC is downward sloping
- The shape of PPC is concave to origin
- The opportunity cost is always increasing
- Resources are not perfectly efficient at making different goods (i.e. not all resources are adaptable)
1.5.3 causes and consequences of shifts in a PPC
Causes of shifts outward
- increase in quantity of FoPs
- increase in quality of FoPs
Causes of shifts inward
- Deep economic recession
- Over-exploitation of scarce renewable resources
- External shocks which destroy FoPs
- Using up non-renewable resources
Consequences of shifts: change in potential output of an economy or economic growth.
1.5.4 significance of a position within a PPC
- Point F: not all resources are utilized; there is unemployment or inefficiency.
- Point A, B, C, D: resources are fully utilized.
- Point E: not attainable with current level of resources.
1.6 Classification of goods and services
1.6.1 nature and definition of free goods and private goods (economic goods)
definition
Private goods — goods that are scarce and have an opportunity cost. It is rival and excludable.
Free goods — goods that are not scarce and have zero opportunity cost.
1.6.2 nature and definition of public goods
definition
Public goods — goods that are non-excludable, non-rival and non-rejectable in consumption.
Non-excludable — when it is impossible to stop a person from benefiting from a good or service's consumption.
Non-rival — when the consumption of the product by a person does not reduce someone else's ability to consume it.
Free-rider problem — a problem arisen from non-excludability. It is not possible to exclude those who had not paid for the product and so the free-rider has no incentive to pay for the consumption.
All public goods have the free-rider problem.
1.6.3 nature and definition of merit goods
definition
Externalities — costs or benefits which can affect third parties.
Merit goods — (positive consumption externalities) goods that are thought to be desirable for consumers, which will be under-produced and under-consumed if left to market forces. It can be caused by information failure.
1.6.4 nature and definition of demerit goods
definition
Demerit goods — (negative consumption externalities) goods that are thought to be undesirable for consumers, which will be over-produced and over-consumed if left to market forces. It can be caused by information failure.