ECN1014

Introductory Economics

LECTURE 1
I N T R O D U C T I ON T O E C O N O M I C S

READING:
SLOMAN AND GARRATT,
CHAPTER 1 AND 2
 Learning Outcomes

 After this lecture, you should be able to:

 Identify scarcity as the central problems of economics

 Explain the basic economic ideas

 Apply production possibilities analysis to illustrate:

 Various production combinations
 Relationship between scarcity, choice and opportunity cost
 The law of increasing and constant opportunity cost
 Unemployment and economic inefficiency
 Economic growth

 Explain how, and assess the desirability of, different economic

systems in allocating scarce resources
Basic Economic Ideas

Reading:
Sloman and Garratt,
Chapter 1, pp.4-11
 Microeconomics versus Macroeconomics

 Microeconomics are concerned with

decision-making by individuals, households
and firms.

 Macroeconomics are concerned with the

economy as a whole.
Ex.1
Scarcity, Choice and Opportunity Cost

 Economics is concerned with how individuals,

institutions, and society allocate limited resources
under conditions of scarcity.
 Scarcity means limited resources (labour, land,
capital and entrepreneurs) relative to unlimited
needs and wants.
 As such, we cannot have everything, therefore we
must make choices in what we will have and decide
what we must forgo or sacrifice.
 What we forgo is called opportunity costs.
Limited Unlimited
 Microeconomics: Choices to Make

 Because resources are scarce, choices have to be

made in relation to the following aspects:
 What to produce
 How to produce
 For whom to produce

 Remember that as a choice implies that the

second-best option must be sacrificed, therefore
there is always an opportunity cost.
 Microeconomics: Rational Choices

 Economics assumes that human behaviour

reflects “rational self-interest”.

 Consumption decisions are driven by a desire

for increasing utility (or satisfaction).

 Production decisions are driven by a desire for

increasing profit.
 Microeconomics: Marginal Analysis

 In economics studies, “marginal” means “extra” or

“additional” or “incremental” or “change.”

 Rational decision-making involves comparing

marginal benefit and marginal cost.

 A rational decision-maker takes an action only if

marginal benefit exceeds marginal cost.
 Microeconomics: Efficiency and Equity

 As microeconomics are concerned with the

allocation of scarce resources, there are
implications on:
 Efficiency
 Productive efficiency: production at the minimum cost
 Allocative efficiency: production which gives
consumers maximum satisfaction
 Equity
 Are resources fairly allocated and distributed?
 Are certain parties unfairly excluded?
 Macroeconomics

 Because of scarcity, societies must ensure that

 Resources must be fully utilized

 National output should grow over time

 Macroeconomic problems are related to imbalance

between aggregate demand and aggregate supply.
 Inflation
 Balance of trade
 Recession
 Unemployment
 Positive and Normative Statements

Positive Normative

 Focuses on facts and  Focuses on value

are descriptive (i.e. how judgement and are
things are) prescriptive (i.e. how
 Examples? things should be)
 Examples?
Production Possibilities Curve

Reading:
Sloman and Garratt,
Chapter 1, pp.11-14
 Scarcity and Choices
scarce resources to produce different
 Society uses its
goods and services.

 In a condition of scarcity, society faces many

production alternatives and needs to make choices.
Production Possibilities Curve (PPC)

 Such decisions can be illustrated by production

possibilities, which assumes the following:

 Fixed amount of resources
 Full employment

 Constant technology

 Only two goods are produced

 Definition of a PPC

 A production possibilities curve (PPC) shows

different combinations of maximum goods and
services a society can produce with a fixed
amount of resources and constant technology.

- Maximum combinations of two goods that

can possibly be produced using available
resources and technology
 PPC: Various Maximum Output Combinations
Y
Point Goods X Goods Y
A 7 10
A B 8 9
10 C 9 6
B
9 D 10 2

6 C

2 D

0 7 8 9 10 X
The PPC / PPF can be used to illustrate the
concepts of :-
- scarcity,
- choice and
- opportunity cost.
 PPC: Scarcity, Choice and Opportunity Cost
Computers
Scarcity:
Point A – beyond the curve
Any output combination
outside the curve
is impossible.
A
Possible Combinations
B =>
C =>

O Cars
 PPC: Scarcity, Choice and Opportunity Cost
Computers

Impossible
Possible combinations of
combinations of computers and cars
computers and cars

O Cars
 PPC: Scarcity, Choice and Opportunity Cost
Computers
Choice:
A country has to choose an
B output combination
10
(B or C or ?)

3 C

O 5 10 Cars
 PPC: Scarcity, Choice and Opportunity Cost
Computers
Opportunity Cost:
Movement along the curve from
point B to C. A country’s can
B only increase the production of
10
cars by reducing the production
of computers.

3 C

O 5 10 Cars
 PPC: Increasing Opportunity Cost

 The PPC is concave towards the origin, a property

which reflects the law of increasing opportunity

cost.

 Opportunity cost increases because resources are

not homogeneous ie. not equally adaptable to

alternative productions.
 PPC: Increasing Opportunity Cost

 As production of cars expands, additional

workers which are more suited for producing
computers may have to be transferred to the
production of cars.
 But these workers are less productive in
producing cars.
 Therefore an ever larger amount of computers
has to be sacrificed for the sake of raising the
production of cars by an equal amount.
 PPC: Law of Increasing Opportunity Cost
Computers When the economy moves
from A to D, it must give up
successively larger
A amounts of computers (1, 3
10 and 4) to acquire equal
B
increment in cars (1, 1 & 1).
9

6 C

2 D

O 7 8 9 10 Cars
PPC: Unemployment and Economic Inefficiency

 Recap: PPC shows the various combinations of two

goods which can be produced with a given amount of
resources and constant technology when the
economy is at full employment.
 With unemployment, the economy would produce
less than the maximum potential, as represented by
any point which falls within the PPC.
 Full employment or economic efficiency takes place
with an economy operating along the PPC, stretching
itself to the maximum potential.
 PPC: Unemployment and Economic Inefficiency
Computers
Full employment or economic
efficiency is achieved when an
B economy operates along the PPC,
as represented by point B and C.

Any point inside the PPC,

such as point A, represents
unemployment or economic
inefficiency for failing to fully
utilise existing resources.
O Cars
 PPC: Economic Growth
Recap:
A PPC shows the maximum combinations of two
goods that can possibly be produced using available
resources and technology

 However, resources and technology are likely to

evolve over time, thereby shifting the position of PPC
and changing the potential maximum output of the
economy.
 PPC: Economic Growth

 Consider the impact on PPC of the following events:

 An increase in or discovery of resource supplies

 Improvement in resource qualities

 Technological advancement

 When PPC shifts outwards, the production of both

goods can be increased simultaneously.
 PPC: Economic Growth
Computers
Economic growth takes
place when the PPC shifts
outward. Production of one
output can be increased
without reducing the other.

O Cars
What is the difference between a shift and
a pivot of a PPC?
Economic Systems and
Resource Allocation

Reading:
Sloman and Garratt,
Chapter 1, pp.15-20; 21-23;
Chapter 2, p.46
 Scarcity, Economic Decisions and Systems

 Due to scarcity, each economy must decide:

 What should be produced

 How to produce

 For whom to produce

 Different economic systems are featured by different

extent to which the government decides how
resources should be allocated to deal with scarcity.
 Planned or command economy
 Free-market economy
 Mixed economy
 1. Planned or Command Economy
 Usually associated with a socialist or communist
state, in a command economy virtually all economic
decisions are taken by the central authority.

 Planning can be studied from three angles:

 Resource allocation between current consumption and
future investment (i.e. what should be produced)
 Output determination (i.e. how to produce)
 Output distribution (i.e. for whom to produce)
 Assessing the Command Economy

 Whatgood can the state do in a command

economy?

 Optimising economic growth by channeling resources

into investment.

 Reducing unemployment by aligning allocation of labour

resource with production requirements and labour skills.

 Equalising income distribution

 Assessing the Command Economy

 But why do most command economies fail?

 Costly implementation and excessive bureaucracy

 Inefficient use of resources as price signals are either
absent or distorted by state control
 Lack of appropriate structures of monetary incentives

 Loss of individual liberty

 Misalignment between production and consumption

 2. Free-Market Economy

 In a free-market economy, virtually all economic

decisions are taken by individual households and
firms and the government plays very minimal role.

 Main features of a free-market economy:

 Individual liberty in making economic decisions
 Importance of the price system as a rationing mechanism

 Reflective of spontaneous changes in demand and supply

 Constant interaction between goods market and factor

market
 Assessing the Free-Market Economy

 What good can the free-market economy do?

 Automatic functioning and spontaneous responses to changes

 Competition and efficiency in production

 Consumer sovereignty

 Alignment between consumption and production

 It is alleged that the functioning of the free-market

economy reflects the pursuits of all individuals of
their own self-interest (i.e. private gain), which in
turn can lead to social good.
 Assessing the Free-Market Economy

 How far has the free-market economy failed?

 Imperfect competition and dominant market power
 Imperfect information

 Consumer exploitation and misleading advertising

 Unequal distribution of power, resources and income

 Macroeconomic instability

 Ethical and moral issues

 Socially undesirable consumption and production

 Selfishness, greed and materialism
 3. Mixed Economy: A Compromise

 Because of the problems produced by both command

and free-market economies, to different extent the
government in may regulate the following:

 Relative prices (taxes, subsidies, or direct price controls)

 Relative incomes (income taxes or welfare payments)

 Legislation of certain consumption and production

 Macroeconomic stabilisation