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The Basic Economic Ideas and Resource Allocation 1
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- 1What is Economics?Economics is the branch of science that deals with the production, distribution, and consumption of commodities.
Note: Economics is generally understood to concern behavior that, given the scarcity of means, arises to achieve certain ends. - 2ScarcityScarcity refers to the basic economic problem, the gap between limited – that is, scarce – resources and theoretically limitless wants.
This situation requires people to make decisions about how to allocate resources efficiently, in order to satisfy basic needs and as many additional wants at possible.
Any resource that has a non-zero cost to consume is scarce to some degree, but what matters in practice is relative scarcity. - 3ChoiceUnderpins the concept that resources are scarce so choices have to be made by consumers, firms and governments
- 4The Fundamental Economic ProblemThe fundamental problem in economics is that resources are scarce and wants are unlimited, so there is always a choice required between competing uses for the resources.
- 5Factors of Production1. Land - all kinds of natural resources
2. Labour - human resources available in an economy
3. Capital - a man-made aid to production
4. Entrepreneur - organises production and is willing to take risks - 6Factor EndowmentThe amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Some economies have a large quantity of high-quality factors of production at their disposal. They can create lots of goods and services to satisfy the wants of their population.
- 7The Factor Endowment TheoryUsed to determine the comparative advantage of an economy. A country will have a comparative advantage in the good that uses the factor with which it is heavily endowed. Because it is heavily endowed with that factor, it will be most efficient at producing the good that requires that factor for production.
The factor endowment theory, while used to explain overarching notions of comparative advantage, in reality only accounts for a small percentage of world trade. - 8Production and ConsumptionProduction is the process of creating goods and services to satisfy consumers in an economy.
Consumption is the process through which consumers satisfy their wants. - 9Unlimited WantsWants differ from person to person. This is because we have a scale of preference with our more urgent wants at the top and the less urgent at the bottom.
Each individual's scale of preference is a product of a complex set of influences, involving culture, upbringing and life experiences.
Our wants are continually expanding and changing. However, due to the fundamental economic problem, we are not able to satisfy all wants. - 10Choice and Opportunity CostGiven scarcity, we make choices on which wants to satisfy.
The true cost of any choice we make between alternatives is expressed by economists through the notion of opportunity cost. - 11Basic Economic Questions1. What to Produce? We have to choose what goods and services to produce in order to maximise satisfaction as there exists scarcity.
2. How to Produce? We need to consider how we can get the maximum use out of the resources available to us. It should be noted, however, that reasons besides purely economic concerns should also be considered when deciding how to produce.
3. For Whom to Produce? On a broad level, we need to decide whether everyone is going to have a more or less equal share of what is produced or not. - 12Ceteris ParibusRefer to the situations where 'other things remain equal'. The idea behind it is to actually simplify complex economic models by assuming that apart from a single part of changing circumstance, everything else is unchanged.
This is clearly a simplification, since in practice there are many things that occur. - 13The MarginMany aspects of microeconomics involve analysing decisions at the margin. By this, it means that a small change in one economic variable will lead to further small changes in other variables. Looking at things in a marginal way is a means of being able to predict what the impact of change might be.
- 14The Time DimensionIn order to take change into account, it i s often necessary to specify the time dimension, to assess how over time, change can influence the concepts that economists are seeking to model and explain.
Short Run - only some inputs can be changed
Long Run - possible for all factors to change
Very Long Run - all factors of production as well as other inputs like technology, regulations, etc will change - 15The Margin and ChangeDecision making by individuals, firms and governments is based on choices at the margin; that is, once behaviour is optimised, any change will be detrimental as long as conditions remain the same.
- 16Positive and Normative StatementsPositive Statements are statements of what will happen, based on empirical evidence,
Normative Statements are when value judgments, or opinions come into analysis. - 17Specialisation and ExchangeSpecialisation refers to a situation where individuals and firms, regions and nations concentrate on producing some goods and services rather than others.
With the expansion of trade and the development of markets, the benefits of regional and nations specialisation become apparent.
Given the pace of change, individuals need to be flexible and multi-skilled and to be able to move between occupations. - 18The Division of LabourThe concentration of a large number of workers within very large productions units where the process of production is broken down into a series of tasks.
Most manufacturing processes are usually split up into a number of tasks.
It allows a worker to be more specialised and can lead to an increase in productivity and an improvement in the quality of the finished product.
Although there is higher output, it often creates dissatisfaction among the workforce as they become deskilled and bored with the monotonous nature of their work. - 19Key Concept Link - SpecialisationThrough specialisation and the division of labour, resources that are available can be used to increase what is being produced, so meeting more wants.
- 20Economic StructuresRefers to the way in which an economy consists of various sectors, namely, primary, secondary, tertiary and quaternary
It shows the balance of economic activity, usually measured in terms of value of total output between these sectors. - 21Systems of Resource AllocationThe choices that are made and that can realistically be made are determined by the economic system of a particular country. This term is used to describe the means or allocative mechanism by which its people, businesses and government make choices.
- 22Key Concept Link - Economic SystemsThe key concept of scarcity and choice exists in all economies. How choices are made depends on the relative importance of the government and the free market mechanism.
- 23The Market Economy I- Decisions on resource allocation are made through the price mechanism
- Prices act to indicate the likely market value of particular resources
- Prices and the self-interest of people and businesses act as a guide to the decisions that have to be taken - 24The Market Economy IIIt is often said that prices and the market mechanism are the best way of handling the economic problems.
Adam Smith first referred that the price system is an 'invisible hand' that brings together private and social interests in a harmonious way.
The government has a very restricted part to play in the market economy.
Market economy is an ideal that does not exist in the modern globalised economy.
E.g. is USA but government plays a significant role. - 25The Planned Economy I- This system in its purest form only exists in theory
- Government has a central role in all decisions that are made and the emphasis is on centralisation
- Central planners determine the collective preferences of consumers and manufacturing enterprises. - 26The Planned Economy IIKey Features of Planned Economy -
- allocation of resources
- the determination of production targets for all sectors of the economy
- the distribution of income and determination of wages
- the ownership of most productive resources and property
- planning the long term growth of an economy