introduction to the best of economics.pptx

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1. Introduction Unit 1 Lipsey and chrystal

2. Economics is the study of how society allocates limited resources to the production of goods and services to satisfy unlimited human wants. There are two main branches of economics: microeconomics and macroeconomics.

3. Microeconomics deals with the analysis of individual parts of the economy. It concerns factors determining the behaviour of a consumer, the behaviour of a firm, the demand for a good, the supply of a good, the price of a good, the quantity of a good, the performance of a market, etc.

4. Macroeconomics deals with the analysis of the whole economy. It concerns factors determining aggregate variables such as aggregate demand, aggregate supply, national output, unemployment, inflation, the balance of payments, etc. As opposed to microeconomics which focuses on the individual parts of the economy, macroeconomics looks at the big picture of the economy.

5. FACTORS OF PRODUCTION In order to produce goods and services, an economy needs to have resources. The larger the amount of resources an economy has, the larger will be the amount of goods and services it can produce. Resources can be divided into four categories known as the four factors of production: land, labour , capital and enterprise.

6. Land refers to the gifts of nature that are used to produce goods and services. It includes plots of land, natural resources, fishes in the sea and trees in the forests . Labour refers to the physical and mental effort that people devote to the production of goods and services.

7. Capital refers to the goods that are produced for use in the production of other goods. It includes factories and machinery . Enterprise refers to the ability and the willingness to take risk.

8.  SCARCITY, CHOICE AND OPPORTUNITY COST Although resources are limited, human wants are unlimited, and this gives rise to scarcity. Scarcity is the situation where limited resources are insufficient to produce goods and services to satisfy unlimited human wants. Scarcity necessitates choice.

9. In other words, due to scarcity and hence the inability to produce all goods and services, society must choose what goods and services to produce. The opportunity cost of a course of action is the benefit forgone by not choosing its next best alternative. When a choice is made, an opportunity cost is incurred. In other words, when society chooses what goods and services to produce, it is choosing what goods and services not to produce.

10. THE PRODUCTION POSSIBILITY CURVE The production possibility curve (PPC) shows all the possible combinations of two goods that can be produced in the economy when resources are fully and efficiently employed, given the state of technology, assuming the economy can only produce the two goods

11. The PPC reflects scarcity, choice and opportunity cost. Although the points inside and on the PPC are attainable, the points outside the PPC are not. Scarcity is reflected by the unattainable points that lie outside the PPC, such as point G and point H. The PPC is a series of points rather than a single point. Choice is reflected by the need for society to choose among the series of points on the PPC, such as point C and point D. The PPC is downward sloping. Opportunity cost is reflected by the negative slope of the PPC which indicates that an increase in the production of one good will lead to a decrease in the production of the other good.

12. Movements along versus Shifts in the Production Possibility Curve A change in the tastes and preferences of society will lead to a movement along the PPC which reflects a change in choice. The tastes and preferences of society may change due to several factors such as technological advancements and campaigning. For example, the inventions of smartphones and tablets have led to a change in the tastes and preferences of society from print publications to digital publications. Healthy living campaigns have led to a change in the tastes and preferences of society from non-diet soft drinks to diet soft drinks.

13. An increase in the production capacity in the economy will lead to an outward shift in the PPC resulting in a decrease in scarcity, and vice versa. When the PPC shifts outwards, some of the points which were previously unattainable will become attainable. The production capacity in the economy may increase due to an increase in the quantity or the quality of the factors of production in the economy. For example, education and training which will lead to greater human capital will increase the skills and knowledge of labour and hence the production capacity in the economy. Research and development which will lead to technological advancement will increase the efficiency of capital and hence the production capacity in the economy.

14.     Shape of the Production Possibility Curve The PPC is concave to the origin because the opportunity cost of producing each good increases as its quantity increases as resources are not equally suitable for producing different goods. As the economy produces more and more of a good, it has to use resources that are less and less suitable for producing the good to actually produce the good. This means that increasingly more units of resources are needed to produce each additional unit of the good. Therefore, increasingly more units of other goods have to be forgone to produce each additional unit of the good resulting in an increase in the opportunity cost.

15.      Economic Efficiency Due to the problem of scarcity, all economies must make three fundamental economic decisions: what and how much to produce, how to produce and for whom to produce. In making these three fundamental economic decisions, the objective is to maximise the welfare of society. Efficiency is one of the criteria used to determine whether this objective is achieved.

16. Productive Efficiency The economy is productively efficient when it is impossible to increase the production of some goods without decreasing the production of other goods, given the quantity and the quality of the factors of production in the economy. This occurs when the economy is producing on the PPC where resources in the economy are fully and efficiently employed. Resources in the economy are efficiently employed when all firms are productively efficient and are fully employed when there is no unemployment of resources.

17.        ECONOMIC SYSTEM All economies face the problem of scarcity and hence are required to make the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce. However , economies vary in the way they make these three fundamental economic decisions in terms of the degree of government intervention. An economic system is a way of making the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce. There are three types of economic systems: the market system, the command system and the mixed system.

18.  The Market System The market system is an economic system in which the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce are made by private individuals with no government intervention. The market system is also known as the free market system, the free enterprise system and the laissez-faire system. The market system was first advocated by Adam Smith in his famous book, ‘An Inquiry into the Nature and Causes of the Wealth of Nations’, which was published in 1776. He argues that the pursuit of self-interest will lead to the benefit of society.

19. In the market system, all the factors of production in the economy are owned by private individuals. All economic decisions are made by private individuals. Private individuals can engage in productive activities, choose what to buy, where to work, etc. There is total economic freedom and the role of the government is confined to the provision of national defence , maintaining law and order, issuing currency, etc. Private individuals pursue self-interest. Firms seek to maximise profit, consumers seek to maximise satisfaction and owners of factors of production seek to maximise factor income. Competition exists in all economic activities. Firms compete for resources and sales, consumers compete for goods and services and owners of factors of production compete for employment of their resources.

20. In the market system, the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce are made by private individuals with no government intervention.

21. What and How Much to Produce? The types and amounts of goods to produce are jointly determined by consumers and firms through the price mechanism. The price mechanism refers to the system in a market economy whereby changes in price due to shortages and surpluses equate quantity demanded and quantity supplied . Consumers indicate to firms the types and amounts of goods that they want by the prices that they are able and willing to pay for them. Firms that seek to maximise profit will only produce the types and amounts of goods that consumers are able and willing to pay for. Therefore, prices signal the types and amounts of goods that are in demand and hence, the profitability of producing these goods. This signalling role of prices is the essence of the price mechanism.

22. How to Produce? The profit motive of firms implies that they will choose the least-cost method to produce any amount of output and this is determined by relative factor prices. If labour is cheaper than capital, firms will use more labour and less capital in production. However, if capital is cheaper than labour , firms will use more capital and less labour in production. Therefore, relative factor prices determine the ways in which goods are produced.

23. For Whom to Produce? The market system distributes goods to consumers with the ability and the willingness to pay for the goods and this is determined by their preferences and income levels.

24.  The Command System The command system is an economic system in which the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce are made by the government with no involvement of private individuals. The command system is also known as the centrally planned system. The command system was first advocated by Karl Marx in his famous book, ‘Das Kapital ’, which was published in 1867. He argues that capitalism will fall which will lead to the rise of socialism and eventually to communism.

25. In the command system, the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce are made by the government with no involvement of private individuals. In other words, economic decision-making is centralised . To do this, the government must choose the combination of goods that it thinks will maximise the welfare of society, direct resources to produce the goods by planning the output level of each industry, decide on the method of production and how the goods are to be distributed. The government can distribute goods directly which is usually done through the issue of rationing coupons, or it can decide on the distribution of income, in which case, it will decide who should be paid what.

26.  The Mixed System The mixed system is an economic system in which the three fundamental economic decisions of what and how much to produce, how to produce and for whom to produce are partly made by private individuals and partly made by the government. Therefore, a mixed economy is comprised of the private sector and the public sector. In reality, every economy is a mixed economy. Due to the flaws of both the market system and the command system, all economies in the world are a mixture of both economic systems. Even command-oriented economies such as North Korea and Cuba rely on the market system to some extent and market-oriented economies such as Singapore and Hong Kong have some degree of government intervention.

27. In the mixed system, some of the factors of production in the economy are owned by private individuals and some are owned by the government. Economic decisions are partly made by private individuals and partly made by the government. Although private individuals can engage in productive activities, choose what to buy and where to work, they are restricted by the government. Although there is economic freedom, it is restricted by the government. Although private individuals can pursue self-interest, they are restricted by the government. Although competition exists, it does not happen in all forms of economic activities.

28. Advantages of the Market System and Disadvantages of the Command System In the market system, allocative efficiency may be achieved as private individuals themselves are in the best position to know what they want. There will be incentive for workers to work hard and for firms to be efficient as they will be rewarded with high income and profit. There will fast decision-making as each private individual only needs to make economic decisions pertaining to their interest. There will be liberty as private individuals are allowed to choose their ways of life.

29. Advantages of the Command System and Disadvantages of the Market System In the command system, allocative efficiency may be achieved as externalities will be taken into consideration by the government. There will be no unemployment as the government will provide a job for every private individual. The distribution of income will be equitable as no private individuals will earn very high or very low income. Public goods will be produced by the government through taxation. There will be no private firms with substantial market power which can charge high prices.