Economics: Introduction to Principles

Economics - Introduction

• Economics is the study of how people allocate limited resources to satisfy unlimited wants.
• Economics is the study of scarcity and choice.
• The aims are to revise Economics principles, differentiate macro and micro economics and understand positive/normative distinctions.
• The aims are to understand economic decision-making regarding the efficient allocation of scarce resources.

Micro vs Macro Economics

• Microeconomics focuses on individual entities.
• Macroeconomics considers wider society-wide phenomena.

Positive vs Normative

• Postive economics involves testing/developing economic theories and facts.
• Normative economics includes opinions and value judgements.
• An example of positive economics is that if the government increases sales tax on tobacco, people will purchase fewer cigarettes
• This is a testable, logical derivative of the law of demand.
• An example of normative economics is that the government should increase the tax on cigarettes.
• This statement is a subjective statement made in hopes to reduce consumption.

Economic Decision-Making

• All economic systems must answer:
• What to produce?
• How to produce?
• For whom to produce?
• Economics deals with production, distribution and consumption, especially the allocation of scarce resources.

The Economic Problem

• People face limited resources but have unlimited wants.
• Scarcity means there are not enough resources to satisfy all wants.
• Choice is a necessary aspect because scarcity forces economical producers and customers to choose what to sacrifice.
• Scarcity leads to trade-offs.

Rational Self-Interest

• Rational self-interest is an assumption about how the Economic Problem is solved.
• Economists use this to explain human behaviour.
• People are assumed to be rational and respond to incentives.
• Rational choices involve considering the costs and benefits of a decision.
• Incentives can alter consumption patterns.

Scarcity and Rational Self-Interest

• Demand for water has increased in Australia relative to its supply.
• Prices for water not reflecting true scarcity can distort decision making and incentivise inefficient use.
• Water use restrictions were put in place by governments to overcome this.
• Economists suggest pricing should reflect scarcity for more careful use, obviating water restrictions.

Types of Economic Resources

• Economic Resources can be described as CELL (Capital, Enterprise, Land, And Labour).

Types of Economic Resources - Natural

• Natural resources are gifts of nature.
• Natural resources include minerals, energy, and water.

Types of Economic Resources - Human

• Human resources consists of quantity and quality of the work force.
• Human resources consists of Enterprise, the coordination and management of production.

Types of Economic Resources - Capital

• Capital consists of man-made items which assists human resources in the production of goods and services.
• Capital specifically refers to physical tools like pens and trucks, not financial.
• Social overhead capital includes infrastructure like transport, power, schools and supplied by the government.

Opportunity Cost

• Opportunity cost is the value of the best alternative that is forgone.
• Understanding opportunity costs improves decision-making in business.

Law of Decreasing Marginal Benefits

• The law of diminishing marginal benefits states as more of a product is consumed, the satisfaction from each unit declines.
• Consumer needs are limited, and the need for a specific unit can be fulfilled with a single purchase.

Marginal Analysis

• Marginal Analysis compares additional benefits to the extra cost incurred.
• Marginal Benefit represents those gains from an increase in unit.
• Marginal Cost represents additional costs incurred from an increase in unit.

Marginal Analysis - Example with Building Hospitals

• Economists use marginal analysis when making decisions about resource use.
• Building 3 hospitals maximises society's net benefit because after this point, marginal costs increase more than marginal benefits.

Economic Models

• Economics explains cause and effect relationships between variables.
• Complex situations can be understood by isolating the cause and effect relationship between each separate variable.
• Ceteris Paribus means all other things being equal/the same.
• Economists use simplified economic models to determine cause and effect relationships between economic variables.
• Economic Models can accurately predict economic events.
• Economic Models are verified through observation and data collection.
• The world not working in ceteris paribus conditions will affect Economic future predictions.

Production Possibility Frontier

• The Production Possibilities Frontier (PPF) curve is an economic model illustrating the concept of opportunity costs.
• The PPF shows the combinations of goods and services that can be produced by an economy with its resources and technology.
• The PPF model assumes resources and technology are fixed, and the economy can only produces 2 goods.
• The PPF captures the concepts of scarcity, choice, and trade-offs.
• The shape of the PPF depends on whether there are increasing, decreasing, or constant costs

PPF Curve

• Points lying on the PPF reveal the productively efficient combinations of output.
• Allocative efficiency cannot be determined without knowing additional preferences.
• The slope of the PPF shows the opportunity cost of producing one good over another.
• Opportunity costs can compared to another producer to determine comparative advantage.

Video Reviewing PPF

• Link to video on PPF and opportunity costs using the PPF is given in the document.

Law of Increasing Opportunity Cost

• As production of one good increases, its opportunity cost also will increase.
• This is because opportunity cost is the value of the next-best alternative when a decision is made.

PPF Model

• Due to the law of increasing opportunity cost, the PPF curve bows outward.
• For goods that are not equally productive, the more of a product which is produce, the resources are not equally productive to one another when products are compared.
• If the technology for producing one bicycle improves, this will mean the curve shifts along the axis for bicycles.

Outward Change in the PPF

• A new optimal allocation of the resources will be showed along a figure representing output change.
• Improvements to products result in outward movement on the PPF curve.
• The PPF depicts economic growth when it shifts outwards and is shrinking due to a failure/deficiency in resources, supplies or technology.

Market Economy

• Individuals make decisions guided by:
• Private ownership with property rights
• Freedom to establish and own enterprises
• Freedom of choice in spending, employment and politics
• Self-interest and profit motive
• Consumer sovereignty through spending decisions

6. Resource allocation through price mechanism.
7. Competition within consumers and markets.
8. Limited government role.

Classifying Economic Systems

• Main criteria to classify systems
• Ownership of productive resources and allocation of property rights.
• Role of markets and the market forces of demand and supply.
• Role of the government in economic life.

Types of Economic Systems

• Market economies are organised through a series of product and factor markets.
• Planned economies are subject to the price system/mechanism which allocates resources by consumer preference.

Planned Economy Characteristics

• Public ownership of property and resources (ex: means of production).
• Limited personal economic and political freedom and a low material standard of living.
• Behavior motivated using loyalty to the state, coercion, and national goals.

4. Absence of freely operating markets
5. Central planning driven resource allocation.
6. Production by state-owned and state-operated enterprises.
7. Dominant role of government.

Planned Economy Questions

• Production decided by central planning which sets targets, resource allocation, and production priorities.
• Government uses estimates of resource balances and demand.
• Distribution is determined by the government, but corruption exists.

Mixed Economy

• Many economies are mixed market economies, referring to the significant role governments play.
• The government can intervene through:
• Regulation protecting consumers.
• Provision of collective goods and services.
• Redistributing income through taxation.
• Stabilising macroeconomy.

Review - Market Economy

• Refers to having economic freedom, private property, voluntary exchange, consumer sovereignty, competition, profit motive, limited government involvement.

The Role of Prices

• Consumers decide what is produced and how much will be produced
• Through consumer spending, consumers cast their dollar for a good or service.
• Producers respond- to changes in demand by producing more or increasing price.

3 Key Economic Questions

• "What to produce": Answered by consumer tastes and preferences.
• "How to produce": Firms operate efficiently and minimise costs to maximise profits by reducing prices.
• "Whom to produce for": Those who are willing and able to purchase

Markets

• Markets help to meet the competing needs by allocating resources.
• Exchanges usually are through households and businesses.

Competitive vs non-competitive markets

• Competitive markets are characterised by a large number of buyers and sellers.
• Firms are price takers in competitive markets.
• Homogenous (similar) products sold in competitive markets.
• No barriers to entry or exit in competitive markets.
• Non-competitive markets are characterised by few firms acting as price setter, product differentiation, and high barrier to enter.

Imperfect Markets- Examples

• Monopoly: One dominant firm, such as Bunnings.
• Duopoly: Two firms, specifically, market with Coles and Woolworths.
• Oligopoly: A few firms which consists of Vodafone, Telstra, and Optus because of ALDI.