Economics

It is a study of how people and society organize scare resources to produce goods and services to satisfy
unlimited human wants

Humans have unlimited wants, consuming goods, and services by others to satisfy their wants

Goods are tangible items. Consumer goods are used to satisfy wants, like housing, clothes, food and
cars. Producer goods do not directly satisfy wants, but are used to produce consumer goods, like a drill
or an assembly line.

Services are intangible items that satisfy our needs by personal attention, like the dentist or the doctor.

Production is the transformation of factors of production into output of goods and services.

Factors of production (resources):

1. Land (natural resources like minerals) ,

2. Labour (human resources, both physical and mental abilities) ,
3. Capital (producer goods),
4. Enterprise (managers the other three, so that they will be used effectively)

Scarcity (relative term) is due to unlimited wants being satisfied by limited resources (most fundamental
concept)

Also, most resources have alternative uses, increasing the problem of scarcity. Like how land can be
used for either growing wheat or for a factory.

Scarcity lead to choices. How should we allocate the resources? Choosing one option leads to the
sacrifice of the other (opportunity cost)

Opportunity cost is the highest valued alternative that had to be forgone to satisfy the particular want.
This is measured in physical terms than in monetary terms. Like trading 2 oranges for 4 grapes, instead
of $2 for $0.50. (need to clarify)

Free goods have no opportunity cost in their use, as nature provides in abundance, like air and water.
They may be free at one time and not free at another.

Economic goods uses scarce resources, involving an opportunity cost.

Microeconomics studies individual units or parts, like the price of a certain good.
Microeconomics studies scarcity, and the three choices made by society:

1. What goods and services should be produced using resources? How much? (Because every
society cannot produce everything it wants, hence it needs to decide)

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 2. How shall they be produced? (What proportions of labour to capital and land)
3. For whom shall they be produced for?

Rational choices is weighing the marginal costs and marginal benefits and deciding if the action/ activity
should be done.

Marginal costs is the additional cost of doing a little more (like 1 unit more if it can be measured in
units).

Marginal benefits is the additional benefits of doing a little more (like 1 unit more if it can be measured
in units).

The objectives of microeconomics is efficiency and equity.

Efficiency is when we are better off when something is done or altered.

Productive efficiency is when each good is produced at a minimum cost.

Allocative efficiency is when the combination of goods and services produced and sold brings
about the maximum satisfaction to each consumer within their means (limited by money? Time?) .

Equity, another word for fairness, is the shrinking of the income gap so that everyone is as equal as
possible. (some will still be more ‘equal’ than others)

Macroeconomics studies the determination of national output and its growth over time, like the
overall prices and unemployment rate.

Societies are concerned that their resources are used as fully as possible and national output keeps
growing over time.

Macroeconomics aims to:

1. Attain full employment

2. Have price stability (reduce inflation)
3. Obtain steady economic growth
4. Maintain a healthy balance of payments

Production possibility model shows the concepts of scarcity, choice, opportunity cost and
the major issues in micro and macroeconomics.

Definition: It shows all the possible combinations of two goods that a country can produce within a
specific time period with all its resources fully and efficiently employed.

The assumption made is that the country devotes all its resources into producing just two goods, that its
resources are fixed and they are efficiently used.

Done by Nickolas Teo Jia Ming, CG 12/11

When the production possibility curve is bowed outwards, there is increasing opportunity cost, as the
economic resources are not equally adaptable to alternative uses.

The PPC is a straight line when the opportunity cost is constant, due to the resources being equally
suited to producing either good.

The PPC is bowed in when there is decreasing opportunity cost, as the increased specialization in one
good allows the country to be more efficient in producing it.

If a country is producing within the PPC, it is not efficient, due to unemployed resources and/or
inefficient use of resources

There is productive efficiency when all resources are fully utilized, producing at the boundary.

Movement in the PPM indicates a recovery from a recession. ( moving from inside the PPC to the
boundary of the PPC)

An outward shift of the PPC indicates an economic growth, allowing the country to produce more.
Possible reasons are: 1. Increase in quantity and quality of capital and labour. 2. Discovery of new
raw materials. 3. Advancement of technology.

An inward shift of the PPC indicates negative growth, allowing the country to produce less. Possible
reasons are: 1. War, strikes. 2. Natural disasters (floods and droughts etc.) 3. Fall in quantity and
quality of labour

The shifts are not always parallel, the advancement in technology may only favor one good, or the
strikes may only affect the production of one good

There is a trade-off between consumer goods and producer goods.

Producing more producer goods results in greater growth, hence more consumer goods can be
produced in the future. However, the reduction in production of consumer goods means less wants are
fulfilled, lowering the quality of life.

A person has a comparative advantage at a given task if his or her opportunity cost of
performing that task is lower than another person’s. It also refers to the ability to produce a good or
service at a lower opportunity cost than other producers. (Depends on opportunity costs)

A person has an absolute advantage over another if he or she takes less time/ resources to perform a
task than the other person. (Depends on resources used)

When people specialize, we satisfy our needs by trading among ourselves. It is more productive, due to
comparative advantage. Everyone does best when each person concentrates on the activities for which
his or her opportunity cost is lowest

Done by Nickolas Teo Jia Ming, CG 12/11

The theory of comparative advantage shows that trade and specialization work to raise productivity and
output (make efficient use of resources)

All societies face the fundamental economic problem of scarcity, hence they need a method of
allocating scarce resources to answer the 3 basic questions. (What….,How….,For whom….)
In a command economy, all economic decisions are made by the government

In a free market economy, all economic decisions are made by individuals and firms with no
government intervention

A market is where buying and selling takes place, like in a building, on the internet, or over the phone.

In practice, all economies are a mixture of the two, it’s the degree of government intervention that
distinguishes the economic systems

The free market economy is a system where decisions made are decentralized.
In a free market economy, there is individual or private ownership of property and economic resources.

There is free enterprise and free choice, people are free to organize resources and produce output to
sell. They are also free to choose their work and how to spend their income

There is competition and unrestricted markets. There are a large number of buyers and sellers, whom
have the freedom to enter and leave the market.

All economic decisions are taken by households and firms, which are assumed to act in their own self-
interest (driving force). The producers aim to maximize profits, the consumer their satisfaction (utility),
the workers their wages and owners of land and capital, want to have the highest returns.

The answers to the 3 basic questions are answered through the price or market mechanism.

The players in the market are buyers and sellers, who determine the price of goods, through demand
and supply.

The price of goods provides information about the economy cheaply and quickly, hence generating the
signal for resource allocation. The price is the amount that a product sells for per unit and it reflects
what society is willing to pay.

The price mechanism answers the problem of what to produce, as it is decided by consumers
by their spending decisions or money votes. They have consumer sovereignty, hence producers will
respond by producing only goods and services that are profitable.

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How to produce the goods are decided by sellers who will combine factors of production in the
cheapest way possible to gain the highest profit, through using least cost techniques and determining
the price of the factors. Hence, inefficient firms will be forced out of business.

For whom to produce is decided as buyers and sellers causes a price to be set for an item, and buyers
who can afford the price obtain the item. The ability to afford depends on the buyer’s money income,
derived from various human and non-human resources owned, and the price of each resource.

The price mechanism works as a change in demand of a certain good results in changes in prices (which
acts as both signals and incentive)

Hence, producers will devote more of their resources to meet the growing demand (resource
allocation), moving out of declining industries into rising ones.

Thus, consumers determine what will be produced by their spending, producers produces goods that
are profitable, sellers decide how to produce and the market decides for whom theses goods are for.

Prices perform three main functions:

1. The signaling function: Prices signal what is available, providing information to everyone
(buyers, sellers, producers,), hence allowing them to plan and coordinate their economic
activity. (Example?)
2. The incentive function: Prices create incentive for households and firms to make decisions in
ways consistent with pursuing and achieving the fulfillment of their self interest
3. The allocative function: When the demand for a good or service rises (relative to the supply),
the price of that good or service will follow. The possibility of bigger profits drives producers to
allocate more resources into the production of the good or service. The need for the increased
production increases the demand for the associated labour and capital. This may raise wages
and price of capital, causing the other producers of labour and capital to shift the supply they
provide into industries where they can increase their profits.

The command economy is a system where decision making is centralized.

There is collective ownership of productive resources.

The answers to the 3 basic questions (what…, how…for whom….) are decided by the state, hence the
price mechanism does not operate

What to produce ? is decided by the central planners, whom decides based on what they think society
needs. Thus, consumers have no say, and have to make do with what the planners decide to produce.

How to produce ? is also decided by the central planners, whom chooses the production method and
puts in place an effective organizational structure

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For whom ? is decided by the central planners again, whom determines wages and distribution of
consumer goods

The mixed economy has both market and government planning in allocation of resources.

Criteria for evaluating economic systems:

1. Efficiency: An efficient economy produces what the people want (satisfy their wants) at the least
possible cost. If the economy does not satisfy the people wants (produces the wrong good) it is
inefficient. It is measured by standard of living, which are the material goods (goods and
services) the people have. And it depends on how well resources have been deployed to
generate wealth. Economic efficiency is achieved when there is productive (minimum cost of
production) and allocative (optimal mix of goods and services) efficiency
2. Equity of distribution: Equity (fairness) is subjective. Does it mean everyone gets goods equally,
regardless of effort? Or is the distribution of goods dependent on effort? To solve this,
economists called for a compromise between the capitalist market’s ‘freedom to exploit’ and
the ethical judgments of ordinary people on the degree of inequality
3. Economic growth: Economic growth occurs when the output per capital or gross domestic
product per capita of the economy increases, hence increasing the standard of living as real
income (income where inflation has been taken into consideration) increases. Economic growth
is brought about by producing producer goods and investing capital to increase capital stock.
However, this comes at the cost of producing consumer goods (affecting efficiency), hence a
balance between high growth rate and current costs in needed.
4. Stability: It refers to low inflation rates and full employment, with positive and steady growth.
Since people don’t like unemployment and erratic inflation, the economic system needs to be
able to handle the problem of business cycle downturns and structural or technological change

Assessment of free market

Advantage:

1. The automatic working of the market mechanism removes the need for complex bureaucracies
to coordinate economic decisions, hence allowing the economy to respond quickly to changing
demand and supply conditions
2. It is the most efficient form of economic organization, since people will be acting in their own
self-interest, hence allowing it to be the most powerful generator of material welfare. There is
also allocative and productive efficiency, given certain assumption. (What are the assumptions?)
3. The free market also grants great personal freedom, with the private ownership of resources.
Hence, preventing the government from gaining too much power

Disadvantage:

1. There is great inequality, as the economy is indifferent to the poor.

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 2. In reality, there rarely is the vigorous competition and free information necessary for the
system to work. Because, the production power lies in the hands of a few big firms (they have a
monopoly), thus they are able to charge high prices and earn huge profits. Also, there is a lack of
consumer sovereignty, due to the presence of overwhelming advertisements persuading
consumers to buy products that they don’t really need.
3. The true cost of production is often not shown in the market price, and external costs, like
pollution and congestion (negative externalities), are ignored. The social cost (private cost +
external cost) is not stated.
4. Some socially desirable goods would not be produced by the market, like public goods like
street lighting (no one would pay for it)
5. Merit goods, like education and health services, would also not be produced in sufficient
quantities
6. There is factor immobility, as labour cannot readily move from one industry to another, like an
Engineer cannot work as a lawyer.
7. The free market booms will result in periodic booms and slumps, alternating inflation with
unemployment (There is macroeconomic instability). After a boom (peak of an economy), there
would be a recession, causing a slump (resulting in depression), followed by a recovery, causing
another boom.
8. There is also the ethical objection, as the economic system rewards self-centered behavior,
selfishness, greed and materialism would be bred.

Assessment of the command economy

Advantage:

1. The government can take an overall view of the economy and direct resources in accordance
with certain national goals. There would be high growth rates if large amounts of resources are
invested. There would be low unemployment, as the government carefully plans the
deployment of labour. The social costs and benefits of production and consumption could be
taken into account, hence avoiding wastage of resources. Goods can be distributed according to
needs rather than income, providing equality.

Disadvantage:

1. There is the problem of coordinating the system, as there is no price signals to make the
thousands of different production decisions. An incorrect decision could have serious
consequences, due to the halting of the production line.
2. No price signals makes deciding on an efficient production method hard, resulting in the
misallocation of resources.
3. There is inefficiency as the wrong good may be produced (the consumers do not want them),
resulting in shortages and surpluses of certain goods.
4. The lack of incentive (driving force) hinders the creation of wealth, due to laziness.

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 5. The central planners may get corrupted, and develop bureaucratic self-interest, becoming
insensitive to the needs of the people.

Reasons for government intervention in mixed economies

1. To provide those essential goods and services, like public and merit goods
2. To protect the interest of the consumers from the problems of a monopoly
3. To regulate the socially undesirable side-effects of production, like pollution.
4. To reduce income equality to a socially acceptable level, conducive to economic growth
5. To regulate the economy to maintain the level of demand, employment and inflation

Done by Nickolas Teo Jia Ming, CG 12/11