Introduction to Economics Unit 1 Introduction to Economics

Objectives Define economics Discuss the basic economic problem Identify the four factors of production Develop a production possibilities curve Describe the four sectors of the economy Demonstrate the interaction of the participants in the economy using the circular flow model

Nature and Scope of Economics Definition: Economics is the study of the use of scarce resources to satisfy unlimited human wants and needs. Economics studies human actions, activities and behaviour. All economic problems that we may face arise from the problem of scarcity. Resources are limited or scarce while human needs and wants are unlimited. This forces us to make choices. Principles of Economics are divided into microeconomics and macroeconomics.  

Microeconomics Microeconomics studies the individual entities in the economy such as households and firms, the choices they make and their interaction in specific markets and industries.

Macroeconomics Macroeconomics studies the economy as a whole. It focuses on the total level of economic activity such as the gross domestic product, inflation, unemployment and many more.

The Problem of Scarcity Scarcity means that there are not enough goods and services to satisfy the wants and needs of everyone. Economic resources are scarce or limited in supply in every society in the world. Therefore the amounts of goods and services that can be produced are also limited. Scarcity governs our lives. We can satisfy some of our needs and wants, leaving many others unsatisfied.

Terms Wants are the things that we as human beings desire and they are unlimited. Needs start with the basic things we need for survival such as food, water, clothes, shelter and jobs. When the basic needs are satisfied we may need things such as education and self- improvement. There is only a demand for goods and services if we have the money to pay for these goods.

Limited Resources Natural resources (land) Labour Capital This refers to inputs into the production process that we get from nature such as land, water, marine resources, coal, oil, minerals, metals, fauna and flora. Payment: Rent Labour  This is the human resource and refers to the physical and intellectual effort of people engaged in the production of goods and services. Payment: Wage Capital This is the man-made resource and includes all manufactured goods used as inputs in the production process such as buildings, tools, equipment, etc. Payment: Interest  Entrepreneurship  This is the act of organizing and assuming the risk of a business venture. Payment: Profit

Unlimited Wants and Needs Maslow’s hierarchy of needs: Physiological needs  This includes all basic needs such as food, clothes and a place to live.  Security needs This comprises the need for physical and financial security. Social needs This comprises the need for love and contact with other people. Status needs This reflects the need to be recognized and respected by other people. Self-actualization needs This refers to the desire for personal development and self-advancement.

Scarcity problem Unlimited needs and wants ↓ Scarce resources People have to make optimal allocation choices Every choice has an opportunity cost

Opportunity cost Definitions: The value of the next best alternative that must be sacrificed when one makes a choice. The benefit foregone when one makes a choice.

Production Possibilities Curve A production possibilities curve (PPC) illustrates graphically the maximum combinations of two goods that an economy can produce, given its available resources and technology. Assumptions All resources are fixed. All resources are fully employed. Technology remains unchanged.

Table 1 Production possibilities schedule   Choice Y-axis Houses X-axis Food (tons) A 50 B 47 (3) 1 C 42 (5) 2 D 32 (10) 3 E 20 (12) 4 F 0 (20) 5

Figure 1: Production possibilities curve

The principle of increasing opportunity cost This principle states that in order to have more of something, one must give up increasing quantities of something else. Please note: All points on the PPC indicate the maximum and efficient use of resources. All points inside the PPC are attainable but indicate the inefficient use of resources and technology. All points outside the PPC are unattainable with the available resources and technology.

Scarcity, choice and opportunity cost Scarcity is illustrated by the fact that all points outside the PPC are unattainable with the available resources. Choice is illustrated by the need to choose among the available combinations along the PPC. Opportunity cost is illustrated by the negative slope of the PPC. More of one good can only be obtained by sacrificing increasing quantities of the other good.

The Four Sectors of the Economy Households Households consist of people living under one roof with a source of income. They are the owners of factors of production which they sell to firms to earn income. Their income is used to buy goods and services. This is known as consumption expenditure (C). The Business Sector (firms)  Firms supply goods and services. They are motivated by profits. Their expenditure on capital goods (production equipment, new buildings and inventories) is known as investment expenditure (I).

The Four Sectors of the Economy Government Sector This sector includes all government bodies that fall under the central, regional and local governments. The government receives revenue in the form of direct and indirect taxes. The revenue is used to finance government expenditure (G). The Foreign Sector (exports – imports) Goods produced in Namibia and sold in foreign countries are known as exports (X). Goods produced in foreign countries and sold in Namibia are known as imports (M). Components of total expenditure: GDP (Y) = C + I + G + (X – M)

Two-Sector Circular Flow Diagram: Y = C+I

Two-Sector Circular Flow Diagram: Y = C+I Stream A: Households sell factors of production to firms. Stream B: Households receive income in the form of rent, wages, interest and profit.  Stream C: Firms use the factors of production to produce goods and services that are sold on the goods market.  Stream D: Households use their income to purchase goods and services.

Four-Sector Circular Flow Diagram: Y=C+I+G+(X-M)

Four-Sector Circular Flow Diagram: Y=C+I+G+(X-M) Stream A: Households sell factors of production to firms and the government. Stream B: Households receive money (income) from firms and the government. Stream C: Goods and services are sold on the product market. Stream D: Households use their income to pay for goods and services. Stream E: This stream moves in both directions. The government buys goods and services and in turn sells goods and services on the market. Stream F: This stream also moves in both directions. The government pays for the goods and services purchased and also receives payment for the goods and services it sells on the market. Stream G: Payments flow from the government to households and firms e.g. transfer payments such as pensions to households and subsidies to firms.

Four-Sector Circular Flow Diagram: Y=C+I+G+(X-M) Stream H: The government receives income from households and firms in the form of direct and indirect taxes. Stream I: Production factors that flow from Namibia to foreign countries and from foreign countries to Namibia through the factor market. Stream J: Payment for production factors from Namibia to foreign countries and from foreign countries to Namibia. Stream K: The flow of exports from Namibia to foreign counties and imports from foreign countries to Namib. Stream L: Payment for imports and exports. Stream M: Financial institutions provide credit to households and firms. Stream N: Interest payments from households and firms to financial institutions.

A Macroeconomic Interpretation of the Circular Flow Model Total Expenditure = C + I + G + (X-M) The market value of all final goods and services produced inside the borders of a country is called the gross domestic product (GDP). The GDP must therefore be equal to the total expenditure. GDP = Total Expenditure Gross domestic expenditure (GDE) refers to the expenditure inside the country and excludes the expenditure by the foreign sector. GDE = C + I + G