Lecture notes Prepared by Anton Ljutic

© 2004 McGraw–Hill Ryerson Limited The Economic Problem CHAPTER ONE

© 2004 McGraw–Hill Ryerson Limited Realize that scarcity, choice and cost are at the heart of economics Explain the three fundamental questions that all societies must address Understand the four major types of economies Discuss whether economics is an art or a science Understand the circular flow of income diagram This Chapter Will Enable You to (I):

© 2004 McGraw–Hill Ryerson Limited This Chapter Will Enable You to (II): Use the production possibilities model to illustrate opportunity cost, efficiency, and unemployment Define economics and understand why it is controversial but of great relevance List the economic goals of society and understand why they are often difficult to achieve

© 2004 McGraw–Hill Ryerson Limited Scarcity, Choice and Opportunity Cost (I) Scarcity –Society must allocate limited productive resources among competing uses Choice –The decision to produce one thing means that some other thing will not be produced Opportunity cost –The value of the next-best alternative that is given up as a result of making a particular choice Consumer goods and services –Products used by consumers to satisfy their wants.

© 2004 McGraw–Hill Ryerson Limited Scarcity, Choice and Opportunity Cost (II) ScarcityChoiceOpportunity cost forces which involves

© 2004 McGraw–Hill Ryerson Limited Benefits of voluntary trade Athens20 breador10 plows Sparta10 bread or 20 plows Athens10 bread and 5 plows Sparta 5 bread and 10 plows Athens20 bread andno plows Sparta20 plows and no bread

© 2004 McGraw–Hill Ryerson Limited Three Fundamental Questions of Economics What to produce? How? For whom?

© 2004 McGraw–Hill Ryerson Limited Types of Economies (I) Cooperation –Determines what work needs to be done, how it is to be done, and who is to obtain what share of the produce Custom –Determines who performs which task and implies that traditional technology is superior to new ways of doing things

© 2004 McGraw–Hill Ryerson Limited Types of Economies (II) Command –Most of the important economic questions are answered by the orders of those in power Market –Competition plays an important role Mixed –Contains elements of command and competition

© 2004 McGraw–Hill Ryerson Limited Factors of Production (I) The productive resources that are available to an economy, categorized as land, labour, capital and enterprise. –Land Any natural resource that can be used to produce goods and services. –Labour Human physical and mental effort that can be used to produce goods and services.

© 2004 McGraw–Hill Ryerson Limited Factors of Production (II) –Capital. All human-made resources that can be used to produce goods and services. –Enterprise. The human resource that innovates and takes risk.

© 2004 McGraw–Hill Ryerson Limited Incomes of Factors of Production (I) Wages –Payment and income for the use of labour Interest –Payment and income for the use of capital Rent –Payment and income for the use of land Profit –Goes to the owners of the firm

© 2004 McGraw–Hill Ryerson Limited Incomes of Factors of Production (II) Factor Land Labour Capital Enterprise Factor payment Rent Wages Interest Profits

© 2004 McGraw–Hill Ryerson Limited Economics: Science or Art? Positive statements Normative statements Hypotheses - theories Scientific method Economics deals in generalities Economics uses models

© 2004 McGraw–Hill Ryerson Limited Positive Versus Normative Statements Positive Statements –Assertions about the world that can be tested by using empirical data Normative Statements –Are based on a value system of beliefs and cannot be tested by using empirical data

© 2004 McGraw–Hill Ryerson Limited Model Example One: Circular Flow Business sector Household sector Factor incomes: rent, wages, interest, profit Consumption spending Factors of production Goods and services $ $ Figure 1.1

© 2004 McGraw–Hill Ryerson Limited Model Example Two: Production Possibilities The model: is a graphical representation of the various combinations of maximum output that can be produced assumes efficiency, full employment and the use of the best technology illustrates scarcity, choice and opportunity cost

© 2004 McGraw–Hill Ryerson Limited The Production Possibilities Table CARSWHEAT Choices% res.useOutput%res. useOutput A B C D E F Table 1.1

© 2004 McGraw–Hill Ryerson Limited The Production Possibilities Curve (I) Wheat Cars Unattainable Attainable Figure 1.2 x a b c d e

© 2004 McGraw–Hill Ryerson Limited The Production Possibilities Curve (II) Scarcity Is represented by points outside the curve Choice – Is represented by points on the curve (efficient) and points inside the curve (inefficient) Opportunity Cost –Is represented by the downward slope of the curve.

© 2004 McGraw–Hill Ryerson Limited The Law of Increasing Opportunity Costs Factors of production are not of same quality. As production of any item increases, the per unit cost of producing additional units of that item will increase. As the production of cars increase, the per unit cost of cars increase, giving the production possibilities curve its bowed-out shape.

© 2004 McGraw–Hill Ryerson Limited Constant Cost Prod. Possibilities Curve Shirts/day Moccasins /day Figure 1.4

© 2004 McGraw–Hill Ryerson Limited Cars Prod. Possibilities and Technological Change Wheat Improved technology in the production of cars. Improved technology in the production of cars.

© 2004 McGraw–Hill Ryerson Limited Different Growth Rates Consumer goods Original curve Slower growth Faster growth Capital goods Figure 1.6

© 2004 McGraw–Hill Ryerson Limited A Definition of Economics The study of… …the ways that humans organize themselves… …to make the necessary choices… …about how scarce resources are to be used to produce goods and services… …necessary to satisfy human wants and needs

© 2004 McGraw–Hill Ryerson Limited Economics: Fields of Study Macroeconomics –The study of how the major components of an economy interact. Includes topics of unemployment, inflation, interest rate policy and government spending and taxation Microeconomics –The study of the outcomes of decisions by people and firms through a focus on demand and supply, the costs of production, and market structures

© 2004 McGraw–Hill Ryerson Limited Macroeconomic Goals Improved standard of living Economic growth Full employment Stable prices Viable balance of international trade Equitable distribution of income Manageable government debt and deficit

© 2004 McGraw–Hill Ryerson Limited Scarcity, choice and cost are at the heart of economics There are three fundamental questions that all societies must address There are four major types of economies Resolve whether economics is an art or a science The circular flow of income diagram Chapter Summary: What to Study and Remember (I)

© 2004 McGraw–Hill Ryerson Limited Chapter Summary: What to Study and Remember (II): Use the production possibilities model to illustrate opportunity cost, efficiency, and unemployment Define economics and understand why it is controversial but of great relevance List the economic goals of society and understand why they are often difficult to achieve