Lecture 1 The Economic Problem Key Points Scarcity Choice Rational Decisions Opportunity Cost Lecture 1 The Economic Problem

How to organise Production and Consumption of goods and services? The Problem…. Scarcity How to organise Production and Consumption of goods and services?

A consequence of scarcity Choice A consequence of scarcity Compare Costs Benefits Rational choice maximises benefit relative to cost

Microeconomic Problems Choices Rational economic decision making Opportunity cost

Macroeconomic Problems Growth Unemployment Inflation International Trade - Balance of Payments problems

Imagine that you won millions of pounds on the National Lottery Imagine that you won millions of pounds on the National Lottery. Would your `economic problem' be solved?

Imagine that you won millions of pounds on the National Lottery Imagine that you won millions of pounds on the National Lottery. Would your `economic problem' be solved? It would not be solved. Many things would still be scarce. For example, you would still have only a finite amount of time to enjoy what the money could buy: there are only 24 hours in a day, and we do not live for ever.

Assume that you are looking for a job and are offered two Assume that you are looking for a job and are offered two. One is unpleasant to do but pays more. How would you make a RATIONAL choice between the two?

Assume that you are looking for a job and are offered two Assume that you are looking for a job and are offered two. One is unpleasant to do but pays more. How would you make a RATIONAL choice between the two? You should weigh up whether the extra pay (benefit) from the better paid job is worth the extra hardship (cost) involved in doing it..

Opportunity Cost The cost of any activity measured in terms of the best alternative forgone

Illustrating choice & opportunity cost Rice The Production Possibility Curve Peas

Illustrating choice & opportunity cost Rice Production possible y not all resources used x Peas

Illustrating choice & opportunity cost Rice Production boundary y1 All resources are used x x Peas

Illustrating choice & opportunity cost Rice Possible choices y1 y2 x1 x2 Peas

Illustrating choice & opportunity cost Impossible choices Rice y2 y1 x2 Peas

Suppose you have a choice of spending Saturday afternoon studying economics or working for £20.00 or watching television. What is the opportunity cost of choosing to study?

Suppose you have a choice of spending Saturday afternoon studying economics or working for £20.00 or watching television. What is the opportunity cost of choosing to study? The £20.00 wages foregone (probably)… The difficulty here is the VALUATION of the ‘watching television’.

Problems of a Social Science Economic reasoning Compare with natural sciences (physics) Used to explain or predict Economic methodology constructs theories or models Problems of a Social Science Controlled experiments not possible Human behaviour unpredictable

Statements about the economy Positive Normative either Statement of fact May be tested The statement may be true or false Statement of fact May be tested Statement of fact Statement of what is desirable, ought to be or what is good or bad Not testable Statement of what is desirable, ought to be or what is good or bad

1 Is the statement below Positive, or Normative or could it be either? “It is wrong that inflation should be reduced if this means that there will be higher unemployment.”.

2 Is the statement below Positive, or Normative or could it be either? “Current Government policies should reduce unemployment”.

3 Is the statement below Positive, or Normative or could it be either? “Cutting the higher rate of income tax will redistribute incomes from the poor to the rich”.

Subjective -difficult to value Summary Opportunity Cost Finite resources Scarcity Costs Benefits compare Choices Subjective -difficult to value