1. 1- 1 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Chapter 1 The general principles of economics

2. 1- 2 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Learning Objectives Understand the nature and methodology of economics. Explain specific problems, limitations and pitfalls encountered in studying economics. Discuss the two fundamental facts that form the basis of the economising problem. Discuss the meaning of economic efficiency.

3. 1- 3 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Learning Objectives (cont.) Illustrate, extend and modify the definition of economics through the use of production possibilities tables and curves. Introduce the concept of opportunity cost and the law of increasing opportunity cost. Use the production possibilities curve model to examine the trade-off between current and future consumption.

4. 1- 4 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Economic Perspective Economics is concerned with the efficient use of limited productive resources for the purpose of attaining the maximum satisfaction of our material wants.

5. 1- 5 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Economic Perspective Reasons for studying economics: –Provides valuable knowledge concerning our social environment and economic behaviour. –Provides knowledge to make fundamental decisions in a democracy. –Provide businesses and consumers with valuable information and a set of methods for analysing information. –Economists view things from a special perspective.

6. 1- 6 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Economic Perspective The economic perspective includes: Scarcity and choice –resources are limited and this necessitates choices Rational behaviour –behaviour that involves decisions and actions in order to achieve the greatest satisfaction or maximum fulfilment of goals –people will make different choices, because their circumstances, preferences and available information differ

7. 1- 7 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Economic Perspective Marginalism: benefits and costs –decisions that compare marginal benefits and marginal costs –incremental benefits available from any changes are compared to the incremental costs of making the change.

8. 1- 8 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Foundation of Economics Two fundamental facts that constitute the economising problem: Unlimited wants –Material wants: the desires of consumers to obtain and use various goods and services that give utility or satisfaction. Scarce resources –Economic resources includes all the natural, human and manufactured resources that go into the production of goods and services. Includes:  property resources – land, raw material and capital  human resources – labour and enterprise

9. 1- 9 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Scarce Resources Two broad categories: Property resources –Land –Raw materials –Capital. Human resources –Labour –Entrepreneurial ability.

10. 1- 10 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Resource Payments Land – rent Capital – interest Labour – wages Enterprise – profit

11. 1- 11 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Five Fundamental Questions How much total output is to be produced? What combination of outputs is to be produced? How are these outputs to be produced? Who is to receive/consume these outputs? How can change be accommodated?

12. 1- 12 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The Methodology of Economics 1. Facts Descriptive, or empirical, economics is concerned with gathering facts relevant to an economic problem and testing hypotheses against those facts. 2. Principles or theories Theoretical economics involves generalising about economic behaviour. 3. Policies Policy economics is concerned with controlling or influencing economic behaviour or its consequences. induction deduction

13. 1- 13 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Induction and Deduction Induction –A method of reasoning that proceeds from facts to generalisations. Deduction –Reasoning from assumptions to conclusions by testing a hypothesis.

14. 1- 14 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Economic Theory Facts must be systematically arranged, interpreted and generalised to derive appropriate economic theory. Theories or principles are the end result of economic analysis. These are meaningful statements drawn from facts.

15. 1- 15 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Terminology of Economic Theory Economists use the terms ‘laws’, ‘theories’ and ‘models’ to represent generalisations, or statements of regularity, concerning the economic behaviour of individuals and institutions.

16. 1- 16 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal The ‘Other Things Being Equal’ Assumption The ‘other things being equal’ assumption –The process of analysis, that all variables, other than the one being considered, are constant. Abstractions in economics –Economic theories do not encompass the full complexity of reality.

17. 1- 17 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Microeconomics and Macroeconomics Microeconomics is concerned with specific economic units and a detailed consideration of the behaviour of these individuals units. Macroeconomics deals with the economy as a whole, or with the basic subdivisions or aggregates that make up the economy.

18. 1- 18 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Policy Economics: Positive and Normative Positive economics are based upon facts without value judgements. Normative economics are based upon subjective beliefs... ‘what ought to be’ –Normative economic statements come into play at the level of policy economics.

19. 1- 19 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Pitfalls of Objective Thinking Bias Fallacy of composition Cause and effect –Post-hoc fallacy –Correlation versus causation.

20. 1- 20 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Economics and Efficiency Efficiency is the use or administering of scarce resources to produce the maximum amount of the desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants. Full employment: When all available resources are employed.

21. 1- 21 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Economics and Efficiency (cont.) Full production: When the maximum amount of goods and services are produced from the employed resources of an economy. –Two kinds of efficiency:  Allocative efficiency  Productive efficiency.

22. 1- 22 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Economics and Efficiency (cont.) Allocative efficiency –Occurs when all available resources are devoted to the combination of goods most wanted by society. Productive efficiency –Occurs when goods or services are produced using the lowest cost production methods.

23. 1- 23 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Specialisation and Efficiency Two major forms of specialisation enhance efficiency: –The division of labour –Geographic specialisation.

24. 1- 24 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Production Possibilities Table Assumptions Efficiency –Full employment and productive efficiency. Fixed resources Fixed technology Two products only –Capital good and consumer good.

25. 1- 25 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Production Possibilities of Chocolate and Tractors with Full Employment ___________________________________________________________ Type of product Production alternatives A BCDE Chocolates (’00 000) 0 1 2 3 4 Tractors (‘000)10 9 7 4 0 ___________________________________________________________

26. 1- 26 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Production Possibilities Curve The Production Possibilities Curve (PPC) can be used to illustrate the concept of choice and opportunity cost. Demonstrates that society must make choices about which goods and services to produce and which to go without.

27. 1- 27 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Production Possibilities Curve (cont.) Points on the PPC represent a maximum output of the two products. Points inside the PPC are attainable, but are inefficient and undesirable. Points outside the curve are superior, but unobtainable given the assumptions of fixed technology and resources.

28. 1- 28 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Q Q Tractors (thousands) Chocolate bars (hundred thousands) 12 11 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 A B C D E W UnattainableAttainable and efficient Attainable but inefficient U Production Possibilities Curve (cont.)

29. 1- 29 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Production Possibilities Curve (cont.) Opportunity cost: –The amount of other products that must be sacrificed to obtain an additional unit of a good. The PPC is concave to the origin because of the law of increasing opportunity costs: –more and more of a good must be given up to obtain additional units of the other good.

30. 1- 30 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Law of Increasing Opportunity Costs Concavity: the slope of the concave PPC becomes steeper as we move from A to E Rationale: –Based on the fact that economic resources are not completely adaptable to alternative uses; they are imperfect substitutes. –Resources lack perfect flexibility or interchangeability.

31. 1- 31 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Allocative Efficiency Revisited Resources are efficiently allocated to any product when the output is such that its marginal benefit equals its marginal cost (MB = MC).

32. 1- 32 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Unemployment and Growth Points inside the production possibility curve illustrate unemployment or productive inefficiency. A movement towards full employment and productive efficiency from a point such as U will entail a greater output of at least one, if not both, products.

33. 1- 33 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Q Q Tractors (thousands) Chocolate bars (hundred thousands) 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8 A B C D E More of either or both is possible U Unemployment and Underemployment

34. 1- 34 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Economic Growth and the PPC Economic growth can be represented as an outward shift (to the right) of the PPC. Economic growth results from: –expanding resource supplies –technological advances.

35. 1- 35 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Q Q Tractors (thousands) Chocolate bars (hundred thousands) 14 13 12 11 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 A′A′A′A′ B′B′B′B′ C′C′C′C′ D′D′D′D′ E′E′E′E′ Economic Growth and the PPC (cont.)

36. 1- 36 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Present Choices and Future Possibilities The PPC can be used to: illustrate the importance of society’s choice between current and future consumption. demonstrate the economic basis for trade between nations.

37. 1- 37 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Goods for the Present Goods for the Future 2003 Curve 2023 Curve 2003 Curve Alphania Betania Economic Growth in Two Countries

38. 1- 38 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Graphs and their Meaning Appendix to Chapter 1

39. 1- 39 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Constructing a Graph Graphing relationships between variables –direct (positive) relationship: where the values of two related variables change in the same direction, e.g. consumption and income –inverse (negative) relationship: where the values of two related variables move in opposite directions, e.g. ticket prices and attendance.

40. 1- 40 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Direct Relationship 0 $500 $400 $300 $200 $100 $100 $200 $300 $400 Consumption (C) Income (Y) Consumption C = 50 + 0.5Y a b c d e As Y increases, C increases

41. 1- 41 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Inverse Relationship 0 $25 $20 $15 $10 $5 4 8 12 16 20 Ticket Price (P) Attendance in thousands (Q) Ticket Demand a b c d f As P increases, Q decreases e P = 25 – 1.25Q

42. 1- 42 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Slope of a Straight Line The ratio of the vertical change to the corresponding horizontal change involved in moving between two points.

43. 1- 43 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Positive Slope o $500 $400 $300 $200 $100 $100 $200 $300 $400 Consumption (C) Income (Y) Consumption C = 50 + 0.5Y a b c d e vertical change = +50 horizontal change = +100

44. 1- 44 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Negative Slope 0 $25 $20 $15 $10 $5 4 8 12 16 20 Ticket Price (P) Attendance in thousands (Q) Ticket Demand P = 25 – 1.25Q a b c d f – 5 + 4 e

45. 1- 45 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Three Addenda The discussion of the slope of a line needs the following three additional comments: –Measurement units –Marginal analysis –Infinite and zero slopes.

46. 1- 46 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Equation Form Linear relationship y = a + bx Where y = the dependent variable a = the vertical intercept b = the slope of the line x = the independent variable

47. 1- 47 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Slope of a Curve Tangent P A A a a X Y

48. 1- 48 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Slope of a Curve (cont.) X Y 40 30 20 10 0 10 20 30 40 P b b

49. 1- 49 Copyright  2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Next Chapter: Demand and supply