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ECONOMICS
– THE CORE ISSUE
• Why are you in this class right now rather
than doing something else?

• What is college costing you?

• Why will you major in electrical rather than

different engineering courses?

“Life is a series of
choices. And economics
is about how people
choose"

Economics is the study of how best to

allocate scarce resources among competing
uses.
uses
 Economist, n.- A scoundrel whose faulty
vision sees
things as they really are, not as they ought to
be.

• What is scarcity, and why is it important even in

relatively wealthy economies?
• What is opportunity cost? Why do economists
place so much emphasis on it?
• What is different about the way economists look
at choices and human decision making?
• What does a production possibilities curve
demonstrate?
• What is the difference between positive and
normative economics?
• What are the two major economic systems?
 Scarcity means having to make choices.

• Resources will always be scarce relative to our

desires.
• How we use those scarce resources will shape
the future.

A good is scarce when

the human desire for it
exceeds the amount
freely available from
nature.
• Labor
• Capital
• Land
• Entrepreneurial Ability
• Labor: broad category of human effort
- Physical and mental
- Time
- Scarcity of time  scarcity of labor

• Capital: Human creations used to produce goods and

services
- Physical capital: factories, machines, tools,
buildings, airports, highways and other manufactured
items employed to produce goods and services
- Human capital: consists of the knowledge and skill
people acquire to enhance their labor productivity
• Land
- Land and other natural resources
- Gifts of nature including bodies of water,
trees, oil reserves, etc.
•Entrepreneurial Ability
- Special kind of human skill
- Talent required to dream up a new product
or find a better way to produce an existing
one
• WHAT to produce with our limited resources.

• HOW to produce the goods and services we

select.

•FOR WHOM goods and services are produced;

that is, who should get them
• Every time we choose to use scarce resources in
one way we give up the opportunity to use them
in other ways.

OPPORTUNITY COST :The value of the best alternative

forgone when an item or activity is chosen
Examples of Opportunity Cost

•Going to college vs. Working

•McDonalds vs. Kopitiam

•New computer vs. Holiday

Note: The lecture notes are incomplete without having attended lectures
Examples of Opportunity Cost

• Opportunity Cost is Subjective

• Calculating OC Requires Time
• Time is the Ultimate Constraint
• OC May Vary with Circumstances

Note: The lecture notes are incomplete without having attended lectures
Principles of individual decision making:
making

• Trade offs – “gun and butter”

- efficiency vs equity
• The cost of something is what you give
up to get it –opportunity cost
• Rational people think at the margin
• People respond to Incentives
 Law of Comparative Advantage

• States that the individual with the lower opportunity cost of

producing a particular output should specialize in producing
that output

• Absolute advantage means being able to produce a product

using fewer resources than other resources require while
comparative advantage focuses on producing where
opportunity costs are lower
 Law of Comparative Advantage

• Comparative advantage between nations exists because of

- Climate
- Workforce skills
- Natural resources
- Capital stock

• Resources will be allocated more efficiently when production

and trade conform to the law of comparative advantage
 Specialization and Exchange
• Barter
- System of exchange in which products are traded
directly for other products
- Works best in simply economies with little
specialization and few goods

•In advanced economies with specialization, money plays an

important role in facilitating exchange
- Money serves as a medium of exchange because it is
the one thing that everyone is willing to accept in
return for all goods and services.
 The Economy’s Production
Possibilities
• Production possibilities are the
alternative combination of final goods
and services that could be produced
in a given period of time with all
available resources and technology.

• Each point on the production

possibilities curve depicts an
alternative mix of output.
The Economy’s Production
Possibilities
 The Economy’s Production
Possibilities

5 A
OUTPUT OF SHOES

4 B

3 C

2 D

1 E

F
0 1 2 3 4 5
OUTPUT OF TELEVISIONS
 The Economy’s Production
Possibilities
Production possibilities illustrates two
essential principles:

Scarce resources – there’s a limit to the

amount we can produce in a given time
period with available resources and
technology

Opportunity costs – we can obtain additional

quantities of any desired good only by
reducing the potential production of another
good.
Increasing Opportunity Costs
A Step 1: give up one shoe
5

B
OUTPUT OF SHOES

4 Step 3: give up another shoe

Step 2: get two TVs C
3
Step 4: get one more TV
2 D

1 E

F
0 1 2 3 4 5
OUTPUT OF TELEVISIONS
Microeconomics
• Examines the factors that influence individual
economic choices
• Studies the individual pieces of the economic
puzzle

Macroeconomics
• Studies the performance of the economy as a
whole
• Focuses on the big picture
• Positive economic statement
-Assertion about economic reality
- Supported or rejected by
reference to the facts

•Normative economic statement

- Opinions
- Cannot be shown to be true or
false by reference to the facts
• Economic System is a set of mechanisms
and institutions that resolve the what,
how, and for whom questions

• Criteria used to distinguish among

economic systems
- Who owns the resources
- What decision-making process is
used to allocate resources and
products
- What type of incentives guide the
economic decision makers
• Private ownership of all resources
• Coordination of economic activity based on price
signals generated in free, unrestricted markets
• Owners have property rights to use their resources
and are free to supply those resources to the highest
bidder
• Voluntary buying and selling
• Market prices guide resources to their most
productive uses and channel goods and services
to consumers who value them most
• Laissez-faire: let people do as they choose
without government intervention
• The market mechanism is the use of
market prices and sales to signal
desired outputs (or resource
allocations).

• The essential feature of the market

mechanism is the price signal.
signal
The laissez-fair policy favored by Adam Smith
has always had its share of critics

free markets tend to concentrate

wealth and power in the hands of the
few, at the expense of the many.

Marx argued that the government not

only had to intervene but had to own all
the means of production.

Karl Marx
• Resources are directed and production is
coordinated not by markets buy by the
“command,” or central plan, of government

• Public or communal ownership of property

• Central plans spell out answers to three questions

• According to Marx, markets permit capitalists
to enrich themselves while the proletariat toil
long hours for subsistence wages.

- Capitalists – those who own the machinery

and factories.
- Proletariat – the workers.
• John Maynard Keynes seemed to offer a less
drastic solution

..The market was pretty efficient in organizing

production and building better mousetraps.

.. However, individual producers and workers had

no control over the broader economy.
• Keynes believed the cumulative actions of so
many economic agents could easily tip the
economy in the wrong direction.

.. government should play an active but not an all-

inclusive role in managing the economy.
• A mixed economy is one that uses both market
signals and government directives to allocate
goods and resources.

• Most economies use a combination of market

signals and government directives to select
economic outcomes.
• A market failure is an imperfection in the market
mechanism that prevents optimal outcomes.

• If the market signals don’t give the best possible

answers, we say that the market mechanism has
failed.
• A government failure is government intervention
that fails to improve economic outcomes.