Unit 1

Scarcity, choice (opportunity cost) and

resource allocation Hence the BASIC
ECONOMIC problem
Factors of Production
Production possibility curves shapes and shifts
Decision making at the margin
Specialization and exchange
Division of labour
Different allocative mechanisms Planned,
Market & free and Problems of transition
Ceteris Paribus, Positive and normative
statements
Money: functions and characteristics
ECONOMICS OIKONOMOUS

oikos household
nomous law/ rules; to manage
resources

Management of Resources
* MicroEconomics - deals with
individual units or groups

* MacroEconomics - deals with nation

or economy as a whole
 This is a
need!

A Want
Our wants are UNLIMITED but resources
are LIMITED

So there is SCARCITY

Hence we have to make

CHOICES
 Economics
is the
Science of CHOICE
(decisions made by you and me, firms,
government )
 Hence scarcity forces us to make
choice

And so Allocation of Resources

 Decision on allocation of
resources, Leads to 3 major
economic problem/
questions:

What to produce
How to produce
Whom to produce
 Basic Economic Problem- 3 decisions

WHAT TO PRODUCE

Food or Clothes
Cars or hospitals
ipods or Cosmetics or military strength
 Basic Economic Problem- 3 decisions

HOW TO PRODUCE

techniques used.
least cost method of production
labour intensive or capital intensive
 Basic Economic Problem- 3 decisions

for WHOM TO PRODUCE

Will everyone get an equal share
of what is produced ?

Would the income be distributed

equally?
 Production: Creating goods and
services

Consumption: Using the goods

and services to satisfy want
FactorsBasic
of Economic
Production
Problem (FOP)
Labour
The Enterpreneur:
- Organizes the 3 factors and production process
- Takes the risk (Profit and Loss)
 Goods produced

Economic Goods Free Good

Made by using FOP not needed.

resources/ FOP
Eg: They have a price
Eg: Air, water
 Enhancement of
Production.

Specialization
Exchange (Trade)
Division of Labour
 Specialization

Firms or Individuals or Regions

or Countries producing some
goods and services which they
are best producing at
 Exchange
No economy can be self dependent
but they have to be interdependent

Trade and exchange of goods and

services helps to resolve the problem
of scarcity to a certain extent
 Division of labour
Adam Smith division of labour
represents a qualitative increase in
productivity
Production Possibility Curve (PPC)
Every decision has an opportunity
cost the cost in foregone
opportunities.
The production possibilities curve
shows the trade-offs among choices
we make.
A production possibility curve is used
to illustrate opportunity cost.
 Opportunity Cost is the
highest-valued option
forgone
 Eg 1
Going to Hong Kong Disneyland
Ticket : Free of charge
Money spent on food, transport =$200
Income forgone = $500

Full cost of going for Disneyland (HK) =$700

 Eg 2
Option 1 going to a 1 hour concert and pays $200
for a ticket
Option 2 working in Parkn as a salesman earning
$30 per hour
Option 3 working as a tutor earning $100 per hour

Full cost of attending the concert = price of ticket +

income forgone (highest-valued option forgone)
Full cost of attending the concert = $200 + $100 =
$300
 A = 24 lbs of coffee
Coffee
B = 16 lbs of cofee & 4 units of computers
(lb/day) C = 8 lbs of cofee and 8 Computers
24 A
D = 12 units of Computer
Cost of
B
16
4 computers= ?
Another 4 Computers= ?
8
C Another 4 Computers = ?
Hence Opportunity cost is
D Computers same
0 4 8 12 (unit/day)

Sli
de
 In our choices of production,
the opportunity cost may

Remain Constant
Increase
Decrease
 Depending on our choices of
Production,
the opportunity cost may

Remain Constant
Increase
Decrease
 Constant O.C Decreasing O.C

Increasing O.C

Unit 1 : Macroeconomics
National Council on Economic
Education
 PPC is also called:
Production Possibility Frontier (PPF)
What you can and cannot produce
Product Transformation Curve
What will it cost you to produce the other
good
When you produce something else, you have to
reallocate resources Reallocation of
Resources
How easily you can reallocate Factor Mobility
A Typical PPF & PTC .
Unattainable

Opportunity
cost of is
increasing

Inefficient
Shift in PPC
Economic Growth
Butter
C Shift in PPC
B
Economic Growth
due to:

0
A Guns

Availibility of resources (Quantity and

Quality)
Increased Labour force
Improved Technology
Butter Shift in PPC
C
A Economic Decline..

0 B D Guns

Due to
Decline in resources
Working population falls
Decision making at the margin
 Consumer Goods
Products purchased by consumers
for personal or household use.

Capital Goods
Producers goods or means of
production (Eg: Machines)
Creating Captial goods Investment
 More Consumer goods Higher standard of
living

But if we do not have sufficient capital goods

to produce consumer goods In the future
Standard of living may fall

So a decision has to be made:

Whether to produce Consumer Goods or
Capital Goods?
Decision making at the margin

100 200 300 400 500 600 700 800 900

 If Capital goods are less than K
Economics Decline

If we produce more capital goods

In the future Economic Growth
 Developing Countries
They have to increase their capital
goods so more resources are
allocated capital goods Low
standard of living.
A minimum amount of resources
allocated for comsumer goods
survival of population
Subsistence Level of Consumption
 In under-developed countries or
poorly developing countries

Most of resources are allocated for

consumer goods for survival of
population
 Economic structure
The Various Sectors in an Economy

Primary sector - agriculture, fishing and mining &

oil extraction

Secondary sector All Manufacturing activities.

Eg: Food processing, textiles and clothing, iron
and steel production, vehicle manufacturing and
electronics.

Tertiary sector service sector. Eg: retailing,

transport, financial services, education, call
centre services & information technology.
 Economic System
Economic system is used to describe the means
or allocative mechanism by which its people,
businesses and government make choices

The (free) market economy

The command/planned economy

Mixed economy
 The Characteristics of Market Economy
Freedom to buy what they want and sell what they make.

Private property

Changes in supply and demand control the prices (and hence

what is made and sold) Adam Smith-invisible hand (the price
system)

Self-interest

Little government interference (control national defence, act

against monopolies, issue money, raise taxes and protect the
rights of the private sector)

Market economy is an ideal which does not exist in todays

economy.
Strengths of (Free) Market Economy
Freedom exists for everyone involved

Relatively small degree of governmental

influence

Variety of goods and services are produced

High degree of consumer satisfaction

 Weaknesses of (Free) Market Economy

The primary weakness is deciding for whom to

produce

The young, sick and old would have difficulty

in a free market environment

Markets sometimes fails (some goods are

overproduction and underproduction or fail
production)
The Characteristics of Command (planned)
Economy
The government makes all the key decisions and has
complete control over all the resources of the country:

Public ownership of all property

Centrally planned production

government dictates prices

Profit is not a factor the government produces what it

feels is in the national interest
The Characteristics of Mixed Economy
The government makes some general policy
decisions

Mostly private but some public ownership of

property. Govt also produces Merit Goods.

In private industry profit is the driver

Government intervention to solve the

problem caused by market failure.
 Problems of transition when central
planning in an economy is reduced
Law and order

Merit goods

Public goods

Quality and standards

Inflation
 Positive economics/statement
Positive statement is about what the
world is. Has a logic or reason.

May be wrong!!

For example:
Inflation will increases the prices
 Normative economics/statement
Is what you think the world should be.

Involves your judgment or opinions, personal

views, political beliefs and ethics

For example:
The government ought to introduce a ban on
smoking in public places.
 Money
A simple definition is that money is
anything that is regularly used to buy goods
and services.

Normally, this is coins and notes but the

definition also includes cheques, debit cards
and credit cards. Oil/ Platinum/Gold
 Barter
The direct exchange of one good or
service for another in this way is
known as Barter.
 Coincidence of wants
For Barter to happen, both parties in a
transaction must have goods/ services
that each other wants.. coincidence of
wants

So money is one such commodity that

everyone would be willing to accept in
exchange for all other goods and services.
 The functions of money

a medium of exchange

a unit of account

a standard for deferred payment

a store of wealth
 Medium of exchange

use it to buy and sell things

57
 Unit of account
The account aspect allows
the sum of money to be
recorded and for different
values to be added or
compared.
it measures the value of a
good and allows you to
compare the value of one
good to another good
Standard of Deferred Payment

Not all payments we make are

immediate.
Payments can be made in the future
once terms have been agreed
between the parties involved.

I shouldnt
have told him I
cant pay him
back.

59
 Store of Wealth
Money can be
held or stored
for a period of
time, usually
with a bank or
other financial
institution,
before it is used.
 The characteristics of money
Acceptability
Durability
Portability
Divisibility
Scarcity
 Ceteris paribus
This Latin phrase translates to
with other things the same or
all other things being equal or held constant.

If the price of beef increases ceteris

paribusthe quantity of beef demanded
by buyers will decrease.
Intrinsic Value of Coins and Notes
Intrinsic Value - The market value of the
constituent metal within a coin/ paper of a
currency.

Intrinsic Value of Coins and Notes is very less

or No Value at all..