Introduction to economics

Chapter 1: Introduction
Economics is concerned with scarcity.
The Economic Problem – How to deal with unlimited wants when there are limited
resources available to satisfy these wants.
Consumer goods and services – Goods and services consumed for our own personal
satisfaction. E.g. TVs, computers
Consumer Durables – Consumer goods which can be used over and over again. E.g.
cars.
Collective Wants – Can only be satisfied if we contribute a little money in the form of
taxes and set up an organization (a government) to provide the services. E.g. education
in schools, military forces.

Wants are:
- unlimited
- sometimes necessities, often luxuries
- changeable
- may be substituted

The Factors of Production are:

- Land: refers to all things provided by nature, e.g. minerals, soils, forests, etc. It is
limited in supply at any point in time
- Labour: Human muscles and brains. Also limited and given time can be
improved.
- Capital: equipment buildings and other things used to produce consumer goods
and services (the Produced Means of Production). Supplies are limited
- Enterprise: consists of organizational skills and willingness to take risks.
Entrepreneur, the risk taker, supplies the enterprise. The enterprise is also
limited.

Every nation has to have a system for deciding three critical questions:
- What to Produce? : Questions have to be answered such as “What goods will be
produced?” This is called decisions on production
- How to Produce? : The economy has to decide how much labour and capital are
to be used to produce goods and services. This is called allocating resources to
production
- For Whom to Produce? : The economy has to decide whose wants are to be
satisfied. This is called the distribution of products or the distribution of
income.

Choosing What to Produce

The decision to produce more of one good involves an opportunity cost because it
means less of something else will get produced.

Production Possibility Curve or Frontier shows:

- The maximum amount of two goods which can be produced when all factors of
production are fully employed given the current state of technology.
- In order to get more of one good, we must sacrifice some of another good.
Opportunity Cost – represents what we have to give up in order to get what we want. It
is the cost of the alternative foregone.
When a point is under the production possibility curve, it can be one of two reasons:
- It has unemployed resources in which case production of both goods can be
expanded by using these resources
- There is full employment of resources, but these resources are not used
efficiently. It might be because of poor management skills, poorly designed
machinery, etc.

Allocative Efficiency – is achieved when a country is operating at any point on its

possibility production curve.
A shift in the PPC may occur due to:
- More resources being available
- The quality of resources improves
- Improvements in technology enable more to be produced by each factor of production

Choosing How to Produce

Labour Intensive – production involves a lot of labour working with little capital or
land
Capital Intensive – production involves much capital working with few workers
Land Intensive – production involves land working with little labour or capital.

Choosing For Whom to Produce

The society must choose a method of income distribution which ensures that production
is consumed. Based on the income level. The higher the income level the more potential
for the purchase of luxury goods, to derive places with high levels of luxury expenditure
market research and trend analysis would be required.

The Future Implication of Current Choices

The decision is on how much of its output will be consumer goods and how much will be
capital goods. If we use more resources to produce capital goods we will have to accept
fewer consumer goods. The outcomes of this decision may be:

CPI (Consumer Price Index) – measure of inflation, or as the rise of the cost of living. It
provides a general measure of changes in the prices of consumer good and services
purchased by Australian households.

Economic Factors Underlying Decision Making

By Individuals

Individuals make choices in order to maximize their satisfaction (called utility). Some of
these choices include:
- To spend or not to spend: Consumers save because of:
 an expected all in prices in the future
 a fear of economic downturn
 to take advantage of current high interest rates

- To work or not work: Reasons a consumer might decide to work less include:
 A higher tax rate on the extra earnings
 The utility gained from the extra money may fall short of the utility
gained from devoting that time to leisure.
  People may have a target income in mind. May respond to pay rise by
working less.
- How much study: higher education means earning a higher income in the future.
But it involves costs which sacrifices income today for a higher future income.

- A question of retire: retirement cuts income from work. Past savings now
generate the income for consumption in retirement.

- Influencing government: Voting provides the opportunity for people to influence

decisions about forces which affect their behaviour as consumers, workers and
savers.

By Business

Businesses try to maximize profits. A firm’s pricing policy will be influenced by the
degree of competition that exists in the industry in which it operates. The pattern of
resource use will be determines by the relative cost of resources.

By Government

Governments influence individual and business decision making by:

- Taxation decisions: influence spending
- Spending decisions: creating jobs
- Regulations

Chapter 2: The Operation of an Economy

The Functions of an Economy
The economy must have means of deciding:
- What to produce and in what quantities
- How to produce
- For Whom to Produce

Outcomes required for the operation of an economy:

Production – resources are to be converted into goods and services
Distribution – shares of goods and services to be determined
Exchange – The process of trading which permits final consumers to obtain goods and
services.
Provision of Income – Households need money income in modern economies
Provision of Employment – Households gain most income from employment
Quality of Life – Made up of material aspects (goods and services consumed) and non-
material aspects (e.g. health, leisure)

Basic Characteristics of Modern Economies

Private Property
Each individual has exclusive use and control of his/her economic resources. Resources
are owned by private individuals and institutions rather than by governments

Freedom of Enterprise
Each person is free to seek wealth in any way he/she chooses, subject to some legal
limitations. The consumer is sovereign.
Competition is Desirable
There are a large number of buyers and sellers so no-one can manipulate the market.
Competition avoids the abuse of power.

Self Interest
When each economic unit tries to achieve the best for itself that it can. Such as
producers trying to maximize profits, consumers trying to get the cheapest price, etc.

Specialization
Refers to the practice whereby businesses and their employees produce one product
exclusively or some part of a product exclusively.

The Use of Money

Goods can be bartered, but I would impose severe constraints on an economy
How will exchange take place?

Barter Money
- Involves producers swapping their - earn money by selling factors of
output for the products their production
household need - is more convenient
- It is time consuming - use money income to buy off other
- Need to find a suitable deal and specialists
need to negotiate a trade deal. - allow transactions from a distance.

The Use of a System of Markets

Price Mechanism – a system of markets which determine the prices of all goods and
services and all factors of production.

There are two main types of markets:

Factor Markets – Households supply the resources or factors of production to firms.
Firms demand them in order to produce goods and services.

Goods and Services Markets – Households demand goods and services from firms as
they spend their incomes. Firms supply those goods and services. The interaction
between firms and households determines the prices.

How Does Australia Solve the Economic Problem?

What to Produce – Largely determined by consumer demand. The government can

alter the price signals to ensure adequate production of goods and services considered
socially desirable.

How to Produce – Determined in the factor markets according to least cost methods of
production. There are government restrictions such as minimum working age and
wages.

For Whom to Produce – Determined ultimately by the pattern of consumer demand as

in the market economy. The government uses the tax system to take money off the rich
citizens and redistributes it to the poorer members of the economy.
The Circular Flow of Income

FIVE SECTOR MODEL

Land – Income is Rent

Labour – Wage
Capital – Interest
Enterprise – Profit.

Income and the factors of production are in the Factor Markets. They show how factors
of production are traded in order to earn income.
Consumption Expenditure and Goods and Services are in the Goods Markets. They
show how goods and services are traded for a price.

Gross Domestic Product (GDP) – the market value of all the goods and services
produced in a year. Three ways the GDP can be measured include:

- The Income Received Method: Adding all rent, wages, interest and profit together,
which gives us the National Income
- The Expenditure Method: Adding all the expenditure in the economy.
- The Production Method: Adding up all the sales receipts of all the firms of the
economy

Therefore:

GDP = National Income (Y) = Total Spending (C)

Output (O) = Income = Expenditure
Real Flows – Flows of goods and resources
Money Flows – Income earned by households and expenditure by households on goods
Equilibrium - is a state where there is no pressure on prices or other variables to
change. It is also a situation where left hand side variables are equal to the right hand
side variables.
Injections  Money flowing INTO the economy i.e. Investment, Government Spending,
Exports

Leakages  Money flowing OUT OF the economy i.e. Savings, Taxation, Imports

The major taxes levied in Australia are:

- Personal income tax: levied on wage and salary earners and on all self employed
persons
- Company income tax: levied on the net profit of companies
- Taxes on goods and services: goods and services tax on most products.

Transfer Payments (Social Security Payments) – They represent a transfer of income

from those most able to afford taxes to less privileged sections of the community.

The Federal Budget Result – is the outcome of government expenditure commitments

(G) and tax revenue collected (T).
- if G = T, the budget is balanced
- if G > T, the budget is deficit
- if G < T, the budget is surplus

Balance of Payments – The balance between the value of our exports of goods and
services and the value of out imports of these items.

Surplus Balance on Goods and Services – Value of out exports exceed the value of our
imports. Therefore it represents a Net Injection.

Deficit Balance on Goods and Services - Value of out imports exceed the value of our
exports. Therefore it represents a Net Leakage.

Chapter 3: Different Approaches to the Economic

Problem
Planned Economy
Within this economy, the State:
- Owns all capital and land
- Takes all decisions and risks associated with production
- Decides on the extent of specialization
- Decides on resource use by allocation all resources to firms.

Laissez-faire Economy (Pure Capitalist Economy)

Within this economy, the Individual:

- Owns capital and labour
- Provide the enterprise
- Entrepreneurs determine specialization and resource use
- Competition should restrict the power of firms and make consumers sovereign
- The State is restricted to providing essential collective wants.
Mixed Economy (USA, Australian, Hong Kong)

- Decision-making by market participants with limited intervention by

governments in the economy.
- Predominantly private ownership of productive assets with some State
ownership which is kept to a minimum
- Price is the rationing device with some government intervention.