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1
ECONOMIC
CONCEPTS
Chapter 1
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2
Lecture Plan
What is Economics?
Scarcity
Basic economic
problems
Production possibilityanalysis
The two sector circularflow model
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Comes from
Greek
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(house) (custom or law)
ECONOMICS
NomosOikos +
Management of a household
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Father of Economics
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Inquiry into the Nature and Causes
of the Wealth of Nations
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Adam Smiths primitive study of economics
paved the way for all future study. He was thefirst to analyze economic theory and its
importance. Adam Smiths ideas still prove to be
very valid today.
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Jean-Baptiste Say (5 January 1767
15 November 1832)
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David Ricardo(19 April 177211September 1823)
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John Stuart Mill (20 May 18068 May
1873),
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14
What is Economics
Alfred Marshall's ------- Principles of Economics
a study of wealth; and on the other, and moreimportant side, a part of the study of man."
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"Economics is thescience of how a
particular societysolves its economicproblems.
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"Economics is a studyof how people use theirlimited resources to tryto fulfill unlimited wantsand involves alternativesor choices
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THE BASIC ECONOMIC
PROBLEMS
Economics is the study of howindividuals and groups makedecisions with limited (scarce)resources as to best satisfy theirunlimited wants and desires.
resources are scarce
human wants are unlimited.
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Resources
Resources are inputs that can be used to produce goodsand services of various types to help satisfy peoplesunlimited wants. Goods and services are scarcebecause resources are scarce
Often referred to as the factors of production.
Resources include land, capital, labourand
enterpreneurship.
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Land
Gifts of nature includingNatural resources
Soil
Trees
Water
Air
Mineral
sunlight
Oil reserves
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Capital
Physical capital : producedgoods that can be used asinputs for furtherproduction.
Examples :factories,
machinery tools,
ComputerHuman capital : consistsof the knowledge and skill
people acquire to enhance
their labor productivity
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Labour
Labour is the physical and mentalwork of people, whether, skilled orunskilled
Examples:
mechanics,doctors,
farmers,
computer programmers,clerks,
fisherman
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Entrepreneurship
Refers to the particulartalent that some peoplehave for organizing the
resources of land, laborand capital to producegoods, seek new businessopportunities and
develop new ways ofdoing things.
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Private vs Public Goods Private goods have two important features
First, private goods are rival in consumptionthe amount consumed by one person is
unavailable for others to consumer
Second, private goods are exclusive
the supplier of a private good can easily
exclude those who fail to pay
Example : car, computer, private college,
private medical centre
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Public Goods
Public Goods are non-rival in consumption
one persons consumption does not
diminish the amount available to others.
Example : public school, public hospital, national
defense.
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Public Goods
Furthermore, once produced, public
goods are available to all they are non-
exclusive suppliers cannot easily
prevent consumption by those who fail to
pay
Because public goods are non-rival and
non-exclusive, private sector firms cannotsell them profitably.
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Need Want
Food Toys
Shelter Jewellery
Clothing Entertainment
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Consumer Needs and Wants
Needs Wantslimited Unlimited
those thingsnecessary forhumansurvival
goods/servicesdesired by theconsumer for acomfortable life
Similar for allindividuals
Varies from one toanother
Example :Food, shelter,clothes
Example : luxurycars, travel,
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SCARCITY
CHOICES
OPPORTUNITY COST
ECONOMIC PROBLEM
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Scarcity.. .means that society has limited
resources and therefore cannot produce all thegoods and services people wish to have.
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Because of scarcity, we all have tomake choices. No one, not even you, can haveeverything they want. Every time you make a
choice, you have to give up something.
Decisions require comparing costs and benefitsof alternatives.
Example : Whether to go to college or to work?Whether to go to class or sleep in?
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The opportunity costof an item is what you give upto obtain that item.
Opportunity costDefinition : The second best alternative
forgone in choosing one need or want
rather than another.
Note: Situations where there is NO opportunity cost = freegoods
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Jason has to make a choice.
If he chooses to goshopping, then theopportunity cost will be
going for holiday.
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Example 2 : Government
Malaysian government has 4 Billion and it wants to buildschools and police stations for the welfare of the citizens.However, the government also faces scarcity because thefund is not sufficient to build both schools and policestations.
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Example 3: Firm
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Example 3: Firm
Firm A wants to diversify its business. It wants to expand its
production to produce dolls and toaster. But the fund it has is
not sufficient to produce both type of products.
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Therefore firm A has to
make a choice, whether
to produce dolls ortoasters.
If it chooses to produce
dolls, then theopportunity cost will be
toasters
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Basic Economic Problem
How much to produce ?
The amount of production. Example : 10000cars per month or 1000 cars per month?
What to produce ?
Every society must choose what goods orservices to produce. Example : computer orradio?
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40
E ONOMI S
MICROECONOMICS MACROECONOMICS
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Microeconomics vs. Macroeconomics
Microeconomicsfocuses on the individual parts of theeconomy.
(Micro = the ancient Greek word for small)
How households and firms make decisions and howthey interact in specific markets
Macroeconomicslooks at the economy as a whole. (Macro is the Greek word for large)
Economy-wide phenomena, including inflation,unemployment, and economic growth
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The production possibilities curve is used toexplain the basic economic concepts of scarcity,choicesand opportunity cost.
The PPC shows various possible combinationsof goods and services that can be produced with
the given amount of resources in a given periodof time.
Production Possibilities Curve (PPC)
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Production Possibility Curve
The following assumptions are made to illustratethe PPC.
There is a fixed quantity of resources
The economy only produces two products
Allresources within the economy are used
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Production Possibility Schedule
Combination Consumer
Goods (Unit)
Capital Goods
(Unit)
A 0 15
B 4 14
C 7 12
D 9 9
E 11 5
F 12 0
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Production Possibility Curve
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Calculation of opportunity cost
Opportunity to move from B to C : (12-14)/(7-4) = - 2/3
meaning : to increase 1 unit of consumer goods, capital goodsmust be reduced as much as 2/3 units.
Opportunity to move from D to E : (5-9)/(11-9)= -2,
meaning : to increase 1 unit of consumer goods, 2 units ofcapital goods must be reduced
This example explains the concept or law ofincreasing opportunity cost.
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Points along the PPC
Any point along thePPC such as A, B, C,D and E and F are
known as efficientpoints because theresources are used
efficiently.
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Points Inside PPC
Point T is known asinefficient pointbecause the resources are
not being fully employed.This point also shows
unemployment.
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Economic Growth
When the country enjoys economic growth, thePPC bounds outward. With economic growth,the production capability of a country increases
as there is expansion of resources such as land,labour, capital and entrepreneurship.
Increase in resources or technology can shift the
PPC to right.
Ri h d Shif i PPC i
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Rightward Shift in PPC - Economic
Growth
Leftward Shift in the Economys PPC
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Leftward Shift in the Economy s PPC
Decrease in the availability
or the quality of resources
shifts the PPF inward
Parallel shift again implies
that the change was equallyapplicable to both consumer
and capital goods
Decrease in availableresources
F t th t Shift th PPF
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Factors that can Shift the PPF
Changes in Resource Availability Increase in Quantity of resourses rightward shift Reductions in Quantity of resources leftward shift
Changes in Quality of Resources
Improvement in Quality of resourses rightward shift Reductions in Quality of resources leftward shift
Increases in the Capital Stock Increases rightward shift
Decreases leftward shift
Technological Change Employs available resources more efficiently rightward shift
Shift in th E n PPF
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Shifts in the Economys PPF
I ncrease in resour ces
or technological
change that benefi ts
consumer goods
Shifts in the Economys PPF
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Shifts in the Economy s PPF
I ncrease in resources
or technological
advance that benefi ts
capital goods
Model:
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Model:
The Circular-Flow Diagram
The Circular-Flow Diagram: A visual model of theeconomy, shows how dollars flow through marketsamong households and firms.
Includes two types of actors:
households
firms
Includes two markets:
the market for goods and services
the market for factors of production
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FIGURE 1: The roles of firm and household
Households: own the factors of production,
sell/rent them to firms for income
buy and consume goods & services
Households
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FirmsHouseholds
Firms:
buy/hire factors of production,use them to produce goods
and services
sell goods & services
Th Cir l r Fl Di r
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The Circular-Flow Diagram
Markets forFactors of
Production
HouseholdsFirms
IncomeWages, rent,profit
Factors of
production
Labor, land,
capital
Spending
G & Sbought
G & Ssold
RevenueMarkets for
Goods &Services
Markets
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Markets
Product markets
Markets in which goods and services are
bought and sold.
Example : supermarket, shoe shop,
restaurant
Resource Markets
Markets in which the resources are
exchanged Example : Job market is the most important
of the resource markets
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Households supply resources in the
resource market and demand goods andservices in the product market.
Firms supply goods and services inproduct market and demand resources in
the resource market
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Money flows in resource market determinewages, interest, rents, and profits which flow
as income to households
Product markets determine the prices for
goods and services which flow as revenue to
firms