scarcity and choice notes
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Basic Economics14th EditionFrank V. Mastrianna
CERTIFICATE IN ECONOMICS &FINANCIAL APPLICATIONS 1
ECONOMICS
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TOPIC 1
The Nature and Scope of Economics
Scarcity & Choice
Economic System
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ECONOMICS DEFINED
How people and institutions within a
society make choices
How the choices determine the use of
societys limited resources
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ECONOMICSASA SCIENCE
An organized body of knowledge
Coordinated, arranged, and systematized according to
general laws and principles
Social science
A study of the behavior and interactions of human beings as
individuals and in groups
Economics is closely link to psychology as it deals with human
behaviour
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ECONOMIC THEORYAND POLICY
Economic theory
Develops rules and principles
A guide for action under a given set of circumstances
Economic policy
Action actually taken under a given set of circumstances
Commonly modified by political, military, and social aspects
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PRODUCTION
Production
The creation or addition of utility
Utility the ability of a good or service to
satisfy a want
Total product the sum of all goods and
services produced by an economy over agiven period of time
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DISTRIBUTION
Distribution
The allocation of the total product among
the productive resources
Monetarily the distribution of money
incomes among the owners of the
productive resources
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PRODUCTIVE RESOURCES
Inputs or resources necessary before a person orbusiness can engage in the production of goods orservices
Labor the time and effort expended by humanbeings involved in the production process
Land the resources of the land, sea, and air(includes all natural resources)
Capital goods used to produce other goods and
services eg machines, buildings, trucks, etc. Investment act of adding to the supply of capital
Enterprise the act of organizing and assuming therisk of a business venture Entrepreneur a person who organizes and assumes the
risk of a business venture
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FUNCTIONAL DISTRIBUTIONOF INCOME
9
RESOURCES
Labor
Land
Capital
Enterprise
TYPES OF
PAYMENT
Wages
Rent
Interest
Profits
TOTAL
PRODUCT
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POSITIVEAND NORMATIVE ECONOMICS
Positive economics
The scientific study of what is among economicrelationships
Concerns matters that are the result ofinvestigationsthat are verifiable
Eg: When price goes up, people usually buy less of agood, ceteris paribus
Normative economics The area of economics dealing with what ought to be
(involving value judgment)
Combines economics and politics and policy 10
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CONSUMPTION
The use of a good or service
The ultimate end of economic activity
Production and distribution are driven
by consumption desires
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ECONOMIC GOODS
An object or service Utilitysatisfy a want
Scarceinsufficient to meet everyones wants
Transferable
Scarcity Not a sufficient amount available to meet everyones wants
A price has to be paid to obtain the good or service
The greater the scarcity of an economic good, the greater itsvalue or price
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GOODSAND SERVICES
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Consumer goods
Capital goodsPublic good
Free good
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FREE GOODSAND PUBLIC GOODS
Free good
A good that lacks the element of scarcity
no price
Eg air, sunshine, water (in some cases)
Public good
An economic good to the supplier Free to the user
Public parks, libraries, and the interstate
highway system
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CONSUMERAND CAPITAL GOODS
Consumer goods
Goods that are directly used by theconsuming public
Books, paper, food, and clothing
Capital goods
Goods used to produce other consumeror capital goods
Buildings, machinery, and equipment,raw materials and WIP
Durable and nondurable
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WEALTHAND INCOME
Wealth
Things of value owned at a particular time
Human capital
The stock of labor talents and skills used to increase
productivity
Total income
The total value of the goods and services produced over a
period of time (usually 1 year)
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MICROECONOMICSAND MACROECONOMICS
Microeconomics
Deals with the economic problems of the individual, the firm,
and the industry
Macroeconomics Deals with the aggregates of economics including total
production, total employment, and general price level
Studies the performance of the economy as a whole
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Scarcity and Choice
Copyright (c) 2007 by Thomson South-Western. All rights reserved.
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MAKING CHOICES
Individual choices With limited income, choices have to be made as to what to
buy and what to give up to maximise our satisfaction
Firm choices Firms and businesses have to decide what to produce, where
to produce, how to produce and who to produce for?
National choices Laborsize, educational level, skills and attitude
Landavailability of natural resources Capitalamount of capital and technological development
Enterpriseentrepreneur skills, foresight and organisationalability
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PRODUCTION POSSIBILITIES CURVE
The concepts of scarcity, choice and opportunity costapply to the individual as well as to the economy as awhole.
An economy is a mechanism which a country uses to allocatescarce resources among alternative uses.
Concepts will be more clearly shown using the PPC.
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PRODUCTION POSSIBILITIES CURVE
Shows the alternative combinations of
different goods and services that a
society can produce given its availableresources and technology
Figure 2-1 illustrates the production
possibilities curve for houses and food
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PRODUCTION POSSIBILITIES CURVE
221 2 3 4 5
15
12
9
6
3
0
Food (millions of pounds)
H
ouses(thousa
nds)
AB
C
D
E
F
Points A and Freferto the maximumamount of each
good that can beproduced
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PRODUCTION POSSIBILITIES CURVE
231 2 3 4 5
15
12
9
6
3
0
Food (millions of pounds)
Houses(thousa
nds)
AB
C
D
E
F
As we move in eitherdirection along thecurve, we choose
among the alternativecombinations of foodand housing
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Production Possibilities Curve
1 2 3 4 5
15
12
9
6
3
0
Food (millions of pounds)
Houses(thousa
nds)
AB
C
D
E
F
At point D, the economycan produce 9,000houses and 3 million
pounds of food can beproduced given existingresources andtechnology
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Production Possibilities Curve
1 2 3 4 5
15
12
9
6
3
0
Food (millions of pounds)
Houses(thousa
nds)
AB
C
D
E
F
If we move from pointDto point E, wesacrifice 3,000 homesand gain 1 million
pounds of food
This trade-off isknown as theopportunity cost
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OPPORTUNITY COST(CHIPHICOHOI)
The value of the next-best
alternative(gia tri su dung) that must
be sacrificed when a choice is made
Thus, the opportunity cost of
increasing the output of food from 3 to
4 million poundsmoving from point
D to pointEequals the 3,000 houses
that must be given up26
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OPPORTUNITY COST
ANEXAMPLEINCALCULATION
Moving from point A to B, 2million units of consumer goodshave to be given up for the first
10 million units of capital goods. OC per unit of capital good
can be calculated as follows:
Change in consumer goods /Change in capital goods
(50
48)/ (10
0) = 2 million/10 million
0.2 unit of consumer good
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OPPORTUNITY COST
ANEXAMPLEINCALCULATION
Moving from point B to C, 5
million units of consumer goods
have to be given up for the
second 10 million units ofcapital goods.
OC per unit of capital good
can be calculated as follows
Change in consumer goods/change in capital goods
(4843)/ (2010)
= 5 million/10 million
0.5 unit of consumer good
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SHAPEOFTHE PRODUCTION POSSIBILITIES CURVE
The production possibilities curve is
curved outward because resources are
not equally suited for producing bothhouses and food
As we move from pointA towards
point F, we sacrifice more and more
houses to gain equal increments of
food opportunity costs increase29
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POINTSINSIDETHE PPC
Attainable combinations BUT representcombinations which do not fully or efficiently
employ resources (e.g. point U). Involve unemployment or underemployment of
resources.
When economy is on a point inside the PPC,additional units of one good can be obtainedwithout getting less of another good.
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EXPANSIONOF OUTPUTFROMWITHINTHECURRENT PRODUCTION POSSIBILITIES CURVE
311 2 3 4 5
15
12
9
6
3
0
Food (millions of pounds)
Houses(thousa
nds)
AB
C
D
E
F
pp1
U
When the nation is operating inside the
current production possibilities curvefor
example, at point Uit is a result of either
idle or unemployed resources from a
recession or from less than maximumefficiency in the use of resources in a full-
employment economy
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POINTS OUTSIDETHE PPC
Represent unattainable combinations, given current fixedresources and technology.
Possible only with new sources of economic growth.
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EXPANSIONOF OUTPUTFROMBEYONDTHECURRENT PRODUCTION POSSIBILITIES CURVE
331 2 3 4 5 6
18
15
12
9
6
3
0
Food (millions of pounds)
Houses(thousands)
pp2pp1
Economic growth an increase in an
economys total output of goods and services
As shown by the shift from
pp1 topp2, the economy cannow produce more of both
houses and food
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SOURCESOF ECONOMIC GROWTH
Addition of labor and capital
New technology
Invention Innovation
Discovery of new resources
Improvements in productivity
Better educated and more highly skilledlabor force 34
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SCARCITYAND CHOICEINTHE UNITED STATES
The United States has an excellent combination of the
four resources
A skilled, versatile, and mobile labor force
A plentiful supply of land and natural resources
The greatest amount of capital in the world
Thriving entrepreneurial spirit
What about the case in Singapore?
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PROBLEMSOF SCARCITY
Some areas of the world lack the proper ratio of land,
labor, and capital
Some areas are short of capital and technology, natural
resources, or skilled labor
Solutionsinclude:
Increased productivity
Aid to developing nations
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SPECIALIZATIONAND EXCHANGE
Specialization
The process of limiting the scope of an economic unitsproductive efforts instead of trying to produce everything itneeds
What is produced in Brazil, Switzerland, Japan, etc??
Exchange
The process of trading surplus quantities of specializedproducts to others for other goods and services
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ABSOLUTEAND COMPARATIVE ADVANTAGE
Absolute advantage
The ability to produce a good or service using fewer
resources than other producers use
Comparative advantage
The ability to produce a good or service at a lower
opportunity cost than other producers face
Law of comparative advantage The individual, firm, or country with the lowest
opportunity cost of producing a particular good should
specialize in producing that good. 38
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COMPARATIVE ADVANTAGE BETWEEN NATIONS
Before specialization
Cotton Wheat
Country Resource Units Bales Resource Units Bushels
Shetland 3 30 2 60
North Mocha 3 15 2 40
Total 6 45 4 100
After specialization
Shetland 5 50 0
North Mocha 0 5 100
Total 5 50 5 10039
OC for 1 bale cotton:40/10 = 4 bushels of wheat
OC for 1 bale cotton:60/20 = 3 bushels of wheat
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EXCHANGE RATE
The exchange rate of wheat to cotton
will be set by bargaining between the
two countries The final settlement will depend upon
economic circumstances and the
economic strength of the parties
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The Economic System
Copyright (c) 2007 by Thomson South-Western. All rights reserved.
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QUESTIONSTOBE ANSWEREDBYALL ECONOMICSYSTEMS
What goods and services to produce
and in what quantities?
How are goods and services
produced?
Efficient use of productive resources
Who gets what is produced?
How output and income is distributed
among all members of society42
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MARKET ECONOMY
An economy in which the decisionsabout:
what to produce, how much to produce,
and how to allocate goods and services
are made primarily by individuals andfirms in the economy
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THE ROLEOF PROFITINA MARKET ECONOMY
Profit
The incentive for obtaining and using
resources to produce goods and servicesthat consumers will buy
The excess of revenue over all costs of
production
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THE ROLEOF COMPETITIONINA MARKET ECONOMY
Rivalry among individuals and firmsfor sales to consumers
The natural regulator that makes thefree market system work
Businesses compete for shares of the
consumers $Firms compete for scarce productive
resources45
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EFFECTIVE COMPETITION
The economy functions efficiently without an overseer
Consumers are protected from shoddy products and
exorbitant prices
Resource owners and workers are protected against
exploitation by the opportunities of alternative
employment options
Adam Smith call this the invisible hand the
impersonal force of competition ensures the flow ofresources towards the most efficient firms because these
firms can afford to offer the highest prices for their use.46
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THE GUIDING PRINCIPLEOFA MARKET ECONOMY
Privately owned firms should produce
the goods and services consumers
want in the quantities they wish to buy Competition is the mechanism for
regulating trade
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THE ROLEOF PRICESINA MARKET ECONOMY
Prices allocate resources
The use of land, labor, and capital is determined by the total
number of dollars spent on particular goods and services
Prices help determine incomes Purchases of individuals also determine the incomes paid to
the various resources in the form of wages, rents, interest,
and profits
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COMPETITION IN THE SINGAPORE
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COMPETITIONINTHE SINGAPOREECONOMY
Government-regulated markets
Public utilities, public transportation
Mixed economy
Contains a mixture of perfect and
imperfect competition
Contains a mixture of regulated and
unregulated industries49
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ECONOMIC LIBERALISM
An economic philosophy that promoted freedom of actionfor the individual and the firm through the doctrines of: Free trade
Self-interest
Private property Laissez faire
A policy of no government intervention in the economic activitiesof individuals and businesses
Competition
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THE ROLEOF GOVERNMENTINTHE ECONOMY
Government intervention
Necessary to remedy inequities that
developed under economic liberismPrevent monopolies and cartels from
undermining competition
Promotion of common good Deregulation and privatization
Eg deregulation of taxi fares,51
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PRIVATIZATION
The shifting or returning of government economic
functions or services to the private sector of the economy
The underlying rationale is that private enterprise can
provide certain goods and services more efficiently andless expensively than the government
Privatization of public utilities, public housing
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GOALSFORAN ECONOMY
Full employment: 95 to 96% ofcivilian labor force employed
Stable prices: Consumer Price Indexmoves 2% or less in either direction
Economic growth
A balanced budget International balance-of-payments
equilibrium 53
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OTHER ECONOMIC SYSTEMS
Traditional economy
An economy based on self-sufficiency,
with barter as the form of trade
Command economy
An economy in which a central
authority makes most of the economicdecisions regarding production,
distribution, and consumption 54
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