Preliminary Economics Topic One: Introduction to Economics

The nature of economics

1.1 The economic problem – wants, resources, scarcity:

The economic problem is that finite resources are scarce in relation to infinite human wants

Economies attempt to solve the economic problem by answering the four functions of the economy: what to produce? (A market economy: consumer demand), how much to produce? (A: consumer demand), how to produce? (A: business profit maximisation), to whom to distribute? (A: determined by individual incomes)

Wants can be classified as: basic wants – needs, recurring wants – wants that must be continually satisfied, substitute wants – interchangeable goods and services, luxury wants – expensive but not essential goods and services, complementary wants – wants derived from other wants, individual wants – wants of each person, collective wants – wants demanded by a community/group

The four factors of production (paid in factor incomes/payments) or types of resources are: land (paid in rent), labour (paid in wages), capital (paid in interest) and enterprise (paid in profit)

1.2 The need for choice by individuals and society:

Both individuals and society are limited by scarcity. This implies that people want more than what is achievable. Because of this, choices have to be made on a daily basis by all consumers, firms and government. We need to realise that economic resources are limited, but human needs and wants are unlimited, so that means we need to make choices, i.e. people need to pick which of their desires they will satisfy and which they will leave unsatisfied.

In this frontier, marginal rate of substitution (MRS) is 1 car for 1 food (or vice versa) and is constant

Points G, H and I are currently unattainable and point X represents an unemployment of resources

1.3 Opportunity cost and its application through production possibility frontiers:

Opportunity cost is the cost of the alternative foregone by presenting consumption or production decisions. eg. buying a $1 apple instead of a $1 orange has an opportunity cost of an orange

Opportunity cost can be graphed as a production possibility frontier from a production possibility schedule:

A frontier can be extended if: more resources are discovered, increase in productivity or an improvement in technology (on one or both goods/services)

A frontier may be concave to the origin when resources are not perfectly substitutable in production

When an economy’s consumer goods (y) and capital goods (x) are graphed on the production possibility frontier, economic growth is shown by an outward movement of the frontier

For figure 1.3 the following assumptions are made: only two goods can be produced with the finite resources available, all resources are fully employed, technology is constant and resources can be allocated to the production of one good or another

1.4 Future implications of current choices by individuals, businesses and governments:

Individuals, businesses and governments engage in economic activity to achieve allocative efficiency

Allocative efficiency is maximising returns from using the resources that are available

For individuals, business and governments all face the following implications:

Spend resources/money now -> Higher living standards now -> Lower living standards in the futureSave resources/money now -> Lower living standards now -> Higher living standards in the future

1.5 Economic factors underlying decision-making by: individuals – spending, saving, work, education, retirement, voting and political

participation, businesses – pricing, production, resource use, industrial relations, governments – influencing the decisions of individuals and businesses:

Income = Consumption + Saving, Y= C+S Higher income earners tend to spend more in total than lower

income earners but save a higher percentage of their incomes Individual – spending: consumption is carried out to satisfy needs

and wants Individual – saving: saving is carried out because of either: the

transactionary motive – saving to spend in the present, the precautionary motive – saving to spend in the unforeseen future, the speculative motive – saving to invest (eg. in shares) to earn a rate of return on the money invested

Individual – work: the higher the level of skill/education/qualification for a job, generally the higher the income earned, thus the higher the potential levels of saving and consumption (and higher standards of living)

Individual – education: the higher the level of education, generally the higher the level of income earned, thus the higher the potential levels of saving and consumption (and higher standards of living)

Individual – retirement: retirement influences decision making because employers legally must contribute 9.25% of employee’s gross wages to superannuation

Individual – voting and political participation: voting patterns tend to reflect a person’s economic decisions (eg. highly paid individual might vote for the liberal party)

Businesses – pricing: businesses aim for profit maximisation (TR=Price x QS) (P=TR-TC), prices are usually determined by: price = costs + mark up (profit margin) and pricing is important because total costs must be covered to gain a sufficient profit to stay/excel in business (businesses will charge at the most profitable price and also price is dependent on costs, demand and level of industry competition)

Businesses – production: a business must decide on the most efficient combination of resources (especially: capital and labour) to use

Businesses – resource use: businesses must utilise resources to their most valued use (allocative efficiency)

Businesses – industrial relations: Since labour costs (wages and salaries) represent over 70 % of production costs for most business and industrial relations, negotiation of wages and working conditions are important because they will determine the employee’s productivity and they will promote worker motivation and satisfaction

Governments – influence the decisions of individuals and businesses in four main ways: governments allocate resources (through

spending decisions) that provide infrastructure, federal government attempts to stabilise economic activity through (usually monetary and fiscal) economic policies, governments redistribute income through taxation, government regulates economic behaviour and attempts to protect consumer rights and increase competition in markets to raise efficiency and lower prices

SWERVS, RIPP, RRIE

The operation of an economy

2.1 Production of goods and services from resources – natural, labour, capital and entrepreneurial resources:

The four factors of production (paid in factor incomes/payments) or types of resources are: land (paid in rent), labour (paid in wages), capital (paid in interest) and enterprise (paid in profit) are the four types of resources used by businesses to produce goods and services

2.2 Distribution of goods and services:

The distribution of goods and services is determined by income Income is determined by: education, training, qualifications, skills,

experience, type of employment Governments redistribute income through taxation (to the

unemployed, the elderly, the disabled, the sick… etc)

2.3 Exchange of goods and services:

Economies use money as a medium for exchanging goods and services

Prices are indicators of the relative value of goods and services The exchange of goods and services takes place in markets (a

situation)

2.4 Provision of income:

Individuals are paid factor income payments in return for the resources they have ‘given’ to be utilised for production (paid in either rent, wages, interest or profit)

Final Income = Gross Income + Social Wage – Taxation – Indirect Taxes The government redistributes income (or gives out social welfare

payments)

2.5 Provision of employment and quality of life through the business cycle:

Employment in Australia is created through the private (84%) and government sectors

Employment can be categorised as in the: primary industry – raw material extraction, seconding industry – manufacturing or tertiary industry – services

The quality of life in an economy depends on the quantity and quality of goods and services in the economy and community

The business cycle is the cycle of economic activity that occurs in market economies

The business cycle consists of four phases: an upswing phase – expenditure, output, income, employment and government spending increase, a boom – expenditure, output, income and employment peak (as economic activity peaks) and shortages of resources lead to inflation, a downswing phase – expenditure, output, income and employment begin to fall, resource demand begins to decrease (unemployment) and a recession – expenditure, output, income and employment are at the minimum level and government attempts to stimulate economic activity

2.6 The circular flow of income: individuals, businesses, financial institutions, governments, international trade and financial flows:

The simple two sector circular flow of income model is based on six assumptions: the economy consists of two sectors (households and firms), households spend all of their income (Y) on consumption (C) (no savings), all output (O) produced by firms is purchased by households through their expenditure (E), there are no financial, government or overseas sectors

Three sector model relaxes assumptions 1-4, four sector model relaxes assumption 5 and five sector model relaxes assumption 6

A closed economy is one in which there is no overseas sector whereas an open economy does have an overseas sector

In the two sector model equilibrium is when Y=E=O In the three sector model equilibrium is when S=I In the four sector model equilibrium occurs when S+T=I+G In the five sector model equilibrium occurs when S+T+M=I+G+X Disequilibrium will occur when leakages do not equal injects, if

leakages > injections then Y, E, O and employment will fall (leading to a

recession and is a contraction in the flow), if leakages < injections Y, E, O and employment will rise (leading to a boom and is an expansion in the flow)

If disequilibrium occurs (in 5 sector model), changes in expenditure, output, income and employment will lead to equilibrium being regain in the economy at a time in the future

Economies: their similarities and differences

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- some general statistics for the exam-