Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & BajadaSlides prepared by George Bredon

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Chapter 1

The general principles of economics


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Learning objectives1. Describe the nature and methodology of economics,

including the two fundamental facts that comprise the economising problem.

2. Explain specific problems, limitations and pitfalls encountered in studying economics.

3. Discuss the meaning of economic efficiency.

4. Introduce the concept of opportunity cost and the law of increasing opportunity cost.


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Learning objectives (cont.)

5. Illustrate, extend and modify the definition of economics through the use of production possibilities tables and curves.

6. Use the production possibilities curve model to examine the trade-off between current and future consumption.


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The economic perspectiveEconomics is concerned with the efficient use of limited productive resources for the purpose of attaining the maximum satisfaction of our material wants.


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The economic perspective (cont.)• Reasons for studying economics:

– provides valuable knowledge concerning our social environment and economic behaviour

– provides the knowledge needed to make fundamental decisions in a democracy

– provides businesses and consumers with valuable information and a set of methods for analysing information

– outlines the special perspective held by economists about scarcity, rational behaviour and the use of marginal concepts in decision making.


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The economic perspective (cont.)The economic perspective includes:• Scarcity and choice

– Resources are limited and this necessitates choices.

• Behaviour based on ‘rational self-interest’– Behaviour involves decisions and actions aimed at achieving

the greatest satisfaction or maximum fulfilment of goals.– Choices differ between people because their circumstances,

preferences and available information differ.

• Marginalism: benefits and costs– Marginal means ‘additional’ or ‘extra’.– Economic decisions compare marginal benefits and marginal

costs.– Additional benefits available from any changes are compared

to the additional costs of making the change.


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The foundation of economicsTwo fundamental facts that constitute the economising

problem:• Unlimited wants

– Material wants: the desires of consumers to obtain and use various goods and services that give utility or satisfaction

• Scarce resources– Economic resources includes all the natural, human and

manufactured resources that go into the production of goods and services. These include:

property resources —land, raw material and capital human resources—labour and enterprise.


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Scarce resourcesTwo broad categories:• Property resources

– Land and raw materials: all ‘gifts of nature’ usable in production

– Capital: aids to production e.g. factories, machinery

• Human resources– Labour– Entrepreneurial ability: initiation and organisation of factors

of production, promotes innovation, takes risks


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Resource payments• Land—rent• Capital—interest• Labour—wages• Enterprise—profit


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Five fundamental questions• How much total output is to be produced?• What combination of outputs is to be produced?• How are these outputs to be produced?• Who is to receive/consume these outputs?• How can change be accommodated?


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The methodology of economics

2. Principles or theoriesTheoretical economics involves generalising about economic behaviour.

induction

deduction

1. Facts Descriptive, or empirical, economics is concerned with gathering facts relevant to an economic problem and testing hypotheses against those facts.

3. PoliciesPolicy economics is concerned with controlling or influencing economic behaviour or its

consequences.


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Induction and deduction

• Induction– A method of reasoning that proceeds from facts to

generalisations.

• Deduction– Reasoning from assumptions to conclusions by testing

a hypothesis.


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Economic theory• Facts must be systematically arranged, interpreted

and generalised to derive appropriate economic theory.

• Theories or principles are the end result of economic analysis. These are meaningful statements drawn from facts.


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Terminology of economic theory• Economists use the terms ‘laws’, ‘theories’ and

‘models’ to represent generalisations, or statements of regularity, about the economic behaviour of individuals and institutions.

• Abstractions in economics– Economic theories do not encompass the full

complexity of reality.


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The ‘other things being equal’ assumption • The ‘other things being equal’ assumption

– Sometimes referred to as ‘ceteris paribus’

– Used in the process of analysis to signify that all variables, other than the one being considered, are held constant

– Used to focus attention on relationship between chosen variables to minimise distracting influence of other variables


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Microeconomics and macroeconomics

• Microeconomics is concerned with specific economic units and a detailed consideration of the behaviour of these individual units.

• Macroeconomics deals with the economy as a whole, or with the basic subdivisions or aggregates that make up the economy.


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Policy economics: positive and normative • Positive economics is based upon facts without value

judgements.• Normative economics is based upon subjective

beliefs . . . ‘what ought to be’– Normative economic statements come into play at the

level of policy economics.


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Pitfalls of objective thinking

• Bias• Fallacy of composition• Cause and effect

– Post-hoc fallacy

– Correlation versus causation


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Economics and efficiency

• Efficiency results from using or administering scarce resources to produce the maximum amount of the goods and services desired by society thereby achieving the greatest possible fulfilment of society’s wants.

• Full employment– When all available resources are employed

• Full production– When the maximum amount of goods and services are

produced from the fully employed resources of an economy

– Underemployment results if full production not achieved


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Economics and efficiency (cont.)

Types of efficiency

•Allocative efficiency– Occurs when all available resources are devoted to the

combination of goods most wanted by society

•Productive efficiency– Occurs when goods or services are produced using the

lowest cost production methods


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Specialisation and efficiency

• Two major forms of specialisation enhance efficiency:– The division of labour builds on existing differences in

abilities and skills.

– Geographic specialisation builds on locational resource advantages.


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Production possibilities table• Used to illustrate the economising problem and the

concepts of scarcity and opportunity cost

Assumptions– Efficiency

Full employment and productive efficiency.

– Fixed resources– Fixed technology– Two products only

Capital good and consumer good.

• In short run resources are scarce so output is limited – Implies that increase in production of one good means shift

of resources from production of the other good


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Production possibilities of chocolate and tractors with full employment

___________________________________________________________

Type of product Production alternatives

A B C D E

Chocolates (100 000s bars) 0 1 2 3 4

Tractors (1000s) 10 9 7 4 0

___________________________________________________________


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Production possibilities curve• The production possibilities curve (PPC) can be used

to illustrate the concept of choice and opportunity cost.

• Demonstrates that society must make choices about which goods and services to produce and which to go without

• Data from the PP table can be used to plot PPC


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Production possibilities curve (cont.)

• Points on the PPC represent a maximum output of the two products.

• Points inside the PPC are attainable, but are inefficient and undesirable.

• Points outside the curve are superior, but unobtainable given the assumptions of fixed technology and resources.


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Q

Q

Tra

cto

rs (

tho

us

an

ds

)

Chocolate bars (hundred thousands)

121110 9 8 7 6 5 4 3 2 1

A B

C

D

E

W

Unattainable

Attainable andefficient

Attainablebut inefficient

U


1 2 3 4 5 6 7 81 2 3 4 5 6 7 8


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• Opportunity cost: – The amount of other products that must be sacrificed

to obtain an additional unit of a good

• The PPC is concave to the origin because of the law of increasing opportunity costs:– more and more of a good must be given up to obtain

additional units of the other good.



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Law of increasing opportunity costs

• Concavity: the slope of the concave PPC becomes steeper as we move from A to E – To gain progressively more chocolate production

society has to give up increasing levels of tractor production and vice versa.

• Rationale:– Economic resources are not completely adaptable to

alternative uses; they are imperfect substitutes.

– Resources lack perfect flexibility or interchangeability.


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Allocative efficiency revisited• Resources are efficiently allocated to any product

when the output is such that its marginal benefit equals its marginal cost (MB = MC).


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Unemployment and growth• Points inside the production possibility curve illustrate

unemployment or productive inefficiency.• A movement towards full employment and productive

efficiency from a point such as U will entail a greater output of at least one, if not both, products.


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Unemployment and underemployment

Q

Q

Tra

cto

rs (

tho

us

an

ds

)


1010 99 88 77 66 55 44 33 22 11

A B

C

D

E

More of either orboth is possible

U

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8


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Economic growth and the PPC• Economic growth can be represented as an outward

shift (to the right) of the PPC.• Economic growth results from:

– expanding resource supplies

– technological advances.


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Q

Q

Tra

cto

rs (

tho

us

an

ds

)


1413121110 9 8 7 6 5 4 3 2 1

AA′′

BB′′

CC′′

DD′′

EE′′

Economic growth and the PPC (cont.)

1 2 3 4 5 6 7 8


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The role of markets and prices

• Market or price system is the basic coordinating mechanism of a capitalist economy.

• Markets bring buyers (‘demanders’) and sellers (‘suppliers’) of a good or service into contact with each other.

• Product and resource prices are set as a result of the choices made by demanders and suppliers in product and resource markets.

• Markets help society make some or all of its decisions about the five fundamental questions raised earlier.


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Present choices and future possibilities

The PPC can be used to:• illustrate the importance of society’s choice between

current and future consumption• demonstrate the economic basis for trade between

nations.


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Goods for the present Goods for the present

Goo

ds f

or t

he f

utur

e

Goo

ds f

or t

he f

utur

e

2012 Curve

2023 curve

2023 curve

2012 Curve

Alphania Betania

Economic growth in two countries


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Graphs and their meaning

Appendix to Chapter 1


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Constructing a graph

• Graphs are a visual representation of the relationship between two variables.

• Possible graphing relationships between variables– Direct (positive) relationship:

where the values of two related variables change in the same direction, e.g. consumption and income

– Inverse (negative) relationship: where the values of two related variables move in opposite directions, e.g. ticket prices and attendance


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Direct relationship

0

$500

$400

$300

$200

$100

Co

nsu

mp

tio

n (

C)

Income (Y)

Consumptionschedule

C = 50 + 0.5Y

ab

cd

e

As Income (Y) increases, consumption (C) increases

$100 $200 $300 $400


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Inverse relationship

0

$25

$20

$15

$10

$5

Tic

ket

pri

ce (

P)

Attendance in thousands (Q)

a

b

c

d

f

As price (P) decreases, so attendance (Q) increases

e

P = 25 – 1.25Q

Ticket demand curve

4 8 12 16 20


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Slope of a straight line• The slope is the ratio of the vertical change to the

corresponding horizontal change involved in moving between two points.

• Ratio stays constant for a straight line


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Positive slope

o

$500

$400

$300

$200

$100

Co

nsu

mp

tio

n (

C)

Income (Y)

ConsumptionC = 50 + 0.5Y

ab

c

de

vertical change = +50

horizontal change = +100

0.5100

50

change horizontal

change verticalSlope

$100 $200 $300 $400


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Negative slope

0

$25

$20

$15

$10

$5

Tic

ket

Pri

ce (

P)

Attendance in thousands (Q)

Ticket demand

P = 25 – 1.25Q

a

b

c

d

f

25.14

5

change horizontal

change verticalSlope

– 5

+ 4

e

4 8 12 16 20


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Three addenda• The discussion of the slope of a line needs the

following three additional comments:– measurement units– marginal analysis– infinite and zero slopes.


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Equation form• Linear relationship

y = a + bx

Where y = the dependent variable

a = the vertical intercept

b = the slope of the line

x = the independent variable


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Slope of non-linear curves

Tangent

A

A

a

a

X

Y

P


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Slope of non-linear curves (cont.)

X

Y40

30

20

10

0

P

b

b

10 20 30 40


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Next chapter

Demand and supply

Documents

Copyright © 2012 McGraw-Hill Australia Pty Ltd PowerPoint presentation to accompany Economic Principles 3e, by Jackson, McIver, Wilson & Bajada Slides