Microeconomics: Introduction

What are economic goods?

What are economic goods?

Economic goods benefit society, have the problem of scarcity and have an opportunity cost. since they are scarce, they have some value, so consumers will pay for them, and they can be traded.

What are free goods?

Free goods have no opportunity cost, because there is no scarcity of the good. For example, air and water are free goods. These goods are not traded because they are freely available.

What is scarcity?

The basic economic problem is scarcity. Wants are unlimited and resources are finite, so choices have to be made. Resources have to be used and distributed optimally. • Scarcity refers to the shortage of resources in relation to the quantity of human wants

What is positive statement?

Positive statements are obiective. They can be tested with actual evidence, and can consequently be rejected or accepted. al Look for words such as 'will', 'is'.

What is normative statement?

Normative statements are based on value judgements. These are subjective and based on opinion rather than tactual evidence. Look for words such as 'should

What are economic agents?

Economic agents play a role in the economy It is assumed that economic agents only act in their own interests.

Who are the economic agents?

Government,Firms and Households.

Government

Governments are assumed to act on behalf of consumers. Governments intervene in the economy to different extents. For example, some might provide healthcare and education, whilst others might leave healthcare to the free market.

Firms

It is generally assumed that firms aim to maximise their profits. This is the reward entrepreneurs receive for taking risks and making investments. Some firms might have different objectives, which might involve maximising social welfare or helping the environment. Some firms might have philanthropic owners who seek to maximise the urity of others

Households

Households have to make decisions about how to spend their limited resources. Usually, consumers choose the option which maximises their utility. Workers demand wages and good working conditions. Maximisation for consumers is when consumers aim to generate the greatest utility possible from an economic decision.

What is consumer utility?

A consumer's utility is the total satisfaction received from consuming a good or service

What are the factor of production and their reward?

Capital: Physical: goods which can be used in the production investment process Fixed: Machines; buildings .Working: finished or semi-finished consumer goods Reward = Interest.

Enterprise: Managerial ability. The entrepreneur is someone who takes risks, innovates, and uses the factors of production. Resources are drawn together into the production process. Reward = Profit.

Land: Natural resources such as oil, coal, wheat, water. It can also be the physical space for fixed capital. Reward = Rent

Labour: Human capital, which is the workforce of the economy. Reward = Wages

What are renewable resources?

Renewable resources can be replenished, so the stock level of the resources can be maintained over a period of time.

What are non-renewable resources?

There are only finite resources, and this scarcity means the resource is unsustainable. Choices have to be made for where these scarce resources are best used.

Rationality in economic decision making

A firm or an individual can make decisions using intuition or rationally. Intuition uses the feelings or instincts of the consumer and does not use facts. Businesses use this when they do not have access to facts or when making the decision is difficult. A rational decision is made using several steps, and it involves analysis and facts.

What is resource allocation?

This refers to how resources are distributed among producers and how goods and services are distributed among consumers.

What are incentives on economic agents for resource allocation?

Economic agents respond to incentives, which can allocate scarce resources to provide the highest utility to each agent. •For the entrepreneur in a firm, the incentive for taking risks is profit. • Rewards are positive incentives which will make consumers better off, whilst penalties make them worse off. • Where incentives are not given properly, resources will be misallocated. • Prices in market economies provide signals to buyers and sellers, which is an incentive to purchase or sell the good. This changes their behaviour. •An entrepreneur wants to avoid loss and gain profit, which makes them want to innovate, so they can reduce their production costs, and improve the quality of their products. • Firms need an incentive to engage in risk taking, so they innovate. Without innovation, production will cost more and there will be a misallocation of resources.

What is the market economy?

• Where governments leave markets to their own devices, so the market forces of supply and demand allocate scarce resources. • Economic decisions are taken by private individuals and firms, and private individuals own everything. There is no government intervention. • In reality, governments usually intervene by implementing laws and public services, such as property rights and national defence. •Adam Smith and Friedrich Hayek were famous free market economists. Adam Smith's famous theory of the invisible hand of the market can be applied to free market economies and the price mechanism, which describes how prices are determined by the spending votes of consumers and businesses. smith recognised some of the issues with monopoly power that could arise from a free market, however. Hayek argued that government intervention makes the market worse..

Market economy : what to produce?

Determined by what the consumer prefers.

Market economy : how to produce it?

Producers seek profits.

Market economy : who to produce it for?

Whoever has the greatest purchasing power in the economy, and is therefore able to buy the good

What are advantages of the market economy?

• Firms are likely to be efficient because they have to provide goods and services demanded by consumers. They are also likely to lower their average costs and make better use of scarce resources. Therefore, overall output of the economy increases. • The bureaucracy from government intervention is avoided. • Some economists might argue the freedom gained from having a free economv leads to more persona freedom.

What are disadvantages of the market economy?

o The free market ignores inequality, and tends to benefit those who hold most of the wealth. There are no social security payments for those on low incomes. o There could be monopolies, which could exploit the market by charging higher prices. o There could be the overconsumption of demerit goods, which have large negative externalities, such as tobacco. o Public goods are not provided in a free market, such as national defence. Merit goods, such as education, are underprovided.

What is the planned economy?

o This is where the government allocates all of the scarce resources in an economy to where they think there is a greater need. It is also referred to as central planning. o Karl Marx saw the free market as unstable. He saw profits created in the free market as coming from the exploitation of labour, and by not paying workers to cover the value of their work. He argued for the "common ownership of the means of production".

Planned economy: what to produce?

Determined by what the government prefers.

Planned economy: how to produce it?

Governments and their employees.

Planned economy: who to produce it for?

Who the government prefers.

What are the advantages of a planned economy?

o It might be easier to coordinate resources in times of crises, such as wars. o The government can compensate for market failure, by reallocating resources. They might ensure everyone can access basic necessities. o Inequality in society could be reduced, and society might maximise welfare rather than profit. o The abuse of monopoly power could be prevented.

What are the disadvantages of a planned economy?

o Governments fail, as do markets, and they may not be fully informed for what to produce. o They may not necessarily meet consumer preferences. o It limits democracy and personal freedom.

What is a mixed economy?

o This has features of both planned and market economies and is the most common economic system today. o The market is controlled by both the government and the forces of supply and demand. o Governments often provide public goods such as street lights, roads and the police, and merit goods, such as healthcare and education

Mixed economy: what to produce?

Determined by both consumer and government preferences.

Mixed economy: how to produce it?

Determined by producers making profits and the government.

Mixed economy: who to produce it for?

Both who the government prefers and the purchasing power of private individuals.

What is productive efficiency?

o Productive efficiency occurs when resources are used to give the maximum possible output at the lowest possible cost. o This helps maximise consumer welfare, but it can be wasteful if the goods and services consumers want are not produced. o Moreover, benefiting one consumer by allocating more resources to them means another consumer loses out. o This is because all resources are used to their maximum productive potential, so there is no spare capacity

What is allocative efficiency?

o Allocative efficiency occurs when resources are allocated to the best interests of society, where there is maximum social welfare and maximum utility. o The goods and services consumers want might be produced where there is allocative efficiency, but they also need to be affordable. Productive efficiency helps keep the price down.

What is Pareto efficiency?

When you can't make someone better off without making someone else worse off. Any point on the PPF is pareto efficiency.

What is opportunity cost?

The value of the next best alternative forgone

What is a trade-off?

When one thing is lost to gain something else

What is a production possibility frontier?

Production possibility frontiers (PPFs) depict the maximum productive potential of an economy, using a combination of two goods or services, when resources are fully and efficiently employed. PPF curves can show the opportunity cost of using the scarce resources.

What is the law of diminishing returns?

The opportunity cost of producing more of one good increases, in terms of the lost units of another good that could have been produced.

Where on the curve is productively efficient ?

Any point on the curve.

Where on the curve is unattainable?

Any point outside the curve.

Where on the curve is productively inefficient?

Any point in the curve.

What are capital goods?

Goods which can be used to produce other goods, such as machinery

What are consumer goods?

Goods which cannot be used to produce other goods, such as clothing.

Disadvantage of opportunity cost

• Some alternatives are not easy to quantify -Moreover, because opportunity costs relate to future events, they are difficult to place a monetary value on.