Topic 1 — Introduction to Economics

What is the economic problem?

The economic problem is the issue of scarcity and how a society can attempt to satisfy unlimited wants with limited resources available. Since all wants cannot be satisfied, choices must be made by ranking preferences. Each decision made involves choosing one option and choosing to forego an alternative

What is an economy?

An economy is the organisational structure in which the economic problem is addressed in society, where there are unlimited wants and needs.

What is economics?

Economics is the study of distribution, exchange and production of goods and services in an economic system, allocating society’s scarce resources to individual and unlimited wants. The study of economics follows the assumption in maximising the wellbeing of its people.

What are wants?

Wants can be defined as the material desires of individuals or the community and are items that provide some degree of pleasure or satisfaction when consumed. Individuals want many different goods and services to increase their quality of life or to feel pleasure.

What are the different types of wants?

Individual wants, collective wants, recurring wants, single wants, complementary wants, substitute wants

What are individual wants?

Individual wants are the desire of each person. These depend on personal preferences but can be influenced by broader social trends. The number of individual wants that can be satisfied differs from person to person.

What are recurring wants?

Recurring wants are wants that are required to be repetitively satisfied at regular intervals.

What are single wants?

Single wants are wants that is only needed to be satisfied once, such as an injection.

What are complementary wants?

Complementary wants are wants which are satisfied as a result of another want. Hence the demand for one of the G or S are derived from the demand of the other G or S.

What are substitute wants?

Substitute wants are products that are consumed as alternatives to each other. The demand for one want will affect the demand for other wants.

What is a collective want?

A collective want is what society demands as a whole, generally provided by governments through tax such as parks and libraries.

Four questions of an economy

What to produce?

How much to produce?

How to produce?

How to distribute production?

What is a luxury want?

Luxury wants are non-essential goods and services desired by consumers, such as sports cars and designer clothes.

How does an economy decide what to produce?

There are limited resources in an economy. An economy must decide which wants it will satisfy first and which it will leave unsatisfied.

How does an economy decide how much to produce?

An economy must allocate limited resources efficiently and maximise the satisfaction of wants. When an economy produces too much of a good, resources will be wasted, and when an economy produces too little, the wants of some individuals will be left unsatisfied.

How does an economy decide how to produce?

An economy must look for the most efficient method of production that uses the least amount of resources, so the greatest number of wants are satisfied at any one point in time.

How does an economy decide how to distribute production?

People on higher incomes can afford to buy more goods and services than people on lower incomes, and therefore recieve a bigger share of total production. An economy must decide whether it wants more of an equitable distribution of production or a more inequitable distribution.

What is the opportunity cost?

The opportunity cost is what is foregone as a result of satisfying an alternative want. Every economic decision involves an opportunity cost, and this can be expressed in terms of output, items or time.

What is the production possibility frontier?

The PPF is a graphical representation of the various combinations of two alternative products that the economy can produce with a given technology and a fixed quantity of resources, when they are used to their full capacity at any given time. Realistically, a production possibility frontier is drawn concave to the origin as substituting resources for the production of two different goods at a constant rate is not realistic.

What are the assumptions of the PPF?

• The economy only produces two goods

• The state of technology is constant

• The quantities of resources available remains unchanged

• All resources are fully employed

What is distribution?

Distribution is the way goods and services are allocated across the economy through the price mechanism.

What is exchange?

Exchange is the transfer of goods and services between two or more parties, where each party gives up something to receive something else of perceived value.

image of a PPF and different features, i will label

What is the effect of new technology on the PPF?

Since more efficient methods of production are adopted, a higher quantity of a good can be produced which causes an outward shift of the PPF. INSERT IMAGE!

What is the effect of the discovery of new resources on the PPF?

Discovery of new resources causes the PPF to shift to the right as more of both goods can be produced.

Where does unemployment lie in relation to the PPF?

Unemployment lies within the PPF as the economy would be producing at a point inside the PPF. There is an inefficient allocation of resources, as the maximum satisfaction of wants with the minimum opportunity cost.

What are consumer goods and services?

Consumer goods and services are items produced for the immediate satisfaction of individual and community needs and wants.

What is a good?

A good is a physically tangible object that can be used to satisfy economic wants.

What are capital goods?

Capital goods are goods used to produce other consumer goods, and are bought by businesses to help grow their businesses. They are usually durable goods such as machinery.

What are services?

Services are physically intangible actions that can be performed to satisfy wants such as hairdressing, car washing and medical care.

What are households?

Households are a unit that consumes goods and services and supplies labor and other resources to firms. Individuals income goes either to spending on consumption of locally produced goods, savings and tax.

What is the future effect of an economy focusing on the production of capital goods in the present?

The economy will increase its productive capacity and experience a higher level of economic growth.

What are the economic factors underlying choices for individuals?

• Age

• Income: how much an individual chooses to save or spend

• Expectations regarding the rise or fall of personal income

• Future plans

• Family circumstances

• Personality factors

• Performance of assets

• Education

• Retirement

What are the economic factors underlying choices for businesses?

• Price of G anf S

• Marketing strategies

• Production and resource use

• Ethical issues: environment, political, labour

• Industrial relations issues

• Wage levels

What are the economic factors underlying choices for government?

• Tax

• Imposing penalties

• Providing incentives

• Result of influencing the decisions of consumers and businesses

What is a factor of production and what are the four main types and their return??

Factors of production are any resources that can be used in the production of G and S. The four main types are

• Capital: Interest

• Enterprise: Profit

• Land: Rent

• Labour: Wages

What is a firm?

Firms are businesses which deal with the production or sale of goods and services.

What is land as a factor of production?

Land refers to natural resources which include all naturally occuring materials in the production process. The reward of rent covers all the income derived from the productive use of natural resources.

What is labour as a factor of production?

Labour is human effort used to produce goods and services and its supply is influenced by social factors such as the size of a country’s population and the school leaving age. The return for labour are wages.

What is capital?

Capital is resources, both physical and financial, used to produce goods and services. Infrastructure is a form of capital that is owned by the community as a whole, such as roads, railways and bridges. The existence of these entities are necessary for the transport of goods and hence the operation of businesses. The owners of capital are rewarded by earning interest.

What is human capital?

Human capital is the level of skills, education, learning, training, experience, productivity and health of an individual or work force.

What is enterprise?

Enterprise involves the organisation of the other factors of production for the purpose of producing goods and services. Profit is the return to enterprise.

What is GDP?

GDP is the value of all goods and services produced in a country in a given period, which is usually one year. It is used to measure economic growth.

What is the business cycle?

The business cycle is a graphical representation of fluctuations in economic activity between peaks and troughs.

What is a recession?

A recession is two consecutive quarters (six months) of negative economic growth.

What is a depression?

A depression is a longer term period of negative economic activity.

What are needs?

Needs are G and S which are considered vital for human survival.

What is the businesses sector?

Businesses engage in the production and sale of G and S and depend on individuals to supply labour for the production process as well as the consumption of G and S produced. Individuals/households would not exist without businesses, they are interdependant

What is real GDP?

Real GDP is the auantitative measure of the increase in productive capacity (output) of an economy after adjusting for inflation.

What is economic growth?

Economic growth refers to increases in output over time and is measured by increases in real GDP. The Australian government desires an annual EG rate of 3-4% per year.

What are financial institutions?

Financial institutions are institutions engaged in the borrowing and lending of money and act as the intermediaries between savers and borrowers of money. Examples of financial instituatins are banks, building societies, finance companies and credit unions. They are needed for individuals and firms to be able to undertake saving and investment. Financial institutions accept savings from individuals and lend these savings to businesses for investment purposes.

What is a leakage?

A leakage is the flow of income out of the circular flow of income, reducing the amount of money available in the respective economy. Decreased income decreases leakages and results in less economic activity.

• Savings, Taxation, Imports

What is investment?

Investment is defined as any current expenditure that is made in order to obtain future benefits and is the process of capital accumulation undertaken by firms. It is an injection into the business sector.

What is the government in terms of the circular flow of income?

The government is an authorative body which seeks to satisfy collective wants through imposing taxes on other sectors in the economy.

What is tax?

What are imports?

Imports refers to spending by Australians on foreign goods and services. Money spent on imports are considered leakages.

What are exports?

Exports refers to spending by foreigners on Australian goods and services. Money spent on exports are considered injections.

What are injections?

Injections are when income flows into the circular flow of income, increasing the amount of money available in the economy. A decrease in injections leads to a decrease in income and output.

• Exports

What is interest?

Interest is compensation to the lender for foregoing other investments that could have been made with the loaned money and is the cost to the borrower.

What are real interest rates?

Real interest rates express the cost of borrowed funds after expected erosion due to the rise in the general price level.

• Real Interest Rate ≈ Nominal Interest Rate - Inflation Rate.

What is the nominal interest rate?

The nominal interest rate is the desired return rate including inflation.

• Nominal Interest Rate ≈ Real Interest Rate + Inflation Rate.

What is a factor income?

Factor income is income gained in return for giving something to the production process.

What is a factor market?

Factor markets are where businesses buy good and services for self benefit, or where the FOP are sold

What is a product market?

A product market is where final products are sold. Households are the demanders and and firms are the suppliers.

When does equilibrium occur in the circular flow of income?

Equilibrium occurs when leakages equal injections

• S + T + M = I + G + X

When does disequilibrium occur in the circular flow of income? When does economic activity grow and decrease?

Disequilibrium occurs when leakages do not equal injections

• Growth in economic activity: S + T + M < I + G + X

• Decrease in economic activity: S + T + M < I + G + X

What are injections?

Injections are the flow of income into the circular flow of income, increasing the amount of money available in the respective economy

• Decrease in injections leads to a decrease in income and output (lower economic growth)

• Investment, govt expenditure, exports

What is a free economy?

A free economy is an economy with an overseas sector.

What is aggregate demand?

Aggregate demand is the total amount of demand for all finished goods and services produced in an economy. 55-60% of aggregate demand is consumption

What is a planned economy?

A planned economy is an economy where the government has total control over its economic decisions.

What is a market?

A market is where buyers and seller meet and agree on a price of a product at a particular time.

What is price mechanism?

Price mechanism is the process by which decisions about production quantities and selling prices are determined by buyers and sellers in the marketplace.

What is consumer sovereignity?

Consumer sovereignity refer to how the pattern of consumer spending determines the pattern of business production and resource allocation.

What is a mixed market economy?

A mixed market economy is an economy which is determined by government decisions and market forces.

• Private ownership

  • Make decisions about production, consumption, investment

  • Free competition

• Government intervention

  • Government provides goods and services

What is a real money flow?

Real money flow refers to the movement of actual goods and services alongside the flow of money in the economy.

What is a financial money flow?

Financial money flow is the movement of cash into and out of sectors in an economy.

What is potential output?

Potential output is the long term expected growth of output due to increases in population, productivity and participation rates of labour.

What is indirect tax?

Indirect tax is when the impact and incidence are different.

What is price?

Price is a monetary indicator of the relative value of G and S in an economy.

What is gross income?

Gross income is the total of an individual’s income from factor incomes before the deduction of taxation

What is disposable income?

Disposable income is gross income minus taxation and is the money that consumers can do whatever they want with. Disposable income is the key driver of consumption.

What is final income?

Final income is gross income minus taxation plus social wage - indirect tax

What is productivity?

Productivity is the output per unit of usually labour per unit of time.

What is a market?

A market is a place where buyers and sellers of goods and services interact at a particular price at a particular time.

What is specialisation?

Specialisation is when individuals, firms, or countries concentrate on producing what they are most efficient at.

What is efficiency?

Efficiency refers to the costs to the producer versus the quality of the products produced.

What are savings?

Savings is the income not spent by an individual and savings are often lent to financial sector in return for interest payments. It is a leakage from household to financial sector in return for interest payments.

What is a primary industry?

Primary industries are usinesses that deal with the extraction of raw materials from the environment, above and below the land.

What is a secondary industry?

Secondary industries are businesses which deal with the conversion of raw materials through manufacturing into final goods or capital goods (10%)

What is a tertiary industry?

Tertiary industries are businesses which provide services, such as banking, retail, plumbing, education (85%)

What is the MPC?

The MPC is the rate of change in ONE DOLLAR of income which leads to a change in DOLLARS spent on CONSUMPTION. It is similar to the gradient of a line and describes the relationship between income and consumption.

What is the MPS?

The Marginal Propensity to Save is the Y intercept on the savings vs consumption graph. MPC + MPS = 1

What is productive/technical efficiency?

Productive/technical efficiency is when the highest level of production is achieved from full employment and resources at the lowest cost to the producer

What is allocative efficiency?

Allocative efficiency is the allocation of resources in best meeting and satisfying the needs of society by minimising the opportunity cost of available resources. Allocative efficiency aims to produce the right amount of goods or services at the right price for the right amount of consumers.

What is dynamic efficiency?

Dynamic efficiency refers to the ability of the economy to accommodate the wants and needs of society.