Basic Economic Problem and Resource Allocation Comprehensive Notes

Basic Economic Problem and Resource Allocation

Scarcity, Choice, and the Marginal Principle

• Scarcity: A situation that arises because people have unlimited wants and limited resources.

• Needs: Anything we cannot live without, such as water and air.

• Wants: Things we desire having but are not a necessity in life. An example includes mobile phones.

• Scarcity and Choice: Everyone needs to prioritize the consumption of whatever commodities they need or would like to have. Due to the existence of limited resources, people cannot prioritize all of their wants.

• The Marginal Principle: This involves thinking in a rational way.     * Customers: Take decisions to purchase an item when the benefits of the purchased item exceed the actual cost or price of the item.     * Firms: Produce a certain amount when the revenue from this amount exceeds the actual cost of its production.

Levels of Economic Study and Opportunity Cost

• Microeconomics Level: Dealing with individual decisions taken by households, firms, or even particular markets.

• Macroeconomics Level: Examining the whole economy, governments, and the entire country.

• Resource Allocation and Opportunity Cost: Due to the existence of limited resources, customers, firms, and governments might sacrifice one thing while deciding to do another. Because wants are always greater than the available resources, opportunity costs are created.

• Opportunity Cost: Defined as the 2nd best alternative forgone arising from taking a decision as a first priority.

Resource Allocation Questions

To manage resources, an economy must answer three fundamental questions:

1. WHAT?: What goods and services should get produced?

2. HOW?: How should these goods and services be produced?

3. WHOM?: Who is the target segment being provided with these goods and services?

Economics Methodology (Economics as a Social Science)

• Positive Statement (FACTS): A statement that heavily relies on facts and actual evidence.

• Normative Statement: A statement that relies on assumptions and value judgments.

• Value Judgments: Statements based on opinions and beliefs rather than facts.

• Ceteris Paribus Assumption: A Latin phrase meaning "other things being equal." In experiments, it means holding other variables constant to understand the impact of a single specific variable solely.

Time Scopes in Economics

• Short run: Increasing the output within the existing factors of production.

• Long run: Increasing the output with the condition of increasing current factors of production.

Factors of Production

Resources used to create a final good or service are called factors of production. Each has a specific reward:

• Land: Natural resources used to produce any goods or services.     * Reward: Rentals of the land itself.

• Labor: Human resources used to produce any goods or services.     * Reward: Wages given to compensate for hours spent at work.

• Capital: Man-made goods that are used to produce other goods or services (e.g., machines).     * Reward: The interest foregone from leaving that amount of money at banks instead of purchasing the machine.

• Enterprise: The individual or entity that combines the other three factors of production together.     * Reward: The profit generated from the business establishment.

Production Possibility Curve (PPC)

• Definition: A curve that shows the maximum combinations of two goods and services that can be produced in a certain period of time given available resources.

• PPC and Opportunity Cost: Allocating more resources to one good leads to sacrificing the production of another because resources are limited.     * Example: Moving from point B to A on a graph might mean sacrificing corn production for the sake of producing more robots.

Types of Opportunity Cost on the PPC

• Increasing Opportunity Cost: Sacrificing more of one product for the sake of producing a lower additional quantity of the other good or service. This is represented by a bowed-out (concave to the origin) curve.

• Constant Opportunity Cost: Sacrificing a fixed amount of production in Product A for the sake of producing the exact same amount of Product B. This is represented by a straight line.

PPC and Economic Growth

• Potential Economic Growth (Efficiency): Becoming more efficient by fully using current existing resources in a better way without waste. This occurs in the short run and does not require increasing resources.

• Actual Economic Growth (Shifting the PPC): The PPC shifts to the right, increasing the maximum capacity of production, whenever there is an increase in resources:     1. Increasing Land: Discovery of new natural resources.     2. Increasing Labor: More immigration, increasing the size of the labor force.     3. Increasing Capital: Investment in technological advances.     4. Increasing Enterprise: Increasing education so more entrepreneurs graduate and establish businesses.

• Note: An increase in resources might occur in only one sector, leading to a shift from one side of the curve only.

Specialization and Division of Labor

• Specialization: The process where workers, firms, or economies concentrate on the production of one good or service more than any other to gain advantage.

• Division of Labor: A manufacturing process split into a sequence of individual tasks.

Advantages and Disadvantages of Specialization

• Advantages:     * Increases productivity.     * Increases efficiency.     * Increases the quality produced.     * Gaining from economies of scale.

• Disadvantages:     * Can lead to worker boredom.     * Workers may become unaware of other production technologies or tasks.     * Workers could be replaced by machines as processes become standardized.     * The firm could suffer from diseconomies of scale.

Economic Systems and Resource Allocation

• Free Market Economy: Resources are allocated only through the private sector and individuals.

• Planned (Command) Economic System: Resources are allocated through the public sector or government only.

• Mixed Economic System: Resources are allocated through both the private and public sectors.

• Transition Economies: Countries moving from centrally planned systems to mixed economies.

Comparison of Economic Systems

Classification of Goods

• Economic Good: Goods that are scarce and have an opportunity cost of use (e.g., TVs, mobile phones).

• Free Good: Goods provided by nature with no opportunity cost (e.g., wind, air).

• Consumer Goods: Goods that satisfy the consumer's needs and wants.     * Durable Consumer Good: Lasts more than $1$ year without expiring (e.g., furniture).     * Non-Durable Consumer Good: Lasts less than $1$ year and expires (e.g., tuna can).

• Capital Goods: Man-made goods used to produce other goods and services (e.g., projectors and printers).

• Merit Goods: Goods beneficial to the economy but typically under-consumed (e.g., healthcare).

• Demerit Goods: Goods harmful to society and typically over-consumed (e.g., cigarettes).

• Private Good: Goods purchased by individuals for their own benefit.     * Excludable: It is possible to prevent someone from consuming it (e.g., by setting a price).     * Rivalry: Consumption by one person reduces the availability for others.

• Public Goods: Provided by the government for everyone; they are Non-Excludable and Non-Rivalry.

• Quasi-Public Good: Goods having characteristics of both public and private goods (e.g., a sandy seaside beach that is shared but may be privately owned).

• Free Rider Problem: A primary problem with public goods where individuals utilize services for free without paying. An example cited is using streetlights to generate electricity for small businesses illegally.