2023ECO152_Chapter_1

Chapter 1: Basic Concepts, Relationships and Issues

Introduction to Economics

• Economics Defined: Science of household management, studying how households (individuals, households, firms, or nations) make decisions regarding scarcity.

• Key Terms:

  • Scarcity: Unlimited wants contrasted with limited means, necessitating choice and decision-making.

  • Choice: Involves opportunity cost.

  • Opportunity Cost: Value of the best alternative that is forgone when making a decision.

Opportunity Cost Explained

• Example Analysis:

  • Scenario comparing the costs of attending Concert A vs. Concert B.

    • Accountant's View: Out-of-pocket cost is $25 for Concert A.

    • Economist's View: Total cost is $25 (ticket) + $15 (benefit of not attending Concert B) = $40.

  • Opportunity cost requires thoughtful consideration and practice.

Microeconomics vs. Macroeconomics

• Microeconomics: Focuses on individual parts of the economy, including consumers, households, firms, utility, and prices.

• Macroeconomics: Examines the economy as a whole, including aggregate economic behavior, production, and price indices.

The Mixed Economy

• Key Questions:

  1. What goods and services should be produced and in what quantities?

  2. How should these goods and services be produced?

  3. For whom should the goods and services be produced?

• Decision Mechanisms:

  • Traditional: Goods produced similarly across generations without innovation.

  • Command: Decision-making by the state.

  • Market: Decisions driven by market mechanisms.

Capitalism and Centrally Planned Economies

• Capitalism: Economic system based on private property rights.

• Centrally Planned Economy: Government controls production and distribution.

• Distinction: Communism is a political system, not an economic one, operating under a single political party.

Major Flows in the Economy

• Key Flows:

  • Production, income, and spending/expenditure are flow variables (measured over time).

• Essence of Economic Activity: Production aims to satisfy wants and generates income.

Factors of Production

• Types:

  • Natural Resources: Emphasis on quality vs. quantity.

  • Labour (L): Skills and human capital.

  • Capital (K): Tools for transforming natural resources.

  • Entrepreneurship: Risk-taking in business.

  • Technology: Often considered the 5th factor of production.

Income as a By-product of Production

• Flipside of Production: Creation of income, which rewards various factors of production.

  • Rent for natural resources, wages for labor, interest for capital, and profit for entrepreneurship.

Spending in the Economy

• Income Distribution: Income is spent across all sectors to fulfill wants:

  • Consumption Expenditure by households (C).

  • Investment Expenditure by firms (I).

  • Government Spending (G).

  • Spending by the foreign sector: Exports (X) and imports (Z).

Circular Flows of the Economy

• Markets:

  • Goods and services and factor markets.

  • Definition: Market as a place for buyers and sellers to meet.

• Households and Firms:

  • Households sell factors of production to firms.

  • Firms sell goods and services to households.

Reverse Flow of Income and Spending

• Income Flow:

  • Firms spend on factors of production which provides income to households.

  • Households spend on goods and services, generating income for firms.

Government Involvement in Circular Flow

• Injections: Government spending adds to the circular flow.

• Withdrawals: Taxes represent leakages from the circular flow.

Financial Institutions Impact

• Injections: Investment spending contributes positively to the circular flow.

• Withdrawals: Savings represent leakages from the circular flow.

Complete Circular Flow Analysis

• Exports and Imports:

  • Exports inject money into the economy.

  • Imports withdraw money from the economy.

Macroeconomic Theory

• Purpose and Function: Simplification and abstraction for explanation, prediction, and policy.

Macroeconomic Policy Objectives

• Key Objectives:

  1. Full employment/low stable unemployment.

  2. Balance of payments stability/external stability.

  3. Economic growth.

  4. Equitable distribution of income.

  5. Price stability/low stable inflation.

Instruments of Macroeconomic Policy

• Monetary Policy: Interest rate adjustments and focus by the South African Reserve Bank (SARB) on inflation.

• Fiscal Policy: Government taxes and spending decisions, managed by the central government.

• Additional Policies: Include industrial, labor market, and trade policies.

Key Watchouts in Economics

• Fallacy of Composition: What is true for an individual case may not be true for the collective.

• Correlation vs. Causation: Correlation does not imply causation.

• Real vs. Nominal Values: Distinguishing between actual levels and percentage changes is crucial.

• Stocks, Flows, and Ratios: Understanding the difference between flow (over time) and stock (at a point in time) variables.

• Recognizing Rates vs. Levels: A decrease in inflation rate does not necessarily indicate falling prices.