ECON

THE NATURE OF THE ECONOMIC PROBLEM

• Definition of the Basic Economic Problem: The basic economic problem is concerned with how best to allocate scarce resources in order to satisfy people's unlimited needs and wants.

• Formula for Scarcity:

  • $\text{Unlimited Wants} + \text{Finite Resources} = \text{Scarcity}$

• Three Fundamental Questions:

  1. What to produce?

  2. How to produce it?

  3. For whom to produce it?

• The Three Main Economic Agents:

  • Individuals/Households: Private individuals in society.

  • Firms: Businesses operating in the private sector with the aim of earning profit for owners.

  • The Government: The public sector directly involved in economic activity, historically focused on providing services like education and healthcare.

• Needs vs. Wants:

  • Needs: Physical goods and non-physical services essential for human survival (e.g., nutritional food, water, shelter, clothing, healthcare, education).

  • Wants: Goods and services demanded by economic agents to fulfill human desires; these are not necessary for survival and are effectively infinite.

• Economic vs. Free Goods:

  • Economic Goods: Physical items that are limited in supply. They are scarce relative to demand, requiring human effort to obtain.

  • Free Goods: Items unlimited in supply (e.g., air, seawater, sunlight). They have no opportunity cost in terms of output.

THE FACTORS OF PRODUCTION

• The Four Factors (CELL):

  1. Capital: Manufactured resources used in production (e.g., machinery, tools, equipment, vehicles, factory buildings).

  2. Enterprise: The skills of an entrepreneur to combine and manage land, labour, and capital, and the willingness to take risks to earn profit.

  3. Labour: Human resources, including both skilled and unskilled mental and physical effort.

  4. Land: All natural resources (e.g., oil, coal, water, wood, metal ores, agricultural products).

• Rewards for Factors (Income):

  • Land: Rent (rental income paid by tenants).

  • Labour: Wages and Salaries (Wages are hourly/weekly; Salaries are fixed monthly).

  • Capital: Interest (the cost of borrowing or reward for lending).

  • Enterprise: Profit (the return for risk-taking after all other costs are paid).

• Mobility of Factors:

  • Geographical Mobility: The extent to which labour is willing/able to move locations for employment. Obstacles include family ties, schooling for children, and regional costs of living.

  • Occupational Mobility: The ease with which workers can switch between different jobs. This is improved by retraining and upskilling.

• Causes of Change in Quality and Quantity:

  • Quantity: Changes in demand/supply of factors, net migration (labour), discovery of new resources (land), or subsidies reducing costs.

  • Quality: Improvements in education and healthcare (labour), or new technology increasing productivity (capital).

OPPORTUNITY COST

• Definition: Opportunity cost is the cost of the next best opportunity forgone when making a decision.

• Decision Making Influence:

  • Consumers: Limited income forces a choice between purchasing different goods.

  • Workers: Choosing to specialize in one profession (e.g., teaching) means giving up the chance to pursue another career (e.g., accounting).

  • Producers: Choice of resource allocation (e.g., a car maker choosing between petrol vs. electric car R&D).

  • Governments: Tax revenue is finite; choosing to spend on infrastructure means less available for healthcare.

PRODUCTION POSSIBILITY CURVE (PPC)

• Definition: The PPC represents the productive capacity of the economy—the maximum combination of two goods/services an economy can produce at a point in time with available resources.

• PPC Diagrams:

  • Points on the curve: Productive efficiency where all resources are used and allocated to their best purpose.

  • Points inside the curve: Inefficiency or spare capacity (unemployment of factors).

  • Points beyond the curve: Currently unattainable given current resources.

• Shifts in the PPC:

  • Outward Shift (Economic Growth): Caused by an increase in the quality or quantity of factors (e.g., new technology, better education, discovery of oil).

  • Inward Shift: Caused by detrimental changes that destroy productive capacity (e.g., war, natural disasters like storms or floods).

• Movement along the PPC: Represents an opportunity cost. To produce more of good A, the economy must produce less of good B.

MICROECONOMICS AND MACROECONOMICS

• Microeconomics: The study of specific markets and individual economic agents (households, firms). Focuses on individual prices, demand for specific goods, and market failures.

• Macroeconomics: The study of the behavior of the whole economy. Focuses on aggregate variables such as GDP growth, inflation, national unemployment, and international trade balance.

THE MARKET SYSTEM AND RESOURCE ALLOCATION

• Market Equilibrium: Exists when quantity demanded ($Q_d$) equals quantity supplied ($Q_s$). The market is "cleared."

• Market Disequilibrium:

  • Shortage (Excess Demand): Price is set below equilibrium (P < P_e). Consumer demand exceeds firm supply.

  • Surplus (Excess Supply): Price is set above equilibrium (P > P_e). Firm supply exceeds consumer demand.

• Price Mechanism: The system of using demand and supply market forces to allocate resources. Features include financial incentives, economic freedom for private agents, and competition creating consumer choice.

DEMAND

• Definition: The willingness and ability of customers to pay a price to buy a product (effective demand).

• Law of Demand: Inverse relationship between price and quantity demanded.

• Determinants (HIS AGE):

  • Habits, fashions, and tastes.

  • Income (real income increases purchasing power).

  • Substitutes (positive relationship with demand for the original good).

  • Advertising.

  • Government policies (taxes and subsidies).

  • Economy (booms vs. recessions).

• Movements vs. Shifts:

  • Movements: Caused only by a change in the price of the good itself (Extensions/Contractions).

  • Shifts: Caused by non-price factors (Increases/Decreases in demand).

SUPPLY

• Definition: The ability and willingness of firms to provide goods/services at given prices.

• Law of Supply: Positive relationship between price and quantity supplied.

• Determinants (TWO TIPS or WITS):

  • Time (short run supply is less elastic).

  • Weather (critical for agriculture).

  • Opportunity cost of production.

  • Taxes (indirect taxes increase costs).

  • Innovations (technology).

  • Production costs (raw materials/wages).

  • Subsidies (government financial assistance).

PRICE ELASTICITY OF DEMAND (PED)

• Formula:

  • $\text{PED} = \frac{\%\Delta Q_d}{\%\Delta P}$

• PED Values:

  • Price Inelastic (\text{PED} < 1): Relatively unresponsive to price changes (e.g., necessities like rice, salt).

  • Price Elastic (\text{PED} > 1): Highly responsive to price changes (e.g., luxury items, goods with many substitutes).

  • Unitary ($\text{PED} = 1$): Percentage change in quantity equals percentage change in price.

  • Perfectly Inelastic ($\text{PED} = 0$): Demand does not change regardless of price (vertical curve).

  • Perfectly Elastic ($\text{PED} = \infty$): Demand drops to zero if price increases at all (horizontal curve).

• Revenue Relationship:

  • If demand is Inelastic: \text{Increase Price} \rightarrow \text{Increase Total Revenue}.

  • If demand is Elastic: \text{Decrease Price} \rightarrow \text{Increase Total Revenue}.

PRICE ELASTICITY OF SUPPLY (PES)

• Formula:

  • $\text{PES} = \frac{\%\Delta Q_s}{\%\Delta P}$

• Determinants:

  • Spare Productive Capacity: More spare capacity = more elastic supply.

  • Stocks (Inventories): High stocks = more elastic supply.

  • Time Period: Supply is more elastic in the long run.

  • Factor Mobility: If factors can switch tasks easily, supply is more elastic.

MARKET ECONOMIC SYSTEM

• Types of Systems:

  • Market Economy: Relies on demand/supply with minimal government intervention (e.g., Hong Kong).

  • Planned Economy: Relies on the government to allocate resources (e.g., North Korea).

  • Mixed Economy: Combination of both; public sector provides essential services while private sector operates for profit (e.g., UK, USA).

• Advantages: Efficiency through competition, freedom of choice, incentives (profit motive).

• Disadvantages: Income inequality, environmental depletion, lack of public goods (e.g., street lighting).

MARKET FAILURE

• Social vs. Private Measures:

  • $\text{Social Cost} = \text{Private Cost} + \text{External Cost}$

  • $\text{Social Benefit} = \text{Private Benefit} + \text{External Benefit}$

• Demerit Goods: Over-consumed in a free market (e.g., cigarettes) due to negative external costs.

• Merit Goods: Under-provided in a free market (e.g., education) despite positive external benefits.

• Public Goods: Non-excludable and non-rivalrous. The free market fails to provide them because there is no profit motive (e.g., lighthouses).

• Monopoly Power: Monopolists can restrict supply and raise prices, leading to inefficient allocation.

• Factor Immobility: Inability of resources to move between jobs/locations prevents efficiency.

MIXED ECONOMIC SYSTEM AND INTERVENTION

• Maximum Price (Price Ceiling): Set below equilibrium to make goods affordable (e.g., rent control). Leads to shortages.

• Minimum Price (Price Floor): Set above equilibrium to encourage supply or protect workers (e.g., National Minimum Wage). Leads to surpluses/unemployment.

• Other Remedies:

  • Indirect Taxes: Applied to demerit goods to reduce demand.

  • Subsidies: Applied to merit goods to reduce price and increase consumption.

  • Privatisation: Selling state assets to the private sector to improve efficiency.

  • Nationalisation: Government purchase of private firms (e.g., bank bailouts in crisis).

MONEY AND BANKING

• Functions of Money: Medium of exchange, measure of value (unit of account), store of value, standard of deferred payment.

• Characteristics of Money: Durability, acceptability, divisibility, uniformity, scarcity, portability.

• Central Banks: The monetary authority that prints banknotes, acts as the government's bank, and serves as the "lender of last resort" to commercial banks.

• Commercial Banks: Retail banks accepting deposits, making advances (loans/mortgages), and creating credit.

HOUSEHOLDS: SPENDING, SAVING, BORROWING

• Spending Factors: Disposable income, interest rates (cost of borrowing), consumer confidence, age, household size.

• Saving Factors: Interest rates (reward), precautionary reasons (emergencies), income level.

• Borrowing Factors: Interest rates, availability of funds, wealth (collateral for loans).

WORKERS AND WAGES

• Wage Factors: Salary, piece rate, commission, bonuses, fringe benefits.

• Non-Wage Factors: Career prospects, challenge, level of danger, training/education required.

• Wage Determination: Interaction of demand for labour (derived demand from product demand) and supply of labour.

• Wage Differentials: Differences based on skill (skilled vs. unskilled), gender, and sector (primary vs. secondary vs. tertiary).

• Specialisation of Labour: Dividing tasks so workers become experts (increased productivity but can lead to boredom).

TRADE UNIONS

• Role: Protect interests of members regarding pay and conditions through collective bargaining.

• Industrial Action: Methods used during disputes (Strike, Work-to-rule, Go-slow, Sit-in).

• Strength Variables: Number of members, degree of unity, and government legislation.

FIRMS AND ECONOMIC SECTORS

• Economic Sectors:

  • Primary: Extraction of raw materials (Agriculture).

  • Secondary: Manufacturing and construction.

  • Tertiary: Provision of services (Retail, Banking).

• Merger Types:

  • Horizontal: Integration of firms in the same industry.

  • Vertical (Backward/Forward): Integration of firms at different stages of production.

  • Conglomerate: Integration of firms in unrelated business areas.

• Productivity: Output per unit of input (Measure of efficiency).

  • $\text{Productivity} = \frac{\text{Total Output}}{\text{Total Input}}$

GOVERNMENT AND MACROECONOMY

• Macroeconomic Aims:

  1. Economic Growth: Increase in real GDP.

  2. Full Employment: Minimizing unemployment.

  3. Stable Prices: Low inflation (usually target around 2%).

  4. Balance of Payments Stability: Avoiding large current account deficits.

  5. Income Redistribution: Reducing wealth gaps.

• Fiscal Policy: Manipulation of taxes and government spending.

  • Expansionary: Lower taxes, higher spending (to fight recession).

  • Contractionary: Higher taxes, lower spending (to fight inflation).

• Monetary Policy: Manipulation of interest rates, money supply, and exchange rates.

• Supply-Side Policy: Long-term measures to increase productive capacity (e.g., education, deregulation, lower corporate taxes).

ECONOMIC DEVELOPMENT AND POVERTY

• Real GDP per Capita: Real GDP divided by population.

• Poverty Types:

  • Absolute Poverty: Income $\le 1.25\,USD$ per day; inability to meet basic needs.

  • Relative Poverty: Low standard of living compared to the average member of a specific society.

• Population Growth: Affected by Birth Rate, Death Rate, and Net Migration Rate.

  • $\text{Net Migration} = \text{Immigration} - \text{Emigration}$

INTERNATIONAL TRADE

• Free Trade Advantages: Access to resources, lower prices (global efficiency), economies of scale.

• Protection Methods: Tariffs (taxes), Quotas (limits), Subsidies, Embargoes (total bans).

• Floating Exchange Rate: Currency value determined by market demand/supply.

• Fixed Exchange Rate: Currency pegged to another currency (e.g., HKD to USD).

• Current Account Components:

  1. Trade in Goods (Visible).

  2. Trade in Services (Invisible).

  3. Primary Income (Investment income).

  4. Secondary Income (Transfers/Gifts).