Study Notes on Economic Concepts

1.1 The Nature of the Economic Problem

The economic problem arises from the conflict between limited resources and unlimited wants. This necessitates choices about what to produce based on consumer needs and wants.

1.1.1 The Basic Economic Problem

Resources are limited while human wants are infinite, leading to the necessity of making choices regarding production.

1.1.2 Needs & Wants

• Needs: Essential for survival.

• Wants: Non-essential desires.

1.1.3 Types of Goods

• Free Goods: Abundant resources, e.g., air.

• Consumer Goods: Satisfy wants, categorized into:

  • Durable Goods: Long-lasting, e.g., furniture.

  • Non-Durable Goods: Short-lived, e.g., food.

• Capital Goods: Resources for producing other goods, e.g., factories.

• Public Goods: Provided by the government, e.g., hospitals.

• Merit Goods: Government-provided goods for societal benefit, e.g., schools.

1.2 Opportunity Cost

Opportunity cost refers to the value of the next best alternative that is forgone when making a choice. Every decision has associated benefits and costs.

1.2.1 Opportunity Cost in the Economy

Choosing the option that provides the greatest satisfaction at the lowest cost is essential. For example, comparing job offers based on salary and necessary expenses.

1.3 Factors of Production

Factors of production are resources used to produce goods and services, categorized into four main types:

• Land: Natural resources, e.g., minerals.

• Labour: Human resources, e.g., teachers.

• Capital: Man-made resources, e.g., machinery.

• Enterprise: Decision-makers, e.g., entrepreneurs.

1.3.1 Factor Rewards

• Land: Rent

• Labour: Wages

• Capital: Interest

• Enterprise: Profit

Mobility of Factors

• Land: Mobile through resource extraction.

• Labour: Workers can move, but not their families.

• Capital: Machinery can be transported, but factories cannot.

• Enterprise: Businesses can operate remotely.

1.4 Production Possibility Curve (PPC)

The PPC illustrates the maximum output combinations of consumer and capital goods, highlighting the trade-offs in resource allocation.

1.4.1 Understanding PPC

As resources are scarce, increasing production of one good necessitates reducing another. The PPC can shift due to:

• Increased natural resources

• Improved workforce quality

• Advancements in technology

• Better education

Factors Decreasing PPC Capacity

• Lack of investment

• Overuse of land

• Political instability

• Understaffing

2.2 Economic Systems

Economic systems vary based on government involvement in resource allocation, production decisions, and distribution.

Types of Economic Systems

• Free Market System: Minimal government intervention (Adam Smith).

• Planned Economic System: All resources owned by the government (Karl Marx).

• Mixed Economic System: Combination of both systems, prevalent globally.

Consumer Sovereignty

In a free market, consumer preferences dictate production decisions.

Market Economy vs. Planned Economy

• Market Economy: Consumers decide production based on purchasing behavior.

• Planned Economy: Government decides production based on perceived needs.

2.3 Demand

Demand is the quantity of a product consumers are willing and able to buy at a given price. Demand curves illustrate this relationship.

2.3.1 Demand Curves

Individual demand refers to one consumer's willingness to buy, while market demand aggregates all consumers' demand.

2.3.2 Price and Demand Relationship

As price increases, quantity demanded typically decreases, leading to a downward-sloping demand curve.

2.3.3 Shifts in Demand Curve

• Right shift: Increase in demand at all price levels.

• Left shift: Decrease in demand at all price levels.

Inferior Goods

Demand for inferior goods decreases as consumer income rises, e.g., public transport usage declines as more people buy cars.

2.4 Supply

Supply refers to the quantity of a product that producers are willing and able to sell at a given price.

2.4.1 Laws of Supply

Higher prices typically lead to an increase in quantity supplied, while lower prices lead to a decrease.

2.5 Price Determination

Market equilibrium occurs when quantity demanded equals quantity supplied, establishing the market price.

Excess Demand and Supply

• Excess Demand: Occurs when prices are below equilibrium, leading to shortages.

• Excess Supply: Occurs when prices are above equilibrium, leading to surpluses.

2.6 Causes of Price Changes

Price changes result from shifts in demand or supply curves, not from price changes themselves.

Impact of Taxes and Subsidies

Government interventions can shift supply curves through taxation or subsidies, affecting market prices and quantities.

2.7 Price Elasticity of Demand (PED)

PED measures the responsiveness of demand to price changes, calculated as:

PED = % Change in Quantity Demanded / % Change in Price

Elastic vs. Inelastic Demand

• Elastic Demand: PED > 1; demand changes significantly with price changes.

• Inelastic Demand: PED < 1; demand changes minimally with price changes.

2.8 Price Elasticity of Supply (PES)

PES measures the responsiveness of quantity supplied to price changes, calculated similarly to PED.

Factors Affecting PES

• Availability of resources

• Time period for production adjustments

• Spare capacity of production facilities

2.9 Market Economic System

Market economies focus on consumer-driven production, leading to a wide range of goods and services but often prioritizing profitability over societal needs.

2.10 Market Failure

Market failure occurs when the market does not allocate resources efficiently, often requiring government intervention to correct externalities.

Government Intervention

• Legislation to protect public interests.

• Taxation to fund public services.

• Subsidies to encourage production of essential goods.

Externalities

Externalities are costs or benefits incurred by third parties due to economic activities, highlighting the need for careful decision-making in production and consumption.

Cost vs. Benefit Analysis

Evaluating the trade-offs between conserving resources and pursuing commercial success is crucial for sustainable economic practices.