Economics

Economics is a study of human behaviour. It involves looking at the ways individuals, families, businesses and governments make decisions or choices about how to use their limited resources to best satisfy their needs and unlimited wants, and in the process improve their wellbeing or living standards.

Microeconomics and Macroeconomics:

Microeconomics: the part of economics concerned with small factors that make up the economy like decisions made by individuals, consumers or firms.

Looks at:

·       Firms (e.g. Woolworths or Coles)

·       Single industries (e.g. mining or retail)

·       An individual market (e.g. Oil or property)

Macroeconomics: the study of the economy as a whole or bigger picture, including topics such as:

·       Inflation.

·       Unemployment.

·       Economic growth.

·       Booms and recessions.

Positive and normative economics:

Positive economics: is the branch of economics that concerns the description and explanation of economic phenomena using data, facts and cause-and-effect behavioural relationships. Involves the development and testing of economics theories. E.g. “if iPhones become cheaper than demand for them will increase”

Normative economics: is a part of economics that expresses value judgement or opinions about economic fairness or what the outcome of the economy or goals of public policy ought to be. E.g. “the Australian government should spend more on defence and less on the unemployed”.

Needs and wants:

Needs: Essentials that we require in order to live. For example, food, shelter, health care and clothing.

Want: Other less essential things that make life more pleasant. For example, iPods, laptops, TV’s.:

Wants are unlimited because:

As one want is satisfied, another appears (e.g. want for food for our next meal)

·       The more we have, the more we want.

·       Growing population.

·       Obsolescence of material goods.

·       Want to keep up with fashions and trends.

To satisfy the demands of consumers, produces require the economic resources (Also called ‘Factors of production’) used to produce goods and services.

·       Land or Natural: the productive inputs that occur in nature (e.g. mineral deposits, forests, oceans, native, animals, weather, etc.)

·       Labour: The various intellectual talents as well as the physical power provided by the labour force.

·       Capital: The manufactured or producer goods used by firms to help make other finished goods and services (e.g. physical plant or machinery)

Relative scarcity arises because the volume and/or efficiency of resources available for production in finite or limited, relative to the level of people’s needs and wants, which are virtually unlimited.

·       Individuals, households, businesses and countries all face the issue of relative scarcity as they don’t have enough resources to fulfill every single ‘want’.

·       How many needs and wants will be satisfied depends on the availability of resources and the level of efficiency that is achieved.

·       The more efficient we are, the more needs and wants we can satisfy, and the better our living standards will be.

Opportunity cost: Relates to the value of production or consumption forgone (i.e. given up) in one area when resources are allocated or diverted to their next best alternative use.

·       Because of the problem of relative scarcity, choices must be made. Importantly choice we make necessarily means that sacrifice an alternative, e.g: If you have $2 to spend and you can either buy a bag of chips ($2) or can of coke ($2), which will you buy?

The production possibility model: a tool that uses a simple economy producing only two goods or services, to illustrate the concepts of scarcity, choice, opportunity cost, efficiency and underutilisation of resources.

The production possibility frontier (PPF): a line that represents the productive capacity or physical limits to a nation’s production of goods and services imposed by the quantity and efficiency of the productive resources available.

Relative scarcity: Given the model economy has limited resources, the PPF shows the maximum combinations of total output that can be produced given the available resources, e.g. Point A = 25 of Coconuts & 20 of Fish.

Opportunity cost: A movement from one point to another along the PFF (e.g. Point A to Point B) means an economy is producing more of one item (Fish) and less of the other (Coconuts).

Underutilisation of resources: Any point inside the PPF (e.g. Point C) indicates the economy is not efficiently using it available resources for production.

Efficiency: aims to get the maximum output of goods and services from the resources currently available. (Represented by any point of the PPF).

Points outside the PPF (e.g. Point D) are not achievable, but the whole PPF will shift out the right (red line) if:

1.    A nation can access more resources (e.g. increased immigration, mineral discoveries)

2.    A nation can increase its efficiency / productivity, (by introducing new technologies such as automation, or upskilling the workforce) which means that waste is decreased, and more resources are used to their full potential.

Productive (or technical efficiency): is the point where a nations resources are producing the maximum amount possible (and at the lowest cost). (Again this is represented by any point such as A & B which are on the PPF).

Allocative efficiency: is where resources are allocated in combinations that allow production to satisfy the maximum possible needs and wants of consumers and the nation.

In a well functioning economy resources are allocated to allow production to most efficiently satisfy the wants and needs of society not just be technically efficient.

Eg. A nation may be productive (technically) efficient at producing both cigarettes and vegetables, but given the negative health effects of smoking, consumers and the nation would be better satisfied if all resource were used to produce healthy vegetables.

As economic agents, any decision we make will typically be made with a view to maximising our satisfaction, and these decisions will always involve trade-offs. This means that to gain something of value with our time or money, we necessarily forego the opportunity to do a range of other things with that time or money.

There are numerous examples of specific trade-offs that are made at both a microeconomic level and a macroeconomic level. For example, trade-offs experienced at the micro economic level might include:

-       The trade-off between spending and saving.

-       The trade-off between work and leisure.

Trade-offs experienced at the macroeconomic level might include:

-       The trade-off between efficiency and equity.

-       The trade-off between economic growth and the environment.

Cost-benefit analysis: The need for trade-offs will often involve the need for a cost-benefit analysis to help determine the best trade-offs to make – one that minimises the opportunity cost associated with any given decision.

A cost benefit analysis is a comparison of the expected costs and the expected benefits of a particular course of action or project.

The three basic economic questions: ‘What and how much to produce?’, ‘How to produce?’, ‘For whom to produce?’:

Who answers these questions?

1.    Price or market system – decisions are made by consumers (consumer sovereignty)

2.    System of government planning – decisions are made by the government (government sovereignty)

3.    Mixture – decisions are made by both consumers and governments Australia (mixed economy)

What and how much to produce?: Consumers in Australia ultimately determine what types of each particular good and service should be produced in order to best satisfy needs and wants of society and raise living standards. Governments do play a role, but the market is primarily driven by consumers.

How to produce?: The combination of what factors of production to use is primarily determined by the market. Government do influence how goods and services are produced to a limited extent – minimum wages, labour laws etc.

For whom to produce?: This considers how the country’s income, goods and services should be shared or distributed among individuals. Whilst the market primarily determines this, the government also intervenes to ensure a more equitable distribution of income and wealth eg progressive tax system.

Economic agents are individuals and organisations that participate in the economy, and make economic decisions.

Examples of economic agents include consumers or households, businesses and producers, and the government and statutory (government authorities and government business enterprises (Australia Post, NBN Co).

Private sector: relates to private ownership and control of resources, and the economic decision made by the owners of these resources. Eg. Households and businesses.

Public sector: relates to government ownership and control of resources and the economic decisions made by the government (all levels) and its agencies.

Material - As economic activity and production rises, incomes and/or employment rises, enabling households to purchase more goods and services, thereby increasing material living standards.

Non-material - Factors such as pollution, stress levels and the depletion of resources are negatively impacted upon by economic growth. This is likely to negatively impact non-material living standards.

Tradition viewpoint of consumer behaviour: Economists have developed models to help them understand how economies and the economic agents within them (e.g. consumers, businesses and governments) work.

Rationality and self-interest: Economists assume that consumers are rational. This basically means that consumers act in their self-interest to maximise their utility or satisfaction given their budget (or income) constraint.

This also includes considering the future consequences of their choices and shopping around for the best deal.

Ordered preferences: Accordingly, a rational consumer will compare the costs and benefits of each choice, and choose those options that give the greatest net benefit

Informed decision making: Assumes that consumers have access to relevant and accurate information in order to make rational decisions.

Marginal benefits from consumption: This means that for each additional unit of good or service that is consumed, less utility or satisfaction is gained (think pizza)

This leads consumers to maximise their utility by consuming a variety of goods and services over time, rather than just the one type.

-       Marketers use of price discounts on a second item.

Incentives are a benefit, reward or cost that motivates economic agents to make specific decisions or act in a particular way.

By contrast, a disincentive discourages economic agents from making specific decisions. A feature of disincentives is the use of costs or penalties to influence behaviour.

Governments may use subsides or cash payments to encourage consumption of beneficial goods and services eg solar panels.

Governments may use tax rebates to encourage the consumption of a desirable good or service eg health care rebate, childcare rebates.

Governments may use legislation to mandate goods/services eg education or encourage anti-smoking laws.

Governments sometimes impose indirect taxes on the consumption of goods that they want to discourage because they are dangerous for buyers or have bad effects on the broader community eg tobacco taxes.

Business and their behaviour as economic agents:

The traditional view of a business is that it generally seeks profit maximisation in both the short-term and especially long-term.

To maximise their profits, most firms make decisions that seek to do two main things – maximise their sales revenues and minimise their production costs.

Governments also use a range of incentives to affect businesses cost of production decisions.

-       Production subsides can be provided to businesses to reduce costs of production and encourage them to produce certain goods and services. Eg funding to schools.

Tax rebates ensure business can reduce their tax cost and are encouraged to expand or undertake certain types of expenditure eg 150% rebate on R&D.

As a negative incentive the increasing of indirect taxes make production more expensive and less profitable.

Government regulations can also act as a disincentive for some business activities. - - Many ban or restrict the production of certain products that bring harm to society. For instance, that are directives applying to illegal drugs, firearms, gambling, alcohol and prostitutions.

In 2012 the federal government placed a price ($23 per tonne) on carbon dioxide emissions by Australia’s biggest 500 polluters. This was to encourage them to reduce their output of carbon dioxide. Businesses tried to minimise their cost of production to maximise their profits, with the emission falling by 7% in 2 years.

This was an example of a negative government incentive for businesses to act in a certain way.

However, the government also provided a positive incentive with financial support for businesses developing sources of renewable energy.

Stabilisation of economic activity:

At the peak (boom) production capacity is exceeded, shortages occur, and inflation increases reducing purchasing power and therefore living standards.

At the bottom of the cycle (trough) GDP, incomes and production falls increasing unemployment and depressing material and non-material living standards.

The role of the government is stabilisation – ensure economic growth is neither too strong nor to weak. 3% - 3.5% GDP growth is seen as ideal. The government will therefore act countercyclically by:

Policy during recession: The government will inject more money into the economy via government spending cutting taxes.

Policy during booms: The government will constrain economic growth and will take more money from the economy (e.g. increase taxes) than it is injecting into the economy (e.g. reduce spending)

An efficient allocation of resources means all of the nation’s resources are being used in the production of goods and services in such a way that national welfare or living standards is maximised. It is also important that the resources are not mis-allocated by being used to produce goods and services not in the nation’s best interest.

The aim is to get efficiency to rise over time, as this means there are more outputs and less inputs as well as ensure socially desirable goods are maximised.

Government laws promote stronger competition: Strong competition is also seen as a good thing for consumers because they get better product and quality service, at a lower price. The Australian government has passed laws to promote stiffer competition between rival businesses (Overseen by the ACCC)

The government provides some socially beneficial goods and services: Insufficient resources may be allocated to the provision of some socially beneficial goods and services like education, health and housing. The problems are that these goods and services are very expensive to produce and so they cannot be sold profitably at a low and affordable price so that everyone, including those on low incomes, can have these.

Laws that discourage socially harmful production: In a pure market economy, there is consumer sovereignty. Firms are happy to produce whatever people demand, as long as it is profitable. Some goods and services might be profitable, but their production and consumption cause harm to others and involve costs, lowering society’s general wellbeing e.g. illicit drugs. Governments can use laws to ban or limit the production of such goods. Alternatively, they can use disincentives like taxing these products heavily, making them less attractive for consumers and producers.

Redistributing incomes more fairly:

Market capitalist economies are very good at rewarding effort, personal betterment, risk taking, innovation and entrepreneurship. This leads to an unequal distribution of income and wealth.

Government role:

To ensure all members of society can have a dignified standard of living Governments try to redistribute incomes in a fair way using:

-       Progressive personal tax system (higher income earners pay more tax)

-       Means (income) tested transfer payments to financially support the most disadvantaged in society.

-       Free access to health and education services.