CHAPTER 1: WHAT ECONOMICS IS ALL ABOUT
Learning Outcomes:
This chapter introduces students to economics and the economic way of thinking. After mastering the
prescribed sections, students should be able to:

Explain what economics is all about;

Define economics;

Define the concept of opportunity cost;

Explain what the main economic problem is;

Illustrate and explain a production possibilities curve / frontier;

Construct a PPC and explain economic growth / economic contraction with the assistance of a PPC;

Describe and identify the different types of goods and services that are produced;

Explain reasons why economics is considered a social science;

Explain the difference between macroeconomics and microeconomics;

Distinguish between positive and normative economics;

Comment on the major reasons why economists disagree on certain issues;

Identify some common mistakes in reasoning about economics; and

Understand and / or define the important concepts listed at the end of the chapter.
Written assignment questions / Tutorial questions / Self-study questions:
Most definitions of Economics (see Box 1-1, p. 3) stress that Economics is a social science that is
concerned with how societies use their scarce resources to satisfy the unlimited wants of their members.
The mindmap below highlights the main issues that need to be discussed when attempting to define the
concept, “Economics”.
1




Explain the main economic problem. In your answer, you need to refer to concepts such as ordinary
business life, unlimited wants, limited means, scarcity and choices and the TANSTAAFL principle (pp.
2 – 3 and p. 5).
(4)
The word economics is derived from the Greek words “oikos” and “némein”. “Oikos” means
house, while “némein”, means manage. Economics is thus the science of household
management and as such is concerned with the ordinary business of life.
The economic problem arises because resources that we have available for production are
scarce (limited), while our human wants for good and services are unlimited.
Because resources are scarce, society is continuously forced to make choices (that are not
always easy or popular to make) about how best to utilise these resources.
With each choice made, an opportunity cost is incurred, thereby reiterating the fact that “there
ain’t no such thing as a free lunch”.
Note:
The three central economic questions that must be solved in any economic system are the following:
1.
What goods and services are produced and in what quantities?
OUTPUT QUESTIONS
2.
How will each of the goods and services be produced?
INPUT QUESTIONS
3.
For whom will the various goods and services be produced? Where will the production occur?
DISTRIBUTION QUESTIONS
2
Distinguish between the concepts “wants”, “needs” and “demand” (p. 4).
(3 X 1 = 3)
Note:
The three types of resources that are the means with which goods and services can be produced are: natural
resources (such as agricultural land, minerals and fishing resources), human resources (such as labour) and
man-made resources (such as machines).
3
Distinguish between the concepts “scarcity” and “poverty” (p. 5).
4
Define the concept “opportunity cost”, clearly stating the main reason for its existence (p. 5).
5
Define the term “production possibility curve / frontier (PPC / PPF)”. Use a diagram of the PPC / PPF
(Fig. 1-1, pp. 5 – 7) to distinguish between efficient, inefficient, attainable and unattainable production
combinations, and explain why the curve is also known as the transformation curve. (Note: whenever
you draw a diagram in Economics the axes and curve(s) must be labelled. Furthermore words as
opposed to letters are required when labelling the axes of a diagram.)
(8)
6
Make use of a PPC / PPF (Fig. 1-1, pp. 5 – 7) to illustrate and explain scarcity, choice and opportunity
cost in a fictitious country that produces only two goods (bicycles and wheat). Ensure that the PPC /
PPF of this fictitious country reflects increasing opportunity costs. Place bicycles on the vertical axis
and wheat on the horizontal axis.
(5)
(2 X 1 = 2)
(2)
The following is a production possibilities table for a small community in the Eastern Cape.
Possibility
Fish
Cabbage
A
0
210
B
2
200
C
4
180
D
6
150
E
8
110
F
10
60
G
12
0
7
a)
b)
c)
Show these data graphically (putting cabbage on the vertical axis).
Label point H inside the PPC you have drawn. What does it indicate?
Label point I outside the PPC you have drawn. What does this point indicate?
(2)
(2)
(1)
For your information:
You should note that if the opportunity cost increases as more of one good or service is produced the PPC /
PPF will be bowed out. Only if the opportunity cost remains constant as the production of a good increases
is the PPC / PPF a straight line.
8
Use the figure below, which indicates a PPC, to indicate the changes that are asked:
a)
b)
Explain how the curve of the PPC reflects the law of increasing opportunity costs.
(2)
Redraw the diagram and then illustrate and explain the effect(s) that an improvement in the production
techniques of only bulldozers will have on the PPC (Fig. 1-2, p. 9).
(2)
Draw a separate diagram to illustrate and explain the effect(s) that an improvement in the production
techniques of only pencils will have on the PPC (Fig. 1-3, p. 10).
(2)
Draw a separate diagram to illustrate and explain the effect(s) that an improvement in the production
techniques of both pencils and bulldozers will have on the PPC (Fig. 1-4, p. 10).
(2)
Name THREE factors that will cause the PPC to shift outward (p. 9).
(3)
Name THREE factors that will cause the PPC to shift inward.
(3)
c)
d)
e)
f)
A
B
C
D
E
Fish
50
45
35
20
0
Lemonade
0
10
20
30
40
9
The table above represents five points on the production possibility frontier for the small country of
BED1Land, which produces only fish (measured in thousands) and lemonade (measured in thousands
of litres):
a)
If the economy is currently at point A, what is the opportunity cost of producing an additional 10000
litres of lemonade? If the economy is currently at point B, what is the opportunity cost of producing an
additional 10 000 litres of lemonade? What if the economy is currently at point D?
(3)
Does the production possibility frontier demonstrate the law of increasing opportunity cost? How can
you tell?
(2)
b)
10
a)
b)
c)
d)

Plot a typical PPF for apples and office furniture (label this PPF 0), putting office furniture on the
horizontal axis.
(2)
Using the original PPF curve from part a), draw a new PPF that reflects the economy a year after
apple blight (a disease that affects apple trees) has killed nearly half of all apple trees in the Western
Cape (label this PPF1).
(1)
Using the original PPF curve from part a), draw the new curve resulting from a technological
breakthrough in apple production that greatly improves yields (label this PPF 2).
(1)
Which economy is likely to have higher growth rates in the future: Economy A that produces more
consumer goods and fewer capital goods now or Economy B that produces more capital goods and
fewer consumer goods now (pp. 7 – 8)?
(1)
Economy B would have the higher growth rate. Producing more capital goods represents
investment in future production that expands the PPF in the future because capital makes
labour more productive.
Note:
The purpose of economic activity is to satisfy human wants. Goods and services satisfy most wants. Goods
are tangible objects like food, clothing and textbooks. These are objects that we can touch, move around,
or keep for another day. (The different types of goods will be examined in Question 11 below.) Services
are intangible things like medical services, legal services and haircuts. In contrast to goods, services
cannot be stored for use at some other time, nor can one touch a service.
11
Differentiate between the following concepts:
a)
b)
c)
d)
e)
consumer goods and capital goods (pp. 7 – 8);
final goods and intermediate goods (p. 8);
private goods and public goods (p. 8);
economic goods and free goods (pp. 8 – 9); and
homogeneous and heterogeneous goods(p. 9).
12
Name and explain the THREE different categories of consumer goods (p. 8).
(5 X 2 = 10)
(3 X 2 = 6)
13
Explain why economics is regarded as a social science (p. 9). In your answer, include a discussion of
the three main ways in which the natural sciences differ from the social sciences (i.e. name and
explain the three main ways in which the natural sciences differ from the social sciences).
(6 X ½ = 3)
Three main ways in which the Social sciences (e.g. economics)
Natural sciences (e.g. physics)
natural sciences differ from
the social sciences
What is studied
Social
sciences,
such
as Natural sciences study the
economics, study the behaviour of natural universe.
human beings, both individually
and as groups.
How it is studied
It is generally impossible to In many natural sciences it is
conduct
controlled
laboratory possible to conduct controlled
experiments in the social sciences. laboratory experiments.
Nature of the generalisations Laws in the social sciences, e.g. Laws in the natural sciences
made
economics, are not as absolute or are usually regarded as being
exact as the laws of the natural immutable (unchanging).
sciences.
Note:
Take note of the phrase “ceteris paribus” on page 11. This is a Latin term meaning “all (other) things being
equal” / “all other relevant things remain the same”. The ceteris paribus assumption is an essential part of
economic reasoning. Economists use the ceteris paribus assumption because in the real world most
economic variables are influenced by more than one other variable (see, for example, Chapter 4). By
invoking the ceteris paribus assumption, economists can focus on the effect of any one variable by itself and
thereby gain a better understanding of the impact of each variable.
14

Mention the three basic purposes of macroeconomic theory (p. 11).
(3)
Macroeconomic theory has three basic purposes. First, to explain (help us understand) how
things fit together in the economy (how the economy functions). Second, to help us to predict
what will happen if something changes. Third, to serve as the basis for decisions on economic
policy. The three key words are thus explanation, prediction and policy.
15
Distinguish between the concepts “microeconomics” and “macroeconomics” and give an example of
an issue each branch of economics studies (see Box 1-3, pp. 11 – 12).
(2 X 2 = 4)
16
Distinguish between the concepts “positive statements” and “normative statements” in economics and
give examples of each (pp. 11 – 12).
(2 X 2 = 4)
17
Name FIVE reasons why economists often disagree on certain economic issues (see Box 1-4, pp. 13
– 14).
(5)
18
Provide an explanation of and give an example of the:
a)
b)
fallacy of composition (p. 15); and
post hoc ergo propter hoc fallacy (p. 15).
(4)
Note:
The paradox of thrift is a notable fallacy of composition that is central to Keynesian economics. For more
information about this fallacy refer to page 15 of Mohr’s textbook.
19

At a Bafana Bafana soccer match the supporters get excited as the team moves closer and closer to
the goal post. In order to get a better view, the last row of spectators in the stand jump up. If all
spectators follow suit, would they all see better? Would this work? Why or why not? Explain
(2)
The strategy will probably not work well. When one row of spectators stand that row of
spectators will be able to see better, but if everyone else stands up too, the view of many
individual spectators will probably worsen. This is what is known as the fallacy of
composition. What is good for the individual is not necessarily good for the whole.
20
Refer to the following article, “Australia's small farmers struggling with low prices 1”. Read the first two
paragraphs of the article. How does the fallacy of composition relate to the ‘problem’ of good
harvests?
(2)
21.
Use the following information regarding the price of petrol (95 ULP) to explain the difference between
the level of a variable and the rate of change in the same variable.
On 1 January 2014 Coastal petrol users paid R13.20 per litre for 95 petrol, while they were required to
pay R10.83 per litre on 7 January 20152.
Application Question (to be discussed during the tutorial):
AQ1 Suppose the government builds and staffs a hospital in order to provide “free” medical care. What is
the opportunity cost of the free medical care? Is it free from the perspective of society as a whole?
AQ2 Explain how a loaf of bread could be a final good or an intermediate good depending on its use.
AQ3 Use a production possibilities curve(s) to illustrate each of the following (putting goods on the vertical
axis and services on the horizontal axis):
a)
b)
c)
d)
a shift in production from services towards goods.
an increase in the potential output of the economy due to a greater availability of factors of production.
an increase in productivity in the services sector.
a decrease in productivity in the goods sector.
Revision:
Indicate whether each of the following statements is True (T) or False (F).
True
(T)
1
2
3
4
5
6
7
8
9
False
(F)
The overall objective of economic activity is to satisfy people’s many and varied material
wants.
Scarcity and choice are central elements of economics.
Scarcity is a problem in poor countries only.
The three central questions in Economics are What? How? and For Whom?
The problem of scarcity arises because wants are unlimited and the resources (or
means) to fulfil these wants are limited.
Demand is simply another term for wants – in other words, if a consumer demands a
good it simply means that he or she wants the good.
The three types of resources that are the means with which goods and services can be
produced are unnatural resources, human resources and man-made resources.
Leisure time sacrificed to study for your BED semester test is an example of an
opportunity cost.
A PPC indicates combinations of goods and services which can be produced when the
community’s resources are employed fully and efficiently.
1Mercer,
P. 2013. Australia's small farmers struggling with low prices. [Online]. Available:
http://www.bbc.com/news/business-24610074 [Accessed 10 February 2015].
2
___. 2015. Media statement – for release on 2 January 2015. [Online]. Available:
http://www.cefgroup.co.za/wp-content/uploads/2013/10/PRESS-RELEASE-2-Jan-2015-Change-7Jan15Audited.pdf [Accessed 10 January 2015].
10
11
12
13
14
15
16
Any movement from one point on a PPC to another point on the curve illustrates the
principle of opportunity cost.
The axes of the production possibility frontier measure quantities of finished
commodities.
Figure 1
Refer to the production possibilities curve in the figure above (i.e. Figure 1). Point E
indicates that resources are NOT fully utilised or are misallocated.
Refer to the production possibilities curve in the figure above (i.e. Figure 1). Point C is
unattainable.
An economy produces two goods, wheat and mutton. The quantity of wheat that must
be given up to produce the extra unit of mutton is the opportunity cost of producing the
extra unit of mutton.
If an economy experiences increasing opportunity costs, its production possibility curve
is convex to the origin.
The economic reason for increasing opportunity costs is that economic resources are not
completely flexible between alternative uses.
17
18
19
20
21
22
23
24
25
26
27
28
Graph 4 depicts a technological breakthrough in the production of Good Y only.
Economic growth can be illustrated by a leftward shift of the PPC.
Unemployment is indicated by a point inside the PPC.
The distinction between goods and services is that goods are tangible while services are
intangible.
In economics, capital is defined as a financial asset such as money, stocks and bonds.
Capital goods are goods that are used in the production of other goods.
Capital refers to all tangible goods that are used to produce other goods.
The production of more capital goods today, means that the potential output of the
economy increases in the future.
A pair of scissors used in a factory where clothes are produced, is an example of a
capital good.
Consumer goods are goods that are used in the production of goods which are ultimately
purchased by consumers.
An economy that wants to experience growth should increase current consumption and
reduce producing capital goods.
Both consumer goods and capital goods satisfy human wants. The consumer goods
29
30
31
32
33
34
35
36
37
38
39
satisfy these wants directly and the capital goods satisfy them indirectly.
The beans bought by a factory to produce tins of baked beans are intermediate goods.
Washing powder is a heterogeneous good since there are different varieties or brands of
washing powder, like Skip, Surf and Mac.
A house that you have lived in for 20 years is an example of a non-durable good.
Economics studies human behaviour and is therefore classified as a natural science.
The ceteris paribus assumption means “all other things equal”.
The study of the total output of the motorcar industry is an example of macroeconomics.
“In 1996 the official unemployment rate in South Africa was 29,3%” is an example of a
positive statement.
In microeconomics we examine the economy as a whole.
To better see a soccer game, one spectator stands. Assuming that everyone trying to
get a good view of the game can also stand represents an example of the fallacy of
composition.
A rooster crows and then the sun rises. The rooster thinks that the sun rises because he
crows. And he is very proud of it. The rooster falls prey to the fallacy of composition.
Every severe recession follows a Republican Presidency in the United States of
America; therefore Republicans are the cause of recessions. A person who makes such
a statement falls prey to the post hoc ergo propter hoc fallacy.