SIXTH EDITION
ECONOMICS FOR SOUTH AFRICAN STUDENTS
PHILIP MOHR AND ASSOCIATES
CHAPTER 1: WHAT ECONOMICS IS ALL ABOUT
Economics is a study of mankind in the ordinary business of life.
-ALFRED MARSHALL
LEARNING OUTCOMES
Once you have studied this chapter you should be able to:
1. explain what economics is all about
2. define economics
3. define the important concept of opportunity cost
4. describe a production possibilities curve or frontier
5. distinguish between microeconomics and macroeconomics
6. distinguish between positive and normative economics
7. explain why economics is a social science
8. identify some common mistakes in reasoning about economics
In this chapter, we introduce you to economics. We first use a number of examples to indicate
what economics is all about and we then introduce the important concepts of scarcity, choice
and opportunity cost. We explain these concepts with the aid of a production possibilities
curve. Next we use production possibilities curves to illustrate different situations. We explain
why economics is a social science, the difference between microeconomics and
macroeconomics, and the difference between positive and normative economics, followed
by a discussion of some common mistakes in reasoning about economics.
1.1 WHAT IS ECONOMICS?
The perception of economics
 Economics was once not as familiar as it is today.
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All this has changed. Nowadays everyone has heard about economics and knows that it is
important. But this does not mean that people know what economics is all about
Many people are convinced that economics is concerned only with making money, buying and
selling shares on the JSE OR studying of balance sheets and profit statements.
ALL THESE VIEWS ARE EXTREMELY NARROW AND DO NOT CAPTURE WHAT ECONOMICS IS ALL
ABOUT…
These definitions, however, point to the fact that economics is concerned with human existence.
The following example provides some indication of the wide-ranging nature of economics, and of the
types of questions and issues that it is concerned with.
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***See page 2 for a more in-depth description.***
People/businesses, government and other decision-makers in society have to make choices every
day.
***Economics is essentially all about making decisions/choices…***
But why are these choices necessary?
***This brings us to the basic fact of economic life – scarcity.***
Without scarcity it would not be necessary to make choices.
People/businesses, government and other decision-makers in society all want to do many things, but
the means with which these wants can be met are limited.
***Wants are plentiful (unlimited) but the means are scarce.***
Choices therefore have to be made all the time.
The relationship between unlimited wants and scarce resources is so central to economics.
Economics is applying scarce resources in order to satisfy our unlimited wants.
Watch the following video:
https://www.youtube.com/watch?v=2YULdjmg3o0
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Definition includes four NB concepts:
 Unlimited wants
 Scarcity ... of resources
 Choices ...
 Opportunity cost ...
Definition of economics:
•
There are unlimited wants
•
But, there are limited resources
•
Thus, scarcity exists
•
Therefore, choices have to be made
•
And this brings forth opportunity cost (OC)
1.2 SCARCITY, CHOICE AND OPPORTUNITY COST?
The basic fact of economic life is that there are simply not enough goods and services to satisfy
everyone’s wants.
***Note that wants are not the same as needs and demand.***
WANTS – Human desires for G & S (Unlimited)
NEED – Necessities (Essential for survival) (Not absolutely unlimited)
DEMAND – Differs from wants, desires or needs. There is a demand for G & S (willingness to pay)
Why do we say resources are limited?
 Three types of resources
 Natural resources (such as agricultural land), human resources (such as labour) and man-made
resources (such as machines).
 These resources are the means with which goods and services can be produced.
 In economics, we call these resources factors of production.
 Because resources are limited, G & S that satisfy our wants are also limited.
 Example: Hendrik goes to the shop with R15 in his pocket. He wants an ice cream, a cool drink,
a chocolate and a packet of chips. But his resources are limited. He cannot buy all the things
he wants with the R15. He therefore has to choose what to buy and what to sacrifice.
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It has to be decided which of the available alternatives will have to be sacrificed.
Scarcity forces us to make choices.
Scarcity ≠ poverty.
The cost of the alternative that has been chosen can be measured in terms of the alternatives
sacrificed. This is called opportunity cost.
The opportunity cost of a choice:
 is the value to the decision-maker
 of the best alternative that could have been chosen but was not chosen.
In other words, the opportunity cost of a choice is the value of the best forgone opportunity. Every
time a choice is made, opportunity costs are incurred.
See in the real world 1-1
Opportunity cost captures the essence of the problems of scarcity and choice.
1.3 ILLUSTRATING SCARCITY, CHOICE AND OPPORTUNITY COST: THE PRODUCTION POSSIBILITIES
CURVE
Scarcity, choice and opportunity cost can be illustrated with the aid of a production possibilities
curve/frontier (PPC).
Production possibilities curve
 Simplified ‘economy’
 Two products are being produced
 Limited recourses are allocated
 Possible combinations of the products
 You have a choice in quantity, or only one
Definition PPC:
The production possibilities curve indicates the combinations of any two goods or services that are
attainable when the community’s resources are fully and efficiently employed.
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By devoting all their available time and other resources to fishing, five baskets of fish per working day
can be produced. On the other hand, if all production time is spent on gardening, 100 kilograms (kg)
of potatoes per working day can be produced. It is possible to produce either five baskets of fish or
100 kg of potatoes, but in each case the entire production of the other good must be sacrificed. It is,
however, also possible to produce any of the combinations shown in Table 1-1.
These combinations represent the maximum amounts that can be produced with all the available
resources. If it is decided to produce combination E, it will be able to produce four baskets of fish and
40 kg of potatoes per day. But what is the opportunity cost (OC) for producing four baskets of fish?
4 baskets of fish = 40 kg of potatoes
OC is always in terms of the product that was not chosen.
TIP: OC = (the maximum production point on the x or y axis of the alternative not chosen where the
alternative chosen is 0) – (the combination point of the alternative not chosen in terms of quantity of
the alternative chosen)
OC = 100 – 40 = 60 kg of potatoes
What is the opportunity cost (OC) for producing 70 kg of potatoes?
70 kg of potatoes = 3 baskets of fish
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OC = 5 – 3 = 2 baskets of fish
***See page 5 for a more in-depth description.***
Watch the following video:
https://www.youtube.com/watch?v=O6XL__2CDPU
1.4 FURTHER APPLICATIONS OF THE PRODUCTION POSSIBILITIES CURVE
With a given level of resources and a given state of technology, the community can produce different
combinations of potatoes and fish. But it cannot move beyond ABCDEF. It indicates the maximum
attainable combinations of the two goods, also called the potential output.
The quantity of available resources may increase and/or production techniques may improve over
time.
It can be illustrated by a production possibilities curve that shifts outwards.
Such an outward movement illustrates economic growth.
What improves? How? What happened?
If an improved technique for producing capital goods is developed, it will be possible to produce more
capital goods with the available factors of production, and vice versa.
If the amount of available resources (e.g. the number of workers) and/or the productivity of the
available resources increase, it will be possible to produce more consumer goods and more capital
goods than before.
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Table 1-2 = NB
Economic problem:
We are looking at …
 What? … production...Qty? (Ch 1/3) = problem of resource allocation
 How? … inputs (Ch 3)
 For whom? …distribution (Ch 3)
What is the difference between goods and services? - Examples?
Differentiate, with the use of examples, between the different types of goods... (Box 1-2)
 Capital goods
 Consumer goods
- Non-durable
- Semi durable
- Durable goods
 Final vs. intermediary
 Private vs. public
 Economic vs. free
 Homogenous vs. heterogeneous
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How?
Production factors (PFs)
 Natural resources
 Labour
 Capital
 Entrepreneurship
 Technology (not important)
Functional distribution of income
Production factors
Natural resources
Labour
Capital
Entrepreneurship
Income
Rent
Wages & salaries
Interest
Revenue
Who will receive the goods and services that are produced?
1.5 ECONOMICS IS A SOCIAL SCIENCE
Self-study
1.6 MICROECONOMICS AND MACROECONOMICS
Definition of microeconomics:
 Focus is on individual parts of the economy.
 Micro = small
 In microeconomics, the decisions or functioning of decision-makers such as individual
consumers, households, firms or other organisations are considered in isolation from the
rest of the economy.
 The individual elements of the economy are examined in detail.
 Example: decisions of individual households (what to do, what to buy, etc.)
 It also includes the study of the demand, supply and prices of individual goods and services.
Definition Macroeconomics:
 Concerned with the economy as a whole.
 Macro = large
 In macroeconomics we focus on the ‘big picture’.
 Overall view of the economic system and studies the total or aggregate economic
behaviour.
 Example: total production, income and expenditure and economic growth
 Macroeconomics is therefore the world of totals.
***See Box 1-3 for a more in-depth description.***
1.7 POSITIVE AND NORMATIVE ECONOMICS
Definition positive economics:
 A positive statement is an objective statement of fact.
 Example: Kaizer Chiefs won the PSL in 2014.
 Positive statements can be proved or disproved by comparing them with the facts.
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Definition normative economics:
 A normative statement involves an opinion or value judgement.
 Example: The South African inflation rate is too high.
 Normative issues can be debated but they can never be settled by science or facts.
1.8 A few point to note
The economic way of thinking
Unfortunately, the economic way of thinking does not come easily to people who have not been
trained in or exposed to economics.
Common mistakes non-economists make when reasoning about economic issues. Even economists fall
into one or more of these traps from time to time:
Blinkered approach (or biased thinking):
 Any particular individual looks at the world from his or her own vantage point.
 Non-economists tend to make highly simplified and biased diagnoses of economic issues and
also propose very simple solutions to the country’s economic problems.
 Example: Engineers believe they are paid too little compared with other workers and personal
income tax rates were too high. The solutions for them were therefore simple – pay engineers
more and reduce personal income tax.
 This is a typical example of blinkered reasoning. Here we had a tax-paying engineer looking at
the economy from his particular vantage point and proposing a solution that suited him
personally.
Fallacy of composition:
 Something that is true for the single case (or a part of the object being studied) is not
necessarily true for the whole.
 Assume that the whole is always equal to the sum of the parts. This is called the fallacy of
composition.
 Example: one worker or group of workers could benefit by obtaining a wage increase. But if
the wages of all workers in the economy are increased, the result could simply be inflation.
Post hoc ergo propter hoc:
 “after this, therefore because of this”
 When two events follow each other closely in time, people often assume that the second
event is the consequence of the first.
 In other words, the first event is regarded as the cause of the second event.
 This is called the post hoc ergo propter hoc fallacy or post hoc fallacy in short.
 Example: The fact that the rooster crows before dawn does not mean that the rooster is
responsible for the sunrise.
Correlation and causation:
 If two events occur together or tend to follow one another, it does not necessarily follow that
the one is the cause of the other.
 In other words, correlation does not imply causation.
 Example: It is sometimes stated, for example, that bowls is the most dangerous sport in the
world since more people die on bowling greens than on any other sports fields. This is of
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course a nonsensical argument. Bowls is a very safe sport. It is quite true that many people
die on bowling greens. But this is simply because so many elderly people play bowls.
Levels and rates of change
 Many people mistakenly believe that economics is only about numbers.
 Economics is an empirical science and economists often use numbers to illustrate principles
or to quantify or analyse those things that can be expressed in numbers.
 One of the most common mistakes is to confuse levels with rates of change.
 Example: “The latest consumer price index is 10 per cent”. CPI measures the level of prices in
a country. The rate of change of that level is calculated to determine inflation. The statement
must therefore read “the latest rate of increase in consumer prices is 10 per cent or latest
inflation rate is 10 per cent”. This can show that people sometimes confuse the level of prices
with rate of increase in prices. In other words, people tend to confuse high prices with rapidly
increasing prices. Likewise, when they hear that the inflation rate has declined, they often
mistakenly think it means that prices have fallen when, in fact, prices are still increasing, but
at a slower rate than before
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