Foundations of Economics
The study of choices leading to the best possible use of scarce resources
in order to best satisfy unlimited human needs and wants
Scarcity, choice, opportunity cost
• Goods – materials that satisfy human wants and provide utility
• Services – a transaction in which no physical goods are transferred from
the seller to the buyer
• Resources (factors of production) – inputs used to create goods and
services
• Scarcity – the situation in which available resources, or factors of
production, are finite, whereas wants are infinite. There are not enough
resources to produce everything that human beings want and need.
• Choices have to be made – what do we use our finite resources to
produce? How? For whom?
Economics
• The study of choices leading to the best possible use of scarce
resources in order to best satisfy unlimited human needs and wants.
• Studying the best outcomes for society.
• Requires justified value judgments.
Three basic economic questions
1. What to produce? Resource allocation
2. How to produce? Resource allocation
3. For whom to produce? Distribution of output and income
• Reallocation, under-allocation, over-allocation
• Distribution of income/ wealth. Redistribution of income/ wealth.
Resources - Factors of production
Land
All natural resources, including all agricultural and non-agricultural
land, as well as everything that is under or above the land, such as
minerals, oil reserves, underground water, forests, rivers and lakes.
Natural resources are also called ‘gifts of nature’.
Resources - Factors of production
Labour
The physical and mental effort that people contribute to the production
of goods and services.
Resources - Factors of production
Capital (physical capital)
Man-made factor of production (it is itself produced) used to produce
goods and services. E.g. machinery.
Capital
• Capital is a factor of production BUT ‘capital’ can refer to various
things.
1. Physical capital – as described in factors of production.
2. Human capital – skills, abilities, knowledge and health of the
population (labour).
3. Natural capital – land as described in factors of production plus
natural resources that are not directly used in the production
process (air, biodiversity, soil quality, etc.)
4. Financial capital – money and investments in financial instruments.
Resources - Factors of production
Entrepreneurship/ enterprise
Human skill possessed by some people, involving the ability to innovate
by developing new ways of doing things, to take business risks and to
seek new opportunities for opening and running a business.
Production
Using inputs (resources) to make outputs (goods and
services) to satisfy the needs and wants of consumers
Activity: Identifying Factors of Production
• Think about a good or service that you consume on a regular basis.
• Give an example of each of the four factors of production that are
used in getting that good or service to you.
• Land, labour, capital, enterprise.
Three basic economic questions
1. What to produce? Resource allocation
2. How to produce? Resource allocation
3. For whom to produce? Distribution of output and income
• Reallocation, under-allocation, over-allocation
• Distribution of income/ wealth. Redistribution of income/ wealth.
Which economic question is being answered?
Opportunity cost
• The value of the next best alternative that must be sacrificed to
obtain something else.
• Scarcity means choices have to be made.
Production Possibilities Curve/ Frontier
1. All resources fully
employed
2. All resources efficiently
used
3. POTENTIAL output
Represents all combinations
of the maximum amounts of
two goods that can be
produced by an economy,
given its resources and
technology, when there is full
employment of resources and
productive efficiency.
Economics as a Social Science
• Focused on human society and social relationships.
The social scientific method:
1. Make observations, select an economic question.
2. Identify the variables we think are relevant.
3. Make a hypothesis about how the variables are related to each other.
4. Make assumptions.
5. Test the hypotheses – does it reflect the real world?
6. Compare the predictions of the hypotheses with the real-world.
Theory, law, model
• Theory – explanation of why certain events occur. Attempt to make
predictions about future events.
• Law – statement with universal validity (always true).
• Model – illustrations of theory.
”An economic model is a hypothetical construct that embodies economic
procedures using a set of variables in logical and/or quantitative correlations.
It is a simplistic method using mathematical and other techniques created to
show complicated processes. An economic model can have many
constraints, which may change to generate different property.”
Eh?
• Consider it a way to describe or predict economic decision making based
on a number of assumptions.
Assumption 1: Ceteris Paribus
• ‘other things equal’
• All other things are assumed to be constant or unchanging.
Rational Economic Decision-Making
• Also known as rational self-interest.
• Individuals act in their best self-interest by attempting to maximise
their utility (satisfaction).
• Firms act to maximise their profits.
• Workers aim to secure the highest possible wage for their job.
• Investors aim for the highest possible returns.
Positive vs Normative
• Positive comments describe the way things are (true or false).
• Normative comments describe how things should be (dependent on
values, opinions, etc.).
• Effective economic policy requires both positive and normative
economics.
• E.g. healthcare should be accessible to everyone (normative). Not
everyone has access to healthcare (positive). Subsidizing healthcare
makes healthcare accessible to more people (positive).
Are the following positive or normative
statements?
a)
b)
c)
d)
e)
It is raining today.
It is too humid today.
Economics is the study of choices.
Economics should be concerned with how to alleviate poverty.
If household saving increases, ceteris paribus, there will be a fall in
household spending.
f) Households save too little of their income.
Micro vs Macro
• Micro – individual decision-making units. Firms (businesses) and
consumers (households).
• Macro - economy as a whole. Looking at aggregates.
Main Themes
1. Distinction between economic growth and economic development.
2. Resource allocation and sustainability.
3. The role of the government in the allocation of resources vs the role
of the market in the allocation of resources.
4. Conflict between economic efficiency and equity