1.
Basic economic concepts
1.1 The nature of economics
• The aim of science is to provide answer or
explanation about real-world phenomena.
• Natural science and social science are positive
science. They both study observable
phenomena of the real world and do not
involve subjective value judgement .
1.
1.2
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Basic economic concepts
What is economics?
In economics, it is assumed that people will
maximize their self-interest. So, people will balance the
marginal benefits and marginal cost when making a choice.
Under the postulate of maximization, people will respond
to incentives.
Economics is the study of human choice. It explains how
people use limited resouces to satisfy their unlimited wants.
Positive statements are statements which can be tested
against facts.
Normative statements are statements involving value
judgements. They cannot be tested against facts.
1.
Basic economic concepts
1.3 Opportunity cost
• Economics explains human choice by the concept of
opportunity cost. This concept means the highestvalued option forgone.
• Time cost refers to the highest value of the resources
in their alternative use within the specified period of
time.
• Interest is the cost of the earlier availability of
resources. An increase in the interest rate reduces
present consumption.
1.
Basic economic concepts
1.4 Goods
• Goods refer to anything that can satisfy human wants.
That is, some is preferred to none. Goods can be
classified into two types: economic goods and free
goods.
• Economic goods are goods whose quantity is not
sufficient to satisfy all human wants, while free goods
are goods whose quantity is sufficient to satisfy all
human wants.
1.
Basic economic concepts
1.5 Scarcity, competition and discrimination
• Scarcity implies competition and discrimination.
• In the market, the number of goods we can get
depends on our willingness and ability to pay the
market price.
2
Economic activities and economic problems
2.1 Economic activities
• Production refers to the activities that turn resources
or input into goods or services. Consumption refers
to the activities that use goods or services directly to
satisfy wants.
• Production allows us to get goods of higher value.
Exchange allows specialization, hence increases
productivity.
2
Economic activities and economic problems
2.2 The three basic economic problems
• Under scarcity, we produce and exchange to satisfy
our wants.
• The economic problems of ‘What to produce?’ (the
types and quantity of goods to be produced) and
‘How to produce?’ (the way of production) involve
resource allocation, while ‘For whom to produce?’
(the criteria for distributing the goods and services
produced) involves income distribution.
2
Economic activities and economic problems
2.3 How to solve the three basic economic problems?
• A capitalist economy implements a private property
right system. Resources are privately owned. In a
socialist economy, resources are owned by the
government.
• Resource allocation by the price mechanism has the
following advantages: it encourages
• production; both sellers and buyers gain from exchange,
and firms can follow the price signal to produce goods
that consumers like.
• People are willing to exchange only if their private
property are protected.
3.
Basic concepts of production
3.1 What is production?
• Production is an activity which turns resources into
output.
• Output can be classified into consumer goods and
producer goods by their use.
• Goods can be classified into private goods and public
goods by rivalry and excludability.
• Primary production is the production activity involving
the direct use of natural resources .
• The three types of production activities are
interdependent. The output of one production activity
may become the input of another.
3.
Basic concepts of production
3.2 Factors of production
• The most important difference between
entrepreneurship and labour is that the former needs to
bear the risks of the business but the latter does not.
• The creation of capital is known as capital formation. It
is a kind of investment and is negatively related to the
interest rate.
• The major forces of economic development of Hong
Kong include good geographical location and
infrastructure, huge investment flows from the
mainland of China and overseas, and a hardworking
population who never hesitates to start their own
businesses.
4.
Labour and Division of Labour
4.1 Labour
• The labour supply of an economy is the total number of
of working hours all its workers.
• The labour supply of an economy is affected by factors
such as the size and structure of the population,
working hours, government policies, and social customs
and practices.
• Average productivity of labour means the average
output per labour. It can be calculated by dividing the
total output by the total input of labour.
4.
Labour and Division of Labour
4.1 Labour
• Labour productivity is mainly affected by factors such as
education and training, production equipment,
production technology and management, and wages.
• Geographical mobility of labour refers to the ease (i.e.,
the willingness and ability) of workers to move from
one place to another.
• Occupational mobility of labour refers to the ease (i.e.,
the willingness and ability) of workers to change from
one occupation to another.
4.
Labour and Division of Labour
4.2 Wage payment methods
• Piece rate calculates wages based on the quantity of
output. Employers can save supervision cost, but the
cost of product quality supervision is higher. It is more
suitable for industries with a large volume of output
and a high degree of standardization.
• Time rate calculates wages based on working hours.
Workers have more stable income, but they cannot earn
more by working more. It is more suitable for
occupations with a wide scope of duties, or output that
is difficult to measure.
• An appropriate basic salary-plus-commission / bonus
scheme can balance various considerations so as to
maximize production output.
4.
Labour and Division of Labour
4.3 Division of labour
• Division of labour is the specialization of labour. It
means each worker specializes in different jobs.
• Division of labour helps save the time to shift from one
process to another and facilitate mechanization .
• Division of labour cannot be applied when there is no
opportunity for trade. It is not suitable for jobs that
require individuality or when there is insufficient market
demand.
5.
Production and Supply
5.1 Basic concepts
• Fixed factors are factors of production that remain
unchanged in quantity as output changes. Variable
factors are factors of production that vary in quantity
as output changes.
• In both short run and long run production, it is assumed
that production technology is fixed and each unit of a
factor has the same productivity.
5.
Production and Supply
5.2 Production in the short run
• The total output from production within a certain
period of time is called total product.
• The marginal product of a factor is the change in total
product brought about by a change in 1 unit of that
factor within a certain period of time.
• The law of diminishing marginal returns: in the short
run, when variable factors keep being added to the
fixed factors, the marginal products will finally fall.
5.
Production and Supply
5.3 Costs in the short run
• In the short run, cost can be divided into fixed cost and
variable cost.
• Marginal cost is the change in the total cost brought
about by a change in 1 unit of the total output.
• The increase of the number of patients does not affect
the rent, but the cost of medicine will rise. In this
example, the rent is a fixed cost and the cost of
medicine is a variable cost.
5.
Production and Supply
5.4 Production and costs in the long run
• A firm’s production scale is larger when the quantities
of all factors of production increase.
• Economies of scale mean the lowering of the long run
average cost as a result of increasing output through
the expansion of scale.
• Diseconomies of scale mean the increase of the long
run average cost as a result of increasing output
through the expansion of scale.
5.
Production and Supply
5.5 Production decision and supply
• The profit of the firm is the difference between total
revenue and total cost. In economics, it is assumed that
the ultimate objective of a firm is profit maximization.
• Profit-maximizing output of individual firms: the output
at which price equalsmarginal cost, given that the price
is not lower than the average cost.
• The quantity supplied is the maximum quantity a firm is
willing and able to sell at a certain price.
• Marginal cost is the minimum supply-price of a firm.
The supply curve of a firm is also its minimum supplyprice curve.
6.
Ownership, Expansion and Integration of Firms
6.1 What is a firm?
• A firm is a unit that makes decisions regarding the
employment of factors of production and the
production of goods and services.
• Based on the form of ownership, Water Supplies
Department in Hong Kong belongs to public ownership;
convenience stores belong to private ownership.
6.
Ownership, Expansion and Integration of Firms
6.2 Public enterprise
• Public enterprise are enterprises owned by the
government.
• Public enterprises can be classified into two main types:
government enterprises and public corporations.
• Public enterprises (except public corporations) do not
respond to price signals to maximize their profit. Hence,
their services and facilities may not suit consumers’
needs.
6.
Ownership, Expansion and Integration of Firms
6.3 Private enterprise
• The main forms of business ownership for starting a
firm in Hong Kong are sole propriertorship, partnership
and limited company.
• The liability of the shareholders of a limited company is
limited to the amount of investment he has in the firm.
• Limited liability allows a company to raise capital from
small investors, which widens the sources of capital.
6.
Ownership, Expansion and Integration of Firms
6.3 Private enterprise
• The transfer of ownership of a private limited company
requires consent from the board of directors,and
preference is given to existing shareholders.
• Public limited companies can sell shares or bonds to
raise capital.
• sole propriertorship, and partnership do not need to
disclose their financial information to the public. Their
accounts need not be audited by professional auditors.
6.
Ownership, Expansion and Integration of Firms
6.4 Expansion and integration of firms
• Expansion means enlarging the scale of a company.
• Internal expansion includes opening new branches and
inventing new products, while integration means taking
over or merging with other companies.
• Backward integration can ensure a stable supply of raw
materials, while
Forward integration can ensure stable sales outlets.
7.
Competition and Market Structure
7.1 Basic concepts
• The definition of a market is any arrangement which
facilitates trade.
• The degree of market power is affected by the nature of
products, which includes unique products, homogenous
products and heterogenous products.
• Market structure is classified according to the features
which affect market competition (or monopoly power).
It is mainly classified into perfect competition and
imperfect competition.
• Imperfect competition is also called a price-searching
market. In economics, this type
of firm is called a
price searcher.
7.
Competition and Market Structure
7.2 Perfect competition
• In a price-taker / perfectly competitive market,
consumers have perfect information about the price ,
quality and availability of the products.
• Under perfect competition, all firms are price takers.
They have to buy and sell according to market prices.
7.
Competition and Market Structure
7.3 Imperfect competition
• Imperfect competition can be sub-divided into
monopoly , oligopoly and monopolistic competition .
• In a market under monopolistic competition , individual
firms have market power, but the power is smaller than
firms in other markets.
• The main reason for monopoly is entry barriers, which
include restricted by law (e.g., government ownership,
government franchise, patent and copyright), natural
monopoly and exclusive ownership of essential
resources for production.
• In oligopoly, the behaviour of big firms affects one
another.
8.
Demand Theory and Consumer Choice
8.1
Quantity demanded and demand
• Quantity demanded is the maximum quantity a
consumer can afford and is willing to buy at a certain
price.
• Individual demand is the demand of a consumer.
• Market demand is the horizontal summation of
individual demand, so the market
demand curve is downward sloping.
• Superior goods are also called normal goods.
8.
Demand Theory and Consumer Choice
8.1
Quantity demanded and demand
• As both noodle and bread can satisfy one’s hunger, they
are substitutes.
• As both bread and butter are jointly needed to satisfy
the want of eating butter toast, they are complements.
• If a consumer expects the price of a good to fall next
week, his demand for the good will decrease.
8.
Demand Theory and Consumer Choice
8.2 Consumer willingness to pay
• Marginal benefit to consumers is the maximum price a
consumer is willing to pay to get one more unit of the
good.
• Diminishing marginal willingness to pay is assumed in
economics: the more the quantity of a good one owns,
the lower one’s willingness to pay for getting one more
unit of the good will be.
• The net gain to a consumer is called consumer surplus.
To maximize the net gain, a consumer will keep buying
a good until his marginal willingness to pay equals the
price .
9.
Demand and Supply: Price Determination
9.1
Demand and Supply
• A change in the price of a good will lead to a change in
its quantity demanded, ceteris paribus.
• A change in other factors will lead to a change in
demand. That is, the quantity demanded changes at all
prices. Such factors include income, prices of substitutes
and complements , expectations, population size and
structure, climate and government policies.
9.
Demand and Supply: Price Determination
9.1
Demand and Supply
• The law of supply states that a rise in price will lead to
an increase in quantity supplied, ceteris paribus.
• Individual supply is the maximum quantity which a firm
is willing and able to sell at different prices, ceteris
paribus. It can be shown with a supply schedule or
supply curve.
• The market supply curve is the horizontal summation of
all individual supply curves. Thus, the market supply is
greater than an individual supply, and the market
supply curve is upward sloping.
9.
Demand and Supply: Price Determination
9.2 The determination of market price
• When quantity demanded is greater than quantity
supplied, there will be a shortage and the price tends to
rise. When quantity demanded is less than quantity
supplied, there will be a surplusand the price tends to
fall.
• If the price is rigid, that is, it cannot adjust according to
changes in supply and demand, either a shortage or a
surplus will persist.
9.
Demand and Supply: Price Determination
9.3 The labour market
• In economics, the demand for factors of production,
such as the demand for labour, is called derived
demand.
• Wage rigidity leads to unemployment or labour
shortage .
9.
Demand and Supply: Price Determination
9.4 The law of demand and the demand-supply theory
• The full price of a good is the sum of the pecuniary
price (貨幣價格) and non-pecuniary price(非貨幣價格) .
• The demand-supply theory mainly explains the changes
in the market price, while the law of demand analyzes
how changes in opportunity cost affects consumption
choice.
10. Price Elasticity of Demand and Supply
10.1 Price elasticity of demand
• Price elasticity of demand measures the responsiveness
of quantity demanded to a change in price.
• If the percentage change in quantity demanded is
greater than the percentage change in price, demand is
elastic. If the percentage change in quantity demanded
is smaller than the percentage change in price, demand
is inelastic. If the percentage change in quantity
demanded equals the percentage change in price,
demand is unitary elastic.
• The more substitutes and the more similar they are, the
the elasticity is higher.
• In general, the longer it is after a change in price, the
the elasticity is higher.
10. Price Elasticity of Demand and Supply
10.2 The relationship between price elasticity of
demand and total revenue
• Total revenue of firms
= Total expenditure
= Total market value
= Price  Quantity transacted.
10. Price Elasticity of Demand and Supply
10.2 The relationship between price elasticity of
demand and total revenue
• How do the following situations affect the equilibrium
price, the equilibrium quantity and the total revenue?
– A fall in demand will make the demand curve shift leftward.
The equilibrium price will fall and the equilibrium quantity will
decrease. As total revenue is equal to price times quantity
transacted, the total revenue will fall.
– A rise in supply will make the supply curve shift rightward. The
equilibrium price will fall and the equilibrium quantity will
increase. As total revenue is equal to price times quantity
transacted, the total revenue will be uncertain.
10. Price Elasticity of Demand and Supply
10.3 Price elasticity of supply
• To calculate the price elasticity of supply, we divide the
percentage change in quantity supplied by the
percentage change in price.
• When supply is perfectly inelastic, the supply curve is a
vertical line; when supply is perfectly elastic, the supply
curve is a horizontal line.
• Factors affecting elasticity of supply include factors of
production, nature of products, market structure and
entry barriers, as well as time.
• The longer it is after a change in price, the higher the
price elasticity of supply is.
11. Market Intervention
11.1 Price intervention
• The two main types of price intervention are price ceiling
and price floor. The former is the maximum price
permitted by law, while the latter is the minimum price
permitted by law.
• The change in total revenue as a result of a price floor
depends on the price elasticity of demand.
• A price ceiling may cause the black market price to be
higher than the equilibrium price.
11. Market Intervention
11.2 Quantity intervention –– Quota
• A quota is the maximum quantity supplied of a product
or service imposed by the government. The aim of
imposing it is to reduce the quantity supplied. Thus, it
must be set below the equilibrium quantity to be
effective.
• Quota makes the supply curve become a kinked one. This
means that before reaching the quota, the supply curve
is upward sloping; when the quantity supplied has
reached the quota, the elasticity of supply equals 0,
which means that supply is perfectly inelastic.
11. Market Intervention
11.3 Unit tax and unit subsidy
• A unit tax is a fixed amount of tax that is imposed on
each unit of goods or services.
• A unit subsidy is a fixed amount of financial assistance
given on each unit of goods or services.
• he consumers or producers who have lower elasticity will
have a larger share of tax burden or subsidy benefits.
12. Efficiency, Equity and the Role of Government
12.1 Efficiency of a market economy
• Efficiency means total social surplus is maximized.
• The decrease in total social surplus caused by the
quantity of production deviating from the efficient
output is called the deadweight loss.
• The rationing function of price means the existing
supplies are distributed to users with the maximum
willingness to pay.
• The allocative function of price means price allocates
resources to highest-valued uses.
12. Efficiency, Equity and the Role of Government
12.2 Government intervention and inefficiency
• Price ceiling and price floor will lead to under-production.
• Imposing a tax will change the equilibrium quantity such
that the marginal benefit of the good is higher than the
marginal cost . This results in a deadweight loss.
• When the marginal benefit to consumers equals the
marginal cost of firms, the
total social surplus is at the maximum; but when a
divergence exists between the marginal benefit to
consumers and the marginal cost of firms, there will be a
deadweight loss to society.
12. Efficiency, Equity and the Role of Government
12.3 Externalities and market failure
• An externality arises when there is a divergence between
private and social cost (benefits) in production or
consumption activities.
• External cost will lead to over-production. The marginal
social cost (MSC) will be higher than the marginal social
benefit (MSB), resulting in a deadweight loss.
12. Efficiency, Equity and the Role of Government
12.4 Income inequality
• Income inequality can be measured with income
distribution statistics, the Lorenz curve and Gini coefficient.
• The Lorenz curve is a curve showing the income
distribution of an economy.
• iii. The Gini coefficient is mainly used to show the general
distribution of household income.
• iv. To more accurately measure income inequality and
understand its meaning, we should also consider the
following factors: differences in economic structure, per
capita income, redistributive effects, life cycle and
permanent income, income mobility, population and
family structure.
12. Efficiency, Equity and the Role of Government
12.5 Policy concerns
• Equity has two meanings: equalizing outcome and
equalizing opportunities.
• Many people support income equalization to a certain
extent. They agree that the government should
guarantee a basic livelihood of all people through taxes
and transfer. However, these measures have a
disincentive effect on production, which means society
has to face a trade-off between equity and efficiency.