What is Economics about? Part One: This is a question that is more often asked at induction evenings for prospective Economics students than any other. This Activity is designed to help you to understand at least something about what you will be studying over the coming months and to be able to identify some of the key economic issues and problems that make up the subject. What will happen when oil eventually runs out? Why can’t we just pay doctors and nurses more money? Why do people get so excited about interest rate changes? Inflation – no idea what it is; it doesn’t affect me! It is obvious that fining polluters will not stop them from doing it! We should forgive/eliminate the debt that third world countries owe us. That song I bought on iTunes was a real bargain at HK$10- I would have paid anything up to HK$30 to get it. It’s crazy; fishermen are catching large quantities of fish but have to throw half of them overboard even though they are dead! It’s unfair that there is only one firm I can buy this product. The service is very expensive but I don’t have any choice. Not another threatened strike! Why don't the employees just go back to work? The above questions and comments are all issues that you might be faced with during the course - many of them will be familiar and there are bound to be many more. In the space below, write down five questions or statements that you think have something to do with economics. 1. 2. 3. 4. 5. Now share your ideas with the rest of the class. Given the range of comments and issues collected by the group could you now write down a definition of what economics is? My definition of Economics is Part Two Economics is essentially a subject that looks at choices - how individuals, governments and businesses make them and what the consequences of making those decisions are. For example, if fines were the answer to pollution - the choice being to pollute and get fined or not pollute and avoid the fine - the question may then be how much of a fine is necessary before those who choose to pollute feel the cost of doing so is too great? The economy therefore is faced with three key questions that have to be answered - irrelevant of the complexity of the economic system involved. 1. What goods and services should be produced? Should the economy focus on being self-sufficient or concentrate on producing goods and services to which its resources are best suited? Should it devote resources to health and education or defence and policing? Should we devote more resources to housing? Should an economy use resources producing goods that are essentially useless - like 'free' toys in cereal packets, football sticker cards and so on? 2. How should goods and services be produced? Should the economy use a system that is labour intensive and thereby ensures everyone has a job who wants one, or should we use more efficient methods of production that involve the use of machines even if this means more pollution and fewer jobs? Should we devote more land to production and thus solve some problems of feeding the population at the expense of encroaching into areas of natural beauty? 3. Who should get the resources that the economy has produced? Should an economy be geared to providing goods and services to every person as equally as possible or should those who work hard get more? How do we distribute our resources? In the space below make a list of answers to these questions - think of the answers in general terms rather than specifics, e.g. food, health, etc. What should be produced? How should these goods and services be produced? Who should get what is produced? Having identified these key questions, now take them a stage further take one item from the list you have in Question 1 and break it down further - for example, in health, should the resources allocated to this area be spent on fertility treatment, heart disease, cancer treatment or research into AIDS, etc? Breakdown for Question 1 Part Three You are now in a position where you have had to make decisions. In doing so, there will inevitably be some sacrifice to be made. The sacrifice is, for example, in deciding that cancer treatment is more important than fertility treatment. You are making judgements; these judgements cannot always be quantified to any great degree. Economists call these sacrifices Opportunity Cost. Opportunity Cost is central to any understanding of economics; if you understand and can apply this concept you are on the way to thinking like an economist - this will be very important as you go through the course! Questions 1: What is the definition of opportunity cost 2: From your own recent experience, give a brief example of opportunity cost 3: Suppose Natasha spends $10,000 on a new car. If she had spent the money on a new car, she could have (in order of preference): 1: purchased $10,000 worth of clothes 2: spent $10,000 traveling 3: given $10,000 to charity or 4: made a $10,000 down payment on a house. Because she could have done any of these things, aren’t all of them the opportunity cost of buying a car? Production Possibilities Curve Economists illustrate the concept through the use of Production Possibility Frontiers (PPFs) or Production Possibility Curves (PPCs). Look at the diagram below. The diagram shows the possibilities for a hospital in the provision of two treatments - one for cancer treatment and one for fertility treatment. The points show the maximum amount of respective treatment that can be given with existing resources (where the PPF intersects with the horizontal and vertical axes). If all resources were devoted to fertility treatment then Fo patients could be treated but the consequences of this would be that there would be no funds available for cancer patients. Conversely, if all resources were devoted to cancer treatment, Co patients would get treated but, as in the first case, there would now be no funds available for patients seeking fertility treatment. SHIFTS IN THE PPC An economy’s production is constantly changing. If its capacity to produce goods and services increases, the production possibility curve will shift outwards to the right. Agricultural Products (million tonnes) Manufactured Products (million tonnes) Among the causes of a rightward shift are: An increase in the labour force An increase in the stock of capital goods An increase in technical knowledge & improvement in training A more educated entrepreneurial class Discovery of natural resource deposits The production possibility curve can also shift inwards to the left if an economy’s production possibility declines. This could occur due to a war or natural disaster, which reduces a country’s resources. Agricultural Products (million tonnes) Manufactured Products (million tones) PPC AND OPPORTUNITY COST Increasing Opportunity Cost The diagrams that you have encountered thus far are the usual shape of the PPC. The curves are concave to the origin of the graph; that is they are bowed outwards. This shows that as more of one good is produced the opportunity cost rises. EXAMPLE: fill in the values for opportunity cost AGRICULTURAL PRODUCTS MANUFACTURED PRODUCTS OPP COST 0 1 2 3 4 5 6 60 58 55 50 42 30 0 ---- From the table, we can see that there are seven different combinations of production that the economy can be at. Let’s say that the economy is at the point where it produces (3, 50). If the economy increases its food production to 4m tonnes, then due to existence of finite resources, it can only produce 42m tonnes of manufactured goods. Thus the economy gives up 8m tonnes of manufactured goods. If the economy increases its food production again and produces 5m tonnes, then it can only produce 30m tonnes of manufactured goods. This time the economy had ton give up 12m tonnes of manufactured goods. Thus the opportunity cost increased. Constant Opportunity Cost There is a chance that if two products use similar methods of production, there may be a constant opportunity cost. In this case the PPC will be a straight line. Example: fill in the values for opportunity cost WHEAT 0 1 2 3 4 5 6 LINSEED OIL 30 25 20 15 10 5 0 OPP COST ---- As you can see every time that the economy increases the tonnage of wheat, it must give up 5 tonnes of linseed oil Questions 1: What two conditions must hold for a point to be on the production possibilities curve? 2: “Because we have to make choices, there is scarcity” What is wrong with this statement? 3: The following table illustrates the production possibilities of a factory producing medicines. Point A B C D E Vaccines 50 45 35 20 0 Tablets 0 50 90 120 140 a) Graph the production points on a PPF. Vaccines should be on the horizontal axis, while Tablets should be on the vertical axis. b) Plot the points H and G. H is an inefficient level of production while G is currently unattainable given the current configuration of resources. c) Calculate the opportunity of vaccines in terms of tablets forgone. Do the same for tablets in terms of vaccines forgone. d) How would the PPF change if the company bought a new machine that increased the number of vaccines a worker could produce but had no effect on the number of tablets that that a worker could produce. e) What factors would increase the productive capacity of this factory. 4: Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”. (a) Draw a production possibilities frontier for guns and butter. Explain why it most likely has a bowed-out shape. (b) Show a point that is impossible for the economy to achieve. Show a point that is feasible but inefficient. (c) Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks might choose and a point the Doves might choose. (d) Imagine that an aggressive neighbouring country reduces the size of its military. As a result, both the Hawks and Doves reduce their desired production of guns by the same amount. Which party would get the bigger “peace dividend” measured by the increase in butter production?