Economics is the study of how to allocate scarce resources in the most effective way. Economics is divided into two traditional fields: Microeconomics and Macroeconomics.
Microeconomics is the study of how households (group of people whose spending decisions are connected) and firms make decisions in markets.
Macroeconomics is the study of issues that affect economies as a whole.
A model is a simplified view of reality that is used by economists as a means of explaining economic relationships.
Wants is anything you would like, irrespective of whether you have the resources to purchase it.
Choice is the selection of appropriate alternatives.
Scarcity is a situation where there are insufficient resources to meet all wants.
Opportunity Cost is the cost of the next best alternative forgone.
The basic economic problem
Economic problem is how to allocate scarce resources among alternative uses.
The resources available in an economy are known as factors of production. An economy produces a lot of goods and services. Goods are products that can be seen or touched, such as cars, food and washing machines. Services are products that cannot be seen or touched, such as banking, beauty therapy or insurance.
There are four main types of factors of production:
Land: natural resources in an economy.
Labour: the quantity and quality of human resources.
Capital: man-made aids to production.
Entrepreneurship: the willingness of an entrepreneur (someone who bears the risks of the business and who organises production) to take risks and organise production.
The worlds poorest countries tend to have few and/or poor quality factor endowment, which is the stock of factors of production.
Specialisation and exchange
A specialisation is a situation where individuals workers, firms, regions of economies concentrate on a particular task or upon producing some goods and services and not others. Trade, which involves the exchange of goods and services normally using money, enables specialisation to take place.
These are the benefits of specialisation:
- An increase in output of goods and services when compared to circumstances where each country provides itself with everything it needs.
- A widening of goods that are available in an economy. For example, the Caribbean specialises in growing bananas; these are traded with the UK and, in return, the money from their sale can be used to buy, say, pharmaceuticals from the UK.
- Exchange between developed (economy with high level of income per head) and developing (economy with relatively low level of income per head) countries.
Specialisation is not without risk. For example:
- If a country has finite resources such as oil, when these run out, the economy is likely to suffer unless the revenues earned from expots have have been wisely invested for the future.
- De-industrialisation – the loss of manufacturing capacity and jobs.
- Bad weather, as experienced in parts of the Caribbean, has wiped out a whole year’s crops.
- The taste or needs of consumers may change.
Subsidy: a payment by a governing body to encourage the production or consumption of a product.
Division of labour
Productivity: output, or production of a good or service, per worker.
Division of labour is the specialisation of labour where the production process is broken down into separate tasks.
An example of the division of labour is the manufacturing of motor vehicles. Here you have separate workers and specialists on separate parts like the engine, body panels and electrical components.
Production Possibility Curve
To show how resources are allocated we can use the production possibility curve (PPC) model. The production possibility curve shows the maximum quantities of different combinations of output of two products, given current resources and the state technology.
The figure below is a production possibility curve.
At point A 750 cars and 1000 televisions are produced. Both A and B indicate an efficient allocation of resources. Point C however, is an inefficient allocation of resources, since the economy is producing less than it could from the resources available. Point D is not a possible outcome, because the economy doesn’t have enough resources to produce this amount of cars and televisions.
The PPC is also used to show opportunity cost. For example, if the economy is operating at point A, the opportunity cost of producing 500 more televisions is 250 cars.
The PPC further indicates that there is a trade-off involved. Trade-off is the calculation involved in deciding on whether to give up one good for another.
If, for example there is an advance in production for television it will be more sets produced for a given number of cars. This is shown in the PPC below.
The PPC changes curve in this way because there has only been a change in the production of televisions, but no change in conditions affecting the car production.
The whole production possibility curve can shift entirely, either to the left or to the right, when the production capacity changes.
There are two main reason why such shifts may occurs:
-More resources or economic growth. Economic growth occurs where the productive potential of an economy changes. Productive potential is the maximum output that an economy is capable of producing.
-Advances in technology continue over time, affecting the position of the PPC of an economy.
PPC can also be used to make difficult choices such as how to allocate scarce resources. In the PPC below (A/D) we see that the production of consumer goods is approaching its maximum leaving only a small amount of resource for capital goods. We see that a small reduction in production of consumer goods, lead to a quite big increase in production of capital (B/D), which means that the economic potential will rise.
Economic systems and the role of the market
The choices that are made and how they are made is determined by the economic system of a particular country. There are three different types of economic system.
These are the market economy, the command or centrally planed economy and the mixed economy.
In the market economy, resources are allocated by the forces of demand and supply through the price mechanism.
Demand is the quantity of a product that a consumer are able and willing to purchase at various prices over a period of time.
Supply is the quantity of a product that producers are willing and able to provide at different market prices over a period of time.
In a market economy, people and firms take decisions about how resources should be allocated. Price and the free operation of the price system (method of allocating resources by the free movement of prices) plays an important part in how resources are allocated.
In the command or centrally planed economy the government has a central role in all decisions that are made. The key features of a command economy are that the government is responsible for the allocation resources.
In a mixed economy resources are allocated through a mixture of the market and the direct public sector involvement. Decisions involve an interaction between firms, labour and the government, mainly through the market mechanism. A mixed economy is the typical economic system.
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