Example 2: same chapter

Definitions:
- Economics: The study of how to allocate scarce resources in the most efficient way, divided in microeconomics( the study of how households and firms make decisions in markets) and macroeconomics. (the study of issues that affect economies as a whole)
- Household: Group of people whose spending decisions are connected.
- Model: A simplified view of reality that is used by economists as a means of explaining economic relationships.
- Factor of production: The resource inputs that are available in an economy for the production of goods and services. Land, Capital, Labor and entrepreneurship.
- Factor endowment: The stock of factors of production.
- Production: The output of goods and services.
- Goods : tangible products such as cars, food and washing machines.
- Services: Intangible products, such as banking, beauty therapy and insurance.
- Land: natural resources in an economy
- Capital: man-made aids to production.
- Entrepreneurship: Management.
- Labour: The quantity and quality of human resources.
- Division of Labour: The specialisation of labour where the production process is broken down into separate tasks. One part producing half-fabricate, other part making final product (perhaps in other countries, improving transport.)
- Opportunity cost : The cost of the next best alternative which is foregone when a choice is made. So if I buy a DVD of 5 pounds I will not be able to buy two sandwiches with the total of price of 5 pounds. The opportunity cost for the DVD is two sandwiches.
- Want: anything you would like, irrespective of whether you have the recourses to buy it.
- Scarcity: A situation where there are insufficient resources to meet all wants. (There is always scarcity)
- Specialisation: The concentration by a worker or workers, firm region or whole economy on a narrow range of goods and services. Specialisation has a wide range of benefits:
1) An increase in the output of goods and services when compared to circumstances where each country provides itself with everything it needs. Globally, this has had an important bearing on raising living standards, since there is more output from a particular volume of resources.
2) A widening range of goods that are available in an economy. Like the Caribbean selling banana’s because of the climate. (Oil-exporting countries!)
3) Exchange between developed and developing countries. This is often influenced by the factors of production. For example: China has been able to grow because of the high export. The high export was the result of the cheap labour in China.

Specialisation isn’t without risks. For example:
1) Countries that have specialized in E.G. oil might have a problem when oil runs out. (Dubai)
2) De-industrialisation. Because of specialization E.G. the British textile industry has moved to low-wage companies like China. This resulted in a huge amount of job-losses.
3) Bad weather, if the Caribbean focus on banana’s and the crops get wiped out because of bad weather they will be in some serious problems.
4) The taste of consumers might change, asking for other goods which will make the demand for you specialized good drop.

- Exchange: The process by which goods and services are traded. The trades can be internal (domestic) and external (international).
- Productivity: Output, or production of a good or service, per worker.
- Developed economy: an economy with a high level of income per head
- Developing economy: an economy with a relatively low level of income per head.
- Productive potential: the maximum output that an economy is capable of producing.
- Economic system: the way in which production is organised in a country or group of countries.

The basic economic problem: the fact that resources are scarce in relation to wants that are unlimited leading to choices having to be made.



Production possibility curve.

The production possibility curve shows how resources are allocated. It shows the maximum quantities of different combinations of output of two products, given current resources and the state of technology.
To explain this model we need to imagine the economy just produces two goods, say: cars and TV’s . It is also assumed that these two industries use all of the economy’s current resources. Sometimes the production possibility curve is called the production possibility frontier, since it draws a type of boundary between what can and cannot be produced.

CARS TV’s
1000 0
800 400
600 800
400 1200
200 1600
0 2000

Also involves opportunity cost: The opportunity cost of making 200 cars is 400 TV’s.

In the example of the cars and TV’s, there are two extremes: producing 1000 cars and producing 2000 TV’s.



Point A and B are on the PPC and are important since they are indicative of an efficient allocation of resources. Point C, however, shows an inefficient allocation of resources because there are less cars and tv’s produced than it could from the resources available. Point D isn’t a possible outcome because this point indicates there are more resources being used than there are resources available.
The graph also indicates there is a trade-off involved. A trade off is the calculation involved in deciding on whether to give up one good for another. If we choose to make more tv’s, we’ll produce less cars.

PPC will move outwards because of:
- Increase in technology; this leads to an over-time increase of productive capacity. (because of higher efficiency)
- More resources, we will be able to produce more because the amount of resources increases. ( With fixed efficiency)
- Economic growth; causes increase of productive capacity due to an increase of capital.

The PPC will move inwards when the productive capacity decreases.

The problems of developing countries in relation to the PPC.
If we look at a PPC for capital goods and consumer goods the problem for the developing countries is that they have a relatively high population in relation to the GDP. Therefore, there is a relatively high demand for consumer goods and there are relatively a lot of consumer goods produced. However, due to the steepness of the line near the extreme of consumer goods a small decline in the production of consumer goods will make the production of capital goods increase significantly.



However, to ensure economic growth in the future capital goods are very important because this will make the productive potential increase.
The choice is always between meeting the current needs and wants of the people(by producing consumer goods) and insuring economic growth. (by producing capital goods)


Economic market systems and the role of the market.


Scarcity involves the choice of governments and organizations to choose:
- What goods and services are to be produced;
- How these goods and services are produced and
- Who should receive these goods and services (allocation)

There are three main types of economic systems:
-Market economy: An economic system whereby resources are allocated through the market forces of demand and supply. Decisions on how resources are allocated are made by millions of people and firms. Price and free operation of the price system are central to the way in which resources are allocated.



-Command economy or centrally planned economy: An economic system in which resources are state owned and allocated by the state.
In the command economy the government has a central role in all decision made like: what to produce, how to produce and for whom the produced goods are. Also, prices of essential items and wages are controlled.
The market does not have a substantive role in the allocation of resources.
Also, in the command economy the government will try to move the PPC more to the capital goods as it would have been in the free market system to ensure future economic growth.
-Mixed economy: an economic system in which resources are allocated through a mixture of the market and direct public sector involvement.
Mostly in mixed-economy the most important companies involving E.G. oil; gas; electricity would have been government owned. However, the last 20 years there has been the trend of privatisation. Those companies are becoming private companies.
Worldwide there has been a move from government-owned companies to privatisation, which mostly caused an extra flow of money to the countries involved due to additional foreign investments. (China, command economy to mixed)

Example: Chapter 1 summary

What is economics?

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.