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Chapter 1
Introduction to Economics
1.1
1.2
1.3
1.4
1.5
1.6
1.7
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What is Economics?
The Language of Economics
What is a Market?
The Circular Flow of Income
The Economic Problem
The Production Possibility Frontier
Economic Systems
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What is Economics?
• Economics is the study of the allocation of
scarce resources.
• Resources are scarce because they are limited
and can be used up (e.g: time, crops, oil,
water).
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Scarcity
• A basic assumption of economics is that a person’s wants
are unlimited and never satisfied.
• Resources are used to satisfy wants.
• As our wants are unlimited and resources are scarce, we
must make choices as to how to use these scarce resources
most efficiently, so that as many wants as possible (and the
most important ones) are satisfied.
• Example Page 11
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Opportunity Cost
• Is the next best choice for the use of an available
resource.
• Opportunity cost measures the trade-off consumers face
when choosing how to use a scarce resource.
• When we use a resource for one purpose we are giving
up using it for something else.
• Example Page 12.
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The Language of Economics
• Positive economics: When economists state a fact.
“The price of butter is $3.00 for 250 grams.”
• Normative economics: When economists make a value
judgment or a statement of what something should be.
Used by policy makers such as politicians.
“The price of butter is too high and ought to be cheaper.”
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The Role of Assumptions
• Economists make a range of assumptions to simplify
complex real world situations to make them easier to
understand.
Some Common Economic Assumptions:
• People act rationally.
• A firm’s goal is to maximise profits.
• “Ceteris Paribus” a Latin phrase meaning “all other
things being equal”
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Incentives
• Basic economic assumption that people respond to incentives.
“What’s in it for me?”
• A financial incentive is payment for a job or task.
• A negative incentive is gaol time for breaking the law.
• An incentive can be the good feeling or the happiness we get out of
doing something for somebody else.
• See example pg 15.
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What is a Market?
• A market is a “place” where buyers and sellers
of goods or services come together.
• In today’s world that place no longer has to be
physical e.g. EBay, the ASX.
• Case Study EBay pg 16.
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The Circular Flow of Income
• Firms are the producers in the economy; they produce
goods and services using the factors of production.
• Households are the consumers in the economy; they
consume goods and services and provide the factors of
production to firms.
• The factors of production are land, labour and capital.
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The Circular Flow of Income
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The Economic Problem
• The set of basic decisions that must be made by society
regarding goods and services produced and consumed.
• What to produce?
• How much to produce?
• How to produce?
• How to increase productivity?
• How much to consume?
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The Production Possibility Frontier
• Shows the set of all feasible production combinations of two alternate
goods.
• At any point on the frontier the economy is using its scarce resources in
the best way to produce the highest possible level of output.
• Any point inside the frontier is inefficient as the economy is producing less
than it could be with its available resources.
• A good example of opportunity cost. At the frontier, an economy cannot
produce more of one good without giving up some production of another
good.
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The Production Possibility Frontier
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Economic Systems:
Command Economies
• A command economy is one in which a central authority or
government controls every aspect of the economy.
• Usually associated with communism or socialism.
• No private ownership of land or goods, everything is owned
by the state.
• Does not take advantage of the fact that people respond to
incentives.
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Economic Systems:
Free Market Economies
• Decisions made by a central planner in a command economy are replaced
by the individual decisions of millions of individuals, households and firms.
• The market is free to look after itself. (No government regulation)
• Advantages :
– Recognises incentives
– Market mechanisms create efficient outcomes
(“The invisible hand” see pg 26)
• Disadvantages:
– Large inequalities between rich and poor
– Promotes overproduction and waste
– Under-produces public goods e.g. parks, hospitals and schools.
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Economic Systems:
Mixed Economies
• Between a free-market economy and a command economy.
• Uses market mechanisms and incentives.
• Some government intervention
(public goods, unemployment benefits, etc.)
• No pure free market or command economies left.
All today’s economies have elements of both types of systems
i.e. mixed economies.
• What is the best mix?
How much government intervention is the right amount?
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