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Microeconomics 1: The economic problem
Basic economic problem and factors of production
Basic economic problem: Scarce resources, unlimited wants
- Finite resources, in nite wants
3 basic economic questions:
1. What: what goods and services should be produced in a society from its scarce
resources
2. How: How should the productive resources of the economy be used to produce
these various goods and services
3. For who: Having produced a range of goods and services, how should these be
allocated among the population for consumption
• Factors of production: Anything used in the production of goods and services
1. Land: All natural resources provided by nature. Reward = Rent
2. Labour: Includes physical and mental e ort of people in the production of goods
and services. Reward = Wages
3. Capital: Man made goods that are used in production. Reward = Interest rate
4. Enterprise: people who take risks to bring new products to the market or to start
a new business. Reward = Pro t
• Due to the problems of scarcity, decisions have to be made by consumers,
producers and the government about the most e cient use of these resources
- More scarce a resource is, higher the price
- Less scarce a resource is, lower the price
• Renewable resource: Resource that is naturally replenished and can be used
continuously
• Non renewable resource: Resource that cannot be naturally replenished at the pace
it is being used at
Opportunity cost and PPF
Opportunity cost: It is the next best alternative forgone for a decision made
- There is an opportunity cost for resource allocation
PPF: Shows the total combinations of 2 goods that can be produced when all factors
of production are fully employed
- Gradient of PPF shows opportunity cost
- Any point inside the PPF is attainable, but ine cient (Shift inwards - Recession)
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, - Any point on the PPF shows e cient production
- Any point outside the curve is unattainable with current factors of production
(Outward shift - Economic growth)
PPF can show:
1. Opportunity cost: Any movement along the PPF shows that the production of one
god can only increase when a tradeo is made by decreasing the production on
the other good
2. Scarcity: Can be shown by any point outside the curve. There are limited/
insu cient resources to produce in nite goods
Market
Market: Any place or mechanism that brings together buyers and sellers in order to
trade or exchange products
Competitive market: A market in which there are large number of buyers and sellers
possess good market information and can easily enter or leave the market
Types of markets
1. Market economy: Market forces operate freely to determine the allocation of
resources
Advantages:
- No tax
- Higher productivity
- Lower prices
- Responds quickly to change in price
- Pro t motive
- Higher quality of good
2. Planned economy: When the government owns all factors and production and
determines the allocation of goods and services
Advantages:
- No monopoly (Prevents exportation of consumers)
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, - Equality
- Focuses of quantity
- Less unemployment
Disadvantages:
- Lower quality
- Less innovation
- Lower e ciency
- May lead to black markets
3. Mixed economy: Resources are partly allocated by the government and partly by
the market
Advantages:
- No harmful goods
- Prevents exploitation of consumers
- Prevent market failure
- No monopoly
- Lower unemployment
Disadvantages:
- Taxes discourage rms to increase production
- Firms may be forced to produce goods that are not pro table
- Government may add very high taxes
Microeconomics 2: Demand and supply
Demand
Demand: It is the ability and willingness of consumers to purchase a speci c quantity
of a good at a speci c price, ceteris paribus
Law of demand: When price increases, quantity demanded decreases. When price
decreases, quantity demanded increases
Extension in demand: Quantity demanded increases due to decrease in price
(movement on the demand curve to the right)
Contraction in demand: Quantity demanded decreases due to increase in price
(movement on the demand curve to the left)
Increase in demand: Outward shift in the demand curve
Decrease in demand: Inward shift in the demand curve
Veblen e ect: Type of luxury good for which the quantity demand increases as price
increases
Normal goods: Goods for which quantity demanded increases as real incomes
increase
Inferior goods: Goods for which quantity demanded decreases real incomes increase
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