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Study Unit 1
What Economics is all about
Economics is a social science that studies how people use scarce resources to satisfy their
unlimited wants. Microeconomics looks at this at an individual, household or firm level while
Macroeconomics is a broader look which is an aggregate of all the individuals, households and
firms in a given economy. The main aspects in Microeconomic theory are supply, demand,
scarcity, choices and opportunity cost.
The Economic Problem
Every individual has a set of needs and wants that they seek to satisfy. Some are important for
day-to-day living, such as food, water, clothing, shelter and health care. In Economics these are
termed needs. Some of the things that the human being wishes to accumulate are not really
necessary for a living. He/she can do without. Examples include sports cars, jewellery, fancy
clothing and luxurious accommodation. These are termed wants. Our needs and want are
never ending, yet the means to satisfy them are limited in supply. Hence the economic problem,
“how to satisfy these never ending wants and needs, given limited resources”. This is the basis
of Economics.
Scarcity
Almost every resource on this planet comes in limited supply. Money, housing, time, food,
labour, machinery, cars all come in limited quantities such that we can`t all get everything that
we need to satisfy our needs and wants. This limit in supply and availability brings another
important principle in Economics, that of scarcity.
,Opportunity Cost and Choice
Opportunity cost is one of the very important concepts in Economic theory. It`s very important to
note that opportunity cost depends on individuals as people value alternatives differently.
Opportunity cost is the value of the next (second) best alternative forgone or sacrificed when a
certain choice is made. The existence of scarcity brings up the concept of opportunity cost when
a choice is made. Because our wants and needs are unlimited/endless, and the resources to
satisfy them are limited, this leaves us with no option but to make choices between competing
alternatives. For example, consider money, a resource which is available in very limited supply,
yet used to satisfy an endless list of unlimited needs and wants. If let’s say you have R1 000 for
use and you choose to use R500 on airtime, it automatically leaves you with R500 for use on
other competing needs. When determining opportunity cost of any choice made it is very
important to rank your alternatives in order of preference, from the most preferred to the least
preferred. Take Tebogo for example. On a Saturday morning he has the following options that
he ranked in order of preference:
1) Work
2) Study
3) Do Laundry
4) Chat
5) Watch Soccer
6) Do Shopping
7) Sleep
Based on the above, Tebogo`s opportunity cost of Work will be Studying. His opportunity cost of
Studying will be Laundry, and that of Laundry will be Chatting. The opportunity cost of Chatting
will be the Soccer forgone. Note that every time the opportunity cost will be the value of the next
best alternative forgone, not the values of all the alternatives forgone.
The Economic Problem
All authorised decision makers are faced with the questions to do with what to produce amongst
the (limited) competing goods and services that satisfy unlimited needs and wants. Should we
erect more hospitals or build more schools, use the land to construct factories for production of
cars and computers or instead use that land for farming to produce maize, wheat and milk?
After the what question has been answered, the how to produce question has to be addressed.
Should we employ more labour or more capital? Now that we have decided to use that land for
farming, how should we produce that maize, wheat and milk? After we have answered that, we
have one more question to answer, for whom to produce? Should we produce the maize,
wheat and milk according to the people`s needs. Say a family of 4 gets 100kg of maize, 50kg
wheat and 20 litres of milk per month while a family of 6 gets 150kg of maize, 70kg wheat and
8litres of milk or should we produce only for those who can afford?
,Production Possibility Curve/Frontier
A production possibility curve is a graph/boundary line that emphasizes the concept of
opportunity cost and choice further. It shows the various combinations of two
goods/commodities that can be produced in an economy using the same fixed amount of
input/resources with a given level of technology. This schedule shows that there are limits I
production so an economy must decide the combinations of goods and services to be produced
to achieve efficiency. It follows from the premise that (because of scarcity), allocation of
resources to the production of one good will automatically reduce the amount of resources left
for production of the other good.
Take an example of an economy that can produce only wine and cotton. All the points on the
PPF (points A, B and C) represent efficient use of resources. Point X represent an inefficient
use of resources, while point Y represent unattainable production levels (with the given
resources) at least in the short run.
All points on the curve show efficiency and represent full utilization of resources, while
those under the curve/frontier indicate inefficiency represent underutilization use of
resources. Those points above the curve are in-achievable or simply not feasible.
Production Possibility Frontier
As can be seen, for the economy to produce more wine, it must give up (sacrifice) some of the
resources it uses to produce cotton. If it decides to produce more cotton, it must divert some of
the resources from wine production and consequently reduce the amount of wine produced. If
,more wine is in demand, the opportunity cost of producing those extra units of wine will be
proportional to the decrease in cotton production
Shifts and Swivels of the PPC (Production Possibility Curve)
Supposed there in an increase in technology in the economy, and the time taken to pick up the
grapes and cotton has been significantly reduced. This means more grapes and cotton can be
produced (with a given level of land, labour and capital). This will cause the PPC to shift
outward as shown by the new dotted PPC. When this happens, we know there is growth in the
economy, as point Y (which earlier had been impossible) will now be attainable and represent
efficient use of resources. More output, reduced unemployment (increased employment), better
living standards. A movement of the PPC inwards would represent a dwindling economy and
this will result in a fall in output.
The Production Possibility Curve will shift outwards under the following scenarios:
• Improvements in Productivity and Efficiency from the available factor resources
• Increases in the productive potential following improvements in technology. This may
emanate from a specific industry, but the effects may be felt in several related industries
(positive spill-over effect).
• Exploitation of more factors of production (Capital and Labour) available for the
production process
The PPC will swivel outwards if the society learns to get better at producing (increase
productivity) only one of the two goods. This would swivel the curve out along the axis of that
good.
,Positive and Normative Statements
Whenever you are reading newspaper articles, listening to news reporters or friends in a
constructive argument, it is important to note the difference between objective statements and
subjective statements.
When a particular individual or group has a particular argument to make, they will include
subjective statements about what ought to happen, or what should happen, depending on the
individual`s opinion. These are value judgements, usually partially or wholly lacking objectivity.
These are called Normative statements, and are very difficult to prove right or wrong as they
represent an individual`s opinion. Examples include:
Inflation is the most serious economic problem
Unemployment is more harmful than Inflation
Resources are best allocated by letting the Market (Price) Mechanism work freely
without Government intervention
The Government should make the minimum wage rate R6 000 per month
The tolling fees for improving the road infrastructure should be collected via a fuel levy
The Government should impose a 20% tax on high sugar content foods to combat
obesity
On the other hand, Positive statements can be tested, amended and/or rejected by referring to
some evidence. Positive statements deal with objectivity and are facts which are prone to
testing for acceptance or rejection. Examples are:
An increase in income will result in rise in demand for normal goods
Strengthening of the rand against other currencies will worsen our Balance Of Payments
deficit
Higher interest rates will lead to an increase in the inflation rate
If the Government raises a tax on beer, this will lead to fall in profits for the brewers
A rise in average temperatures will lead to an increase in the demand for ice cold
products
,Past Exam Practice Questions
May/June 2011
1 Economics may be defined as
[1] the empirical testing of value judgements through the use of logic.
[2] the use of policy to refute facts and hypotheses.
[3] the social science concerned with how society manages its scarce resources.
[4] a study of how limited resources can be used to satisfy limited wants.
2 Microeconomics is concerned with
[1] positive economics but not normative economics.
[2] an overall view of the operation of the economic system.
[3] the study of the demand, supply and prices of individual goods and services.
[4] the combined decisions of all firms in South Africa.
3 The three major flows in the economy are
[1] total production, total investment and total spending.
[2] total spending, total income and total production.
[3] total production, total spending and total savings.
[4] total income, total savings and total consumption.
4 Assume that your neighbour pays R5 000 per month for a personal loan while you pay R2
000 per month for yours. Suppose your neighbour’s instalment increases by 2 percent
while yours increases by 5 percent.
Which one of the following options is correct?
[1] Your neighbour’s instalment increase in rand terms is less than yours.
[2] Your neighbour’s instalment increase in rand terms is more than yours.
[3] Your neighbour’s instalment increase in rand terms is the same as yours.
[4] None of the options is correct.
5 An economic system
[1] requires a grouping of private markets linked to one another.
[2] is the organisation of production, consumption and distribution to answer the basic
economic questions.
[3] requires a centralised authority (such as government) to coordinate economic
activity.
, [4] is a plan or scheme which allows a firm to make profit at some other firm’s expense.
6 Opportunity cost is best defined as
[1] the monetary price of any production resource.
[2] the amount of labour that must be used to produce one unit of any product.
[3] the ratio of the prices of goods imported to the prices of goods exported.
[4] the amount of one product that must be given up to produce one more unit of
another product.
Use Table 1 below to answer questions 7 and 8.
Table 1
Combination Pencils Pens
A 0 16
B 6 14
C 8 11
D 10 7
E 12 0
7 Assume that one pencil costs 25 centsand one pen costs 50 cents. The opportunity cost
of producing the eighth pencil in money terms when moving from combination B to C is
[1] 25 cents.
[2] 50 cents.
[3] 75 cents.
[4] R1.
8 The opportunity cost of increasing the production of pens from 7 to 14 units is ________
pencils.
[1] 2
[2] 4
[3] 6
[4] 8
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