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1Chapter 1
1.1. Scarcity, Choice, Opportunity Cost
• The economic problem arises because the resources that we have available for the production of goods and services are
limited, while our wants for goods and services are unlimited.
• Definition of Economics: Economics is the study of how society decides what, how and for whom to produce
• Wants are human desires for goods and services. Our wants are unlimited.
• Needs are necessities, those things that are essential for survival, such as food, water, shelter and clothing.
• Demand is different from wants, desires or needs. There is only a demand for goods and services if those who want to
purchase it have the ability to do so.
• Due to this scarcity of resources that arises because of our unlimited wants, choices - that are not always easy or
popular- need to be made about
Resources: Natural/ Human/ Man – Made limited
• The production possibility curve indicates the combinations of any two goods or services that are attainable when the
society's resources are fully and efficiently employed.
• A shift of the production possibility curve occurs when the quantity of available resources increases and/or an improvement
in production techniques takes place.
• The production possibility curve is a very useful way of illustrating scarcity, choice and opportunity cost.
• The curve is concave to the origin and indicates that to produce more of a product (for instance Y), a decline in the
production of the other product (for instance X) is required. the amount of good X that must be sacrifice.
The opportunity cost of producing extra units of Y rises as more of it is produced.
• DEF: The production possibility curve indicates the combinations of any two goods or services that are attainable when the
society's resources are fully and efficiently employed.
• Opportunity cost- There ain't no such thing as a free lunch
• The opportunity cost of a choice is the value to the decision maker of the best alternative that could have been chosen but
was not chosen.
• In economics the true cost of any decision is the value of the next best outcome (of all the other possible outcomes) that
is given up because of that decision. This differs from accounting cost in that accounting costs do not consider forgone
opportunities. Since there are not enough resources to meet all wants and desires every choice has a cost because
every choice involves a trade-off: something is given up in favour of something else.
• In other words, the opportunity cost is the next best thing, in your own view, that you could have done with your limited
resources, your income or time.
• Note that since only one alternative choice is actually forgone the opportunity cost is not the sum of the various
alternatives but only the cost of the best alternative that you gave up.
1.2. Economics as a science
• Economics as a social science: behavior of human beings in changing environment versus Natural science controlled
environment, example chemistry
• Ceteris paribus: “all things being equal” to explain unpredictable outcomes.
• Also Empirical science: measured economic performance
• Macroeconomics - overall economic performance
Macroeconomics is concerned with the economic issues that involve the overall economic performance of the
economy, rather than that of particular individuals, markets or firms.
The emphasis is on topics such as total production, total income and total expenditure, economic growth, aggregate
employment (and by implication unemployment), the general price level, inflation and balance of payments. Examples
include the study of the causes of fluctuations in the level of output, the determinants of economic growth and the use
of economic policy to influence the performance of the economy
• Microeconomics - behavior of individual agents
Microeconomics is concerned with issues that involve the economic behavior of individual agents such as individual
consumers, individual decision makers in households, firms and other organizations. Examples include the study of
how individuals decide what goods and services to buy and how firms decide what goods and services to produce
and how to produce it.
Micro Economics Macro Economics
Price of a single product The Consumer Price Index
Change in the price of a product Inflation
The production of maze The total output of all goods and services in the economy
Decisions of individual consumers The combined outcome of the decisions of all consumers in
the country
Decisions of individual firms or businesses The combined decision of all firms
The Market for individual goods The market for all goods and services in the economy
Demand for products The total demand for all goods and services in the economy
An individual’s decision whether to work or not The total supply of labour in the economy
A firms decision whether to expand production Changes in the total supply of goods and services in the
economy
A firms decision to export Total exports of goods and services to other countries
A firms decision to import Total imports of goods and survives from other countries
• Meso-economics: “In between”
• Positive economics - objective statement of fact - what is
A positive statement is an objective statement of fact. It is a statement about what is and contains no indication of
approval or disapproval. Notice that a positive statement can be wrong. The statement "in 2003 the rate of unemployment
in South Africa was 3%" is incorrect since it was much higher than 3%. It is, however, still a positive statement because it is
a statement about what exists
• normative economics - opinion or value judgment - what ought to be
A normative statement involves an opinion or value judgment. It expresses a judgment about what ought to be.
Normative issues can be debated but they can never be settled by science or an appeal to the facts. An example of
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normative statements is that "the minimum wage is a good thing". If you disagree with it, you have no sure way of
convincing someone who believes the statement that he or she is wrong
• Normative statement: Debated – opinion or judgment
natural science
Natural sciences study the natural universe
social science
Social sciences study the behaviour of human beings, both individually and as groups
Rates of change (percentages)
Rates of change are usually expressed as percentages. The
rate of change is calculated by dividing the absolute change
by the first number and then multiplies it by 100.
A large percentage of a low number is still a low number. For
instance, a 10% increase in the GDP for Uganda (2002 = $6
billion) is only R0.6 billion.
A small percentage of a large number can be a large
number. For instance, a 2% increase in the GDP for
Australia (2002 = R411 billion) is $8.22 billion.
Levels and Rates of Change
Levels: example, wages and income versus Rates: example,
inflation and growth
CPI increased from 200 to 220 = 10%
50 % of 300 = 150
1% of 15 000 =150
It is important to distinguish between levels and percentages
or rates.
Chapter 2
The three Economic Questions
What should be produced?
The purpose of all production is consumption. Due to the scarcity of resources it is not possible to produce enough of all goods and
services. A decision therefore needs to be made concerning what goods and services should be produces.
The decision on what to produce incorporates the decision how much of each good and service to produce, as well as the decision what not to
produce.
One possible way of answering the question is to leave it to the market mechanism. According to the market mechanism approach, only those
goods and services that consumers are willing to spend their income on and which can be supplied profitably will be produced.
How should it be produced?
Once a decision has been taken about what goods and services should be produced, the next question is how these goods and services should
be produced.
Production takes place through a combination of the factors of production. Because these factors of production are scarce, they have to be
used efficiently.
In a market system producers are forced to combine resources in the cheapest possible way. Their decisions are governed by the price of the
various factors and their productivity.
Competition between the producers in the market ensures that inefficient producers are punished by a loss in profits, while efficient producers
are rewarded through profits.
For whom should it be produced?
Since needs are unlimited and resources are scare, and it is not possible to produce enough of all goods and services, society must decide who
will receive the goods and services. This issue deals with the controversial issue of the distribution of income. The higher your income the more
goods and services you are able to consume. According to the market mechanism approach, income is the reward for contributions to the
production of goods and services. The more valuable your contribution and that of the resources you own, the higher your income.
What should be produced?
Capital goods
Capital goods are goods that are used in the production of other goods. Examples include all types of machinery, plant and equipment used in
manufacturing and construction, school buildings, university residences, roads, dams, and bridges. Capital goods do not themselves yield direct
consumer satisfaction, but they permit more production and satisfaction in future
consumer goods
Consumer goods are goods that are used or consumed by individuals or households (ie consumers) to satisfy wants. Examples include food,
wine, clothing, shoes, furniture, household appliances and motor cars
3 Different categories of consumer goods -
Non- Durable goods (food, wine tobacco)
Semi- Durable goods (clothing shoes )
Durable goods (Wash Machine , cars)
final goods and services
Final goods and services refer to those goods and services that are consumed by households and firms (loaf of bread )
intermediate goods
In the production of the final goods and services intermediate goods are used. Intermediate goods are purchased to be used as inputs in
producing other goods before they are sold to end users. Production – flower to bake the bread
private good
a private good is a good that is consumed by individuals and households. All typical consumer goods (like food, clothes, furniture and motor
cars) are private goods.
Pure private goods and services are characterised by excludability and rivalry in consumption. Examples abound: motor vehicles, aeroplanes,
ski boats, houses, hiking boots, school books, pieces of art, theatre tickets, cellular phones, stoves, toothbrushes, paraffin, painkillers, stockings,
jam, haircuts, and so on. The efficient allocation of such goods can be done through the market, that is, without government intrusion.
Public goods
A public good is a good that is used by the community or society at large. Pure public goods are characterised by non-rivalry in consumption
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and non-excludability. One person=s consumption of a pure public good or service therefore does not reduce its availability to other persons,
and a person cannot be excluded from the consumption of such a product if he/she does not pay the indicated or negotiated price. A traffic light,
for example, is a public good. Other examples are defence and weather forecasts
economic goods
Economic goods are goods that are produced with scarce resources and can command a price in the market. Economic goods are also called
scarce goods.
Free goods
free goods are things that are not scarce and therefore have no price. Examples are sunshine and air
Heterogeneous goods
Heterogeneous or differentiated goods are goods that have different varieties, qualities or brands.
Homogeneous products
Homogenous products are identical. There is therefore no reason for buyers to prefer the product of one seller to the product of another seller.
This ensures that sellers and buyers compete with one another in terms of the price of the product. The is one of the characteristics or
conditions of perfect competition. Examples of homogenous products are for instance agricultural products, metals, electricity and water.
An increase in the quantity of available resources and/or an
improvement in production techniques the production possibility of
both goods can increase.
It is also possible that due to an increase in the quantity of available
resources and/or an improvement in production techniques that the
production of one of the goods, for instance good X, increases -
Point A = Unattainable – not enough resources
Move between Point B to C – less of B is produced to produce more of
C
Move between Point C to B – less of C is produced to produce more
of B
Point D = not optimal use of resources – can indicate unemployment
0 = Origin
How should it be produced?
Factors of production
Factors of production are the resources used to produce goods and services. There are four main factors of production: natural resources (or
land), labour, capital and entrepreneurship
Technology – sometimes = the 5th factor of production.
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Natural resources
Natural resources refer to natural wealth and includes water, arable land, mineral deposits and the environment
labour
Labour refers to the human effort put into the production of goods and services. This effort includes both physical and mental exertion
capital
Capital comprises all manufactured resources such as machines, tool and buildings, which are used in the production of other goods and
services
entrepreneurship
Entrepreneurs are people who are prepared to take calculated risks and who seize opportunities as they arise. They are responsible for
combining the factors of production in order to produce goods and services
technology
Technology is sometimes identified as the fifth factor of production. At any given time, a society has a certain amount of knowledge about the
ways in which goods can be produced. When new knowledge is discovered and put into practice, more goods and services can be produced
with a given amount of natural resources, labour, capital and entrepreneurship. If this happens we say that technology has improved
Money is not a factor of Production
Money is not a factor of production – goods and services cannot be produced with money. Money is a medium of exchange. Money is
something that facilitates the exchange of goods and services.
Choice of technique
Production process is dominated by machines = capital intensive production
Production process is dominated by humans = labour intensive production
For whom should it be produced?
Another aspect of distribution is distribution between government sector and the rest of the economy – who will received the goods and services
produced.
Primary sector
The primary sector is the sector in which raw materials such as agricultural, fishing, forestry and mining products are produced
Secondary sector
The secondary sector is the manufacturing part of the economy in which raw material and other inputs are used to produce other goods. This
includes the beneficiation of primary products (eg canning fruit and vegetables and processing minerals into mineral products such as steel),
and the manufacturing of consumer goods (such as machinery, buildings, roads and railways).
Tertiary sector
The tertiary sector comprises the services and trade sections of the economy. It is often referred to as the service sector. Activities in the
tertiary sector include trade, transport, communication and education, as well as financial, personal and government services
Income for factors of production
Rent = natural resources
Wages and Salaries = labour
interest = capital
profit = entrepreneurship
Solutions to the central Questions: Economic systems
3 types of mechanisms which provide answers to the 3 central questions What, How, For Whom
Traditional System– oldest solution, men did what their fathers did – people use the same technique.. Command System/central planning
A centrally planned economic system such as command socialism is an economic system characterized by public ownership of the factors of
production. Decision making is centralized and is coordinated by a central plan, which contains binding directives to the system's participants -
(socialist or communist)– instructed what and how to produce by central authority , large scale planning - Like China
DEF: a market is any contract or communication between potential buyers and sellers of goods or services – bring buyers and sellers together.
Market System– individual decisions and preference are communicated through the market mechanism – most important is market prices.
Market prices are signals of scarcity in market capitalism; economic activity is driven by self interest.
Competition is an important feature of market capitalism. Competition should not be confused with negotiation – which occurs between buyers
and sellers.
For a market to exists
1. Must be one potential buyer and seller
2. Seller must have something to sell
3. The buyer must have the means with which to purchase it
4. An exchange ratio – the market price - must be determined
5. The agreements must be guaranteed by law or by tradition
Mixed economy
In a mixed economy not all the factors of production are in the hands of private people, some are government owned. Economic decisions are
made partly through the market and partly by government. The degree of the mix varies from country to country
privatisation
Privatisation refers to the transfer of ownership of assets from the public sector to the private sector (ie the sale of state-owned assets to the
private sector).
commercialisation
Commercialisation or corporatisation means the transformation of state-owned enterprises into commercial entities, subject to commercial legal
requirements and governance structures, while retaining state ownership. In other words, the enterprise remains in the public sector but is run
like a private company and is also liable for tax.
nationalisation
Nationalisation means that government takes over the ownership or management of private enterprise (with or without compensation).
Chapter 3
3.1 Production, Income and spending
three major flows in the economy = Production, Income and Spending
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