Transcript what is economics

WHAT IS ECONOMICS
Though economic activity is so important, economics as a discipline is
hard to define
• One suggestion might be that economics is about money but in fact
economic activity can be conducted without money (e.g. barter)
• Two of its main areas relate to production and consumption
- so each society therefore has need to produce various goods and
services such as food, clothing and education which are then
consumed by the general population
• A third area relating to distribution is also included so that a key
problem for every society is to decide how all the goods and services
produced should be distributed among the population
DEFINITIONS OF ECONOMICS
1.
Economics is about man in the ordinary business of life. It examines
that part of individual and social action which is most closely
connected with the attainment and with the use of the material
requisites of well-being. (Alfred Marshall)
2.
Economics is about the production. consumption and distribution of
scarce goods and services.
3.
Economics is the art of making the most of life. (George Bernard
Shaw)
4.
Economics is the science which studies human behaviour as a
relationship between ends and scarce means that have alternative
uses. (Lionel Robbins)
5.
The theory of economics does not furnish a body of settled
conclusions immediately applicable to policy. It is a method rather
than a doctrine, an apparatus of the mind, a technique of thinking,
which helps it possessors to draw correct conclusions. (Keynes)
PROBLEM OF SCARCITY
• The fundamental problem of every economic society is scarcity
This is clearly true in poor countries such as in Africa. However
even in the most affluent societies most people want more than they
can afford to purchase
- So even here human wants in the desire for goods and services
such as houses, cars and foreign holidays are (potentially)
unlimited, whereas the resources from which they can be produced
are always in short supply
• This leads therefore to the problem of scarcity and the consequent need
for choice
• Goods which are not scarce such as air and (tap) water - though
extremely important for life - have little or no economic value (because
they are not scarce). These therefore are free goods
- paradox of diamonds and water
• Need for rational choice so as to avoid waste
FACTORS OF PRODUCTION
• Economists often refer to the basic resources (used to produce goods
and services) as the factors of production
There are four factors of production each with its own reward (which
represents a form of income)
• Land. This includes all raw materials (e.g.agricultural produce, oil and
minerals) provided by nature. The income reward here is rent
• Labour. This can be assessed in terms of numbers and skills. The
income reward here is wages and salaries
• Capital. This refers to goods (e.g. factories and machinery) that enable
the more efficient production of goods and services. The income
reward is interest
• Enterprise. A special form of labour that organises production and
undertakes the risk of business. The income reward is profits
So all income in society relates to the factors of production
GOODS AND SERVICES
• As consumers we have a direct demand for goods and services
• Consumer goods are tangible i.e. food, clothing, housing, durable
goods such as cars TV’s, fridges etc
• Services are intangible such as health, education, entertainment, travel,
professional such as legal and medical and business such as marketing
and consultancy
Sometimes economists use the word commodity to refer to either a good
or service
We can have both consumer and capital goods
Capital goods have an indirect value in that they can make production
more efficient e.g. factories and machinery and also necessary
infrastructure such as roads railways and social overhead expenditure (e.g.
schools and hospitals)
DEMAND AND SUPPLY
• Demand relates to consumers and their expressed wants for goods and
services
• Supply relates to producers and the amount of goods (or services)
made available
• Transactions for goods and services take place in markets. So in every
market e.g. the housing market, there is demand (people wanting and
able to buy houses), supply (builders making them available) and
finally a price (at which the houses are sold)
• Goods and services can also be made available directly by Government
without market activity e.g. primary education and basic health care
• The private sector is defined by market activity and the public sector
by non-market (or only partial market) activity.
DIVIDING UP ECONOMICS
• Economics is traditionally divided into two branches
• Microeconomics deals with the individual parts of the economy, such
as consumer behaviour, production by firms and the behaviour of
individual markets
• Macroeconomics deals with the economy as a whole. Some areas of
special interest are the rate of growth in the economy, the rate of
inflation i.e. general price level, the level of employment (and
unemployment) and the balance of payments i.e. difference between
overall value of exports and imports
• Early economists - following Adam Smith - tended to emphasise
microeconomics
• Macroeconomics grew in importance following the work of J. M.
Keynes in proposing a solution to the Great Depression
POSITIVE AND NORMATIVE ECONOMICS
• Positive economics attempts to deal with issues in a detached fashion
(without moral values intruding (i.e. what is the situation)
- so a statement that the unemployment rate is 10% does not entail a
value judgement (that it is good or bad) and is thereby positive
• Normative economics attempts to deal with policy issues which
necessarily entails value judgements (i.e. that one policy is better than
another and therefore ought to be undertaken)
- so a statement that the Government should increase investment in the
economy so as to reduce unemployment is a normative statement
FUNDAMENTAL CHOICES
• Because resources are scarce (in any society) choices have to be made.
The three main categories of choices are
• What goods to produce and in what quantities (relating ultimately to
consumption). For example if a society spends a great deal of money
on building new roads there may not be much left for other areas like
health and education.
• How goods are to be produced (relating ultimately to production). For
example a firm could use a lot of labour (labour-intensive) or
alternatively plenty of machinery (capital-intensive).
• Finally society has to decide for whom goods are to be produced
(relating ultimately to distribution).
At one extreme we may have a small minority that is super rich with
the majority of the population remaining very poor.
However we could aim at another more equal situation - as in some
socialist states - where households get a roughly similar amount of
what is produced
OPPORTUNITY COST
• Because resources are scarce the production of one good involves the
sacrifice of other goods that could otherwise be provided.
- for example a farm might be able to produce 1000 tons of wheat or
2000 tons of barley. Therefore in this case the opportunity cost of
producing the 1000 tons of wheat is 2000 tons of barley. In other
words if we produce 1000 tons of wheat we therefore have to forego
the opportunity of producing 2000 tons of barley.
• Opportunity cost is relevant in all our daily lives. For example you
may have a certain limited amount of income at college. Therefore
when you spend money on some item (e.g. a meal) you will have to
sacrifice some alternative purchase (e.g. a CD). So in this case the
opportunity cost of purchasing the meal is the consequent value of the
CD (which thereby has not been purchased). So a rational decision
here would entail that the value you place on the meal is greater than
that which you place on the CD.
• Opportunity cost can be illustrated using production possibility curves
(See Diagram).
Increasing opportunity costs
8
Units of food (millions)
7
x
6
1
5
y
1
2
4
z
3
1
2
1
0
0
1
2
3
4
5
Units of clothing (millions)
6
7
8
Making a fuller use of resources
x
Food
Production inside
the production
possibility curve
y
v
O
Clothing
Growth in potential output
Food
5 years’ time
Now
O
Clothing
MARGINAL NOTIONS
• Marginal notions are extremely important in Economics
For example we have marginal utility, marginal cost, marginal
revenue, marginal propensity to consume etc.
• The marginal unit in any context is the last one to be considered.
e.g. if a person drinks 4 cups of coffee, the marginal unit is the last cup
consumed.
• The importance of the marginal unit relates to the fact that value in
exchange i.e. economic or monetary value, relates to the value to the
consumer of the last unit
• This can be used to explain the paradox of value whereby tap water
which has much greater value in use than diamonds yet has a much
lower value in exchange
The circular flow of goods and incomes
Goods and services
£
Consumer
expenditure
Wages, rent
dividends, etc.
£
Services of factors of production (labour, etc)
ECONOMIC SYSTEMS
All countries have some form of economic system
• At one extreme are the centrally planned or command economies that
were formerly associated with communist countries (e.g. Soviet Union
and China). These have now largely died out though Cuba remains a
good example.
• At the other extreme lie completely free-market economies where there
is no government intervention and all economic decisions are taken by
individuals and firms. There is no pure example of this as Governments
intervene to some extent everywhere. However Singapore and Hong
Kong and to a lesser extent the US represent economies where the free
market philosophy is very strong.
• In practice all economies are mixed in that they combine a mixture of
both extremes (which can vary considerably). In Europe the Scandinavian
countries would have a high level of government intervention. Others like
the Netherlands and the UK would have a lesser degree. Ireland stands
somewhere in the middle as regards intervention.
Classifying economic systems
Mid 1980s
Totally
planned
economy
N. Korea China
Poland
Cuba
UK
France
USA
Hong
Kong
Totally
free-market
economy
N. Korea
Cuba
China
Poland France
USA
UK
China
(Hong
Kong)
Late 2000s
COMMAND ECONOMY
In the command economy land and capital are collectively owned. The state
plans the allocation of resources at three levels
• It decides on the important breakdown as between consumer and
investment goods. In Stalin’s era a huge amount of Soviet resources went
into investment (at the expense of the consumer)
• It dictates the amount which each production unit will produce, and the
techniques of production used
• It also dictates the distribution of resources as between consumers,
generally by deciding on people’s incomes and then letting them make their
own decisions as regards consumption
• There are lots of problems with the command economy
- it requires a huge amount of information; planning tends to be
inefficient; it may be difficult to provide incentives for workers and it can
involve a great loss of liberty for workers
THE COMMAND ECONOMY
• Plans allocation of resources between consumption and investment
• Plans output of each industry, techniques that will be used and labour and
raw materials required
• Plans distribution of output between consumers
PROBLEMS
• The larger and more complex the economy, the greater the task of
collecting information essential to planning
• If a rigid system of prices is set it is likely to lead to inefficiency
• Difficult to provide incentives
• Can entail a considerable loss of individual liberty
• Plans may be enforced even when unpopular
• Can lead to unwanted shortages and surpluses
FREE MARKET ECONOMY
This is also known as the capitalist (or laisser faire) system where land and
capital are privately owned.
•
Here consumers and producers are assumed to act in their own self interest ; all
important decisions are based on the operation of supply, demand and resulting
prices in the various markets throughout the economy
As a result of the price mechanism (Adam Smith’s invisible hand) there is no little
for government intervention to allocate goods and services.
If the price is too low a shortage will build up where consumers will be willing to
pay more. This will thereby cause price to rise. Alternatively when there is a
surplus, the price will drop. Therefore through the adjustment of price, demand and
supply are always brought into equilibrium with markets clearing at the resulting
price.
•
Thus in free market systems, efficiency is brought about through the willingness of
both consumers and producers to follow price signals. This enables a remarkably
complex economy to evolve based on numerous markets without any need for
direct intervention.
•
However the main weakness of the free market system is that it can be very
inequitable. Thus in practice we often have mixed economies whereby the state
takes substantial control of social areas like education, health and social welfare.
THE MIXED ECONOMY
• The government and the private sector interact in solving problems
• In practice most Western economies are mixed though the degree of private
and public participation can vary considerably
• Advantages
- enables greater balance as between economic and social objectives
- can help to prevent abuse of economic power
• Disadvantages
- can lead to too much government interference
- can become unduly bureaucratic and inefficient
MARKETS
A set of arrangements by which buyers and sellers are in contact to exchange
goods or services
• Some markets have a definite physical location e.g. shops and stalls
• Other markets operate through intermediaries on behalf of clients
• E-commerce is conducted through the Internet
• Sometimes price is set by sellers e.g. supermarket items; in other cases it is
set directly through buyers bidding against each other e.g. house auctions
or through prospective buyers haggling with sellers
Though superficially different all markets perform the same basic functions
TYPES OF MARKETS
A market is any arrangement through which exchange as between buyers
and sellers can take place
It need not have a definite location
• Goods and Services
e.g. food, education
• Factors of Production
e.g. labour and capital
• Financial
e.g. stock exchange, currencies
• Intermediary
e.g. car components
INTERDEPENDENCE OF MARKETS
1.
Goods Market
•
•
•
•
Demand for good rises
This creates shortage
This causes price of good to rise
This eliminates the shortage by choking off some of the demand and
encouraging firms to produce more
2.
Factor Market
•
•
•
•
Increased supply of goods causes an increase in demand for factors
This causes a shortage of these inputs
This causes their price to rise
This eliminates their shortage by choking off some of the demand and
encouraging suppliers to make more available
THE NATURE OF ECONOMIC REASONING
• Economics as a science
– models in economics
– building models
– using models
– assessing models
• Economics as a social science
– difficulties in conducting controlled experiments in many parts of
the subject
– problems of predicting human behaviour