Transcript Chapter 1 Notes - Ms cochrane`s CorneR

Canadian Economy
2203
Chapter One Notes
Fundamental Principles of Economics
What is Economics?
As we face daily
questions about what we
need, what we want, and
what we can afford to
have, we are engaged in
economics. Economics is
the study of human
activity involved in using
scarce resources to
satisfy wants.
What is Economics?
Economics is considered a social
science like either history or
geography and these sciences
attempt to understand an
important aspect of the human
condition in the world in which we
live.
Today, economics is often referred to as the
science of scarcity and choice, and basically
entails the study of the way we make decisions
about the use of scarce resources. The main
difference between economics (as a social
science) and the "pure" sciences (such as
physics or chemistry) is that the social sciences
are based on human behaviour and value
systems. The difference, therefore, is the fact
that human behaviour changes over time.
Economics, like all other natural and
social sciences, uses a common
investigative approach called the scientific
method. Essentially there are four
components to this method:
•
observation
• data collection
• explanation
• verification
The Economic Concept of SCARCITY
Scarcity, choice, and cost are sometimes
referred to as the fundamental trilogy of
economics because of the strong
interrelationships between the three concepts.
Since resources are limited, compared to
wants, individuals and families face the problem
of scarcity in deciding how to allocate their
incomes and their time. For economists,
scarcity is always related to our wants and our
resources.
The truth is that scarcity (of a
resource) only really exists if there
is a demand for that resource. On
the other hand, if nobody wants the
resource, even though it is in short
supply, then scarcity doesn't really
exist as it relates to that resource.
Economists reason that, since
human wants are infinite, but the
earth's resources to meet those
wants are limited, there will never
be a time when all human wants
will be satisfied. We will always be
forced to contend with the problem
of scarcity.
Indeed, as the earth's population
continues to increase as
advances in medicine and an
increased standard of living
fosters such growth, the demand
on the earth's resources will
become even more strained.
And the effect of this increased
demand will result in increased
value being placed upon these
scarce resources. Generally
speaking, the more scarce the
resource, the greater in value it
becomes. Why is this so?
What is Opportunity Cost?
Unlike most costs discussed in
economics, an opportunity cost is not
always a number. The opportunity cost of
any action is simply the next best
alternative to that action - or put more
simply, "What you would have done if you
didn't make the choice that you did".
You have a number of alternatives of how to
spend your Friday night: You can go to the
movies, you can stay home and watch the
baseball game on TV, or go out for coffee with
friends. If you choose to go to the movies, my
opportunity cost of that action is what you
would have chose if you had not gone to the
movies - either watching the baseball game or
going out for coffee with friends.
Note that an opportunity cost only considers
the next best alternative to an action, not the
entire set of alternatives.
Some of these decisions may or may not
involve a financial cost. Nonetheless, many of
our decisions are linked to some financial cost
to the consumer.
Production Possibilities Curve
The Basic Principles of Production
The Production Possibilities Curve
The Production Possibilities Curve: This model
provides a visual explanation of the production
choices faced by people in a simple economy. It
is used to illustrate the fundamental problem of
SCARCITY.
The model is based on THREE basic
assumptions.
1. Only two products can be produced by
this simple economy
In an economy capable of producing
hundreds of thousands of different
products, this model assumes that only two
products can be produced by this economy.
This makes the economic concept of
TRADE OFFS very clear - the increased
production of one good can be achieved
only by sacrificing a sufficient quantity of
the other good being produced.
2. The economy has fixed technology
and resources
Since this model is examining an
economy over a short period of time, it
assumes that no technological innovations
will be introduced to improve the rate of
production. It also assumes that the
amount of resources used to produce the
two types of goods do not increase.
3. The economy is at full
employment
The model assumes that all
productive resources, including
labour, are fully employed and that
they are being used effectively and
efficiently to produce the maximum
output of the two types of goods.
A standard production possibilities curve for an
hypothetical economy is presented here. This
particular production possibilities curve
illustrates the alternative combinations of two
goods--crab puffs and storage sheds--that can
be produced by the economy.
According to the assumptions of production
possibilities analysis, the economy is using all
resources with given technology to efficiently
produce two goods--crab puffs and storage
sheds.
This curve presents the alternative
combinations of crab puffs and storage
sheds that the economy can produce.
Production is technically efficient, using
all existing resources, given existing
technology. The vertical axis measures
the production of crab puffs and the
horizontal axis measures the production
of storage sheds.
Types of Economics
There are two types of economics
based to explain human behaviour.
The type of decision making by humans
uses both a fact and value
considerations. They include:
1. Analytical or Positive Economics
2. Normative Economics
Analytical or Positive economics is the branch of
economics that concerns the description and explanation
of economic phenomena . It focuses on facts and causeand-effect relationships and includes the development
and testing of economics theories.
To illustrate, an example of a positive economic
statement is as follows:
The price of milk has risen from $2 a litre to $4 a litre in
the past five years. This is a positive statement because it
can be proven true or false by comparison against real
world data. In this case, the statement focuses on facts.
Normative economics is the branch of
economics that incorporates value judgments
(that is, normative judgements) about what the
economy ought to be like or what particular
policy actions ought to be recommended to
achieve a desirable goal. Normative
economics looks at the desirability of certain
aspects of the economy. It underlies
expressions of support for particular economic
policies.
To illustrate, an example of a normative economic
statement is as follows:
The price of milk should be $5 a litre to give dairy
farmers a higher living standard and to save the
family farm.
This is a normative statement because it depends on
value judgments and cannot be proven true or false
by comparison against real world data. This specific
statement makes the judgment that farmers need a
higher living standard and that family farms need to
be saved. Consumers who purchase more expensive
milk products might argue otherwise.
Common Fallacies
in
Economics
What is a Fallacy in Economics?
FALLACY: is a hypothesis that
has been proven false but is still
accepted by many people
because it appears, at first
glance, to make sense.
Three Common Fallacies
1. The Fallacy of Composition
2. The Post Hoc Fallacy
(also known as the Cause-andEffect Fallacy)
3. The Fallacy of Single Causation
1. The Fallacy of Composition
What is good for the individual is
automatically good for society as a
whole. This mistaken belief that
individual benefit automatically
translates into social benefit for
everyone is a fallacy of composition.
This fallacy can also work the other way
-what is good for society as a whole
must be good for the individual.
Example: A farmer decides to clear more
land and plant more corn in an attempt to
earn extra income. If every farmer in
Canada attempts the same strategy
collectively, the result may create an
overproduction of corn that would drive
market prices lower. If prices are too low
farmers may not be able to pay their
operating expenses therefore, bankruptcy
may occur.
2. The Post Hoc Fallacy
(also known as the Cause-and-Effect
Fallacy)
Sometimes people assume that, because it
took place after event A, event B must
have been caused by event A. This is the
false assumption that what comes before
automatically causes what follows. Some
prior events are obviously not connected
to later events in any meaningful way.
Example: A rooster wakes
up every morning before the
dawn and instinctively
crows. Moments later the
sun rises. Would it not be
ridiculous to assume that the
rooster's crowing (and not
the rotation of the Earth)
causes the sun to rise?
3. The Fallacy of Single Causation
Closely related to the post hoc fallacy, the
fallacy of single causation is based on the
premise that a single factor or person caused a
particular event to occur. In reality, however,
other factors are the main contributors of the
event and the single event that is perceived is
merely a symptom of the event.
Oversimplification (the event) is often used
to clarify an event that is really complicated.
Example: People believe that
the stock market crash of 1929
caused the Great Depression
of the 1930's. In reality,
several events leading up to
and after the crash of the stock
market are the real reasons for
the Great Depression.
Economic Laws Affecting
Production Possibilities
1. The Law of Increasing Relative Cost
2. The Law of Diminishing Returns
3. The Law of Increasing Returns to
Scale
1. The Law of Increasing Relative
Cost
This law comes into play whenever
a society, in order to get greater
amounts of one product, sacrifices
an ever-increasing amount of other
products (one output increases the
other output decreases).
For example, as more sheds are
produced, fewer crab puffs are
made. According to this law, as
more time and money is devoted to
producing more of one good, less
time and money can be devoted to
the other product. (See figure 1.10
in text)
2. The Law of Diminishing Returns
This law deals with the relationship
between an input (a productive
resource such as labour) and the
resulting output. This law states that
the outputs will increase when a
particular input is increased, but
only to a point.
After this point has been reached,
increasing inputs will not have an
effect on output. In fact, the output
will eventually decrease. In this
situation, only one input is changed.
(See figure 1.14)
3. The Law of Increasing Returns to
Scale
This law states that when all productive
resources are increased (both inputs),
simultaneously, output will also increase.
The scale of operation is constantly
increasing because both inputs are
increased which thereby increases the
output. (See figure 1.15).