2 Overview Administration and Introductory Comments The Economic Problem The Price Mechanism
3 Administration My name is email: Download a copy of the unit guide from the unit web page: https://ilearn.mq.edu.au/login/MQ/3 hours of lectures per week3 workshops held during normal lecture times in weeks 5, 7, and 13.
4 WorkloadYou should be spending at least 6-9 hours at home studying this unit each week.
5 Key Dates for Within Semester Assessment Tasks Test 1 – First hour of the week 4 lecture. Note: For this test you must attend the lecture in which you are enrolled.Joint ECON649 and 991 assignment to be handed in during class in Week 9 (November 8 – 12) – No late assignments accepted.ECON991 students only hand in their second assignment at the front desk on Level 2 of E4A on the 2nd of November – No late assignments accepted.
6 TextbookHubbard, R.G., Garnett, A.M., Lewis, P., and O’Brien, A.P., 2010, Essentials of Economics, Pearson Education, Australia.
7 Web ResourcesThe unit web site is at https://ilearn.mq.edu.au/login/MQ/MyEconLab –see unit web site for details about how to access MyEconLab
8 Course Outline MICROECONOMICS Introduction: The Economic Problem, An Overview of the Price Mechanism, Reasons for Government InterventionSupply and Demand AnalysisApplications of Supply and Demand, Elasticity ConceptsProduction and CostsPricing in Different Market Structures: Perfect Competition and Monopoly
9 Course Outline MACROECONOMICS Introduction to Macroeconomics; An Overview of Keynesian Theory & Classical TheoryThe Income-Expenditure Model; Inflationary and Deflationary Gaps; MultipliersMoney and Interest RatesAD-AS ModelMonetary & Fiscal Policy
10 What is Economics?Economics is concerned with how society allocates scarce resources in order to satisfy unlimited wants. There are 2 branches of economics: MICROECONOMICS and MACROECONOMICS Micro=small Macro=large
11 MicroeconomicsIs concerned with economic decisions made by a single individual, household, firm or industry. e.g. The market for petrol. If the price of petrol increases will an individual person buy more or less? Will a petrol producing firm supply more or less petrol to the market?
12 MacroeconomicsIs concerned with economic decisions and the performance of the economy as a whole. It examines economy-wide variables such as inflation, unemployment, exports, imports, and the exchange rate; as well as the effects of changes in policies, such as monetary policy and the federal budget (fiscal policy).
13 Fallacy* of composition Fallacy of Composition – fallacy that what is true for the individual is true for the groupThe basis for distinguishing between micro and macro-level analyses*Fallacy means a misleading or false ideaFallacy of compositionEXAMPLE 1 – if one person stands up in a football stadium to get a better view they will – but if everyone stands up it is not true that everyone will have a better view.EXAMPLE 2 – a farmer experiences a very good season and his harvest of wheat is larger than normal, so he expects to do well financially. However, all the other farmers have also experienced the same season and their harvests are also larger than normal. The effect of this is to increase supply and cause the price of wheat to fall, so that the farmer does not make any extra return compared to other years.EXAMPLE 3 - A tiger eats more food than a human being. Therefore, tigers, as a group, eat more food than do all the humans on the earth.EXAMPLE 4 - Atoms are colourless. Birds are made of atoms, so birds are colourless.EXAMPLE 5 - Ocean Fishing: Every fisherman logically puts out more boats to increase profits. The additional profits provide funds for even more boats and fishing. But as total fishing approaches the sustainable ocean fishing capacity, the effort required per fish caught increases, which reduces profits because all are less efficient.EXAMPLE 6 - The fallacy of composition arises mainly in macroeconomics where economic units (households, businesses) are treated as if they were one unit. When individual parts interact with each other, the outcome for the whole may be different from that intended by the individual part. To illustrate: A firm (an individual part) lays off employees in order to cut down on expenses and increase profits. If all firms (the whole) do the same, incomes and spending will fall. The sales for the firm are smaller and its profits do not increase.
14 Post Hoc Ergo Propter Hoc (Fallacy of Association) Latin phrase meaning “after this, therefore because of this”Fallacy that a first event causes the second event, because the first event occurred before the secondEXAMPLE 1 - You observe that when people put on their raincoats it then rains. You draw the conclusion that wearing raincoats causes it to rain.EXAMPLE 2 – I have a University degree and now I earn a high income. Therefore gaining any University degree will guarantee a person a high income.
15 Positive & Normative Statements Positive statements – statements that can be verified by reference to factsNormative statements – statements that involve opinions, “what ought to be”; they cannot be testedPositive statements – statements that can be verified by reference to facts – they can be true or false, i.e.: what ise.g. The current rate of inflation is within the Reserve Bank of Australia’s target range of 2-3%.Normative statements – statements that involve value judgements, “what should be” – they express an opinion and cannot be tested against facts to be proved true or falsee.g. Keeping inflation under control should be more important than keeping unemployment low.
16 Economic Models We use the scientific method to develop models: Identify the variables of interest.Formulate a theory or hypothesis which tries to explain relationships between the variables.Need to make simplifying assumptions.3. Test the predictions of the theory to see if they line up with reality.4. If the model works we can use it to make forecasts or predictions, otherwise we need to start again.
17 Ceteris ParibusOne of the most important assumptions in economics is CETERIS PARIBUS. Ceteris Paribus = all other things remain constant (or unchanged)This assumption allows us to focus on the relationship between the variables of interest. Without it we cannot be sure whether the relationship we observe is due to the interaction of the two variables or caused by some other factor changing e.g. changes in income, population, preferences etc…
18 The Economic Problem We live in a world of unlimited wants. Resources are scarce.Wants > ResourcesOur desire for goods and services exceeds the capacity of the economy to produce those goods and servicesTherefore choices have to be made.Choices involve:Rational self interest/ rational decision making – more on this latercomparing marginal benefits to marginal costs – more on this latertime and information
19 Resources = factors = inputs There are 4 factors of production:Land – any natural resource, e.g. land, coal, oil, water, air. Can be renewable or non-renewable.Labour – the mental and physical capacity of people to produce goods and services. Includes both time spent working and work effort. Is influenced by quality (e.g. education level, health) and quantity.Capital – physical equipment, buildings and machinery used to produce other goods and services.Entrepreneurial ability – special human skill. An entrepreneur is someone who creates and runs a business and organises the other factors of production to make goods and services.Resources are the inputs used to produce goods and services.LAND – means any resource provided by nature, such as forests, minerals, oil, wildlife, fish, the ocean, rivers, sun and moon. Some natural resources are renewable (i.e. can be replaced by nature without human interference, e.g. fruit, crops, animals). Others are non-renewable and as such will not automatically be replaced (i.e. coal, oil, copper, gold etc..).LABOUR – means the mental and physical capacity of workers to produce goods and services. Labour is affected by both quality (education, health, motivation, experience) and quantity (the sheer number of workers available).e.g. teachers, accountants, miners, football players, farmers, economists, sales assistantsCAPITAL – is the physical plant, machinery and equipment used to produce other goods. Capital goods are those made to produce goods and services, but do not directly satisfy human wants. E.g. hammer, shovel, factories, office buildings, trucks, warehouses etc…IMPORTANT NOTE: The meaning of CAPITAL in ECONOMICS is not the same as the normal everyday meaning – it does NOT refer to shares, money, or the money value of assets – this is financial capital.ENTREPRENEURIAL ABILITY – is a special kind of human skill – they are people who are willing to take risks, organise production, find better ways
20 Resources = factors = inputs The incomes earned by these factors are:Land → rentLabour → wagesCapital → interestEntrepreneurial ability → profits
21 Resources produce commodities Resources produce commodities. commodities = goods + services tangible intangible Goods & Services = means of satisfying wants
22 Choices What to produce? How to produce? For whom? All societies face choices of:What to produce?How to produce?For whom?At the level of an individual consumer choice is an every day fact of lifeWhat to produce – what combination of goods & services are chosen.How to produce – aim to produce the most output at the lowest cost using the most efficient techniques. Depends on relative abundance of factors of production.For whom – the problem of distribution – depends upon your income.
23 ChoicesConsider a consumer with a certain amount of money, he decides to buy more booksCould say cost of a book = so many dollarsORLook at cost in terms of what other consumption our consumer must forego to obtain this item.
24 Choices Suppose consumer gives up some movies If Pbook = 3 times price of a movie then cost of a book = 3 movies forgone.
25 Opportunity CostEconomists use the term, opportunity cost to express the cost of a given activity in terms of the value of the next best alternative forgoneOpportunity cost = opportunity lost
26 Opportunity Costindividuals Opp cost applies to firms economy (e.g. the cost of a new road can be expressed as so many new hospitals forgone)
27 Rational Self Interest This is a key assumption in microeconomics.A rational self-interested individual uses all available information to achieve their goals.A rational self-interested individual attempts to achieve something desirable to his or her own self.A rational self-interested individual weighs the benefits and costs of an action, and they only choose to undertake an action if it has a positive net benefit.Net Benefit = Benefits - CostsWhen choosing between different actions a rational self-interested individual will choose the action with the greatest positive net benefit.That is whatever people’s preferences are they pursue them.They aim to make decisions that will leave them better off or at least no worse off than before.
28 Marginal AnalysisRational self-interested individuals are assumed to know that optimal decisions are made at the margin.Recall that scarcity → need to make choicesFrequently choices being made involve incremental or decremental changes to the status quo*.(*status quo = the existing situation)
29 Marginal AnalysisConsumers are concerned with whether to purchase an extra juice, whether to spend an extra hour studying. Producers may face choice about whether to run an extra post graduate class, whether to produce an extra kilo of bananas. These are all marginal decisions.
30 Marginal AnalysisEach decision yields some additional or marginal benefit (MB) and incurs some form of marginal cost (MC).If MB > MC then the activity will yield a net benefit and a rational individual will be induced to undertake the activity.Marginal Analysis = techniques of assessing costs and benefits at the margin to decide:if status quo worthwhile andThe ideal level of activity
31 Scarcity, Choice & the Production Possibility Frontier (PPF) We can use the PPF to illustrate the economic problem.Assume:Given time periodGiven technologyFixed supply of resourcesEconomy produces two items (“guns” and “butter”)Assumptions designed to “freeze” the economy so we can focus on the production possibilities given the available resources and technology
32 PPFTPPF shows all the maximum combinations of guns and butter that can be produced if all available resources are fully employed and used efficiently.Q of GunsDQ of Butter
33 * If all resources devoted to butter production → OD units of butter PPFTA* If all resources devoted to butter production→ OD units of butterBut zero guns* If all resources devoted to production of guns→ OT units of gunsbut zero butter* All points on PPF between end points butter plus gunsMQ of GunsEKBRPXSDQ of Butter
34 PPF is concave to the origin (more on this later). ZMPPF is concave to the origin (more on this later).PPF separates attainable from unattainable output combinations.Attainable = combinations on & underneath PPF=Q of GunsFBRTalk about what it means to be on a point inside the PPF – e.g. inefficient, resources may be unemployed.PSDQ of Butter
35 The slope of the PPF = guns/ butter AMCQThe slope of the PPF= guns/ butter= quantity of guns that economy must forgo if butter production is increased by 1 unitQ of GunsGVBRPNWSDQ of Butter
36 * Movement A → B shows movement into more butter production PPFTA* The negative slope shows the opportunity cost when production of one of the goods in the diagram is increased.* Movement A → B shows movement into more butter production* The opportunity cost of producing PS more butter is distance MR of guns forgone.MQ of GunsBRPSDQ of Butter
37 Slope increasing along PPF TThe concave shape of the PPF reflects the law of increasing opportunity cost.Law states as more of a particular good is produced, larger and larger Q’s of an alternative good must be forgone.This is shown by an increase in the slope of the PPF as we move along it.Q of GunsDQ of Butter
38 What is the economic rationale for increasing opportunity cost? small - ∆ gunsTAMCQCompare points A and G regarding size of guns when butter ↑ by 1 unit.What is the economic rationale for increasing opportunity cost?Q of GunsGVBRPNWSDlarge - ∆ gunsQ of Butter
39 What is the economic rationale for increasing opportunity cost What is the economic rationale for increasing opportunity cost? ANSWER: Resources are not completely adaptable to alternative uses (i.e. some resources are better suited to the production of one good than another). Butter ↑ and ↑ takes more and more resources most suited to gun production increasingly greater sacrifice of guns With perfect adaptability of resources → straight line PPF → constant slope → constant opportunity cost
40 PPF is quite illuminating: Illustrates concept of scarcity With given amount of resources, economy can only achieve certain combinations of G & SNot all wants can be satisfied during given time periodNeed to make choices about which combination of G & S to produceChoice opportunity costs are involvedConcavity illustrates law of increasing opportunity cost
41 Shifts in the PPFA change in the availability or amount of resources will cause a shift in the PPF.Q of GunsQ of Butter
42 Shifts in the PPFA change technology may cause both a change in the slope and location of the PPF. The change does not have to affect both goods equally. e.g. diagram shows effects of a positive change in technology for gun production only (suppose found a more efficient way of producing guns)Q of GunsQ of Butter
43 Alternative Economic Systems or Economies Returning to the questions of:What ?How ?For whom ?Different types of economic systems answer these questions differently.
44 Tradition-oriented economy Main forces organising production and distribution = custom & traditionTasks and skills handed downDistribution is via age-old patterns e.g. communal feasts
45 Command or centrally planned Economy Central planning authority asserts its will on:How many guns, cars, bottles, etc..Plus how to produce required G & S
46 Market EconomyIn a pure market economy, Mechanism is known as “market mechanism”Prices & Markets & IndividualsProvide mechanism for communication and coordination of different choices being madeMarket mechanism – is the mechanism where wishes of consumers are matched those by producers. It allows for exchange to take place between buyers and sellers of g&s.
47 Functions of PricePrices are the language of markets. They transmit information between market participants.Prices have an important role as measure of exchange value.Exchange value – the value of a particular commodity which a person will be prepared to exchange for another commodity. If this other commodity is the standard medium of exchange (i.e. money) then the value of the commodity is its price.
48 Functions of Price P’s are a rationing device P’s act as an incentive Additionally:P’s are a rationing deviceP’s act as an incentiveP’s serve to allocate resourcesP’s serve as incomeP’s also viewed as cost of productionMicroeconomics is so concerned with prices and impact of price changes that it is often called Price Theory.Rationing device – because supply is scarce (scarcity of resources) relative to demand, those consumers who cannot afford the goods will be eliminated from the market.Incentive – relative prices act as a guide to producers concerning what to produce, and which factors to employ. Also encourages resources into some activities and not others.Allocate resources – in choosing the most efficient mix of factors of production firms are guided by relative prices.Income – they are a payment for resources, e.g. wages are the price of labour.Cost of production – e.g. wages are a cost to firms
49 Mixed Economy The Australian economy is a mixed economy. It is market-oriented but it also has a command element since government plays an important role.Government intervenes in both macro and micro economy.The government sector is also called the public sector.
50 The Size of the Government Sector There are three commonly used ways of measuring the size of the government (public) sectorThe value of the goods and services produced by the government as a proportion of total production in the economy (gross domestic product, GDP).The number of people employed as a proportion of total employment in the economy.The level of government expenditure as a proportion of total expenditure in the economy (as measured by GDP).This measure includes transfer payments, such as pensions, unemployment benefits and family support payments.
51 The Size of the Government Sector Method of measurementAustralia, 2008Government purchases as a percentage of GDP22%Government employment as a percentage of total employment16%Government expenditure as a proportion of total expenditure35%Note: Increases in government expenditure as a proportion of GDP will see the figures increasing significantly.
55 REQUIRED READING This week’s lecture: Introduction to Economics Hubbard, Garnett, Lewis & O’Brien, Essentials of Economics Chapters 1 & 2, Ch 11(pp only)
56 REQUIRED READING Next week’s lecture: Reasons for Government InterventionHubbard, Garnett, Lewis & O’Brien, Essentials of Economics Chapters,3, 5(pp ) & 11 (pp )Demand and SupplyHubbard, Garnett, Lewis & O’Brien, MicroeconomicsChapters 3 & 5(pp )