Economic Issues

Economics What is Economics? Macroeconomics vs. Microeconomics Demand and Supply

What is Economics?

What is Economics? “Oikonomos” – One who manages a household The production of goods and services The consumption of goods and services The study of how the people allocate their limited resources to satisfy their unlimited wants (It is the study of how people make choices – involves sacrifice) Central Economic Problem: Scarcity

Resources & Wants Resources are things that have value and are used to produce things that satisfy people’s wants (Supply) Wants are all of the things that people would consume if they had unlimited income (Demand)

Resources Factor of production –Human resources: Labor –Natural resources: Land, raw materials –Manufactured resources: Capital

Branches of EconomicsMicroeconomics = Individual Macroeconomics = Whole

Macroeconomics The branch of economics that studies economics aggregates – demand and supply The part of economic analysis that studies the behavior of the economy of a whole – deals with economy wide phenomena e.g. GDP, CPI

GDP & CPI GDP –A measure of the total income and expenditures of an economy –The total market value of all final goods and services produced within a country in a given period time CPI –A measure of the overall cost of the goods and services bought by a typical consumer

GDP & economic well-being GDP is a good measure of the economic well- being of a society GDP per person tells us the income and expenditure of the average person in the economy But it misses… –Leisure reduction increases GDP but may reduce well-being –The value of clean environment –Non-market activities?

Macroeconomic Issues Aggregate demand – The total level of spending in the economy Aggregate supply – the total amount of output in the economy AD > AS –Inflation –Balance of trade deficit (Export & Import) AD < AS –Recession –Unemployment

Macroeconomic policy AD = AS –Demand-side policy –Supply-side policy

Microeconomics The part of economic analysis that studies decision making undertaken by individuals and by firms Focus on the small part of economics

Microeconomics Issues Choices: –What –How –For whom Opportunity cost Rational decision making –Weighting up the benefit (Value for money) Marginal Costs & Marginal Revenues Social implications/consequences of choices

Economic Models “Ceteris Paribus” (other things being equal) Production Possibility Curve Circular Flow of Goods and Incomes

Units of clothing (millions) Units of food (millions) Units of food Units of clothing (millions) (millions) 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m A production possibility curve

Units of clothing (millions) Units of food (millions) Units of food Units of clothing (millions) (millions) a 8m 0.0 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m a A production possibility curve

Units of clothing (millions) Units of food (millions) Units of food Units of clothing (millions) (millions) 8m 0.0 b 7m 2.2m 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m b A production possibility curve

Units of clothing (millions) Units of food (millions) Units of food Units of clothing (millions) (millions) 8m 0.0 7m 2.2m c 6m 4.0m 5m 5.0m 4m 5.6m 3m 6.0m 2m 6.4m 1m 6.7m 0 7.0m c A production possibility curve

Units of clothing (millions) Units of food (millions) x A production possibility curve w

Production Possibility Curve Microeconomics & PPC –Choices and opportunity cost –Increasing opportunity cost Macroeconomics and PPC –Production within the curve –Shift in the curve

Units of clothing (millions) Units of food (millions) Increasing opportunity costs x y 1 1 z 1 2

v x y O Making a fuller use of resources Food Clothing Production inside the production possibility curve

O Growth in potential output Food Clothing Now

O Food Clothing Now Growth in potential output 5 years’ time

Goods and services £ Consumer expenditure Wages, rent dividends, etc. £ Services of factors of production (labour, etc) The circular flow of goods and incomes

The Circular Flow of Income Macroeconomic issues –The size of total flows Microeconomic issues –Individual markets –Choices within goods and factor markets

Economic Systems Command economy (Socialist/Communist) Free-market economy –Price mechanism: price respond to shortage and surpluses –Equilibrium Mixed market economy

Command Economy Planning –Consumption and investment –Matching of inputs and outputs –Distribution of output Advantages –High investment, high and stable growth –Social goal pursued –Low unemployment

Command Economy Problem –Gathering information –Expensive to administer –Inefficient allocation of resources Inappropriate incentives no system of prices –shortages and surpluses –lack of response to consumer demand

Free-Market Economy Based on free decision making by individuals and firms Demand and supply decisions Price mechanism –Price respond to shortage and surpluses –Equilibrium

Goods Market DgDg  shortage (D g > S g ) PgPg  SgSg  DgDg  until D g = S g Factor Market SgSg  SfSf  DfDf  until D f = S f  DfDf shortage (D f > S f ) PfPf  The price mechanism: the effect of a rise in demand The price mechanism: the effect of a rise in demand

Competitive Market Perfectly competitive market Price taker