Basic Economic Problem
(choice and the allocation of resources)
Nature of the economic problem
Our needs are limited (finite) e.g. food, water, air, shelter, warmth. These are known as Free Goods. 2)
Our wants are unlimited (infinite) e.g. clothes, cars, holidays, jewelry. These are known as Economic Goods. We have infinite wants but limited resources in the world. Economic Agents- (individuals, firms, and governments) have to make rational choices between competing wants. Economic welfare refers to the benefit a person/society gets from the allocation of these competing resources Role of an Economy
The purpose of economic activity is to produce goods/services to provide both what people need and what we want. •
The role of an economy is to maximize the economic welfare of its citizens by answering 3 questions: a)
What should we produce?
How should it be produced?
For whom should it be produced?
Factors of Production (used to produce goods/services)
Land – resources available for production: land, buildings, shops 2.
Labor – human effort available for production: workforce 3.
Capital – man-made physical goods used to produce other goods/services: machinery, equipment, money (human capital- skills/abilities of workers resulting from investment in education/training) (anything that was bought or spent for) 4.
Enterprise- Entrepreneur, who organizes FoP’s and risks his capital, managerial ability. Payments
Land – rent
Labor – wages
Capital – interest
Enterprise – profit
All about making choices between alternatives
Opportunity cost = the benefit lost from the alternative foregone E.g.:
A farmer plants maize. 0pp cost = growing other crops, pasture farming. A lawyer who earns $100 per hour takes the day off. Opp cost = Money lost Resource Allocation : Opportunity Cost
When an economy is working at full capacity, you can’t have more of one commodity without having less of another.
Production Possibility Curve = PPC
On the PPC, an economy/firm is working at full efficiency
In the short term, the FoP’s are fixed. In the long term, FoP’s can be increased so the dotted line can move more upwards. Economic System| Allocation of Resources (FoP’s)
UK Cuba,NK Free-Market
Command (Planned) Economies
Allocate resources centrally through government
All FoP’s are owned by the state (except labor)
There is no concept of owning “private property”
E.g Soviet union, Vietnam, North Korea, Cuba
Free Market Economies
Allocate resources through the spending decisions of millions of different consumers (buyers) and producers (sellers) •
Both consumers and producers are motivated by self-interest and private gain a)
Consumers aim to maximize individual welfare
Producers aim to maximize rent, interest, and profits
Allocate resources through both the government and the private sector •
Consumers and producers are motivated by self interest/private gain •
Government is motivated by considerations of the good of the community •
The degree of “mixing” in the Economy, varies greatly by country How Markets Operate
A market is anywhere where buyers and sellers come together to exchange goods and services for money
Buyers → Demand (products)
Sellers → Supply (products)
A demand curve is a downward sloping curve.
The quantity of a good/service that will be bought at a given price
A Price Increase
A Price Decrease
-When price changes there is said to be a movement alongthe demand curve Supply
The amount offered for sale at each given price
Economist make 2 assumptions about suppliers
That all suppliers (firms) want to maximize profits...
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