Topic 1

Introduction to Economics
The Central Economic
Problem
Scarcity is the central economic
problem
Our inability to satisfy all our wants (from
your textbook)
Scarcity is a result of unlimited wants but
limited resources to satisfy these wants
Limited resources (factors of production)
Unlimited wants (goods & services)
Scarce Resources
Factors of production - the basic categories of
inputs used to produce goods and services.
Land & Raw Materials (Natural Resources)
A shorthand expression for any natural resource
provided by nature
Labour (Human Resources)
The mental and physical capacity of workers to
produce goods and services
Capital (Manufactured Resources)
The physical tools, machinery, equipment and
buildings used to produce other goods
Not to be confused with financial capital
Entrepreneurship
The creative ability of individuals to seek profits by
combining resources to produce innovative products

Scarcity and Choice
Scarcity forces us to make choices
Rational Choices refers to choices that
involve weighing up the benefit of any activity
against its opportunity cost
Opportunity cost
The highest-valued alternative that is given
up to get something.
Sacrifice
Next best thing forgone
Can be in monetary or non-monetary terms

Scarcity
Choice
Opportunity
Cost
What is Economics
Economics:
The study of choices that individuals,
businesses, governments and societies make to
cope with scarcity and the incentives that
influence and reconcile those choices.
Macroeconomics
Studies the performance of the national economy
and global economy
Studies decision-making for the economy as a
whole
Microeconomics
Studies the choices that individuals and
businesses make, the way these choices interact
in markets, and the influence of governments (on
specific markets)
Studies decision-making by a single individual,
household, firm, industry

Macroeconomic Issues
Economy as a whole (Aggregate demand &
Aggregate Supply)
Economic growth & cyclical fluctuations
Recession - national output falls for 2 quarters or more
Unemployment
Singapore - Unemployed defined as persons aged 15 years
and over who did not work but are available for work and
were actively looking for work during the reference period
(calendar week preceding date of the Labour Force Survey
interview)
Inflation
General rise in price levels throughout the economy
Balance of trade problems
Deficits where imports exceed exports
Microeconomic Issues
Individual parts (economic agents)
Individual units such as households,
firms and industries
Demand and supply of particular goods
and services
Market structure
Methodology of Economics
The purpose of an economic model is
to forecast or predict the results of
various changes in variables
A model is a simplified description of
reality used to understand and predict
the relationship between variables.
Three basic steps in the model-
building process
Identify the problem
Develop a model based
on simplified assumptions
Collect data and
test the model
Hazards to Economic Way of
Thinking
Two pitfalls (reasoning mistakes):
Failing to understand the ceteris paribus
assumption
When testing a model we often use the assumption
of ceteris paribus
Means that while certain variables can change, all
other things remain unchanged
Confusing association (correlation) with
causation
Association - two events can occur together but one
event is not the cause of the other
Cannot always assume that when one event follows
another, the first caused the second
Choosing at the Margin
People make choices at the margin they
evaluate the consequences of making
incremental changes.
Marginal benefit (MB) the benefit that arises from
pursuing an incremental increase in an activity.
Marginal cost (MC) the opportunity cost of pursuing an
incremental increase in an activity.
Marginal benefit and marginal cost act as
incentives
When MB > MC, people have an incentive to do more of
that activity.
When MC > MB, people have an incentive to do less of
that activity.

Three Fundamental Economic Questions
What, how and for whom
What type & what quantities of goods & services
How to produce these goods & services
what mix of resources is needed for production
For whom to produce for
basically who gets what
All societies and nations need to answer these
three questions
Economic Systems
Economic systems
The organization and methods used to
determine what goods and services are
produced, how they are produced, and for
whom they are produced
All economic systems answers the three
fundamental economic questions
Command economy, Market economy,
Mixed economy
Totally
planned
economy
Totally
free-market
economy
N. Korea
N. Korea
Cuba
China
Poland
Poland France
France
UK
UK
USA
USA
Early 1980s
Early 2000s
Classifying economic systems
China Hong
Kong
Cuba
China
(Hong
Kong)
Command Economy
Command Economy (also known as
Centrally Planned & similar to communism)
A system that answers the What, How, and For
Whom questions by central authority(i.e.
government)
The three fundamental economic questions are
answered through central planning
Plans what will be produced and in what quantities
Decides which resources will be used for the production
of various goods and services
Decides on the distribution of the goods and services
produced
All economic decisions are taken by the central
authorities
Factors of production are owned by the central
authorities



Command Economy
Advantages of a command economy
High focus on investment goods by
government will lead to high economic
growth
Stable growth if properly overseen by
central planning prevents extreme
fluctuations in economic growth
Low unemployment if there is accurate
matching of labour needs
Social goals can be pursued (e.g. income
equality, basic needs met)
Government can prevent the destruction of
the environment (e.g. control pollution)
Command Economy
Problems of a command economy
Problems of gathering information for central
planning due to complexity of economies (very
expensive to administer)
Inefficient use of resources as there are no price
signals, price arbitrarily decided by government
Inappropriate incentives for producers (not profit
driven) and workers may lead to poor quality and
low variety of goods
Loss of individual liberty
Shortages and surpluses can occur with poor
planning (for the case of shortages, this may lead
to a black market where buyers pay much higher
prices)
Market Economy
Market Economy (also similar to
Capitalism)
An economic system that answers the What,
How, and For Whom questions using prices
determined by the interaction of the forces of
supply and demand
The price mechanism (demand and supply) will
answer the three fundamental economic questions
Firms will decide what goods and services to produce and
households will decide what goods and service to buy
Firms will decide what resources to use and households
will decide what resources to supply
All economic decisions are taken by individual
households and firms with no government
intervention
All factors of production are privately owned
Market Economy
Adam Smiths Invisible Hand
A phrase that expresses the belief that the best
interests of a society are served when
individual consumers and producers compete
to achieve their own private interests
Market Economy
Advantages of a free-market economy
Price mechanism transmits information
between buyers and sellers leading to wide
range of products - no need for costly
bureaucracy
Competitive markets (with many sellers and
buyers) leads to lower prices
Quicker response time to market changes
by reacting to changes in demand and
supply
Incentives to be efficient and produce quality
products as firms and individuals are driven
by self-interest
Market Economy
Problems of a free-market economy
Competition may be limited which leads to the
problem of market power (where a monopoly
will sell goods a high prices)
Social goals may not be met (e.g. income
inequality and unequal distribution of wealth
and power)
Environment / social problems may be ignored
Negative externalities such as pollution
Lack of desirable public goods (e.g. street lights)
Poor ethics / values (selfishness)
There may be macroeconomic instability (high
fluctuations in economic growth and high
unemployment)
Mixed Economy
The mixed economy
An economic system that answers the What, How,
and For Whom questions through a mixture of
command and market systems
Both government and private sector (individuals and firms)
make economic decisions
Some examples of government intervention:
relative prices of goods & services (taxes, price controls)
relative incomes (taxes, welfare payments, legislations)
pattern of production & consumption (taxes, legislations,
state-owned companies)
macroeconomic problems (fiscal & monetary policies)