WHAT IS ECONOMICS

1
WHAT IS ECONOMICS

• Though economic activity is so important,
  economics as a discipline is
• hard to define
• One suggestion might be that economics is about
  money but in fact economic activity can be
  conducted without money (e.g. barter)
• Two of its main areas relate to production and
  consumption
• - so each society therefore has need to produce
  various goods and
• services such as food, clothing and
  education which are then
• consumed by the general population
• A third area relating to distribution is also
  included so that a key problem for every society
  is to decide how all the goods and services
  produced should be distributed among the
  population

2
DEFINITIONS OF ECONOMICS

1. Economics is about man in the ordinary business
   of life. It examines that part of individual and
   social action which is most closely connected
   with the attainment and with the use of the
   material requisites of well-being. (Alfred
   Marshall)
2. Economics is about the production. consumption
   and distribution of scarce goods and services.
3. Economics is the art of making the most of life.
   (George Bernard Shaw)
4. Economics is the science which studies human
   behaviour as a relationship between ends and
   scarce means that have alternative uses. (Lionel
   Robbins)
5. The theory of economics does not furnish a body
   of settled conclusions immediately applicable to
   policy. It is a method rather than a doctrine, an
   apparatus of the mind, a technique of thinking,
   which helps it possessors to draw correct
   conclusions. (Keynes)

3
PROBLEM OF SCARCITY

• The fundamental problem of every economic society
  is scarcity
• This is clearly true in poor countries such as
  in Africa. However
• even in the most affluent societies most people
  want more than they
• can afford to purchase
• So even here human wants in the desire for goods
  and services such as houses, cars and foreign
  holidays are (potentially) unlimited, whereas the
  resources from which they can be produced are
  always in short supply
• This leads therefore to the problem of scarcity
  and the consequent need for choice
• Goods which are not scarce such as air and (tap)
  water - though extremely important for life -
  have little or no economic value (because they
  are not scarce). These therefore are free goods
• - paradox of diamonds and water
• Need for rational choice so as to avoid waste

4
FACTORS OF PRODUCTION

• Economists often refer to the basic resources
  (used to produce goods and services) as the
  factors of production
• There are four factors of production each with
  its own reward (which
• represents a form of income)
• Land. This includes all raw materials
  (e.g.agricultural produce, oil and minerals)
  provided by nature. The income reward here is
  rent
• Labour. This can be assessed in terms of numbers
  and skills. The income reward here is wages and
  salaries
• Capital. This refers to goods (e.g. factories and
  machinery) that enable the more efficient
  production of goods and services. The income
  reward is interest
• Enterprise. A special form of labour that
  organises production and undertakes the risk of
  business. The income reward is profits
• So all income in society relates to the factors
  of production

5
GOODS AND SERVICES

• As consumers we have a direct demand for goods
  and services
• Consumer goods are tangible i.e. food, clothing,
  housing, durable goods such as cars TVs, fridges
  etc
• Services are intangible such as health,
  education, entertainment, travel, professional
  such as legal and medical and business such as
  marketing and consultancy
• Sometimes economists use the word commodity to
  refer to either a good
• or service
• We can have both consumer and capital goods
• Capital goods have an indirect value in that they
  can make production
• more efficient e.g. factories and machinery and
  also necessary
• infrastructure such as roads railways and social
  overhead expenditure (e.g.
• schools and hospitals)

6
DEMAND AND SUPPLY

• Demand relates to consumers and their expressed
  wants for goods and services
• Supply relates to producers and the amount of
  goods (or services) made available
• Transactions for goods and services take place in
  markets. So in every market e.g. the housing
  market, there is demand (people wanting and able
  to buy houses), supply (builders making them
  available) and finally a price (at which the
  houses are sold)
• Goods and services can also be made available
  directly by Government without market activity
  e.g. primary education and basic health care
• The private sector is defined by market activity
  and the public sector by non-market (or only
  partial market) activity.

7
DIVIDING UP ECONOMICS

• Economics is traditionally divided into two
  branches
• Microeconomics deals with the individual parts of
  the economy, such as consumer behaviour,
  production by firms and the behaviour of
  individual markets
• Macroeconomics deals with the economy as a whole.
  Some areas of special interest are the rate of
  growth in the economy, the rate of inflation i.e.
  general price level, the level of employment (and
  unemployment) and the balance of payments i.e.
  difference between overall value of exports and
  imports
• Early economists - following Adam Smith - tended
  to emphasise microeconomics
• Macroeconomics grew in importance following the
  work of J. M. Keynes in proposing a solution to
  the Great Depression

8
POSITIVE AND NORMATIVE ECONOMICS

• Positive economics attempts to deal with issues
  in a detached fashion (without moral values
  intruding (i.e. what is the situation)
• - so a statement that the unemployment rate is
  10 does not entail a
• value judgement (that it is good or bad)
  and is thereby positive
• Normative economics attempts to deal with policy
  issues which
• necessarily entails value judgements (i.e.
  that one policy is better than
• another and therefore ought to be
  undertaken)
• - so a statement that the Government should
  increase investment in the
• economy so as to reduce unemployment is a
  normative statement

9
FUNDAMENTAL CHOICES

• Because resources are scarce (in any society)
  choices have to be made. The three main
  categories of choices are
• What goods to produce and in what quantities
  (relating ultimately to consumption). For example
  if a society spends a great deal of money on
  building new roads there may not be much left for
  other areas like health and education.
• How goods are to be produced (relating ultimately
  to production). For example a firm could use a
  lot of labour (labour-intensive) or alternatively
  plenty of machinery (capital-intensive).
• Finally society has to decide for whom goods are
  to be produced (relating ultimately to
  distribution). At one extreme we may have a
  small minority that is super rich with the
  majority of the population remaining very poor.
  However we could aim at another more equal
  situation - as in some socialist states - where
  households get a roughly similar amount of what
  is produced

10
OPPORTUNITY COST

• Because resources are scarce the production of
  one good involves the sacrifice of other goods
  that could otherwise be provided.
• - for example a farm might be able to produce
  1000 tons of wheat or
• 2000 tons of barley. Therefore in this
  case the opportunity cost of
• producing the 1000 tons of wheat is 2000
  tons of barley. In other
• words if we produce 1000 tons of wheat we
  therefore have to forego
• the opportunity of producing 2000 tons of
  barley.
• Opportunity cost is relevant in all our daily
  lives. For example you may have a certain limited
  amount of income at college. Therefore when you
  spend money on some item (e.g. a meal) you will
  have to sacrifice some alternative purchase (e.g.
  a CD). So in this case the opportunity cost of
  purchasing the meal is the consequent value of
  the CD (which thereby has not been purchased). So
  a rational decision here would entail that the
  value you place on the meal is greater than that
  which you place on the CD.
• Opportunity cost can be illustrated using
  production possibility curves (See Diagram).

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Increasing opportunity costs
x
y
Units of food (millions)
z
Units of clothing (millions)
12
Making a fuller use of resources
Food
O
Clothing
13
Growth in potential output
Food
Now
O
Clothing
14
MARGINAL NOTIONS

• Marginal notions are extremely important in
  Economics
• For example we have marginal utility, marginal
  cost, marginal revenue, marginal propensity to
  consume etc.
• The marginal unit in any context is the last one
  to be considered.
• e.g. if a person drinks 4 cups of coffee, the
  marginal unit is the last cup consumed.
• The importance of the marginal unit relates to
  the fact that value in exchange i.e. economic or
  monetary value, relates to the value to the
  consumer of the last unit
• This can be used to explain the paradox of value
  whereby tap water which has much greater value in
  use than diamonds yet has a much lower value in
  exchange

15
The circular flow of goods and incomes
Goods and services
Consumer expenditure
Wages, rent dividends, etc.
Services of factors of production (labour, etc)
16
ECONOMIC SYSTEMS

• All countries have some form of economic system
• At one extreme are the centrally planned or
  command economies that were formerly associated
  with communist countries (e.g. Soviet Union and
  China). These have now largely died out though
  Cuba remains a good example.
• At the other extreme lie completely free-market
  economies where there is no government
  intervention and all economic decisions are taken
  by individuals and firms. There is no pure
  example of this as Governments intervene to some
  extent everywhere. However Singapore and Hong
  Kong and to a lesser extent the US represent
  economies where the free market philosophy is
  very strong.
• In practice all economies are mixed in that they
  combine a mixture of both extremes (which can
  vary considerably). In Europe the Scandinavian
  countries would have a high level of government
  intervention. Others like the Netherlands and the
  UK would have a lesser degree. Ireland stands
  somewhere in the middle as regards intervention.

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Classifying economic systems
Mid 1980s
N. Korea
Hong Kong
UK
China
Poland
Cuba
France
USA
Totally planned economy
Totally free-market economy
China
N. Korea
Poland
France
USA
Cuba
UK
China (Hong Kong)
Late 2000s
18
COMMAND ECONOMY

• In the command economy land and capital are
  collectively owned. The state
• plans the allocation of resources at three levels
  
• It decides on the important breakdown as between
  consumer and investment goods. In Stalins era a
  huge amount of Soviet resources went into
  investment (at the expense of the consumer)
• It dictates the amount which each production unit
  will produce, and the techniques of production
  used
• It also dictates the distribution of resources as
  between consumers, generally by deciding on
  peoples incomes and then letting them make their
  own decisions as regards consumption
• There are lots of problems with the command
  economy
• - it requires a huge amount of information
  planning tends to be
• inefficient it may be difficult to
  provide incentives for workers and it can
• involve a great loss of liberty for
  workers    

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THE COMMAND ECONOMY

• Plans allocation of resources between consumption
  and investment
• Plans output of each industry, techniques that
  will be used and labour and raw materials
  required
• Plans distribution of output between consumers
• PROBLEMS
• The larger and more complex the economy, the
  greater the task of collecting information
  essential to planning
• If a rigid system of prices is set it is likely
  to lead to inefficiency
• Difficult to provide incentives
• Can entail a considerable loss of individual
  liberty
• Plans may be enforced even when unpopular
• Can lead to unwanted shortages and surpluses

20
FREE MARKET ECONOMY

• This is also known as the capitalist (or laisser
  faire) system where land and
• capital are privately owned.
• Here consumers and producers are assumed to act
  in their own self interest all important
  decisions are based on the operation of supply,
  demand and resulting prices in the various
  markets throughout the economy
• As a result of the price mechanism (Adam Smiths
  invisible hand) there is no little for government
  intervention to allocate goods and services.
• If the price is too low a shortage will build up
  where consumers will be willing to pay more. This
  will thereby cause price to rise. Alternatively
  when there is a surplus, the price will drop.
  Therefore through the adjustment of price, demand
  and supply are always brought into equilibrium
  with markets clearing at the resulting price.
• Thus in free market systems, efficiency is
  brought about through the willingness of both
  consumers and producers to follow price signals.
  This enables a remarkably complex economy to
  evolve based on numerous markets without any need
  for direct intervention.
• However the main weakness of the free market
  system is that it can be very inequitable. Thus
  in practice we often have mixed economies whereby
  the state takes substantial control of social
  areas like education, health and social welfare.

21
THE MIXED ECONOMY

• The government and the private sector interact in
  solving problems
• In practice most Western economies are mixed
  though the degree of private and public
  participation can vary considerably
• Advantages
• enables greater balance as between economic and
  social objectives
• can help to prevent abuse of economic power
• Disadvantages
• - can lead to too much government interference
• - can become unduly bureaucratic and inefficient

22
MARKETS

• A set of arrangements by which buyers and sellers
  are in contact to exchange
• goods or services
• Some markets have a definite physical location
  e.g. shops and stalls
• Other markets operate through intermediaries on
  behalf of clients
• E-commerce is conducted through the Internet
• Sometimes price is set by sellers e.g.
  supermarket items in other cases it is set
  directly through buyers bidding against each
  other e.g. house auctions or through prospective
  buyers haggling with sellers
• Though superficially different all markets
  perform the same basic functions

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TYPES OF MARKETS

• A market is any arrangement through which
  exchange as between buyers and sellers can take
  place
• It need not have a definite location
• Goods and Services
• e.g. food, education
• Factors of Production
• e.g. labour and capital
• Financial
• e.g. stock exchange, currencies
• Intermediary
• e.g. car components

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INTERDEPENDENCE OF MARKETS

• Goods Market
• Demand for good rises
• This creates shortage
• This causes price of good to rise
• This eliminates the shortage by choking off some
  of the demand and encouraging firms to produce
  more
• Factor Market
• Increased supply of goods causes an increase in
  demand for factors
• This causes a shortage of these inputs
• This causes their price to rise
• This eliminates their shortage by choking off
  some of the demand and encouraging suppliers to
  make more available

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THE NATURE OF ECONOMIC REASONING

• Economics as a science
• models in economics
• building models
• using models
• assessing models
• Economics as a social science
• difficulties in conducting controlled experiments
  in many parts of the subject
• problems of predicting human behaviour