LECTURE

Introduction To Economics, PPF & Economic Systems

What is Economics?
Economics is a social science which studies how resources are allocated.
A study of human behaviour emphasizing how human actions are influenced by the constraints of society, therefore they need to make choices to satisfy certain objectives. As such, economics is also known of the science of choice.

What is Economics?
Economics is derived from the Greek word oikos,

which means 'family, household, estate', and nomos, which means 'custom, law Hence, combining both it means "household management" and "management of the state"

What is Economics?
Economics is broadly divided into two(2) major

concerns namely: (1) (2) Microeconomics Macroeconomics

Microeconomics
A branch in economics that examines the functioning

of individual market/industry and the behaviour of individual decision making units- for example business firms and households. Microeconomics studies individual markets such as the market for coffee or tea or ice-cream.

Microeconomics
Example: For the case of coffee, it explains - why the price of coffee is at a certain level?

- how changes in coffee prices may affect the market for tea? - why are there so many people are employed in coffee production?

Macroeconomics
The other branch of economics that examines the

economic behaviour of aggregates or it studies the overall performance of an economy. The study of aggregate demand, output or inflation are all part of study of macroeconomics. Instead of looking at the individual price, we look at the general price level.

Macroeconomics
Instead of looking at the individual firms output, we look at the national output.
If the society wishes to avoid or to reduce the negative effects of fluctuations in output, employment and price level, it must have some idea of how the macroeconomy works.

Resources: Case & Fair (2010) Principles of Economics

Positive and normative statements

In the analysis of the particular problem, economists

usually ask two(2) types of questions, namely positive and normative in nature. What is the difference between the two?

Positive and normative statements

A positive statement is a factual statement obtained from survey and research, without making judgements whether the outcomes are good or bad.

Example: The equilibrium wage rate is RM4.50 per hour. The unemployment rate for last year is 4.6%

Positive and normative statements

A normative statement is based on value judgement, using an approach that analyzes the outcome of economic behaviour, evaluates them as good or bad, and may prescribe courses of action.

Example : The minimum wage should be raised every year. The government should play an active role in redistribution of wealth in this country.

Basic Economic Questions

We need to answer three(3) basic questions to

understand the functioning of the economic system. What is to be produced? How is it produced? For whom it is produced?

Economic resources
Every society, no matter how big or small has a

system that works to transform the resources and provide them into goods and services. The goods produced are called outputs, they are produced by using resources called inputs or factors of production

Factors of Production
What are the resources?
The basic resources available to the society are often

referred to as inputs or factors of production. Three(3) key factors of production are: (i) land (ii) capital (iii) labour

Concept of Scarcity
To get it started, the presumption is that human wants

are unlimited, but the resources are not. Scarcity arises because people desire more things than available resources can provide. For e.g. money, time and energy

Scarcity and Choice

In economics, limited or scarce resources force

individuals and societies to choose among competing uses of resources, i.e. people have to make choices These scarce resources are then transformed into useful goods and services.

Rationality and Choices

When making choices, human beings are assumed to

be rational. By rationality, economists asserts that: (i) Humans beings act with a purpose (ii) With a purpose, he or she makes choices which are consistent with his or her preferences in order to maximise his or her net gain

Rationality and Choices

In short, Consumers will seek to maximise their satisfaction or utility Firms will seek to maximise their profits These form the basic ingredients and foundations of the study of Economics.

Opportunity Cost
Because the resources are scarce and human wants are unlimited, we have to choose to consume certain good and service.
Consequently, this implies that we are unable

to consume something else. We have to forgo or give up consuming some other goods and services. The value of goods and services forgone is equal to the opportunity cost

Opportunity Cost
Opportunity Cost is also known as the best alternative forgone for choosing a particular action. The example of the is given as follows: At a given level of income, instead of going for a movie which costs RM10.00, I choose to go for a drink at Starbucks which costs the same. Hence, the opportunity cost of enjoying Starbucks coffee is ________________.

Production Possibility Frontier (PPF)

PPF is a graph that shows all the combinations of

goods and services that can be produced if all the societys resources are used efficiently. It helps to illustrate the principles of scarcity, choice and opportunity cost.

Production Possibility Frontier (PPF)

An example of a PPF of an economy producing only

capital goods and consumer goods

Capital goods Machines A

800

F
E D B Consumer goods - Cars

550

1100

1300

Production Possibility Frontier (PPF)

The assumptions for the frontier are: 1. All resources are fully employed, zero unemployment 2. There are only two(2) goods produced 3. Resources can be transferred from the production of capital goods to consumer goods or vice-versa at no cost 4. Level of technology is assumed constant 5. All resources are fixed in quantity

Production Possibility Frontier (PPF)

Referring to the frontier, all points below (point D)

and exactly on the curve (points A,B,E & F) represents combinations of capital and consumer goods that are possible for the society given the available resources and existing technology.
Point D shows the combination of two goods which are

not at the maximum as there are unemployed resources in the society (inefficiency).

Production Possibility Frontier (PPF)

Points A & B shows the maximum combination of two

goods that can be produced as all resources are fully employed (productive and allocative efficiency).
Point above and to the right of the curve such as point

G, represents combinations that cannot be reached, given the available resources and existing technology.

Production Possibility Frontier (PPF)

The concept of scarcity, choice and opportunity can be explained by the movements of the points on the PPF.
Assuming that the economy is operating at full employment level (all resources are fully employed), the economy decides to produce more capital goods than consumer goods.

Thus, there is a movement from point E to F on the PPF.

Production Possibility Frontier (PPF)

Moving from point E to F indicates that:

1. 2.

A rise of 250 units in the quantity of capital goods produced (from 550 units to 800 units) A fall of 200 units in the quantity of consumer goods produced (1300 units to 1100 units)

Production Possibility Frontier (PPF)

Given the existing resources available, scarcity is prevalent when the economy is unable to produce more of both capital and consumer goods.
Thus, the economy will have to make a choice of which good to produce. In the case here, capital good is chosen, as a result there is additional 250 units of capital goods to be produced.

Production Possibility Frontier (PPF)

The economy will have cut down on the production of

consumer goods by 200 units. In other words, the opportunity cost of producing an additional 250 units of capital goods is the 200 units of consumer goods that we have to forgo.

Production Possibility Frontier (PPF)

From the PPF, it is observed that more and more of

consumer goods will have to be given up in order to produce additional units of capital goods. This is due to the concave shape of the PPF. This is known as Increasing Opportunity Cost.

Production Possibility Frontier (PPF)

For point G on the PPF, these combinations can be achieved if there is an outward shift of the PPF.

How can this happen?

It is due to the existence of economic growth! An economic growth is characterized by an increase in total output of an economy.

Production Possibility Frontier (PPF) and Economic Growth

Factors causing economic growth: Discovery of new resources Higher labour productivity Improvement in human capital Technological advancement Immigration of skilled foreign labour Favourable government policies

Economic Systems
Given scarce resources, how exactly do large and complex societies go about answering the three basic questions?

What gets produced? How is it produced? For whom it is produced?

Now we shall explore the alternative economic systems and their means of allocating resources.

The command economy

It is also known as the centrally-planned economy In a pure command economy, the basic questions are all answered by the government. The central authority usually comprises a group of committee of top government officials, which assumes that it owns the natural, capital and labour resources.

The command economy

Through the government ownership of state enterprises, the government either directly or indirectly, determines what to produce, the level of output to produce, the method of which it is produced and to whom it is produced for.
Examples: North Korea, Cuba and the former Soviet Union.

The command economy

Advantages: Full employment with moderate inflation Distribution of wealth is equal More public goods are provided High level of savings and capital accumulation

The command economy

Disadvantages: High costs in planning Difficult to plan when the economy becomes more advanced and complex Low efficiency, poor quality No incentive to innovate

The free market economy

It is also called the capitalist or laissez-faire economy. In a free-market economy, individuals and firms pursue their own self interests without any central direction or regulation. Consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (or not to purchase)

The free market economy

Basically, the economic questions are answered without the help of a central government plan or directives. Free market means the system is left to operate on its own, with no outside interference. Government is responsible for the law of the land and provision of public goods and other facilities. Examples: United States and Hong Kong

The free market economy

Advantages Maximise consumer sovereignty Efficient allocation of resources through price mechanism Competition ensures high productivity Free market ensures that there is no shortage or surplus of goods and services

The free market economy

Disadvantages Goods produced may not be in the best interest of the society (alcohol, tobacco) Unequal distribution of wealth Unemployment of labour Underproduction of public goods Pollution and wastage

The mixed economy

In reality, there are no pure planned/command economies or pure free market economies in the world. All systems are in some sense mixed. The individual enterprise exists and government involves in the decision making as well. The basic questions are jointly answered by the market forces and the government.

The mixed economy

Free market enterprises may not be perfect as they do not produce at the lowest cost and it may also lead to unfair income distribution.
Therefore, it justifies the need for government involvement to ensure an and efficient and equitable distribution of resources Examples: Malaysia, United Kingdom, Japan and most of the countries in the world