1- 1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Chapter 1 The general.

1- 1Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & BajadaBy Muni Perumal

Chapter 1

The general principles of economics


Learning Objectives• Understand the nature and methodology of

economics.• Explain specific problems, limitations and pitfalls

encountered in studying economics.• Discuss the two fundamental facts that form the basis

of the economising problem.• Discuss the meaning of economic efficiency.


Learning Objectives (cont.)

• Illustrate, extend and modify the definition of economics through the use of production possibilities tables and curves.

• Introduce the concept of opportunity cost and the law of increasing opportunity cost.

• Use the production possibilities curve model to examine the trade-off between current and future consumption.


The Economic Perspective• Economics is concerned with the efficient use of

limited productive resources for the purpose of attaining the maximum satisfaction of our material wants.


The Economic Perspective• Reasons for studying economics:

– Provides valuable knowledge concerning our social environment and economic behaviour.

– Provides knowledge to make fundamental decisions in a democracy.

– Provide businesses and consumers with valuable information and a set of methods for analysing information.

– Economists view things from a special perspective.


The Economic PerspectiveThe economic perspective includes:• Scarcity and choice

– resources are limited and this necessitates choices

• Rational behaviour– behaviour that involves decisions and actions in order to

achieve the greatest satisfaction or maximum fulfilment of goals

– people will make different choices, because their circumstances, preferences and available information differ


The Economic Perspective • Marginalism: benefits and costs

– decisions that compare marginal benefits and marginal costs– incremental benefits available from any changes are

compared to the incremental costs of making the change.


The Foundation of EconomicsTwo fundamental facts that constitute the economising

problem:• Unlimited wants

– Material wants: the desires of consumers to obtain and use various goods and services that give utility or satisfaction.

• Scarce resources– Economic resources includes all the natural, human and

manufactured resources that go into the production of goods and services. Includes:

property resources – land, raw material and capital human resources – labour and enterprise


Scarce ResourcesTwo broad categories:• Property resources

– Land– Raw materials– Capital.

• Human resources– Labour– Entrepreneurial ability.


Resource Payments• Land – rent• Capital – interest• Labour – wages• Enterprise – profit


Five Fundamental Questions• How much total output is to be produced?• What combination of outputs is to be produced?• How are these outputs to be produced?• Who is to receive/consume these outputs?• How can change be accommodated?


The Methodology of Economics

1. Facts

Descriptive, or empirical, economics is concerned with gathering facts relevant to an economic problem and testing hypotheses against those facts.

2. Principles or theories

Theoretical economics involves generalising about economic behaviour.

3. Policies

Policy economics is concerned with controlling or influencing economic behaviour or its consequences.

induction

deduction


Induction and Deduction• Induction

– A method of reasoning that proceeds from facts to generalisations.

• Deduction– Reasoning from assumptions to conclusions by testing a

hypothesis.


Economic Theory• Facts must be systematically arranged, interpreted

and generalised to derive appropriate economic theory.

• Theories or principles are the end result of economic analysis. These are meaningful statements drawn from facts.


Terminology of Economic Theory• Economists use the terms ‘laws’, ‘theories’ and

‘models’ to represent generalisations, or statements of regularity, concerning the economic behaviour of individuals and institutions.


The ‘Other Things Being Equal’ Assumption • The ‘other things being equal’ assumption

– The process of analysis, that all variables, other than the one being considered, are constant.

• Abstractions in economics– Economic theories do not encompass the full complexity of

reality.


Microeconomics and Macroeconomics• Microeconomics is concerned with specific economic

units and a detailed consideration of the behaviour of these individuals units.

• Macroeconomics deals with the economy as a whole, or with the basic subdivisions or aggregates that make up the economy.


Policy Economics: Positive and Normative • Positive economics are based upon facts without

value judgements.• Normative economics are based upon subjective

beliefs . . .

‘what ought to be’– Normative economic statements come into play at the level

of policy economics.


Pitfalls of Objective Thinking• Bias• Fallacy of composition• Cause and effect

– Post-hoc fallacy– Correlation versus causation.


Economics and Efficiency• Efficiency is the use or administering of scarce

resources to produce the maximum amount of the desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants.

• Full employment: When all available resources are employed.


Economics and Efficiency (cont.)• Full production: When the maximum amount of goods

and services are produced from the employed resources of an economy.

– Two kinds of efficiency: Allocative efficiency Productive efficiency.


Economics and Efficiency (cont.)• Allocative efficiency

– Occurs when all available resources are devoted to the combination of goods most wanted by society.

• Productive efficiency– Occurs when goods or services are produced using the

lowest cost production methods.


Specialisation and Efficiency• Two major forms of specialisation enhance efficiency:

– The division of labour– Geographic specialisation.


Production Possibilities TableAssumptions• Efficiency

– Full employment and productive efficiency.

• Fixed resources• Fixed technology• Two products only

– Capital good and consumer good.


Production Possibilities of Chocolate and Tractors with Full Employment

___________________________________________________________

Type of product Production alternatives

A B C D E

Chocolates (’00 000) 0 1 2 3 4

Tractors (‘000) 10 9 7 4 0

___________________________________________________________


Production Possibilities Curve• The Production Possibilities Curve (PPC) can be

used to illustrate the concept of choice and opportunity cost.

• Demonstrates that society must make choices about which goods and services to produce and which to go without.


Production Possibilities Curve (cont.)• Points on the PPC represent a maximum output of

the two products.• Points inside the PPC are attainable, but are

inefficient and undesirable.• Points outside the curve are superior, but

unobtainable given the assumptions of fixed technology and resources.


Q

Q

Tra

cto

rs (

tho

us

an

ds

)

Chocolate bars (hundred thousands)

121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

A B

C

D

E

W

Unattainable

Attainable andefficient

Attainablebut inefficient

U

Production Possibilities Curve (cont.)


Production Possibilities Curve (cont.)• Opportunity cost:

– The amount of other products that must be sacrificed to obtain an additional unit of a good.

• The PPC is concave to the origin because of the law of increasing opportunity costs:– more and more of a good must be given up to obtain

additional units of the other good.


Law of Increasing Opportunity Costs • Concavity: the slope of the concave PPC becomes

steeper as we move from A to E • Rationale:

– Based on the fact that economic resources are not completely adaptable to alternative uses; they are imperfect substitutes.

– Resources lack perfect flexibility or interchangeability.


Allocative Efficiency Revisited• Resources are efficiently allocated to any product

when the output is such that its marginal benefit equals its marginal cost (MB = MC).


Unemployment and Growth• Points inside the production possibility curve illustrate

unemployment or productive inefficiency.• A movement towards full employment and productive

efficiency from a point such as U will entail a greater output of at least one, if not both, products.


Q

Q

Tra

cto

rs (

tho

us

an

ds

)


1010 99 88 77 66 55 44 33 22 11

1 2 3 4 5 6 7 81 2 3 4 5 6 7 8

A B

C

D

E

More of either orboth is possible

U

Unemployment and Underemployment


Economic Growth and the PPC• Economic growth can be represented as an outward

shift (to the right) of the PPC.• Economic growth results from:

– expanding resource supplies– technological advances.


Q

Q

Tra

cto

rs (

tho

us

an

ds

)


1413121110 9 8 7 6 5 4 3 2 1

1 2 3 4 5 6 7 8

AA′′

BB′′

CC′′

DD′′

EE′′

Economic Growth and the PPC (cont.)


Present Choices and Future PossibilitiesThe PPC can be used to:• illustrate the importance of society’s choice between

current and future consumption.• demonstrate the economic basis for trade between

nations.


Goods for the Present Goods for the Present

Goo

ds f

or t

he F

utur

e

Goo

ds f

or t

he F

utur

e

2003 Curve

2023 Curve

2023 Curve

2003 Curve

Alphania Betania

Economic Growth in Two Countries


Graphs and their Meaning

Appendix to Chapter 1


Constructing a Graph• Graphing relationships between variables

– direct (positive) relationship: where the values of two related variables change in the same direction, e.g. consumption and income

– inverse (negative) relationship: where the values of two related variables move in opposite directions, e.g. ticket prices and attendance.


Direct Relationship

0

$500

$400

$300

$200

$100

$100 $200 $300 $400

Co

nsu

mp

tio

n (

C)

Income (Y)

ConsumptionC = 50 + 0.5Y

ab

c

de

As Y increases, C increases


Inverse Relationship

0

$25

$20

$15

$10

$5

4 8 12 16 20

Tic

ket

Pri

ce (

P)

Attendance in thousands (Q)

Ticket Demand

a

b

c

d

f

As P increases, Q decreases

e

P = 25 – 1.25Q


Slope of a Straight Line• The ratio of the vertical change to the corresponding

horizontal change involved in moving between two points.


Positive Slope

o

$500

$400

$300

$200

$100

$100 $200 $300 $400

Co

nsu

mp

tio

n (

C)

Income (Y)

ConsumptionC = 50 + 0.5Y

ab

c

de

vertical change = +50

horizontal change = +100

5.0100

50

change horizontal

change verticalSlope


Negative Slope

0

$25

$20

$15

$10

$5

4 8 12 16 20

Tic

ket

Pri

ce (

P)

Attendance in thousands (Q)

Ticket Demand

P = 25 – 1.25Q

a

b

c

d

f

25.14

5

change horizontal

change verticalSlope

– 5

+ 4

e


Three Addenda• The discussion of the slope of a line needs the

following three additional comments:– Measurement units– Marginal analysis– Infinite and zero slopes.


Equation Form• Linear relationship

y = a + bx

Where y = the dependent variable

a = the vertical intercept

b = the slope of the line

x = the independent variable


Slope of a Curve

Tangent

PA

A

a

a

X

Y


Slope of a Curve (cont.)

X

Y40

30

20

10

010 20 30 40

Pb

b


Next Chapter:

Demand and supply

1- 1 Copyright 2007 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles 2e, by Jackson, McIver & Bajada By Muni Perumal Chapter 1 The general.

Documents

economic problem

economic behaviour

economic perspectiveeconomics

economic perspectivereasons

meaning of economic

theoriestheoretical

policiespolicy economics

definition of economics