Basic Introduction to Economics

Adam Smith (1723-1790)

Father of modern economics
Wrote: An Inquiry into the Nature and Causes of the Wealth and
Nations (1776) at beginning of Industrial Revolution
Believed in the free market
Free market= consumer may buy what they like and producers
may produce what they like, no government interference
It would serve public interest well
Laissez-fair= consumers and producers make own decisions and
gain max. benefit for all from market system
Didnt advocate complete freedom; understood that companies
could adjoin and exploit people, or firms growing too large and
dominating the market
Basics of Economics
The Earth is finite; only finite amount of resources
Resources finite means goods and services are also finite
Goods are physical objects (vegetables, meat, cars) and Services
are intangible things (repairs, haircuts, and insurance)
Human needs and wants are infinite, needs are things we need
to survive, and wants are things we would like to have but dont
need for survival (TV and phones)
There is a conflict between finite sources available and infinite
sources needed and wanted; you cant have everything you
desire, so you need to ration
Economics- study of rationing systems; study of how scarce
resources are allocated to fulfill infinite wants

Scarcity
Anything with a price is relatively scarce; means it is scarce in
relation to demand
Price is used to ration the goods and services available
Anything with a price, which is being rationed, is an economic
good
scarcity has a different meaning in an economic context than
the real world
Choice

Not having infinite incomes means you need to make choices

Must decide allocation of financial resources so must always
choose between alternatives

Opportunity Cost
Next best alternative foregone when an economic decision is
made
Basically, what you give up to have something else; not
expressed in monetary units
Salt water and air arent limited in supply and dont have an
opportunity cost when consumed; we dont need to give
something up for it; so, they are free goods
The Basic Economic Problem
Choices are expressed in 3 questions and represent basic
economic problem:
o What should be produced and how much of it?
o How should something be produced?
o Who should things be produced for? Go to people who can
afford or in some fair manner?
System used to allocate resources needs to answer these
questions
Two theoretical allocation systems
o Free market system
o Planned economy
In reality, economies are mixed, so they are a combination of
both
Government interference is debatable

Land
Everything that grows on the land or is found under it (sea) and
everything that is found under the sea
Includes all natural resources
Such as: gold, coal, oil, gas, wheat, rice, pineapples
Some resources are renewable (pineapples) some arent (oil)

Labour
Human factor
Physical and mental contribution of the existing workforce to
production
Capital
Factor of production that comes from investment in physical and
human capital
Physical capital- stock of manufactured resources (factories,
roads, tools)
Human capital- value of workforce
Investing in human capital through education or improved health
care may contribute to economic growth
Infrastructure (social overhead capital) are large scale projects
and facilities (railway, bus, airports, nuclear plants)
Infrastructure comes from government investment and
improving it may lead to better economic growth and
development
Management (entrepreneurship)
Organising and risk taking factor
Profit is never guaranteed and investment loss may occur, that is
the risk taking part
Production Possibilities Curves/Frontiers
Used to show concepts of scarcity, choice, and opportunity cost
Shows max combinations of goods ans service that can be produced
by an economy in a time period, if everything is being used fully and
efficiently and state of tech. is fixed aka potential output
PPC always show the most efficient, so thats theoretic; countries
are always working inside their PPC
Movement that closer towards the PPC is called actual growth

A point outside the PPC is only attainable if the PPC itself grows; so
you can have an increase in potential ouput (PPC moves) and you can
have potential growth (from one point to another point in increase)
Potential output increase can only happen from the improvement in
quantity or quality of factors of production; if there is an increase in
theoretical output, doesnt mean there will be in actual output
Fall in quantity or quality would result in fall of PPC or inward shift,
could come from natural disasters or war
Utility
Measure of usefulness and pleasure; given an idea of how much
usefulness or pleasure a consumer receives when they consume a product
2 basic ways- total utility and marginal utility
Total utility
total satisfaction gained from consuming a certain quantity of a
product
Marginal utility
Extra utility gained from consuming one more unit of a product
Usually as consumption increases, marginal unity decreases.

Microeconomics and Macroeconomics

Microeconomics- smaller, discrete economic agents and reactions
to changing events; individual consumers ad their decisions
about demand and expenditure; individual firms- what to
produce and how much, and individual industries- how theyre
affected by government actions

Macroeconomics- wider view; measures all economic activity in

the economy, inflation, unemployment, and distribution of the
income as a whole

Positive economics and normative economics

Positive economics- deals with areas of subject capable of being
proven to be correct or not
Normative economics- deals with areas of subject that are open
to personal opinion and belief
Economics and Model Building
Economists build theoretical models
They are then manipulated to see what the outcome will be if
there is a change in variables
Holding all but one variable constant is called ceteris paribus
(latin: all other things being equal)
Government is responsible for law and order, national defence,
adjusting the economy to achieve agreed economic aims, provide
certain goods and services,
State owned sector is called public sector; firms and households
are the private sector
Rationing Systems: planned economies versus free market
economies

Planned Economies:
o Decisions for what to produce, how, and who for and made
by government
o All resources are collectively owned
o Government handles all production, wages, and set prices;
decisions are made by government
o Number of decisions, data to be analyzed, and factors to
be allocated to huge making it difficult; forecasting future
events makes it even more difficult

Free Market Economies:

o Prices are used to ration goods and services
o Production is in private hands and demand and supply are
left free to set wages and prices
o Should work efficiently
o Individuals make decisions about price and what they want
and producers decide whether they agree or not,
depending on profit
o Changes in pattern of demand means changes in pattern of
supply

o Free market system is self righting system

In reality, it is mixed; government involvement is important

because left alone, free market might get dangerous

Economic Growth
National income is value of all goods and services produced in an
economy in a given time period (commonly one year)
Can be measured by adding up all activity
In order not to overstate the value, any increase in prices is
ignored and the national income after ignoring is called real
national income; real maens having allowed for the effects of
inflation
If there is increase in real national income then there is growth;
but if pop. grows the same percentage then income per head
wont grow
To be accurate, increase is measured in real national income per
capital (per head); measure of the increase in economic activity
known as economic growth
Doesnt tell the actual welfare of the country
Economic growth aka growth in GDP= increase in actual output
Economic Development
Measure of welfare, a measure of wellbeing
Includes education indicators, health indicators, and social
indicators
The Human Development Index (HDI) is commonly is one of the
most commonly used development measures (includes real
national income per head, literacy rate for adults, average
schooling years, and life expectancy)
HDI is calculated and is between 0 and 1, the closer to one, the
more developed
Sustainable Development
The World Commission on Environment and Development was
formed in 1983 by UN and in 1987 they published Our Common
Failure
The opinion was that if environmental degradation continues,
then we can keep up the growth
Sustainable development means the development that meets the
needs of the present without compromising the ability for the
future generations to meet their own needs