Introduction to Economies

What is economics?

Economics: the study of the way an economy uses its scarce resources to satisfy the
unlimited needs and wants of its people by making choices

Economic problem:

The problem where wants are unlimited, but the resources that are used to satisfy
those wants are limited

Economic faces choices about:

What goods to produce

Which wants to satisfy first, and which will leave unsatisfied

How much to produce

Too much of a good -> resources will be wasted

Too less -> wants of individuals will be left unsatisfied

How goods are produced

Must look for the most efficient method of production that uses the least amount of an
economy's resources

Who will get the goods that are produced

Decisions of whether the economy wants a more equitable distribution or uneven

distribution
More efficient systems may produce less equitable outcomes
Price is a measure of their scarcity
Eg. Air is not scarce -> free and has no price

Needs:

Needs: desires for the basic necessities of life

Eg. Food and shelter

Wants:

Wants: material desires of individuals or the community

Utility: satisfaction or pleasure
Individuals derive utility from consumption of goods and services

Types of wants:

Recurring
wants:

Wants
that must
be
continually
satisfied
Eg. Food,
water,
petrol,
newspaper
s

Substitute wants: Complementa

Wants that
ry wants:

are
interchangea
ble
Eg. Butter
and
margarine

Wants
that follow
naturally
from
another
want
Eg. Car &
petrol

Individual
wants:

Desires of
each
individual
according
to their
preference
s and
income
Eg. Toys

Collective
wants:

Wants of
the whole
community
Usually
provided
by the
governmen
t
Eg. Parks,
roads,
schools

Main types of goods used to satisfy wants:

Consumer goods and services

Used to immediately satisfy consumer wants

Single use goods and services do not exist once they are consumed
Eg food
Durable consumer goods may be used repeatedly
Eg cars, computers

Capital goods:

Used to produce more consumer and capital goods in the future

Durable
Subject to depreciation (wear and tear)
Have to be replaced in the future
Eg. Machines, tools

Opportunity Cost:

A want which is foregone in order to satisfy another want

Marginal Opportunity Cost (per unit) = what you FOREGO/ what you GAIN

Individual Consumer:
o
o
o

Limited income
Makes choices between satisfying different wants
Eg. Overseas holiday or new car -> if consumer chooses a car, the opportunity cost
would be the overseas holiday

Business Firm
o
o

Must make a choice in the allocation of its scarce resources

Eg. If the firm decides to produce shoes, they give up the opportunity to produce
something else

Government
o
o

Limited resources that it can use to satisfy community wants

Eg. If they build a new motorway, the opportunity cost would be building a new school

Societies
o
o

Also face choices in the way they allocate limited resources

Eg. Might allocate more resources to the production of food, clothing such as building
new factories.

Production Possibility Frontier

Used to demonstrate how opportunity

costs arise when individuals or the
community make choices
Graphical representation of all the possible
combinations of the production of two goods
or services for two types of goods that the
economy can produce at any given time
Can be used to demonstrate how
opportunity costs arise when we make
choices.
A straight line PPF shows a constant
opportunity cost between two products.

Simplified model
PPF does not always have to be drawn
as a curve
If the opportunity cost for producing two
products is constant, then we draw the PPF
as a straight line.
Based on a number of assumptions:
o
The economy produces only two
goods - food and clothes
o
State of technology is constant
o
Quantity of resources available
remains unchanged
o
All resources are fully employed

New technology

Application of new technology -> development of more efficient methods of production

Allows us to produce a higher quantity of a good with the same amount of resources
Represented through outward shift of PPF
Can shift both ways or just for one product

New resources

Increases the inputs available for production

Enables us to produce more of one/two goods
Represented through an outward shift on PPF
Eg. Discovery of new resources, expansion of population through immigration

Unemployment

Unemployment: problem of a person being available for work but unable to find it
When resources are not fully employed, position of economy changes in relation to PPF
Economy would be producing at a point below the PPF

Future implications of choices

Economy as a whole can choose between producing goods that satisfy consumer
demand immediately (consumer goods) and goods that will increase our productive
capacity in the future (capital goods) eg machinery.
In the long run, focusing on the production of capital goods will increase its productive
capacity and experience a higher level of economic growth
Choosing to produce more capital goods now is making the choice to forego satisfying
some of the immediate wants.

Individuals:
o
o
o

May choose to forego an overseas holiday to take out a mortgage and purchase a
house
Short term: sacrificing time to save up money and paying off mortgage
Long term: home ownership improves an individual's financial security

Business:
o
o
o
o

Have a limited amount of labour, capital, entrepreneurial skill and other resources
Must focus on products which they are likely to have the greatest success
Most effective if they can identify where the next wave in business growth is likely to
occur
Eg. Businesses that invested in communications and IT a decade ago have would
achieve extraordinary financial success now

Government:
o
o
o
o

Decisions of gov have important long term implications

If government chooses to give highest priority in its spending to satisfy immediate
needs (eg. Increased welfare benefits & health care)
May provide less funding for other areas of expenditure
In the long term, results in a lower level of economic growth due to:
Lower skills base in workforce
Less innovation
Weaker infrastructure

Economic Factors underlying choices

Individuals:

o
o
o
o
o

Factors which influence economic choices made by individuals:

Age
Income
Expectations
Future plans
Family circumstances

Personality
- Eg. Some people are keen to change and risk while others may avoid risk
Individuals must make a choice to save or spend
^ Influenced by age, income level, expectations of whether future income would fall or
rise
Contribute to economic decision making by voting in elections

Business:

Pricing products: may choose a higher prise hoping for maximising of profits
Pricing decisions are based on businesses marketing strategy
Businesses seek to minimise costs
Face choices on whether to encourage union representation or involvement from
employees in decision making

Examples:
o May face higher costs in the purchase of better quality equipment that requires less
maintenance
o Businesses will generally choose the cheapest available resources, but if not assured
they may choose to pay more to a more reliable supply
o Ethical issues; businesses may consider to pay a higher price for using recycled paper
instead of non-recycled paper

Government:

Have significant influence over economic choices of individuals and businesses through
making choices less or more expensive
Influence on the economy is a result of both influencing the decisions of individuals and
businesses and providing goods and services directly
Eg. Taxing cigarettes more heavily, to discourage individuals from smoking
Governments may seek to influence economic behaviour by prohibiting certain
activities and imposing heavy penalties
Eg. Businesses operating in the same industry are prohibited from meeting together to
set prices for their industry -> can harm the interests of consumers
Eg. To encourage individuals to join a private health insurance scheme, Aus Gov
provides 30% tax rebate to low and middle income earners for private health insurance
payments and imposes Medicare Levy Surcharge on higher income earners

Factors of Production
Factor of
Definition
production

Examples

Income Limits on Supply

Natural
Resources

-Include all the resources

provided by nature that
are used in the
production process

Soil, water,
forests

Rent

-Amount of natural
resources available for
production (eg. Land, fossil
fuels, water)

Labour

Is human effort, both

physical and mental, used
to produce goods and
services

Physical work
of a carpenter,
service
provided by
doc/lawyer

Wages

-Population size, labour

market skills, willingness to
work

Capital

Is the 'produced means of Machinery,

Interest - The extent to which
production'
tools, factories,
government and private
computers
sector are willing to invest
- Level of domestic/
overseas savings available
for investment

Enterprise

Involves organising the

other factors of
production (eg. Natural

Entrepreneur
running a
business

Profit

-Size of population, ability

and willingness of
individuals to innovate and

resources, labour) for the

purpose of producing goods
and services

take risks

Distribution and exchange of goods and services

GDP: total market value of all final goods and services produced in an economy over a
period of time
^ Measures the total income of a society that is received for the production of goods and
services
Main function of economic system: to determine how to distribute and exchange goods
and services in the economy
Market economies: provide people with income as a reward for their contribution to the
production process
Price that is paid for inputs determines the individual's share of total output
^ depends on how scarce or highly demanded their resources are
Income levels are influenced by:
-How much they work
-Skills and expertise
-Educational qualifications
-Bargaining power in wage negotiations with employers
Benefit: provides incentives for people to obtain better skills and work harder in order
to improve their share of output
^ improves resource base, encourages innovation, technological advancement
Problem: can be unfair, (for people who are unable to contribute due to illness, age,
disability)
Government takes money from higher income earners through taxation & redistributing
it to lower income earners through social security payments
Individuals and businesses use money as a medium for exchanging goods and services
Barter: Non-cash exchange of goods and services

Business Cycle
-

Business Cycle: refers to fluctuations in the level of economic growth due to

domestic or international factors
Generally has a trend of growth in output but is followed by an economic
slowdown
Recession: stage of business cycle where there is decreasing economic activity,
defined as two consecutive quarters (six months) of negative economic growth.
Increase in unemployment -> families rely on social security payments ->
reduction in consumption -> contraction of economy -> living standards fall ->
health problems rise -> lower quality of life
Economic upturn -> increase disposable income available -> leads to further
expansion -> improvement in quality of life

Impacts of Business Cycle

Recession
Falling production of
goods and services
Falling levels of
consumption and
investment
Rising unemployment
Falling income levels
Falling quality of life

Boom

Increase production of
goods and services
Rising levels of
consumption and
investment
Falling unemployment
Rising income levels
Rising quality of life

Circular Flow of Income

TWO SECT
HOUSEHOLDS &
THREE SEC
HOUSEHOLDS, FIRMS & F
FOUR SECT
HOUSEHOLDS, FIRMS, FINANCIAL
FIVE SECT
HOUSEHOLDS, FIRMS, FINANCIAL, GOVERN

Assumptions of Two Sector Model

Economy consists of 2 sectors
Households spend all of their income on goods and services. Ie. No Saving
(E) expenditure
All output by firms is purchased by households
(O) output
No financial sector
(Y) income
No government sector
CLOSED ECONOMY
(C) consumption
No overseas sector
(M) imports
Note: in 2 sector; because every cent is spent,
C = O, Y = O -> Y = O

(S) savings
(I) investm
(T) taxes
(G) gov. sp
(X) exports

S+T+M=I+G+X
Aggregate Demand:
AD = C + I + G + (X - M)
Y (Income) = GDP (Output) = AD (
Y = GDP = C + I + G + (X M)

LEAKAGES: When money is not being spentEquilibrium:

(LEAKS out of circular flow)
Y=E=O
SAVINGS, TAXES, IMPORTS
Y=C+S
O=C+I
C+S=C+I
S into
= I the flow)
INJECTIONS: When money is being put into flow. (INJECTED
INVESTMENT, GOV SPENDING, EXPORTS

Individuals:

Supply factors of production (inputs) eg. Labour, enterprise to businesses

Receive income as a reward in forms of wages, rent, interest and profit
Income goes to:
Spending on consumption savings
Paying tax
Purchasing imports

Businesses:

Consists of all business firms engaged in the production and sale of goods and services
Depend on individuals to supply the resources needed for the production process
Depend on individuals on consumption of goods and services produced
Individuals and businesses are interdependent
Circular flow depicts flow of money between individuals and businesses

Financial Institutions:
AKA capital market
Consists of all institutions engaged in the borrowing and lending of money
Act as intermediaries between savers and borrowers or money
Eg. Banks, building societies, finance companies, credit unions etc
Needed for individuals and firms to be able to undertake saving and investment
Accept savings (deposits) from individuals, and lend them out to businesses for
investment
Perform the function of mobilising savings to be used for investments
Leakage of savings:
Leads to a reduction in size of circular flow of income -> reduction in economic activity
Causes fall in expenditure on goods and services -> fall in production -> fall in demand
for resources -> fall in income -> rising unemployment
Injection of investment:
Investment: any current expenditure that is made in order to obtain benefits in the
future
Savings are essential for investment to occur
Allows creation of new capital goods
Investing in capital goods -> improve the future productive capacity of the economy
Increases our stock of productive resources -> produces an even greater volume of
goods and services
Increases circular flow of income
Causes increase in production of capital goods -> increase demand for resources ->
increase income

INDIVIDUALS, BUSINESSES, FINANCIAL INSTITUTIONS -> PRIVATE

SECTOR

Governments:

Consists of three levels: Commonwealth, state and local

Involved in satisfaction of collective wants (eg. Roads, railways, schools etc)
Obtains resources through imposing taxes on the other sectors in the economy

Roles:

Imposing taxes on individuals and businesses

Uses the tax revenue to undertake various government expenditure
Provides income to government employees, employees of private businesses

 Mmakes transfer payments (eg pensions, unemployment benefits)

Taxation -> decrease in expenditure -> decrease in demand etc

Government expenditure -> rise in income
Referred as public sector
- INDIVIDUALS, BUSINESSES, FINANCIAL INSTITUTIONS, GOVERNMENT ->
DOMESTIC SECTOR

International Trade and Financial Flows:

Covers all transactions that the economy has with the rest of the world
Includes exports, imports and international money flows
Imports: goods and services produced overseas but sold in Australia
Leakage because money is withdrawn from the economy to be paid to businesses
overseas
Reduces size of circular flow
Exports: goods and services produced in Australia but sold to overseas customers
Injection because money is paid to Aus businesses by consumers in other countries
Stimulates production and employment opportunities in Australia
Increase size of circular flow

Equilibrium:

When there is no tendency for change

Sum of all leakages is equal to the sum of all injections

Disequilibrium:

When there is an inequality between total leakages and total injections

Economy tends to move towards equilibrium

Total leakages > total injections:

o Downturn in the level of economic activity (ie. Falling income, falling production, rising
unemployment)
o As level of economic activity falls, total leakages from economy will also fall (since
consumers have less income to save and spend)
o Leakages and injections will eventually be equal and in equilibrium, but at a lower level
of income in the flow
Total injections > total leakages:
o -Upturn in level of economic activity (ie. Rising income, rising production, decreasing
unemployment)
o -Level of total leakages will increase due to increasing level of economic activity (since
consumers have more to save, more to spend on imports, more collected as tax)
o -Leakages and injections will eventually be equal and in equilibrium, but at a higher
level of income in the flow

Note:

Government has significant influence on circular flow

Government can change levels of taxation and government revenue -> can manipulate
size of total leakages and injections & overall level of economic activity.

Case Study: Australia vs. China

Australia
Economic Growth
and Quality of Life:

Middle sized economy with a

relatively small population
4th largest economy in the Asian

China

Experienced fast
growth with average
economic growth of 7.5%

economic region
Has not experienced rapid
economic growth in recent decades
Has highest living standards in the
Asian region
Living standards are on average
eight/nines times higher than the
average citizen in other Asian
economies.
Temperate climate and relaxed
lifestyle
High degree of cultural diversity

over the past three

decades
Ranked 91
according to the Human
Development Index
(narrow measure of
quality of life that takes
into account income

Employment and
Unemployment:

2014: unemployment rate of 6.1%

Above most economies in Asia
Similar to most advanced
economies

general upward
trends in unemployment

Distribution of
income:

Social welfare system providing a

greater level of assistance than in most
Asian countries
Relatively equal distribution of
income due to Australia being a mixed
economy
Has government intervention to
ensure not a small amount of people get
richer only

relatively unequal
societies because of large
divisions between poorer
rural areas and wealthier
urban areas

Mostly think that we have less

water and air pollution, more national
parks and more efficient industrial
process
Poor record of preserving
biodiversity
Does not make good use of its
water resources as measured by water
productivity
Most significant issue facing
Australia is climate change (due to
emission of greenhouse gases)
Increased greenhouse gases
could lead to average global
temperature rising between 1.0 and 5.4
degrees
Consequences include rising sea
levels, more severe and unpredictable
weather events, and increased threat to
global economic growth, food security
and human health

emissions of carbon
dioxide will have a major
impact on the worlds
climate

planned economies
eg China have reduced
government control over
economic decision-making
and market forces supply
and demand have played
a greater role
public health

Environmental
Sustainability:

The Role of
Government in
Health Care,
Education and
Social Welfare:

Governed primarily by market

forces

eg agriculture, mining,
construction and manufacturing
Role of government in
telecommunications, aviation, banking
and insurance

2014: Australia as the third freeest economy

well established system of
universal healthcare (Medicare)
public spending on health care is
just over 6 percent of GDP
universal free education
trend in Australia is towards
restricting social welfare by tightening
eligibility
Government funding is above
average compared with Asian nations

systems are relatively

undeveloped
some rely on private
health care
public spending on
healthcare is 3 percent of
GDP