ECON 211

Important Reminder
“Economics is not primarily a collection of facts to be memorised, though there are
plenty of important concepts to be learned. Instead, it is better thought of as a collection
of questions to be answered or puzzles to be worked out. Most important, economics
provides the tools to work out those puzzles.” - Principles of Economics, OpenStax

Definition(s) of Economics:

Economics is a study / social science that examines how people…

● allocate scarce (limited) resources.
● make decisions in the face of scarcity.
● choose among the available alternatives.
● Etc.

The list can be easily extended. However, keep in mind and do not forget that choice or
scarcity - rather than money or even markets - is a fundamental feature of economics!

Scarcity, Choice, Opportunity Cost, etc.

● Scarcity: conflict between human nature and reality.

Scarcity exists because people have unlimited wants in a world of limited resources.

● What is the difference between scarcity and poverty?

Generally, being rich does not eliminate the problem of scarcity but only changes its
form. Example: a consumer allocates his low income between rice, potatoes and beer;
when the income goes up, the allocation is between white truffles, caviar, champagne,
etc.

Lucius Annaeus Seneca (c. 4 BC - AD 65) described poverty in a very particular way: “It
is not the man who has little that is poor, but the one who wants to have more.” As you
can see, talking about poverty, he actually describes scarcity.

● Scarcity is sometimes said to be the mother of economics. Why?!

If the resources were unlimited, there would be no reason to make choices… and to
study economics.
 ● What is the relationship between scarcity, choice, trade-off, (budget) constraint
and opportunity cost?

It may seem strange that many economics textbooks use the word “scarcity” to define
economics, explain its importance, etc. in the introductory chapter and then almost
never use it in the rest of the text. In fact, scarcity is always present in economic
analysis but takes different and more specific forms (and names) depending on the
context.

Scarcity and Prices

● As you know, the best things in life are free.

● If the above saying is true, then economics is not about the best things in life.
Can you explain why?

Something which is scarce cannot be free. (Otherwise, it could be obtained without any
sacrifice. Note that the price to pay does not have to be in terms of money; it may be
related to effort, time, etc.). Therefore, the “best things in life” are not scarce and do not
belong to what economists usually study.

● Alternative point of view: Whoever says money can't buy happiness does not
know where to shop.

Note that both attitudes are good examples of normative, rather than positive,
statements. (See below the difference between positive and normative statements.)

If scarcity implies a conflict, how can this conflict be (at least partially) solved or
alleviated?

● Either: try to reduce the wants and wishes, or/and replace them with “the best
things in life”
=> Psychology, Sociology, Philosophy, Religion, etc.

● Or: try to increase the amount of goods and services available for consumption
=> Economics

● How can the economy produce a greater quantity of goods and services?
This logical question brings us to another key concept in economics, that of efficiency.
Efficiency
Economists distinguish among
● productive efficiency: producing goods at the lowest cost, i.e. without waste.
● allocative efficiency: producing goods (or, to make it more explicit, allocate the
resources to the production of goods) that the consumers appreciate.

An example of an economy which is productively efficient but allocatively inefficient is

low-cost production of shoes which are all for the left foot. Another example (mentioned
in class) is building a large hotel in the middle of a desert with no customers…

● distributive efficiency: goods and services are obtained by those people who
attribute the highest value to them.

The three types of efficiency correspond to what is sometimes called the three
fundamental questions of economics: What to produce? (allocative); How to produce?
(productive); and For whom to produce? (distributive).

Specialisation, or division of labor

Example: production of pins (Adam Smith, 1723 - 1790)

A team of 10 workers performing 18 different tasks to produce pins.

What is the best (most efficient) way to organise the production process given the fact
that all workers are able to do each task?

The number of pins produced per day goes up from 200 (if each worker performs all the
tasks individually) to 48 000 (if the tasks are allocated among the workers)!
Benefits of specialisation explained:

● Comparative advantages (exogenous - exist even before the work): the

allocation of tasks should take into account that people have different skills (due
to different educational backgrounds, professional experiences, interests, etc.)
and may be better at some tasks/jobs than at others.
● Learning by doing (endogenous - appears in the process of working): focusing
on certain tasks (rather than doing every task) often allows to produce more
quickly and with higher quality.
● Economies of scale (will be considered later in more detail): Average cost goes
down when the amount of production goes up. In this particular example, lower
cost corresponds to more efficient use of time, which is saved when the worker
does not have to go from one task to another, change instruments, etc.

Cost of Specialisation and Benefit of Cooperation

● Specialisation increases productive efficiency; however, it may potentially create

other problems. For example, it makes workers interdependent and the
production process vulnerable to situations in which a missing worker cannot be
replaced if she/he is the only one who can do the task.
● An economy relying on specialisation has to organise cooperation between
workers/firms, and exchange of goods and services. It can be done in different
ways. (See below the distinction between command and market economic
systems.)
● Markets and money:

A market is an institution or a mechanism that brings together buyers and sellers. Even
though direct exchange of goods and services between buyers and sellers (barter) is
possible, it is often highly inefficient (e.g. time consuming, etc.) Money serves as a
medium of exchange and facilitates market transactions.

Let us briefly summarise:

● Efficiency alleviates the problem of scarcity

● Specialisation increases (productive) efficiency
● Exchange of goods and services makes specialisation possible
● Market is a convenient way to organise exchange
● Money makes markets more efficient
Economic systems: how economies can be organised

● Traditional economy: production and exchange based on (family) tradition, with

no or little economic progress, development, government intervention, etc.
(extremely rare nowadays, exists only in some isolated societies)
● Command (or planned) economy: (1) decisions are centralised; (2) means of
production are owned by the state. Basically, it is the government that gives the
answers to the three fundamental questions: what to produce, how and for
whom. Moreover, the government may also fix the prices, salaries, educational
choices, etc.
● (Free) Market economy: based on private enterprise and voluntary transactions,
relies on interaction of demand and supply (which we are going to see in more
detail next week) to allocate limited resources.
● Market economy is not only associated with freedom of individual choice. It often
leads to efficient allocation of resources. Moreover, it is based on competition
and, therefore, encourages innovation and technological progress, which also
increases (productive) efficiency.
● However, markets may also be inefficient (or even nonexistent); for example,
creating environmental damage or failing to coordinate joint efforts of individual
economic agents. (Later, we will study the problems of incomplete information,
externalities and public goods, which are all classic cases of “market
failures”.)
● Even when the markets are efficient, they may be “immoral”, not respect social
justice, equity, be perfectly compatible with huge income disparities, etc.
● Note that government intervention in the functioning of the market economy may
be justified on the grounds of both efficiency and equity!
● The distinction between command and market economies is more a matter of
degree than a matter of kind. Government and markets coexist with varying
degrees of importance in any country. Therefore, in the real world, all the
economies are mixed, i.e. combine elements of both systems.
Circular Flow Diagram/Model/Matrix
illustrates the primary interactions between the main groups of economic agents

● What are the main types of economic agents?

Households, firms, banks (also firms but playing a special role in market exchanges,
etc.) , the government, the rest of the world (foreign households, firms, banks,
governments involved in export/import transactions).
Note also that both households and firms can be buyers and sellers depending on
which market they operate.

● What are the main types of markets?

Product markets, Resources markets

● What are the main types of economic resources/factors of production?

Labour, Capital (physical, not financial !!), Natural resources (also called Land),
Entrepreneurship (combining labour, capital and natural resources)

● What are the main types of government intervention in the economy?

Taxes, subsidies, price controls (price floors, price ceilings), etc.

● By the way, what is the difference between goods and services?

Goods are tangible; are produced before they are consumed; can be stored in
inventory, etc.

Normative and Positive Statements:

how the economy works vs. how it should work
● Positive: descriptive (objective) statement, testable hypothesis, which can be
verified with data and either confirmed or disproven

Example: If the price of cigarettes goes up, the consumers will buy less cigarettes.

Note that a positive statement does not have to be true; what is important is that it can
be verified.

● Normative: prescriptive (advisory) statement based on subjective judgement or

opinion (and which cannot be shown to be true of false).
Example: The government should increase the price of cigarettes in order to reduce
smoking.
 ● Note that the distinction between positive and normative analysis is not specific
to economics, is also relevant in other sciences.
● Example: Water freezes at zero degree Celsius. (If you replace “zero” by any
other number, the statement will become false but it will stay positive.)
● Question: Which type of statements should the economists/politicians use?

Using both is possible. (Normative) opinions may be even more convincing if supported
by (positive) facts.

Example: The government should promote and subsidise free access to sport facilities
for students (normative) because it is good for health and increases the efficiency of
education (positive).

What is not acceptable is presenting your opinions as if they were facts.

Microeconomics and Macroeconomics

two branches of economics, which are closely related

● Microeconomics: studies the actions of individual economic agents

(households, firms).
● Macroeconomics: studies the economy as a whole. Examples of topics in
macroeconomics include economic growth, inflation, unemployment, fiscal and
monetary policies, etc, which we will analyse in the second half of our module.

As the textbook says: “Microeconomics and macroeconomics are not separate subjects,
but rather complementary perspectives on the overall subject of the economy.” Both use
similar concepts and principles: markets, prices, supply, demand, equilibrium, etc. Both
are interrelated: we can talk about micro foundations of macroeconomics, etc.