1.1. What is economics?

© Suzanne Drouet

The problem of choice & resource allocation

q Economics q Factors of production q Opportunity cost
Land Labour = Costs of an economic decision measured in
OIKO + NOMOS = natural capital = human capital
home rule, law terms of the best alternative choice forgone
= nat. resources used in = human res. required in
= the management of a household the prod. process the prod. process
= there is no free lunch
Ex. water, oil, coal Ex. physical & intel.
⟶ a social science rent wages / salaries
↳ the study of people in society and how they q Free goods
interact w/ each other Enterprise Capital
↳ the study of how resources are allocated to = skills, creativity & = physical capital = Products w/ a natural abundance of supply
risk-taking abiliy to manage = manufactured prod. ⟶ unlimited supply & no demand
satisfy the unlimited needs & wants of individual, the other FOP ex. machinery, tools, infra.
gov. and firms in an economy ⟶ opportunity cost = 0
profit interest

q Micro. vs macroeconomics q Scarcity The basic economic questions

→ Both focus on the allocation of scarce resources
in an efficient way = Refers to the finite resources of an economy What / How much
relative to the unlimited needs and wants of How to produce?
MICRO: concerned w/ the behaviour of individuals individuals For whom
and firms in distinct mkts.
⟹ needs: essential G/S → Gov. intervention
⟹ wants: human desires, not necessary
MACRO: operation of the economy as a whole Economic system
⟹ goods ⟺ services
↳ often more controversial than mico
= tangible = intangible FREE MARKET MIXED PLANNED
Ex. causes of business fluctuations, LR eco. growth,
= produced = provided = Minimal Combination of (socialist /
unemployment, inflation, income / wealth dist. intervention both systems communist)
products OR economic goods = Market = Gov. allocates
mechanism scarce
intervention in case
Ø Link to sustainability: renewable resources resources
of mkt failure
(can regenerate / replenish)
Ø Scarcity is relative
 1.1. What is economics? © Suzanne Drouet
q The productive possibility curve (PPC) q Features
⟶ Slopes downward from left to right
E = the diagrammatic representation of the = more from Good A ⟶ less from Good B
A maximum combination of 2 products that an ⟶ Concave to the origin
C economy can produce = there is an increasing cost of oppty
= the productive capacity of the economy

D To be on the curve, two conditions: q Assumptions

⟶ Full employment: all FOP are utilised ≫ Fixed production possibilites
B ⟶ Efficiency: all resources are put to their best ≫ Scarcity of resources
use, no wastage

Why it is concave? q What the PPC illustrates

Constant cost of
Increasing cost of oppty ⟶ Opportunity cost
A opportunity
= gradient of the tangent ⟶ Scarcity
= perfect indifference
B = marginal rate of ⟶ Choice
transformation ⟶ Level of employment of resources
⟶ Efficiency
C ⟶ Actual growth vs. growth in prod. possibilities
outward / moving towards the PPC
inward shift

q The economic methodology q Positive economics q Normative economics

= objective econ. analysis = Opinions, beliefs and statements of “what
= processes, practices & principles of economics = the study of economics that is provable should be”
= includes the models, theories & assumptions ∟ factual statements (“what is”) = Express a value judgement about what is
underlying the discipline ∟ relies on reasoning, logic, empirical evidence desirable for the economy.
= concerned with ∟ uses hypotheses (educated guesses) Value judgement: beliefs about what is right or
how economy functions ∟ relies on models (repeatedly tested) wrong, influenced by morals/ethics/cult. values.
how it could function ∟ formulates theories (generalisations to
⟹ Each society has to choose between
how it should function explain situations)
equity & equality
∟ uses the ceteris paribus assumption (all fairness in the dist. regards everyone
other things being equal) of resources as being equal
q Classical economics q Communism ⟹ News systems needed
= Competition, free int’l trade “The history of all hitherto societies is the
= The mkt self-regulates to allocate resources history of class struggles.” q Behavioural economics
efficiently. = Conflict between workers / property owners Critique of classical economics: the rational
leading to workers overthrowing bosses consumer does not exist.
Adam Smith, The Wealth of Nations (1776) & creating a classless & egalitarian system
millions of choices ⟺ neither intelligent
⟶ laissez-faire approach
& decisions nor logical
⟶ no gov. intervention
Karl Marx, Das Kapital (1867)
⟶ the invisible hand
= against private K, alienates exploited workers
Richard Thaler (Nobel 2017), Nudge (2008)
= metaphor describing how people acting in their ⟶ understand how actual cons. make decisions
= unequal dist. of power: owners accumulate K,
self-int. end up serving the common good ⟶ to help cons. make better choices & help gov.
profits only for capitalists
= equilibrium is naturally reached design policies that encourage better choices
= capitalism ignores the needs of the masses
⟶ Nudge: influence cons.
≫ David Riccardo: theory of comparative advantage Communism to make choices voluntarily
≫ J.B. Say: supply creates its own demand = coll. ownership of means of prod. that are better for them
≫ Alfred Marshall: utility theory = collective planning
BUT: did not achieve econ. efficiency BUT: individual rights? How does the gov. know?

q Keynesianism q Neoliberalism q Circular economy

John Maynard Keynes, Friedrich Hayek, The Road to Serfdom (1944) Critique of the linear econ.: Take, make, waste
A general theory of money, ⟶ gov. control of the economy = totalitarianism = overexploitation & degradation of natural res.
interest & employment (1936) ⟶ gov. never produced the results expected
⟶ demand-side theory: demand (not supply) ⟶ cause of mkt inefficiencies: money supply Circular economy
determines the overall level of nat. income ⟶ prosperity is driven by creativity, ⟶ long-lasting production
⟶ prices & wages take time to adjust entrepreneurship & innovation ⟶ materials come from reusing
⟶ advocated for denationalising or recycling old products
⟹ in time of recessions: gov. should correct mkt money (cryptomoney) ⟶ maintenance > manufacture
inefficiencies by using fiscal & monetary policies to ⟶ ownership stays w/ producer
spur growth & unemployment Monetarism (Milton Friedman, Chicago School)
= gov. as stabiliser of the economy, manages the
Kate Raworth, The doughnut economy (2017)
= money supply is the main determinant of national ⟶ Issue: narrow view of econ. growth
level of total demand input = inequalities, destruction of the living
⟶ For the privatization of many functions that had ⟶ Goal: meet the human rights of every person
Critique of classical economics: free market leads been assumed by the gov. = deregulation within the means of the planet
to underproduction / consumption of certain G/S

© Suzanne Drouet 1.2. How do economists approach the world?

2.1. Demand HL Income
Higher real income (RI) = ability
Number of Substitutes
= Products that are in
consumers
© Suzanne Drouet to buy more products
NORMAL GOODS: Products with
More consumers = more
competitive demand because
they can be used in place of each
demand
higher demand when RI increa- other
DEMAND: Quantity of a good / service that = higher prices
ses (necessities + luxuries)
customers are both willing and able to buy at a Ex. Housing market
INFERIOR GOODS: Demand for
given price, per period of time. these fall when RI increases + weather
(negative income elasticity) + demographics

LAW OF DEMAND: The quantity demand for a good

/ service falls as its price rises, ceteris paribus. Non-price determinants of demand
MARKET: A place where transactions take place Expectations of Complements Tastes &
between buyers & sellers. = Products that are jointly
future prices demanded
preferences
When inflation: better to buy --> Linked to fashion
now --> Information / health
UTILITY: Level of consumer satisfaction from the
--> Brands loyalty
consumption of a product.

Assumptions underlying the law of Movements along the demand Shift of the demand curve
demand: curve = caused by a change in any non-px factor
INCOME EFFECT: as the price of a product falls, the = caused by px changes only that affects demand
real income of consumers increases. Price Price
Lower price = More products ($) ($)

SUBSTITUTION EFFECT: as the price of a product Contraction

falls, more customers are able to buy it. P2 (Decrease in Q D) Decrease in D
Agents substitute high price products with lower Expansion
(shift to the left)
P1 P1
price products. (Increase in Q D) Increase in D

(shift to the right)

P3
LAW OF DIMINISHING MARGINAL UTILITY (DMU):
as agents consume more of a good, the marginal Quantity Quantity
utility declines. Q2 Q1 Q3 (units) Q2 Q1 Q3 (units)