ECO1007S - Week 1
What is economics about?
Cecil Mlatsheni (cecil.mlatsheni@uct.ac.za)
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Overview of week 1 content:
What is Economics?
The Economic Problem, Scarcity, PPF model
How the economy works
- Economic Systems
- Elements of the market economy
- Circular flow of income in the economy
Material:
Textbook Chapters 1, 2, 3
Mohr and Associates, ‘Economics for South African Students’, (2015 onwards) Van Schaik Publishers
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What is Economics?
“Economics is a study of mankind in the ordinary business of life”
Alfred Marshall (c1890)
“Economics is the study of how society manages its resources”
Gregory Mankiw (1958-)
“[T]he science which studies human behaviour as a relationship
between ends and scarce means which have alternative uses.”
Lionel Robbins (1898-1984)
“The branch of knowledge concerned with the production,
consumption, and transfer of wealth” Google definition
“Economics is the study of how societies use scarce resources to
produce valuable commodities and distribute them among
different people.” Paul Samuelson (1915-2009)
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So what is Economics then?
SOCIAL SCIENCE
• economics tries to systematically explain patterns of behaviours
• use of models which simplify behaviour to core elements
• Economics tries to explain the choices and actions of individuals and
societies.
• if you can explain the past and present, then you may be able to
predict the future.
• Unfortunately, dropping a rock off the top of a building is easier to
understand than the complexity of individual decisions
“Dismal Science” Thomas Carlyle 19th century
• Despite the origins of this term* it has stuck around probably
because economics presents the world in terms of trade-offs as
opposed to problems and solutions
* For an interesting history of the term see: http://www.econlib.org/library/Columns/LevyPeartdismal.html
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Economics is about choices under scarcity
Unlimited wants limited resources
> >
The Economic Problem:
• We cannot satisfy all of our wants ➔ This is called scarcity.
• We must choose between alternatives.
• Choices are directed by:
• preferences
• incentives
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Individual Scarcity: National Scarcity:
one is forced to choose a limited Society as a whole is forced to
number of items from the shop choose how to spend a limited
because one can generally not national budget
afford everything
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Trade offs: “Opportunity Cost”
“there ain’t no such thing as a free lunch”
• Choices involve trade-offs
• Monetary, time, leisure.
• Present vs future
• The ‘opportunity Cost’ is the highest valued alternative that we
give up to pursue a certain action
What is the opportunity cost of
• Spending R20 buying pizza for lunch?
• Attending University?
• Attending this lecture?
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Production Possibility Frontier Model (PPF)
To understand how things work, economists build models that generalize
economic theory
Since the real world is a complicated place, these models are simplified and rely
on assumptions
Aim of PPF to model :
• Scarcity
• Choice
An economic good is a good or service
that has a benefit (utility) to society. Also,
economic goods have a degree of
scarcity and therefore an opportunity cost
Simplifying assumptions:
• we focus on two goods at a time
• hold the quantities of all other goods and services constant. “ceteris paribus”
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The Production Possibility Frontier Points on the PPF are points
of productive efficiency -
maximum production of the 2
Productive Efficiency goods A and B
Models scarcity: cannot
produce beyond PPF given
current resources
Good A
Attainable
Unattainable
Scarcity Zone
PPF
Good B
Tradeoffs: We cannot produce more of one good without
producing less of another
X→ Y: must give up some of good B to get more of good A
Y→ X: must give up some of good A to get more of good B
Y
Z:point of productive
inefficiency: resources
Good A
are either
Z X
unemployed or
misallocated.
PPF
Good B
PPF: Increasing Opportunity costs:
Usually the PPF is drawn with a concave shape
→ shows increasing opportunity costs as more
of good B is produced
E F consider the difference in
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Employing resources
Good A
that are efficient in opportunity costs of moving from
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prodcing good B to good
B from good A E→ F versus from G→ H
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6
G
5
Employing more resources
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to good B that are efficient
in producing good A H
3
2
1
1 2 3 4 5 6 7 8 9 Good B
PPF: increasing Opportunity costs:
Usually the PPF is drawn with a concave shape
→ shows increasing opportunity costs as more
of good B is produced
E F consider the difference in
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Good A: Academic hours per day
opportunity costs of moving from
8
E→ F versus from G→ H
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Example: if all UCT
employees were involved
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in either academics or as
G
5
administrators
4
H Resources (e.g. Staff) are
3
not equally productive in all
activities.
2
1
1 2 3 4 5 6 7 8 9 Good B: Administrator
hours per day
Economic growth
A new technology or
an increase in
resources that
enables a greater
production of all
Good A
PPF1 PPF2
economic growth resources
e.g.:
Increase in labour supply or
skill or land.
Introduction of electricity
Good B
B A technology that enables a greater
production of one good only
Current PPF
improvement in good A
Future PPF
A
Example: Imagine a small town with 2 industries : fishing and forestry. The town has
to allocate it’s work force as well as its machinery between these 2 activities
Timber (ton) per day Fish (ton) per day
A 0 75
B 1 70
C 2 60
D 3 45
E 4 25
F 5 0
1. If economy is originally at C and wants 1 more ton of timber what is the opp cost?
2. Can this economy produce 5 tons of timber and 75 tons of fish per day?
3. Can the economy produce 3 tons of timber and 25 tons of fish per day?
1. 15 tons of fish per day
2. No (beyond PPF - Unattainable)
3. Yes (production inefficiency point)
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Example: Imagine a small town with 2 industries : fishing and forestry. The town has
to allocate it’s work force as well as its machinery between these 2 activities
Timber (ton) per day Fish (ton) per day
A 0 75
B 1 70
C 2 60
D 3 45
E 4 25
F 5 0
1. If economy is originally at C and wants 1 more ton of timber what is the opp cost?
Moving to position D on the PPF, this means giving up 15 tons of fish. This is the
opportunity cost of 1 more ton of timber.
2. can this economy produce 5 tons of timber and 75 tons of fish per day?
No. Beyond PPF. Not available given current resources.
3. Can the economy produce 3 tons of timber and 25 tons of fish per day?
Yes but it is a point of inefficiency (i.e. Not on the PPF) 16
Production Possibility Frontier
- summary
• Points on PPF:
– Productive efficiency - maximum production of
any combination of products
– we cannot produce more of one good without
producing less of another
• Models choice (opportunity choice): what we
give up to get an extra unit of a good
– Slope of PPF
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Economic Systems
Each economic system tries to answer these questions:
1. What goods and services will be produced?
2. How will they be produced, using what resources?
3. For whom to produce?
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The scope of economics
Limited
Unlimited
Resources
wants
SCARCITY
CHOICES
WHAT to HOW to FOR WHOM
produce produce to produce
WHAT to produce?
What do we
produce & in
what quantities?
Consumption HOW to produce?
goods & services
vs capital goods Which productive
& services. resources (factors
of production) do
we use, and in
what proportions?
FOR WHOM
to produce?
How are the
incomes from
production
distributed?
WHAT to produce?: What does SA produce & in what quantities?
Table A. Gross value added by kind of economic activity
2018 (%)
resources derived from the land
10%
21%
69%
100%
• The shares of each sector have remained relatively constant over recent times.
• 2011 primary sector = 12% vs 10% in 2018
• 2011 manufacturing = 20% vs 21% in 2018
• 2011 tertiary sector = 68% vs 69% in 2018
PART 1: THE WHAT
The decision of what to produce is really about how
to allocate the scarce resources among different
possible uses. on the PPF
RESOURCE ALLOCATION
→Where on the PPF to produce:
E.g. more timber or more fish?
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PART 2: THE HOW: Factors of Production (FoP)
• Time and effort
Labour • human capital measures the quality of labour
• Owners of labour earn wages
• Includes natural resources (minerals, etc)
Land • Owners of land earn rent
• Tools, machines and buildings
Capital • NOTE: we are NOT talking about financial capital
(money, stocks)
• Owners of capital earn rent or interest
• The skill of organizing FoP
Entrepreneurship • Innovators
• Carry risks of business decisions
• Entrepreneurs earn profit
PART 3: Who makes the decisions
Traditional Economies
• Economic Questions answered by custom – very little inter-generational
mobility (you follow in your parent’s footsteps).
• Predominately Agriculture/subsistence economies
• Trade and barter oriented exchanging goods/services for other
goods/services without using money
• Technology stays fairly constant which results in low growth and
development. In fact, this system does not adjust well to anything new – a
new product, career, technology, etc.
• Economic activities usually secondary to religious and cultural beliefs.
• We still observe some of these characteristics in modern economies (e.g.
the Inuit community, the Amish community, and Family Business).
• It makes relationships and behavioral patterns predictable, because they
always follow custom.
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PART 3: Who makes the decisions
Spectrum of Economic Systems
Market Mixed Command
“capitalist” “Socialist”
“free-market” “Centrally
Decision making: planned systems”
Government involvement in
LESS More
economic coordination
(what, how, for who, by whom)
Individual Ownership State
Private property Property Rights “society at large”
rights 25
The Mixed EconomyEconomies
Command
• All economies (incl. SA) are a mixture of traditional,
command and market systems. Each country has a different
structure of public (government) and private sector
(individual) involvement
• Economic coordination is guided mainly by market forces
i.e. interactions between individuals with Government
involvement:
– Legal framework: Setting rules and regulations e.g. protection of
property rights
– Redistribution of wealth e.g. tax system, welfare provision
– Involvement when the market isn’t working well.
• Prevent the overuse of natural resources
• Provide public goods (parks, police service)
– Economic Stability
• Low inflation rate, stable exchange rate
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Understanding elements
of the market
- Markets, price
- Circular flow of income
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Markets
• Any contact or communication
between potential buyers and
sellers of a good or service.
• Markets can be physical places but
can also be
• personal, local (JSE) or global (London
Gold Market), digital (gum tree)
• Markets coordinate individual
decisions through price adjustments.
• Both from the consumer and the
producer
• flexible
Prices in the Market Scarcity → opportunity cost, what
one has to give up to get that item.
• Prices are signals of scarcity
• Individuals decide for themselves whether to sell or
buy
• voluntarily, with reference to the prices available in
the market.
• Prices respond more or less to the forces of demand
and supply.
Circular flow of production, income
and spending in the economy
• Production creates Income and this income is
spent to buy the products.
• Everything happens at the same time: the circular
flow of production, income and spending in the
economy.
• Factor market: households supply factors of
production and get remunerated by firms
• Goods markets: households pay firms for goods
and services
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A very simple economy….
Domestic Blue arrows
Households households show flow of
provide payments
Factors of → Factor Market
production → Goods Market
Payments for
goods and
services
Factor Market
Goods Market
Income paid to fFOP
Firms / Domestic Firms provide goods
producers and services 31
With the Government (public sector)…..
households
Government
Taxes
spending
Payments for goods
Income paid to and services
factors of production
G Government
spending
Taxes Government
Domestic producers 32
With the financial sector…
Savings
Domestic households
Income paid to Payments for
factors of goods and
production services
The financial sector
Investments
Domestic producers
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With the foreign sector…
Imports
Domestic households
Income paid to Payments for
factors of goods and
production services
The foreign sector
Exports
Domestic producers
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The circular flow - only showing payments
Domestic Imports (outflow of money)
households
Gvt spending Taxes Savings
Payments for
Income paid
households for
factors of
production
G goods and
services
The financial
The foreign
sector
sector
Investments
Exports (inflow of money)
Domestic producers
Economics as a social science
In carrying our economic analysis, economists distinguish
between two types of statements.
Positive statements are about “what Normative statements are about
is”. They say what is currently “what ought to be”. These statements
believed about the way the world depend upon values and cannot be
operates. For example: tested. For example,
(i) “Our planet is warming because of (i) “We ought to cut back on our use of
the amount of coal that we are coal”;
burning”; (ii) “The minimum wage should not be
(ii) “A rise in the minimum wage will increased”.
bring more teenage unemployment.” These statements express an opinion,
These statements may be right or but they don’t assert a fact that can be
wrong, and they can be tested. checked. They are not economics.
Microeconomics & Macroeconomics
• We all face scarcity and
economics is about how
individuals, businesses,
and governments make
the best possible choices
to get what they want, and
about how those choices
interact in markets.
• Economics as a subject is
divided into two broad
parts: microeconomics
and macroeconomics.
Microeconomics
• Microeconomics is the study of the choices that individuals
and businesses make and the way these choices interact
and are influenced by governments.
• It is concerned with individual entities, not just individuals.
• Some examples of microeconomic questions are:
• Will you buy an Apple TV or just subscribe to Netflix?
• Will Coca Cola sell more cans of Coke if it cuts the price?
• Will a cut in the income tax rates encourage people to work
longer hours?
• Will an increase in the cigarette tax encourage people to
quit smoking?
Macroeconomics
Macroeconomics is the study of the aggregate (or
total) effects on the national economy and the
global economy of choices that individuals,
businesses and governments make.
• Some examples of macroeconomic
questions are:
• Why has South Africa been on a
downwards GDP growth trend?
• Why are incomes growing so much
faster in China and India than in South
Africa?
• Why is unemployment in South Africa so
high?
Micro & macro: the tree & the forest
• The key difference between
micro and macro views is
reflected in the fact that
microeconomics studies
individual choices &
macroeconomics considers
the aggregate (combined)
market outcomes of all
choices.
• Micro looks at the individual
trees.
• Macro looks at the forest.
