Chapter 1 | The Who & The Why

↪ The Economic Perspective

-​ A viewpoint that envisions individuals + institutions making RATIONAL decisions by comparing the
marginal benefits & marginal costs associated with their actions

a. Scarcity + Choice

-​ There are scarce ECONOMIC RESOURCES meaning there are limited goods + services + time

> economic resources - the land, labour, capital and entrepreneurial ability that are used in the
production of good and services, productive agents and factors of productions

> scarcity LIMITS the options / choice we demand - brings in opportunity cost ( sacrifices )

b. Opportunity Cost

-​ The amount of other products that must be FORGONE to produce / consume the next best unit of a
product

E.g. a holiday or a car?

> a cost is always bared

c. Rational Behaviour

-​ Economists assume that human behaviour REFLECTS rational self-interest or utility

> utility - the want satisfying power of a good or service, the SATISFACTION a consumer obtains
from the consumption of the good or service

-​ Customers allocate time, energy and money to MAXIMISE satisfaction

> Weigh costs and benefits

1.​ Consumers are rational in deciding what goods and services to buy
2.​ Business firms are rational in determining what products to produce + how to create them
3.​ Government entities are rational in determining what public services to produce and how to
finance them

d. Rational Consumers

-​ Someone who maximises utility subject to a BUDGET CONSTRAINT

> a consumers resources at their disposal are LIMITED

> budget limitations CAN be exceeded, however, borrowed money must sooner or later be PAID
BACK

> these are credit limitations

e. Rational Producers
 -​ A producer who seeks to maximise the profit of the firm they happen to run

1.​ Some may FIRST decide on the quantity of the goods or services produced, and then try to
do it COST-EFFECTIVELY
2.​ Others determine the sum of money they CANNOT exceed during production, and then try
to produce as much as possible within the budget

> the producer must choose the production technique + inputs that will bring the
HIGHEST POSSIBLE PROFIT

f. Marginal Analysis ( main focus )

-​ The comparison of ADDITIONAL marginal benefits + costs

> usually for decision making

> ask yourself ‘is it worth doing?’ - ‘what is the opportunity cost?’

↪ Theories, Principles and Models

> helps simply the economic scope

a. Economics relies on a scientific method

> scientific method - the procedure for the systematic pursuit of knowledge involving the
OBSERVATION of fact, and the FORMULATION + TESTING of hypotheses to obtain theories,
principles and laws

b. Economists develop theories

-​ Theories are developed of the BEHAVIOUR of individuals ( consumers + workers ) and

institutions ( businesses + governments ) engaged in the PRODUCTION, EXCHANGE and
CONSUMPTION of goods & services

> explain + predict economic facts of HOW individuals & institutions behave in PRODUCING,
EXCHANGING + CONSUMING goods and services

c. Economic principles

-​ a widely accepted generalisation about the economic BEHAVIOUR of individuals or institutions

> highly useful in ANALYSING economic behaviour + UNDERSTANDING how the economy
operates

> TOOLS for ascertaining cause / action or effect / outcome

1.​ Generalisation - the typical tendencies of the average CONSUMERS, WORKERS or

BUSINESS FIRMS

E.g. consumers buy more of a product that's price has fallen

2.​ Other things equal assumption - the assumption that factors other than those being
considered are held constant / equal ( ceteris paribus )
 3.​ Graphical expression

E.g. graphs, tables etc

↪ Macroeconomics & Microeconomics

a. Macroeconomics

-​ The part of economics concerned with the economy as a WHOLE / aggregate as households,
business and government sectors

> aggregate - a collection of specific economic units treated as one

E.g. price level, GDP, total output, total employment, aggregate expenditure

> deals with INFLATION & UNEMPLOYMENT

b. Microeconomics

-​ The part of economics concerned with decision making by INDIVIDUAL units as a household,
firms and industry

> involves individual markets, specific goods + services etc

> deals with individual CONSUMER SPENDING, DEMAND + CHOICES

↪ Positive + Normative Economics

a. The analysis of FACTS or DATA to establish scientific generalisations about economic behaviour

-​ Focuses on FACTS and CAUSE-and-EFFECT relationships

> includes description, theory development and theory testing ( theoretical economics )

-​ Avoids value judgements, while establishing scientific statements about economic behaviour -
critical to good policy analysis

> concerns ‘WHAT IS’

b. The part of economics involving value judgements about what the economy SHOULD be like - focusing
on economic goals + policies

-​ Focuses on RECOMMENDING ideas

> concerns ‘WHAT OUGHT TO BE’

SUMMARY

1. Economics is the social science that examines how individuals, institutions and society make optimal
choices under conditions of scarcity.
2. The economic perspective includes three elements: scarcity and choice, purposeful behaviour and
marginal analysis. It sees individuals and institutions making rational decisions based on comparisons of
marginal costs and marginal benefits.

3. Economists employ the scientific method, in which they form and test hypotheses of cause-and-effect
relationships to generate theories, laws and principles. Economists often combine theories into
representations called models.

4. Macroeconomics looks at the economy as a whole or its major aggregates. Microeconomics examines
specific economic units or institutions.

5. Positive economic analysis deals with facts; normative economics reflects value judgements

Chapter 2 | Economic Systems

↪ Economic Systems

-​ A particular set of institutional arrangements and a coordinating mechanism for solving the
economising problem

> to respond to the problem of scarcity

> a method of organising an economy, of which the MARKET SYSTEM and the COMMAND
SYSTEM are the two general types

-​ Determines multiple factors

1.​ What goods are produced 2.​ How they are produced

3.​ Who gets them 4.​ How to accommodate change

5.​ How to promote technological progress

-​ Economic systems are described with reference to;

> its ROLE PLAYERS ( economic subjects + decision takers )

a.​ households b.​ Business enterprise

c.​ The government d.​ The foreign sector

> its objects ( products, goods + services )

> its processes ( production, consumption, investment + saving )

↪ A Closed Economy Circular Flow

-​ Resources flow FROM households TO businesses through the resource market

 -​ Products flow FROM firms TO households through the product market

-​ HOUSEHOLDS receive incomes FROM firms through the resource market

-​ BUSINESSES receive revenue FROM households through the product market

> GOVERNMENTS form part of the flow BETWEEN markets, and taxes and services FROM
households TO firms

↪ Laissez-Faire Capitalism ( ‘Let it Be’ )

-​ Also known as PURE capitalism

-​ Government is kept from interfering with economy ( avoids reduced HUMAN WELFARE -
government corrupted by special interests )

-​ Government's role is limited

a.​ To protecting PRIVATE PROPERTY
b.​ To establishing a legal environment ( in which contracts are enforced + people interact in
markets to BUY & SELL goods, services and resources )

> results should bring HIGHEST POSSIBLE level of human satisfaction

↪ The Command System

-​ The government OWNS most property resources

-​ Economic decision making is set by a central economic plan ( created + enforced by the
government )

E.g. Soviet Union, Cuba + North Korea

-​ Government’s role
a.​ Owns most business firms ( produce according to GOVERNMENT DIRECTIVES )
b.​ Central planning board determines production goals for each enterprise
 > specifies resource allocation to achieve production goals
c.​ Decided division of output between CAPITAL + CONSUMER GOODS
d.​ Allocated capital goods among industrie based on long-term priorities

1.​ The evolution of command economies

-​ It is unrealistic for an economy to rely exclusively on a central plan for allocation

> why the soviet union, a prominent command economy, tolerated some private ownership
before its collapse in 1992.
> why Reforms in Russia and Eastern European nations transformed command economies
to capitalistic, market-oriented systems.
> why China's reforms reduced reliance on central planning, increasingly relying on free
markets.

2.​ The demise of the command system

-​ The command system is prone to fail after encountering TWO insurmountable problems

a. The coordination problem

-​ Millions of INDIVIDUAlL DECISIONS by consumers, suppliers + businesses needed to be

coordinated

> annual production targets + necessary inputs + production transportations were decided

> outputs of ONE industry serve as inputs to ANOTHER industry

( failure of one caused a CHAIN OF REPERCUSSIONS )
> this became more prominent as ECONOMIES EXPANDED
( products + production processes became more sophisticated + intensive )

-​ Product VARIETY decreased as a solution to cope

-​ Also due to lack of reliable SUCCESS INDICATORS

> other economies ( market economies ) rely on PROFIT as a success indicator

–> in contrast; command economies rely on QUANTITATIVE PRODUCTION TARGETS as an
indicator

-​ Production costs + product quality were SECONDARY considerations

b. The incentive problem

-​ When central planners MISJUDGED how many products were demanded - PERSISTENT
SHORTAGES + SURPLUSES arose

( as long as production goals were met, nothing was changed ) → no incentive to adjust for
shortages / surpluses

> products were unavailable, IN SHORT SUPPLY

> products were OVERPRODUCED, and sat in warehouses

-​ Some economies also lacked ENTREPRENEURSHIP ( e.g. soviet union + china )

 > NO profit motive
> NO reward for innovation

> businesses were based solely on political shrewdness

↪ Five Fundamental Questions

-​ Reflect the REALITY of scarce resources in a world of unlimited wants

1. What goods + services will be produced?

-​ Goods + services produced at a CONTINUING PROFIT will be produced , those at a continuing

loss will not
> continuing economic profit = TR > TC

> industries will then expand production + movement of resources ( existing firms grow, new firms
enter )

> continuing economic loss = TR < TC

> industries will reduce production + exit resources ( existing firms shrink, others go out of
business )

-​ Market systems obtain consumer sovereignty

Consumer sovereignty > determination BY consumers of the types + quantities of goods &
services that will be produced with scarce resources ( consumers direct production with RAND
VOTES )

> have the ABILITY + WILLINGNESS to buy a product

> if rand votes create a profit, business WILL produce

> if rand votes do NOT create revenues, business WILL NOT produce

-​ Same reasoning goes with RESOURCE SUPPLIERS

2. How will the goods + services be produced?

-​ What combination of RESOURCES + TECHNOLOGY will be used for production?

-​ How is production ORGANISED

> want to minimise the COST PER UNIT of output ( because of competition )

-​ Efficient production techniques depends on;

a.​ The available technology that is the various combinations of resources that will produce
desired results
b.​ The prices of the needed resources

-​ Can be supported by calculations

( price ✖️ required quantity of resources = total production cost )

3. Who will get the goods + services?

-​ There are two ways when determining the DISTRIBUTION of total output

a.​ Based on their ability + willingness to pay for products at their EXISTING market price

> their ability depends on the AMOUNT of INCOME, PRICE and PREFERENCES

> RESOURCE PRICES ( wages, interest, rent, profit ) are crucial in determining the size of a
person's income

4. How will the system accommodate change?

-​ Market systems are dynamic ( preferences, technology and supply ALL CHANGE )

> particular RESOURCE ALLOCATION is therefore needed

( changes in consumer taste patterns, technological alternatives ranges + amount of available
resources )

-​ Price plays a big role in COMMUNICATING change

> self interest will INDUCE existing competitors to expand output, enticing NEW competitors
( growth of incomes GROW industries, leading to a domino effect of positive growth in the
economy )

5. How will the system promote progress?

-​ Society desires ECONOMIC GROWTH + HIGHER LIVING STANDARDS

> the market system should promote technical improvements + capital accumulation that
contribute to these desires

a. Technical advance

-​ Enables better PRODUCTS and PROCESSES to replace inferior ones

> includes NEW + IMPROVED methods that reduce production and distribution costs

> brings in ‘Creative Destruction’

( the hypothesis that the creation of new products and production methods simultaneously
DESTROYS the market power of existing monopolies )

b. Capital accumulation

-​ The market system provides the resources necessary to produce those goods through INCREASED
rand votes for CAPITAL GOODS

> involves redistribution of income

a.​ Paying interest

b.​ Selling ownership shares
c.​ Produce MORE capital goods
SUMMARY

1. Laissez-faire capitalism and the command system are the two broad types of economic systems. In
the market system (or capitalism), private individuals own most resources, and markets coordinate most
economic activity. In the command system (or socialism or communism), the government owns most
resources, and central planners coordinate most economic activity.

2. The market system is characterised by the private ownership of resources, including the capital, and
the freedom of individuals to engage in economic activities of their choice to advance their material
well-being. Self-interest is the driving force of such an economy and competition functions as a regulatory
or control mechanism.

3. The command systems of the Soviet Union and pre-reform China met their demise because of
coordination difficulties under central planning and the lack of a profit incentive. The coordination problem
resulted in bottlenecks, inefficiencies and a focus on a limited number of products. The incentive problem
discouraged product improvement, new product development and entrepreneurship.

4. In the market system, markets, prices and profits organise and make effective the many millions of
individual economic decisions that occur daily.

5. Emerging markets are the possible global economies of the future.

6. Specialisation, use of advanced technology and the extensive use of capital goods are common
features of market systems.

7. Every economy faces five fundamental questions: (a) What goods and services will be produced? (b)
How will the goods and services be produced? (c) Who will get the goods and services? (d.) How will the
system accommodate change? (e) How will the system promote progress?

8. The market system produces products whose production and sale yield total revenue sufficient to
cover total cost. It does not produce products for which total revenue continuously falls short of the total
cost. Competition forces firms to use the lowest-cost production techniques.

9. Economic profit (total revenue minus total cost) indicates that the industry is prosperous and promotes
its expansion. Losses signify that industry is not prosperous and hasten its contraction.

10. Consumer sovereignty means that both businesses and resource suppliers are subject to the wants
of consumers. Through their rand votes, consumers decide on the composition of output.

11. The prices that a household receives for the resources it supplies to the economy determine that
household's income. This income determines the household's claim on the economy's output. Those who
have the income to spend get the products produced in the market system.

12. By communicating changes in consumer tastes to entrepreneurs and resource suppliers, the market
system prompts appropriate adjustments in the allocation of the economy's resources. The market
system also encourages technological advance and capital accumulation, both of which raise a nation's
standard of living.