ECO111F/L

Chapter 1: What is Economics?

© VAN SCHAIK PUBLISHERS

 What is economics?

“Economics is the study of how our scarce productive

resources are used to satisfy human wants”
- George Leland Bach

“Economics is the study of how society manages its

scarce resources”
- N. Gregory Mankiw

“Economics is the study of how individuals, firms,

governments and other organizations within our society
make choices and how those choices determine how the
resources of society are used”
- Joseph Stiglitz

© VAN SCHAIK PUBLISHERS

 Microeconomics vs
Macroeconomics
 Microeconomics
• Focus is on individual parts of the economy
• Individual elements of the economy are put under
a microscope and examined in detail

 Macroeconomics
• Study of the nation as a whole i.e. looking at the
‘big picture’
• Develop an overall view of the economy and study
aggregate economic behavior
 Scarcity, choice and opportunity cost

• Scarcity refers to a situation whereby the resources that

are available at a particular point in time are not enough
to satisfy all the needs of individuals, let alone all their
wants
• NB: Scarcity is the ECONOMIC PROBLEM

• Because of scarcity, choices have to be made

• Every time a choice is made, opportunity cost is incurred

• Opportunity cost – the value to the decision maker of the

best alternative that could have been chosen but was not
chosen
© VAN SCHAIK
PUBLISHERS
 Scarce Resources: Factors of
Production
 Factors of production – scarce resources that are used to
produce goods and services

 Natural resources (land)

 Labour
 Capital
 Entrepreneurship
 Money is not a factor of production!
 Factors of production help in answering the problem

associated with “how should it be produced”

 i.e. We utilise factors of production in order to

produce goods and services
 Classification of Goods and
Services
 (1) Consumer goods are utilised or
consumed by individuals/households to
satisfy wants e.g. food, clothing.

 - Classified as durable, non durable,

semi-durable

 Capital goods are utilised in the

production of other goods e.g. machinery,
equipment.
 Classification of Goods and
Services
 (2) Final goods are used or consumed by individuals,
households and firms i.e. end products, such as a loaf
of bread.
 Intermediate goods are goods that are purchased to be
used as inputs in producing other goods e.g. flour.
 (3) Private goods are excludable products, consumption
by others can be excluded e.g. motor vehicles.
 Public goods are used or consumed by communities or
societies at large e.g. traffic lights. These goods cannot
be excluded.
 Classification of Goods and
Services
 (4) Economic goods are goods produced at a cost from
scarce resources. Most goods are thus economic goods.

 Free goods are goods that are not scarce and therefore
have no price attached e.g. sunshine, sea water.

 (5) Homogenous goods are goods that are exactly alike.

 Heterogenous goods are differentiated products; these

are goods that are available in different varieties, qualities
or brands.

 Illustrating scarcity, choice and opportunity
cost: the production possibilities curve
 Scarcity, choice and opportunity cost can be
illustrated by means of the PPC curve.
• The PPC curve shows the combinations of any
two goods or services that are attainable when
an economy’s resources are fully and
efficiently employed.
 Consider a community which survives on two products,
fish and potatoes:
• If all resources are concentrated on fish, they will produce
5 baskets of fish. If all resources are used in producing
potatoes they will produce 100 kgs of potatoes.
• However to achieve a balance diet they may choose a
combination of the two products.
Illustrating scarcity, choice and
opportunity cost: the production
possibilities curve
Production possibilities for the Wild Coast community

© VAN SCHAIK
PUBLISHERS
Illustrating scarcity, choice and opportunity cost: the
production possibilities curve

A production possibilities curve for the Wild Coast

community

© VAN SCHAIK
PUBLISHERS
Illustrating scarcity, choice and opportunity
cost: the production possibilities curve

 Fish production is measured along the horizontal axis

and potato production on the vertical axis.
 The different combinations are represented by points A,
B, C, D, E and F in the diagram.
 Joining the different combinations gives us the curve,
the Production Possibility Curve.
 Moving along the PPC from A to B through to point F,
the production of fish increases, whilst the production
of potatoes decreases.
Illustrating scarcity, choice and opportunity
cost: the production possibilities curve

 To produce the first basket of fish, the

community has to sacrifice 5 kgs of potatoes
(100 to 95).
 To produce the second basket of fish the
sacrifice is an additional 10 kgs of potatoes (95
less 85).
 The opportunity cost of each additional basket
of fish increases as we move along the PPC.
 The PPC bulges outward from the origin
because of increasing opportunity cost.
Illustrating scarcity, choice and opportunity
cost: the production possibilities curve

 Points A, B, C, D, E and F represents attainable and

efficient combinations of potatoes and fish.
 Point H in the diagram denote 70 kgs of potatoes
and two baskets of fish.
 -This is attainable but inefficient because
more potatoes (85 kgs) can be produced at C
without sacrificing any production of fish.
 Points such as G are desirable but not attainable.
Illustrating scarcity, choice and opportunity
cost: the production possibilities curve
 The PPC can therefore illustrate scarcity, choice and
opportunity cost.
 Scarcity- all points to the right such as G are
unattainable.
 The PPC forms a frontier or boundary between what is
possible and impossible.
 Choice – Is illustrated by the need to choose among the
available combinations along the curve.
 Opportunity cost – is illustrated by the negative slope of
the curve which means more of one good can be
obtained only by sacrificing the other good.
 In other words opportunity cost involves a trade-off
between the two goods.
 Further applications of the production
possibilities curve
Improved technique for
producing capital
goods
(Textbook page 9)

© VAN SCHAIK
PUBLISHERS
 Further applications of the production
possibilities curve

Improved technique for producing consumer goods

© VAN SCHAIK
PUBLISHERS
 Further applications of the production
possibilities curve

Increase in the quantity or productivity of the available resources

© VAN SCHAIK
PUBLISHERS
 Further applications of the production
possibilities curve
The production possibilities curve (PPC): a summary

© VAN SCHAIK
PUBLISHERS
 Positive and normative economics

Positive economics - includes statements of fact,

which can be proved or disproved by looking at the
facts. Concerned with “what is”.
- e.g. Kaizer Chiefs won the PSL in 2014
Normative economics – statements about how things
ought to or should be, and are based on individual
values or opinions. These statements are subject to
debate.
- e.g. Bafana Bafana can play much better than
they did against Brazil in March 2014 © VAN SCHAIK
PUBLISHERS
 Important concepts
• Wants and needs • Durable goods
• Means or resources • Services
• Scarcity (unlimited wants • Final goods
and limited resources) • Intermediate goods
• Choice • Private goods
• Opportunity cost (or trade- • Public goods
off) • Economic goods
• Production possibilities curve • Free goods
• Potential output • Homogeneous goods
• Economic growth • Heterogeneous goods
• Consumer goods • Resource allocation
• Capital goods • Social science (versus
• Non-durable goods natural science)
• Semi-durable goods © VAN SCHAIK PUBLISHERS
 Important concepts

• Ceteris paribus • Schedule

• Microeconomics • Graph
• Macroeconomics
• Positive economics
• Normative economics

© VAN SCHAIK
PUBLISHERS
 LECTURE 2
Economic systems and government
intervention

23
Lecture Concepts
 Three economic questions revisited
 Economic systems

◦ Traditional
◦ Command
◦ Market
 Government intervention and the Mixed
Economy
 Market failure

24
 Three Economic Questions

All economies must answer these three questions:

1. What goods and services will be produced?
2. How will they be produced?
3. For whom will they be produced?

25
Economic Systems
 There are three distinct behavioural patterns or
economic systems
 Traditional
 Command
 Free market

26
 Economic Systems
 The three central economic questions will be answered
according to the type of society and the specific
economic system present.
 We distinguish between the following societies, each
associated with a different economic system:
• Traditional society
‒Economic questions solved by tradition, habit, and
customs
‒Production and distribution methods remain the
same for generations; passed on through families
‒Rather stagnant
‒Scarce
Introduction 27
 ECONOMIC SYSTEMS

Traditional Economy:
Strengths:
 everyone knows their role & life is stable &
predictable
 Little uncertainty over the what, how, & for
whom questions
Weaknesses:
 discourages new ideas
 lack of progress leads to lower standard of living.
 Economic Systems
 Command society
‒Government owns most of the property resources, and
they decide what, how and for whom
‒Economic questions addressed by some form of central
authority
‒Production and distribution take place according to a plan
‒Economies became stagnant and inefficient
‒Have not been known for the creation of wealth that
accrues to the population at large
‒Economic system in such societies are also known as
‘communism’
‒Becoming increasingly scarce
‒Also associated with high levels of corruption and abuse
by government Introduction 29
 Economic Systems
 Free Market economy
‒ Economic questions solved by the market mechanism of
demand and supply
‒ Production and distribution methods are determined by
prices
‒ Adam Smith and the ‘invisible hand’: proposed
minimum interference by the government (‘laissez
faire’)
‒ Allows for the creation of wealth and a high standard of
living
‒ Drawback: high levels of welfare available only to those
who are part of the process that created this welfare
‒ If people can’t afford a certain good, they will have to
do without it
Introduction 30
Free Market Economy
 What? Consumers decide what should be produced
in a market economy through the purchases they
make.
 How? Production is left entirely up to businesses.

Businesses must be competitive in such an economy

and produce quality products at lower prices than
their competitors.
 For whom? In a market economy, the people who

have more money are able to buy more goods and

services

31
Advantages of the Free Market
Economy

 It is productively efficient because firms are always

under pressure to produce at the lowest cost possible.
 It is allocatively efficient because output produced is

that which maximises the total satisfaction enjoyed

by the members of the society.
 There are incentives to produce better products.

 It is flexible.

32
Disadvantages of Free Market Economies

 Great rift between the wealthy and the poor

 Some firms try to monopolize markets
◦ i.e. take over and charge exorbitant prices
 There`s no provision of public goods
◦ No government involvement
 Market failure!
33
 Economic Systems
Mixed Economy
 It is important to note that economies are not purely

traditional or purely command or purely free market

 A mixed economy is a combination of the free market

and command economy

◦ Government takes care of peoples` needs.
◦ The market takes care of people`s wants.
 Most nations have a mixed economy
 South Africa is a mixed economy, that is

characterised by a substantial degree of government

intervention

34
 Economic Systems
• Mixed economy
 Economic questions solved by the market mechanism
but is corrected by government
 Government:
• directs part of the stream of wealth to the
needy
• provides affordable medical services, houses
for the homeless, basic food to the hungry etc.

• regulates monopolies
• provides services that the market would not
(public goods)
‒ Goods and services financed by taxes paid to the
Introduction 35
Why is the government important in
an economy?

 To prevent market failure

 When firms in an economy do not produce

necessary goods and services or when firms

harm the economy, the situation is referred to as
market failure.
Examples of market failure
 Public goods-Failure of market to provide public
goods
◦ Government intervenes to ensure provision of public
goods, and levies taxes for such provision
 Imperfect competition-firms may organise
themselves to reduce competition
 Externalities -These are costs or benefits of a
transaction or activity that are borne or enjoyed by
parties not directly involved in the transaction or activity
 Economic instability
 Inequality