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PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser

PART 1ECONOMIC CONCEPTS AND SYSTEMSChapter 1Economic concepts

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PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser

Lecture Plan

• What is Economics?• Scarcity• Basic economic problems• Production possibility analysis

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PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser

What is Economics?

• Economics is the study of how people and society choose to employ scarce productive resources to produce goods and services and distribute them among various groups of society

ECONOMICS

Macroeconomics Microeconomics

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Microeconomics vs. Macroeconomics

• Microeconomics = the study of individual consumers, firms and industries

– (‘Micro’ = the ancient Greek word for ‘small’)• It focuses on:

– The pricing and production decisions of industrial firms– Consumer behaviour and – The output and state of single industries

• Macroeconomics is concerned with how the economy functions as a whole (e.g. total income)

– (‘Macro’ is the Greek word for ‘large’)

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Scarcity

• Every economy is endowed with what we call resources, which are inputs used in the production of goods and services for consumption to satisfy our needs and wants

• The basic economic problem of any society is the relative scarcity of resources in relation to the unlimited needs and wants of consumers

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Resources

• Resources = All inputs that can be combined in many different ways to produce goods and services of various types to help satisfy people’s unlimited needs and wants

• Often referred to as the factors of production• Resources include land, capital, labour and

enterprise

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Land

• All natural resources and endowments

• Examples: soils, crops, minerals, forests, oceans

• Critical resource for Australia (e.g. exports)

• The least flexible resource• Factor income: rent• Abundant resource for Australia but

an increasingly scarce resource for East Asian countries (e.g. Singapore)

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Capital

• Any good or service used to produce others (i.e. intermediate goods)

– e.g. factories, tools, machinery and equipment

• Most abundant factor for industrial countries (e.g. United States, Japan)

• Factor income: interest• Note: Expenditure on capital is

Investment

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Labour

• Labour = Physical and mental work of people, whether, skilled or unskilled

• Examples: mechanics, doctors, farmers, computer programmers

• Most flexible resource• Most abundant resource in

developing countries• Factor income: wages

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Enterprise

• Management (e.g. ownership, control and/or coordination) of the other three factors of production (entrepreneurship)

• Covers the various organisational skills of ‘entrepreneurs’

• Example: business managers• Factor income: profit

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Characteristics of Resources

• Scarce– Have alternative uses– Limited, finite

• Quantity of resources– Physical amount of resources available– Affected by resource endowment and population– Australia’s cropland is 463 000 sq. km, while Indonesia’s

cropland is 324 000 sq. km– Australia’s labour force is around 9–10 million people,

while Indonesia’s workforce is over 90 million people

(cont.)

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Characteristics of Resources (cont.)

• Quality of resources– Productivity of resources– Affected by technology, education and training of

workforce– Land productivity (yield/ha)– Labour productivity (production per person)

• We achieve economic growth by increasing the quantity and/or quality of resources

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Consumer Needs and Wants

• Needs: those things necessary to human survival e.g. food, shelter

• Wants: goods/services desired by the consumer e.g. hi-fi, travel, luxury cars

• Characteristics:– unlimited– recurrent– complementary– changeable

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Satisfying Needs and Wants

Production

Distribution

Consumption

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Basic Economic Questions

Scarcity Choices must be made

1. What To Produce?2. How To Produce?3. For Whom To Produce?

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Opportunity Cost

• The Basic Economic Problem of Relative Scarcity is illustrated by two concepts:

– Opportunity Cost, and – The Production Possibility Frontier (PPF)

• Opportunity cost = The sacrifice (or alternative forgone) in choosing to satisfy one need or want rather than another

• Note: Situations where there is NO opportunity cost = free goods

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Production Possibility Frontier (PPF) Theory

• A simplified economic model which portrays scarcity, choice and opportunity cost

The Static Production Possibility Frontier• Analyses the economy at a fixed point in time• Is based on the following assumptions:

– There is a fixed quantity of resources– The economy only produces two products– Resources can be used interchangeably– All resources within the economy are used– Resources are used at maximum efficiency

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An Example of the Static PPF Model

Production Possibility Schedule

A B C D E

Tractors 0 100 200 300 400

VCRs 800 600 400 200 0

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The PPF Graph

Tractors

Video recorders

200-

400-

300-

100-

800400200 600

PPFE

D

B

C

0

A

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Maximum Output Levels

• The PPF shows the maximum output of the economy

• If the economy devotes all of its resources to the production of VCRs it is able to produce 800 (+ zero tractors)—Production Possibility A

• Alternatively, if the economy chooses Production Possibility C it is able to produce 200 tractors and 400 VCRs

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Opportunity Costs

• The PPF shows that to produce more of one product means producing less of another

• Opportunity costs of production can be measured e.g. if the economy moves from point C to D (along the PPF) it will produce an extra 100 tractors BUT 200 VCRs must be sacrificed

• Hence the opportunity cost is 200 VCRs

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Points Outside the Static PPF

• Points outside the PPF (e.g. X) are not possible using existing technology and resources

A

B

.X

PPF

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Points Inside the Static PPF

• At point Y, the economy is satisfying fewer needs and wants than is possible

• This is due to:– Resources not being fully

employed and/or– Resources not being used in

the most efficient way

A

B

. Y

PPF

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The Dynamic PPF Model

• This model differs from the static PPF in that it incorporates changes over time

• It demonstrates the effect of changes in the quantity and quality of productive resources e.g. new resource discoveries, improvements in technology

• Changes in the quantity and/or quality of resources will SHIFT the PPF

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PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser

Dynamic PPF

• When the quality/quantity of resources increases (decreases), the economy can produce more (less) of both products and the entire curve will SHIFT outwards (inwards)

A

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Note

• If the change in resources affects ONLY one product, the PPF will ONLY shift on one axis e.g.:

A

B

A

B

OR

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PPT Slides t/a Economics for Business 3e by Fraser, Gionea and Fraser

The Significance of PPF Shifts

• Increased maximum output levels enable:1. higher levels of consumption

2. greater satisfaction of consumer needs and wants

• Improvements in the quality of resources results in the more efficient use of scarce resources