Microeconomics Study Chapter 1

Microeconomics Study chapter 1
The nature and method of economics:

* Economics is concerned with the efficient use of limited productive resources for the purpose of attaining the maximum satisfaction of our material wants.

The study of economics is important because; * Constitutes the basis of much government economic policy or shapes the design and impact of this policy. * Informs those involved with the design of economic policy and the analysis of its impact. * Improves our understanding of the economic consequences of economic and social policy, and makes us better informed citizens who can make better decisions when electing public officials. * Provides basic economic information and allows the interpretation of this information in ways that help people make rational business decisions. * Encourages us to take a social perspective on economic problems and provides the techniques with which we can do this.

* Macroeconomics: is concerned with either the economy as a whole or with the basic subdivisions aggregates that that make up the economy.
(Aggregate: a collection of specific economic units that are treated as if they were one unit) * Microeconomics: is concerned with specific economic units and a detailed consideration of the behaviour of these individual units.

The practise of economics usually combines three elements; * Describing or gathering facts. * Developing principles or theories that make generalisations about economic behaviour. * Applying the insights gained from economic statistics and analysis in the form of policy or strategy prescription.

Two approaches taken by economists to develop economic theories; * The deductive approach: beginning at the level of theory and proceeding to the verification or rejection of this theory by appealing to the facts. Economists may draw on a casual observation, to frame an untested principle called a hypothesis. * The inductive approach: begins with the accumulation of facts, which are then arranged systematically and analysed so as to permit, the creation of a principle.

* Positive economics: deals with the facts and avoids value judgement (what is). Attempts to set out scientific statements about economic behaviour. * Normative economics: Normative economics involves someone’s value or judgement about what the economy should be like or what particular policy action should be recommended (what ought to be).

Policy prescription requires; * A movement from positive economics to normative economic, and the recognition of the importance and impact of value judgements on policy choices. * The statement of economic goals-
- Economic growth
- Full employment
- Economic efficiency
- Price-level stability
- Economic freedom
- An equitable distribution of income
- Economic security
- External balance * Recognition of the possible effects of alternative economic policies, their costs and benefits, and the political feasibility of their implementation. * An intent and willingness to conduct an evaluation and consequences of the chosen economic policy.

* Fallacy of composition: to assume incorrectly that what is true for the individual or part is necessarily also true for the group or whole.
e.g. A wage increase for John is desirable because, given product prices, it increases John’s purchasing power and standard of living. But if everyone receives a wage increase, product prices may rise and inflation may result. Thus, Johns standard if living may be unchanged or worse. * Post-hoc fallacy: to assume that, simply because one event proceeds another, the first caused the second.

Our ability to engage in valid economic reasoning faces a number of potential obstacles; * The biases and preconceptions we bring to the study of economics, which may lead to a desire to see specific results emerge from our analysis regardless of their validity. * A desire on the part of some individuals and organisations to use loaded terminology in outlining their case, which may impair the ability of some individuals to analyse their argument objectively. * Confusion or disagreement over the intended meaning of a term used in economics when this differs from the accepted meaning of that term used in everyday speech. * The fallacy of composition. * The post-hoc fallacy. * Confusing a correlation between economic variables or events. * Economic quackery.

The economic perspective involves; * Scarcity and choice: The recognition that, for society as a whole, resources are limited, requiring society to accept limits to its ability to produce goods and services, and requiring choices to be made between the production of one alternative over another. * Rational behaviour: an assumption that individuals operate on the basis of self interest, meaning they make decisions that provide them with the greatest benefits given their limited resources. * Marginal analysis: whereby the incremental benefits available from any change to the status quoi are compared with the incremental costs of making the change, suggesting that only those choices where marginal benefit exceed marginal cost should be accepted.

Graphs and their meaning: * Direct relationship: where the values of two related variables change in the same direction. E.g. consumption and income * Inverse relationship: where the values of two related variables move in opposite directions. E.g. ticket prices and attendance * Dependant variable: variable, which changes as a consequence of a change in some other (independent) variable; the effect or outcome. * Independent variable: variable, which causes change in some other (dependant) variable.
e.g. Income (independent) causes consumption (dependant) to be what it is. * The slope of a straight line is the ratio of rise over run. The slope of an up-sloping line is positive, and the slope of a down-sloping line is negative. * The intercept and the slope can be put into a linear equation;
Y = a + bx Y= dependent variable A= vertical intercept B= the slope of line X= independent variable * The slope of a curve at any point is determine by calculating the slope of a straight line that is drawn as a tangent to that point.

The economising problem: * Material wants: the desires of consumers to obtain and use various goods and services that give utility. * Utility: the economists term for pleasure or satisfaction * Economic resources: all the natural, human, and manufactured resources that go into production of goods and services.

Resource categories; * Land: an economic resource that includes all natural resources that go into the production of goods and services. E.g. arable land, forests, mineral, oil deposits, water.
Capital: all the manufactured aids to production used to produce goods ad services and distribute them to the final consumer without directly satisfying human want. E.g. factory, storage, transport, distribution facilities and tools. The process of producing and accumulating capital goods is known as investment. * Labour: a broad term the economist uses for all human physical and mental talents (excluding entrepreneur activity) that can be used in producing goods and services. E.g. builder’s labourer, retail clerk, mechanist, teacher, investment banker. * Entrepreneurial ability: the human resource that combines the other resources to produce a product, make non routine decisions, innovate and bear risk. * Property resources: land, raw materials, capital. * Human resources: labour and entrepreneurial ability.

In exchange for supplying resources, the owners of the resources receive income payments; * Rent for land * Interest for capital * Wages for labour * Profit for entrepreneurial endeavour

* Land- (labour, capital) intensive commodity: a commodity in which the production process uses relatively large amounts of the land (labour, capital) resource compared with the average rate at which this resource is combined with other in the economy’s production process.

* Land intensity commodity: if its production process uses relatively large amounts of the land resource compared with the average rate at which this resource is combined with other resources in the economy’s production processes. E.g. production of gold. * Labour intensive: if its production progress uses relatively large amounts of labour resource compared to the average use of labour in production processes throughout the economy. E.g. production of hairdresser services. * Capital intensive: if product in its production process when it uses capital n relatively greater proportion. E.g. oil refining.

* The foundation of economics lies in the two fundamental facts that constitute the economising problem: * Society’s material wants are unlimited * The economic resources available to satisfy these wants * Material wants: represent those goods and services that, when consumed, provide utility (satisfaction) to customers.

* Efficiency: the result of using or administering scarce resources to produce the maximum amount of desired goods and services, thereby achieving the greatest possible fulfilment of society’s wants.

* Economic efficiency is achieved when society gains the maximum output from its scarce resources. This requires both;

* Full employment: the employment of all available resources. –no unemployment. * Full production: the maximum amount of goods and services that can be produced from the employed resources of the economy.

* Allocative efficiency: occurs when all available resources are devoted to a combination of goods most wanted by society.

* Productive efficiency: occurs when good or services are produced using the lowest cost production methods.

* Achievement of productive efficiency depends on optimising the benefits of the division of labour- maximising the contributions of different ability’s, making use of the effects of learning by doing and reducing time loses involved in the transfer from one activity to another- and geographic selection in a way such that no resources are underemployed.

Production possibility curve:

* Opportunity Cost: shown by the slope of the production of a possibility curve. The opportunity cost of a product represents the amount of an alternative product that must be sacrificed to obtain an additional, or marginal, unit of that product.

* The law of increasing opportunity cost is reflected in the concave shape of the production possibility curve. As we increase the production of product A at the cost of product B, we move resources that are less and less suited to the production of A away from the production of B.

* We may illustrate unemployment or inefficient production (underemployment) within the production possibility framework by locating the current output of the economy at a point that lies within the production possibility curve.

* When the supplies of resources increase or an improvement in technology occurs, the production possibility curve shifts outwards to the right.

* Economic growth can be reflected as a rightward shift of the production possibilities curve; it is the result of increases in resource supplies, improvements in resource quality and technological advance.

* The consequence of growth is that our full-employment economy can enjoy a greater output of both products, even though economic growth does not typically entail proportionate increases in a nations capacity to produce each alternative product.

The Economising problem can be broken down into five component parts or fundamental questions; 1. How much total output should society produce? The location of the producing possibility curve is determined by s the level at which resources should be utilised in the production process. 2. What combination of outputs is to be produced? Society must decide which specific goods and services are to be produced and in what quantities to most fully satisfy its wants. 3. How are these outputs to be produced? Society must determine which firms should produce the outputs, and how to choose the least-cost combination of resources and the best technology of production process. 4. Who is to receive and consume these outputs? 5. How can the system adapt to change?