Alan Van

1. Intro to Economics

1.1 The economic problem and the role of choices

Economic problem how a society can satisfy the unlimited wants with the
limited resources available
Our wants are unlimited
Resources are scarce
Since we cant satisfy all our wants we must choose between them
We need to rate our preferences leave some wants unsatisfied
Economics trying to allocate our limited resources for the satisfaction of our
unlimited and competing wants must make choices choosing one option and
deciding against an alternative option
Opportunity cost represents the cost of satisfying one want over an
alternative want - the satisfaction you would receive from the alternative option
i.e. give up opportunity to buy new car for a holiday opportunity cost =
satisfaction you could have gotten from car purchase

Individual limited resources (due to limited income) e.g. holiday or car

Firm choice in allocation of scarce resources e.g. produce shoes or
furniture
Government limited resources to satisfy community wants e.g. new
motorway or hospital

Needs goods and services that are essential for life/survival e.g. food, shelter
and services like health and education
Wants other goods and services that would make our lives easier or give us
pleasure e.g. car, holiday
Our wants are unlimited but our means of satisfying them is limited
Utility satisfaction or pleasure
Individual wants
e.g. high income = new
phone, low income =
basic food, clothing,
shelter

Collective wants
e.g. education (schools),
safety (defence and
police forces)

Our wants are

unlimited
e.g. always want newest
technology

Our wants change

over time

Desires of each person depend on personal

preferences
How many of these wants can be satisfied will differ
depending on ability to purchase goods and
services (i.e. income)
Less income fewer wants able to be satisfied
Wants of whole community depend on community
as a whole
Usually provided by government
o Local parks, libraries, local sporting facilities
o State hospitals, schools
o Federal satisfies wants of entire nation e.g.
defence force, enabled by taxation
But means of satisfying our wants is limited
Must choose between wants prioritise
Some will be satisfied sooner at the expense of
others
Age
Income increase in income increase range of

Alan Van

e.g. 1yo pram, 7yo

scooter, 19yo car, 90yo
wheelchair

1. Intro to Economics

wants that can be satisfied

Technology introduces new wants that people seek
to satisfy
Fashion

All economies must answer the following questions:

1. What to produce limited resources cant satisfy all wants prioritise
wants to satisfy decide what goods and service to produce
2. How much to produce aim to maximise satisfaction of wants
Produce too much resources wasted
Produce too little wants of some individuals will be left unsatisfied
3. How to produce decide how to allocate resources in production process
and look for most efficient method of production
4. How to distribute production modern economies share of production
depends on income (higher income afford to buy more larger share of
production), economies must decide:
Equitable distribution even
Inequitable distribution uneven
Often conflict between equity and efficiency more efficient less
equitable

1.2 The production possibility frontier

Used to demonstrate opportunity costs when individuals/communities

make choices
Shows various combinations of 2 alternative products that can be
produced at a given point in time
Society must choose what combination is most desirable
On curve efficient, all resources fully employed
Outside curve unattainable at the moment
Inside curve resources arent fully employed

Based on assumptions:
Economy only produces 2 goods
State of technology is constant
Quantity of resources remains unchanged
All resources are fully employed

Alan Van

1. Intro to Economics

New technology

More efficient methods of production

Higher quantity goods, same amount
resources

Upward shift of frontier

New resources

Increase in inputs e.g. discovery new

resources or increased population due to
immigration
Able to produce more of both goods

Push frontier upwards

Unemployment

Inefficient allocation of resources

Total output less than what it could be
producing within/underneath frontier

Frontier wont change but our position in

relation to it would we would be inside

Shape

Things arent always equally

substitutable
Straight line = must be possible to shift
all resources between production of
goods so opportunity cost is constant
Real world = not the case cannot move
resources without loss of productive
capacity

Concave

Alan Van

1. Intro to Economics

1.3 The future implications of choices

Generally an economy can choose between producing consumer goods

and capital goods
Consumer goods satisfy consumer demands immediately
Capital goods goods that will increase productive capacity in future i.e.
will be used in the production of other goods e.g. machinery
Capital goods dont satisfy consumer wants and demands immediately,
they expand economys production ability satisfying consumers to a
greater extent and more efficiently in the future
Long-term focuses on production of capital goods increase productive
capacity higher level of economic growth
Economy must decide to produce consumer or capital goods satisfy
wants of consumers or maximise potential satisfaction in future
Individual holiday or house and mortgage, immediate satisfaction or
financial security
Firm must choose area of market to focus on access potential success
over medium to long term
Government satisfying immediate needs may mean less funding to
another area e.g. putting money into education = economic growth and
skill base, govts often influenced by political popularity

1.4 The economic factors underlying choices

Individuals
Age
Income
Expectations e.g. income rise/fall in future
Future plans e.g.
o Education forgo income for a few years usually rewarded with
high income
o Work
o Family one partner may have to forego income for a few years
o Retirement must adjust to lower income
Personality factors risk/security
Voting in elections i.e. vote for way economy operates
Firms
Pricing e.g. number of sales, profit
Marketing strategy i.e. target market
Produce consumer or capital goods
Source of resources - cheaper or more expensive with reliable supply
Ethical issues e.g. environment

Alan Van

1. Intro to Economics

Industrial relations issues e.g. award wage/wage agreements with whole

workforce/individual contracts

Governments
Have influence on economic choices of individuals and firms making it
more/less expensive to make choices e.g. tax on cigarettes
May prohibit certain activities, penalties for breaking law e.g. businesses
in same industry meeting to set prices for industry (would harm consumer
interest)
Incentives to encourage certain activities e.g. tax for people who dont
have private health care

2.1 The production of goods and services

Factor of production any resource that can be used in the production of
goods and services
Quantity and quality of an economys factors of production (resources)
influence how wealthy/poor that economy will be
Examples
Improvements in educational standards changes in size and quality of
labour force
Higher investment in machinery increased availability of capital
Environmental damage reduce quantity of natural resources that can be
used in production process
Natural resources any resources provided by nature that are used in the
production process
Labour human effort, both physical and mental, used to produce goods and
services
Capital the produced means of production
Enterprise involves organising the other factors of production for the purpose
of producing goods and services
Resource
Natural
resources

Reward
rent

Labour

wages

Capital

interest

Examples
water
forests
mineral deposits
depends on
pop. birth/death rates, immigration
school leaving age and retirement age
social attitudes women in workforce
availability of childcare
owed privately by individuals/firms
machinery

Alan Van

Enterprise

1. Intro to Economics

profit

tools
factories
computers
owned by community
roads and railways
schools
telecommunications networks
entrepreneur makes management
decisions concerning all aspects of
production and bears rick that these
may not be correct ones
profit earned because entrepreneur
run successful business despite
considerable risk
o revenue minus expenses
o rent for land they own in
production process
o wages for work effort
o interest for capital invested in
business

Scarcity in economies four resources in limited supply

Natural resources limited available
Labour limited b pop. Size, labour market skills, peoples willingness to
work
Capital limited by extent to which govts and private sector are willing to
invest
Enterprise supply of entrepreneurial skills limited by willingness of
individuals to innovate and take risks

2.2 The distribution and exchange of goods and services

Market economies dont attempt to distribute output evenly within society
Provide income as a reward for contribution to production process
Owners of natural resources, capital and entrepreneurial skill receive
income based on that value of their input
+ Incentives for better skills and harder work to improve their share of
output
Can be unfair, some people may be unable to contribute to production due
to illness age or disability

Governments may decide to intervene to correct inequitable market

outcomes, help people who would not otherwise receive an adequate level
of income
Governments can influence distribution of goods and services

Alan Van

1. Intro to Economics

Taking money from higher income earners taxation and

redistributing it to lower income earners social security

Alan Van

1. Intro to Economics

2.3 The business cycle

Business cycle fluctuations in the level of economic growth due to domestic
or international factors
Recession the stage of the business cycle where there is decreasing economic
activity, defined as 2 consecutive quarters of negative economic growth
Boom the stage of the business cycle where there is increasing economic
activity

Impacts of the business cycle

Recession
falling production of goods and
services
falling levels of consumption and
investment
rising unemployment
falling income levels
falling quality of life
falling inflation (deflation)

Boom
increasing production of goods and
services
rising levels of consumption and
investment
falling unemployment
rising income levels
rising quality of life
rising inflation

Governments
Aim to smooth the business cycle using:
o Fiscal policies i.e. govt budget and spending
o Monetary policies i.e. RBA cash rate and inflation target
During recessions stimulate economic growth
Long term ensure the economy can sustain economic growth for a long
period of time to avoid major economic downturn
Inflation a measure of the increase of general levels of prices
CPI (Consumer Price Index) main measure of inflation in Aus
RBA use interest rates to control inflation

Alan Van

1. Intro to Economics

Want income increase greater that inflation difference = real wage

increase
2.4 An overview of the economy: the circular flow of income
Circular flow of income model
Describes the operation of the economy and the linkages between the
main sectors in the economy

Savings = S

Income = Y

Investment = I

Taxation = T

Output = O

Govt spending = G

Imports = M

Expenditure = E

Exports = X

Leakages items that remove money from the circular flow of income
aggregate income
economic activity
S+T+M
Injections items that put money into the circular flow of income
aggregate income
economic activity
I+G+X

Alan Van

Sector
Households

1. Intro to Economics

Firms

Financial institutions e.g.

banks, building societies,
finance companies, credit
unions, superannuation funds,
life insurance companies

Governments

International trade and

financial flows e.g imports,

exports, international money

flows (i.e. borrowing, lending)

Depend on businesses to: produce the goods

and services they demand, provide them with
the income to buy them
Owners of factors of production, consumers
Supply factors of production (e.g. land, labour,
capital, enterprise) to businesses
Reward = rent, wages, interest, profit
Income goes into spending on locally
produced goods, savings, tax or purchasing
imports
Depend on households to: supply resources,
consume of goods and services
Buys factors of production from households
and use them to make goods and services
Act as intermediaries between savers and
borrowers
Savings (leakage) essential for investment
(injection) to occur creation of new capital
goods
Main aim redistribute income, reallocate
resources
Help satisfy collective/community wants e.g.
roads, railways, schools, hospitals, defence
2 roles in circular flow of income
1. Imposes tax (leakage) on households
and firms
2. Uses tax for gov expenditure (injection)
Transactions our economy has with the rest of
the world
M = leakage, X = injection

.
Equilibrium
Occurs in the circular flow of
income when S + T + M = I +
G+X
i.e. sum of leakages = sum of
injections
Disequilibrium
S+T+M<I+G+X
or S + T + M > I + G + X
i.e. S + T + M I + G + X

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Alan Van

leakages > injections

level of economic activity o Y, production, u/e
In circular flow - economic
activity leakages (consumers
have less to save, spend on M or
collected as tax)
Leakages will eventually =
injections
o Restored to equilibrium
but at a lower level of Y
i.e. economy is
contracting

1. Intro to Economics

injections > leakages

level of economic activity
o Y, production, u/e
In circular flow - economic
activity leakages (consumers
have more to save, spend on M
or collected as tax)
Leakages will eventually =
injections
o Restored to equilibrium
but at a higher level of Y
i.e. economy is expanding

3.1 The market economy

Pure market economy* all major economic decisions are made by individuals
and private firms, who are both motivated by self interest
Capitalist, free enterprise, laissez-faire (let things be)
Centrally planned economy government planners make economic decisions,
little scope for individual choice to influence economy, public ownership of
factors of production allows gov to allocate resources as it sees fit
e.g. China and Russia in past, no economies are centrally planned now
*The main weakness of a pure market economy is that the people who controlled
factors of production would become very wealthy, while majority were exploited,
vulnerable to volatile economic cycle
Modifications govs now play larger role in decision making without going
as far as centrally planned
Characteristics of a market economy
The market system

Market a network of buyers and sellers seeking to exchange a particular

product at a particular price
In a free market economy there are markets for goods and services and
the resources that produce them
o Product market the interaction of demand for and supply of the
outputs of production i.e. goods and services
o Factor market a market for any input into the production process
(natural resources, labour, capital, enterprise)
Consumers want to buy at lowest possible price so they can satisfy more
wants, businesses want to sell at highest price to maximise profits
o Price mechanism brings supply and demand together to determine
the price for each g+s

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Alan Van

1. Intro to Economics

Price mechanism the process by which the

forces of supply and demand interact to
determine the market price at which goods and
services are sold and the quantity produced

Changes in demand and supply in the product market will also influence supply
and demand in the factor market
demand of products demand of resources that make them up +
labour prices
To attract resources away from other areas of production, the
manufacturer will offer higher prices for them e.g. higher wages for labour

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