Ch 1

Basic Concepts of Economics

What is Economics?
a subject of studying the allocation of resources. Examples:
A seat offered by a university A job vacancy The first prize of Mark Six

Why do we need to study economics? Scarcity!

Scarcity
Scarcity exists when there is not enough resources to satisfy human wants. Human wants: unlimited
You wants to be a millionaire. You wants to be young forever.

Resources: Limited
Money Time

Make Choice

Choice
Make choice: which wants to be satisfied, which to be given up Some options / resources must have to be given up Opportunity Cost When people ask for the same resources Conflict Ways to solve conflicts Competitions

Competition
The criteria to discriminate winners and losers. Price Price competition
Lucky First come, First served Non-Price Power competition Ability Etc

Economies are classified as Market / Command economy according to their ways to solve conflicts

Market economy
Price competition
Most of the goods and services are allocated by price signal. Consumers and Producers look at the price to make decision. HK, Japan, the US, etc.

the majority of the resources are Privately Owned.

Command economy
Command / Order
Most of the goods and services are allocated by Government Command. China, N. Korea, Cuba, etc.

the majority of the resources are State Owned.

Three basic Question of resources allocation

1. What to produce?
Types and quantities of goods and services

2. How to produce?
Methods, locations, techniques, resources

3. For whom to produce?

Who should get the output

Three basic Question of resources allocation

1. Should textbook or lecture note be produced? Type of product, what to produce 2. Should I conduct the class in English or Cantonese? Way to make it, how to produce 3. Is this course giving to secondary school or university students? People getting this product,
for whom to produce

How market economy solve the 3 questions?

$100
what to produce

Photo $2000

$100 $10
For whom to produce how to produce

$20 $5000

Economy
a place where economic activities occurred.
Consumptions Productions Transactions

Parties in an economy:
Households (Consumers / Workers) Firms (Producers / Employers) Government Foreigners

Structure of an economy
Household
Labour service income Good/service expenditure

factor market

Circulation of an economy
cost revenue

Product market

input
Firm

output

Classification of goods
Goods: satisfy human wants Three types of goods: Free good, economic good and bad
Involve production cost x /X More is preferred x x

Free good Economic good Bad

Classification of goods

House Involve production cost More is preferred Economic goods

Classification of goods

Fresh air Not Involve production cost

More is not preferred

Free goods

Classification of goods

Advertisment Involve production cost

More is not preferred Bad

Classification of goods
Economic good Consumer good Capital good Generating income

Satisfying consumer wants

Classification of goods
Is stock a capital good?

NO! Stock is not a good at all!

Classification of goods
Is a computer a capital good?

Yes, if it is bought by a household for self-use.

No, if it is bought by a firm as its equipment.

Remark: A good can be either a Capital or Consumer good, depending on the propose of using it.

Classification of goods
Is a house a capital good?

Yes, you can rent it out to earn rental income. Remark: No matter for what purpose, government treats spending on house/flat as capital spending.

Classification of goods
Is a puppy in pet shop a capital good?

Yes, the dog is produced by the pet shop owner for making profit.

Classification of goods
Is a teacher in a school a capital good?

No! Human beings is not classified as good.

Opportunity Cost
(Cost) Opportunity cost =

the highest valued option(s) forgone.

Opportunity Cost
Example: You have the following options are available to you. Option1: having EF3440A class. Option2: watching 2. Option3: working overtime in office. Opportunity cost = Remark: Only the highest ranked options in the not-chosen group is your opportunity cost.

Opportunity Cost
Example: You have 3 hours and the following options are available to you. Option1: having EF3440A class. (3 hours) Option2: watching 2. (1.5 hour) Option3: working overtime in office. (1.5 hour) Opportunity cost = Remark: An opportunity cost of an action depends on the resources required.

Opportunity Cost
Example: Having EF3440A class. resources requirement: 3 hours + $6300
2 Iphone Time cost Money cost

Remark: always consider the total resources requirement of an action. Total Cost = Time Cost + Money Cost

Opportunity Cost
Example: Option1: having EF3440A class. (3 hrs+ $6300) Option2: work overtime and earn $100 per hr. Total CostOption1 = 3 hrs + $6300 = 3x$100 + $6300 = $6600 Remark: As we can always use $ to express the value of time, total cost can be

Opportunity Cost
Example: Option1: Having baby. (requested by your mother and your mother-inlaw) Option2: N.A. Option3: N.A. Opportunity cost of Option1 = Nil Remark: As there is no option forgone, there is no opportunity cost.

Opportunity Cost
Question: You have been waiting for a bus for 30mins already and you are told that the bus will come in 10mins time. What is your opportunity cost of waiting for the bus at this moment? A.10mins B. 30mins C. 40mins How about the already spent 30mins? Cost Sunk

Sunk Cost
The cost has been paid already. It will not affect your decision making. Sunk Cost is not a Cost. From previous example:
30min 10min

Wait / Not
Wait / Not

30min

60min

Remark: Only the cost will be incurred in the future counts!

Application of Sunk Cost

You decided to buy a flat in Parc Oasis ( ). It costs you $3M. After reading the least economic data, you expect the price of the property may drop further. As you have already paid $50000 as the first Sunk Cost deposit, should you keep on buying this flat?

Application of Sunk Cost

You planned to visit the US after this semester and paid $6000 in total for the air ticket. As you worry about the spread of H1N1, you are thinking whether to cancel the trip. Will your decision be affected if the airline company agrees to refund i) nothing or ii) 50% of the price to you?

Change in Opportunity Cost

Either one of the following changes will lead to a change in opportunity cost of an action: 1.Change in the value of the highest valued option forgone. 2.Change in the ranking of the options forgone. 3.Change in the resources requirement of the option being taken.

Change in Opportunity Cost

Option1: having EF3440A class. 100 Option2: watching 2. 50 -10 Option3: working overtime in office.
Option1: having EF3440A class. 100 80 Option2: watching 2. -10 Option3: working overtime in office. Change in the value of the highest valued option forgone.

Change in Opportunity Cost

Option1: having EF3440A class. 100 Option2: watching 2. 50 -10 Option3: working overtime in office.
Option1: having EF3440A class. 100 50 Option2: watching 2. 70 Option3: working overtime in office. Change in the ranking of the options forgone.

Change in Opportunity Cost

Option1: having EF3440A class. 2hrs Option2: watching 2. 2hrs 2hrs Option3: working overtime in office.
Option1: having EF3440A class. 4hrs 2hrs Option2: watching 2. 2hrs Option3: working overtime in office. Change in the resources requirement of the option being taken.

Change in Opportunity Cost

After class you went to the student canteen to have dinner. There were three options available: 1. small car noodles, 2. sandwiches, 3. Rice with two dishes. You decided to go for option 1. However after several bites, you discovered that a small living creature was swimming in the bowl. Would this affect you opportunity cost of choosing option 1? No! Change in value of the chosen option.

Production Possibility Frontier

PPF shows the maximum amount of outputs being produced by an economy with all its resources. Assumptions: 1.Only two goods (food and movie) are produced 2.Four labours with different productivities. 3.People are rational.

Production Possibility Frontier

Food Movie
Movie 10 9 7

A 1 4

B 1 3

C 1 2

D 1 1

Q: What information is given A: OC of producing 1 unit of Food in by the slope of the PPF? terms of Movie.

Q: Why is the PPF look like this? 4 A: It is an increasing Concave to the origin cost production.
1 2 3 4 Food

Production Possibility Frontier

Question: Under what situation, the PPF does not show the shape of concave to the origin?

Concept Map
Scarcity Make Choice Conflict Competition Price Competition Non-Price Competition
(Order)

Opportunity Cost

Market Economy How market work?

Command Economy