Fundamental economic problems
of societies
• Scarcity
• Choice
• Economic goods
• “Free goods"
• What to produce?
• How to produce?
• For whom?
Opportunity Cost
• "The sacrifice of the next best alternative"
• Always measured in terms of the "next best
alternative", never in money terms!
Production Possibilities
• The marginal rate of transformation (e.g. 1 car to 2.5
chemicals)
• Constant returns versus diminishing returns
• Full employment, unemployment and under-employment
• Capital accumulation and technological change
• The social welfare function (SWF) or sometimes called
the community indifference curve
• Technical (least resources to achieve objective) and
allocative efficiency (least cost resources to achieve
objective).
Positive and normative statements
1. There are more than 6 cars in the car park
2. There is an elephant in the car park
3. There is not enough space in the car park
4. The government should try to reduce the level of
unemployment
5. A rise in interest rates will, ceteris paribus, cause a fall
in consumption expenditure
6. Terriers are dangerous dogs
7. Economics is more difficult than Business Studies
8. When the price of a good falls the quantity demanded
rises.
The division of labour 1
• Advantages of the division of labour
– Greater level of skills developed in a narrow range of
tasks
– Less training required owing to smaller range of tasks –
although specialised training could be more expensive
– Considerable experience of the task
– Less equipment required by the worker (one set of
tools)
– Time saved by not changing from job to job
– Can make use of individual aptitudes
– Higher productivity (output / input) owing to increased
skills
The division of labour 2
• Disadvantages of the division of labour
– boredom (alienation)
– inflexibility
– interdependency (may be a problem) strikes by small
number of workers or breakdowns in the ‘chain’ can be
disruptive to a wide range of workers and outputs
Features of the market economy
• Decentralised decision making - Adam
Smith’s ‘invisible hand’
• Scope for enterprise
• Enterprise and initiative rewarded
•
Free market system
Consumers, producers, private ownership and
government
• Consumers attempt to maximise their utility or
welfare
• Producers attempt to maximise benefits to those
connected to the firm - in (very) simple terms they
try to maximise (long-run?) profits
• Government supplies the police force, the legal
system and external defence to enable contracts to
be respected and that production and trade can
take place free from internal or external
disturbance
Centrally Planned Economies
• The nature of centralised planning and
control
• Problems of deciding "demand" and
allocating factors of production
• The principles of linear programming as
illustration of the practical problems
Mixed Economies
• Nearly all economies are mixed economies
• Real government expenditure, transfer
incomes, economic controls and regulations
• Nationalisation v. privatisation
The Market Mechanism
• Adam Smith's "invisible hand"
• The nature of demand, supply and market price
• Private ownership, initiative and responsibility
• The role of prices (including wages, profits,
dividends, interest and rent) as a signalling device
• Differences between market goods, non-market
goods, free goods, public goods and merit goods
Weaknesses of the Market
System
• Time lags, that is, information, decision and
implementation delays
• Market imperfections e.g. monopoly power,
cartels
• Unequal (unfair?) distribution of income and
wealth
• The production of "bads" (negative externalities
e.g. pollution & congestion) as well as “goods and
services”
Disadvantages of market system
• Absence of certain property rights leads to
problem of externalities
• Inequality of (‘voting’) purchasing power
• Inadequate information
• Public goods
• Monopoly power
Examples of problems in the free
market economy
• Bus services to outlying areas
• The poor who cannot afford ‘minimum’
purchases of goods and services
• The polluting factory
• The noisy neighbour
Market efficiency
• Three criteria:
– Consumption efficiency
– Production efficacy
– Exchange efficiency
Absolute advantage
• “A country has an absolute advantage over
another in the production of a good if it can
produce it with less resources than the other
country can.”
Definition from Sloman 5th Ed., Glossary.
• Thus, the focus is on the absolute amount of resources used to
produce a good rather than on relative efficiency.
