The nature of economics The economic problem scarcity

The Economic Problem: Wants are unlimited but resources are scarce (limited resources) The problem of scarcity ensures that choices need to be made on how best to use scarce resources Because of this scarcity, economists and governments try to answer these questions:

1.What to produce? Which wants it will satisfy first, and which it will leave unsatisfied. Therefore it must decide what goods and services to produce. 2.How much to produce? To allocate limited resources efficiently and maximise the satisfaction of wants. 3.How to produce? Most effective method of production that uses the least amount of an economys resources 4.How to distribute production The allocation of these goods and services is based on income. People on higher incomes can afford to buy more goods and services than people on lower incomes and therefore receive a bigger share of total production.

Wants Types of Wants

Basic wants: Needs to survive Recurring wants: Must be continually satisfied, such as food Substitute wants: Can be used instead of another Luxury wants: Wants that are unnecessary to survive Complementary wants: Wants derived from other wants, such as petrol for a car. Individual wants: Personal preference Collective wants: Those wanted by a community or group.

Resources

Resources are known as factors of production and there are four of them. Factor of Production 1. Land 2. Labour 3. Capital 4. Enterprise Natural resources All forms of human effort used in the production process Resource used to create products, machinery and equipment Ability of entrepreneurs to take risks in organising resources to produce goods. Characteristics

The need for choice by individuals and society

The problem of relative scarcity means that individuals and societies always have choices to how best to satisfy their needs.

Opportunity cost and its application through production possibility frontiers

Opportunity cost something that is sacrificed in order to gain something else. It is the cost of the alternative foregone. For example, an individual who has 20$ to spend may want a new shirt or a new book. He or she decides to buy the book, so the opportunity cost is the value of the shirt. This illustrated using a model called the production possibility frontier. The model is a graph which shows us all the combinations of goods and services that can be produced by an economy at any given time, with the available resources and technology.

 X, demonstrates a point in which resources are not fully utilised by an economy or the economy is experiencing unemployment.

Y demonstrates a point in which the level of resources increases and hence more can be produced. Y can be achieved: More resources being available The quality of resources improves Improvements in technology enable more to be produced by each resource Improvements in technology used in the production of one good or reallocation of resources used for the production of that good result in a shift on the PPF A shift shows that more overall goods can be made using the same amount of resources.

Future implications of current choices by individuals, businesses and governments

Allocative Efficiency- Resources are allocated according to preference in society in order to maximize returns. But the current choices have implications for future choices. This is know as: Inter-temporal Budget Constraint- ie spending more money now means less money in the future and spending less money now may mean more money in the future.

Consumers: Consumers must make the choice to either spend their income for current satisfaction or save part of their income for future satisfaction. Income = Consumption + Saving: Y=C + S Consumption: C = Y - S Saving: S = Y C Business: Firms face opportunity cost of producing some goods and services and forgoing others Government: Budget for a deficit (spending > revenue) in the present may face higher debt levels and lower spending in the future Budget for a surplus (spending < revenue) government can repay current debt and spend more in the future

Economic factors underlying decision-making by: Individuals spending, saving, work, education, retirement, voting and participation in the political process
Ability to spend or save high income earners have greater choices than low income earners Work, education and retirement longer you work the more income received and as a result the more wealth you create to spend during retirement Voting and political process participation decisions on areas such as health care, education and taxation will all influence your quality of life and choices you are able to make

Business pricing, production, resource use, industrial relations

Pricing seeking profit maximization. Pricing is important as total cost must be covered and still have surplus to maintain sufficient profit or return on their capital goods to stay in business. Production and resource use aim is to produce efficiently at minimum cost. Businesses must decide their method of production based on finding the to produce efficiently at minimum cost using various resources such as Land, Labour and Capital. As technology changes, so to will a companies methods of production.

Industrial relations management of employees: pay rates, encouraging union representation, individual contracts or wage agreements with whole workforce

Governments influencing the decisions of individuals and business.

Make decisions about revenue and expenditure that influence the decisions of consumers and business The taxes (personal income and GST) influences businesses and individual Produce goods and services to meet demand Regulate operation of market (laws)

The operation of an economy Production of goods and services from resources Natural, labour, capital and entrepreneurial resources
Factors of Production- the inputs into the production process that are required to make goods and services.

RESOURCES
Land Labour Capital Enterprise

Resources that come from that land Includes: Productive Resources: Natural Resources - Trees - Minerals - Animals

Means of production (E.g. Machines in the factory) Work done that will bring about the product

Human effort (work)

Capacity to take land, labour & capital & organise them into productive outputs (A person who can achieve this is called an entrepreneur)

Distribution of goods and services

Gross Domestic Product (GDP): - The total number of g + s produced in an economy in a given year - Measures the total income of a society that is received for the production of g + s One of the main functions of an economic system involves giving everyone an income. Individuals can then exchange this income to obtain g + s

Exchange of goods and services

Individuals and businesses use money as a medium for exchanging. To maximise the use of resources, individuals and businesses should concentrate on producing those goods and services, which they are best at producing. This concentration of production is referred to as specialisation.

Provision of income
People can earn income by selling resources, goods and services or producing goods or services. The operations of the economy will allow people to earn income. The four factors of production can generate income. Factor of production Land Labour Capital Enterprise Factor income return Rent Wages Interest Profit

Provision of employment and quality of life through the business cycle

The operation of the market facilitates the use of resources to produce different goods and services. By doing this, the operation of the economy creates employment for people. The increased production of employment are considered to improve the quality of life or people

During periods of recessions, firms usually postpone plans for new investment, reduce their production and reduce demand for labor. As a result, employment falls and many people become unemployed. During periods of growth, firms invest in employment and demand for labor increase. As a result, employment rises and improves quality of life Business Cycle Boom (expansion): Rising levels of consumption and investment Falling unemployment Rising income levels Rising quality of life Recession (trough): Falling production of goods and services Falling levels of consumption and investment Rising unemployment Falling income levels Falling quality of life

The circular flow of income

The Circular flow of income describes how economic activity occurs between different sectors. We can divide the Australian economy into five sectors: individuals, businesses, financial institutions, governments, international trade and financial flows. Saving, taxation and spending on imports represent leakages Investment, government spending and export revenue represent injections Leakages decrease economic activity Injections increase economic activity

Individuals
Households/individuals: Spend income on goods and services Supply factors of production to business to carry out production (labor) Rewarded with income, rent, interest and profit

Businesses
Businesses o Purchases factors of production and utilizes them to produce goods and services o Rely on individuals, households to supply resources, as well as to consume goods and services

2 SECTOR MODEL:
Factors of Production: Land, Labour, Capital & Goods & Services Consumption Expenditure
Income Output Enterprise

HOUSEHOLDS

BUSINESSFIRMS

Income from factors of production: - Wage - Profit - Interest - Rent

Financial institutions
Financial Sector: Made up of financial enterprises and financial markets They take savings from household sector, pay interest for the money and lend the businesses to carry out investment Level of savings does not have to equal the level of investment in the economy

3 SECTOR MODEL:
Factors of Production: Land, Labour, Capital & Enterprise
Aggregate Income

Goods & Services

Consumed

Saved

HOUSEHOLDS
Consumption Expenditure

BUSINESSFIRMS

Savings (S)

Income from factors of production: - Wage - Profit - Interest - Rent

Investment (I)

Collective Income of Every Household Added Together

FINANCIAL SECTOR
Banks Are Intermediaries

Governments
Government takes part of your income in the form of taxation Government injects money by government expenditure on roads, education, health, defense etc The Government uses the Financial Sector and Government Sector to manipulate the economy through the Fiscal Policy and the Monetary Policy.
Factors of Production: Land, Labour, Capital & Enterprise

4 SECTOR

MODEL:

Goods & Services

HOUSEHOLDS
Consumption Expenditure

BUSINESSFIRMS

LEAKAGE
Taxation (T)

Savings (S)

Income from factors of production: - Wage - Profit - Interest - Rent

Investment (I) Government Spending (G)

INJECTION

FINANCIAL SECTOR
Banks Are Intermediaries

GOVERNMENT SECTOR

International trade and financial flows

Involves transfers of money to and from overseas in exchange for goods and services X > M leads to higher economic growth X < M slows economy down Net exports = exports imports where a positive level is expansionary and a negative value is contractionary

5 SECTOR Model
Factors of Production: Land, Labour, Capital & Enterprise

Goods & Services

HOUSEHOLDS
Consumption Expenditure

BUSINESSFIRMS

Savings (S)

Income from factors of production: - Wage - Profit - Interest - Rent

Investment (I) Government Spending (G)

LEAKAGE

Taxation (T)

FINANCIAL SECTOR
Banks Are Intermediaries

Exports (E)

INJECTION
Imports (M)

GOVERNMENT SECTOR INTERNATIONAL SECTOR

Equilibrium Equilibrium when injections = injection (balance) In the five-sector model, the circular flow is in equilibrium when all leakages are matched by injections. This is when:
Savin gs a x a x Impo rts Investme Go nts vt. Expo rts

Injection and Leakages definition

Injections are investment (I), government expenditure (G) and exports (X) Leakages are savings (S), taxation (T) and imports (M)

Injection

When injections become greater then leakages, we have economic growth Injections > Leakages when more income is going into the circular flow, which leads to increased demand and production. Then expansion in economy
Savin gs

Leakages Injections < withdrawals less spending is taking place which reduces demand for labor and production

T a x

Imp orts

Investme Go nts vt.

Exp orts

S + T + M > I + G + X then contraction in economy

Economies: their similarities and differences Types of economic systems Economic System Ownership of Resources Private ownership of Market Economy (USA) resources
Role of the Market Market allocation of resources Price mechanism is the main device for resource allocation Market allocation of resources Role of the Government Limited government intervention

Mixed Market Economy (Australia)

Private ownership of resources Price determines distribution

Substantial government intervention Enforce laws and order Stabilizer of eco activity Redistribution income through taxation and welfare

Planned Economy (Korea)

Public ownership of properties and resources Private ownership of resources High rates of economic growth and high rates of domestic saving and foreign investment Changing from planned to market economic systems

Limited role of markets No freely operated market Market allocation of resources

Government plays a dominant role in economic, political and cultural life

Newly Industrialized Economy (Taiwan) Formerly developing economies but not had developed a high rate of economic growth Economy in Transition (Poland)

Major role in develop strategic industries

Increasing role of market allocation

Significant but declining role of government

Economies can be compared based on a number of economic variables: Economic growth (GDP or GNP)

 Employment and unemployment (rate of unemployment, underemployment, employment by sector) Quality of life (the HDI) Environmental quality (links to economic growth, government policy) Role of government (level and type of intervention)

Examine similarities and differences between Australia and Indonesia

Australia Economic growth

Indonesia

15th largest economy in the world Average rate of GDP pc growth was 1.7% HDI of 0.965 Ranked 4th in the world Far higher living standards Participation rate of the working age pop. was 65.3% Workforce: 55.2% males, 44.8% females Largest percentage of workforce in tertiary industries Richest 10% of income earners account for 25.4% of wealth High level of environmental quality Land zone, government policy Govt. consumption accounts for 18% of GDP High tax base Achieves regular surpluses High percentage of expenditure spent on social welfare

20th largest economy in the world Average rate of GDP pc growth was 5.1% HDI of 0.726 Ranked 109th in the world Far lower living standards Participation rate of the working age pop. was 68% Workforce: 62.1% males, 37.9% females Largest percentage of workforce in primary industries, followed by tertiary Richest 10% of income earners account for 28.5% of wealth Deterioration in the quality of the environment Significant deforestation Govt. consumption accounts for 8% of GDP Low tax base Achieves regular surpluses Spends less on health, education and social welfare than Aus. Govt. as a percentage of GDP and in terms of total govt. expenditure. Low percentage of expenditure spent on social welfare

Quality of life

Employment and unemployment

Distribution of income Environmental sustainability

The role of government in health care, education and social welfare