Test 1 (Basic Economic Problem, The Allocation of Resources)
Definitions:
● Economics: The study of how individuals and society make decisions and
allocate scarce resources.
● Micro-Economic: The study of making decisions by individual and businesses
concerning the distribution of resources and prices of goods and services (deal
with individual units or groups)
● Macro-Economic: The study of how the whole economy behave (deal with
nation and economy as a whole)
● Needs: Goods and services that are required for surviving.
● Wants: Goods and services that are not necessary but people desire or wish
to have it.
● Production: Creating goods and services.
● Consumption: Using the goods and services to satisfy wants.
Goods and Services
● Goods are tangible (can be seen, touched) and can be consumed.
- Consumer goods: product purchased by consumers for personal/ household
use.
- Capital goods: means of production (machinery)
- Non-durable goods: do not last for a long time (perishable), e.g. Food, fruit,
biscuit
- Semi-durable goods: last for less than 1 year, e.g. Clothing for winter
- Durable goods: last for more than 1 year, e.g. Cars, house’;
● Services are intangible (cannot be seen, touched), it is usually actions that
people perform.
- E.g. Medical services, education services, haircut.
Basic Economic Problem
● Scarcity and choices
● Resources are limited but wants are unlimited, therefore we have to make
choices to allocate scarce resources.
Choice
● The term “choices” from a business perspective refers to what to produce, how
to produce and for whom to produce.
, ● What to produce: Goods and services that the economy should produce to
satisfy people’s needs and wants.
● How to produce: The process of using skills and resources to produce goods
and services (with the least amount of material to earn the most profit)
● For whom to produce: How the goods and services are allocated and
distributed in the society (target market).
● These are the questions that are trying to solve the basic economic problem.
Factors of Production
● Capital
- Man-made aid for production that humans used to produce goods and services.
- E.g. Machinery, tool, vehicle
- Reward for capital is interest
● Enterprise (Entrepreneur)
- The risk taker who organizes the whole production process and the other 3
factors of production to earn the profit.
- Reward for the enterprise is profit
● Labour
- Human input into production, required man’s mental and physical ability.
- Reward for labour is wages/salaries
● Land
- Natural physical resources
- E.g. Mining, agriculture, fishing, forestry
- Reward for land is rent
Economic Goods and Free Goods
● Economic Goods
- Created by human
- Scarce, not free
- With price, pay before getting it.
- Demand more than supply
- (E.g. Electricity, Piped water, car)
● Free Goods
- Created by nature
- Free, not scarce
- No price, don’t need to pay
- Supply more than demand
- (E.g. Air, sea water, rainwater)
,Mobility of Factors of Production
● It means the transfer or movement of the factors of production from one industry
(place) to the other.
● Geographical mobility
- Geographical mobility is the movement of factors of production (except land)
from one place to the other.
- Usually caused by factors such as migration control, family and social ties, and
difference in cost of living.
- Land has no mobility because it is immobile (fixed), we can’t shift it from one
place to the other
● Occupational mobility
- Occupational mobility is the movement of labour to transfer from one occupation
or jobs to the other.
- Usually caused by the level of transferable skills and the educational
requirements of the jobs.
Opportunity Cost
● The next best alternative forgone (the next best alternative that is sacrificed
when making a choice)
● E.g. You give up studying for the test and choose to watch a movie, the
opportunity cost of watching the movie will be the good grade that you will
receive if studying for the test.
● Opportunity cost should be considered when making economic choices to
prevent undervaluing and overuse of important resources.
● The reason for making a certain choice could be the opportunity cost of not
having this is higher/lower than the other.
Production Possibility Frontier
● A curve depicting the various combinations of 2 products (or 2 types of
product) and the maximum possible output that can be produced when all the
available resources are fully and efficiently employed. (various combination of 2
goods, maximum possible output of 2 goods)
● Law of increasing opportunity cost:
- When all resources are fully and efficiently employed, an increase in the
production will lead to a greater forgone production of another good.
- As the production of one good increases, the opportunity cost to produce another
good will increase (the production decreased)
● The amount of decreased product is the opportunity cost of producing more of
the other product.
, ● How does the PPF show opportunity cost?
- The specific number of goods you are giving up each time is the opportunity
cost of producing another good.
● How does the PPF show scarcity?
- The frontier shows limited resources
- You can’t produce anywhere beyond the production possibility curve.
● How does the PPF show efficiency?
- Any point inside the curve shows that resources are not fully and efficiently
utilised.
- Any point on the curve shows that resources are fully and efficiently utilised to
reach its maximum production possibility.
- Points outside the curve are unattainable, it is impossible at the current level of
resources.
● Any point inside the PPF
- Resources are not fully and efficiently utilised
● Any point outside the PPF
- Impossible at the current level of resources (unattainable, someone may
have done mistakes)
● On a curved line, the opportunity cost is not constant, and we can see the
influence of the law of diminishing returns.
- The opportunity cost of the unit of goods that are given up each time are
increasing.
- Law of diminishing returns:
→ Only occur when one factor of production is fixed, the other varies
→ If the varied factor of production increases, there comes a point where it will
become less productive and less efficient.
→ If a capital is fixed, but extra workers are added, they could get into each
other’s way, and the production will increase but more and more slowly.
● A straight line PPF shows a constant opportunity cost between 2 products
- The opportunity cost of the unit of goods that are given up each time are the
same.
● PPF shift outwards (expand)
- If we have a change in resources (capital, labour, land), the productivity
increased, and the PPF will expand and shift outwards.
- The new resources are able to be utilised and allow more to be produced.
- Increase in technology → increase in productivity
- Training (education) → skills improved → Increase in productivity
● PPF shift inwards (contract)
- The productivity decreased
Definitions:
● Economics: The study of how individuals and society make decisions and
allocate scarce resources.
● Micro-Economic: The study of making decisions by individual and businesses
concerning the distribution of resources and prices of goods and services (deal
with individual units or groups)
● Macro-Economic: The study of how the whole economy behave (deal with
nation and economy as a whole)
● Needs: Goods and services that are required for surviving.
● Wants: Goods and services that are not necessary but people desire or wish
to have it.
● Production: Creating goods and services.
● Consumption: Using the goods and services to satisfy wants.
Goods and Services
● Goods are tangible (can be seen, touched) and can be consumed.
- Consumer goods: product purchased by consumers for personal/ household
use.
- Capital goods: means of production (machinery)
- Non-durable goods: do not last for a long time (perishable), e.g. Food, fruit,
biscuit
- Semi-durable goods: last for less than 1 year, e.g. Clothing for winter
- Durable goods: last for more than 1 year, e.g. Cars, house’;
● Services are intangible (cannot be seen, touched), it is usually actions that
people perform.
- E.g. Medical services, education services, haircut.
Basic Economic Problem
● Scarcity and choices
● Resources are limited but wants are unlimited, therefore we have to make
choices to allocate scarce resources.
Choice
● The term “choices” from a business perspective refers to what to produce, how
to produce and for whom to produce.
, ● What to produce: Goods and services that the economy should produce to
satisfy people’s needs and wants.
● How to produce: The process of using skills and resources to produce goods
and services (with the least amount of material to earn the most profit)
● For whom to produce: How the goods and services are allocated and
distributed in the society (target market).
● These are the questions that are trying to solve the basic economic problem.
Factors of Production
● Capital
- Man-made aid for production that humans used to produce goods and services.
- E.g. Machinery, tool, vehicle
- Reward for capital is interest
● Enterprise (Entrepreneur)
- The risk taker who organizes the whole production process and the other 3
factors of production to earn the profit.
- Reward for the enterprise is profit
● Labour
- Human input into production, required man’s mental and physical ability.
- Reward for labour is wages/salaries
● Land
- Natural physical resources
- E.g. Mining, agriculture, fishing, forestry
- Reward for land is rent
Economic Goods and Free Goods
● Economic Goods
- Created by human
- Scarce, not free
- With price, pay before getting it.
- Demand more than supply
- (E.g. Electricity, Piped water, car)
● Free Goods
- Created by nature
- Free, not scarce
- No price, don’t need to pay
- Supply more than demand
- (E.g. Air, sea water, rainwater)
,Mobility of Factors of Production
● It means the transfer or movement of the factors of production from one industry
(place) to the other.
● Geographical mobility
- Geographical mobility is the movement of factors of production (except land)
from one place to the other.
- Usually caused by factors such as migration control, family and social ties, and
difference in cost of living.
- Land has no mobility because it is immobile (fixed), we can’t shift it from one
place to the other
● Occupational mobility
- Occupational mobility is the movement of labour to transfer from one occupation
or jobs to the other.
- Usually caused by the level of transferable skills and the educational
requirements of the jobs.
Opportunity Cost
● The next best alternative forgone (the next best alternative that is sacrificed
when making a choice)
● E.g. You give up studying for the test and choose to watch a movie, the
opportunity cost of watching the movie will be the good grade that you will
receive if studying for the test.
● Opportunity cost should be considered when making economic choices to
prevent undervaluing and overuse of important resources.
● The reason for making a certain choice could be the opportunity cost of not
having this is higher/lower than the other.
Production Possibility Frontier
● A curve depicting the various combinations of 2 products (or 2 types of
product) and the maximum possible output that can be produced when all the
available resources are fully and efficiently employed. (various combination of 2
goods, maximum possible output of 2 goods)
● Law of increasing opportunity cost:
- When all resources are fully and efficiently employed, an increase in the
production will lead to a greater forgone production of another good.
- As the production of one good increases, the opportunity cost to produce another
good will increase (the production decreased)
● The amount of decreased product is the opportunity cost of producing more of
the other product.
, ● How does the PPF show opportunity cost?
- The specific number of goods you are giving up each time is the opportunity
cost of producing another good.
● How does the PPF show scarcity?
- The frontier shows limited resources
- You can’t produce anywhere beyond the production possibility curve.
● How does the PPF show efficiency?
- Any point inside the curve shows that resources are not fully and efficiently
utilised.
- Any point on the curve shows that resources are fully and efficiently utilised to
reach its maximum production possibility.
- Points outside the curve are unattainable, it is impossible at the current level of
resources.
● Any point inside the PPF
- Resources are not fully and efficiently utilised
● Any point outside the PPF
- Impossible at the current level of resources (unattainable, someone may
have done mistakes)
● On a curved line, the opportunity cost is not constant, and we can see the
influence of the law of diminishing returns.
- The opportunity cost of the unit of goods that are given up each time are
increasing.
- Law of diminishing returns:
→ Only occur when one factor of production is fixed, the other varies
→ If the varied factor of production increases, there comes a point where it will
become less productive and less efficient.
→ If a capital is fixed, but extra workers are added, they could get into each
other’s way, and the production will increase but more and more slowly.
● A straight line PPF shows a constant opportunity cost between 2 products
- The opportunity cost of the unit of goods that are given up each time are the
same.
● PPF shift outwards (expand)
- If we have a change in resources (capital, labour, land), the productivity
increased, and the PPF will expand and shift outwards.
- The new resources are able to be utilised and allow more to be produced.
- Increase in technology → increase in productivity
- Training (education) → skills improved → Increase in productivity
● PPF shift inwards (contract)
- The productivity decreased
