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Chapter 1- Economics Foundations and models.docx

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Monash University
Philip Grossman

Microeconomics Week 1 Chapter 1 Economics the study of the choices people and societies make to attain their unlimited want, given their scarce resources. In other words the study of choices consumers, business managers and government officials make to attain their goals, given their scarce resources  Choice- the choice reflects the trade-offs people face because we live in a world of scarcity. The choices we make influence our incentives i.e. reward or penalty.  Scarcity- the situation in which unlimited wants exceed the limited resources available to fulfil those wants.  Resources- inputs used to produce goods and services, including natural resources such as land, water and minerals, labour, capital and entrepreneurial ability. These are otherwise referred to as factors of production There are three important economic ideas, when people make choices: 1. People are rational- assumes that consumers and firms sues as much of the available information as they can to achieve their goals. Rational individuals weigh the benefits and costs of each action, and they choose an action only if the benefits out weight the costs. 2. People respond to economic incentives- the emphasis that consumers and firms respond to economic incentives i.e. reward or penalty 3. Optimal decisions are made at the margin-economists use the word ‘marginal’ to mean extra or additional. The optimal decision is to continue any activity up to the point where the marginal benefit equals the marginal cost. SCARCITY, TRADE-OFFS AND THE ECONOMIC PROBLEM THAT EVERY SOCIETY MUST SOLVE As we live in a world of scarcity, society cannot have it all. Therefore, society faces trade- offs. Trade-off is the idea that because of scarcity, producing more of one good or serve means producing less of another good or service. Trade is VOLUNTARY exchange between two or more people (for money, for other goods i.e.: barter, for satisfaction) that makes ALL PARTICIPANTS BETTER OFF! There are three fundamental questions for trade-offs: 1. What goods and services will be produced? Opportunity cost- any activity is the highest-valued alternative that must be given up to engage in that activity 2. How will the goods and services produced? 3. Who will receive the goods and services produced? THE TWO TYPES OF ECONOMIES We have two types of economy: 1. Centrally planned economy- an economy in which the government decides how economic resources will be allocated  Example : Soviet Union  The government decides what goods to produce, how the produce them and who would receive them. Thus, objective is not to satisfy consumers but follow orders.  Disadvantage: not successful in producing low-cost, high quality goods and services 2. Market economy-an economy in which the decisions of households and firms interacting in markets allocate economic resources.  Example: high-income democracy countries such as Australia, Canada etc…  Rely on primarily on privately owned firms to produce goods and services and deice how to produce them.  Markets rather than government determine who receives the goods and services produced. The objective is to satisfy consumers in terms of their wants and needs. In essence ultimately consumers decide what goods and services will be produced, thus the concept called consumer sovereignty. Consumer sovereignty concept that firms produce goods and services that meet the wants of consumers or the firms will go out of business. Therefore it is ultimately consumers who decide what goods and services will be produced. EFFICIENCY AND EQUITY Market economy tends to be more efficient than centrally planned
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