Chapter 1: Economic Issues and Concepts
-Market as self organizing
-Importance of scarcity, choice and opportunity cost
-Circular flow of income and expenditure
-Different types of economies (mixes of free markets, tradition and government intervention)
-Self interest, not benevolence, is the foundation of economic order.
-In transactions, both sides (the buyer and the vendor) profit
-Efficiency refers to organizing available resources to produce the goods and services that people most
value, when they most want them, and by using he fewest possible resources to do so.
4 Main characteristics of market economies
-Self interest guides individuals
-Individuals respond to incentives
-Prices and quantities are set in (relatively) free markets in which individuals trade voluntarily
-Institutions, created by the state, protect private property and enforce contractual obligations
-Think of Japan and New Zealand. About same size. One has 60 million sheep and 3 million people, the
other has 190 million people and 3 sheep. Where is land more scarce? In Japan, because humans result
in higher demand for land. So scarcity is about how many we have relative to how many we want. Prices
typically reflect scarcity (high prices usually means either there is a small supply or high demand).
Scarcity is NOT an absolute concept. Economics is the study of the use of scarce resources to satisfy
unlimited human wants.
-Implies the need for choice
-A society's resources are usually divided in land, labour and capital. (Inputs)
-Economists refer to resources as factors of production
-Outputs are goods (tangibles) or services (intangibles)
PPB (Production Possibility Boundary/Frontier)
-Downward sloping line because as one resource is used more for one product, it has to be used less for
another product. Represents opportunity cost.
-Concave from the origin: Because we have a lot of resources, which are not all equally well sorted to
produce various goods.
4 Key Economic Problems 1. What is produced and how?
-Resource allocation determines the quantities of various goods that are produced
2. What is consumed and by whom?
-What determines how economies distribute total output? Why do some people get a lot while
others only get little?
-Will the economy consume exactly what is produces?
-Microeconomics is the study of the allocation of the resources
3. Why are resources sometimes idle?
-An economy is operating inside its production possibilities boundary if some resources are idle.
-Under what circumstances are workers seeking jobs unable to find them?
-Should governments worry about the idle resources? Is there anything governments can do about
4. Is productive capacity growing?
-Growth in productive capacity is shown by an outward shift of the PPB
The complexity of Production
-Production usually displays two characteristics noted long ago by Adam Smith: specialization and
division of labour
-Specialization is the allocation of different jobs to different people. It is more efficient than self
-Individual abilities differ-Comparative advantage
-Focusing on one activity leads to improvements-learning by doing
Markets and Money
-Money facilitates trade.
-Specialization must be accompanied by trade.
-Money eliminates the cumbersome system of barter by separating the transactions involved in the
exchange of products, thereby facilitating specialization and trade.
-Underlying modern globalization is the rapid reduction of transportation and communication costs in
the last half of the 20th century
Today, no country can take an isolationist economic stance and hope to take part un the global
In this course we will discuss the extent to which the process of globalization changes markets and
changes the way government policy can influence economic outcomes.
1.4 Is there an Alternative to the Market Economy?
-Types of economic systems:
There are three pure types of economic systems: Traditional, Command, Free-Market
-Traditional: People do what there parents do. Ex: If Dad is a blacksmith son will also be a blacksmith -Command: People forced into their employment. Prices fixed by command. Ex: Soviet Union (1922 on)
-Free Market: In practice, every economy is a mixed economy, in the sense that it combines significant
elements of all three systems.
The Great Debate
-A century after Adam Smith, Karl Marx (1818-1883) argued that free-market economies could not be
relied upon to generate a "just" distribution of output.
-He argued the benefits of a centrally planned system
-By the last few decades of the 20th century, most of these countries were unable to provide their
citizens the rising living standards that existed in the more free-market economies
-In the last two decades of the 20th century, most governments replaced their systems of central
planning with much freer markets.
-->The Failure of Centralized Planning
-The failure of the centrally planned economies des not demonstrate the superiority of completely free
market economies. Instead, it shows the superiority of mixed economies.
Governments in the Modern Mixed Economy
-Key government-provided institutions in market economies are private property and freedom of
-Governments also intervene to:
-Correct market failures
-Provide Public Goods
-Offset the effects of externalities
-Markets often work well, but sometimes government policy can improve the outcome for society as a
Supply, Demand and Quantity