3 Nov 2012
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•Lecture 2
SECTION I. MARKET BASICS
Chapter 1. Economic Issues and Concepts
Content:
–view the market economy as self-organizing in the sense that coordination and order emerge
from a large number of decentralized decisions.
–the importance of scarcity, choice, and opportunity cost, and how all three concepts are
illustrated by the production possibilities boundary.
–the circular flow of income and expenditure.
–all actual economies are mixed economies, having elements of free markets, tradition, and
government intervention.
1.1. The complexity of the Modern Economy
The Self-Organizing Economy
Who or what provides the goods and services individuals desire?
Early economists noticed that the interaction of self-interested people creates a spontaneous social
order – the economy is self organizing.
Self-interest, not benevolence, is the foundation of economic order.
Adam Smith (1723-1790) : In the Weath of Nations, Smith was the first to develop this insightfully:
“It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but
from their regard to their own interest. We address ourselves not to their humanity but to their self-
love, and never talk to them of our own necessities but of their advantages.”
Efficient Organization
Loosely speaking, efficiency refers to organizing available resources to produce the goods and services
that people most value, when they most want them, and by using the fewest possible resources to do so.
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
1.2. Scarcity, Choice, and Opportunity Cost
Economics is the study of the use of scarce resources to satisfy unlimited human wants.
Resources
A society's resources are usually divided into land, labour, and capital.
Economists refer to resources as factors of production.
Outputs are goods (tangibles) or services (intangibles).
Scarcity and Choice
Resources can produce only a fraction of the goods and services desired by people.
Scarcity implies the need for choice.
Four Key Economic Problems
1. What Is Produced and How?
–resource allocation determines the quantities of various goods that are produced.
–In terms of our previous illustration, what combination of civilian and military goods will be
chosen?
–Will the economy be inside the production possibilities boudary – inefficiently used resources?
2. What Is Consumed and By Whom?
–what determines how economies distribute total output? Why do some people get a lot while
others get only a little?
–will the economy consume exactly what it produces?
–Microeconomics is the study of the allocation of resources as it is affected by the workings of
the price system.
3. Why Are Resources Sometimes Idle?
–an economy is operating inside its production possibilities boudary if some resources are idle.