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Principles of Microeconomics Production Possibility FrontiersINTRODUCTIONAlfred Marshall the founder of modern Microeconomics in 1890 defined Economics as the study of mankind in the ordinary business of life it examines that part of individual and social action which is most closely connected with he attainment and with the use of the material 1requisites of wellbeingRecent textbooks prefer the following definition Economics is the study of how society chooses to allocate its relatively limited resources among the unlimited wants of its membersMarshalls definition is more general and compatible with any approach to Economics The textbook definition uses the most important terms in microeconomicsscarcity choice resource allocation and wantsbut also contains the assumption that human wants are unlimitedThis approach follows from the understanding of an economic good as scarce ie one for which wants Demand are greater than the availability quantity SupplyIf quantity is greater than wants such as for oxygen there is no scarcity and thus no problem of allocation among choicesThe statement that wants are unlimited ensures that there will always be economic goods since wants will always expand faster than our technological ability to satisfy themEconomic theory begins with clear definitions and simplifying assumptions and then proceeds by logic to conclusions about economic relationshipsThis approach appears definitive in its abstraction but is based on years of empirical observation and debatesThe definitions and assumptions are simplified to facilitate the logical analysis but this simplification is the source of most criticism of the theory since the subsequent logic is usually unassailableThe issue of assumptions is at the heart of the distinction between positive and normative economicsMost modern economists subscribe to positive economics which claims to describe reality through empirical observation without introducing assumptions about what ought to beThe normative approach sees economics as the means to achieve ethical endsPositive economics attempts to 1 Alfred Marshall Principles of Economics Prometheus Books 1997 11 Principles of Microeconomics Production Possibility Frontiersunderstand the phenomenon of homelessness for example while normative economics focuses on eliminating homelessness due to the assumption that it is unfair or demeaning Milton Friedman the most influential economist in the second half of the twentieth century insisted that the correctness of assumptions was not as important to economic theory as the ability to predict reality He argued that the effectiveness of theory improves with the simplification of assumptions relative to realityA map for example is most effective as stylized lines to represent roads rather than a faithful depiction of the differences between the roads ResourcesDefinition Commodities are goods physical and services nonphysical exchanged in marketsDefinition Resources are the inputs used in the production of goods and servicesIt is the limit to resources that limits the production of commoditiesClassical economics 17701870 divided resources into three categoriesLand Capital and Labourcalled the factors of production but modern economics adds Entrepreneurship as a fourth category of resourceEach factor of production has a corresponding factor return Rent for Land Interest for Capital Wage for Labour and Profit for EntrepreneurshipSince we concentrate only on Labour and Capital in this course we will typically use profit for the return to capital but this is not strictly correctLandLand is defined as a natural resource ie a nonhuman input not produced by societyCapital KCapital is defined as a nonhuman input that has been produced by human societyNoteCapital is always physical not merely financialBonds stocks mortgages etc are financial assets but they are not capital because a they are not inputs in the production process and2
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