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economics

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It is necessary for a better understanding of the world in which we live. As citizens we are required to vote for various political parties which have definite policies to be implemented when they are in power.Economics began just over 200 years ago when Adam Smith published "an inquiry into the nature and causes of the wealth of nations" in 1776."Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses". Lionel Robbins

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John Maynard Keynes

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English economist, defined Economics as "an apparatus of the mind, a technique of thinking".

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Adam Smith

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published "an inquiry into the nature and causes of the wealth of nations" in 1776.

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Resources or factors of production

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Resources are anything which can be used to satisfy wants - also known as "factors of production".For something to be regarded as a resource it must be known and available for use in the production process. Land, Labour, Capital, Enterprise

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Land

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Land is all the things which nature provides and which may be used in the production of things people want eg. Food, minerals, water, timber, sunlight, air

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Labour

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Labour is all forms of human work Economists are concerned with: (a)the quantity of work done (b)the quality of work done

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quantity

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Time, Desire/incentive, Pay, Size of population, Age structure of the population, Sex composition of the population, Length of working week, Retirement age

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quality

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education and training, working conditions, machinery and technology available

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Capital

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Capital is NOT money, Capital is any good which has been produced specifically for the purpose of producing other goods. Eg. Machines, tools, computers Some types of capital are known as social capital - this is non-commercial assets which are owned by society which indirectly contribute to future production. Eg: parks, libraries, public transport, hospitals

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Enterprise

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Enterprise is the ability to initiate the production process by organising and combining all of the necessary factors of production. This is done by the entrepreneur. If this is done efficiently the entrepreneur will make a profit. The entrepreneur also takes all the risks associated with production

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Scarcity

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Because people have infinite wants and the resources available to satisfy those wants are finite, economists talk about the problem of scarcity.The scarcer something is, the higher will be its economic value - its cost, or what you have to give up in order to obtain it.

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how do you know if a good is scarce

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1. It must be limited in supply 2. People must want it 3. Society must give something up in order to obtain it

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choice and opportunity cost

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Because of the problem of scarcity, all economies are faced with decisions of choice. Since resources are used up in production, each economic system must make decisions concerning which goods and services to produce. The act of choosing between wants means that the act of satisfying one want inevitably results in the foregoing of another. The alternative foregone is referred to as the opportunity cost.

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the economic problem

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Wants are unlimited. Resources which are used to satisfy wants and which have alternative uses, are limited. Since there are not sufficient resources to satisfy all our wants, we must make a choice. We must choose which wants we will satisfy, and which we will leave unsatisfied.

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factors of production (the 3 main questions)

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1. What to produce? (And how much?) 2. How to produce? 3. For whom to produce?

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What to produce? (And how much?) (DEFINE)

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Of all the goods and services which could be produced, which ones will our society actually produce?

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How to produce? (DEFINE)

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Of the various techniques which could be used to produce, which ones will we actually use?

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For whom to produce? (DEFINE)

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(or how to distribute the goods produced to the various members of society)

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All societies have an organisational and institutional pattern called an economic system which solves the economic problem in different ways. Eg. Government, firms, trade unions, universities Institution- a way of doing things

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...

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solving the economic problem: economic systems

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History has produced 3 economic systems which each try to solve the economic problem in different ways: 1. the traditional or subsistence economy 2. the market economy (or private enterprise or capitalist economy) 3. the centrally planned economy (or communist, command, planned economy)

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A major difference between the market economy and the communist economy is the role of the government. Australia is clearly a market economy, but the government also plays a major role - in fact Australia is a MIXED MARKET ECONOMY.

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...

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the market economy

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The key features of a market economy are as follows: private ownership of property use of market prices- the "price mechanism" self-interest as peoples motivation minimal government interference

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There are 2 important groups in this society:

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Circular flow system:

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What to produce? (And how much)

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This is decided by the interaction of consumers and firms in the market place. the nature and prices of goods and services produced are determined by dollar votes cast in the market place by consumers.

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How to produce?

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The entrepreneur will decide the production method by attempting to combine the factors of production in the most efficient manner.

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for whom to produce?

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This is determined by the incomes received by each person and the prices at which goods are sold.

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advantages of the market economy

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1.The free operation of the PM (price mechanism) gives rise to an efficient allocation of resources, 2.Firms, seeking profits, will produce a great volume and variety of goods and Services, catering for a wide variety of tastes and choices, 3.Firms will always try to innovate, 4.The system is adaptable and flexible - chasing profits and facing tough competition means that firms adapt to changes as quickly as possible (or go out of business), 5.The market economy is self-regulating - problems of over-supply or shortage are solved by the price mechanism without the need for an expensive government bureaucracy, 6.The market economy gives people the maximum amount of personal and economic freedom

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disadvantages of the market economy

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1.Competition and the price mechanism lead to income inequalities. 2.Inequality of income leads to inequality of opportunity. 3.On its own, the price mechanism fails to provide an adequate volume of collective goods and services eg public transport, health, defence, education do not produce much profit and would therefore not be produced in sufficient quantity. 4.The market system doesn't consider social costs. 5.Self interest and the pursuit of profit will mean competition. 6.The free market tends to be quite unstable, leading to fluctuations in the level of economic activity.

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trade cycle

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...

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the circular flow model

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The modern economy is a complex organisational system. In order to develop an understanding of how it works, we must first break it down into its major component parts. These parts are known as the sectors of the economy.

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Total Income ($) = Total Output ($) = Total Expenditure

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...

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Y=

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total income

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O=

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total output

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E=

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total expenditure

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YOE formula

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Y=O=E

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total expenditure

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Income and expenditure are closely related.The expenditure of one person is income to another person.Thus expenditure by households on goods and services represents income to firms which produce those goods and services

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Investment

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the production and the purchase of new capital goods by business firms

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the financial sector

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consists of what we call financial intermediaries (in other words banks, building societies etc).

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Equilibrium: the equality of saving and investment

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It is the injection of investment expenditure which offsets the leakage of saving from the circular flow. We can write this condition for equilibrium as an equation

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equilibrium equation

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S = I

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taxation

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Taxation, of all kinds, represents a leakage from the circular flow. For example, when households pay income tax the amount of money they have for expenditure is reduced.

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Government expenditure

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Government expenditure represents an injection into the circular flow.When the government spends money on collective goods and services the incomes of those involved in producing these things rise. When the government spends more on welfare payments (such as pensions, unemployment benefits etc) the incomes of those households receiving them rise.

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Equilibrium and the four-sector model

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If leakages remove money from the circular flow and injections add money back in, our model must now be in equilibrium if the sum of leakages equals the sum of injections. Thus the 4 sector economy will be in equilibrium when: S + T = I + G

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Government intervention in the circular flow - the Budget

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The Federal Government finances its expenditure mainly through taxation. If the government spends more than it receives in taxation it may need to borrow - such borrowing takes place through the financial sector.Government plans for spending, taxing and borrowing are known as fiscal policy

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The budget can have 3 possible outcomes.......

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1.Total government spending may equal total tax collections (G = T). This is called a balanced budget. 2.Government spending may exceed tax collections (G > T). This is a budget deficit. The government will have to borrow to finance the difference between G and T. 3.Government spending may be less than tax receipts (G < T). This is a budget surplus. The excess of T over G represents saving by the government sector.

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The Budget and equilibrium

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From the above equations, if S = I, then for the economy to be in equilibrium, the government must balance its budget - ie G must equal T. If S > I, the government can achieve equilibrium by budgeting for a deficit. The government can raise the extra funds needed by borrowing. If I > S, the government can achieve equilibrium by budgeting for a surplus. By using its budget, therefore, the government can influence the level of income, output and expenditure for the economy as a whole.

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Imports

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Imports are a leakage from the circular flow. When Australians buy imports the money flows out of our economy and goes overseas. Like all leakages, imports reduce the overall size of the circular flow.

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exports

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Exports represent an injection into the circular flow. When Australians sell exports overseas they receive payments from foreigners and the money flows into the Australian circular flow. Thus the incomes of Australian households increase. Exports increase the size of the circular flow.

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Equilibrium and the five sector model

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As before, the circular flow model will be in equilibrium if the sum of leakages equals the sum of injections. Thus our five sector circular flow model will be in equilibrium when: S + T + M = I + G + X

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S + T + M = I + G + X

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X=M, X>M (surplus of net exports), X<M (deficit of net exports) Again, this does not necessarily mean that S = I, G = T, and M = X.

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Inequality of leakages and injections

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At any particular time it is highly unlikely that total leakages will exactly equal total injections

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Total leakages greater than total injections

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If total leakages exceed total injections, more money is being withdrawn from the circular flow than is being added to it. The level of income and therefore the level of spending in the economy will fall. Declining demand for goods and services will cause firms to reduce production. Some people will lose their jobs and the level of unemployment will start to rise.

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Total injections greater than total leakages

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If total injections exceed total leakages, more money is being added to the circular flow than is being removed from it. Consequently, income and expenditure will rise. As the demand for goods and services increases, firms will hire more workers, unemployment will fall and therefore total incomes will rise

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The role of government

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Clearly, inequalities between leakages and injections will lead to increases or decreases in the level of economic activity and therefore to booms and recessions. the government can use the fiscal policy to alter its levels of taxation and government spending. By changing G and T the government can therefore directly change the size of the circular flow

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