SCARCITY, CHOICE AND OPPORTUNITY COST

Economics as a social science: It is concerned with human

beings and the social systems by which they organize their activities to
satisfy basic material needs (eg, education, knowledge, food, golf and
shelter)
Economics: Concerned with the production of goods and services,
and the consumption of these goods and services. Every country whether
rich or poor has to make choices and is confronted with the key economic
problem of scarcity.
Scarcity: A situation where unlimited wants exist but the resources
available to meet them are limited.
Resource allocation: The way that resources within an economy
are split between their various uses the way in which resources are
used.
Factors of Production:
Land: natural resources, i.e trees, ocean, fertile land, minerals,
sunshine
Labor: human resources, physical or mental
Capital: capital resources, man-made resources used in the
production process i.e. machines in a factory
Enterprise: organizing the above three in the production of goods
or services
Ceteris Paribus: All things being equal one of the assumptions
used in many economic models, where an individual factor is changed
while all others are held constant. (Use it!!)
Choice: The result of the economic problem of scarcity, and how
you allocate resources to deal with the economic problem.
Utility: Benefits or satisfaction gained from consuming goods and
services hard to measure but we assume consumers make decisions
based on maximizing utility.

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Opportunity Cost: Cost measured in terms of the next best
alternative forgone.
Economic Good: Things people want that are scarce there is an
opportunity cost involved.
Free Good: Commodities that have no price and no opportunity
cost, i.e fresh air and sunshine
Production Possibility Curve: A curve showing all the possible
combinations of two goods that a country can produce within a specified
time with all its resources fully and efficiently used. The boundary
between what is attainable and what is unattainable, given the current
resources.

1.1 SCARCITY, CHOICE AND OPPORTUNITY COST

The fundamental problem of economics: scarcity
and choice
Economics is about scarcity and those things that are scarce.
Goods and services that are scarce are known to be economic
goods.
If theyre not scarce, they are considered as being free goods.
As the world develops, more free goods are becoming into
economic goods (such as sea animals, tropical rain forests etc.).
Due to scarcity, humans have created the economic system that
aims to figure out what to do with scarce resources.
NB: If there is no demand, there is no scarcity
THE PROBLEM IS: CHOICE, RESOURCES AND USES WILL
NEVER BE EQUAL. We try to develop a system where people can
make a choice that will maximise their utility (satisfaction).
The study of economics arises because peoples needs and wants
are unlimited, or infinite. Yet it is not possible for societies and the people
within them to produce or buy all the things they want. This is because
there are not enough (limited) resources. Resources are the inputs
used to produce goods and services wanted by people (known as factors
of production).

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TL;DR: Scarcity Is the situation in which available resources, or
factors of production, are finite, whereas wants are infinite. There are not
enough resources to produce everything that human beings want and
need.
The issue of choosing what to do with economic goods will always
exist, no matter what the wealth or level development of an economy.
Since people cannot have everything they want, they must make choices.
Resource scarcity forces society to make a choice between available
alternatives. Economics is therefore a study of choices.
Since resources are scarce, it is important to avoid waste in how
they are used. If resources are not used effectively and are being wasted,
they will end up producing less: or they may end up producing goods that
people do not really need or want. Economics must try to find how best to
use scarce resources so that waste can be avoided.
THE DEFINITION OF ECONOMICS: The study of choices
leading to the best possible use of scarce resources in order to
best satisfy unlimited human needs and wants.
Economics is the social science that deals with the allocation
of earths scarce resources among the competing wants and
needs to society

Three basic economic questions: resource allocation

and output/income distribution
Due to scarcity, an economy must always answer three basic
questions:

What to produce (what particular goods and services and at what

quantities of these they should produce)
How to produce (how to use their resources in order to produce
goods and services- e.g. more human labor, less machines, or more
machines and less labor)- different combinations of factors of production,
using different skill levels of labor and different technologies
For Whom to produce (the distribution across the population.
Who will be prepared to pay for it? Should some get more than others or
an equal amount?

What to produce and How to produce are about resource

allocation
For whom to produce is about income/output distribution

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Resource allocation refers to assigning available resources to
specific uses chosen among many possible alternatives.

Resources as factors of production

There are four broad categories in which factors of production come
under:

Land

includes all natural resources, including all agricultural and

non-agricultural land, as well as everything that Is under or above the land
(Examples: minerals, oil reserves, underground water, forests, rivers and
lakes. Natural resources are also called gifts of nature)
Labour includes the physical and mental effort that people
contribute to the production of goods and services (Examples: teachers,
construction workers, economists, doctors, taxi drivers and plumbers all
contribute to producing goods and services)

Capital

also known as physical capital is a man-made factor of

production used to produce goods and services. (Examples: machinery,
tools, factories, buildings, road systems, airports, harbours, electricity
generators and telephone supply lines.
Entrepreneurship (management) includes a special human
skill possessed by some people, involving the ability to innovate by
developing new ways of doing things, to take business risks and to seek
new opportunities for opening and running a business. Entrepreneurship
organises the other three factors of production and takes on the risks of
success or failure of a business.

Opportunity cost
Opportunity cost is defined as the value of the next best alternative
that must be given up or sacrificed in order to obtain something else. In
other words, it refers to the next best alternative that was foregone as a
result of selecting to use resources in a particular way.
Opportunity cost refers to the cost of the next best alternative that
is foregone (given up) as a result of selecting to use resources in a
particular way. It asks us to consider the next best thing we would have
used the resources for if we hadnt used them the way we did. It does not
mean all of the alternative uses, just the thing we would have done next.
All resources are finite in quantity and by definition are at the core of the
economic problem of scarcity. Any economic system is concerned with
how we allocate a finite quantity of resources to an infinite and competing
number of different uses.

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The production possibility model (PPC/PPF)

The production possibilities model is a simple model of the economy
illustrating some important concepts. The production possibilities curve
(or frontier) (PPC/PPF) represents all combinations of the maximum
amounts of two goods that can be produced by an economy, given its
resources and technology, when there is full employment of resources and
productive efficiency. All points on the curve are known as production
possibilities.
The PPC illustrates the possible combinations of goods or services
that can be produced by a single nation, firm or individual using resources
efficiently
In order for the economy to produce the greatest possible output
(anywhere on the PPC), two conditions must be met:
All resources must be fully employed This means that
all resources are being fully used. If there were unemployment of some
resources, in which case they would be unused, the economy would not
be producing the maximum it can produce.

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All resources must be used efficiently. There must be

productive efficiency. The term efficiency in a general sense means that

resources are being used in the best possible way to avoid waste.
Productive efficiency means that output is produced by use of the fewest
possible resources; alternatively, we can say that output is produced at
the lowest possible cost. If output were not produced using the fewest
possible resources, the economy would be wasting some resources.

If the economy is anywhere INSIDE the PPC, it means

that there is either unemployment of resources or
productive inefficiency (or both).
TL;DR: An economys actual output, or the quantity of output
actually produced, is always at a point inside the PPC, because in the real
world all economies have some unemployment of resources and some
productive inefficiency. The greater the unemployment or the productive
inefficiency, the further away is the point of production from the PPC.
Law of increasing opportunity cost: As the production of a particular
good increases, the opportunity cost of producing an additional unit rises.
This is because economic resources are not completely adaptable to
alternative uses. Many resources are better at producing one type of good
than ta producing others
The concept of opportunity cost can be illustrated using the
production possibility curve (frontier) model. This model has the following
assumptions:
The economy has a fixed quantity of resources
The resources can be used to create two alternative products
The economy does not trade
An economy cannot produce outside the PPC
The PPC (points on the curve) represent the maximum possible
output combinations of goods and services (and thus maximum
satisfaction possible) from the available resources
Points within the PPC are indicative of an inefficient use of
resources (unemployment) and that it would be possible to
increase the efficiency of resource use. This would result in a
movement towards the PPC and an increase in the total level of
satisfaction experienced in the economy
The PPC can move out over time as a result of one of or both of
the follower:
o Discovery of new resources within the economy
o Discovery/creation of new technology or production
techniques that increase the efficiency of resource use
meaning that for any given quantity of input (resource)
there is an increase output (quantity of production)

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The production possibilities curve and scarcity,
choice and opportunity cost

The condition of scarcity does not allow the

economy to produce outside its PPC
The condition of scarcity forces the economy to
make a choice about what particular combination
of goods it wishes to produce
The condition of scarcity means that choices
involve opportunity costs, If the economy were to
move at any point on the curve, it would be
impossible to increase the quantity produced of
one good without decreasing the quantity
produced of the other good.
Four key components necessary for a successful transition from a
command to a market economy
Liberalization: The process of allowing most prices to be determined in
markets and lowering trade barriers that had shut off contact with the
price structure of the worlds market economies
Macroeconomic stabilization: Primarily the process through which
inflation is brought under control and lowered over time
Restructuring and privatization: The processes of creating a viable
financial sector and reforming the enterprises in these economies to
render them capable of producing goods that could be sold in free
markets and of transferring their ownership into private hands
Legal and institutional reforms: These are needed to redefine the role
of the state in these economies, establish the rule of law, and introduce
appropriate competition policies
Product and Resource Markets
Product Market:
Consumers buy goods and services from firms
Households use their money incomes earned in the resource
market to buy goods and services
Expenditures by households become revenues for firms
Firms seek to maximize their profits
Households seek to maximize their utility (happiness)
Resource Market:
Households supply productive resources (land, labor, capital)
Firms buy productive resources from households. In exchange for
their productive resource, firms pay households:

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o Wages: payment for labor

o Rent: payment for land
o Interest: payment for capital
o Profit: payment for entrepreneurship
Firms seek to minimize their costs in the resource market
Firms employ productive resources to make products, which they
sell back to households in the product market

Buyers
Sellers
Bought/sold
Money flow
Goals for F and H
Reason for benefits

Product markets
Households
Firms
Goods and services
Households -> firms
Maximize profit (F) and
utility (H)
Exchanges are mutual
and voluntary

Resource markets
Firms
Households
Capital, land, labour
Firms -> households
Minimize costs (F) and
maximize income (H)
Exchanges are mutual
and voluntary

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Product Market
Resource Market
- Firms employ productive
- Productive resources:
resources to make finished
Households provide firms with the
goods and services. They sell
productive resources they need to
their products to households in
produce goods and services (i.e.
exchange for money
land, labor, capital and
- Households spend their
entrepreneurship)
income from the sale of their
- Resource payments: Firms pay
resources
households for their resources,
- Households make
using revenue from the sale of
expenditures on goods and
their goods and services, which
services
creates income for households
- Firms earn revenue, which is
(i.e. rent, wages, interest and
needed to cover their costs. Any
profit)
revenue earned beyond all
costs is considered economic
profit
- The goal of households is to
maximize happiness (utility)
- The goal of firms is to
maximize profit

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Utility
In economics we will assume that all behaviour is considered rational.
That means that we can logically assume that no one will undertake an
action unless it is going to benefit them.
Utility can be measured in two ways:
Total utility- this is the total satisfaction (benefit) gained from
consuming a certain quantity of a product
Marginal utility- this is the additional utility gained from
consuming one additional product (it is the difference between
total utility prior to consuming the item and total utility
immediately after consuming the additional product). We would
normally observe that as the consumption of a product increases
that the utility gained from the next consumed starts to fall. This
means, that there is less utility from each extra item consumed
up to the point it becomes negative. This concept is known as
diminishing marginal utility. It would be irrational to consume any
item that results in negative or disutility, as total utility would
start to fall.
Model building
Economists use models to try and understand bigger and more
complex concepts and to illustrate their theories. The models are
manipulated to consider the impact of changes in a variable on other
phenomenon. This is done in a controlled manner so that it is the effect of
the change in a chosen variable that is being assessed and not a whole
range of factors. In economics this is done by holding all other things
constant- this is referred to as the condition of ceteris paribus. It means
that we consider the change in ONE/CHOSEN variable on the model while
keeping all other components stable/static. This means that any impact
that is observed will be as a result of the change in the chosen variable.
We understand that models are simplistic representations of more
complex and complicated systems that that they are usually accompanied
by sets of assumptions that may limit their applicability to real world
situations and events.

DEFINITIONS
Macroeconomics: The branch of economics which studies the
working of the economy as a whole, or large sections such as all
households, all business and government. The focus is on aggregate
situations such as economic growth, inflation, unemployment,
distribution of income and wealth, and external viability.

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Microeconomics: The branch of economics that studies individual
units i.e. sections of households, firms and industries and the way in which
they make economic decisions. (both macro and microeconomics look at
the three basic questions below)
Positive Statement: A statement that can be verified by
empirical observation i.e. Brazil has the largest income gap in Latin
America.
Normative Statement: a value judgment about what ought or
should happen, i.e. more money should be spent on teachers salaries
and less on WMDs.
Public sector: That part of the economy where goods and services
are provided by the government, i.e. public hospitals, roads, schools,
parks and gardens.
Private sector: That part of the economy that is characterized by
private ownership of the means of production by profit seeking
individuals.
Command Economy: An economy where all economic decisions
are made by a central authority. Usually associated with a socialist or
communist economic system
Free Market Economy: an economy where all economic decisions
are taken by individual households and firms, with no government
intervention.
Mixed Economy: an economy where economic decisions are
made partly by the government and partly through the market. (nearly
every economy in the world)
Sustainable Development: Development that meets the needs
of the present without compromising the ability of future generations to
meet their own needs. (a key definition from the UN in 1987)
Economic Growth is the increase in a countrys output over time;
that is an increase in national income.
Economic Development is a much broader concept that purely
economic growth, involving non-economic and often quite intangible
improvements in the standard of living, for example freedom of speech,
freedom from oppression, health care, education and employment
It is very difficult to totally define as it involves normative or value
judgments (always state this!!), but remember some areas can be
quantified as well.

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Market: an organization or arrangement through which goods and
services are exchanged do not have to physically meet markets can be
local (bikes in Fort Bonifacio), national (cars in the Philippines) or
international (mobile phone market for the world)
Price mechanism: is the process by which prices rise or fall as a
result of changes in demand and supply. Signals and incentives are
given to producers and consumers to produce more or less or consume
more or less.
Perfect competition: A market structure where there are many
firms, where there is freedom of entry into the industry, where all firms
produce an identical product, and where all firms are price takers figure
4.1 shows the industry and the firm.
Monopolistic competition: a market structure where, like perfect
competition there are many firms and freedom of entry, but where each
firm produces a differentiated product, and thus they have some control
over the price. Examples: restaurants, hairdressers
Oligopolistic competition: a market structure dominated by only
a few firms or where a product is supplied by only a few firms (there may
be many firms but it is dominated by only a few) examples: car industry in
the USA, mobile phone industry.
Monopoly: where is there is only one dominant firm in the industry
remember they dont have to control 100%, example: Microsoft is a
monopoly sometimes hard to define. A bus company may have a
monopoly over bus travel in a city but not all forms of transport extent of
monopoly power depends on the closeness of substitutes.

1.2 ECONOMICS AS A SOCIAL SCIENCE

The nature and method of economics
The social sciences are academic disciplines that study human
society and social relationships. They are concerned with discovering
general principles describing how societies function and are organised.
Economics is a social science because it deals with human society and
behaviour, and particularly those aspects concerned with how people
organise their activities and how they behave to satisfy their needs and
wants. It is a social science because its approach to studying human
society is based on the social scientific method

The scientific method

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Economics tries to explain in a systematic way why economic
events happen in the way they do, and attempts to predict economic
events likely to occur in the future. The social scientific method consists of
the following steps:

1. Make observations of the world around us, and

select an economic question we want to answer.
2. Identify variables we think are important to
answer the question
3. Make a hypothesis about how the variables are
related to each other
4. Make assumptions
5. Test the hypothesis to see if its predictions fit
with what actually happens in real life
6. Compare the predictions of the hypothesis with
real-world outcomes
Economists as model builders
Models are often closely related to theories, as well as laws. Models
are often built on the basis of well-established theories or laws, in which
case they may illustrate, through diagrams or mathematical questions,
the important features of the theory or law.
NB: MODELS ARE NOT ALWAYS REPRESENTATIONS OF
THEORIES.

Ceteris paribus: other things equal. This means that all other
things are assumed to be constant or unchanging.

Positive and normative concepts

Positive statements
About something that is, was or will be.
May describe something
o E.g. the unemployment rate is 5%; industrial output grew
by 3%
May be about a cause and effect relationship, such as in a
hypothesis
o E.g. If the government increases spending, unemployment
will fall
May be statements in a theory, model or law
o E.g. a higher rate of inflation is associated with a lower
unemployment rate
May be true or they may be false
Plays an important role in positive economics, where they are
used to describe economic events and to construct theories and
models that try to explain these events.

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Economists use positive statements in order to describe, explain
and predict
Normative statements
About what ought to be (subjective about what should happen)
o E.g. The unemployment rate should be lower
o Health care should be available free of charge
o Extreme poverty should be eradicated
Cannot be true or false
Assessed relative to beliefs and value judgements
Used in normative economics, where they form the basis of
economic policy- making
Government actions that try to solve economic problems

MICROECONOMICS AND MACROECONOMICS

Microeconomics: examines the behaviour of individual decisionmaking units in the economy. The two main groups of decision makers we
study are consumers (households) and firms (businesses). Microeconomics
is concerned with how these decision-makers behave, how they make
choices and how their interactions in markets determine prices.
Macroeconomics: examines the economy as a whole, to obtain a
broad or overall picture, by use of aggregates, which are wholes or
collections of many individual units, such as the sum of consumer
behaviours and the sum of firm behaviours, and total income and output
of the entire economy, as well as total employment and the general price
level.

Microeconomics
- Individual markets
- Behaviour of firms and
consumers
- Allocation of land, labour and
capital resources
- Supply and demand
- Efficiency of markets
- Product markets
- Profit maximization
- Utility maximization
- Competition
- Resource markets
- Market failure

Macroeconomics
-

National markets
- Total output and income of
nations
- Total supply and demand of
the nation
- Taxes and government
spending
- Interest rates and central
banks
- Unemployment and inflation
- Income distribution
- Economic growth and
development
- International trade

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ECONOMIC GROWTH AND ECONOMIC DEVELOPMENT
Economic growth: When the quantity of output changes, if it increases
there is economic growth. If it decreases, there is economic contraction or
negative economic growth.
Economic development: Raising the standard of living and well-being
of people. This means increasing incomes and outputs, reducing poverty
among very poor people, redistributing income so that the differences
between poor and rich become smaller, reducing unemployment and
increasing provision of important goods and services (food, shelter,
sanitation, education and health care services)
Difference between the economic growth and economic
development
Economic growth is the quantity of output of goods and services
produced. The quantity of output produced by countries increases over
long periods of time, but there are differences between countries in how
much output they produce and in how quickly or slow this increases over
time. The World Bank has organized them into more developed and
less developed according to their income levels, which are related to
quantities of output produced. Whereas economic development refers to
raising the standard of living and well being of people by increasing
output and incomes and reducing poverty. Redistributing income so that
the difference between the very rich and very poor is minimalized
High levels of output and low provision of social service (e.g.
health care services and sanitation) vs. low levels of output and
high provision of social services
Countries with lower levels of output and higher provision of social
services are more developed. Although there are several benefits that
come with having higher levels of output which indicates economic
growth, issues such as healthcare, employment and other social services
should also have priority as these are necessities that can improve quality
of life and possibly solve issues that revolve around this. However, by
having higher provision of social services, the country can then focus on
improving levels of output.

SUSTAINABLE DEVELOPMENT
Sustainability: Sustainability involves using resources in
ways that do not reduce their quantity or quality over time for
future generations. Sustainable resources such as forests and air
quality are able to reproduce themselves should be used at a rate
that will give them enough time to reproduce themselves, so that
depletion of the resource is avoided.

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Sustainable development: Development that meets the needs of the
present without compromising the ability of future generations to meet
their own needs. It occurs when societies grow and develop without
leaving behind fewer or lower-quality resources for future generations.
Threats to sustainability arise from the ways that societies
answer mainly the first two of the three basic economic
questions. Major threats come from our current patterns of
resource allocation, in other words, from the ways societies are
choosing to answer the what to produce and how to produce
questions.
What to produce: the issue in high income societies involves
consumption relying strongly in fossil fuels that pollute the
environment
How to produce: methods of production (industrial production)
that also rely on heavy use of fossil fuels.

THE EXTENT TO WHICH GOVERNMENTS SHOULD

INTERVENE IN THE ALLOCATION OF RESOURCES
There are two main methods that can be used to make choices
(what, how and for whom to produce): the market method and the
command method.
Market method: resources are owned by private individuals or
groups of individuals, and it is mainly consumers and firms who make
economic decisions by responding to prices that are determined in
markets.
Command method: resources are owned by the government,
which makes economic decisions by commands. In practice, commands
involve legislation and regulations by the government, or in general any
kind of government decision-making that affects the economy.
In the real word, there has never been an economy that is entirely a
market economy or entirely a command economy.
Real world economies combine markets and commands in many
different ways, and each country is unique in the ways they combine
them
In communist systems, they lean towards the command economy
In market-oriented economies, they lean towards the market economy.
In mixed market economies (economies that are strongly based on
markets but also have some command methods), the command
methods of making allocations and distribution decisions are referred
to as government intervention.