ECONS 101 Introduction to Economics 1

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1 ECONS 101 Introduction to Economics 1 Session 2 Introduction II Lecturer: Mrs. Hellen Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing and Distance Education 2014/ /2017

2 Session Overview This session involves understanding the concept of resources in economics and analyzing some fundamental such as scarcity and choice as well as opportunity cost. It also discusses specialization and trade, economic systems and allocation of resources Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 2

3 Session Objectives At the end of the session, the student should be able to: Identify types of economic resources and types of income associated with various factors. Define the economizing problem, incorporating the relationship between scarcity (limited resources) and unlimited wants. Understand the concept of opportunity cost and how to determine the opportunity cost of a chosen decision. Use the concept of PPF to demonstrate scarcity, opportunity cost, efficiency, and economic growth. Understand Absolute and Comparative advantages in trade. Appreciate the fundamental Economic problems, the types of economic systems and the ways of allocating resources to solve basic problems. The student should also be able to give real life examples of each of the economic systems discussed. Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 3

4 Session Outline The key topics to be covered in the session are as follows: Factors of Production Scarcity and Choice Opportunity Cost The Production Possibility Frontier Specialization and Trade Absolute and Comparative Advantage Economic Systems Mrs. Hellen Seshie-Nasser, Dept of Economics, Slide 4

5 Reading List Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11 th Edition. Oxford University Press. Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4 th Edition. Boston: Pearson Education Inc., Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7 th Edition. McGraw-Hill Slide 5

6 What are Resources? Economic resources, also referred to as factors of production, are the inputs employed in the production of goods and services. These include: Land Labour Capital Entrepreneurship Slide 6

7 Types and Nature of Resources Land: The term land in economics widely refers to all natural productive resources (inanimate) freely given by nature such as: Arable land, Forests, wildlife Rivers Sea, Mineral Mineral deposits which man has no hand in its creation Slide 7

8 Labour: It refers to all human resources, both mental and physical, inherited and acquired which are employed in the creation of wealth (production of goods and services) for which economic reward in the form of wages and salaries are received in return. It is the services of labour which is bought and sold and not labour itself. Measures of labour size of labour force (quantity) skills of labour force (quality) human capital the value of time Slide 8

Types of Labour Skilled Developed or specialized mental effort used in the production of goods and services e.g. Doctors, Accountants, engineers.

9 Types of Labour Skilled Developed or specialized mental effort used in the production of goods and services e.g. Doctors, Accountants, engineers. Unskilled The use of manual or physical strength and little or no training at all e.g. watchman, grave digger, chop bar fufu pounder, porter, etc. Slide 9

10 Capital: These are man-made goods which are not consumed directly but used in the production of goods and services. It has two main characteristics; It is man-made and accumulated out of income through savings and investment. It is not consumed directly. Physical capital -- goods used to make other goods -- factories -- machines -- infrastructure NOT financial capital (stocks, bonds, bank loans) financial capital facilitates building of physical capital Slide 10

11 Entrepreneurship Entrepreneurship/Enterprise: It is the act of coordinating the other three factors of production in order to produce goods and services. An entrepreneur is the risk bearer who co-ordinates the other three factors of production in the most efficient way in order to maximize profit. Human resource Ideas about -- doing things better -- e-commerce -- new products Slide 11

12 Characteristics of Factors of Production Resources are relatively scarce They have alternative uses They are combined in varying proportions to produce a given good or service. In other words, resources are substitutable. One can be substitute for the other. Slide 12

13 Scarcity and Choice Scarcity Situation in which the amount of resources available is insufficient to satisfy all the alternative uses for it. As a result, economic agents end up making choices from the alternative uses Slide 13

14 Scarcity and Individual Choice There are an unlimited variety of scarcities, however they are all based on two basic limitations; Scarce time Scarce spending power Limitations forces each of us to make choices. Economists study choices we make as individuals, and consequences of those choices. Economists also study more subtle and indirect effects of individual choice on our society. Slide 14

15 Scarcity and Social Choice The problem for society is a scarcity of resources Scarcity of Labour Time human beings spend producing goods and services Scarcity of Capital Something produced that is long-lasting, and used to make other things that we value Human capital Capital stock Scarcity of land Physical space on which production occurs, and the natural resources that come with it Scarcity of entrepreneurship Ability and willingness to combine the other resources into a productive enterprise Slide 15

16 Scarcity and Economics As a society our resources (land, labor, and capital) are insufficient to produce all the goods and services we might desire. In other words, society faces a scarcity of resources The scarcity of resources and the choices it forces us to make is the source of all of the problems studied in economics Households allocate limited income among goods and services Business firms choices of what to produce and how much are limited by costs of production Government agencies work with limited budgets and must carefully choose which goals to pursue Slide 16

17 Economists study these decisions to: Explain how the economic system works Forecast the future of the economy Suggest ways to make that future even better Slide 17

18 Opportunity Cost The basic economic problem is scarcity: -- wants are unlimited, but resources are limited so with scarcity, we must make choices, and with choices, come costs Cost is the opportunity cost -- what you give up when you make a choice -- there s no such thing as a free lunch Slide 18

19 Cost of going to college includes: what you can buy with the tuition fees what you could earn by working what you could do with the free time you are willing to give up to come to the university because you expect higher income or more rewarding career -- tuition -- wages -- leisure time Slide 19

20 Opportunity cost is the cost of goods or services measured in terms of the lost opportunity to pursue the best alternative activity with the same time or resource. It includes the explicit cost of the chosen alternative and the lost benefits that accrue to the next best alternative activity in which the resource can be put to use. Slide 20

21 Illustration of Opportunity Cost Cost of education/college Tuition and fees 5800 Books and supplies 400 Transportation to and from school 400 Room and boarding 2900 Personal expenses 700 Total out of pocket cost If instead of sitting in the classroom, he decides to get an employment, how much would he have made, e.g Budget for Opportunity cost Tuition and fees 5800 Books and supplies 400 Transportation 400 Forgone income 8000 Opportunity cost Slide 21

22 Costs of room & boarding and personal expenses are not part of the opportunity cost of college because in making such costs one is not really giving up the opportunity to spend on something else. Whether one goes to school or not he will eat, live somewhere and buy clothes. Slide 22

23 The Production Possibility Frontier The PPF is a curve showing the combination of maximum outputs of two goods (and services) that can be produced at a point in time by fully utilising the limited resources available and the best known technology. The curve can be used to illustrate the concepts of; Efficiency Trade-offs Opportunity Cost Economic Growth Slide 23

24 The PPF Assumptions We are dealing with a very simple economy in which only two goods are produced, say X and Y (food and defence). There are fixed level of resources, X and Y The level of technology is constant Resources can be combined in various ways to produce the goods or services The economy uses all its available resources Slide 24

25 Assuming given technology and the resources of the economy, these combinations of X and Y can be produced. Bundle Y X A 80 0 B C D E To move from one combination to other, say from A to B, some units of Y are lost while some units of X are gained because all resources are utilized in the production process. Hence, there is a trade-off. The opportunity cost of moving from one bundle to the other is calculated as: Y The information is presented in a graph called PPF as follows A G B C F D The opportunity cost of producing more of X by moving from A to B E X Slide 25

26 Features of the PPF Producing along the PPF A to E means the economy is producing efficiently, i.e. resources are being utilized efficiently. Point G indicates the concept of scarcity. It is an unattainable point, i.e. resources, are not sufficient enough to produce at point G. At point F, resources are being under-utilized or underemployed. They are not used efficiently. The slope of the PPF indicates the concept of opportunity cost The frontier is curvy and not a straight line because there is no perfect substitutability among the factors of production. Some commodities are better produced than others given the same level of resources. E.g. labour for producing food or tractor. Slide 26

27 Shifts in the PPF Changes (increases) in resource endowment OR Technological improvement then the PPF will shift out produce more food and more defence economic growth! Slide 27

28 Shifts in the PPF Defence Food Slide 28

29 Specialization and Trade You might have woken up this morning to an alarm clock made in Korea. You might have taken a beverage made of cocoa grown in Ghana and the Milo made in Nigeria. You put on some clothes made of cotton grown in USA or Ghana and sewn in factories in Thailand. You watch/listen to the morning news broadcast on your TV/Radio made in Japan. You receive calls on a phone made in China, USA or UK You drive (driven in) to class in a car made of parts manufactured in a half-dozen different countries. Slide 29

30 Specialization In ancient times, we had hunters and gatherers who made most of the things for themselves. But in modern societies where people began agricultural production and began living in towns, it is almost impossible to make everything for oneself; leading to specialisation in specific jobs. The question of how do we get the most out of our resources? became dominant. Specialization of labour is the allocation of different jobs to different people. We specialize in what we do best and trade that for what we need Slide 30

31 Specialization For example: I teach. I get paid for it. I use the money to buy food fuel Clothes made by others Slide 31

32 If I grew my own food made my own clothes Specialization fixed my own car I would not consume as much Specialization produces gains! I can consume more than what I could make on my own Slide 32

33 Specialization How do we satisfy our wants and needs in a global economy? We can be economically self-sufficient. We can specialize and trade with others, leading to economic interdependence. Individuals and nations rely on specialized production and exchange as a way to address problems caused by scarcity. But this gives rise to two questions: Why is interdependence the norm? What determines production and trade? Slide 33

34 Specialization Why is interdependence the norm? Interdependence occurs because people are better off when they specialize and trade with others. What determines the pattern of production and trade? Patterns of production and trade are based upon differences in opportunity costs. Slide 34

35 The Principle of Comparative Advantage Differences in the costs of production determine the following: Who should produce what? How much should be traded for each product? Differences in Costs of Production Two ways to measure differences in costs of production: The number of hours required to produce a unit of output (for example, one basket of potatoes). OR The opportunity cost of sacrificing one good for another. Slide 35

36 Absolute Advantage Absolute advantage is the comparison among producers of a good according to their productivity. It describes the productivity of one person, firm, or nation compared to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. Slide 36

The Rancher needs only 20 minutes to produce a kilogram of meat, whereas the

37 Example A Rancher needs only 10 minutes to produce a bunch of plantain, whereas the Farmer needs 15 minutes. The Rancher needs only 20 minutes to produce a kilogram of meat, whereas the Farmer needs 60 minutes. Rancher Farmer The Rancher has absolute advantage in the production of both plantain and meat. Slide 37

38 Opportunity Cost and Comparative Advantage In determining comparative advantage producers of a good are compared according to their opportunity cost. That is, whatever must be given up to obtain some item. The producer who has the smaller opportunity cost of producing a good is said to have a comparative advantage in producing that good. From the earlier example; Who has the absolute advantage? The farmer or the rancher? Who has the comparative advantage? The farmer or the rancher? Slide 38

39 Opportunity cost of 1 Kg of Meat 1 bunch of Plantain Farmer 4 baskets of cassava ¼ kg of meat Rancher 2 bunch of plantain ½ kg of meat The Farmer s opportunity cost of a kilogram of meat is 4 bunches of plantain, while the Rancher s opportunity cost of a kilogram of meat is only 2 bunches of plantain. The Rancher has a lower opportunity cost here. The Farmer s opportunity cost of a bunch of plantain is ¼ kilograms of meat, whereas the Rancher s opportunity cost of a bunch of plantain is ½ a kilogram of meat. The Farmer has a lower opportunity cost here. so, the Farmer has a comparative advantage in the production of cassava but the Rancher has a comparative advantage in the production of meat. Slide 39

40 Comparative Advantage Differences in opportunity costs are the basis for specialized production and trade. Whenever potential trading parties have differences in opportunity costs, they can each benefit from trade. Slide 40

41 The bottom line: Scarcity & opportunity cost are unavoidable. BUT Efficiency & specialization makes the most of scarce resources Slide 41

42 Economic Systems and Allocation of Resources Scarcity means there are not enough resources to satisfy all wants, hence choices must be made. This therefore poses three fundamental economic questions: 1. What to produce? 2. How to produce (the stuff in #1)? 3. For whom to produce? (who gets the stuff in #1?) Slide 42

43 Economic Problems Any given economy decides what to produce to satisfy the wants of the people. It then decides how to produce what has been decided. The question of should the method of production be labour-intensive or capital-intensive, is addressed? The economy chooses that method or technology at which production is done at the least cost. Finally, the decision of who gets what, is made. The issue of distribution of the goods and services produced is made deciding how the goods and services are shared among the people. The solutions to these economic problems based on the decisions made by each economy leads to different economic systems. Slide 43

44 Economic Systems Economic systems are arrangements made to employ the scarce resources in order to satisfy the wants of the people. It is about; Who owns the factors of production, and The method used to co-ordinate and direct economic activities. Thus, the methods employed in solving the fundamental economic problems. Basically, there are four types of economic systems: Traditional Capitalism/market economy Socialism/command economy Mixed economy Slide 44

45 Traditional Systems In this system, economic decisions are based on tradition, custom and habit. The technique of production is also based on traditional patterns. Distribution is based on long-established traditions. The answers to the economic questions of what to produce, how to produce and how to distribute are determined by what happened in the past. Slide 45

46 Capitalism/Market Economy In this economic system, decisions about who owns factors of production and the method used in controlling and directing economic activities are determined by private individuals and businesses, based on the price-mechanism. It is also called lasser-faire. Characteristics It is based on private ownership of resources and the freedom of the individual to conduct his affairs aimed at maximizing profit. The system emphasizes the freedom of the individual both as a consumer and as the owner of factors of production. There is limited government interference. Prices and outputs are determined through the free interaction of forces of demand and supply. There is a high degree of competition and every economic agent is a maximizer. Slide 46

47 Socialism/Command Economy This is an economic system in which firms are owned and controlled by a central authority or by the government acting in the name of the people, and all the basic economic decisions about the allocation of resources are taken by the central government rather than individuals or firms. The main instrument for resolving economic problems is through central planning. Examples of countries in which this is practiced are former U.S.S.R., China, North Korea and Cuba. Characteristics Government/ central authority own virtually all resources There is limited economic freedom of the individual Economic decision making is through a central economic planning authority. Slide 47

48 Mixed Economy It is an economic system in which both the public and private sectors contribute significantly to allocation of resources, and other economic decisions. Characteristics There is private ownership and various degrees of government control through the use of legislation such as pollution laws, safety laws, labour laws etc. Essential goods and services such as electricity, railways, part of road transport, civil service and defence are controlled by the state while others such as manufacturing of goods and the commercial sectors are controlled by the private sector (enterprise). 48

49 Ghana s Case The Ghanaian economy is a mixed market economy, since government plays a role - regulates markets, taxes to provide goods & services It must be noted, however, that the economic systems of countries change overtime. Example is the former Soviet Union. Slide 49

ECON 101 Introduction to Economics1

ECON 101 Introduction to Economics1 Session 10 Cost Concept Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing