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Lecture 1
The
Economic
Problem
Key Points
Scarcity
Choice
Rational Decisions
Opportunity Cost
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The Problem….
Scarcity
How to organise Production
and Consumption of goods
and services?
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Choice
A consequence of scarcity
Compare
Costs
Benefits
Rational choice maximises
benefit relative to cost
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Microeconomic Problems
• Choices
• Rational economic decision
making
• Opportunity cost
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Macroeconomic Problems
• Growth
• Unemployment
• Inflation
• International Trade - Balance of
Payments problems
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Imagine that you won millions of
pounds on the National Lottery. Would
your `economic problem' be solved?
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Imagine that you won millions of
pounds on the National Lottery. Would
your `economic problem' be solved?
It would not be solved. Many things would still
be scarce. For example, you would still have
only a finite amount of time to enjoy what the
money could buy: there are only 24 hours in
a day, and we do not live for ever.
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Assume that you are looking for a job and
are offered two. One is unpleasant to do
but pays more. How would you make a
RATIONAL choice between the two?
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Assume that you are looking for a job and
are offered two. One is unpleasant to do
but pays more. How would you make a
RATIONAL choice between the two?
You should weigh up whether the extra pay
(benefit) from the better paid job is worth
the extra hardship (cost) involved in doing it..
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Opportunity Cost
The cost of any activity measured
in terms of the best alternative
forgone
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Illustrating choice &
opportunity cost
Rice
The Production
Possibility Curve
0
Peas
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Illustrating choice &
opportunity cost
Rice
y
0
Production
possible
not all
resources
used
x
Peas
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Illustrating choice &
opportunity cost
Rice
Production
boundary
y1
All resources
are used
0
x
Peas
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Illustrating choice &
opportunity cost
Rice
Possible
choices
y1
y2
0
x1
x2 Peas
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Illustrating choice &
opportunity cost
Rice
Impossible
choices
y2
y1
0
x2 Peas
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Suppose you have a choice of spending
Saturday afternoon studying economics or
working for £20.00 or watching television.
What is the opportunity cost of choosing to
study?
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Suppose you have a choice of spending
Saturday afternoon studying economics or
working for £20.00 or watching television.
What is the opportunity cost of choosing to
study?
The £20.00 wages foregone (probably)…
The difficulty here is the VALUATION of the
‘watching television’.
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Economic reasoning
Economic
methodology
constructs
theories or
models
Used to
explain or
predict
Compare with
natural sciences
(physics)
Problems of a
Social Science
Controlled
experiments not
possible
Human
behaviour
unpredictable
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Statements about the
economy
either
Positive
Statement of
fact
May be tested
The statement
may be true or
false
Normative
Statement of what
is desirable, ought
to be or what is
good or bad
Not testable
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Is the statement below Positive, or
Normative or could it be either?
1
“It is wrong that inflation should be
reduced if this means that there will
be higher unemployment.”.
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Is the statement below Positive, or
Normative or could it be either?
2
“Current Government policies
should reduce unemployment”.
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Is the statement below Positive, or
Normative or could it be either?
3
“Cutting the higher rate of income
tax will redistribute incomes from
the poor to the rich”.
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Summary
Opportunity
Cost
Finite
resources
Scarcity
Costs
compare
Benefits
Choices
Subjective difficult to value