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Chapter 5: Fundamentals of economic analysis
Economic resources
Economics is the study of people, firms, and societies and how they use scarce productive resources to fulfill their never-ending wants.
Factors of production, are commonly separated into four groups
Labor: This is human capital and can be improved by education and training.
Land: All types of natural resources like fertile land and what is found under it like oil etc.
Physical capital: All resources produced by men like technology, roads and machinery
Entrepreneurial ability: This is the ability of the entrepreneur to combine and make use of the firm’s resources effectively
Scarcity
All factors of production are limited in supply due to which the production of goods and services is also scarce or limited in supply.
Labor: Workers may face scarcity in their labor hours due to which production of goods and services may also be limited in supply
Land/natural resources: The availability of natural resources like trees and other types of natural fuels like oil or coal is limited, combined with a lack of people’s income to purchase more. This leads to scarcity of their availability and use.
Capital: Resources for use, like computers and machinery, may be scarce for the firm.
Entrepreneurial ability: Lack of thoughtful ideas and innovative methods for making good use of resources.
Trade-Offs
Individuals face trade-offs in daily lives like which school to send their child for good education or deciding where to apply for a job to get a good pay
Firms may choose between what to produce or how much quantity to produce using what production method they have and the limited resources
The government faces trade-offs while deciding taxes or what to construct for the benefit of citizens like new roads or better transport
Opportunity Cost
The forgone option in trade-offs is called opportunity cost
You may spend your savings on buying a new book for your exam instead of buying a video game
Here the video game is your opportunity cost, as it was the option left by you.
Cost-Benefit Analysis
Weighing the costs of an action against the benefits of that action is referred to as cost-benefit analysis.
When you go to the mall and like a piece of clothing, you would check several things like if you can afford it or will it be of use to you for long or not
Total cost is the total value of that thing you want to buy and is divided into two further categories explicit cost and implicit cost.
Explicit cost is the direct expense of your action in terms of money, like the cost of the dress you liked at the mall or the expense of travelling till the mall.
Implicit cost is the cost of that action, like the purchase of the dress may reduce the amount you have to pay your bills.
Absolute cost is the overall satisfaction of doing that purchase and the willingness to buy it from the view of the purchaser.
The decision is when you finally decide if you are willing to and are able to make the purchase keeping in mind the total cost and the cost-benefit analysis.
The willingness to pay should be greater than or equal to your total cost, in order to make the decision.
Marginal Analysis
Weighing the costs and benefits of doing something is called marginal analysis.
If you have studied an hour for your math exam and wish to study another additional hour for it, you will have to measure its benefits and the cost of doing so.
From the consumer’s point of view, Marginal cost is the additional cost of consuming or using another unit of good or service.
Marginal benefit is the additional benefit of consuming or making use of another unit of good or service.
Production Possibilities
Pastries | Pizza Crust |
|---|---|
0 | 10 |
1 | 8 |
2 | 6 |
3 | 4 |
4 | 2 |
5 | 0 |
Production Possibilities Curve is made by economists to assess production and opportunity cost by comparing two goods or services, using scarce resources.
A Production Possibilities Table lists a choice's opportunity costs by summarizing what alternative outputs you can achieve with your inputs
In a production possibility curve, each point on the curve represents some maximum output combination of the two products shown.
This curve is also referred to as the production possibility frontier.
The opportunity cost of each good is also easily understandable in the slope of the production possibility curve.
Resource Substitutability
It is necessary in a firm, that all resources must be reallocated like labor must be given different tasks or resources could be used to make a different product than before
Law of Increasing Costs
The Law of Increasing Costs explains how producing more of a good leads to greater opportunity cost for the firm
As the firm produces more of a product, the curve on the production possibility curve goes upwards.
The law of increasing costs tells how it becomes more costly to produce a good if it is produced more.
Comparative Advantage and Specialization
Comparative Advantage and Specialization tell us how individuals, nations, and societies can get more goods at lower costs.
Absolute advantage is the ability to produce a greater quantity of a good or service with the same quantity of resources
Comparative advantage is when something can be produced at a lower cost than anyone else.
Specializing and lowering costs benefit the firm to make great profits and allow people to purchase goods at cheaper prices.
Another way of determining comparative advantage is how nations trade with each other to see who is at a comparative advantage.
Efficiency
Productive efficiency is when the economy is producing the maximum output from a fixed level of technology and resources.
All points on the production possibilities frontier are productively efficient in this
Allocative efficiency is when the economy is producing the best mix of goods and services.
If society is allocatively efficient, it is at the best point on the frontier
Growth
Economic growth enables the firm to produce larger output if there is an increase in quantity of resources, quality of resources or increase in technology.
Functions of Economic System
Market Systems
Individuals own resources and not the government, such as private offices and other buildings
Individuals have the freedom to own resources to produce goods and services and can choose what to buy and sell.
Personal interests attract people to buy and sell
As buyers and sellers have freedom, there is greater competition among firms to sell.
Prices encourage and discourage economic activity, as lower prices attract more buyers and higher prices reduce sales.
If firms offer higher wages, more people would apply for a job