Overview
This lecture covers foundational microeconomic concepts including scarcity, opportunity cost, the price mechanism, elasticity, and market failure, as well as macroeconomic objectives and related policies.
Central Economic Problem
- Scarcity arises because unlimited wants exceed limited resources, leading to the need for choice and opportunity cost.
- Opportunity cost is the value of the next best alternative forgone when a choice is made.
- Ceteris paribus means all other factors remain unchanged for analysis.
- Positive statements are testable facts; normative statements involve value judgments.
- Factors of production (CELL): Capital, Entrepreneurship, Labour, Land.
- The Production Possibility Curve (PPC) illustrates scarcity, choice, and opportunity cost.
- Economic agents (consumers, producers, governments) make rational decisions by weighing marginal benefits and costs.
The Price Mechanism
- Effective demand: quantity consumers are willing and able to buy at given prices.
- Law of demand: price rises, quantity demanded falls (inverse relationship).
- Law of diminishing marginal utility: additional consumption yields decreasing added satisfaction.
- Non-price determinants of demand: Expectations, Government policy, Income, Related goods, Tastes, Credit, Population, Exchange rates.
- Supply: quantity producers are willing and able to sell at various prices.
- Law of supply: price rises, quantity supplied rises (direct relationship).
- Market equilibrium occurs where quantity demanded equals quantity supplied; shortages cause prices to rise, surpluses cause prices to fall.
- Price mechanism allocates resources via signaling, incentive, allocative, and rationing functions.
Elasticity of Demand and Supply
- Price Elasticity of Demand (PED): responsiveness of quantity demanded to price changes.
- PED > 1 is elastic, < 1 is inelastic; PED is always negative.
- Determinants of PED: substitutes, time, necessity, income proportion.
- Price Elasticity of Supply (PES): responsiveness of quantity supplied to price changes; always positive.
- Income Elasticity of Demand (YED): responsiveness of demand to income changes (positive for normal, negative for inferior goods).
- Cross Elasticity of Demand (XED): responsiveness of demand for one good to the price change of another (positive for substitutes, negative for complements).
- Elasticity impacts total revenue and the effect of shifts in supply/demand on equilibrium.
Market Failure and Government Intervention
- Market failure is the inefficient allocation of resources by the free market.
- Causes: externalities (positive/negative), imperfect information, public goods, factor immobility, market dominance.
- Negative externalities: government can intervene with taxes, regulations, permits.
- Positive externalities: governments use subsidies, regulations, direct/joint provision.
- Imperfect/asymmetric information: market failure due to decision-makers lacking full info; remedies include regulation and education.
- Public goods are non-excludable and non-rival; provided by government to overcome the free rider problem.
- Factor immobility: inability of resources to move between uses or locations; corrected by training and subsidies.
Macroeconomic Objectives and Policies
- Actual growth: realised increase in output; potential growth: increase in productive capacity.
- Sustained growth: stable growth without high inflation; sustainable growth: growth without harming future generations; inclusive growth: growth benefits all social groups.
- Demand-side policies: fiscal (spending/tax changes), monetary (interest/exchange rate).
- Supply-side policies improve productivity and resource quality.
- Limitations: time lags, crowding out, multiplier size, debt, interest insensitivity.
- Policies for sustainable/inclusive growth: environmental taxes, subsidies for skills, redistributive policies.
Key Terms & Definitions
- Scarcity — limited resources versus unlimited wants.
- Opportunity cost — value of next best forgone option.
- Ceteris paribus — all else held constant.
- Positive statement — fact-based, testable claim.
- Normative statement — value-based opinion.
- Factor of production (CELL) — Capital, Entrepreneurship, Labour, Land.
- PPC — shows maximum possible output combinations.
- PED/PES — measures of responsiveness in demand/supply to changes.
- Market failure — inefficient resource allocation by free market.
Action Items / Next Steps
- Review and practice PPC diagrams and elasticity calculations.
- Read textbook sections on market failure and government policy tools.
- Complete practice questions on macroeconomic policies and their effects.