Topic 1: Introduction

Question 1

What is scarcity and why is it important?

Answer 1

scarcity: means that society has limited resources and cannot produce all the goods and services people want

Why is this important?

the way a society decides to allocate its resources is a major factor in the standard of living its citizens enjoy (not ‘greed’ or money)

Question 2

What are fundamental questions in resource allocation?

Answer 2

1. What goods and services will be produced?
2. How will the goods and services be produced?
3. Who will receive the goods and services produced?

Question 3

What are lessons from economics?

Answer 3

1.People face trade offs

• as resources are scarce and our wants are unlimited, ‘to get one thing we usually have to give up another thing’
• efficiency v. equity trade off
  
  • efficiency: society gets the most that it can from its scarce resources
  • equity: the benefits of those resources are distributed fairly among the members of society, qualitative measure

2.The cost of something is what you give up to get it (opportunity cost)

• def.: the highest-valued alternative that must be given up to engage in the activity under consideration
• knowing what the next best alternative is allows us to see whether we are using this resource in the best (most efficient) way

3.Rational people think at the margin

• rational people: individual consumers and firms use all the available information to weigh up the costs and benefits associated with any decision and choose the option that maximises the net benefit
• marginal change/unit: are small incremental adjustments to an existing plan of action, people make decisions by comparing costs and benefits at the margin

4.People respond to incentives

• an incentive is something that induces a person to act, for instance the prospect of reward or punishment
• rational people respond to incentives because they make decisions comparing costs and benefits.
• the study of people’s incentives are a crucial part of economics, as it plays an important role in analysing how markets work and why some public policies are working or failing.
• examples:
  
  • economic solutions to climate change: put a tax on carbon to reduce how much we consume
  • Baby Bonus introduction in 2004: babies born 30 June, 2004 = $0, born 1 July, 2004 = $3000. Result: 1st July 2004 had the most births recorded on a single day in Australian history.

5.Trade can make everyone better off

• a fundamental principle in economics, people gain from their ability to trade (voluntary exchange) with one another.
• competition results in gains from trading.

6.Markets are a good way to organise activity

• market economy: is an economy that allocates resources through the decentralised decisions of many firms and households as they interact in markets
  
  • firms decide who to hire and what to produce
  • households decide what to buy and who to work for
• Adam Smith (1700s) ‘invisible hand’ metaphor: buyers and sellers act in their own interest but end up unknowingly taking into account the social costs of their actions, prices thus guide decision makers to outcomes that tend to maximise the welfare of society as a whole.

7.Governments can sometimes improve market outcomes

• although markets are generally the best mechanism through which to allocate resources, sometimes markets fail i.e. an externality is the impact of one person or firm’s actions on the wellbeing of a bystander
• in these situations, we often require the government to intervene in the market to produce the socially efficient outcome