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Why does the baker sell bread

Rationale self interest (of both parties + society as a whole)
– The baker sells bread to you to make profit; the baker gains –And, you gain from buying it from the baker

Adam Smith

2 sides of rationale self interest
1. Exchange theory – gains from production and trade / investment and exchange
2. Conflict theory – war, litigation, strikes, crime


Define scarcity

the limited nature of societies resources


Define economics

the study of how society manages scarce resources


define opportunity cost

The best alternative that must be given up to obtain some item


Define market economy

An economy that allocates resources through the decentralized decisions of many firms and households as they interact in markets for goods and services


Define the production possibility frontier

Graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology


Define the philips curve

short term trade off between inflation and unemployment


Difference between micro and marco economics

Micro economics = Study of how households and firms make decisions and how they interact in markets

Macroeconomics = Study of the economy as a whole including inflation, employment and eco growth


Define positive statements

Positive statements = Claims that attempt to describe the world as it is (by examining evidence


Define normative statements

Normative statements = claims that attempt to prescribe how the world should be


The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development, should you go ahead and do so? What is the most that you should pay to complete development?

In order to maximise profit, you would go ahead with the development. The $5 million already spent is called a SUNK COST and so, being in the past, is irrelevant to decision making. What matters is the costs, and revenues (benefits) going forward. In this case, the benefits have fallen to $3 million but the costs to finish the product are $1 million more. Thus, the most that you would pay to complete development is the expected revenue from the development, which is $3 million.

Note that after the product has been developed and sold, you and the firm may regret having developed it, since it will have cost $6 million to develop but generated only $3 million in revenue, resulting in a loss of the difference, which happens to also be $3 million. Yet, at the moment that you receive the revised expected sales revenue, it does make sense to continue with the product development.


explain the trade off faced:
a company director deciding whether to open a new factory

When a company director decides whether to open a new factory, the decision is based on whether the new factory will increase the firm’s profits compared to other alternatives. For example, the company could upgrade existing equipment or expand existing factories. The bottom line is ‘Which method of expanding production will increase profits the most?’ and ‘Does that method increase profit?


Your flatmate is a better cook than you are, but you can clean more quickly than your flatmate can. If your flatmate did all of the cooking and you did all of the cleaning, would you chores take you more or less time than if you divided each task evenly? Give a similar example of how specialization and trade can make two counties both better off.

By specialising in each task, you and your flatmate can finish the chores more quickly. If you divided each task equally, it would take you more time to cook than it would take your flatmate, and it would take him more time to clean than it would take you. By specialising, you reduce the total time spent on chores. Similarly, countries can specialise and trade, making both better off. For example, suppose Spanish workers take less time to make clothes than French workers do and French workers make wine more efficiently than Spanish workers do. Then Spain and France can both benefit if Spanish workers produce all the clothes and French workers produce all the wine, and they exchange wine and clothes.


By how much are you willing to redistribute incomes from the rich to give to the poor in Australia?

There is no right or wrong answer. However, it is worth pointing out that incentives increase total income but they also can increase inequality. Tying compensation to performance increases incentives. This increases total income but it also increases inequality. A common way to reduce inequality is to increase tax rates to finance redistribution. However, increasing tax to redistribute incomes reduces incentives. So, there is a trade-off between incentives and redistribution. People vary in their willingness to redistribute.


Draw diagram on page 53



Define absolute advantage

The ability to produce a good using fewer inputs than another producer

Productivity – output produced per unit of inputs.
• Absolute advantage occurs when an individual/firm/country has greater productivity.
• However, even if an entity has absolute advantage, it can still gain from trade.


Define comparative advantage

Ability yo produce a good at a lower opportunity cost than another producer

form of Specialisation
–Specialisation and division of labour increases productivity – Specialisation increases incentives to invest in technology that expands frontier


Define imports

G+'s that are produced abroad and sold domestically


Define exports

G+'s produced domestically and sold abroad