Economics for Business

Online / SDL

Unit 1: Introduction to Microeconomics

Module Overview / Unit 1 / Session 1
Session 1 Session 2 Session 3

What is economics?

 

Economics can be defined as a study of the allocation of scarce resources to meet or satisfy unlimited wants. Scarce resources refers to any type of resource that individuals and firms have to use to meet the different needs and wants that they have. Resources include incomes that you might have such as a salary or wage or it can refer to assets that you have invested or any wealth that you own can be used to obtain  or pay for wants in the form of goods and services.

 

 

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If you think about your own wants and compare them against the income that you have, you will probably realise that the wants far outweigh your income. This is why economists call them scarce resources. On the one hand, human beings have unlimited wants while on the other hand they have limited resources. The more the income increases, the more one will want to buy more and more things.

 

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Consider for example if you have a basic income. It might be that what you would like to buy yourself  is food, and clothes and perhaps pay the rent. Once your income increases you may want to buy yourself a house rather than rent one and perhaps buy a car instead of taking public transport. Once your income increases again you may want to change the car to a better car buy a bigger house, perhaps in a more affluent area and so on. Human wants are unlimited.

When we think about economic activity, we think in terms of production and consumption. Production-when we think of scarce resources in terms of production, we think of the land, Labour, and capital. These are the different resources that firms use to produce goods and services. Once these goods and services have been produced, they are sold to individual households and are consumed by these households.

The ‘unlimited wants’ that firms have is the profit and therefore firms exist to maximise their profits. From the consumption point of view, scarce resources are incomes and wealth. The unlimited wants would be represented by the utility or satisfaction that households derived from consuming different goods and services.

Because the resources are limited relative to the wants that they are meant to satisfy, choices need to be made. When choices are made, some activities or consumption bundles must be given up. Consider for example, the fact that you are sitting now and studying means that you have given up time which could be doing something else such as going to the shops, watching TV or working to earn some money.

The cost of any activity measured in terms of the best alternative forgone, something else that you could have been using your time rather than sitting down and studying, is what we call opportunity cost. We can say therefore that scarcity implies resource allocation.

When choices are made, they must be made rationally, that is to say, individuals are assumed to be rational in the way they make decisions; they weigh the costs and benefits and  pick  the alternative which gives them the best value for their money or resources. Resource allocation implies that questions must be answered.

Answering these questions gives us the mechanism by which every society must transform its limited resources into goods and services. The process creates the link between the resources, the producers and the households will consume the final product. The diagram below depicts this relationship.

 

 

 

 

The diagram illustrates the three key questions; what, how, and for whom, which do not necessarily have to be answered in that order.

 

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The three key questions are as follows:

  • What?
  • How
  • For whom?

 

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What?

What goods and services will be produced and offered for sale and in what quantities will they be produced?

When a firm is deciding to produce a good, remember that its ultimate goal is to maximise profits. It must therefore think very carefully about what product would enable it to maximise profits. Does the good to be produced have demand on the market?

If the firm decided to produce mobile phones as an example, what kind of mobile phones will it produce? Smart-phones or basic phones? 

What kind of competition does the product have?

All these questions feed into the ‘what’ question in order to decide the type of good or service that will be produced.


How?

How would the goods and services be produced?

Firms must think about the methods that will go into the process of producing the good. For example, the firm must think about the technology that will be used to produce the good or service. Will the product rely mainly on labour or machinery (labour intensive or capital intensive)?

Which of these factors is more expensive and will therefore reduce the anticipated profits? Are there cheaper options?

All these questions feed into the ‘how’ question.

 

For whom?

Who will consume the goods that are being produced?

This question is important because the target consuming group influences the ‘what’ and ‘how’ questions as well.  If you want to produce mobile phones for an affluent society, the technology and features that you will include in the phone will be different from basic mobile phones that you would produce for a less affluent society. The materials you use will be more durable and it will have more features, which affects both the ‘what’ and ‘how’ questions.

 

 

 

Exercise

 

Insert the missing words in the sentences.

 

  1. Economics is the study of resources versus .

  2. The three key questions that economists attempt to answer are: , , and ?

  3. According to economists, three factors of production are:  , and .

  4. The “next best alternative use of a resource that is foregone” is the .

 

 

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  1. Economics is the study of limited resources versus unlimited wants.

  2. The three key questions that economists attempt to answer are: what, how, and for whom?

  3. According to economists, three factors of production are: land, labour and capital .

  4. The “next best alternative use of a resource that is foregone” is the opportunity cost .

 


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