1.1 Scarcity, choice and opportunity cost

🔥 The Fundamental Economic Problem

The fundamental economic problem is that we have unlimited wants but face scarce resources. This forces us to make choices.

Resources: Inputs available for the production of goods and services.

Needs	Wants
Items necessary for survival.	Goods and services people would like to have but are not essential.
Eg: Food, shelter, and clothing.	Eg: Televisions, cars, and other luxuries that improve quality of life.

Everyone has a scale of preference, which ranks their wants from most to least urgent. This scale is dynamic and influenced by culture, upbringing, and life experiences.

Choice and opportunity cost

Because of the fundamental economic problem, choices must be made by all economic agents: individuals, firms, and governments.
- A firm is any business that hires factors of production to produce goods and services.

🔥 Opportunity Cost

Opportunity cost is the true cost of any choice. It is the value of the next best alternative that is forgone when a decision is made.

Basic questions of resource allocation

The fundamental economic problem leads to three central questions that all economies must answer:

What to produce?
- Since no economy can produce everything, firms and governments must decide which goods and services to produce and in what quantities, always considering the opportunity cost.
How to produce?
- This question concerns how resources are used to achieve maximum efficiency. Sometimes, firms may need to compromise efficiency for moral or ethical reasons.
For whom to produce?
- This involves the distribution of the economy's output. It addresses who receives the goods and services produced, which is largely determined by the distribution of income. Governments often play a major role in answering this question.

1.2 Economic methodology

Economics as a social science

Social: It studies human behaviour related to satisfying needs and wants.
Science: It uses a scientific process to develop and investigate theories (called models) that explain economic phenomena.
- The Scientific Process:
  1. Define the problem.
  2. Propose a theory (model).
  3. Investigate the theory with evidence.
  4. Accept or reject the theory.

Positive and normative statements

🔥 Positive Statements

A positive statement is an objective statement based on facts or actual evidence that can be tested and proven true or false. It does not involve opinion.

Example: "A 10% increase in tourist numbers in Mauritius has created 10% more employment."

🔥 Normative Statements

A normative statement is a subjective statement based on an economist’s opinion or value judgement. It cannot be proven true or false and often includes words like "should" or "ought to."

Example: "The inflation rate of 8% in 2021 was the worst in 10 years."

Ceteris paribus

A Latin phrase meaning “other things remaining equal.”
Economists use this assumption to build models that isolate the effect of one variable at a time.
Example: When analyzing how a change in price affects consumer demand, economists assume that all other factors (like income and tastes) remain constant (ceteris paribus).

The margin

In economics, the margin refers to the additional or incremental changes resulting from a decision.
Marginal Cost: The cost of producing one additional unit.
Marginal Revenue: The additional income from selling one more unit.
Marginal Utility: The additional satisfaction from consuming one more unit.
Marginal analysis helps firms and consumers make decisions by comparing the extra benefits and costs of a small change.

Importance of the time period

Economists use different time periods to analyze how change influences economic models.

Short run: A time period where at least one, but not all, factors of production can be changed. Typically, labour is variable while capital is fixed.
Long run: A time period where all factors of production are variable, but key inputs like the state of technology are constant.
Very long run: A time period where all factors and key inputs are variable, including technology, government regulations, and social norms.

1.3 Factors of production

Factor	Description	Reward
Land	All natural resources available in an economy.	Rent
Labour	All human resources available in an economy.	Wage
Capital	All man-made, physical resources that aid in production.	Interest
Enterprise	The human capital that organises the other factors and takes risks.	Profit

🔥 Analysing the Factors of Production

When analysing the factors of production, it is crucial to consider both their quality and quantity.

Example (Labour):

Quality: Education and training improve the skill level of the workforce.

Quantity: Cultural limitations (e.g., preventing women from working) can reduce the available labour force.

Physical vs human capital

Physical Capital: Refers to the man-made physical resources (machinery, buildings) that are part of the factors of production.
Human Capital: Refers to the value of labour and its contribution to economic growth, encompassing the skill, knowledge, and experience of the workforce.

Specialisation and division of labour

Specialisation is the process where individuals, firms, and economies concentrate on producing goods and services where they have an advantage.
- This leads to a surplus of goods, which necessitates trade.
Division of Labour is the splitting of a manufacturing process into a sequence of individual tasks.
- Advantages: Increases output per worker and improves quality.
- Disadvantages: Can lead to worker dissatisfaction due to repetitive tasks and de-skilling.

1.4 Resource allocation in different economic systems

The economic system of a country determines how the three basic economic questions are answered.

Market Economy:
- Resources are allocated by the forces of demand and supply (the market mechanism).
- Decisions are made by millions of individuals and firms.
- The price signal provides information to consumers and producers.
- The government's role is minimal, typically intervening only in cases of market failure.
Planned Economy:
- Resources are state-owned and allocated by a central government body.
- The government determines wages, owns most productive resources, and may impose price controls.
- Close Examples: Cuba and North Korea.
Mixed Economy:
- The most common system, featuring both a private sector (market forces) and a public sector (government) involved in resource allocation.
- Virtually all modern economies are mixed economies, though the degree of mix varies.

1.5 Production possibility curves

A Production Possibility Curve (PPC) is a model showing the maximum level of output an economy can achieve with its current resources and technology. It is also known as the Production Possibility Frontier (PPF).
Points on the curve: Efficient allocation of resources.
Points inside the curve: Inefficient allocation (unemployment of resources).
Points outside the curve: Unattainable with current resources and technology.

Types of PPCs

Straight Line PPC → Constant Opportunity Cost
- This occurs when factors of production are equally suited for producing both goods.
Curved PPC → Increasing Opportunity Cost
- This is more realistic, as resources are not equally efficient in producing all goods. To produce more of one good, you must give up progressively larger amounts of the other.

🔥 Key Concepts Shown by the PPC

Scarcity: The unattainable region beyond the curve.

Choice: Any point on the curve represents a production choice.

Opportunity Cost: The trade-off required to move from one point on the curve to another.

Efficiency: Points on the curve are efficient; points inside are inefficient.

Causes and consequences of a shift in the PPC

A PPC can shift if there is a change in the quality or quantity of resources or the state of technology.

Outward Shift (Economic Growth): Caused by an increase in the quantity or quality of resources (e.g., immigration, new technology).
Inward Shift (Economic Contraction): Caused by a decrease in resources (e.g., natural disaster, war).
Disproportionate Shift: An improvement in technology for one good will pivot the curve outwards along that good's axis.

1.6 Classification of goods and services

Goods can be classified based on two characteristics: excludability and rivalry.

Excludability: It is possible to prevent someone from consuming the good.
Rivalry: One person's consumption reduces the availability for others.

Types of Goods

Private Goods: These are excludable and rival. They are scarce and have an opportunity cost. Most goods and services are private goods.
Public Goods: These are non-excludable and non-rival.
- Because they are non-excludable, they suffer from the free-rider problem, where people can benefit without paying. As a result, the free market often fails to provide them.
- Examples: National defence, street lighting.
Free Goods: These have zero opportunity cost and are not scarce. Example: Air.

Classification of Goods

Merit and demerit goods

These classifications relate to information failure, where consumers lack full information to make optimal decisions.

🔥 Merit Goods

A merit good is a good that is more beneficial for consumers than they realize (has positive externalities), but is underprovided by the market due to information failure.

Examples: Education, healthcare, vaccinations.

🔥 Demerit Goods

A demerit good is a good that is more harmful to consumers than they realize (has negative externalities), but is overprovided by the market due to information failure.

Examples: Cigarettes, junk food.