understanding economics

UNDERSTANDING ECONOMICS

Kuala Lumpur Klang Ipoh Seremban Johor Bahru Bangkok Bank Muar Sungai Petani Kuantan

Petaling Jaya Melaka Penang Kuala Terengganu Kota Bharu Kota Kinabalu Kuching

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UNDERSTANDING ECONOMICS Advisor : Dato Idrus Mohd. Satha Coordinator : Chow Mee Ling Content Developer : Siti Zainorida Mahadi Editor : Khadijah Haidi Khalid Reviewer : Graphic Designer : Azfa Nazuha Azizan Publisher: Cosmopoint Sdn. Bhd. Ground Floor, Wisma Sachdev 16-2, Jalan Raja Laut 50350 Kuala Lumpur Tel: (603) 2694 9455 Fax: (603) 2691 4079 web site: http://www.cosmopoint.com.my Cosmopoint Copyright Reserved 2006 All rights reserved. No part of this book may be reproduced or transmitted in any form or by any means without the written permission of the publisher. Microsoft and Windows are either registered trademarks or trademarks of Microsoft Corporation in the United States and other countries. Other product and company mentioned herein may be the trademarks of their respective owners. The names of example companies, products, people, characters and/or data mentioned herein are fictitious and are in no way intended to represent any real individual, company, product or event, unless otherwise noted.

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Introduction to Understanding Economics Economics is the study that deals with the best allocation of scarce resources. It is a common academic discipline offered by most of the colleges and universities for the relevant curriculum. The major topics discussed in economics are production, market, income, wealth and welfare. Understanding Economics is fundamental to design and implement economic policy. It helps us to understand how resources are to be used optimally and how households and firms interact to meet the demand and supply. This understanding is required at both the individual (micro) and the aggregate (macro) levels. Economic theories discuss both static (dealing with output, employment, income, trade and finance) and dynamic (dealing with innovation, technical progress, economic growth and business cycles). The study of Economics requires an understanding of resources, agents, institutions and mechanisms. Moreover, since virtually no economy operates in isolation, it is important that these phenomena are studied in an international context.

Course Objectives On completion of this course, student will be:

Able to demonstrate knowledge of the core principles of economics. Able to understand those core principles that relates to economic problems and

issues. Exposed to a more detailed knowledge and understanding of an appropriate

number of specialized fields of economics (e.g. money creation). Able to understand the knowledge of quantitative techniques appropriate to the

study of economics. Exposed to the power of abstraction to focus on the essential features of an

economic problem and to provide a framework for the evaluation of the effects of policy.

Able to analyze an economic problem or issue using an appropriate theoretical framework.

Able to have an understanding of appropriate concepts in economics that may be of wider use in decisionmaking context (e.g. opportunity cost).

Able to demonstrate a facility in numeric and other quantitative techniques, such as correctly interpreting graphs.

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Academic Planner The following is a guideline for lecturers to plan the number of lecture hours per chapter based on the content available and its importance. Lecturers are to adjust these hours according to the length of the semester:

Week Topics Chapter Hours

1 Introduction to Economics 1 3

2 Factors of Production 2 3

3 Demand and Supply 3 3

4 Demand and Supply 3 3

5 Price Determination and Elasticity 4 3

6 Consumers Behaviour 5 3

7 Production and Production Costs 6 3

8 Production and Production Costs 6 3

9 Market Structures 7 3

10 Market Structures 7 3

11 Role of Government and Economic Growth 8 3

12 The Banking System, Money and Inflation 9 3

13 National Income and Theory of Income Determination 10 3

14 International Trade 11 3

14 weeks 42 hours

T a b l e o f C o n t e n t s

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Table of Contents Table of Contents .................................................................... v 1 Introduction to Economics.......................................... 1

1.1 Introduction to Economics....................................... 2 1.1.1 What is economics all about? 2 1.1.2 Scarcity 3 1.1.3 Microeconomics and Macroeconomics 4 1.1.4 Economic Systems 6 1.1.5 Mixed Economy 7 1.1.6 Planned Economy 8 1.1.7 Market Economy 9 1.1.8 The reasons why the government needs to

intervene in the market economy 11 1.1.9 Traditional Economy 14 1.1.10 Allocation of Resources 15 1.1.11 Economic Concepts 15 1.1.12 Production Possibility Frontier 17 1.1.13 Production Possibilities Curve 17 1.1.14 Opportunity Cost 20

1.2 Case Study............................................................. 23 1.3 Summary ............................................................... 25 1.4 Exercises................................................................ 27

1.4.1 Answer the following questions 27 2 Factors of Production................................................ 31

2.1 Factors of Production............................................. 32 2.1.1 Land 33 2.1.2 Labour 33 2.1.3 Capital 35 2.1.4 Entrepreneur 37

2.2 Case Study............................................................. 39 2.3 Summary ............................................................... 41 2.4 Exercises................................................................ 43

2.4.1 Choose the correct answer 43 3 Demand and Supply .................................................. 45

3.1 Demand and Supply............................................... 46 3.1.1 Definition of Demand 46 3.1.2 Demand Curve and Demand Schedule 47 3.1.3 Quantity Demanded (Qd) 48 3.1.4 The Law of Demand 50 3.1.5 Changes in demand versus changes in

quantity demanded 51 3.1.6 The Exceptional Demand Curve 54 3.1.7 Definition of Supply 56 3.1.8 Supply Curve and Supply Schedule 56 3.1.9 Quantity Supplied (Qs) 58 3.1.10 The Law of Supply 58 3.1.11 Changes in supply versus changes in quantity

supplied 59 3.2 Summary ............................................................... 62 3.3 Exercises................................................................ 63

3.3.1 Answer the following questions 63 4 Price Determination and Elasticity .......................... 66

4.1 Price Determination and Elasticity ........................ 67 4.1.1 Price Determination 67 4.1.2 Market Equilibrium 67 4.1.3 Price Ceiling and Price Floors 70 4.1.4 Price Elasticity of Demand (PED) 73 4.1.5 Calculating PED 74 4.1.6 Factors Affecting the Price Elasticity of

Demand 78 4.1.7 Income Elasticity of Demand 79 4.1.8 Cross Elasticity of Demand 80 4.1.9 Price Elasticity of Supply 81 4.1.10 Factors Determining Elasticity of Supply 83 4.1.11 Applications of the Concept of elasticity 84

4.2 Case Study .............................................................87 4.3 Summary................................................................89 4.4 Exercises ................................................................90

4.4.1 Answer the following question 90 5 Consumers Behaviour ..............................................92

5.1 Consumers Behaviour...........................................93 5.1.1 The Marginal Utility Theory 93 5.1.2 The Law of Marginal Utility 95 5.1.3 The Indifference Curve and the Budget Line 97 5.1.4 The Properties of Indifference Curves: 98 5.1.5 Budget Line 98

5.2 Case Study ...........................................................100 5.3 Summary..............................................................102 5.4 Exercises ..............................................................103

5.4.1 Answer the following questions 103 6 Production and Production Costs ...........................106

6.1 Production and Production Costs .........................107 6.1.1 The Production Theory 107 6.1.2 Cost and Inputs 108 6.1.3 Short-Run Cost 109 6.1.4 Production in the short-run: The Law of

Diminishing Marginal Returns 109 6.1.5 Short-Run Cost Curves 110 6.1.6 Marginal Cost and Average Cost 111 6.1.7 Long-Run Cost 114 6.1.8 Production in the Long-Run: The Scale of

Production 114 6.1.9 Economies of Scale (EOS) 115 6.1.10 Diseconomies of Scale (DOS) 115

6.2 Summary..............................................................117 6.3 Exercises ..............................................................118

6.3.1 Answer the following questions 118 7 Market Structures....................................................122

7.1 Market Structures.................................................123 7.1.1 Perfect Competition 124 7.1.2 Short-Run Equilibrium in Perfect

Competition 125 7.1.3 Long-Run Equilibrium in Perfect

Competition 126 7.1.4 Entry and Exit 127 7.1.5 Monopolistic Competition 128 7.1.6 Short-Run and Long-Run Equilibrium in

Monopolistic Competition 129 7.1.7 Perfect Competition versus Monopolistic

Competition in the Long-Run Equilibrium 131

7.1.8 Monopoly 132 7.1.9 How Monopoly Arises 132 7.1.10 Monopoly in the Long-Run and Short-Run 132 7.1.11 Perfect Competition versus Monopoly 133 7.1.12 Oligopoly 134 7.1.13 Comparison of the Market Structures 135

7.2 Case Study ...........................................................137 7.3 Summary..............................................................138 7.4 Exercises ..............................................................139

7.4.1 Answer the following questions 139 8 Role of Government and Economic Growth

(Macroeconomics) ....................................................142 8.1 Role of Government.............................................143

8.1.1 Economic growth and development 143 8.1.2 Government revenue and expenditure 145 8.1.3 Areas of government intervention 147

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8.1.4 Differences between developing and developed countries 149

8.1.5 Problems faced by developing countries in achieving economic growth 151

8.2 Case Study........................................................... 152 8.3 Summary ............................................................. 156

9 The Banking System, Money and Inflation (Macroeconomics).................................................... 158

9.1 The Banking System, Money and Inflation.......... 159 9.1.1 Money 159 9.1.2 The Earliest Money and Barter Trade 159 9.1.3 Types of Money 161 9.1.4 Banking System 162 9.1.5 Classification of Banks 163 9.1.6 Powers of the Central Bank 164 9.1.7 What is Monetary Policy? 164 9.1.8 Consumer Price Index (CPI) 166 9.1.9 Inflation 167 9.1.10 Measurements of Inflation 168 9.1.11 Demand-Pull Inflation and Cost-Push

Inflation 170 9.1.12 Unemployment 172 9.1.13 Business Cycle 176

9.2 Case Study........................................................... 178 9.3 Summary ............................................................. 180 9.4 Exercises.............................................................. 182

9.4.1 Answer the following questions 182 10 National Income and Theory of Income

Determination (Macroeconomics) .......................... 188 10.1 National Income and Theory of Income

Determination...................................................... 189 10.1.1 Definition of National Income Accounting 189 10.1.2 Gross Domestic Product (GDP) 189

10.1.3 Methods of Calculating National Income 191 10.1.4 Why GDP equals to aggregate expenditure

and aggregate income 196 10.1.5 The Circular Flow of National Income and

Expenditure 197 10.1.6 Uses of National Income Statistics 198 10.1.7 Why GDP is important? 199 10.1.8 Problems in Calculating National Income 200

10.2 Case Study .....................................................201 10.3 Summary........................................................203 10.4 Exercises ........................................................205

10.4.1 Answer the following questions 205 11 International Trade (Macroeconomics)..................210

11.1 International Trade .........................................211 11.1.1 Distinction between Domestic and

International Trade 212 11.1.2 Advantages and Disadvantages of Trade 214 11.1.3 Absolute Advantage versus Comparative

Advantage 214 11.1.4 Terms of Trade 216 11.1.5 Protectionism 218 11.1.6 Balance of Payments 219 11.1.7 Foreign Exchange 221

11.2 Case Study .....................................................223 11.3 Summary........................................................225 11.4 Exercises ........................................................227

11.4.1 Answer the following questions 227

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1 Introduction to Economics Introduction to Economics What is economics all about? Scarcity Microeconomics and Macroeconomics Economic Systems Mixed Economy Planned Economy Market Economy Traditional Economy

Allocation of Resources Economic Concepts Production Possibility Frontier Production Possibility Curve

Opportunity Cost

Objectives At the end of this chapter students should be able to:

Define economics and distinguish between microeconomics and macroeconomics

Explain the three big questions of microeconomics

Understand the types and functions of economic systems

Explain how the economy can produce a limited amount of resources and a certain level of technology by using the production possibility curve

Understand the concept of opportunity cost

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1.1 INTRODUCTION TO ECONOMICS What can you understand by the word economics?

The word economics is derived from the Greek word, Oikonomikus, which means skilled in household management. The Economists Dictionary of Economics defines economics as The study of the production, distribution and consumption of wealth in human society. One can also view economics as the science that deals with the production, allocation, and the use of goods and services.

It is important to study how resources can be best distributed to meet the needs of the greatest number of people. The fact is that economics affects our daily lives and creates an awareness of local, national and international economic issues: whether it be price increases, interest rate changes, fluctuations in exchange rates, unemployment, economic recessions or balance of payments problems.

The ultimate objective of economics is to make a feasible decision which solves the problem of limited resources to meet the need of human beings.

1.1.1 What is economics all about? Economics also examines how we make choices - college tuition or a new car; more hospitals or more highways; more free time or more income from work? It gives us a way of understanding how to make the best use of natural resources, machinery, and peoples work efforts.

Briefly, economics is the study of making choices. In other words, economics is concerned with how people make decisions in a world of scarcity. In analysing the economic facts, a few core questions would help economist to solve problems and ensure optimal utilization of limited resources. In economics we study: How we decide what to produce with our limited resources. How we ensure stable prices and full employment of our resources.

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I n t r o d u c t i o n t o E c o n o m i c s

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How to provide a rising standard of living both for ourselves and for future generations? Is economics concerned with money? Yes, economics has a lot to do with money how it is made, lost, used and misused.

One important idea in economics is that of needs and wants. This would include the need for food, clothing, shelter, health care, and etc.

Wants are what people desire or wish to have or to experience, such as getting a car, watching movies or receiving medical attention.

One may need clothes, but one may not need a dress designer. Needs are the goods or services which are essential or basic to a persons life such as food, clothing and a place to stay.

Why economics is considered a social science It is the study of human behaviour in the context of how society allocates scarce resources with competing uses to satisfy unlimited wants.

Since it deals with human behaviour, its laws and theories are not the same as scientific laws; it cannot be verified under experimental conditions, but is based on empirical observation.

1.1.2 Scarcity The concept of scarcity is important to the definition of economics because scarcity forces people to choose how they will use their limited resources in an attempt to satisfy their unlimited wants and desires.

Economics is sometimes called the study of scarcity because an economic activity would not exist if scarcity did not force people to make choices. Scarcity means that there are not enough, or there can never be enough goods, and services to satisfy the needs of individual, families and societies. Scarcity requires choice. People must choose what they desire for; they will either be satisfied or otherwise. A decision of consuming more of a good or service will lessen the consumption of others because of limited resources.

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Scarcity refers to the fact that peoples wants are more than what is available, as neither goods nor services are often enough. As a society, limited resources (such as manpower, machinery, factors of production, and natural resources) fix a maximum on the amount of goods and services that can be produced. For example, an individual wants a big house and cars. And the need for personal computers is more important than that for video cameras. This means that every resource needed is limited in amount and a choice has to be made.

When there are scarcity and choice, there are costs. Central to the decision-making process is the value of the best alternative foregone.

Economists call this opportunity cost. Making choices in a world of scarcity means we have to pass up some goods and services to obtain those that we want. What do we mean when we talk about cost? For example, the cost of reading is passing up the opportunity of sleep. Because of scarcity, whenever you make a choice, you must pass up another opportunity; you must incur an opportunity cost. We will study opportunity cost at the end of this chapter. When our economy does well, we, as a nation, do well. But when our economy is in crisis or doesnt do well, the nation suffers and we will not get the goods and services we need or either they will be in shortage. Therefore it is important that all citizens be informed about the economy. The study of economics involves many subdivisions of the entire systems and the two major ones are: Microeconomics Macroeconomics

1.1.3 Microeconomics and Macroeconomics Some economists believe that in order to really understand macroeconomics, you must fully understand microeconomics.

How does microeconomics relate to macroeconomics? Let us look at the differences between microeconomics and macroeconomics.

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Microeconomics Macroeconomics

Microeconomics is the study of

individual decision-making units and markets within the economy.

It looks at decision-making and how it

influences the behaviour of individual in businesses and households.

It focuses on the specific expenditure and

decisions of individual consumers and the forces (tastes, prices, incomes) that influence those decisions.

Microeconomics is the components of the

larger economy - the details of macroeconomics.

The key questions about

microeconomics: How to utilize resources most

efficiently?

What goods and services to produce?

o What will be the demand and supply?

How are goods and services

produced? o Where to get the

resources? Is it scarcity or otherwise?

o The resources that businesses use to produce goods and services are from the factors of production such as land, labour, capital and entrepreneur.

For whom are goods and services

produced? o Who gets the goods and

services? o Land earns rent

Macroeconomics is the study of the

entire economy in terms of the total amount of goods and services produced, total income earned, the level of employment of productive resources, and the general price level.

It is concerned with the economy as a

whole. It is the branch of economics that studies the overall level of prices, output and employment in the economy inclusive of the following:

Inflation

Recession

Balance of trade

Unemployment

The key questions about

macroeconomics:

What determines the standard of living?

What determines the cost of

living?

Why does our economy fluctuate? Macroeconomics can be used to analyze

how best to influence policy goals such as economic growth, price stability, full employment and the attainment of a sustainable balance of payments.

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o Labour earns wages o Capital earns interest o Entrepreneurship earns

profit How to allocate the goods and services

that are produced? Where there is consumer demand

and producer supply, in a market economy, goods and services are allocated based on the ability to pay.

Chapter 2 will cover the area on Factors of Production, and Macroeconomics, from Chapter 8 to 11.

1.1.4 Economic Systems An economic system is the way in which an economy is organized to make the basic economic decisions. It can be said as a mechanism which deals with the production, distribution and consumption of goods and services in a particular society. An economic system is composed of people, institution, and their relationship to resources, and it addresses the problems of economics such as the allocation and scarcity of resources. It is a way of answering these basic questions. Different economic systems answer them differently.

The main economic decision-makers are households, with firms, governments, and the rest of the world serving as supporting actors. Households are considered to be the lead actors since they supply resources used in the production, and demand goods and services produced by other actors. Firms, governments, and the rest of the world are supporting actors because they demand the resources that households supply and use them to produce and supply the goods that households demand. How these basic economic questions are answered determines which sort of economic system will be followed. The most basic and general economic systems are: Mixed economy Market economy

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Planned economy Traditional economy Lets take a look at Figure 1-1 which shows the three key questions of microeconomics and ends up with the concept of various economic systems.

Figure 1-1 Shows how scarcity is created and how the answers to the three basic economic questions

(what, how and who) lead to philosophically different economic systems

1.1.5 Mixed Economy Mixed economy is an economic system with some combination of market and centralized decision making. In this economy the government and the private sector jointly solve economic problems. Thus, most of the real-world economies are a mixture of the two systems. The government will not intervene in all but four areas: The business sector Output market The household sector Input market

Even countries, like US, which practices more enthusiastically the free market or capitalist approach, still have substantial levels of government activity in the public goods and services, and the regulation of markets.

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As for China, it is theoretically a communist economy, yet they are now developing into private enterprises. Malaysia is a good example of a mixed economy since government intervention in market is almost equal. Economic policies are mostly made in a mixed fashion including partial intervention.

Free market is a market in which the government does not intervene.

1.1.6 Planned Economy Planned economy is also termed as command economy in which the basic economic decisions are made by the planners rather than by private individuals and businesses. In this economy, everything is controlled by the government and there is no private sector. In this economy a government planning office decides what will be produced, how it will be produced, and for whom it will be produced.

Consumers have no choice but to accept what has been decided by the government or the central authority. Such planning is complicated. The planned economy is usually associated with the socialist or communist economic system, where land and capital are collectively owned. Communism Planned economic system in which the government owns and operates all

major sources of production. Socialism Planned economic system in which the government owns and operates

selected major sources of production. However, countries like China, Cuba, North Korea and those countries from the Soviet Bloc have a large measure of central directions and planning. The state owns factories and land, and decisions are made by them about what people should consume, how goods should be produced, and how people should work.

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Imagine that you had to run by command in the city which you live the food, clothing, and housing allocation decisions you would have to make! It means that consumers have no choice but to accept what has been decided by the government.

A fundamental problem with this economy is that it is impossible to plan for everything, so lots of things fall between the cracks. This economy usually suffers a shortage of spare parts, because no one plans for machine break downs. Secondary effects, such as environmental impact, are often ignored. Furthermore, planners do not have control of the purchase of goods, so they have to guess what consumers really want. Individuals have little incentive to address these problems, because on meeting planned targets they would be rewarded, not on improving the overall system.

Table 1-1 Strengths and Weaknesses of Planned Economy

(Source: Patrick J Welch & Gerry F Welch, 2004)

1.1.7 Market Economy A market economy (also known as free market economy and free enterprise economy) is an economic system in which the production and distribution of goods and services take place through the mechanism of free market guided by a free price system rather than like a planned economy.

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It refers to the study of an economy in which the basic economic decisions are made by the individual buyers and sellers in markets using the language of price. It also refers to the study of business decisions based on decision makers knowledge of the external environment.

Also called a price system market; one in which buyers and sellers communicate through prices in markets. Before we proceed, every student should know what a market means A market is defined as a place or situation in which buyers and sellers of a product

interact for the purpose of exchange. The distinguishing characteristics of each of the market models are centred on three areas,

that is: number of sellers; product type; entry and exit. These three areas are important for determining the type and amount of competition that exist in a market.

For example, Mc Donalds is trying to sell Big Macs by making them available at a particular price, and students tell Mc Donalds that they want Big Macs by paying the price asked. The exchange of the burger is made because the price is suitable to both the buyer and seller.

Market economy may be practical, but it also depends on the fundamental principles of individual freedom: Freedom as a consumer to choose among competing products and services. Freedom as a producer to start or expand a business and share its risks and rewards. Freedom as a worker to choose a job or career, join labour union, or change employers. It is possible for a market economy to have government intervention in the economy.

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1.1.8 The reasons why the government needs to intervene in the market economy

In a market economy, the private sector is not willing to supply public goods such as street lights, road signs, defensive device and etc. There will be problem of free riders where people who want to make use of goods but refuse to pay for them. This is the reason why public goods have to be provided by the government. The government has to curb the power of the monopoly both from economic and political viewpoints. What is monopoly? The term monopolist is a sole trader who is the only one seller of a good but there are many buyers. The monopolist or the sole trader tends to exploit the consumer by charging higher prices and lower output. The government can attempt to ensure an equitable income distribution in the economy. They will impose high direct taxes on the rich and give subsidies to the poor. In the market economy there are no provisions made for the disabled, the unemployed, the elderly or even children living in poverty. So, when the government intervenes there will be a protection for such people.

Now let us look at Figure 1-2 illustrating the Circular Flow Model - the real and money flows between households and businesses in output product, markets and input resource and markets. This model shows how business (firms) and households relate to one another as buyers and sellers. Firms choose the quantities of the various goods and services to produce. Households choose the quantities of labour, land, capital and entrepreneurship to sell or rent to firms in exchange for wages, rent, interest, and profit. Households then spend their incomes on consumption of goods, in taxes paid to governments and on assets that flow through the financial sector and are then used to buy investment and other goods.

Figure 1-2 Circular Flow Model

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Households as resource suppliers: Use limited resources: labour, capital, land and entrepreneurial ability to satisfy unlimited

wants. Use these resources to produce goods and services in the home. Sell these resources in the resource market to earn income. Households as demanders for goods and services: Households spend over 70% of their income on consumption of goods which include:

Durable goods automobiles, refrigerators, etc. Non-durable goods food, clothing, etc.

Services medical care, haircuts, travel, etc.

As mentioned in the planned economy, the governments economic planners, production experts, and political officials establish production levels for goods and designate which factories will produce them.

They will also establish the prices for the shirts and blouses, as well as the wages for the workers who make them. Predictably, the products are limited and sell out quickly, disappearing from store. Why? It is because factories fail to meet their production quotas. This phenomenon doesnt happen in the market economies, because that kind of economic system works in a very different way. Economic decisions on what, how and who are handled by the business (management) itself. No ministry decides how many shirts or blouses to manufacture, or styles and colours. Any one individual or company can decide to produce and sell shirts and blouses, and many will do just that if they believe they can sell these products at prices high enough to cover their production costs. The market economy and the free price system make goods from around the world available to consumers. It also gives the largest possible scope to entrepreneurs, who risk capital to allocate resources so as to satisfy the future desires of the mass of consumers as efficiently as possible. The Malaysian economy is a small and relatively open economy. In 2005 Malaysia was the 33rd largest economy by purchasing power parity where its gross domestic product (GDP) for 2005 was estimated to be RM290 billion. Some of the visible projects from that period are Putrajaya, Kuala Lumpur International Airport (a new international airport), a hydroelectric dam (Bakun dam), the Petronas Towers and the Multimedia Super Corridor.

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Kuala Lumpurs Landmark, The Petronas Twin Towers

The Kuala Lumpur Tower

Table 1-2 Strengths and Weaknesses of Market Economy


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1.1.9 Traditional Economy Traditional economy relies largely on tradition, custom or ritual when making the basic economic decisions. The decisions such as the who, how, what and for whom questions are all made on the basis of custom, beliefs, religion, habit, etc. Some economists view economies in Saudi Arabia, parts of Pakistan and India, Iran, Iraq, Afghanistan, Native Americans, South America and Africa as examples of economies that maintain some elements of traditional economies. Their people are still making clothing and shelter exactly the same way as they did in the past.

Example: This is what my grandfather did and what his grandfather did.. Boys tend to take up the occupations of their father, while girls stay at home with their mother. There may be little room for freedom, innovation, or change.

It is very hard to say that this system is not for the most part, market driven. Even Saudi Arabia produces and markets its oil using some element in traditional system thus it is market driven.

Table 1-3 Strengths and Weaknesses of Traditional Economy


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1.1.10 Allocation of Resources Allocation of resources is an apportionment of productive assets among uses. The aim is always to allocate resources in such a way as to obtain the maximum possible output from a given combination of resources.

Resource allocation is important in economics because the resources of a society are in limited supply, whereas human wants are usually unlimited. The allocation is determined by the three key words: What to produce? Consumers have the purchasing power to dictate the types of goods. How to produce? It depends on the cheapest method of production, where the producer

will use the least input to produce a given level of output. For whom to produce? Those having the purchasing power will eventually get the goods

that have been produced. Factors of production/resources these are those elements that a nation has at its disposal to deal with the issue of scarcity. How efficiently these are used determines the measure of success a nation attains. Factors of Production consists of:

Land and raw materials natural resources, etc

Capital investment monies

Labour human capital, the work force;

size, education, quality, work ethic

Entrepreneurs inventive and risk taking spirit

We will cover in details the area on Factors of Production in Chapter Two.

1.1.11 Economic Concepts Every economy, in order to produce and consume, needs to address basic issues such as the following: The goods and services that should be produced and in what quantities.

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The scarce resources such as labour and capital should be allocated to produce goods and services.

The availability of supplies of goods and services that should be distributed across the

population. The price that should be charged for goods or services. Fundamentals of Economic concepts (microeconomic level): Scarcity. The result of not enough goods and services to satisfy all wants and needs. Choice. Scope of making your own choice. Supply. The different amounts of a product that a seller wish to sell at different prices in a

given time period. Demand. The different amounts of a product that a buyer wishes to purchase at different

prices over a given period. Consumers. Emphasizes consumers as individuals and household members. Producers. Who creates utility or helps bring it into existence which supports human life.

The earth, of course, is the real producer. For example, the crops and livestock produced in the agriculture sector become food products in the manufacturing sector, and then moved to households through the wholesale and retail trade.

Natural resources. Land, fish, wildlife, air, water, groundwater, drinking water supplies,

and other such resources are included in natural resources. Natural resources are renewable.

Money. Generally accepted means of payment for delivery of goods or settlement of debt.

It is the medium of exchange. Pricing. Measurable value to measure the flow of supply and demand. Markets. Composed of firms selling products and competing for the same group of

buyers. Specialization of labour. Allow a nation to produce more with its supply of labour and

resources. Barter trade. Barter trade has a medium of exchange. Goods are swapped for other goods. Public goods. A good or service that has the features of non-rivalry and inexclusiveness

and as a result would not be provided by the free market. Examples are street lighting, flood-control dams, pavement, public drainage, lighthouse, and public services such as defence and law enforcement.

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1.1.12 Production Possibility Frontier The production possibility frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot. It is the simplest way to represent the basic production decision: How much of each good should be produced?

The entire production system is represented by two alternative goods. Any combination (or mix) of these two goods can be produced, within the limitations of existing resources and technology. The PPF is a curve depicting all maximum output possibilities of two or more goods given a set of inputs (resources, labour, etc). The PPF assumes that all inputs are used efficiently.

1.1.13 Production Possibilities Curve The production possibilities curve is a simple model designed to show the production capabilities of an economy given current resources. Three factors to consider:

1. an increase or improvement in technology 2. the employment of migrant workers (that is, an increase in labour force) 3. an increase in population

Figure 1-3 shows the production outside the curve is unattainable, given existing resources and technology.

Production inside the curve is attainable (inefficient), since resources (including labour) and/or technologies are under-utilized. The economy is not efficient and the resources are not fully utilized or optimally used. In other words, unemployment exists (unemployment is a condition where some available resources are not being used in the production of goods and services).

Production on the curve (efficient) represents all of the possible mixes of maximum output for both goods. Here all resources and technologies are fully and efficiently used.

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Figure 1-3 The Production Possibilities Curve

What can shift the PPF? Economic growth is reflected by an outward shift in the PPF. Changes in resource availability people working longer hours, wars. Capital stock more capital goods produced during this period results in an outward shift

of the PPF in the next period. Technology discoveries that will employ resources more efficiently. Example: Under what conditions is it possible to increase production of one good without decreasing production of another? An economy can produce more of one good without sacrificing production of other goods if it is operating inside its PPF. The economy is inside the PPF when some resources are idle or when they are allocated efficiently. Therefore, production can be increased by using more of the idle resources or by allocating resources more efficiently. The PPF model is commonly used to illustrate the optimal mix between security and food referred to as Guns and Butter. We must give up some guns to get more butter or give up some butter to get more guns. Let us look at the example shown in Figure 1-4 .

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Figure 1-4 The PPF Model of Guns and Butter

Figure 1-4 shows some combinations of the quantities of butter and guns that can be produced. The x-axis shows the quantities of butter produced, and y-axis shows the quantity of guns produced. Because PPF shows the limit of production, we cannot attain the points outside the frontier. They are points that describe wants that cannot be attained. We can produce all the points inside the PPF and on the PPF- they are attainable points.

Let us look at another example of PPF shown below. This boundary (Figure 1.5) is what we can attain and what we cannot attain and it is defined as trade-off. Every choice along the PPF involves a trade-off we must give up something to get something else. Trade-off arises in every imaginable real world situation. By using our available technologies, we can employ the factors of production (land, labour, capital and entrepreneur) to produce goods and services. But we are limited in what we produce. Figure 1-5 illustrates some combinations of the quantities of Product A (y-axis) and Product B (x-axis) that can be produced. As indicated point A, B, and C represent the points at which production of good A and good B is most efficient. The line passing through these points (A-C) is the PPF. It separates the attainable (X) from the unattainable (Y). Point X demonstrates the point where resources use are inefficient, or are not being used in the efficient production of both goods. Point Y demonstrates an output that is unattainable with the given inputs.

Figure 1-5 The PPF Model of Product A, B, and C

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Examples of trade-off are: When your parents say that you should study more, they are suggesting a trade off: more

study time for less leisure or sleep. When doctors say that we must spend more on AIDS and cancer research, they are

suggesting a trade off: more medical research for less of some other things. When the Prime Minister says that he wants to spend more on education and health care,

he is suggesting a trade off. All trade-offs involve a cost known as opportunity cost.

1.1.14 Opportunity Cost Opportunity cost can be defined as the next best alternative foregone. It is the cost or decision measured of any choice options that a person gives up.

For example, if you give up the option of playing a computer game to read this text, the cost of reading this text is the enjoyment you would have received rather than playing the game. One can view that the cost of choosing an option as the sacrifice involved in rejecting the other choice (which are the benefits one loses when one rejects the other choice). Opportunity cost can also be known as the real cost of the goods.

Example of opportunity cost for the

individual:

To work or waste time or leisure

Present consumptions or savings

Doing homework or playing games

Example of opportunity cost of a government:

Civilian goods or military goods

Foreigners or local

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Example of opportunity cost of a producer:

Labour

Capital

Opportunity cost also relates to the cost of pursuing one alternative versus another. When economists refer to the opportunity cost of a resource, they mean the value of the next highest value alternative use of that resource. If, for example, you spend time and money going to a movie, you cannot spend that time at home reading a book, and you cant spend the money on something else. If your next best alternative to seeing the movie is reading the book, then the opportunity cost of seeing the movie is the money spent plus the pleasure you forego by not reading the book.

Technically, the opportunity cost is not limited to the cost of investing the money, but also includes any other opportunity you could spend the money on (investing, buying something else, saving the money, etc).

Example 1. If you were going to spend RM500 on a new bike, the opportunity cost would be that you would not be able to buy anything else with or invest that RM500. For the purpose of financial planning, you should look at the cost versus the benefit of each decision you make. In this case, you would spend RM500 on the bike or you could invest the RM500 in a savings account. In five years, the bike will be worth RM25 and the RM500 investment will be worth RM650 (including interest). The opportunity cost of buying a bike is the long-term benefit

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that you will receive if you did not buy the bike and invested it instead.

Example 2. When governments subsidize college education, most students still pay more than half of the cost. Take a student who pays RM2,000 in tuition at a college. Assume that the government subsidy to the college amounts to RM5,000 per student. It looks as if the cost is RM7,000 and the student pays less than half. But looks are deceiving. The true cost is RM7,000 plus the income the student foregoes by attending school rather than working. If the student could have earned RM15,000 per year, than the true cost of the education is RM7,000 plus RM15,000. Of this RM22,000 total, the student pays RM17,000 (RM15,000 plus RM2,000.) Both of the examples have powerful implications on the opportunity cost. What about the cost of room and board while attending school? This is not a true cost of attending school at all, because whether or not the student attends school, someone must pay for room and board. Opportunity cost is expressed in relative price, that is, the price of one choice relative to the price of another.

For example, if milk costs RM4 per gallon and bread costs RM2 per loaf, then the relative price of milk is 2 loaves of bread. If a consumer goes to the grocery store with only RM4 and buys a gallon of milk with it, then one can say that the opportunity cost of that gallon of milk was 2 loaves of bread (assuming that bread was the next best alternative).

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1.2 CASE STUDY

The opportunity costs of studying economics What are you sacrificing?

You may not have realised it, but you probably consider opportunity costs many times a day. The reason is that we are constantly making choices: what to buy, what to eat, what to wear, whether to go out, how much to study and so on. Each time we make such choice, we are in effect rejecting some alternative. This alternative foregone is the opportunity cost of the action we chose. Sometimes the opportunity cost of our actions are the direct monetary costs we incur. Sometimes it is more complicated. Take the opportunity costs of your choices as a student of economics. Buying a textbook costing RM69.96 This does involve a direct money payment. What you have to consider is the alternatives you could have bought with the RM69.95. You then have to weigh the benefit from the best alternative against the benefit of the textbook. 1. What might prevent you from making the best decision? Coming to classes You will be paying tuition fees. Thus there is no extra (marginal) monetary cost in coming to classes once the fees have been paid. You will not get a refund by skipping classes! So are the opportunity costs zero? No: by coming to classes you are not working in the library; you are not having an extra hour in bed; you are not sitting drinking coffee with friends, and so on. If you are making a rational decision to come to classes, then you will consider such possible alternatives. 2. If there are several other things you could have done, is the opportunity cost the sum

of all of them? Choosing to study at university or college What are the opportunity costs of being a student in higher education? At first it might seem that the cost would include the following: tuition fees

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books, stationery and so on accommodation expenses transport food, entertainment and other living expenses. But adding these up does not give the opportunity cost. The opportunity cost is the sacrifice entailed by going to university or college rather than doing something else. Let us assume that the alternative is to take a job that has been offered. The correct list of opportunity costs of higher education would include: tuition fees books, stationery and so on additional accommodation and transport expenses over what would have been

incurred by taking the job wages 3. Why is the cost of food not included? 4. Make a list of the benefits of higher education. 5. Is the opportunity cost to the individual of attending higher education different from

the opportunity costs to society as a whole? (Source: Sloman & Norris, 2005)

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1.3 SUMMARY The subject of economics is usually divided into two main branches: Microeconomics deals with the activities of individual units within the economy: firms,

industries, consumer, workers, etc. Macroeconomics deals with aggregate such as the overall levels of unemployment, output

growth and prices in the economy. Economics is all about: What goods and services are going to be produced and in what quantities? How are things going to be produced, given that there is normally more than one product? For whom are things going to be produced? Scarcity means that there are not enough, or there can never be enough goods, and services to satisfy the needs of individual, families and societies. Mixed economic systems combine elements of market and centralized (planned) decisions. Mixed economies arise in respond to planning and market failures. Modern economies are mixed, relying on the market but with a large dose of government intervention. In planned economy, government planners make the basic economic decisions. Planned economies can allow societies to achieve non-economic goals more easily than in market economies, can limit unemployment, and can provide for a more equal distribution of goods/services if that is the goal of society. In a market economy, buyers and sellers communicate their wants and needs in markets, and the language they communicate are the prices. A market economy will only produce goods and services if buyers demand them at a price that allows sellers to produce them at a profit. Economists use a circular flow model to illustrate the basic structure of a market economy. The circular flow of goods and incomes shows the interrelationships between firms and households relate to one another, as buyers and sellers in output and input markets. The circular flow model also identifies where government can intervene in the market economy to correct problems or improve conditions. The central economic problem is that of scarcity. Given that there is a limited supply of factors of production, it is impossible to provide everybody with everything they want. These factors of production are of three broad types:

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Labour human resources Land and raw materials natural resources Capital physical assets factory, machinery, management Economic concepts: Scarcity Choice Consumers Producers Natural resources; human resources; capital resources Pricing Markets and etc. The Production Possibility Frontier (PPF) shows the possible combinations of two goods that a country/business can produce in a given period of time. It shows the maximum amount of one good that can be produced given the output of the other goods. It depicts the trade-off or menu of choices for society in deciding what to produce. Resources are scarce and points outside the frontier are unattainable. It is sufficient to produce within the frontier. The boundary shows in the PPF on what we can attain and what we cannot attain is defined as trade-off. Every choice along the PPF involves a trade-off we must give up something to get something else. The opportunity cost of a good is the quantity of other goods sacrificed to make an additional unit of the good. It represents the slope of the PPF.

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1.4 EXERCISES

1.4.1 Answer the following questions 1. The science that deals with the production, allocation, and use of goods and services,

and how resources can best be distributed to meet the needs of the greatest number of people is ________________.

a. Biology b. Psychology c. Economics

2. The study of the entire system of economics is ____________________.

a. Macroeconomics b. Microeconomics c. Finance

3. The study of how the economic system affects ones business or the study of parts of the

economic system is __________________.

a. Microeconomics b. Macroeconomics c. Business organization

4. Goods and services that are necessary for living such as food, clothing, and shelter are

_____________________.

a. needs b. wants c. advertising

5. Goods and services that are not necessary for living such as toys, games, and

entertainment are ___________________.

a. needs b. wants c. advertising

6. This is an important part of economics that helps to ensure peoples needs and wants are

met.

a. Scarcity b. Advertising c. Distribution

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7. A time when there are not enough goods and services to meet peoples need and wants is _____________________.

a. scarcity b. advertising c. distribution

8. A person who supports a centrally planned economy would most value ____________.

a. competition b. cooperation c. individuality d. materialism

9. The production possibilities frontier illustrates the _________________________

_______________________________.

a. resources the economy process, but not its level of technology. b. limits to people wants. c. maximum combinations of goods and services that can be produced. d. goods and services that people want.

10. In order for Malaysia to grow more durians, textile production must decrease. This

situation is an example of _________________.

a. a free lunch b. opportunity benefit c. a trade off d. zero opportunity cost

11. A recession, during which unemployment increases, will place an economy

________________________________________.

a. outside its production possibilities frontier. b. on the production possibility curve but moved a little upwards. c. on the production possibility curve but moved a little downwards. d. inside its production possibility frontier.

12. Which economic feature often results from the use of the other three features?

a. profit b. labour c. land d. capital

13. Why does a nation experience increasing opportunity cost?

a. Resources are not equally efficient in producing different kinds of goods and

services. b. As the nation moves from a production point within the PPF to one on the PPF,

opportunity costs increase.

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c. As the nation moves from a production point within the PPF to another point also within the PPF, opportunity costs increase.

d. When the amount of resources increases, the opportunity cost of all goods and services increases.

14. A country has a comparative advantage in the production of a good if it can

_______________.

a. produce more of the goods than another country. b. trade-off producing the goods for another good. c. produce the goods at the lowest opportunity cost. d. produce more of the goods most efficiently.

15. In the circular flow diagram, if Ringgit payments flow to businesses, what flows back to

households?

a. labour b. labour and other resources c. goods and services d. payments to factors of production

16. What can you understand by opportunity cost, and give an example.

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

17. What is production possibility curve (PPC)?

________________________________________________________________________

________________________________________________________________________

________________________________________________________________________

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2 Factors of Production Factors of Production Land Labour Capital Entrepreneur


Understand the factors of production Understand and define land Understand and define labour Understand and define capital Understand and define entrepreneurship

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2.1 FACTORS OF PRODUCTION Factors of production are also called productive resources. Factors of production are the resources used in producing goods and services to meet human wants. Economic resources are relatively scarce to the infinite needs and wants of people and businesses operating in the economy. It is important to use these resources efficiently in order to maximize the output. Productivity is a measure relating a quantity or quality of output to the inputs required to produce. For example, labour productivity, which can be measured by quantity of output per numbers of worker. Production refers to the transformation of inputs (labour, land) to outputs (any product) by firms in order to earn profit. In a market economy, entrepreneurs combine land, labour, and capital to make profit. In a planned economy, central planners decide how land, labour, and capital should be used to provide for maximum benefit for all citizens.

Economists make a distinction between four types of resources: Land naturally-occurring goods such as soil and minerals that are used in the creation

of products. The payment for land is rent. Labour human effort used in production which also includes technical and marketing

expertise. The payment for labour is wage or salary. Capital human-made goods (or means of production) which are used in the production

of other goods. These include machinery, tools and buildings. In a general sense, the payment for capital is called interest.

Entrepreneurship skill of organizing and operating economic activities such as profit

making business initiatives. Usually entrepreneurs are risk takers to start and manage business activities.

Consider labour and entrepreneurial ability: both are people, a person who represents labour today might be willing to take a risk and organize production tomorrow, becoming an entrepreneur. Labour and capital: capital is production factor of production, but some labour is also produced through education and training - some labour is actually capital, human capital attached to people. Human capital - the skill and knowledge of people, it comes from education, on the job training, and work experience.

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2.1.1 Land Land is a kind of factor of production which is natural and provided only by nature: e.g., unimproved land and mineral deposits (oil and gas, iron ore, coal, copper) in the ground.

Other raw materials or primary product such as agricultural crops, forest products, fisheries products and so on are also produced using land as input. Land has the following characteristics:

It is a durable asset

It is limited in supply

It is a gift of nature

It is said to be immobile

It is owned by people but can be rented out

2.1.2 Labour The terms labour and human resources have essentially the same meaning and often used synonymously. The human inputs (including technical and marketing expertise) are involved in production.

A simple definition of labour is all forms of human input, both physical and mental, in current production. Labour is also limited as a factor of production. There are two important points to remember about labour as a factor of production: A housewife or a keen gardener produce goods and services, but she/he does not get paid

for them. She/he is producing non-marketed output and the her/his output is not included in GDP (Gross Domestic Product which means the total production of an economy in a year. GDP will be discussed elaborately in the macroeconomic section).

Not all labour is of the same quality. Some workers are more productive than others

because of their education, training and experience.

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The manufacturing, construction, transport and communication and service sectors utilize human resource in skilled or unskilled form. Labour force and quality of labour are basic issues in strengthening national economy. Labour has the following characteristics:

A labourer offers his services

Labour services cannot be kept or stored

Labour has greater mobility than land

Labour is not homogeneous product

(different people have different skills and attitude)

The value of labour like all the factors of production is determined by a few factors such as: Total supply Elasticity of supply Elasticity of demand for product using factors; and Physical productivity of factor Malaysia has a population of approximately 23.8 million. The economy grew 8.3 percent in 2000, but slowed in 2001 to a growth rate of 0.4 percent growth. Malaysians services and manufacturing accounted for 49.6 percent and 31.5 percent of the GDP. The unemployment rate was approximately 3.6 percent in 2001. Over recent years there has been a sustained increase in the employed labour force providing more labour resources with which to increase total outputs (GDP Gross Domestic Product). The Malaysian economy maintained its momentum growing 7.1% (real GDP) in 2004, after expanding 5.3% in 2003. The better than expected expansion in 2004 was fuelled primarily by the continuing strength of the manufacturing sector, particularly the electronics and chemical industries.

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2.1.3 Capital Capital refers to the machines, factories, tools and so on which are used as input in producing other goods and services. It is something owned which provides ongoing services.

In the national accounts, or to firms, capital is made up of durable investment goods, normally summed up in units of money. Broadly: land plus physical structures plus equipment. The idea is used in models and in the national accounts.

The wages for workers as well as any machinery and equipment, computers, office furniture and all other goods that are used in the production of good and services. Capital makes labour more productive. Capital has the following characteristics:

It is a durable asset

It is owned by people but can be rented out

Capital factor and services are

generated over a production period

Capital goods first have to be produced

There are three types of capital:

Fixed capital

Working capital

Social capital

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Fixed Capital

Fixed capital is a physical asset or durable which does not vary as the level of output varies. It will not change in the production process even if the output is zero.

Fixed capital is sometimes known as supplementary, indirect or overhead factor.

Examples are machinery, plant and equipment, new technology, factories and buildings all goods designed to increase the productivity potential of the economy in the future.

We can include the social capital created from Government investment spending,

i.e. the building of new schools, universities, hospital and spending on expanding the national road network.

Working Capital

Working capital is the stock of goods that vary with the level of output. When output increases, the working capital also increases. When output is zero, the amount of working capital will be zero also.

Working capital includes stocks of finished and semi-finished goods

(components) that will be either consumed in the near future or will be made into finished consumer goods.

Working capital is the amount we need to pay for the day-to-day operating costs

of our business.

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Social Capital

Social capital is normally provided by the government. It includes educational, medical, housing and recreational centre.

Social capital is not directly related to production of goods and services, but to

increase the productivity of the general workers, that is labour force of the country.

2.1.4 Entrepreneur There are a variety of definitions of the concept of entrepreneurship. Most commonly, an entrepreneur is a person who has skills of creative decision-making, risk-taking or starting a business venture.

The Entrepreneurial skills of an entrepreneur help in organizing or bringing other factors together and the entrepreneur takes the risk of success or failure. Without an entrepreneurs efforts, a new business ventures does not occur. Understanding the factor of entrepreneurship is an important part of understanding the dynamics of the market economy.

The entrepreneur can be an individual or a group. It is the entrepreneur who sees new opportunities to satisfy a demand and who finds new, better way or less-costly ways to use resources. An entrepreneur also finds new ways to meet consumer demands in order to earn a profit.

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Give an example of the factors of production as inputs in the production process.

1. List the inputs involved in the supply of cakes by a confectionery.

2. Classify these inputs according to the four factors of production. Solution: Land shop space, eggs. Land may be regarded as any input provided directly by nature.

We may classify eggs as land in the sense that it derived directly from nature too. The physical building which forms the shop should be classified as capital since it is man- made. However, we may regard the space it occupies as land.

Labour baker, cashier, sales assistant. Capital oven, flour, baking powder, cream, sugar, egg-beater, and tray. Entrepreneur - confectionary owner.

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2.2 CASE STUDY

Green Economics Taking account of factors of production

People have become concerned by a number of environmental problems in recent years. These include the following: Land and river pollution. The tipping of toxic waste into the ground or rivers can

cause long-term environmental damage. Soils can be poisoned; rivers and seas can become polluted. It is not just industry that is to be blamed here. Sewage pollutes rivers and seas. Nitrogen run-off and slurry deposits from farming are also major pollutants.

Acid rain. This is caused by sulphur and nitrogen emissions from power stations,

industry and cars. An irresponsible company has been blamed for forest death and the contamination of many lakes and streams, with the death of fish and plant life.

The greenhouse effect. This is caused by carbon dioxide and other gases emitted

again by power stations, various industries and cars. The fear is that these gases will cause a heating of the Earth's atmosphere. This will lead to climatic changes which will affect food production. It will also lead to a raising of sea levels and flooding as part of the polar ice caps melts.

Nuclear radiation. The fear is that accidents or sabotage at nuclear power stations

could cause dangerous releases of radiation. The disposal of nuclear waste is another environmental problem.

It was not until the late 1960s and early 1970s that the environment became more firmly part of the political agenda in most industrial countries. The government realised that if economic growth was to be sustained then environmental damage could grow at an alarming rate. The problems that the government has encountered in attempting to change attitudes and economic strategies have been equally pressing. The costs of pollution ignorance are high, especially in the short-run. As long as these short-run costs are greater than the perceived costs of continuing pollution, the industry and government will continue to incur them. The consequences of this, however, could be irreversible and are far more costly in the long-run, in both a financial and an environmental sense. What can economists say about the causes of these environmental problems? They have three common features: Ignorance. It is often not till many years later that the nature and causes of

environmental damage are realised.

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The polluters do not pay. The costs of pollution are rarely paid by the polluters.

Economists call such costs as the external costs. Since polluters rarely pay to clean up their pollution or compensate those who suffer, they frequently ignore the problem.

Present gains for future costs. The environmental costs of industrialisation often build

up slowly and do not become critical for many years. The benefits of industrialisation, however, are more immediate. Thus the government, consumers and industries are frequently prepared to continue with various practices and leave future generations to worry about their environmental consequences. The problem then is a reflection of the importance people attach to the present relative to the future.

Environmentalists recognise these problems and try through the political process and various pressure groups, to reduce peoples ignorance and to change their attitudes. They stress the need for clean technologies, for environmentally sound growth and for greater responsibility by industry, consumers and government alike. Policies, they argue, should prevent problems occurring and not merely be a reaction to them once they are nearing a crisis point. If growth is to be sustainable into the long-term, with a real increase in the quality of life, then current growth must not be at the expenses of the environment. The environmentalists claim is that far too little is being done. The cost of coping with environmental degradation will continue to grow, even if the current international agreements are implemented. Discuss the mentioned case study

1. Should all polluting activities be banned? 2. Could pollution ever be justified? 3. Will the environmental problems be improved by using modern technology?

Explain your answer in relation to the four types of resources.

(Source: Sloman and Sutcliffe, 2003/2005)

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2.3 SUMMARY Factors of production are also called productive resources. The four types of resources are: Land (natural resources) Labour (human resources) Capital (man-made) Entrepreneur (individual or group) The concepts of production refer to: Manufacturing of goods Distributing the goods produced Providing services Natural resources are not human made, but it is a gift of nature. In economics, land includes natural resources such as soil, water, plants and minerals available for production. In economics, labour refers to human inputs, that is, services and rewards received. Labour is not a homogeneous product. Different people have different skills, some with experience, education and training, and some vice versa. Capital in economics means investment in goods that can produce other goods in the future. Capital makes labour more productive. Without capital, production would be done by hand. All capital is wealth, but not all wealth is capital. There are three types of capital: Fixed capital physical assets which do not vary as the level of output varies. Social capital created from government investment spending, such as educational,

hospital, housing and road network. Working capital stocks of goods that vary with the level of output. An entrepreneur can be an individual or a group.

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His functions is to organize or bringing other factors together and taking the risk of success or failure. An entrepreneur coordinates the factors of production (land, labour, capital) to satisfy demand and to maximize profits. An entrepreneur is always concerned with research and development, in order to be more competitive than his rivals.

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2.4 EXERCISES

2.4.1 Choose the correct answer 1. In the production of automobiles, the factory and assembly lines are examples of

________________.

a. labour b. land c. capital d. property

2. Why is the availability of labour often a minor consideration in locating an industry?

a. New industry will usually pay low wages to workers. b. People will usually move to areas of new industry. c. People will usually have to be retained for jobs. d. New industries usually only hire skilled labour.

3. There are many steps involved in the production of a product before the product is sold.

First, an entrepreneur comes up with an idea for a product and makes plan for its production. A factory must then be built (or rented) and equipped with the proper machinery. Raw materials needed to produce the product are bought, workers are hired and production begins. The owner must then transport and sell the items to consumers. Only then does the owner begin to receive a return (profit) on his investment. Which step in the production process described represents land as a factor of production?

a. Buying the raw materials needed b. Hiring workers to produce the item c. Equipped the factory with machinery d. Transporting the products to market

4. Which economic feature often results from the use of the other three features?

a. Land b. Profit c. Labour d. Capital

5. One characteristic of a model market economy is that____________________________.

a. businesses are guaranteed a profit b. societys production is shared equally c. government regulates competition d. property is privately owned

6. Which definition is basically a definition of an entrepreneur?

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a. a person who develops new inventions b. a person who invests in the stock market c. a person who lends money to new businesses d. a person who risks a loss to make a profit

7. The income approach to GDP includes all of the following items, except _____________.

a. wages of workers b. self employed income c. interest income d. Corporate profits e. Investment spending

8. The relationship between real GDP and the quantity of labour employed when all other

influences on production remain the same is the ________________________________.

a. aggregate supply b. supply of labour c. production possibilities frontier d. production function

9. All of the following factors influence labour productivity except ___________________.

a. Technology b. Capital c. Human capital d. Wage rate

10. To increase in the supply of labour will lead to a ________________________________.

a. no change in the position on the production function and no shift in the production function.

b. movement along the production function. c. rightward shift in the production function. d. leftward shift in the production function.

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3 Demand and Supply Definition of Demand Demand Curve and Demand Schedule Quantity Demanded (Qd)

The Law of Demand Changes in demand versus changes

in quantity demanded The Exceptional Demand Curve

Definition of Supply Supply Curve and Supply Schedule Quantity Supplied (Qs)

The Law of Supply Changes in supply versus changes in

quantity supplied


Explain the influences on demand Understand the law of demand Explain the influences on supply Understand the law of supply Explain how demand and supply determine

prices and quantities bought and sold Use demand and supply to make predictions

about changes in prices and quantities

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3.1 DEMAND AND SUPPLY

3.1.1 Definition of Demand Demand can be defined as the amount of a particular good or service that a consumer or group of consumers will want to purchase at a given price during a specific time, ceteris paribus (the Latin phrase that means all other things remain constant).

It is an economic event of consumers desire and willingness to pay for a good or service. If there is no ability (means or affordability) or no desire (will or want) to have a good or service, there would not be any demand for the good.

For example, Mr. Safa wants to buy an apple and he agrees to pay a specific price at a particular time. There is a demand for an apple from Mr. Safa. If he does not want to spend any money on it but he wants to buy an apple is not a fact of demand. Or, if he wants to spend money on it but does not want to have it also is not a fact of demand.

Thus, means and desire are the two basic elements of demand. Demand is illustrated by the demand curve and the demand schedule.

Demand, Wants and Needs are not the same. Wants and needs were defined earlier in the first chapter. Wants and needs have no basic elements to be fulfilled whereas demand has means and desire to be fulfilled. For example, Anthony has some money and he demands for a music cassette by saying that he is willing and able to buy 3 music cassettes a month at RM19.90 per cassette.

Another example, how many six packs of Orange juice will people buy each month if the price is RM4? What if the price is RM2 or RM6? The answers reveal the relationship between the price of Orange juice and the quantity purchased. This relationship is called the demand for Orange juice.

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3.1.2 Demand Curve and Demand Schedule Demand can be expressed as a demand schedule or curve. A Demand curve is a graph showing the relationship between the price of a product and the quantity of the product demanded over a given period of time. The price is measured on the vertical axis; whereas quantity demanded (Qd) is measured on the horizontal axis (Refer Figure 3-1) The demand curve shows the relationship between the quantity demanded (Qd) of a product and its price (P) when all other influential factors to consumer buying intention remain the same. A demand curve can be different in shape, a straight line, a concave curve, or a convex curve. It must be observed that the slope of the demand curve also depends on the scale used.

Figure 3-1 Demand Curve

Figure 3.1 shows the demand curve usually slopes downwards from left to right the lower the price, the more of commodity goods we are willing to buy. The demand curve slopes downward, reflecting the law of demand: price and quantity demanded are inversely related, other things being constant.

A Demand schedule is a table showing the quantities of a product a consumer is willing and able to buy at varying prices in a given period of time, when all other influences on prices of related goods, expected future prices, income, population and etc remain the same (ceteris paribus). Figure 3.2 shows an example of a demand schedule for mangoes in Village X. At a price of RM1.40, 10 thousands a week are demanded; at a price of 80 sen per piece, 40 thousands a week are demanded. As price decreases, the Qd increases. For a given price, the demand curve tells us the quantity people plan to buy. For a given quantity, the demand curve tells us the maximum price that consumers are willing and able to pay. For example, the maximum price that a consumer will pay is RM1.00.

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A demand schedule for mangoes per day in village X

Figure 3-2 Demand Schedule

3.1.3 Quantity Demanded (Qd) Before discussing the Law of Demand, quantity demanded is required to be discussed for the easy understanding of demand. If you demand for something, it means you want it, you can afford it, and you plan to buy it. It reflects the decision about getting something that satisfies you.

Therefore quantity demanded (Qd) is the amount of goods that people are willing and able to buy at a particular price, during a specific time period. Qd does not refer to what people would simply like to consume. The term Qd is illustrated by a point of the demand curve the Qd at a particular price.

The Qd is measured as an amount per unit of time.

For example, suppose that you drink a cup of tea at a Mamak stall a day. The quantity of tea that you demand can be expressed as 1 cup per day, 7 cups per week, or 365 cups a year. Without a time dimension, we cannot tell whether the quantity demanded is small or large. Figure 3-3 and 3-4 shows the examples.

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Figure 3-3 The Demand Curve

Figure 3-3 shows that any point on the demand curve represents a single price: quantity demanded relationship PER UNIT OF TIME.

To distinguish between shifts in and movements along demand curves, it is usual to distinguish between a change in demand and a change in quantity demanded (Qd).

A shift in demand is referred to as a change in demand, whereas a movement along the demand curve as a result of the change is referred to as change in quantity demanded (Qd) due to a change in price.

Other variables that may affect the demand and make an upward or downward movement of the entire demand curve include: the money income of consumers, prices of related goods, consumer expectations, number of consumers, and consumer tastes.

Figure 3-4 Quantity Demanded (Qd)

Figure 3-4 shows that Qd is a flow variable (measured over a period of time a week, month or a year) rather than a stock variable (measured at a point in time). A change in Qd is represented by a movement along the existing demand curve.

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3.1.4 The Law of Demand As the price of a product falls, people tend to purchase more of it, but when the price increases, the demand will fall.

Think of buying soft drinks. You go into the market. A six-pack sells RM6.50. You buy a given number, say, two packs. Next week there is a sale, the price is RM4.90 a six-pack. You stock up and buy five six-packs! The following week, the price has risen to RM7.50. This is just too expensive; you dont buy any at all! The result is familiar to anyone who shops for anything regularly. The above example is referred to as the law of demand, where as the price of the product rises (falls), the quantity demanded of the product falls (rises). It shows the inverse or negative relationship between the price of goods and Qd. The reasoning behind the law of demand goes back to the fundamental problem of scarcity and choice. The root of scarcity problems is that people have limited resources to satisfy their unlimited wants and needs. The law of demand holds that other things remaining the same, the Qd will rise as the price decreases and will decrease as the price rises. Or other things remaining the same, the higher the price of a good, the smaller is the Qd.

For example, people who promote films want to fill the movie theatre with screaming fans. But fans have limited income and desires for other goods. Normally, fans will buy tickets depending on the price. If the promoter sets a high price for the ticket, there will be lots of empty seats in the theatre. If the price is too low, the promoter may lose potential sales revenue. What the entire promoter needs to know is what price will induce a Qd that conforms to the number of seats available. By constructing a demand curve, the promoter might get the solution of the correct price evidently

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The inverse relationship between the price and the Qd can be represented graphically by a downward sloping demand curve. The amount of a good that buyers purchase at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying the good. Lets look at the demand relation curve on Figure 3-5.

Figure 3-5 shows that the curve is a downward slope, why? A, B, and C are points on the demand curve. Each point on the curve reflects a direct correlation between Qd (Q) and price (P). So, at point A, the Qd will be Q1 and the price will be P1, and so on. The demand relationship curve illustrates the negative relationship between price and Qd. The h

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