Basic Economic Ideas free essay sample

Meaning of scarcity and the inevitability of choices at all levels (individual, firms, governments) – Opportunity cost – Basic questions of what will be produced, how and for whom Unlimited Wants Human beings, in order to survive need a lot of things. Some of these things are very important for our existence. For example, food, clothing, water, shelter and air. These things can be classified as Needs. Apart from this there are things which are needed by us but they are not important for our survival and we can live without them also. For example, going on an expensive holiday, owning a 57 inches Plasma TV. These are known as Wants. This list is never ending and is continuously increasing. Limited Resources On the other hand, we have limited resources to produce these goods and services we want. There are not enough car factories to provide cars to everybody on earth. Everything on this planet has some limits except for our Wants. When unlimited wants meet limited resources, it is known as Scarcity. The Economic Problem of Scarcity The fundamental problem of economics is that we have unlimited wants, but limited resources to satisfy these wants. When wants exceed the resources available we have scarcity. Scarcity occurs because human wants exceed the limits of available resources. Economics deals with the basic fact that scarcity exists in our everyday lives and in our economy. Resources such as raw materials are in finite supply and must be allocated to their best use. Virtually all resources are scarce, meaning that more of them are desired than is available. Economics is concerned with the way people have to make choices in order to overcome the problems of scarcity. Inevitability of choices Each and every level of economic agent (individuals, firms or government) have to make the choices as all of them are confronted with central economic problem (scarcity). Government have to decide on the best possible way to allocate resources (where and what kinds of factories should be build), the firms have to decide how to maximize profit (what is the most efficient way to produce goods) and individual have to decide how to maximize their welfare (which goods will give them most satisfaction). In the process of this choice they have to give up other alternative so the concept of opportunity cost also implies in each and every level of economic agents. Opportunity Cost The relevant cost of any decision is its opportunity cost the value of the next-best alternative that is given up. This will mean that if we choose more of one thing, we will have to have less of something else. Economists use the term opportunity cost to explain this behaviour. The opportunity cost of any action is the value of the next best alternative forgone. By making choices in how we use our time and spend our money we give something up. Instead of following the economics classs, what else could you be doing? Your best alternatives may involve sports, leisure, work, entertainment, and more. Thus, the concept of opportunity cost is your best alternative to the choice that is made. If you choose to go to a restaurant this evening, the money that you spend on dinner will not be available for other uses, even saving. Businesses and governments also deal with opportunity costs. Businesses must choose what type of goods to produce and the quantity. Given limited funds, the opportunity cost of producing one type of good will arise from not being able to produce another. Opportunity cost in economics refers to the value of second best alternative forgone or given up. Simply put, lets assume that when you get up in the morning you have two options, going to the classes or sleeping late in the warm cozy bed. And if you decide to go to class anyhow, your opportunity cost would be the benefits you would have obtained by sleeping in the warm cozy bed. Opportunity cost is the cost related to the next-best choice available to someone who has picked among several mutually exclusive choices. It is a key concept in economics. It has been described as expressing â€Å"the basic relationship between scarcity and choice. † The notion of opportunity cost plays a crucial part in ensuring that scarce resources are used efficiently. Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered opportunity costs. The concept of an opportunity cost was first developed by John Stuart Mill. Because people face trade-offs, making decisions requires comparing the costs and benefits of alternative courses of action. In many cases, however, the cost of an action is not as obvious as it might first appear. Consider the decision to go to college. The main benefits are intellectual enrichment and a lifetime of better job opportunities. But what are the costs? To answer this question, you might be tempted to add up the money you spend on tuition, books, room, and board. Yet this total does not truly represent what you give up to spend a year in college. There are two problems with this calculation. First, it includes some things that are not really costs of going to college. Even if you quit school, you need a place to sleep and food to eat. Room and board are costs of going to college only to the extent that they are more expensive at college than elsewhere. Second, this calculation ignores the largest cost of going to college—your time. When you spend a year listening to lectures, reading textbooks, and writing papers, you cannot spend that time working at a job. For most students, the earnings given up to attend school are the largest single cost of their education. The opportunity cost of an item is what you give up to get that item. When making any decision, decision makers should be aware of the opportunity costs that accompany each possible action. In fact, they usually are. College athletes who can earn millions if they drop out of school and play professional sports are well aware that their opportunity cost of college is very high. It is not surprising that they often decide that the benefit of a college education is not worth the cost. Examples of Opportunity Cost A person who invests $10,000 in a stock denies themselves the interest they could have earned by leaving the $10,000 dollars in a bank account instead. The opportunity cost of the decision to invest in stock is the value of the interest. If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone of the next best thing which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports centre on that land, or a parking lot. Economic Goods: The goods that are scare and thus have economic value are called economic goods. They can be bought or exchanged through medium of exchange often called money or trade. Examples of such goods are car, television, laptops. Free Goods: The goods that do not have economic value and are not scarce are called free goods. They are either unlimited in supply or abundant. Or in some cases they might be of no human economic use. The examples of such products are water (exception: the sale of packed bottles of waters) and air (exceptions cylinders of oxygen used by mountaineers while climbing the mountains) What, how and for whom to produce? What to produce primarily depends on consumers in free market. The consumers choose the product they like and thus their choices direct the types of production that should be carried out. The firms will follow this because this is the most profit maximizing combination. How to produce will primarily depend on firm. They will seek to maximize profit thus they will adopt the most cost efficient way of production. They will either choose the labor intensive (using more labor as compared to machines) or capital intensive (more machines as compared to labor) depending upon their cost structure. For whom to produce will depend on the government and firms. The consumers are the primarily target but what kind of consumers the firms want to target is in the question. The government usually produce for all general public where as the firms can seek to maximize profit by producing to high and rich level customers. Different allocative mechanisms – Market economies – Planned economies – Mixed economies Plus the problems of transition when central planning in an economy is reduced The central problem of every economic society is to allocate resources in deciding what, how, and for whom to produce. These three questions are dealt with in different ways in each and every economy. They are dealt with depending on the economic and political frameworks of that country. Broadly speaking, the economic systems are classified into 3 categories namely: 1. The market economy or laissez-faire system or capitalist economy. 2. The command or planned economy 3. The mixed economy. MARKET ECONOMY In a market economy resource allocation is carried out by private individuals only. All factors of production are privately owned and managed. There is no government intervention and everyone is free to operate according to his will and desire. The main characteristics of such a system are: 1. Price/ market mechanism which manipulates the allocation of resources or tries to resolve the three fundamental questions of what, how and for whom to produce. In other words, resources are allocated through changes in relative prices. Adam Smith referred to it as the â€Å"invisible hands† of the market. 2. Consumer’s sovereignty exists, that is, consumer is a king because it directs the allocation of resources to a large extent while satisfying its own needs. His basic aim is to maximize satisfaction. The consumer’s decision can dictate economic actions as what and how to produce. 3. Producers aim at profit maximisation and rely on higher prices as a â€Å"green signal† to higher production. The foundation is the profit motive. Evidently, the production of those commodities will be more profitable which are demanded more by consumers. 4. Fierce competition among firms exists and basically it is this competition which encourages technological change, innovation and higher investment. 5. Easy mobilization of capital due to profit maximisation and regular innovations. Obviously, these do encourage industrialization and economic development. Features All resources are privately owned by people and firms. Profit is the main motive of all businesses. There is no government interference in the business activities. Producers are free to produce what they want, how much they want and for whom they want to produce. Consumers are free to choose. Prices are decided by the Price mechanism i. e. the demand and supply of the good/service. Advantages 1. There is consumer sovereignty. This means that consumers can influence what goods are produced directly by their purchase. In fact, they are free to buy whatever goods and services from which they can derive maximum satisfaction. Similarly, the greater use of price mechanism will provide an automatic and quick way to signal to producers what consumers want. 2. Free market responds quickly to the people’s wants: Thus, firms will produce what people want because it is more profitable whereas anything which is not demanded will be taken out of production. 3. The market provides a wide variety of goods and services to meet consumer’s wants. Indeed, the consumers may have a greater choice of a number of private-sector producers. This increased competition may increase the quality of products since rival producers will seek to attract new customersby improving the standard of their goods. 4. The market system provides incentives to producers in the form of profits and workers in theform of higher wages. This should encourage entrepreneurs to produce high quality products and to innovate, and workers to work hard. 5. There is greater efficiency. The aim of firms in a market economy is to make maximum profit. Hence, the market system encourages technological change, that is, the use of new and better methods and machines to produce goods and services at low cost. Those firms, which do not produce what people want at low cost and low prices, may go out of business. Disadvantages 1. Unemployment: Businesses in the market economy will only employ those factors of production which will be profitable and thus we may find a lot of unemployment as more machines and less labour will be used to cut cost. Certain goods and services may not be provided: There may be certain goods which might not be provided for by the Market economy. Those which people might want to use but don’t want to pay may not be available because the firms may not find it profitable to produce.