Introduction to Economics, Production Possibilities

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4008AFE The Economic Environment of Business
Week 1: Introduction to Economics, Production Possibilities
Frontier and Opportunity Cost.
Dr Alban Asllani
What wewill learn today
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What is Economics?
Study what activities arebeneficial for the individual or the
society.
Economics and the Economyaredifferent things.
What is the Economy?
Actors: Consumers,firms, corporations, countries,
organizations, markets.
Behaviour : Decision makingprocess.
Outcomes: Profit/loss, rent/return, etc.
What wewill learn today
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Why studyEconomics?
Essential Tool for every daydecisions,e.g. purchasesomething
or allocate time watching Netflix instead ofstudying.
They allow usto analyze data, makeinformed decisions and
form expectations for the future.

Main Issue
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What is economics about?
The central economic issue
The difference between micro & macro economics
Economic Systems
Explain the key ideas that define the economic way ofthinking
What wewill learn today
What is the main issue ineconomics?
Answer
Scarcity: The difference between limited, ie scarce, resources
and theoretically limitless wants. In other words, our inability
to satisfy all our wants is called scarcity.
All economic questions arisebecause wewant morethan we
can get.
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Scarcity
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Because of scarcity, wehaveto makechoices.
The choices wemakedependon the incentives weface.
An incentive is areward that encourages an action or a
penalty that discouragesanaction.

Scarcity
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People want to maximise their utility (consume goods).
Firms maximise their profit. Firms needinputs/resources to
producegoods (labour, capital, land, rawmaterials)
The issue is how to efficiently allocate resourcesinproduction.
Fundamental Questions
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What to produce?
It changesover time asadvancesin technology allow usto
produce more. Transitions of primary (agriculture), to
secondary (manufacturing) to tertiary sector(services).
How to produce?
Factors of production: Land, Labour, Capital,Entrepreneurship
Who buysthe goods/services?
Income. Land earnsrent. Labour earns wages.Capital earns
interest. Entrepreneurship earnsprofit.

The Economic Way of Thinking
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Every choice involves asacrifice, trade-off
You chooseto buy coffeeinstead of tea.
You chooseto watch Gameof Thrones instead of studying.
People makerational choices by comparing benefits and costs.
Benefit is what you gain fromsomething.
Cost is what you must give upto get something.
Rational Choice
How do people makechoices?
Key Concept/Assumption
Rational Choice: We assume that every individual has some
preferences and will always choose
rationally the action that
will maximise their utility.
A rational choice is one that compares costs and benefits and
achieves the greatest benefit over cost for the person making
the choice.
The idea of rational choice providesan answerto the first
question: What goods and services will beproduced and in
what quantities?
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Trade-off
The economic wayof thinking places scarcity and its implication,
choice, at centre stage.
All choices have aprice: Opportunity Cost.
Key Concept
Opportunity Cost : The ”opportunity cost” of a resource,
refers to the value of the next-highest-valued alternative use
of that resource,
Concise Encyclopedia ofEconomics
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Opportunity Cost
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Opportunity cost hastwo components:
What is your opportunity cost of going to aconcert?
1 The things you can’t afford to buy if you purchasethe ticket. 2
The things you can’t do with your time spent at theconcert.
ClassExercise:Think some examples.

Example
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Occupation Median Cost Estim.
Lorry driver £23,000 Tuition fees £9,000
Postal worker £18,500 Living expenses £12,000
Tube driver £42,000 Salaryfromjob £29,000
Refusecollector
Electrician
£18,000
£23,500
TOTAL (per year) £50,000
Plumber £21,000
Accountant £27,000
HR manager £32,500
Investment Banker £59,000
Lecturer £34,500

Table: Opportunity cost of going to university
Production Possibilities Frontier
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How doesthe economy produces?
Do weusethe resourcesin an efficient way?
The production possibilities frontier (PPF) is the boundary
between those combinations of goods and services that can be
produced and those that cannot.
For simplicity, wefocus on two goods,ceteris paribus.
Example
Figure on the left showsthe PPF
for two goods: Wheat and
Cotton.
Any point on the frontier such as
A and B and any point inside the
PPF suchasCare attainable.
Points outside the PPF are
unattainable.
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Production Efficiency
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Weachieve production efficiency if wecannot produce more
of onegood without producing lessof someothergood.
Points on the frontier are efficient.
Any point inside the frontier, suchasC, is inefficient.
It is possible to produce more of one good without producing
less of the other good. At C, resources are either unemployed or
misallocated.

PPF and Opportunity Cost
From the PPF wecan understand
the concept of
opportunity cost.
As wemovedown along the PPF,
weproducemoreCotton but the
quantity of Wheat decreases.
The opportunity cost of awheat
is the cotton forgone.
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PPF and Opportunity Cost
Moving from D to E, the
quantity of Cotton produced
increasesby 1ton.
The quantity of wheat produced
decreasesby 5tons.
The opportunity cost of
producing the 4
thton of cotton is
5 tons wheat. Oneton of cotton
costs5 tons of wheat.
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Efficient Use of Resources
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Weareproducing at apoint on the PPF.
When wecannot producemore of any onegood without giving
up someother good, wehaveachieved
productionefficiency.
When wecannot producemore of any onegood without giving
up someother good that wevalue morehighly, wehave achieved
allocative efficiency.
Weareproducing at the point on the PPF that weprefer
aboveall other points.

PPF and Opportunity Cost
Moving from D to E, the
quantity of Cotton produced
increasesby 1ton.
The quantity of wheat produced
decreasesby 5tons.
The opportunity cost of
producing the 4
thton of cotton is
5 tons wheat. Oneton of cotton
costs5 tons of wheat.
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Economic Growth
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The expansion of production possibilities and increasein the
standard of living is called economic growth. Two keyfactors
influence economicgrowth:
1 Technological change is the development of newgoods and
of better waysof producing goods and services.
2 Capital accumulation is the growth of capital resources,
which includes human capital.
Economic growth is not free. Wesacrifice resourcesin
researchand development.
The opportunity cost of economic growth is lesscurrent
consumption.

Micro- vs Macro- economics
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Microeconomics is the part of economics that studies the
decisions of the individuals (distribution of resources)
It allows usto explain what weexpect to happen if some
conditions change.For example, what will happen to the
market of coffeeif anatural disaster destroysalargepart of
the harvest.

Micro- vs Macro- economics
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Macroeconomics is the part of economics that studies how
the aggregateeconomy behaves.
It allows usto explain how national incomechanges,inflation,
unemployment, finance, international trade etc. For example,
what will happen to national incomeif the government
increasespublic spending.

Economic Systems
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What is the role of the government in the economy?
Free Market:
Market not government decides:laissez-fairecapitalism.
Firms & consumersdirect their choices.
Command Economy:
Also known as”Planned Economy”
Government decides:what, how, forwhom
Government directs firms, andworkers.
Mixed Economy:
Firms & consumersdirect somechoices/interests
Government directs other choices& interests
Government regulates firms
Economic Systems
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Examples
FreeMarket: Capitalism. Oneof the few examples is the US
during the 19
th century.
Command Economy: Communism. The communist Soviet
Union, Cuba today, North Korea.
Mixed Market: Socialism. Most countries today belong to this
type.

Next time
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To help our analysis wetalk about markets
Markets arethe theoretical place where buyersand sellers of a
good or aservice meet and interact with each other.
Exchange goods/services
Markets
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Every market consists of two sides:Demand and Supply.
Demand refersto how much of agood is desired by buyersat a
given pricelevel.
Supply refersto how much of agood is offered by sellers at a
given price level.

What We Learned Today
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Main issuein Economics is the scarcity ofresources.
Weneedeconomics to find efficient waysto allocate resources.
Every decision wemakeinvolves a sacrifice.
Opportunity cost.
Government involvement
Conclusion
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Review today’s lesson
ReadPart 1 of the book (Including all boxes and case studies)
Searchonline for moresources.
Ask questions in seminar if anything isunclear
Do self-test questions at the endof the chapters and online
Thank youfor your attention.
Questions?
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