1 BASIC ECONOMIC IDEAS & RESOURCE ALLOCATIONTOPIC objectives: Explaining the concept of economics Describing a Production possibility curve/ frontier Explaining the functions of money & resource allocation Describing the classification of goods

2 Intro: What is economics?Discussion point: It’s a social science that deals with the study of how to allocate scarce resources in the most efficient way. Task:  Give examples to illustrate that resources e.g. money are never enough!! 

3 Human needs & wants are always unlimited while the means of providing them (resources) are scarce.Thus choices must be in order of priority of how to satisfy them Task:  draw the illustration..

4 Economic analysis It follows a scientific framework in studying the behaviour of economic agents. Task  Draw the diagram on page 3. Give examples of how economists study unemployment….

5 There are 3main economic agents/players in a market/economyFirms- producers Households- consumers Government- regulator.

6 Top tip  The complex structure within which these agents lie is called the Economy The road to economic explanation follows 2 main approaches 1. positive statements (Objective) These are factual statements that can be verified and/or falsified by looking at the known facts

7 Such statements are acceptable to all economists eg the rate of inflation in 2009 in Kenya was 4.23 % 2. Normative statements (Subjective) They are personal opinions that reflect value judgements which can not be verified by looking at the facts.

8 They are personal views about what ought to happen.Eg the government should cut fuel tax to reduce the rate of inflation. Q /11/M/J/11 Which is a normative statement? A An increase in the rate of inflation will lead inevitably to an increase in unemployment.

9 B A reduction in unemployment below a certain level will lead to higher inflation.C Inflation can be reduced only by increasing the level of unemployment. D Unemployment is more harmful than inflation.

10 Q3 9708/01/M/J/09 What must be true of a positive statement?A It is one that can be shown to be correct or incorrect. B It is one that deals with positive changes in economic well being. C It is one that is true by definition. D It is one with which everyone is in agreement.

11 Classification of economics;Microeconomics Macroeconomics

12 1. Microeconomics; It deals with the study of individual economic agents e.g. person, household, firm, or industry) Eg how a consumer allocates his income among various uses.

13 2. Macroeconomics: It involves the study of aggregate economic principles which affects the whole economy. Eg unemployment, inflation, national income etc. Macro economics vs microeconomics video

14 The economist tool kit It refers to the skills & techniques for the analysis of economic problems. It consists of 2 main skills; 1. Ability to interpret and use data 2. to write in a clear way.

15 Data skills 1. time series datatask:  Summarize the bullet points on page 4. Types of data 1. time series data Its data recorded over a long time period Eg. UK unemployment data for 10years

16   2. cross sectional data This is data in snapshots or piecemeal3. discreet data This is data in whole numbers 4. continuous data This is data that is not in whole numbers but in decimals eg economic growth

17 How to write clearly & effectivelyThis is useful especially in examinations….hand out 1. Be clear and precise in your writing: Use simple language avoiding jargons which you don’t understand 2. Write impersonally avoiding first person singular [ I or we] when writing economic essays.

18 3. Match your writing to your audience- use appropriate economic terms and concepts.4.Be careful with sentence structure and punctuations- avoid spelling mistakes. 5. Use one idea per paragraph& develop your ideas & arguments

19 6. Support your arguments- elaborate and develop your arguments.7. Avoid humour & jokes in exam essays. 8. Be professional: do not insult or offend

20 Data & graphical skillsThis involves being able to read and interpret data from graphs. i.e. ability to pick out main features in a data set. Also involves ability to interpret economic information in a visual form.

21 Example Use the graph below to answer the following questions;(handout) Describe the behavior of oil prices between 1965 to 1974 [2] Explain the trend in oil prices between 1975 to 1982.[2] Suggest what would have caused constant price fluctuations between s [4]

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23 What does the graph indicate about oil prices between 1985-2000 [3]Why do you think oil prices are rising from year 2000 onwards[6] Explain the difference between nominal and real prices.[4] C:\The basics of graphing video 00: 7: 21.

24 The basic economic problemAKA fundamental economic problem. Problem of scarce resources relative to unlimited human wants. It’s a problem of ‘scarcity & choice’. Task:  copy the key terms: page 13 It causes economic agents to make choices of what to consume and to sacrifice/forego

25 Top tip:  The economic problem refers to scarce resources in relation to unlimited wants. It forms the basis of other economic problems facing individuals and governments e.g. unemployment How do economic agents react to this problem?

26 They seek to answer the three basic economic questions:3 economic questions video 1. What to produce: since resources are never enough producers must decide the quantity of goods and services to produce from the bulk of scarce resources available

27 2. How to produce; Refers to a choice on the best method of production in order get maximum benefit from the resources. Method used could be labour intensive (man power) or capital intensive(machinery).

28 3.For whom to produce; C:\Users\pnduati video. Economic scarcityIt’s the determination of consumers since its not possible to satisfy the wants of all the people in the economy. Firms will invest in R &D to determine consumer preferences. Target market could be a niche or mass C:\Users\pnduati video. Economic scarcity

29 Students tasks Draw fig 1.1 pg 13Prep task: Self assessment task 1.2_China: the challenges of an ageing population: pg 16-17 Due on Monday

30 The meaning of ceteris paribusThis is Latin phrase for: other things being equal or holding other factors constant: Assumption that economic agents will consider one variable when making economic decisions E.g. A consumer may consider price only when buying an iPod ceteris paribus!

31 The margin and decision makingEconomics involves making decisions of what to consume and what to sacrifice. The margin refers to the utility or value of one additional unit of an item. Decision making “at the margin” It means making economic choices based on the value of the additional amount of costs & benefits

32 Example Give practical examples of the cost & benefits of oil exploration in ‘Ngamia 2 well’ in Turkana . The decision maker looks at the additional or marginal cost(MC) of an action, & the additional or marginal benefit(MB) of the decision. If the incremental benefit/MB is greater than the incremental cost/MC, the action is taken

33 Top tip   If MB > MC Take the decision since the incremental benefit is more than the incremental cost If MB < MC reject the decision since the incremental benefit is less than the incremental cost.

34 Choice and opportunity costOpportunity cost is the cost/benefit foregone in order to consume the next best alternative. Since resources are scarce compared to the unlimited wants, choices must be of which wants to satisfy before the others E.g. A student decides to stay in her room and study instead of going to the cinema.

35 Opportunity cost video Task Identify the opportunity cost facing her……………. Its used by various economic agents for decision making Opportunity cost video C:\Users\pnduati. Opportunity cost video 00:07:41

36 Production possibility curve (PPC)AKA production possibility frontier (PPF). It’s a graphical representation of the basic economic problem & opportunity cost It represents the maximum level of output an economy can achieve when using its existing resources in full. It can be a straight line or a curve

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38 Make observations Production within the ppf shows underutilization/unemployment of resources. On the boundary: …….efficient resource Above the curve…. Calculate the opportunity cost of making 8 hammers

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40 Prodn above the PPF is not possible with the present bulk of resourcesObservations All points on the PPF represents combinations of two goods an economy can produce at a given technology when all resources are fully engaged. Production within the PPF shows inefficient utilization of resources (underutilization) Prodn above the PPF is not possible with the present bulk of resources

41  Top tip:  1. The PPF is concave to the origin because of increasing opportunity costs as resources are switched to produce the alternative product. 2. A linear (straight line) PPF implies constant opportunity cost in the prodn of the two products & its hypothetical.

42 3. The resources available together with the technical know-how determines an economies production possibility. i.e. how many goods & services to be produced

43 4.The PPF is also called product transformation curve since along the curve different combinations are produced due to increasing opportunity cost. PPF video C:\Users\pnduati. PPF I & II

44 Shifts in the PPF: The PPF assumes that technology and resource levels of an economy are constant but they may change overtime It can either shift upwards or downwards.

45 An expansion in production possibilitiesShown by an outward shift of the PPF It represents economic growth. Draw the diagram. Reasons behind the upward shift Discovery of new resources Improvement of technology

46 immigration in to a countryCapital inflows to a country e.g. foreign loans etc NB: All this is due to economic growth and expansion

47 A reduction in production possibilitiesShown by an inward shift of the PPF It represents economic recession. Draw the diagram. Reasons behind the downward shift Adoption of an inferior technology Exhaustion of some resources e.g. oil

48 Emigration outside the countryRegulations requiring adoption of green production methods. etc NB: All this could be due a declining economic growth rate

49 9708/1 Jun03 2 The diagram shows a production possibility curve LM.

50 What might cause the curve to shift to NP?A technological progress B unemployment of resources C the depletion of natural resources D a reallocation of resources

51 9708/01/M/J/07 1 The diagram shows a production possibility curve for an economy that produces only two goods, X and Y.

52 The economy produces 400 of good Y and produces on its production possibility curve.Which quantity of good X is given up? A 600 B 800 C 1200 D 1600

53 9708/01/M/J/09 2 The diagram shows two production possibility curves (EF and GH), before and after technological progress has taken place.

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55 After technological progress has taken place, what is the opportunity cost in capital goods of producing OX consumer goods? A MH B OH C OM D YF Q2.9708/13/O/N/2012

56 Applications of the PPFThe choice between production of capital and consumer goods: Consumer goods are used to satisfy wants directly while capital goods are used to produce other goods eg machinery Capital goods are created through investment & are subject to capital consumption/depreciation which is the process of wear and tear

57 Gross investment - depreciation= net investmentA choice has to be made btn. producing consumer goods or producing capital goods. More consumer goods will imply high living conditions but this may reduce in future if capital goods are not produced to replace those worn out.

58 This implies a hard choice so as to balance out the two goodsHard choices for developing economies They are faced with low living standards hence they must increase their capital stock investment

59 They must devote more resources from current consumption to investment so as to grow while producing enough consumer goods to feed their high populace. The issue of high population causes lots of resources to be committed for subsistence at the expense of capital investment.

60 This problem is referred to as ‘jam today or more jam tomorrow’.Task: draw fig 1.11 from page 31 Observations: o-a is the capital consumption/depreciation O-b is the quantity of consumer goods

61 Producing o-b units of consumer goods will improve welfare today only.This is because depreciation rate will be higher than the quantity of capital goods produced. Self assessment task: page 30

62 Economic resources: These are the factors of production or the factor inputs necessary to create goods and services. They are always limited/scarce in supply since human wants are insatiable and recurrent in nature. Categories of resources 1. Land;

63   It’s a natural resource, free gift of nature.It includes the earths surface, water bodies, forests, atmosphere and mineral deposits. 2. Labour; It’s the human effort used in production. No production can occur with out labour.

64 3. Capital These are man made aids to production.Capital goods assist land and labour to produce more output e.g. machinery, 4. Enterprise/entrepreneurship- business skills The entrepreneur, business person, organizes other factors of production for maximum productivity.

65 The enterprise involves risk taking in undertaking various production activities especially in a free enterprise economy. Top tip:  Economies with abundant resources are said to have good factor endowment

66 Factor rewards- earning to factors of prodnFactor input Factor reward labour Salaries/wages Land Rent Capital Interest Entrepreneurship profit

67 Economic resource videoC:\Users\pnduati. Production and consumption Production is the process of creating goods and services, from economic resources, to satisfy human wants. Process of creating utility(usefulness of goods & services) Consumption is the process of using goods and services to satisfy human wants

68 Note  Production occurs in 3 distinct periods. 1. short run (SR)Time period during which a firm can only change some and not all factor inputs. E.g. in the SR a firm can increase production by hiring more workers ceteris paribus.

69 2. Long run (LR) Time period during which all factor inputs can be varied. E.g. in the LR a firm can hire more capital 3.Very long run Time period during which all key inputs in to production are variable E.g. govt regulations, tech etc

70 SPECIALIZATION AND EXCHANGESpecialization refers to the process whereby economic agents concentrate on one economic activity e.g…Japan specializes in the production of technology & cars It leads to creation of surplus/excess output which can be exported abroad.

71 . C:\Users\pnduati.Specializatin video.This allows world living standards to rise It also contributes to unemployment since specialized workers lack flexibility to work elsewhere . C:\Users\pnduati.Specializatin video.

72 Division of labour: Breaking down of a production process into a sequence of individual tasks where different workers concentrate according to their levels of skills and experience It was introduced by Adam smith in his book an inquiry in to the nature and causes of wealth of nations (1776)

73 He suggested that production of pins could be split in to 18 operations so as to increase output.Apart from raising factory output, this process leads to monotony due to constant repetition of similar tasks. Merits & demerits handout

74 Examples Henry Fords use of the conveyor belt in car manufacture in the US.

75 Economic structure It refers to the way in which an economy is organized in terms of sectors: Primary sector Secondary sector Tertiary sector Quaternary sector

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77 1. The primary/extractive sector-It deals with extraction & use of raw materials in their natural form It includes the production of raw material and basic foods. Occupations here include- fishing, quarrying, farming etc

78 2. Secondary Sector This sector manufactures finished goods from raw materials. This sector includes all of manufacturing, processing, and construction . occupations here include: automobile production, textile production, aerospace manufacturing etc

79 3. Tertiary Sector This is the service industry.It provides services to the general population and to businesses. Occupations here include; tourism, insurance, banking, healthcare, hair dressing etc.

80 4. Quaternary sector It consists of intellectual activities especially in the provision of info. E.g. ICT, R &D, Libraries& universities etc Task: identify the sectors in which the following occupations lie… \self assessment task page 21: do in class

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82 DIFFERENT ALLOCATIVE MECHANISMSThe basic economic problem leads to different economic systems. An economic system describes the means through which economic agents make choices of resource allocation Types of economic systems: They are 3 main types

83 ECONOMIC SYSTEMS Command/planned Market economy Mixed economy

84 1. The market economy AKA free market economy, free enterprise economy or capitalism. It was advocated by Adam smith(1776) & can be represented by the USA The system is an ideal case not present in today’s modern economies.

85 Features No government regulation in a pure market economyProfit maximization is the main goal of buyers & sellers. All resources are privately owned by the firms and the households.(private sector) who make decisions on how to allocate resources.

86 Many buyers & sellers who interact freely.Prices are determined by the market forces of demand and supply. i.e. invisible hands of the market/market mechanism Consumer sovereignty- freedom of what to consume

87 Advantages Consumers are free to choose what they want to buy.No taxes charged. This is a motivation as workers can keep all the profits Businesses compete with each other freely and this could keep prices low.

88 Freedom of enterprise- New businesses are encouraged to set up.Efficient allocation of scarce resources according to market forces. Disadvantages: Public services e.g. health and education are not adequately provided

89 Disadvantages: contd’Production of harmful goods due to absence of govt regulation Monopolies can develop and hence lead to consumer exploitation Possibility of high inflation as market demand rises There lacks fair play in the market since there is no govt regulation

90 Research task Read and make short notes on functions of price mechanism in a free market economy [10] Reference S-cool Tutor2u DineshBakshi Economicsonline.com Any other online source

91 Command/planned economy.AKA socialist or communist economy. It was advocated by Karl Marx (1818) A pure planned economy does not occur in practice. Examples: former USSR, Cuba, North Korea etc

92 Features All resources are owned and controlled by the governmentPublic sector dominates the economy. Resource allocation decisions are made centrally by the govt or some state agency on behalf of the govt.

93 The government determines collective market preferences in a planned economy.Central govt is responsible for: ..copy the bullet point from page 22.

94 Government decides what should be produced, how much and for whom Advantages Government decides what should be produced, how much and for whom Decreases inequalities between the rich & poor. Both public & merit goods are adequately provided Enhances balanced regional development

95 Govt controls may reduce innovations & inventionsDisadvantages: Its expensive to run a government structure Centralised decision making may conflict the market forces of dd & ss. Government systems may have excess red tape Govt controls may reduce innovations & inventions

96 Video 00:09:13 C:\Users\pnduati Capitalism vs Socialism

97 The Mixed economy It’s a combination of both the market & command economy as in present day countries. Features The private sector & public sector are actively involved in resource allocation thru PPP’s

98 Degree of govt control varies from country to countrySome resources are owned by the State and some by private individuals Businesses make decisions & the Government tries to influence and control some areas such as Taxes & Laws. Degree of govt control varies from country to country

99 However some public sector business may be inefficient leading to privatisation.Advantages; Government control eliminates unhealthy business competition. It may lead to high economic growth due to freedom of enterprise thru PPP

100 Advantages: contd’ Govt ensures uniform resource distribution to benefit all. It controls production of harmful products eg narcotics Disadvantages; There is less incentive to work as the government fixes wages and taxes

101 The government may not produce goods which people want to buy.The lack of absolute freedom of enterprise may discourage production. Task: Draw the diagram from page 24

102 The transition economyit is one that is changing from central planning to free market i.e. moving from command to free enterprise economy. The problems of transition economies Q1/9708/11/M/J/2012

103 1. Rising Unemployment- A command economy employs more pple due to active govt regulation in the public sector. Under a free market, private sector may adopt capital intensive prodn at the expense of labour intensive prodn

104 2. Rising inflation This is due to the removal of price controls imposed by governments. Private firms charge high prices, due to pursuit of profit motive, leading to inflation

105 3. Corruption Its possible that under free market corrupt business activities may thrive. This leads to production of harmful products eg narcotics

106 4. Lack of a sophisticated legal systemMarket-driven economies will only develop when citizens are granted extensive property rights, and can protect these rights through the legal process. This was large absent in the former communist transition economies. 

107 5. Lack of infrastructureThe transition economies also suffered from a lack of real capital and technology. This was partly because of the limited development of financial markets and the little foreign direct investment

108 Reading task: Role of enterprise in a modern economychina’s radical moves…page 26

109 BARTER TRADE A system of exchange by which goods or services are directly exchanged for other goods or services without money. The limitations of barter 1.Need for presence of double coincidence of wants:

110 For barter to occur between two people each would need to have what the other wants.2. Absence of common measure of value: There lacks a standard ‘measure of value’ of the worth of products being exchanged

111 3. Indivisibility of certain goodsIts not possible to divide/breakdown commodities in to smaller units Eg you can’t divide a live cow in to smaller pieces. 4. Lack of standards for deferred payments: To ‘defer payment’ means to make it happen in the future (financing credit)

112 5. Difficulty in storing wealthIf a society relies exclusively on perishable goods, storing wealth for the future may be impractical. Research Task Read & make short notes on the advantages of barter trade

113 Money What is money? It s an important aid to trade and is anything that is generally acceptable as a means of paying for goods and services. It includes notes & coins, cheques, debit cards, credit cards or other valuable items Money as a resource is scarce in supply

114 Near money Non cash assets that are highly liquid.E.g. savings accounts, bonds etc. Assets that are cash or cash equivalent are called liquid assets.

115 The origin of money Before the invention of currency, people relied on barter trade Money was invented due to the impracticability of barter system. Characteristics/ qualities of money General acceptability https://www.google.co.ke/?gws_rd=ssl#q=legal+tender

116 Durability Portability Divisibility Cognizability Scarcity- most important Malleability

117 Functions of money 1. Medium of exchangeIt’s a medium that buyers use for purchases and that sellers are willing to accept in exchange for products bought. It’s a means of paying for goods and services

118 2. unit of account: It’s a unit by which prices are established e.g. $, £ , Kshs etc. It applies for current and future transactions (eg loan repayment) 3. Store /measure of value It can be accumulated for a long time (bank) to form a source of wealth.

119 4. Standard of deferred payment It can also be held in form of financial securities [stocks, bonds, treasury bills, etc ] assuming that its value will not be wasted by inflation. 4. Standard of deferred payment Money is used to finance credit transactions.

120 It settles future payments at an agreed date.Eg rent and utility bills paid at the end of the month Top tip: if these functions break down, people will lose confidence in money & the economy will collapse Q4/9708/11/O/N/2013 Q4/9708/12/M/J/2012

121 Q4/9708/W/11/2013 A website compares the prices of groceries. Which function of money is illustrated by this? A medium of exchange B standard of deferred payment C store of value D unit of account

122 CLASSIFICATION OF GOODSThere are four categories of goods; Capital/producer versus Consumer Free versus economic Private versus public Merit versus demerit

123 Capital/producer goodsThey are used to produce consumer goods eg plant machinery in a factory Consumer goods They are produced for immediate consumption by end users. Eg TV’s, food etc

124 Free goods They are abundant in supply and have no opportunity cost. They have no prices e.g. air Economic goods They are scarce in supply and have an opportunity cost and a price attached to them.

125 Private goods. This is one where consumption by one person results in the good not being available for consumption by another. Give an example… Characteristics 1.Excludable- Consumers are excluded from using the product if they are not willing or able to pay for it. E.g. A movie ticket.

126 2.Rivalry One persons’ consumption reduces the amount left for others to consume. Scarce resources are used in producing and supplying the good or service. 3.Rejectability- One can chose to buy/use it or not. Eg you can choose the type of ice cream flavour to buy

127 Public goods Goods that are non rival and non excludable and difficult to charge a price. E.g. defence, fishing light house & street lighting. Characteristics Non excludable: Once provided, no person can be stopped from benefitting from it

128 2. Non rival: Consumption of the good by one person does not reduce the benefit to others. i.e. as more consume, the benefit to those already consuming is not diminished.

129 3. Non-rejectable There is no choice as whether to use it or not e.g. defence Note:  Quasi public goods have some but not all the characteristics of public goods. E.g. seaside beach & roads. Task: explain how a beach can be made exclude and rival….

130 The problem of public goodsIn a free market, they will not be provided at all! This is because of the ‘free rider problem’: consumers will wait for others to purchase them and then use them for free! In the lighthouse case, the fishermen will wait for one ‘foolish’ fisherman’ to provide it then enjoy the benefit

131 Task Solution Copy the definition of the free rider from page 34.Public goods need to be provided by the government and force everyone to its cost through taxation. Video on private and public goods

132 Q16/9708/11/M/J/2013 A good is more likely to be supplied by the government rather than a private company if it is A excludable and non-rival. B excludable and rival. C non-excludable and non-rival D non-excludable and rival  Check out for more quizs in the booklets

133 Merit goods Goods that have positive side effects associated with them. i.e. they provide more benefits than the consumer perceives. They are under produced & under consumed due to info failure hence they are provided by governments e.g. education and health.

134 E. g. inoculation against PolioE.g. inoculation against Polio. It not only protects the individual but the whole community! https:// free Rotavirus vaccine Task: draw Fig 3.5 on page 132 (2nd edition bk) Observations:

135 If consumers know the true value of the product, the correct demand would be D1 leading to higher dd. Since consumers undervalue the product, demand is registered at D2, leading to underprodn & under consumption at Q2. This is below the optimum level: The market has failed.

136 Demerit goods: Goods that have adverse side effects associated with them when consumed. E.g. junk foods & cigarettes. They are worse for the individual than he /she realises. They are overproduced and over consumed due to info failure E.g. smoking cigs is not only harmful to active but also to passive smokers.

137 The market has failed because tooTask: draw figure 3.6 page 132 Observations The ‘correct’ dd should be at D1 which leads to less quantity being demanded. Because consumers over-value the product, dd is registered at a higher level This leads to overprodn and over consumption. The market has failed because too

138 much resources are devoted to the production of this demerit good.Information failure Occurs where pple lack full info about the benefits and harmful effects of certain goods.

139 Discussion point;  Why do people consume demerit goods yet they are knowledgeable about their side effects? Addiction, value judgment etc

140 Moral Hazard Why do you go to see a doctor when unwell?Occurs when people misallocate resources due to lack of info A doctor may prescribe some expensive drugs for a trivial case so as to extort a patient who has no option but to pay.

141 This causes misallocation of resources & market failure since the DrThis causes misallocation of resources & market failure since the Dr. has more info than the patient! NB: seller has more info than the buyer. Adverse Selection Refers to a market process in which bad results occur due to information asymmetries between buyers and sellers NB: Buyer has more info than the seller

142 The buyers have information that sellers don't about some aspect of product quality.Eg when buying medical insurance, one may provide inaccurate medical info so as to avoid high premiums. When the risk occurs, the premiums for healthy people will have to be raised so as to compensate many claimants.

143 Many ‘bad risk’ customers will cause the insurer to allocate lots of resources for compensation which is market failure. XXXXXXXXXXXXXXXXXX Read the summary from page 37 Prep questions = page 37 End of topic test: Monday 09/11/2015.

144  The end  Students tasks Further reading:Read about the market for lemons by George Akerlof online  The end 