This introductory chapter looks at the basic economic problem. Students need to understand the problem of unlimited wants and finite resources that gives rise to scarcity and inevitable choices. The fundamental economic problem is faced by consumers, producers and the government. Ensure you can distinguish between renewable and non-renewable resources and be able to explain the concept of sustainability. Value judgements influence economic decision making and policy in all countries so make sure you are clear on the difference between positive and normative statements.

1. Scarce Resources, Choices and
Economic Systems

2. Introduction to Micro
Scarce Resources,
Choices and
Economic
Systems

3. Microeconomics
• Microeconomics is the study of
economics at the level of the
individual firm, industry or
consumer/household.
• We study how prices and wages are
determined; how consumers decide
what to buy; how businesses
determine what is produced and
how that output is supplied.
• Microeconomics also involves
analysing the effects of government
regulations, subsidies, taxes and
maximum and minimum prices on
the prices and quantities of different
goods and services.
Consumer
Behaviour
Business
behaviour
Economics studies the choices
taken under conditions of scarcity
and uncertainty

4. Assumptions about the Objectives of Agents
• In the majority of the AS micro
course we assume that
1. Rational consumers wish to
maximize their satisfaction or utility
from consumption by correctly
choosing how to spend their limited
income.
2. Producers/firms wish to maximize
profits, by producing at minimum
cost goods and services that are
desired by consumers. Profit = total
revenue – total costs.
3. Government wishes to maximize the
overall level of utility of its citizens.
Doe we always
engage in rational
behaviour?
Are all businesses
looking to maximise
their profits?

5. Consumer Welfare and Rationality
• What makes people happy?
• Why despite several decades of rising living standards, surveys of
happiness suggest that people are not noticeably happier than
previous generations?
• Typically we assume that, when making decisions people aim to
maximise their welfare.
• They have a limited income and they allocate money in a way
that improves gives them the highest total satisfaction.
• In reality, day-to-day, consumers rarely behave in a well-
informed and rational way.
• Often decisions are based on incomplete information which
causes a loss of welfare not only for people themselves and
affect others and our society as a whole.

6. Behavioural Economics
• Behavioural Economics tries to mix insights from Psychology
with Economics, and looks at problems through the eye of a
“Human”, rather than an “Econ”.
• It uses insights from psychology to explain why people make
apparently irrational decisions such as why people eat too much,
take too little exercise, or do not save enough for retirement.
• An Econ is said to be infinitely rational and immensely intelligent,
an emotionless being who can do cost-benefit analyses at will,
and is never (ever) wrong.
• The reality is different!
• Most of us are not infinitely rational, but rather face “bounded
rationality”, with people adopting simple, intuitive “rules of
thumb” instead of calculating optimal solutions for every
decision they have to make.

7. Positive and Normative Statements
• Positive statements:
– Positive statements are objective statements that can be tested,
amended or rejected by referring to to available evidence.
– Positive economics deals with objective explanation and the testing
and rejection of theories.
– For example: The falling price of crude oil on world markets will lead
to a fall in demand for fuel efficient cars
• Normative statements:
– Normative statements are subjective statements – i.e. they carry
value judgments about what ought to be
– For example: Unemployment is more harmful than inflation
Most economic decisions and policy are influenced by value judgements, which
vary from person to person, resulting in debate between political parties

8. Opportunity Costs
• Opportunity cost measures the cost of any choice in terms of the
next best alternative foregone.
1. Work-leisure choices: The opportunity cost of deciding not to
work an extra ten hours a week is the lost wages foregone.
2. Government spending priorities: The opportunity cost of the
government spending nearly £10 billion on investment in
National Health Service might be that £10 billion less is
available for spending on education or defence equipment.
3. Investing today for consumption tomorrow: The opportunity
cost of an economy investing resources in capital goods is the
production of consumer goods given up for today.
4. Use of scarce farming land: The opportunity cost of using
farmland to grow wheat for bio-fuel means that there is less
wheat available for food production causing food prices to rise.

9. Factors of Production and their Factor Rewards
Students are expected to have a sound knowledge and clear
understanding of the meaning and nature of factors of production
Land Labour
Enterprise Capital
Natural resources
available for
production
The human input
into the production
process
Goods used in the
supply of other
products e.g. tech
Entrepreneurs
organise factors of
production and
take risks
Rental income to
owners of land
Wages and salaries
from employment
Profits
Interest from
savings + dividends
from shares

10. Capital and Consumer Goods
• Capital goods
– Goods used to make consumer goods and services.
– Capital inputs include fixed plant and machinery, hardware,
software, factories and other buildings.
• Consumer goods and services
– Goods which satisfy our needs and wants directly.
– There is a sub-division between:
– i) Consumer durables: Products that provide a steady flow of
satisfaction / utility over their working life (e.g. a washing machine
or using a smartphone).
– ii) Consumer non-durables: Products that are used up in the act of
consumption e.g. drinking a coffee or turning on the heating)
– iii) Consumer services: E.g. a hair cut or ticket to a show/gig

11. Renewable Resources and Free Goods
• Renewable resources:
– Renewable resources are commodities
such as solar energy, oxygen, biomass,
fish stocks or forestry
– Renewable resources in theory are
inexhaustible or replaceable over time
providing that the rate of extraction of
the resource is less than the natural
rate at which the resource renews
itself
• Free Goods
– Free goods do not use up any factor
inputs when supplied. They have a zero
opportunity cost
Renewable
resources
Free goods

12. Non-Renewable Resources
• Non-renewable resources:
– Finite non-renewable resources
cannot be renewed.
– With plastics, crude oil, coal,
natural gas and other items from
fossil fuels, no mechanisms exist at
present to replenish them.
– The rate of extraction of finite
resources depends in part on the
current market price – businesses
with rights to extract will have a
greater incentive to do so when
prices are high.
Deforestation –an
example of the
tragedy of the
Commons
Have we reached peak
oil? If so, why are oil
prices falling?

13. Economic Systems
An economic system is a network of organisations used to resolve
the problem of what, how much, how and for whom to produce
Freemarket
• Markets
allocate
resources
• Driven by the
profit motive
• Limited role
for state
• Private sector
dominates
Mixedeconomy
• Mix of state
and private
ownership
• Government
intervention
in markets
• Mix will vary
from country
to country
Plannedeconomy
• Most
resources are
state owned
• Planning
allocates
resources
• Little role for
market prices

14. The Role of the State in a Mixed Economy
A mixed economy has a mixed of private and public (Govt) sectors
• Businesses wholly or part state-
owned – for example: Royal Bank of
Scotland, Royal Mail
State-Owned
Industries
• Broad range of welfare benefits
• Universal e.g. state pension
• Means-tested e.g. housing benefit
Welfare State
• Spending on education & health
• Capital spending on infrastructure
Government spending
on public services

15. Get help from fellow
students, teachers and
tutor2u on Twitter:
@tutor2u_econ

16. Tutor2u
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