Final Examination 2008

Economics Notes – Review for

Mocks and Final Exam
Section 1 – Introduction to
Economics
What is economics?
Economics is a branch of knowledge concerned with the production,
consumption and tranfser of wealth. Economics is considered to be a
social science, a scientific study of human society and social relationships.

Economics is about studying how people use their limited resources to

satisfy unlimited wants. Economics is divided into microeconomics
(Section 2) and macroeconomics (Section 3).

Microeconomics: The study of economic behaviour of households and

firms, and how the price of goods and services are determined.

Macroeconomics: The study of the economy as a whole and economy-

wide issues such as unemployment, inflation and growth.

Before moving into more details about the various different fields, one
have to be familiar with the terminology used:

Economic growth: The increase in an economy’s real level of output (all

the goods and services produced) over a period of time.
Development: A process to improve the lives of all people in a country.
This involves not only raising living standards through the provision of
more and better quality goods and services, but the promotion of self-
esteem, dignity and respect.

Sustainable development: Using resources in a way that allows future

generations to meet their own needs. In terms of natural resources this
means to use the resources in such a fashion that the Earth can replenish
them.

Factors of Production
To produce goods and services requires resources, these economic
resources are scares relative to the infinite needs and wants of people and
businesses operating in the economy. It is important to use these
resources efficienty in order to maximise the output.

There are four distinct types of resources

• Land
• Labour
• Capital
• Entrepreneurship

Land

Land is the natural resources available for production. Some nations are
endowed with natural resources and exploit these by specialising in the
extraction and production of these resources, e.g. Oil in the Middle East.

Only one major resource is for the most part free; air. The rest are scarce
because there are not enough natural resources in the world to satisfy the
demands of consumers and producers. Air is classified as a free good
since consumption by one person does not reduce the air available for
others.

Labour

Labour is human input to the production, i.e. the work force. Two
important points need to be remembered about labour as a resource:

1. A housewife, a keen gardener and a DIY entusiast all produce goods

and services, but they do not get paid for them. They are all
producing a non-marketed output and the output of these people is
not included in the Gross Domestic Product (GDP).
 2. Not all labour is of the same quality. Some workers are more
productive than others because of the education, training and
experience they may have received.

Human capital refers to the quality of labour resources, which can be

improved through investments in education, training and health.

Capital

To an economist, capital has several meanings — including the finance

raised to operate a business. Normally the term capital means investment
in goods that can produce other goods in the future.

Capital refers to the machines, roads, factories, tools, etc. which human
beings have produced in order to produce other goods and services. A
modern industrialized economy possesses a large amount of capital, and
it is continually increasing. Increases in the capital stock of a nation are
called investment. Investment is important if the economy is to achieve
economic growth in the long run.

Capital accumulation or capital formation is the process of adding to the

net physical capital stock of an economy in an attempt to achieve a
greater total output, i.e. to produce more. The rate of accumulation of an
economy’s physical stock is an important determinant of the rate of
growth of an economy. There are two distinctions between rates of capital
accumulation:

Capital widening: Capital stock rising at a rate which keeps pace with
labour force growth so the proportion of capital to labour remains
unchanged.

Capital deepening: Capital stock grows faster than labour force so that
proportionally more capital to labour is used to produce national output.

Capital consumption: A reduction in a country’s capital stock incurred in

producing a years’s GDP. This is a result of depreciation of roads,
machines, vehicles, etc. over time these become worn out or obsolete. In
order to maintain or increase next year’s GDP a proportion of new
investment must be devoted to replacing worn out capital stock.

Entrepreneurship

Entreprenours are people who organize other productive resources to

make goods and services. Some economists regard entreprenours as a
specialist form of labour input. Others believe that they deserve
recognition as a separate factor of production in their own right.

The success and/or failure of a business often depends critically on the

quality of entrepreneurship.
Section 2 – Microeconomics
Markets
Demand
Demand is defined as the quantity of a good or service consumers are
able and willing to buy at a given price in a given time period.

The law of demand states that there is an inverse relationship between

the price and demand of a good. As prices fall there is an expansion of
demand, demand shifts out, and if the prices rise there is a contraction of
demand.

There is only a demand when consumers are able and willing to pay for a
good, this is referred to as effective demand. Demand can also be said to
be latent if consumers are willing to pay for a good, but not able to.

Consumers will tend to act rationally when considering a product. They

will chose the good or service that gives the most in return for their
money.

Supply
Supply is the quantity of a good or service that a producer is able and
willing to supply onto the market at a given price in a given period of time.
Normally, when demand rises supply will shift outwards in order to meet
the demand and thus there is an extension of supply.

The law of supply states this, saying that higher quantity will be supplied
at higher prices, all other factors stays the same.

There is a positive relationship between the market price and the quanity
supplied. This is due to three main factors, one of them being that it
becomes more profitable for businesses to increase their output when the
price of a good increases.

The second factor is that higher prices send signals to firms that there is a
potential to increase production. With increased production comes
increased production costs and thus a higher price is needed to cover the
extra costs associated with the increased production.

The third factor is that when prices goes up it becomes more profitable for
other firms to enter the market, which in turn leads to an increase in
supply.

This is why there is a higher quantity supploed at a higher price level.

Elasticities
Elasticity is the measure of responsiveness in one varable when another
changes. For example, if the price of cigarettes falls how much will the
quantity demanded change? We use this analogy because elasticities
streches and changes in length. As the price of a good changes, the
quantity demanded changes, but by how much? There are four key
elasticities to examine:

1. Price elasticity of demand

2. Income elasticity of supply
3. Cross elasticity of