Discusses In Detail The Term Economic Resources With Reference To Service Industry.

Explain The Link Between Scarcity, Choice And Opportunity Cost. Economic Resources:
Microeconomics is the study of the behaviors and decisions of individuals and businesses in markets across the economy. We start our study of microeconomics by looking at the resources which an economy may have available to supply and produce goods and services to meet the ever-changing needs and wants of individuals and society as a whole. In economics we classify goods as tangible products, example might include food and drink, cars, digital televisions, flat-screen televisions, energy products and cricket bats! Services are sometimes known as intangibles, education and health-care are two important services and tourism, business consultancy, cleaning and home insurance are all examples of services.

Question # 1

Finite resources:
There are only a finite (or limited) number of workers, machines, acres of land and reserves of oil and other natural resources on the earth. Because most of our resources are finite, we cannot produce an unlimited number of different goods and services and by producing more for an everincreasing population we are in real danger of destroying the natural resources of the planet. This has important consequences for the long-term sustainability of economies throughout the world and potentially huge implications for our living standards and the quality of life.

Tuna reaches the quayside and will soon be supplied to the market but over-fishing may have destroyed fish stocks and risks the whole future of the tuna fishing industry in the European Union

Tuna at risk of extinction:

Bluefin tuna are at risk of extinction in the Mediterranean and eastern Atlantic according to a report from the Worldwide Fund for Nature. They lay the blame on fishermen who have caught more than the quotas allowed under current European Union rules. Over-fishing has led to a reduction in stocks of tuna and average catch sizes are declining. The WWF has called for an immediate halt to bluefin tuna fishing arguing that failure to act now will lead to the complete destruction of what should be a renewable resource. Source: Worldwide Fund for Nature and BBC news reports Environmental pressure groups such as Friends of the Earth and Greenpeace seek to highlight the permanent damage to the stock of natural resources available throughout the world and the dangers from economic development and global warming. One such issue is the huge threat posed by the global shortage of water as the worlds demand for water for household and commercial use continues to grow each year. At the heart of improving resource sustainability is the idea of de-coupling a process of trying to increase the efficiency with which resources are used in producing goods and services and breaking the link between ever-increasing output and resource depletion.

Factors of production:
Factors of production refer to the resources we have available to produce goods and services. We make a distinction between physical and human resources.

Land:
Land includes all of the natural physical resources for example the ability to exploit fertile farm land, the benefits from a temperate climate or the ability to harness wind and solar power and other forms of renewable energy. Some nations are richly endowed with natural resources and then specialize in the extraction and production of these resources for example the development of the North Sea oil and gas in Britain and Norway or the high productivity of the vast expanse of farm land in Canada and the United States and the oil sands in Alberta, Canada. Other countries have a smaller natural factor endowment and may be more reliant on importing these resources. Japan for example is the worlds second largest economy but remains heavily dependent on imported oil.

Labour:
Labour is the human input into the production process. It is inevitable that some workers are more productive than others because of the education, training and work experience they have received. What matters is the size and quality of the workforce. An increase in the size and the quality of the labour force is vital if a country wants to achieve economic growth. In recent years the issue of the migration of labour has become important, can migrant workers help to solve some of the labour shortages that many countries experience? And what of the long-term effects on the countries who suffer a drain or loss of workers through migration?

Capital:
To an economist, investment is not the money that people put into the stock market or into bank and building society accounts. Instead, in economics the term capital means investment in capital goods that can then be used to produce other consumer goods and services in the future. Fixed capital includes machinery, plant and equipment, new technology, factories and other buildings. Working capital refers to stocks of finished and semi-finished goods (or components) that will be either consumed in the near future or will be made into finished consumer goods.

The global oil and gas industry uses a huge amount of capital equipment to get the product crude oil to the refineries and processing stages.

Capital inputs and productivity:

New items of capital machinery, buildings or technology are generally used to enhance the productivity of labour. For example, improved technology in farming has vastly increased the productivity of our agricultural sector and allowed people to move out of working on the land into more valuable jobs in other parts of the economy. And, investment in information and communication technology can increase the efficiency of workers across many industries.

Infrastructure:
Infrastructure is the stock of capital used to support the entire economic system. Examples of infrastructure include road & rail networks; airports & docks; telecommunications eg cables and satellites to enable web access. The World Bank regards infrastructure as an essential pillar for economic growth in developing countries.

The Gatwick Express the railway infrastructure is an essential part of our transport network

Entrepreneurship:
An entrepreneur is an individual who seeks to supply products to a market for a rate of return (i.e. to make a profit). Entrepreneurs will usually invest their own financial capital in a business (for example their savings) and take on the risks associated with a business investment. The reward to this risktaking is the profit made from running the business. Many economists agree that entrepreneurs are in fact a specialized part of the factor input 'labour'.

Renewable resources:
Renewable resources are commodities such as solar energy, oxygen, biomass, fish stocks or forestry that is inexhaustible or replaceable by new growth providing that the rate of extraction of the resource is less than the natural rate at which the resource renews itself. This is becoming an enormously important issue in environmental economics, for example the issue of the over-extraction of fish stocks, and the global risks of permanent water shortages resulting from rising use of ground water stocks. Finite resources cannot be renewed. For example with plastics, crude oil, coal, natural gas and other items produced from fossil fuels, no mechanisms exist replenish them.

Factor Rewards:
Factors of production are used to create output to be sold in markets. Each factor used in production can expect some reward. High oil prices help Shell to record profits Soaring crude oil prices are boosting oil companies' profits around the world. Royal Dutch Shell has announced record annual profit for a UK stock market listed company. Shell generated profits of 13.12bn in 2005 up nearly a third on the 2004 level. Most of Shells profits come from finding and extracting oil, and then selling it on to the worlds oil markets.

Income:
Income represents a flow of earnings from using factors of production to produce an output of goods and services which are then sold in markets. The main sources of income for individuals and households are: 1. Wages and salaries from work often supplemented by overtime and productivity bonuses. 2. Interest from savings held in banks, building societies and other accounts. 3. Dividends from share ownership. 4. Rent income from the ownership of property. For the majority of people, most of their weekly or monthly income comes from their job. The government cans also affect peoples disposable (or post-tax) income by taxing incomes and by giving welfare benefits to households on low incomes or to people who are out of work.

Wealth:
Wealth is defined as a stock of assets that creates a flow of income and it can be held in a variety of forms by individuals, firms and also the nation as a whole: Financial wealth - stocks and shares, bonds, savings in bank and building society accounts and contributions to pension schemes. Marketable wealth - consumer durables that can be sold for a price e.g. rare antiques. Social capital including social infrastructure such as transport systems, schools and hospitals. It is important to distinguish between income and wealth. For example, if you receive a higher wage or salary from your job then this adds to your monthly income and if this is saved in a bank, or by making contributions to a pension fund then you are adding to your financial wealth. Being wealthy can also generate income for if you own shares in companies listed on the stock market then you expect to receive dividend income once or twice a year. And if you have money in a savings account, you will be paid interest on your savings balances. Likewise, if you own properties, then you can earn some income from renting it out to tenants. There has been a huge expansion in recent years in the buy-to-let sector of the housing market with hundreds of thousands of people buying properties and then letting them out. By the summer of 2006 in the UK there were over 700,000 people who had bought property and then let it out to tenants as part of the buy-to-let sector of the housing market. Of course the value of financial wealth can fluctuate over time. In the UK in recent years we have seen a boom in the UK housing market leading to sharp rises in average house prices, particularly in London and the South East. The result has been a jump in housing wealth for people with mortgages, but a growing problem of affordability for people looking to enter the housing market for the first time on relatively low incomes. Share prices have also been volatile with a collapse in prices from 2000-2003 and then a recovery in the stock market over the last three years.

Inequality in the distribution of income and wealth:

Factor incomes or factor rewards are rarely if ever distributed equitably in any country. Indeed it is a fact of life that the distribution of income and wealth in the UK is highly unequal there is a huge gap between the richest and poorest households in our society. For example, the latest available data shows that 94% of the total wealth in this country is held by 50% of the population. Put another way, the other half of our population can lay claim to only 6% of total wealth. Millions of people must rely on relatively low incomes with little opportunity to accumulate wealth. Is this fair? What are the consequences of a high level of inequality? Should the government intervene to change the distribution of income? And what might be some of the effects of such policies? These are important questions and we will return to them when we consider the issue of market failure.

Income of the richest UK families is sixteen times that of the poorest

In 2004-05, the average gross (pre-tax) income of the richest 20% of families in Britain was 66,300, more than 16 times that of the poorest 20% who earned 4,300 on average. After adjusting for taxes and welfare benefits such as income support and

the state pension, however, this ratio fell to four-to-one. For direct taxes, the top fifth of households pay 25% of their gross income in direct taxes such as income tax while for the poorest households the figure is 10%. Levels of inequality are little changed from that seen during the years of the Thatcher government.

Labour and Wages

Most people have the ability to do some form of work. If they are of working age and actively seeking a job then they are included in the working population. In industries and jobs where labour is not particularly scarce, wages tend to be lower. Millions of workers in the UK are paid hourly wages well below the national average. The minimum wage (currently 5.05 for all adult workers it rises to 5.35 in October 2006) seeks to address some of the problems associated with low pay. On the other hand, some people have skills that are quite rare, and these people will command high salaries in the labour market.

Capital and Interest

Businesses often need to borrow money to fund capital investment. The reward for investing money is called interest. Interest rates can of course go up or down. If the interest rate is high, it becomes less worthwhile to borrow money because any project will have to make more money than before to be profitable since more interest is now being paid.

Enterprise and Profit

In return for having innovative business ideas and taking the risk in putting funds into a business the entrepreneur takes any money that the business has left after the other factors of production have received their rewards. This is called gross profit. Taxes then have to be paid to the government, and the entrepreneur takes what is left. This after-tax profit is called net
profit.

Profits flow from increased passenger numbers

The low-cost airline EasyJet is reaping the benefits of higher sales and it is forecasting that pre-tax profits in 2006 will be up by as much as 50 per cent. The business is creating higher profits by increasing passenger revenue per seat and achieving extra sales and income from ancillary revenues. EasyJet has managed to overcome the challenge of higher oil prices partly by making cost savings in other parts of their business. EasyJet said it carried 2.6 million passengers in June 2006, up 15.6 percent from a year earlier, while its load factor, a measure of how efficiently it is filling seats on each flight, was 87.6 percent, 2 per cent higher than at the same time in 2005. EasyJet is part of the Easy Group of companies.

Passenger data and passenger revenue for Easy Jet

12 months to June 2006 Passengers Load Factor Total Revenue

32,122,137 84.4% 1,535m

12 months to June 2005 28,291,843 85.1% 1,261m

Change over the year

+13.5% -0.7% +21.8%

Source: EasyJet Investor Relations web site, accessed July 2006

Economists often assume that one of the main objectives of a business is to achieve maximum profits. But this is not always the case! Some businesses are looking to achieve a rising market share and increasing market share might mean having to sacrifice some profits in the short run by cutting prices and under-cutting rival suppliers in the market. There is also a growing interest in the concept of ethical businesses and corporate social responsibility where the traditional assumption of businesses driven solely by the profit motive is being challenged and where businesses are encouraged to take account of their economic, social and environmental impacts.

Factor
Land

Description all natural resources (gifts of nature) including fields, mineral wealth, and fishing stocks

Reward
The reward for landlords for allowing firms to use their property is rent

Labour

The physical and mental work of people The reward for workers giving up time to whether by hand, by brain, skilled or help create products is wages or salaries unskilled Man made goods used to produce The reward for creditors lending money to more goods including factories (plant), firms to invest in buildings and capital machines and roads. equipment is interest

Capital

An entrepreneur risks financial capital The reward for individuals risking funds and organizes land labour & capital to and offering products for sale is profit. produce output in the hope of profit Unsuccessful firms make losses. Source: Richard Young, Markets Question and Answer, Tutor2
Enterprise

LINK BETWEEN SCARCITY, CHOICE AND OPPORTUNITY COST

The purpose of economic activity Road space throughout the world is becoming increasingly scarce as the demand for motor transport increases each year what do you think are some of the best solutions to reducing the problem of congestion on our roads?

It is often said that the central purpose of economic activity is the production of goods and services to satisfy consumers needs and wants i.e. to meet peoples need for consumption both as a means of survival but also to meet their ever-growing demand for an improved lifestyle or standard of living. The basic economic problem is about scarcity and choice since there are only a limited amount of resources available to produce the unlimited amount of goods and services we desire. All societies face the problem of having to decide: What goods and services to produce: Does the economy uses its resources to operate more hospitals or hotels? Do we make iPod Nanos or produce more coffee? Does the National Health Service provide free IVF treatment for thousands of childless couples?

Or, do we choose instead to allocate millions of pounds each year to providing betainterferon to sufferers of multiple sclerosis? How best to produce goods and services: What is the best use of our scarce resources of land labour and capital? Should school playing fields be sold off to provide more land for affordable housing? Or are we contributing to the problem of obesity by selling off these playing fields? Who is to receive goods and services: What is the best method of distributing products to ensure the highest level of wants and needs are met? Who will get expensive hospital treatment - and who not? Should there be a minimum wage? If so, at what level should it be set?

Scarcity Water, water everywhere:

We use an average of 158 liters of water a day in Britain, for which we pay a price of 28p per liter but much of it is just cash down the drain, according to water companies. Most are campaigning to cut the amount we use. And the front-line weapon in their campaign is the water meter. They want us all to have one and one company is seeking powers to make them compulsory. When a meter is installed, in most homes, consumption drops by 20 per cent and, in some, it goes down by a third. According to Ofwat, the water industry regulator, the average water and sewerage bill for homes with a meter is 248 compared with 289 for those with flat-rate bills. At present only 25 per cent of households have meters and most of those are in East Anglia. They are installed free by water companies but households then have about 43 added to each bill to cover the cost of installing and reading the meter. Unsurprisingly, we use more water in summer. Peak demand on hot days can be 50 to 70 per cent above average. Most of this is for lawns, flowers, paddling pools and extra showers and baths.
Source: Adapted from an article by Valerie Elliott, the Times, 9 July 2005

If something is scarce - it will have a market value!

If the supply of a good or service is low, the market price will rise, providing there is sufficient demand from consumers. Goods and services that are in plentiful supply will have a lower market value because supply can easily meet the demand from consumers. Whenever there is excess supply in a market, we expect to see prices falling. For example, the prices of new cars in the UK have been falling for several years and there have been huge falls in the prices of clothing as supply from countries such as China and Vietnam has surged.
Insatiable human wants and needs

The Swedish furniture giant IKEA sells to millions of consumers throughout the world

Human beings want better food; housing; transport, education and health services. They demand the latest digital technology, more meals out at restaurants, more frequent overseas travel, more leisure time, better cars, cheaper food and a wider range of cosmetic health care treatments. Opinion polls consistently show that the majority of the electorate expect government policies to deliver improvements in the standard of education, the National Health Service and our transport system. (Whether voters are really prepared to pay for these services through higher taxes is of course another question!) Economic resources are limited, but human needs and wants are infinite. Indeed the development of society can be described as the uncovering of new wants and needs - which producers attempt to supply by using the available factors of production. For a perspective on the achievements of countries in meeting peoples basic needs, the Human Development Index produced annually by the United Nations is worth reading. Data for each country can be accessed and cross-country comparisons can be made.

Making choices:
Because of scarcity, choices have to be made on a daily basis by all consumers, firms and governments. For a moment, just have a think about the hundreds of millions of decisions that are made by people in your own country every single day. Take for example the choices that people make in the city of London about how to get to work. Over six million people travel into London each day, they have to make choices about when to travel, whether to use the bus, the tube, to walk or cycle or indeed whether to work from home. Millions of decisions are being taken, many of them are habitual (we choose the same path each time) but somehow on most days, people get to work on time and they get home too! This is a remarkable achievement, and for it to happen, our economy must provide the resources and the options for it to happen.

Trade-offs when making choices:

Making a choice made normally involves a trade-off - in simple terms, choosing more of one thing means giving up something else in exchange. Because wants are unlimited but resources are finite, choice is an unavoidable issue in economics. For example:

1. Housing: Choices about whether to rent or buy a home a huge decision to make and one full of uncertainty given the recent volatility in the British housing market! There are costs and benefits to renting a property or choosing to buy a home with a mortgage. Both decisions involve a degree of risk. 2. Working: Choosing between full-time or part-time work, or to take a course in higher education lasting three years how have these choices and commitments been affected by the introduction of university tuition fees? 3. Transport and travel: The choice between using Euro-Tunnel, a speedy low-cost ferry or an airline when traveling to Western Europe. Your choices about which modes of transport to use to get to and from work or school each day.

Consumer welfare and rationality:

What makes people happy? Why despite several decades of rising living standards do surveys of happiness suggest that people are not noticeably happier than previous generations? When we study the decisions of consumers in different markets, we can start to consider and explore what their aims are. Our working assumption for the moment is that consumers make choices about what to consume based on the aim of maximizing their own welfare. They have a limited income (i.e. a limited budget) and they seek to allocate their funds in a way that improves their standard of living. Of course in reality consumers rarely behave in a perfectly informed and rational way. We will see later that often decisions by people are based on imperfect or incomplete information which can lead to a loss of satisfaction and welfare not only for people themselves but which affect other and our society as a whole. As consumers we have all made poor choices about which products to buy. Do we always learn from our mistakes? To what extent are our individual choices influenced and distorted by the effects of persuasive advertising? Multinational companies have advertising and marketing budgets that often run into hundreds of millions of pounds. We are all influenced by them to a lesser or greater degree and there is always the risk that advertising can be misleading.

Economic Systems:
An economic system is best described as a network of organizations used by a society to resolve the basic problem of what, how and for whom to produce. There are four categories of economic system.

Traditional economy: Where decisions about what, how and for whom to produce are based on custom and tradition. Land is typically held in common ie private property is not well defined. Free market economy: Where households own resources and free markets allocate resources through the workings of the price mechanism. An increase in demand raises price and encourages firms to switch additional resources into the production of that good or service. The amount of products consumed by households depends on their income and household income depends on the market value of an individuals work. In a free market economy there is a limited role for the government. Indeed in a highly free market system, the government limits itself to protecting the property rights of people and businesses using the legal system, and it also seeks to protect the value of money or the value of a currency.

Planned or command economy: In a planned or command system typically associated with a socialist or communist economic system, scarce resources are owned by the state (i.e. the government). The state allocates resources, and sets production targets and growth rates according to its own view of people's wants. The final income and wealth distribution is decided by the state. In such a system, market prices play little or no part in informing resource allocation decisions and queuing rations scarce goods. Mixed economy: In a mixed economy, some resources are owned by the public sector (government) and some resources are owned by the private sector. The public sector typically supplies public, quasi-public and merit goods and intervenes in markets to correct perceived market failure. We will come back to all of these concepts later on in our study of microeconomics.

Opportunity Cost:
There is a well known saying in economics that there is no such thing as a free lunch! Even if we are not asked to pay a price for consuming a good or a service, scarce resources are used up in the production of it and there must be an opportunity cost involved. Opportunity cost measures the cost of any choice in terms of the next best alternative foregone. Many examples exist for individuals, firms and the government. Work-leisure choices: The opportunity cost of deciding not to work an extra ten hours a week is the lost wages foregone. If you are being paid 6 per hour to work at the local supermarket, if you choose to take a day off from work you might lose 48 from having sacrificed eight hours of paid work. 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 the transport network. Investing today for consumption tomorrow: The opportunity cost of an economy investing resources in new capital goods is the current production of consumer goods given up. We may have to accept lower living standards now, to accumulate increased capital equipment so that long run living standards can improve.

Making use of scarce farming land:

The opportunity cost of using arable farmland to produce wheat is that the land cannot be used in that production period to harvest potatoes. Sectors of production in the economy Primary sector: This involves extraction of natural resources e.g. agriculture, forestry, fishing, quarrying, and mining Secondary sector: This involves the production of goods in the economy, i.e. transforming materials produced by the primary sector e.g. manufacturing and the construction industry Tertiary sector: the tertiary sector provided services such as banking, finance, insurance, retail, education and travel and tourism

Quaternary sector: The quaternary sector is involved with information processing e.g. education, research and development

Manufacturing industry in the United Kingdom only accounts for 18 per cent of national output. The bulk of our income and employment comes from the service sector.

Why Do Consumers, Producers And Governments Have To Make Choices?

The invisible hand the workings of the price mechanism
Adam Smith, one of the Founding Fathers of

Question # 2

economics famously wrote of the invisible hand of the price mechanism. He described how the invisible or hidden hand of the market operated in a competitive market through the pursuit of self-interest to allocate resources in societys best interest. This remains the central view of all free-market economists, i.e. those who believe in the virtues of a free-market economy with minimal government intervention. The price mechanism is a term used to describe the means by which the many millions of decisions taken each day by consumers and businesses interact to determine the allocation of scarce resources between competing uses. This is the essence of economics!

Adam Smith

The price mechanism plays three important functions in any market-based economic system: The signaling function

The price of digital printing is coming down this will have an effect on the demand for substitute forms of image printing. How will traditional photo imaging retailers respond?

Firstly, prices perform a signaling function. This means that market prices will adjust to demonstrate where resources are required, and where they are not. Prices rise and fall to reflect scarcities and surpluses. So, for example, if market prices are rising because of high and rising demand from consumers, this is a signal to suppliers to expand their production to meet the higher demand. Consider the left hand diagram on the next page. The demand for computer games increases and as a result, producers stand to earn higher revenues and profits from selling more games at a higher price per unit. So an outward shift of demand ought to lead to an expansion along the market supply curve.

In the second example on the right, an increase in market supply causes a fall in the relative prices of digital cameras and prompts an expansion along the market demand curve Conversely, a rise in the costs of production will induce suppliers to decrease supply, while consumers will react to the resulting higher price by reducing demand for the good or services.

The Transmission of preferences

Through the signaling function, consumers are able through their expression of preferences to send important information to producers about the changing nature of our needs and wants. When demand is strong, higher market prices act as an incentive to raise output (production)

because the supplier stands to make a higher profit. When demand is weak, then the market supply contracts. We are assuming here that producers do actually respond to these price signals! One of the features of a free market economy is that decision-making in the market is decentralized in other words, the market responds to the individual decisions of millions of consumers and producers, i.e. there is no single body responsible for deciding what is to be produced and in what quantities. This is a remarkable feature of an organic market system. The Rationing Function
Prices serve to ration scarce resources when demand in a market outstrips supply. When there is shortage of a product, the price is bid up leaving only those with sufficient willingness and ability to pay with the effective demand necessary to purchase the product. Be it the demand for tickets among England supporters for the 2006 World Cup or the demand for a rare antique, the market price acts rationing device to equate demand with supply. The prices for using the M6 Toll Road are a good example of the rationing function of the price mechanism. A toll road can exclude those drivers and vehicles that are not willing or able to pay the current toll charge. In this sense, motorists and road haulage businesses and other road users are paying for the right to use the road, road space has a market price instead of being regarded as something of a free good. The current charges are below: Prices on the M6 Toll Road June 2006 Class 1 (e.g. motorbike) Class 2 (e.g. car) Class 3 (e.g. car & trailer) Class 4 (e.g. van/coach) Class 5 (e.g. HGV) Day (06:00 - 23:00) 2.50 3.50 7 7 7 Night (23:00 - 06:00) 1.50 2.50 6 6 6

What would happen if the day-time charges increased to 5 for cars? The growing popularity of auctions as a means of allocating resources is worth considering as a means of allocating resources and clearing a market. The phenomenal success of EBAY is testimony to the power of the auction process as a rationing and market clearing mechanism as internet usage has grown. The price mechanism is the only allocate mechanism solving the economic problem in a free market economy. However, most modern economies are mixed economies, comprising not only a market sector, but also a non-market sector, where the government (or state) uses the planning mechanism to provide public goods and services such as police, roads and merit goods such as education, libraries and health. In a state run command economy, the price mechanism plays little or no active role in the allocation of resources. Instead government planning directs resources

to where the state thinks there is greatest need. The reality is that state planning has more or less failed as a means of deciding what to produce, how much to produce, how to produce and for whom. Following the collapse of communism in the late 1980s and early 1990s, the market-based economy is now the dominant economic system even though we are increasingly aware of imperfections in the operation of the market i.e. the causes and consequences of market failure.

Prices and incentives

Incentives matter enormously in our study of microeconomics, markets and instances of market failure. For competitive markets to work efficiently all economic agents (i.e. consumers and producers) must respond to appropriate price signals in the market. Market failure occurs when the signaling and incentive function of the price mechanism fails to operate optimally leading to a loss of economic and social welfare. For example, the market may fail to take into account the external costs and benefits arising from production and consumption. Consumer preferences for goods and services may be based on imperfect information on the costs and benefits of a particular decision to buy and consume a product. Our individual preferences may also be distorted and shaped by the effects of persuasive advertising and marketing to create artificial wants and needs.

Government intervention in the market

Often the incentives that consumers and producers have can be changed by government interventional markets. For example a change in relative prices brought about by the introduction of government subsidies and taxation. Suppose for example that the government decides to introduce a new tax on aviation fuel in a bid to reduce some of the negative externalities created by the air transport industry.

How will airlines respond? a. Will they pass on the tax to consumers? b. Can they absorb the tax and seek cost-savings elsewhere in their operations? If the tax raises price for air travelers, will they change their behavior in the market? Is an aviation tax the most effective way of controlling pollution? Or could incentives for producers and behavior by consumers wanting to travel by air be changed through other more effective and efficient means?

Agents may not always respond to incentives in the manner in which textbook economics suggests. The law of unintended consequences encapsulates the idea that government policy interventions can often be misguided of have unintended consequences! See the revision focus article on government failure.

What Is Meant By A Production Possibility Frontier? Illustrate Your Answer. What Other Names Are Used Instead Of Production Possibility Frontier? Production Possibility Curve
Definition Graphical representation of the alternative combinations of the amounts of two goods or services that an economy can produce by transferring resources from one good or service to the other. This curve helps in determining what quantity of a non-essential good or a service

Question # 3

an economy can afford to produce without jeopardizing the required production of an essential good or service. Also called transformation curve The Production Possibility Frontier Consider the case of an island economy that produces only two goods: wine and grain. In a given period of time, the islanders may choose to produce only wine, only grain, or a combination of the two according to the following table: Production Possibility Table

Wine (thousands of bottles) 0 5 9 12 14 15

Grain (thousands of bushels) 15 14 12 9 5 0

The production possibility frontier (PPF) is the curve resulting when the above data is graphed, as shown below Production Possibility Frontier

The PPF shows all efficient combinations of output for this island economy when the factors of production are used to their full potential. The economy could choose to operate at less than capacity somewhere inside the curve, for example at point a, but such a combination of goods would be less than what the economy is capable of producing. A combination outside the curve such as point b is not possible since the output level would exceed the capacity of the economy.

The shape of this production possibility frontier illustrates the principle of increasing cost. As more of one product is produced, increasingly larger amounts of the other product must be given up. In this example, some factors of production are suited to producing both wine and grain, but as the production of one of these commodities increases, resources better suited to production of the other must be diverted. Experienced wine producers are not necessarily efficient grain producers, and grain producers are not necessarily efficient wine producers, so the opportunity cost increases as one moves toward either extreme on the curve of production possibilities. Suppose a new technique was discovered that allowed the wine producers to double their output for a given level of resources. Further suppose that this technique could not be applied to grain production. The impact on the production possibilities is shown in the following diagram: Shifted Production Possibility Frontier

In the above diagram, the new technique results in wine production that is double its previous level for any level of grain production. Finally, if the two products are very similar to one another, the production possibility frontier may be shaped more like a straight line. Consider the situation in which only wine is produced. Let's assume that two brands of wine are produced, Brand A and Brand B, and that these two brands use the same grapes and production process, differing only in the name on the label. The same factors of production can produce either product (brand) equally efficiently. The production possibility frontier then would appear as follows: PPF for Very Similar Products

Note that to increase production of Brand A from 0 to 3000 bottles, the production of Brand B must be decreased by 3000 bottles. This opportunity cost remains the same even at the other extreme, where increasing the production of Brand A from 12,000 to 15,000 bottles still requires that of Brand B to be decreased by 3000 bottles. Because the two products are almost identical in this case and can be produced equally efficiently using the same resources, the opportunity cost of producing one over the other remains constant between the two extremes of production possibilities.

Question # 4
Discuss the Contrasting Features of A Market Based Economy to A Command Economy and Give Their Advantages and Disadvantages.
A market economy is, strictly speaking, an economy in which prices of things are freely set based on the laws of supply and demand, unfettered by interference from a government or other outside body. A market economy is, at its most basic, an economy run entirely by the market itself. In the real world, however, there is no such thing as a truly unfettered market economy, and so the term is used to describe economies which are largely dictated by market forces. As a result, whether or not a given economy is actually a market economy can be open to some debate. A market economy can be contrasted by a command economy, where the prices for things are set by a force outside the market, such as a government. Strict Communist economies, for example, do not allow the market to dictate prices, making them command economies. In recent years, however, many Communist states have begun incorporating aspects of a market economy into their systems. China is a good example of this model, often called market socialism or the socialist market economy. Under market socialism, many key industries are actually owned and operated by the government rather than private industry, but the government allows the prices of goods and services to fluctuate based on the market, rather than using their monopoly to set the prices as they choose. A related type of market economy is known as Anarcho-capitalism, in which all government interference in the market is removed entirely. Under Anarcho-capitalism all involvement in larger projects, such as defense spending or infrastructure, is on a voluntary basis. The government does not regulate any sales or ownership in any way, shape, or form, and the market is regulated only to the extent that individuals choose to limit their own actions. This has a great deal in common with the ideal, strictly laissez-faire market economy, but is markedly different in its rejection of all apparatuses of the state as a necessary pre-condition to a truly free market.

Most economies in the West are defined as mixed economies, incorporating some elements of a socialist command economy and some elements of a market economy. These economies can be seen as falling along a spectrum, with varying degrees of market freedom. The United States, for example, can be seen as falling fairly far on the side of a true market economy, with steady deregulation of industries and privatization of even once government-owned industries. In contrast, many nations in Western Europe can be seen as falling more on the socialized end of the spectrum, with fairly substantial regulation of industries, and government ownership of some key businesses, such as prisons, water systems, telecommunications systems, health-care systems, and others. The idea of the market economy is intricately connected with larger political ideals as well. Many theorists, most notably Milton Friedman, one of the great proponents of the market economy, have posited that a free-market economy is a necessary pre-condition for a truly free political system. They hold that the degree to which a nation embraces a free market correlates over time to the degree to which that nation will provide civil and political freedoms to its citizens, with command economies eventually stripping away individual rights. A Mixed Economy: The Role of the Market The American free enterprise system emphasizes private ownership. Private businesses produce most goods and services, and almost two-thirds of the nation's total economic output goes to individuals for personal use (the remaining one-third is bought by government and business). The consumer role is so great, in fact, that the nation is sometimes characterized as having a "consumer economy." This emphasis on private ownership arises, in part, from American beliefs about personal freedom. From the time the nation was created, Americans have feared excessive government power, and they have sought to limit government's authority over individuals -- including its role in the economic realm. In addition, Americans generally believe that an economy characterized by private ownership is likely to operate more efficiently than one with substantial government ownership.

Why? When economic forces are unfettered, Americans believe, supply and demand determine the prices of goods and services. Prices, in turn, tell businesses what to produce; if people want more of a particular good than the economy is producing, the price of the good rises. That catches the attention of new or other companies that, sensing an opportunity to earn profits, start producing more of that good. On the other hand, if people want less of the good, prices fall and less competitive producers either go out of business or start producing different goods. Such a system is called a market economy. A socialist economy, in contrast, is characterized by more government ownership and central planning. Most Americans are convinced that socialist economies are inherently less efficient because government, which relies on tax revenues, is far less likely than private businesses to heed price signals or to feel the discipline imposed by market forces. A Mixed Economy - The Limits to Free Enterprise

There are limits to free enterprise, however. Americans have always believed that some services are better performed by public rather than private enterprise. For instance, in the United States, government is primarily responsible for the administration of justice, education (although there are many private schools and training centers), the road system, social statistical reporting, and national defense. In addition, government often is asked to intervene in the economy to correct situations in which the price system does not work. It regulates "natural monopolies," for example, and it uses antitrust laws to control or break up other business combinations that become so powerful that they can surmount market forces. Government also addresses issues beyond the reach of market forces. It provides welfare and unemployment benefits to people who cannot support themselves, either because they encounter problems in their personal lives or lose their jobs as a result of economic upheaval; it pays much of the cost of medical care for the aged and those who live in poverty; it regulates private industry to limit air and water pollution; it provides low-cost loans to people who suffer losses as a

result of natural disasters; and it has played the leading role in the exploration of space, which is too expensive for any private enterprise to handle. In this mixed economy, individuals can help guide the economy not only through the choices they make as consumers but through the votes they cast for officials who shape economic policy. In recent years, consumers have voiced concerns about product safety, environmental threats posed by certain industrial practices, and potential health risks citizens may face; government has responded by creating agencies to protect consumer interests and promote the general public welfare. The U.S. economy has changed in other ways as well. The population and the labor force have shifted dramatically away from farms to cities, from fields to factories, and, above all, to service industries. In today's economy, the providers of personal and public services far outnumber producers of agricultural and manufactured goods. As the economy has grown more complex, statistics also reveal over the last century a sharp long-term trend away from self-employment toward working for others.

Question # 5
According To The Central Deduction Of Economic Theory, Under Certain Conditions Markets Allocate Resources Efficiently. Efficiency Has A Special Meaning In This Context. This Theory Suggests That Markets Will Produce An Outcome Such That, Given The Economys Scarce Resources, It Is Impossible To Make Anybody Better Off Without Making Somebody Else Worse Off. Economic Theory, In Other Words, Offers A Proof Of Adam Smiths Big Idea: In A Market Economy, If Certain Conditions Are Met, An Invisible Hand Guides Countless Apparently Un Co-Coordinated Individuals To A Result That Is, In One Plausible Sense, The Best That Can Be Done. In rich countries, markets are too familiar to attract attention. Yet certain awe is appropriate. When soviet planners visited a vegetable market in London during the early days of perestroika, they were impressed to find no queues, shortages, or mountains of spoiled and unwanted vegetables. They took their hosts aside and said: we understand, you have to say its all done by supply and demand. But can you tell us what is really going on? Where youre planners and what are their methods? 1. Explain What Is Meant By Efficiency. 2. Market Economy. 3. Comment on Two Conditions Which Have To Be Met For a Market Economy to Work Efficiently. 4. Explain What Is Meant, in the Context of the Extract, By Its all done By Supply And Demand. 5. What Was The Role Of Soviet Planners In The Former Soviet Union?

EXPLAIN WHAT IS MEANT BY EFFICIENCY

Economic efficiency is a term typically used in microeconomics when discussing product. Production of a unit of good is considered to be economically efficient when that unit of good is produced at the lowest possible cost. Economics by Perkins and Bade give a useful introduction to the difference between economic efficiency and technological efficiency:

There are two concepts of efficiency: Technological efficiency occurs when it is not possible to increase output without increasing inputs. Economic efficiency occurs when the cost of producing a given output is as low as possible. Technological efficiency is an engineering matter. Given what is technologically feasible, something can or cannot be done. Economic efficiency depends on the prices of the factors of production. Something that is technologically efficient may not be economically efficient. But something that is economically efficient is always technologically efficient. A key point to understand is the idea that economic efficiency occurs "when the cost of producing a given output is as low as possible". There's a hidden assumption here, and that is the assumption that all else being equal. A change that lowers the quality of the good while at the same time lowers the

cost of production does not increase economic efficiency. The concept of economic efficiency is only relevant when the quality of goods being produced is unchanged.

MARKET ECONOMY
A system of allocating resources based only on the interaction of market forces, such as supply and demand. A true market economy is free of governmental influence, collusion and other external interference.

The questions "What is a market economy?" "What is a standard market economy?" or rather "What are the standards for a market economy?" would naturally pop up when people are talking about some countries being market economy countries and some enterprises being market economy enterprises. For if not so, how come the conclusion as to whether a country is or is not a market economy country? As a matter of fact, the existence of criteria of a market economy is controversial. Each one gets a reason to support his or her own idea. We hereby accept a proposition, i.e., criteria of market economy do exist, put forward due to anti-dumping cases involved in international trade, but also believe that the criteria are established on a relative basis. Some well-recognized market economy countries, we have discovered, practice various economic systems. It is difficult to say, therefore, that certain country is a standard market economy country, while any other country not exactly the same cannot be regarded as a market economy country. Due to different traditions and development phases, countries inevitably differ in the form, even the contents of their market economy to a certain extent. The existence of differences does not mean there are no market economy criteria, however, and it is unacceptable to deny the existence of market economy criteria due to such differences. As an economic system in human history, the market economy came into being in modern times and is flourishing nowadays. It differs from either historical self-sufficient economy or planned economy, and certainly has its intrinsic definition that refers to the commonness of various market economy countries at different development stages. The commonness, being sorted out from various market economy countries, shapes a framework, which will facilitate us to judge a country's status of market economy in anti--dumping cases. While it is reasonable to admit that there are certain criteria of market economy, it is incorrect to rigidly apply such criteria in an arbitrary way. The framework of market economy criteria is a range of fundamental characteristics of market economy, a status section with certain allowable differences and variations, and a varied status section of market economy taking the commonness of different countries' market economy as a dominant factor and supplemented with variations, rather than an absolute concept, a point or a line.

Supply and Demand - The Basics

Supply and Demand analysis is relatively straight-forward once the terminology is understood. The important terms are as follows: Price Quantity Demand and Demand Curve Quantity Demanded Supply and Supply Curve Quantity Supplied Equilibrium Surplus Shortage Basic supply and demand analysis is done one of two ways - either graphically or numerically. If done graphically, it is important to set up the graph in the 'standard' form.

The Graph
Traditionally economists have placed price (P) on the Y-axis and quantity (Q), as in quantity consumed or quantity purchased/sold on the X-axis. An easy way to remember how to label each axis is to remember 'P then Q', since the price (P) label occurs above and to the left of the quantity (Q) label. Next there are two curves to understand - the demand curve and the supply curve.

The Demand Curve

A demand curve is simply a demand function or demand schedule represented graphically. Note that demand is not simply a number - it is a one-to-one relationship between prices and quantities. The following is an example of a demand schedule:

Demand Schedule $10 - 200 units $20 - 145 units $30 - 110 units $40 - 100 units Note that demand is not simply a number such as '145'. The quantity level associated with a particular price (such as 145 units @ $20) is known as a quantity demanded. A more detailed description of the demand curve can be found at: The Economics of Demand. The Supply Curve

Supply curves, supply functions and supply schedules are not conceptually different than their demand counterparts. Once again, supply is never represented as a number. When considering the problem from the point of view of the seller the quantity level associated with a particular price is

known as quantity supplied. A more detailed description of the supply curve can be found at: The Economics of Supply. Equilibrium Equilibrium occurs when at a specific price P', quantity demanded = quantity supplied. In other words, if there is some price where the amount buyers wish to buy is the same as the amount sellers wish to sell, then equilibrium occurs. Consider the following demand and supply schedules:

Demand Schedule $10 200 units $20 - 145 units $30 - 110 units $40 - 100 units Supply Schedule $10 - 100 units $20 - 145 units $30 - 180 units $40 - 200 units At a price of $20, consumers wish to purchase 145 units and sellers which to provide 145 units. Thus quantity supplied = quantity demanded and we have an equilibrium of ($20, 145 units) Surplus A surplus, from the supply and demand perspective, is a situation where, at the current price, quantity supplied exceeds quantity demanded. Consider the demand and supply schedules above. At a price of $30, quantity supplied is 180 units and quantity demanded is 110 units, leading to a surplus of 70 units (180-110=70). Our market, then, is out of equilibrium. The current price is unsustainable and must be lowered in order for the market to reach equilibrium. Shortage A shortage is simply the flip-side of a surplus. It is a situation where, at the current price, quantity demanded exceeds quantity supplied. At a price of $10, quantity supplied is 100 units and quantity demanded is 200 units, leading to a shortage of 100 units (200-100=100). Our market, then, is out of equilibrium. The current price is unsustainable and must be raised in order for the market to reach equilibrium.