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1. Introduction
Unit 1
Lipsey and chrystal

2. • Economics is the study of how society
allocates limited resources to the production of
goods and services to satisfy unlimited human
wants.
• There are two main branches of economics:
microeconomics and macroeconomics.

3. • Microeconomics deals with the analysis of
individual parts of the economy. It concerns
factors determining the behaviour of a
consumer, the behaviour of a firm, the demand
for a good, the supply of a good, the price of a
good, the quantity of a good, the performance
of a market, etc.

4. • Macroeconomics deals with the analysis of
the whole economy. It concerns factors
determining aggregate variables such as
aggregate demand, aggregate supply, national
output, unemployment, inflation, the balance
of payments, etc. As opposed to
microeconomics which focuses on the
individual parts of the economy,
macroeconomics looks at the big picture of
the economy.

5. FACTORS OF PRODUCTION
• In order to produce goods and services, an
economy needs to have resources. The larger
the amount of resources an economy has, the
larger will be the amount of goods and
services it can produce. Resources can be
divided into four categories known as the four
factors of production: land, labour, capital and
enterprise.

6. • Land refers to the gifts of nature that are used
to produce goods and services. It includes
plots of land, natural resources, fishes in the
sea and trees in the forests.
• Labour refers to the physical and mental effort
that people devote to the production of goods
and services.

7. • Capital refers to the goods that are produced
for use in the production of other goods. It
includes factories and machinery.
• Enterprise refers to the ability and the
willingness to take risk.

8. SCARCITY, CHOICE AND
OPPORTUNITY COST
• Although resources are limited, human wants
are unlimited, and this gives rise to scarcity.
• Scarcity is the situation where limited
resources are insufficient to produce goods
and services to satisfy unlimited human
wants.
• Scarcity necessitates choice.

9. • In other words, due to scarcity and hence the
inability to produce all goods and services,
society must choose what goods and services to
produce. The opportunity cost of a course of
action is the benefit forgone by not choosing its
next best alternative. When a choice is made, an
opportunity cost is incurred. In other words,
when society chooses what goods and services to
produce, it is choosing what goods and services
not to produce.

10. THE PRODUCTION POSSIBILITY CURVE
• The production possibility curve (PPC) shows
all the possible combinations of two goods
that can be produced in the economy when
resources are fully and efficiently employed,
given the state of technology, assuming the
economy can only produce the two goods

11. • The PPC reflects scarcity, choice and opportunity cost.
Although the points inside and on the PPC are attainable,
the points outside the PPC are not.
• Scarcity is reflected by the unattainable points that lie
outside the PPC, such as point G and point H.
• The PPC is a series of points rather than a single point.
Choice is reflected by the need for society to choose among
the series of points on the PPC, such as point C and point D.
The PPC is downward sloping. Opportunity cost is reflected
by the negative slope of the PPC which indicates that an
increase in the production of one good will lead to a
decrease in the production of the other good.

12. Movements along versus Shifts in the
Production Possibility Curve
• A change in the tastes and preferences of society will
lead to a movement along the PPC which reflects a
change in choice.
• The tastes and preferences of society may change due
to several factors such as technological advancements
and campaigning.
• For example, the inventions of smartphones and
tablets have led to a change in the tastes and
preferences of society from print publications to digital
publications. Healthy living campaigns have led to a
change in the tastes and preferences of society from
non-diet soft drinks to diet soft drinks.

13. • An increase in the production capacity in the economy will
lead to an outward shift in the PPC resulting in a decrease in
scarcity, and vice versa. When the PPC shifts outwards,
some of the points which were previously unattainable will
become attainable.
• The production capacity in the economy may increase due
to an increase in the quantity or the quality of the factors of
production in the economy. For example, education and
training which will lead to greater human capital will
increase the skills and knowledge of labour and hence the
production capacity in the economy.
• Research and development which will lead to technological
advancement will increase the efficiency of capital and
hence the production capacity in the economy.

14. • Shape of the Production Possibility Curve
• The PPC is concave to the origin because the opportunity
cost of producing each good increases as its quantity
increases as resources are not equally suitable for producing
different goods. As the economy produces more and more
of a good, it has to use resources that are less and less
suitable for producing the good to actually produce the
good. This means that increasingly more units of resources
are needed to produce each additional unit of the good.
Therefore, increasingly more units of other goods have to be
forgone to produce each additional unit of the good
resulting in an increase in the opportunity cost.

15. • Economic Efficiency
• Due to the problem of scarcity, all economies
must make three fundamental economic
decisions: what and how much to produce, how to
produce and for whom to produce. In making
these three fundamental economic decisions, the
objective is to maximise the welfare of society.
Efficiency is one of the criteria used to determine
whether this objective is achieved.

16. • Productive Efficiency
• The economy is productively efficient when it is
impossible to increase the production of some goods
without decreasing the production of other goods, given
the quantity and the quality of the factors of production
in the economy.
• This occurs when the economy is producing on the PPC
where resources in the economy are fully and
efficiently employed. Resources in the economy are
efficiently employed when all firms are productively
efficient and are fully employed when there is no
unemployment of resources.

17. ECONOMIC SYSTEM
• All economies face the problem of scarcity and hence
are required to make the three fundamental economic
decisions of what and how much to produce, how to
produce and for whom to produce.
• However, economies vary in the way they make these
three fundamental economic decisions in terms of the
degree of government intervention. An economic
system is a way of making the three fundamental
economic decisions of what and how much to produce,
how to produce and for whom to produce. There are
three types of economic systems: the market system,
the command system and the mixed system.

18. The Market System
• The market system is an economic system in which the
three fundamental economic decisions of what and how
much to produce, how to produce and for whom to
produce are made by private individuals with no
government intervention.
• The market system is also known as the free market
system, the free enterprise system and the laissez-faire
system. The market system was first advocated by
Adam Smith in his famous book, ‘An Inquiry into the
Nature and Causes of the Wealth of Nations’, which
was published in 1776. He argues that the pursuit of
self-interest will lead to the benefit of society.

19. • In the market system, all the factors of production in the economy
are owned by private individuals. All economic decisions are made
by private individuals. Private individuals can engage in productive
activities, choose what to buy, where to work, etc.
• There is total economic freedom and the role of the government is
confined to the provision of national defence, maintaining law and
order, issuing currency, etc. Private individuals pursue self-interest.
Firms seek to maximise profit, consumers seek to maximise
satisfaction and owners of factors of production seek to maximise
factor income. Competition exists in all economic activities. Firms
compete for resources and sales, consumers compete for goods and
services and owners of factors of production compete for
employment of their resources.

20. • In the market system, the three fundamental
economic decisions of what and how much to
produce, how to produce and for whom to
produce are made by private individuals with
no government intervention.

21. What and How Much to Produce?
• The types and amounts of goods to produce are jointly determined
by consumers and firms through the price mechanism. The price
mechanism refers to the system in a market economy whereby
changes in price due to shortages and surpluses equate quantity
demanded and quantity supplied.
• Consumers indicate to firms the types and amounts of goods that
they want by the prices that they are able and willing to pay for
them. Firms that seek to maximise profit will only produce the
types and amounts of goods that consumers are able and willing to
pay for. Therefore, prices signal the types and amounts of goods
that are in demand and hence, the profitability of producing these
goods. This signalling role of prices is the essence of the price
mechanism.

22. How to Produce?
• The profit motive of firms implies that they
will choose the least-cost method to produce
any amount of output and this is determined by
relative factor prices. If labour is cheaper than
capital, firms will use more labour and less
capital in production. However, if capital is
cheaper than labour, firms will use more
capital and less labour in production.
Therefore, relative factor prices determine the
ways in which goods are produced.

23. For Whom to Produce?
• The market system distributes goods to
consumers with the ability and the willingness
to pay for the goods and this is determined by
their preferences and income levels.

24. The Command System
• The command system is an economic system in which
the three fundamental economic decisions of what and
how much to produce, how to produce and for whom to
produce are made by the government with no
involvement of private individuals.
• The command system is also known as the centrally
planned system. The command system was first
advocated by Karl Marx in his famous book, ‘Das
Kapital’, which was published in 1867. He argues that
capitalism will fall which will lead to the rise of
socialism and eventually to communism.

25. • In the command system, the three fundamental economic
decisions of what and how much to produce, how to
produce and for whom to produce are made by the
government with no involvement of private individuals. In
other words, economic decision-making is centralised.
• To do this, the government must choose the combination of
goods that it thinks will maximise the welfare of society,
direct resources to produce the goods by planning the output
level of each industry, decide on the method of production
and how the goods are to be distributed. The government
can distribute goods directly which is usually done through
the issue of rationing coupons, or it can decide on the
distribution of income, in which case, it will decide who
should be paid what.

26. The Mixed System
• The mixed system is an economic system in which the three
fundamental economic decisions of what and how much to
produce, how to produce and for whom to produce are
partly made by private individuals and partly made by the
government. Therefore, a mixed economy is comprised of
the private sector and the public sector.
• In reality, every economy is a mixed economy. Due to the
flaws of both the market system and the command system,
all economies in the world are a mixture of both economic
systems. Even command-oriented economies such as North
Korea and Cuba rely on the market system to some extent
and market-oriented economies such as Singapore and
Hong Kong have some degree of government intervention.

27. • In the mixed system, some of the factors of production
in the economy are owned by private individuals and
some are owned by the government. Economic
decisions are partly made by private individuals and
partly made by the government.
• Although private individuals can engage in productive
activities, choose what to buy and where to work, they
are restricted by the government. Although there is
economic freedom, it is restricted by the government.
Although private individuals can pursue self-interest,
they are restricted by the government. Although
competition exists, it does not happen in all forms of
economic activities.

28. Advantages of the Market System and
Disadvantages of the Command
System
• In the market system, allocative efficiency may be
achieved as private individuals themselves are in
the best position to know what they want. There
will be incentive for workers to work hard and for
firms to be efficient as they will be rewarded with
high income and profit.
• There will fast decision-making as each private
individual only needs to make economic decisions
pertaining to their interest. There will be liberty as
private individuals are allowed to choose their
ways of life.

29. Advantages of the Command System
and Disadvantages of the Market
System
• In the command system, allocative efficiency may
be achieved as externalities will be taken into
consideration by the government. There will be
no unemployment as the government will
provide a job for every private individual.
• The distribution of income will be equitable as no
private individuals will earn very high or very low
income. Public goods will be produced by the
government through taxation. There will be no
private firms with substantial market power
which can charge high prices.