Economic Foundations
Economic Foundations
Theory of Economics
- The study of economics involves understanding how individuals, firms, and nations make choices on allocating resources to satisfy their needs and wants.
- Economic activity revolves around the production, distribution, and consumption of goods and services.
- Economics is divided into microeconomics, which studies individual factors affecting an economy, and macroeconomics, which explores larger-scale economic factors.
Scarcity
- Scarcity is a fundamental concept in economics, which arises because resources are limited and human wants and needs are infinite.
- It requires choosing among different feasible alternatives and implies the need for trade-offs.
- Understanding scarcity helps in making decisions about how to use and distribute resources effectively and efficiently.
Supply and Demand
- The law of demand states that there is an inverse relationship between the price of a good and the quantity demanded.
- The law of supply says that there is a direct relationship between the price of a good and the quantity supplied.
- The equilibrium price is established when the quantity demanded equals the quantity supplied.
- Factors affecting demand could include income, price of substitute goods, price of complementary goods, tastes and preferences, and expectations on future prices.
- Factors affecting supply could include cost of production, technological change, taxes and subsidies, prices of other goods, and expectations about future prices.
Market Structures
- Perfect competition represents a market situation where there are a large number of buyers and sellers, homogeneous product, free entry and exit, and perfect knowledge about market conditions.
- Monopoly represents a market condition where there's a single seller selling a unique product with no close substitutes.
- Monopolistic competition characterises a market where there are many sellers selling differentiated products.
- An oligopoly is a market structure where a limited number of firms have control of the market selling similar or differentiated products.
- Understanding these different market structures helps in determining the level of competition, the pricing of goods and services, and the level of market efficiency.
Role of Prices
- Prices play a key role in a market economy by acting as a signal for producers and consumers.
- Prices serve as an incentive guiding the actions of consumers and producers.
- Through the changes in prices, resources are allocated and distributed efficiently in a market economy.
- The price mechanism refers to how supply and demand interact to set the price and quantity of goods and services sold in a market.
Trade and Specialisation
- Trade allows countries to focus on producing goods they can make most efficiently. This is the concept of specialisation.
- Due to specialisation, countries can produce beyond their own needs and trade excess goods for goods they cannot produce as efficiently.
- The theory of comparative advantage suggests that trade can benefit all parties such as individuals, firms, or nations, even if one can produce every item more efficiently than the other.
- This theory suggests that economic efficiency is increased if each country specialises in the production of the goods and services in which it has a lower opportunity cost.