Principle of Economics Module-A Solution

 

2. Scarcity brings in the problem of choice’- Explain.

Our resources are limited; however, desires are unlimited. Economics is concerned about how to meet our unlimited desires with limited resources. We would always like more and better housing, more and better education more and better of practically everything. If our resources were also unlimited, we could say yes to each of our wants and there would be no economics. Because our resources are limited, we cannot say yes to everything. To say yes to one thing requires that we say no to another. Whether we like it or not, we must make choices. Our unlimited wants are continually colliding with the limits of our resources, forcing us to pick some activities and reject others. Scarcity is the condition of having to choose among alternatives. A scarce good is one for which the choice of one alternative use of the good requires that another be given up. A free good is one for which the choice of one use does not require that we give up another. Coconut on an island may be free good for a certain period of time. There are not many free goods. Scarcity confronts people with choices, and the associated fundamental economic questions. Every economy must determine what should be produced, how it should be produced, and for whom it should be produced.

What should be produced? Using the economy’s scarce resources to produce one thing requires giving up another. Producing better education, for example, may require cutting back on other services, such as health care. A decision to preserve a wilderness area requires giving up other uses of the land. Every society must decide what it will produce with its scarce resources.

How should goods and services be produced? There are all sorts of choices to be made in

determining how goods and services should be produced. Should a firm employ a few skilled or a lot of unskilled workers? Should it produce in its own country or should it use foreign plants? Should manufacturing firms use new or recycled raw materials to make their products?

For whom should goods and services be produced? If a good or service is produced, a decision must be made about who will get it. A decision to have one person or group receive a good or service usually means it will not be available to someone else. For example, representatives of the

poorest nations on earth often complain that energy consumption per person in the United States is many times greater than energy consumption per person in the world’s scores of poorest countries. Critics argue that the world’s energy should be more evenly allocated. Should it? That is a “for whom” question.

 

3.What is the relevance of Opportunity Cost in economics?

It is within the context of scarcity that economists define an important concept in all of economics, the concept of opportunity cost. Opportunity cost is the value of the best alternative forgone in making any choice. Opportunity cost refers to what one has to give up to buy in terms of other goods or services. When economists use the word “cost,” he/she usually means opportunity cost. Thus, opportunity cost is what must be sacrificed when a choice is made. That cost may be financial; it may be measured in time, or simply the alternative foregone. The concept of opportunity cost must not be confused with the purchase price of an item. Consider the cost of a college or university education. That includes the value of the best alternative use of money spent for tuition, fees, and books. But the most important cost of a college education is the value of the forgone alternative uses of time spent studying and attending class instead of using the time in some other endeavor. Students sacrifice that time in hopes of even greater earnings in the future or because they place a value on the opportunity to learn.

Opportunity costs play a determining role in markets. It is precise because individuals and

organizations have different opportunity costs that they enter into exchange agreements. If you are a skilled plumber and an unskilled gardener, while your neighbour is a skilled gardener and an unskilled plumber, then you and your neighbour not only have different capabilities, you also have different opportunity costs, and you could gain by trading your skills. In the context of financial industry, a simple example of opportunity cost is to let us suppose that a person is having BDT 50000 in his hand and He has the option to keep it with himself at home or deposit in the bank which will generate interest of 4% annually so now the opportunity cost of keeping money at home is BDT 2000 per year as opposed to Bank.

4. What are the three basic questions an economy confronts?

Every economy must determine what should be produced, how it should be produced, and for whom it should be produced.

What should be produced? Using the economy’s scarce resources to produce one thing requires giving up another. Producing better education, for example, may require cutting back on other services, such as health care. A decision to preserve a wilderness area requires giving up other uses of the land. Every society must decide what it will produce with its scarce resources.

How should goods and services be produced? There are all sorts of choices to be made in determining how goods and services should be produced. Should a firm employ a few skilled or a lot of unskilled workers? Should it produce in its own country or should it use foreign plants? Should manufacturing firms use new or recycled raw materials to make their products?

For whom should goods and services be produced? If a good or service is produced, a decision must be made about who will get it. A decision to have one person or group receive a good or service usually means it will not be available to someone else. For example, representatives of the poorest nations on earth often complain that energy consumption per person in the United States is many times greater than energy consumption per person in the world’s scores of poorest countries. Critics argue that the world’s energy should be more evenly allocated. Should it? That

is a “for whom” question.

 

5. Give examples of positive and normative statements.

Examples of positive Economics: Keeping other factors constant, increase in interest rate causes decrease in demand for loans.

Examples of Normative Economics: Considering the existing economic scenario, interest rate should be reduced for improving investment

6. Interpret ‘Capital’ as a factor of production. 

Capital: Capital resources are resources that contribute to the production process of other goods. Hence, economic capital is different from financial capital. There are various types of economic capital. Machinery and tools are classified as fixed capital. Partly-produced goods (work-in-progress) and inventory are considered working capital. Financial capital refers to money in a broad sense, which doesn’t contribute to the production process, though it is essential for businesses and entrepreneurs to carry on their economic activities.

7. Explain ‘Human Resources’ and ‘Entrepreneurship’ as factors of production.

Human Resources: Human resources are also termed as labour. Human resources not only

contribute to the production of goods but also play an essential role in offering services. Human resources generally possess some form of education and skills. Businesses need to ensure their labour force is capable of conducting the production processes required by providing appropriate training and ensuring the safety of the work environment. However, human resources are also capable of adjusting themselves, because they are a dynamic factor of production. They can increase their productivity to contribute more to the efficiency of production. In terms of education or training, businesses can source labour from a specific educational background to reduce the training time. When hiring for different departments of banks, a bank looks for candidates with an educational background in banking, finance or business other similar subjects.

 

Entrepreneurship: Entrepreneurship is a special human resource that refers to the ability to come up with ideas that would be potentially turned into economic goods, risk-taking, decision-making, and running the business, which requires the incorporation of the other three factors of production. An entrepreneur would need to take the risks of borrowing, renting land, and sourcing appropriate employees. The risk, in this case, involves the chances of not being able to pay the loan due to a failure in the production of goods or sourcing the factors of production. In the process of today’s production process technology is playing crucial roles, the knowledge that can be applied to the production of goods and services. The interplay of entrepreneurs and technology affects all our lives. Entrepreneurs put new technologies to work every day, changing the way factors of production are used. Finance Professionals, farmers and factory workers, engineers and electricians, technicians and teachers all work differently than they did just a few years ago, using new technologies introduced by entrepreneurs.

11. What is the difference between a positive and a normative statement? Give an example of each.

1.Base: Positive Economics refers to a science which is based on data and facts. Normative economics is described as a science based on opinions, values, and judgment.

 2.Nature: Positive economics is descriptive, but normative economics is prescriptive.

 3.Activity: Positive economics explains cause and effect relationship between variables. On the other hand, normative economics pass value judgments.

4.Perspective: The perspective of positive economics is objective while normative economics have a subjective perspective.

5.Explanation: Positive economics explains ‘what is’ whereas normative economics explains ‘what should be’.

6.Test Activity: The statements of positive economics can be scientifically tested, proved or disproved, which cannot be done with statements of normative economics.

7.Economics Issues: Positive economics clearly define economic issues. Unlike normative economics, in which the remedies are provided for the economic issues, on the basis of value judgment

Examples of positive Economics: A rapid growth rate of money is the cause of inflation

Examples of Normative Economics: The government should keep the growth rate of money low.

12. Why do economists sometimes offer conflicting advice to policymakers?

Economists sometimes offer conflicting advice to policymakers for two reasons: 

(1) Economists may disagree about the validity of alternative positive theories about how the world works

(2) Economists may have different values and, therefore, different normative views about what public policy should try to accomplish.

13. ‘The circular-flow diagram illustrates that, in markets for the factors of production, where households are sellers, and firms are buyers.’- Do you agree? Explain.

The circular flow model demonstrates how money moves through society. Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money. The models can be made more complex to include additions to the money supply, like exports, and leakages from the money supply, like imports. In the basic (two-factor) circular flow model, money flows from households to businesses as consumer expenditures in exchange for goods and services produced by the businesses, then flows back from businesses to households for the labor that individuals provide.

Household Sector: In a two-sector model, circular flow models start with the household sector that engages in consumption. Households contribute to an economy by working (giving away time and labor) and by buying products (giving away money). In return, households consume products and utilize government programs.

 

Business Sector: In a two-sector model, circular flow models also include the business sector that produces the goods. Businesses absorb a variety of production costs including labor, materials, and overhead. As a result, many companies are able to manufacture products that benefit other

parties.

 

15. ‘A point on the production possibilities curve is feasible and efficient.’- Explain.

Productive efficiency means you are getting the most out of your resources.It is important not to put value judgments on this economy. Whether they choose to produce only corn, only robots, or some combination of both, it is productively efficient. Any point of production inside the curve is considered inefficient because the economy is not fully utilizing its resources. In macroeconomics, points inside the curve are used to illustrate a recession. In a recession, unemployed workers are not producing goods and services, so the economy is not producing its long run potential.

 

16. Explain major economic systems following a historical perspective.

An economic system is a way how a society produces and distributes goods and services. It involves how things are made, who gets to make them, how they are distributed, and how people get access to them. An economic system serves as a regulatory system for controlling different aspects of production and distribution, including capital, labor, land and other physical resources.In an economic system, there are many essential entities, agencies and decision-making authorities. Based on historical evidences and evaluation of the economic systems, some other forms of financial systems that are commonly named as follows:

 

Mixed Economic System: A mixed economy combines elements of command and market

economies. All of the societies present-day have features of both systems and are frequently called mixed economies, despite the fact that almost all societies tend to lean toward one form of the economy more than the other. A mixed economy is an economy that combines parts of command and market economies. A mixed economy aims to reduce the drawbacks of both systems while implementing the advantages. In a mixed economy, government can intervene in key sectors like education, or healthcare while leaving other, less important from the perspective of a well-being of the society, sectors to private companies. The increasing government involvement also ensures that less competitive individuals are looked after. This eliminates one of the drawbacks of a market economy, which favors only the most successful or inventive.

 

Traditional Economic System: With traditional economies, historical norms and habits govern what and how things are created, distributed, and spent. Every individual within this society understands their place in the greater group. Because occupations are handed down through generations, there is minimal change in professions over time. Traditional economic systems are often found in rural or remote areas where access to modern technology and infrastructure is limited. These systems tend to be self-sufficient and sustainable, but they may also be susceptible to external shocks and disruptions. A traditional economy is an economy where historical norms and habits govern what and how things are created, distributed, and spent. While money can be used in traditional economies, but it is often limited to certain transactions and may not be the primary medium of exchange. In many traditional economies, bartering is more common than using money.

17. Explain the difference between Market and Command Economy based on their characteristics.

Market Economic System: Market economy also referred to as capitalism or in its extreme form laissez-faire economy. Market economies are economic systems wherein market decisions are governed by price fluctuations that occur when sellers and consumers interact to set the sale of products. In a market economic system communities, firms and proprietors act in self-interest to decide how to allocate and distribute resources, what to produce and who to sell to. Governments in market systems typically have little intervention in how businesses operate and generate income, however, can regulate factors like fair trade, policy development and honest business operations. Decision-making in a market economy is dictated by price fluctuations that happen between producers and consumers. Main characteristics of the market economy are private ownership, competition, and minimum to no government intervention. The amount individuals pay for items is determined by the law of supply and demand. One advantage to this type of economy is that buyers can locate what they want and purchase as many of the items as they want and can finance. An issue is that there is no pricing stability, and enterprises that are mishandled can fail.

Market Economic System is featured with certain objectives: provides incentive for innovative entrepreneurship; gives consumers a choice in goods, services and purchase prices; creates market competition for resources, resulting in quality offerings and efficient use of resources to produce goods; and inspires research, development and advances in goods and production of goods. There are certain recognized disadvantages like highly competitive markets can cause a scarcity in resources for disadvantaged individuals; potential for monopolizing of industries and niches, such as technology, health care and pharmaceuticals; and can increase income disparity by placing focus on economic needs over societal, community and human needs.

 

Command Economic System: A command economy, also called planned economy, is an

economic system in which the government makes all the economic decisions regarding the

production, distribution, and consumption of goods and services. In command economic systems, governments and centralized powers control much of the economic processes, including allocating and distributing resources, goods and services. In a command economy, the government plays a key role in directing and intervening in business processes that provide essential goods and services to the community. Many command economies consist of governments that have total control over the distribution and use of valuable resources, like oil and gas. Additionally, these types of systems may operate under governing entities that have ownership of essential industries like transportation, utilities and energy, and technology. Command economies can be beneficial for creating sustainability, however, there are a few potential drawbacks to this type of system. The advantages of a command economy or planned economy are that central planning allows the elimination of market failures, and in theory, better allocation of resources, prioritizing social needs over profits. More specifically, the command economy creates potential for mass mobilization of necessary resources due to government control; creates additional jobs for community members and citizens due to increased mobility of resources; focuses on benefits to society over individual interests; encourages more efficient use of valuable resources. Disadvantages, on the other hand, include limited consumer choice and a lack of incentives for innovation. More specifically the command economic system may create scarcity due to an inability to plan for individual needs; force government rationing due to inability to calculate demand on set prices; eliminates market competition, resulting in a lack of innovation and advancement; inhibit employees' freedom to pursue creative jobs and careers.

 

18. You win BDT100 in a basketball pool. You have a choice between spending the money now and putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the BDT100 now?

Answer: Tk.5.00

 

19. Identify positive and normative statements from the following:

a. The new law will reduce national income; (Normative)

b. New Bank Companies Act is a good piece of legislation; (Positive)

c. Parliament ought to pass law X; (Positive)

d. President should veto the new law. (Positive)

 

20. Classify the following topics as relating to microeconomics or macroeconomics:

a. A family’s decision about how much income to save; (Microeconomics)

b. The effect of government regulations on auto emissions; (Microeconomics)

c. The impact of higher national saving on economic growth; (Macroeconomics)

d. A firm’s decision about how many workers to hire; (Microeconomics)

e. The relationship between the inflation rate and changes in the quantity of money; (Macroeconomics)