Canadian Economy 2203

1. Canadian Economy2203 Chapter One Notes Fundamental Principles of Economics

2. What is Economics? As we face daily questions about what we need, what we want, and what we can afford to have, we are engaged in economics. Economics is the study of human activity involved in using scarce resources to satisfy wants.

3. What is Economics? Economics is considered a social science like either history or geography and these sciences attempt to understand an important aspect of the human condition in the world in which we live.

4. Today, economics is often referred to as the science of scarcity and choice, and basically entails the study of the way we make decisions about the use of scarce resources. The main difference between economics (as a social science) and the "pure" sciences (such as physics or chemistry) is that the social sciences are based on human behaviour and value systems. The difference, therefore, is the fact that human behaviour changes over time.

5. Economics, like all other natural and social sciences, uses a common investigative approach called the scientific method. Essentially there are four components to this method: • observation • data collection • explanation • verification

6. The Economic Concept of SCARCITY Scarcity, choice, and cost are sometimes referred to as the fundamental trilogy of economics because of the strong interrelationships between the three concepts. Since resources are limited, compared to wants, individuals and families face the problem of scarcity in deciding how to allocate their incomes and their time. For economists, scarcity is always related to our wants and our resources.

7. The truth is that scarcity (of a resource) only really exists if there is a demand for that resource. On the other hand, if nobody wants the resource, even though it is in short supply, then scarcity doesn't really exist as it relates to that resource.

8. Economists reason that, since human wants are infinite, but the earth's resources to meet those wants are limited, there will never be a time when all human wants will be satisfied. We will always be forced to contend with the problem of scarcity.

9. Indeed, as the earth's population continues to increase as advances in medicine and an increased standard of living fosters such growth, the demand on the earth's resources will become even more strained.

10. And the effect of this increased demand will result in increased value being placed upon these scarce resources. Generally speaking, the more scarce the resource, the greater in value it becomes. Why is this so?

11. What is Opportunity Cost? Unlike most costs discussed in economics, an opportunity cost is not always a number. The opportunity cost of any action is simply the next best alternative to that action - or put more simply, "What you would have done if you didn't make the choice that you did".

12. You have a number of alternatives of how to spend your Friday night: You can go to the movies, you can stay home and watch the baseball game on TV, or go out for coffee with friends. If you choose to go to the movies, my opportunity cost of that action is what you would have chose if you had not gone to the movies - either watching the baseball game or going out for coffee with friends.

13. Note that an opportunity cost only considers the next best alternative to an action, not the entire set of alternatives. Some of these decisions may or may not involve a financial cost. Nonetheless, many of our decisions are linked to some financial cost to the consumer.

14. Production Possibilities Curve The Basic Principles of Production

15. The Production Possibilities Curve The Production Possibilities Curve: This model provides a visual explanation of the production choices faced by people in a simple economy. It is used to illustrate the fundamental problem of SCARCITY. The model is based on THREE basic assumptions.

16. 1. Only two products can be produced by this simple economy In an economy capable of producing hundreds of thousands of different products, this model assumes that only two products can be produced by this economy. This makes the economic concept of TRADE OFFS very clear - the increased production of one good can be achieved only by sacrificing a sufficient quantity of the other good being produced.

17. 2. The economy has fixed technology and resources Since this model is examining an economy over a short period of time, it assumes that no technological innovations will be introduced to improve the rate of production. It also assumes that the amount of resources used to produce the two types of goods do not increase.

18. 3. The economy is at full employment The model assumes that all productive resources, including labour, are fully employed and that they are being used effectively and efficiently to produce the maximum output of the two types of goods.

19. A standard production possibilities curve for an hypothetical economy is presented here. This particular production possibilities curve illustrates the alternative combinations of two goods--crab puffs and storage sheds--that can be produced by the economy. According to the assumptions of production possibilities analysis, the economy is using all resources with given technology to efficiently produce two goods--crab puffs and storage sheds.

23. This curve presents the alternative combinations of crab puffs and storage sheds that the economy can produce. Production is technically efficient, using all existing resources, given existing technology. The vertical axis measures the production of crab puffs and the horizontal axis measures the production of storage sheds.

24. Types of Economics There are two types of economics based to explain human behaviour. The type of decision making by humans uses both a fact and value considerations. They include: 1. Analytical or Positive Economics 2. Normative Economics

25. Analytical or Positive economicsis the branch of economics that concerns the description and explanation of economic phenomena . It focuses on facts and cause-and-effect relationships and includes the development and testing of economics theories. To illustrate, an example of a positive economic statement is as follows: The price of milk has risen from $2 a litre to $4 a litre in the past five years. This is a positive statement because it can be proven true or false by comparison against real world data. In this case, the statement focuses on facts.

26. Normative economicsis the branch of economics that incorporates value judgments (that is, normative judgements) about what the economy ought to be like or what particular policy actions ought to be recommended to achieve a desirable goal. Normative economics looks at the desirability of certain aspects of the economy. It underlies expressions of support for particular economic policies.

27. To illustrate, an example of a normative economic statement is as follows: The price of milk should be $5 a litre to give dairy farmers a higher living standard and to save the family farm. This is a normative statement because it depends on value judgments and cannot be proven true or false by comparison against real world data. This specific statement makes the judgment that farmers need a higher living standard and that family farms need to be saved. Consumers who purchase more expensive milk products might argue otherwise.

28. Common Fallacies in Economics

29. What is a Fallacy in Economics? FALLACY: is a hypothesis that has been proven false but is still accepted by many people because it appears, at first glance, to make sense.

30. Three Common Fallacies 1. The Fallacy of Composition 2. The Post Hoc Fallacy (also known as the Cause-and- Effect Fallacy) 3. The Fallacy of Single Causation

31. 1. The Fallacy of Composition What is good for the individual is automatically good for society as a whole. This mistaken belief that individual benefit automatically translates into social benefit for everyone is a fallacy of composition. This fallacy can also work the other way -what is good for society as a whole must be good for the individual.

32. Example: A farmer decides to clear more land and plant more corn in an attempt to earn extra income. If every farmer in Canada attempts the same strategy collectively, the result may create an overproduction of corn that would drive market prices lower. If prices are too low farmers may not be able to pay their operating expenses therefore, bankruptcy may occur.

33. 2. The Post Hoc Fallacy (also known as the Cause-and-Effect Fallacy) Sometimes people assume that, because it took place after event A, event B must have been caused by event A. This is the false assumption that what comes before automatically causes what follows. Some prior events are obviously not connected to later events in any meaningful way.

34. Example: A rooster wakes up every morning before the dawn and instinctively crows. Moments later the sun rises. Would it not be ridiculous to assume that the rooster's crowing (and not the rotation of the Earth) causes the sun to rise?

35. 3. The Fallacy of Single Causation Closely related to the post hoc fallacy, the fallacy of single causation is based on the premise that a single factor or person caused a particular event to occur. In reality, however, other factors are the main contributors of the event and the single event that is perceived is merely a symptom of the event. Oversimplification (the event) is often used to clarify an event that is really complicated.

36. Example: People believe that the stock market crash of 1929 caused the Great Depression of the 1930's. In reality, several events leading up to and after the crash of the stock market are the real reasons for the Great Depression.

37. Economic Laws Affecting Production Possibilities 1. The Law of Increasing Relative Cost 2. The Law of Diminishing Returns 3. The Law of Increasing Returns to Scale

38. 1. The Law of Increasing Relative Cost This law comes into play whenever a society, in order to get greater amounts of one product, sacrifices an ever-increasing amount of other products (one output increases the other output decreases).

39. For example, as more sheds are produced, fewer crab puffs are made. According to this law, as more time and money is devoted to producing more of one good, less time and money can be devoted to the other product. (See figure 1.10 in text)

40. 2. The Law of Diminishing Returns This law deals with the relationship between an input (a productive resource such as labour) and the resulting output. This law states that the outputs will increase when a particular input is increased, but only to a point.

41. After this point has been reached, increasing inputs will not have an effect on output. In fact, the output will eventually decrease. In this situation, only one input is changed. (See figure 1.14)

42. 3. The Law of Increasing Returns to Scale This law states that when all productive resources are increased (both inputs), simultaneously, output will also increase. The scale of operation is constantly increasing because both inputs are increased which thereby increases the output. (See figure 1.15).