EMS – Grade 8



BASIC ECONOMIC CONCEPTSThe Economic Problem How do we sum up the basic economic problem? We all suffer from it and spend most of our lives trying to resolve it. Essentially, the economic problem stems from the fact that as humans, we have unlimited wants and needs. A NEED is something that can be seen as being essential to survival, such as food, water, shelter and warmth.A WANT is something that we would like to have but which is not essential to survival - a car, the latest version of the PlayStation, the cell phone with all the latest gadgets etc.The problem is that the world and every individual in it have LIMITED resources but UNLIMITED wants and needs, in other words everyone and every nation in the world faces the problem of SCARCITY. We never have enough money to get what we 'want'. There are never enough resources to make sure the health service works properly; teachers and doctors will always moan about how they never have enough resources to do their job properly. In recent times, we have heard much about the problems faced by the police force 'not having the resources to get the job done'. The government has limited funds from taxes, which have to be spent on a wide range of things - if we diverted more funds to the police force, there would have to be cuts elsewhere in the government's spending programme - or a rise in taxes.All these things are symptomatic of the tension between scarce (limited) resources and infinite (unlimited) wants and needs. That is what the economic problem is all about.At this stage, you might point to the fact that countries like the United States produce massive amounts of waste every year. You might look at the food that is wasted in restaurants, fast food outlets and even the school canteen every day to wonder why there is so much wasted food, with so many people in the world hungry and on the verge of starvation.Part of the problem is the fact that resources are not distributed evenly between countries and societies. The terms 'wants' and 'needs' are also relative terms. 'I really, really want a Ferrari' might be the comment of a pupil at Bishops; 'I really, really want to be able to walk only two miles to get the daily ration of water for my household' might be the cry of a child in the Sudan. To each individual, they are both important - we might be able to point out that the Ferrari is not really that necessary; a 1997 Golf will do just as well!ActivityCategorise Wants and Needs into segments with examples of each categoryResearch Abraham Maslow and his Hierarchy of NeedsResources (Factors of Production).Resources are a specific term used a great deal in ECONOMICS. It describes all the things available at our disposal that can be used to satisfy our needs and wants. In ECONOMICS, these resources are normally classified into four categories. These are:Land - all the natural resources of the earth. This includes the fish in the sea, all the minerals found in the earth; metals, sand, stones, rocks, timber, food from the soil and so on. Economists have a name for the reward for the income from 'land' which is rent. Labour - all the human mental and physical effort that goes into production. This will include people who work as street cleaners, people who are interior designers, teachers, the police, doctors, bricklayers, architects and so on. The financial reward for labour is referred to as salaries and wages. Regardless of the task, the human resource of labour comes in many different forms. Labour offers its services in exchange for a reward or price - wages. Capital - all the equipment, machinery and buildings that are not used for its own sake but for the contribution it makes to production. This includes things like office desks and chairs, computers, lorries, cranes, specialist machinery in a factory, the humble office coffee machine and so on. The 'price' of acquiring capital is referred to as interest. Enterprise – the skills needed to organise the other resources into some form of production. Some people would put enterprise as a specialist skill within labour but enterprise does have some distinctive characteristics (e.g. risk taking) that merit its own category. The return for enterprise is called profit. If we had an unlimited supply of resources at our disposal we would be able to meet any want or need. The problem is, we do not have unlimited resources at our disposal. We therefore have to make choices. Economics, could, therefore, be described as the science of CHOICE.Choices are made at many different levels. You might go into a shop and see two great-looking pairs of jeans but you only have enough money (resources) to buy one of them. A hospital manager may have 50 patients all wanting to have an operation immediately but there might only be sufficient resources (doctors, nurses, equipment, rooms, beds etc.) at that time to treat 20 of them. A business might have received a major order for its products and wants to increase production but does not have the staff or the equipment and raw materials to meet the order in full. All these examples highlight the problem of scarce resources in relation to wants and needs. When we are faced with these choices, we have to go through some quite sophisticated decision making. We might not always be aware that we are making sophisticated decisions but in reality we are. Such decision making is at the heart of the subject of economics and tells us something about how humans try to tackle the economic problem. Opportunity CostOpportunity cost is one of the most important and fundamental concepts in the whole of economics. Given that we have said that economics could be described as a science of choice, we have to look at what sacrifices we make when we have to make a choice. That is what opportunity cost is all about.The definition of opportunity cost is:The cost expressed in terms of the next best alternative foregone or sacrificed.The language used here is a bit technical but it expresses a very easy but often misunderstood principle. We need to unpick the definition to help get the understanding right. Cost implies something is being sacrificed or involves having to give up something. We often use the term 'cost' in the wrong way. How many times have you used 'cost' when you mean 'price'? Take the following example: 525780016256000Say you recently bought a new pair of shoes which cost R900. The cost here is being expressed in terms of the amount of money you had to give up to acquire those shoes. Because we all have a common understanding of 'money' as being notes and coins that we use to exchange for the things we want, we can pretty much understand this sentence.What statements like this fail to convey, however, is the true picture of what you are sacrificing by choosing to buy the shoes. It is more accurate to say something like 'the price you paid for those shoes were R900.' To get an idea of the true 'cost', we would really need to know something of the sacrifice you made in giving up that R900. R900 can buy a number of things - let us assume that it can also buy the following: Five CDs A new sweater A meal out for four. A flight from Cape Town to Durban.When thinking about how to dispose of your money, you have to make choices and these represent the choices at this moment in time. These choices represent different aspects of value. Each of the items might represent some value to you but they may be different. It is important to remember that you might, in an ideal world where there were no scarce resources, want all these things. It might be possible to order the value of each of these items – for example you might value the items in the following way:Shoes: 9/10 (because my existing shoes have a hole in the sole) 5 CDs: 6/10 - I do have plenty of other CDs but there are new releases by my favourite artists – but they will still be around next month. The sweater: 2/10. - Not bad but nothing better than I have already got. A meal out for four: 5/10 - nice but not essential at the moment Flight to Durban: 4/10 - a luxury but one I can manage without at the moment. Having gone through the mental process of attaching a value to your choices, it is clear that there is only one choice to make - the shoes. In buying the shoes you have had to sacrifice the opportunity to purchase one of the other items in your choices list. What is the next best alternative foregone? It will be the item that gives the next highest value - the 5 CDs in this example. The cost of the shoes, therefore, is better expressed as the 5 CDs sacrificed. We can assume from your decision that you value the benefit or satisfaction you will gain from the shoes at this point in time higher than the value you place on the CDs. Looking at cost in this way enables us to make some interesting insights into the behaviour of individuals, international institutions, the government and businesses, and helps us to comprehend decision-making at all levels.Basic economic decisionsNo two economies are organized in exactly the same way, but all have to solve three fundamental problems:1. What should be produced in the economy?What quantities of food, mobile phones or banking services should be produced by the economy? How many trees need to be felled to meet the demand for pulp for newspapers and magazines? Should we spend extra money on national defence or should more resources be devoted to health care and education?2. How should production be organised?Should a firm use labour or machinery to produce their goods? How many workers should be employed? Should production take place in Port Elisabeth or Cape Town or in South Africa or Botswana? Should Ford buy its components from the USA or Australian suppliers? These are all examples of important production decisions.3. For whom should production take place?Should everybody be entitled to an identical share of production, or should some receive more than others? We know that the distribution of income and wealth in South Africa and every other economy is not equal. There are large-scale inequalities in people's living standards. Indeed the gap between rich and poor world-wide has increased considerably over the last twenty years.Economic systemsLet’s see how these different systems answer the three basic economic questions. There are four main types of economic system:464820071755001. Traditional or subsistence economy.A subsistence economy is one where:There is little specialisation and trade within the economy and with other countries The productivity of workers tends to be low leading to low incomes and a poor standard of living People tend to live in family groups, and grow most of their own food, make their own houses, gather their own fuel and provide their own leisure activities i.e. to a great extent they are self-sufficient Few goods and are marketed and command a price or value - there is little surplus production to export 4693920-18415002. Free market economyA free market economy is one where:Nearly all of the country’s factors of production are owned privately. Although it might make sense to argue that firms own some of the resources, it is private individuals, or groups of individuals, who own the resources. They then rent them out to the firms so that they can produce the goods and services. This brings into play one of the government’s limited roles. Through the legal system, the government must uphold the property rights of these private individuals.Everyone in this system is motivated by pure self-interest. Consumers maximise welfare, firms maximise profits and the private individuals, who own the factors of production, aim to maximise rents (on land), wages (on labour), interest (on capital) and profit (on enterprise).Firms can sell anything they want. They effectively respond to the consumers, who are allowed to buy anything that is sold by the producers. Workers can take on any job they want (this may seem obvious, but wait and see what happens in the command economy).There are high levels of competition. It is assumed that nearly every market is a perfectly competitive one, with numerous buyers and sellers and no barriers to entry or exit. Firms are competing desperately for customers and the consumers are competing with each other for the goods on offer.The price mechanism allocates the economy’s resources. The reason why it is called the ‘price’ mechanism is because the price acts as a signal and an incentive for producers to act in the required way so as to maximise their gain, which, in turn, optimises the allocation of resources in the whole economy.In a free market economy:What will be produced?You might think that the firms decide what is finally produced. Actually, in a free market economy, it is the consumers who have all the power. Consumer sovereignty exists. In a free market, a firm will only produce a good if the consumer is prepared to buy it. Through their purchases (or money ‘votes’) consumers effectively dictate to the firms what should be produced. If consumers, on mass, stop buying Fanta Grape (perhaps they prefer drinking Fanta Orange) then the producers would stop making it. So the answer to the question is, “whatever the consumers want.”How will it be produced?The simple answer is, “by the firms.” But there is more to this question than that. “How” also means “how well.” Due to the highly competitive environment that exists, there will be pressure on firms to produce the goods as efficiently and cheaply as possible. For whom will it be produced?In other words, who actually ends up consuming the goods that are produced? Well, we said earlier that consumers’ money votes determine what is actually produced. But it will also determine what consumers can actually buy. Those with more money will be able to consume more of the goods produced. Who has the most money? The rich, of course, but why are they rich? For some, it is inherited wealth, earning high incomes from the sales of the factors of production that they own (renting land and making interest and profit from capital and enterprise). For others, who inherited nothing, their wealth may come from the successful sale of their labour services. David Beckham came from nothing, but he is able to sell his labour services (kicking a football!) for tens of thousands of pounds a week!Of course, in this system, if you have nothing and you do not have marketable labour skills (for most people this will be a good education), and then you will remain poor. The free market system tends to create an unfair distribution of income. The wealthy consume a disproportionately large share of what is produced.3. A command economyA command economy is one where:Nearly all of the country’s factors of production are owned publicly by the government (or the state). The only factor over which the government does not have total control is labour, but as you will see, they certainly have indirect control over the workers.There is the complete opposite of the pure self-interest of the free market system. No one (in theory) thinks of himself (or herself). Consumers, workers and the government are all assumed to be working for the ‘common good’. This system is often associated with communist Soviet Union (as it was before 1989), but the fascist Hitler ran a ‘planned’ economy, albeit rather dictatorially. Democratic countries often attempt a less severe form of planned economy via socialism.There is no free enterprise.There is very little competition. There is no competition, so there is no price mechanism. The authorities set the prices. It is because they set prices at low levels to make sure that everyone can afford the goods that excess demand occurs causing long queues for goods outside shops. Another inevitable consequence is the creation of black markets.There is a planning system: This is an extra characteristic of the command economy. The other five has tried to follow the five given in the ‘free market economy’ section. As the government runs the system, they have the job of planning how all the resources should be used. They have to decide what should be produced and in what quantities. They must decide how the goods are to be made. What labour should be used and where? What techniques of production shall we use? How will the completed goods be divided between the workers (or consumers)? The key point is that they directly set the output levels and price levels.464820011366500In a command economy:The answers to the questions of what, how and for whom are basically up to the planners themselves.?What will be produced?The consumer no longer has any control. The planners (or the government) decide what will be produced. The question is, how do the planners know what the consumers want and need better than the consumers themselves?How will it be produced?There are no such things as ‘firms’ in a planned economy. The planners direct the resources into producing ‘units’. They are not really firms. They have no autonomy. So, as we said above, the planners decide on the quantities of output and methods of production.For whom will it be produced?In the free market, the richer you were, the more you could buy. Of course, very poor people could end up with very little. The planner tries to be fair in distributing the output of the economy. Wages are determined by the planners, as are the prices of the goods produced. So the government is, effectively, determining how much each consumer can consume.4648200-71755004. A mixed economyA mixed economy is one where:The government owns some of the country's factors of production publicly and some are owned privately. Again, a combination of the two extremes. The market part of the economy will be motivated by self-interest (Adam Smith). Firms will profit maximise, consumers will maximise their welfare and the factor owners will maximise rent, interest and profit. The government, again, has the ‘common good’ goal. We will see what that entails later.There is free enterprise in the market part of the economy (the private sector).The private sector can be quite competitive. It depends on the market structure that prevails in the various industries. In the real world few industries are perfectly competitive. Governments do tend to set up bodies, though, whose job is to make sure that industries do not become too uncompetitive (The Competition Board).The price mechanism operates in the private sector. Its efficiency depends on how competitive the market structures are. The government run activities, like the health and education, which tend to be provided free for the poorer sectors of the community.Real world examplesIn the real world it is fairly easy to assess how ‘mixed’ an economy is. Economists simply look at the percentage of a country’s Gross Domestic Product (GDP) that is devoted to government spending.The USA is often thought of as the economy with the most capitalist or ‘free market’ model. The statistics bear this out – the government spend just over 30% of GDP. This is one of the lowest figures in the world, and yet the government is still a huge player in the economy. Even in the capitalist centre of the world (the land of the free!), there is a need for a defence system and a system of law. There is a health system and a system of welfare payments, but they are only used as a last resort, or by the poor who have no choice. Those who can afford it have health insurance.Many European governments spend up to 50% of their GDP (France, for example), but the largest percent is Sweden, whose government spend almost 60% of its GDP (it was as high as 70% in the mid-90s!) State benefits and pensions are generous; the health service is of a good quality and is free at the point of use; there is automatic retraining for those who lose their job and free child minding facilities for women wanting to go back to work. There are no student loans either!The question that governments have to ask themselves is, “Do I want our economy to be like the USA or more like Sweden?” It is difficult to get the mix right. A government never manages to please all the people all of the time. If I was an unemployed person with little spare cash, I think I’d rather live in Sweden, where I’d get free health care and training for a job. If I were rich I’d rather live in the USA; I could afford good health care and a private pension, etc., from my post-tax income and still have money over to enjoy as I wished.The advantages of a free market economy (and the disadvantages of command economies)Efficiency. We said earlier that free market economies are very competitive. As a result they tend to allocate their resources more efficiently. Decisions about what to produce are made by the people who will actually consume the goods. Planners from command economies are less likely to make the correct decisions across the whole economy.Choice. Firms will produce whatever consumers are prepared to buy. Remember that the consumer is sovereign. Due to free enterprise, there are no restrictions on what the firms can produce. It is of no surprise, therefore, that there will be a much larger choice of goods and services in a free market economy compared with a command economy. The planner will be more concerned with making sure there are enough essential goods to go around rather than providing all the goods consumers want.Innovation. Firms will always be looking to produce something new to get ahead of their competitors. We said earlier that, even though the government’s role is limited, one of its jobs is to protect property rights. This will include intellectual property rights through patents. Hence, there are incentives in the free market system for firms to be innovative and produce better quality products. Obviously there is no incentive for the planner to be innovative. As long as factories produce the essentials the planners will be happy.Higher economic growth rates. One does not have to be an expert economic historian to see that countries whose economic system has been nearer to the free market model have grown much faster than those with a command economy since the Second World War. The most successful economy in the world (in terms of size) has been the USA, and they have been one of the freest economies in the world (China has also grown very rapidly recently as a result of moving towards a free market economy). Given the three factors above, it is not surprising that this is the case. The disadvantages of a free market economy (and the advantages of a command economy)Public, merit and demerit goods. Some goods (public goods and merit goods) are not provided or are underprovided in the market economy. Other goods (demerit goods) like cigarettes, drugs and alcohol are over provided. In a command economy this should not occur.Unequal distribution of income. For many, this is the big disadvantage of a free market economy. In a free market with very limited government, benefits will be low, the health service poor and schools under funded. If you start life with very little, and do not even get a good education, then there will be very little protection from poverty. A command economy might not have the efficiency and enterprise for the successful to make millions, but at least the strong government will try to make sure that nobody falls through the safety net. It will be a fairer economy, even though it is likely to be less successful overall. The environment. Free market economies are likely to produce more pollution, which is bad for the environment. Command economies can make sure that the production processes that they chose are as environmentally friendly as possible. They should be able to make sure that the level of output is the socially optimal level of output. Governments can try to force firms into producing the socially optimal level of output through the use of taxes, but governments with a limited role will not be keen to use taxes. Having said all that, the command economies of the 80s had notoriously poor records on the environment. In theory, they should have been able to monitor pollution levels closely, given that they had control of production, but this simply did not happen. ................
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