Grade 11, economics notes

A Level Economics Grade 11
Explain the following economic terms
a) opportunity cost
b) externality
c) Pareto optimality
a) Opportunity Cost:
Every time one makes a choice, one is incurring an opportunity cost. Opportunity Cost is measured in terms of forgone alternatives. The making of a choice arises because of scarcity. Resources are scarce relative to demand and human wants are unlimited. Thus the problem of choice arises. Opportunity Cost is the real cost of a good that is sacrificed to obtain more of other goods.
In economics, we assume that both producers and consumers are rational. So they aim to achieve maximum utility in the form of profit and satisfaction respectively. Consumers prioritise their wants and the OC of choosing the first want is the second choice given up.
Eg: On a national scale, the OC of producing consumer goods is the capital goods that could have been produced using the same resources
b) Externalities:
Externalities refers to , spill over costs and benefits that accrue to parties not directly involved in the production or consumption of goods.
Externalities as the name suggests, are external: out4side the market mechanism. That is , the market can not measure or qualify them in monetary terms.
Externalities may impose costs on society These are negative externalities (External cost). The existence of external costs means that private costs do not fully represents the cost incurred by society. Externalities can arise in production or consumption. An example of the former is air or water pollution. Smoking is an external cost generated by consumers.
External benefits or positive externalities are benefits received by outside parties for economic activities of the direct parties. It means that consumers pay a price less than the total benefits received from a good. it can arise in production such as innovation of one producer helping all producers to improve their products.
c) Pareto Optimality:
Pareto Optimality refers to the efficient use of resources. Pareto optimality is attained when the nation’s resources are employed in such a way that no relocation can make one better off without making others worse off. It is at the level of out put where Marginal cost of a good exactly equals the opportunity cost the other goods sacrificed. This is where price of the good equates [1]its marginal cost (P=MC). This is called allocative efficiency.
Productive efficiency is achieved when the output is produced using the least costly combination of resources given in the technology. This is where the price is equals to average cost (P=AC)
Thus Pareto Optimality is achieved at the level of output where;
P = MC = AC = MR = AR


A Level Economics Grade 11

Positive and Normative economics
In studying economics it is useful to distinguish between Positive and Normative statements. It helps people to appreciate the scope and limitation of economics.
Positive Economics
Positive economics deal with objective or scientific explanation of the economy. These deal only with facts. it may be right or wrong, but its accuracy can be tested by appealing to the facts. ’ unemployment is rising, ‘inflation will be over 6% by next year etc are Positive statement. It is capable of refutation. It is argued by some economists that Positive models are value free.

Normative Economics
The study and presentation of policy prescription involving value judgement is called normative economics. It is usually including the word ‘ought’ or should’. They reflect people’s moral attitude. 'more aid should be given to developing countries’, ‘income should be distributed more equally’, ‘the government ought to reduce inflation’ are all normative statement. These statements are based on value judgement.


Positive Economics

Normative Economics

1. It is a statement of facts
2. It deals with objectives
3. It may right or wrong
4. It is the scientific explanation
5. Eg: Price determination,
Inflation rates



1. It is a statement of value.
2. It contains value judgement
3. It tells what is ‘good ‘or ‘ssbad’
4. It can not be proved
5. Eg: Government ought to reduce inflation, Tax the rich more than the poor.



Specialisation and Division of Labour
Specialisation
Specialisation is the production of limited range of goods by an individual or firm or country in co- operation with others. So that together a complete range of good is produced. It is the technique of breaking down the production into large number of specialised tasks. Specialisation can occur between nations or within the economies.
Division of Labour: Specialisation by individual is called Division of labour.
Stages of division of labour
i) Specialisation by craft: Even under the most primitive conditions of human existence there as some division of labour. Later in village communities , some occupations required specialisation as millers, carpenters, smiths, barbers etc
ii) Specialisation by process: The second stage of division of labour tends to be associated with the Industrial Revolution. The development of the factory system led to a great extension of the principle of the division of labour.
iii) Regional Specialisation: A further extension of division of labour occurs when industries are located in particular areas.
iv) International division of labour: The final stage in the division of labour occurs when countries specialise in the production of those commodities for which they have the greatest comparative advantage over them.
Advantages
a) Greater skill of workers: Division of labour results in workers acquiring greater skill at their job. The constant repetition of a task makes its performance almost automatic. In other words, “Practice makes perfect”.
b) A saving of time: There is a saving of time in division of labour. By keeping to a single operation , a workman can accomplish a great deal more, since he wastes less time between operations.
c) Employment of Specialists: Specialisation makes possible for each workman to specialise in the work for which he has the greatest aptitude.
d) It makes possible the use machinery: It may be put forward as a further advantage of the division of labour that it made possible a greater use of machinery. Division of labour paved the way for the introduction of machinery and mass productive methods.
e) Less Fatigue: It is sometimes claimed that the workers habituated to the repetition of simple task becomes less fatigued by his work.
Disadvantages
a) Monotony of the worker: Specialisation process means that each workman performs only one small operation. He has to do it a great many times during each working day. His work ,there for e ,becomes very monotonous and tend to dull the intelligence.
b) Great risk of unemployment: Division of labour increases the complexity of the production So it may lead to a great deal of unemployment in the society.
c) Problem of break down: Another problem with specialisation is that a break down in part of production can cause chaos with in the system
d) Dependents upon one another: It is another problem related with the specialisation. Every workman is depending upon each other. Since it is interdependent ,each person has to wait others for their work.

Economic Systems
Free Market Economy
All societies are faced with the problem of scarcity. One important difference between societies is in the degree of government control of the economy.
A Free Market economy is an economy where all economic decisions are taken by individual household and firm and with less government intervention.
In a Free Market economy there is no government intervention at all. All decisions are taken by individuals and firms. Household decide how much labour and other factors to supply and what goods to consume. Firms decide what goods to produce and what factor to employ.
Market economy is also known as Laissez faire or Free enterprises Economy or Capitalist Economy. It is allowing people to-do as they please without governmental regulations and control. Emphasis is laid on the freedom of the individual.
Main Features
1. Main actors: The four main actors with in the system are consumers, producers, owners of private property (Land and Capital) and government.
2. Private ownership: Most of all factors of production with in the economy is owned by private individuals and organisations.
3. Free decision making by the individual: Free Market economy is usually associated with a pure capitalist system. Here land and capital are privately owned. All economic decisions are taken by households and firms under the following assumptions:
a. Firms seek maximise profits
b. Consumers aim to maximise their individual welfare.
c. Workers seek to maximise their wages.
d. Government seeks to maximise social welfare.
4. Competition: By competitive market ,we mean :
· there is large numbers of buyers and sellers
· there is a perfect knowledge about market conditions
· freedom of entry and exit
Buyers and sellers compete against one another and among themselves for each commodity. No one is able to influence price by his own action.
5. Price Mechanism: In a Free market economy, the government or central authority does not decide what goods to produce, how they are to be produced. Production and distribution are governed by the price or market mechanism.
The price mechanism works through the interaction of prices, that is:
· the prices of goods and services
· the prices of factors of production
· the profit motive of the production


The interaction of demand and supply determine the price of the good. Changes in demand and supply relatively lead to changes in market prices.
S D
Price
P


D S
O Q
Quantity
The producers will produce at quantity where the demand cuts the supply curve at OQ as in
the figure above.
6. Profit motive: Making maximum profit is one of the main features of the free market economy.
7. Limited role of the government: In Free market economy the role of the government is limited. The government is responsible for the issue of money and for the maintenance of its value.
Advantages
a) The free market responds quickly to peoples want: In the free market system if people want a good or service and can afford to by it, then it becomes profitable to make it.
b) The market produces a wide variety of goods and services to meet consumers want.
c) The market system encourages the use of new and better methods and machines to produce gods and services: The aim of a firm in the market economy is to make as much profit as possible. New methods and machines reduce the cost of producing gods and services.
d) Quality and innovation: One advantage claimed a free market economy is that there are strong incentives built in the system to innovate and produce high quality goods. Companies which fail to do both are likely to be out of business by more efficient firms
e) Economic growth: In a free market economy, there may be considerable dynamism. However, some free market economies have grown at a considerably faster rate than other economies.



Disadvantages
a) Factors of production will be employed only if it is profitable to do so: If a profitable use can not be found for some of the scarce resources then they will be unemployed.
b) The free market economy fail to produce certain goods and services: For example everyone enjoys the benefit of street lighting at night but no private firm could provide this. Government may therefore to provide such goods and services for the general public.
c) The free market economy encourage the consumption of harmful gods: Some people may wish to buy dangerous drugs and if they can afford to buy that, then the free market will find it profitable to provide these goods.
d) The social effects of production may be ignored: Factories bellowing smoke into the air can affect us all. Also the noise from factories, airport and roads affect people who live nearby. Private firms may not consider the social effects of these actions.
e) Ethical objection: Finally, there is ethical objection, that a free market economy by rewarding self interested behaviour may encourage selfishness, greed, materialism, and the acquisition of powers.


Role of government in a Free Market economy
Ø Some goods like public goods will not be produced by the market mechanism. Therefore the government has to provide these god s and raise taxes to pay for them.
Ø The government is responsible for the issue of money and the maintenance of its value.
Ø The government needs to ensure an adequate ‘legal frame wok for the allocation and enforcement of properly rights.
Ø Government needs to have power to break up monopolies, prevent practices which restrict free trade and control the activities of trade union.
The role government is vital in a market economy. Without government, there would be anarchy. But government regulation should be the minimum necessary to secure the orderly working of the market economy.









COMMAND ECONOMY

Command economy is an economic system in which resources are allocated by government through a central planning process. All the decisions are taken by the government. Command economy is otherwise known as planned economy or socialist economy.

Characteristics
Main actors : government or planners
Consumers
Workers
welfare Motive
Public ownership
Centralised planning

A planned economy is characterised as one where everything is controlled by the government and there is no private sector. There is no consumer sovereignty .It means consumers have no choice but to accept the choices made by the government the people’s standard of living is lower due to the lack of choice. There may be over production of certain goods.
In a centrally planned economy there is no private motive. If there is a profit motive the producers will produce at the most efficient method so as to increase their profit. The producers just produce at a quantity that is instructed by the planners. Loss will be underwritten by the state.









Mixed economy

A mixed economy is a mixture of a planned economy and a free market enterprise. Mixed economies are economies where the balance between allocation by market mechanism and allocation by planning process is much more equal.
In practice no pure planned econo0mies or free market enterprises economies exist in the world.
Characteristics
A mixed economy possesses a number of characteristics.
· a) The main actors: The four main types of actors with in the system are consumers, producers, factor owners, and government.
· b) Motivation: In the private sector of the economy, consumers, producers, factor owners are assumed to be motivated by pure self interest. The public sector is motivated by welfare of the society.
· c) Ownership: The factors of production are partly owned by private individuals and organisation. At the same time state also owns a significant proportion.
· d) Competition: In the private sector of the economy there is competition. In the state sector, however, resources will be allocated through the planning. This means that consumers are offered choice of goods and services with in the private sector of the economy but little or no choice with in the public sector.
· e) Government: Government has a number of important functions in a mixed economy.
Regulate economic activities of the private sector
to provide public goods and merit goods (education ,health etc)
owners of key sectors ( postal, railways, electricity etc)





Why there are mixed Economies


Mixed economy is an economic system which combines both the features of market economy and command economy. At present this system is being adopted by many nations in the world.
a) Economic Stability: A market economy suffers from economic stability. But in mixed economy because of state regulation and planning of the economy, there is no economic instability.
b) Rapid economic growth: In a mixed economy the rate of economic growth will be more as compared to market or command economy. In mixed economy the growth rate is more as both private and public sectors produce more goods with competitive spirit.
c) Preservation of freedom: A mixed economy 6i based on democratic principles. It promotes economic, political, civil and cultural freedom of the people. There is also freedom of occupation, pres and speech which are not found in a completely command economy or completely market3 economy.
d) Consumer’s sovereignty: Consumers sovereignty is not found in command economy. But in a mixed economy the commodities will be produced according to the taste of the consumers. Consumers will feel more happy as they purchase goods which they like.
e) Profit and welfare: Private sector is guided by profit motive where as public sector is guided by service motive. Some industries will be under the joint ownership of private individuals and government. Government will control and supervise the private sector by way of price policy, tax policy, etc. In mixed economy everything will be directed by the planning commission to innovate, and there is no reward for hard work. Due to lack of competition, economic growth is low. But in a market economy the economic growth is very high but there is social costs such as pollution damage to environment, crime etc. But in a mixed economy social costs are controlled by the government and there will be steady economic growth.

From this discussion it is concluded that mixed economy might preferred to a market or a command economy.