We can use economics to explain much of what we encounter in our daily lives. This unit focuses on the practical problems and issues that affect individuals, firms and governments by providing students with a narrative of everyday economics within our society and biosphere.
Comprehend the background and implications of contemporary economic issues. Identify fluctuations in the global and Australian economies and their likely effects on business. Identify, using economic thinking, appropriate strategies to protect the natural environment.
Outcomes or desired results
At the end of this unit, a student will be able to: P1 demonstrate understanding of economic terms, concepts and relationships P2 explain the economic role of individuals, firms and government in an economy P5 analyse the relationship between individuals, firms, institutions and government in the Australian economy P6 explain the role of government in the Australian economy P7 identify the nature and causes of economic problems and issues for individuals, firms and governments P8 apply appropriate terminology, concepts and theories in economic contexts P10 communicate economic information, ideas and issues in appropriate forms
Economics is much more than just numbers and graphs. In fact, we can use economics to explain much of what we encounter in our daily lives. For instance, why is customer service at your local restaurant usually better than that of the cable company? To find the answer we can take a closer look at the incentives at play. For another example, we look to eighteenth century Great Britain. What did bad incentives have to do with the death rate of prisoners shipped from England to Australia? Let’s find out together in this first video of MRU’s course on Principles of Economics: Microeconomics.
Answer these 4 questions to check your understanding.
Read, then consider your answers for the questions that follow.
If you’ve ever had the feeling you ought to know a lot more about economics than you do – even if only to make it harder for economists to bamboozle you – here’s my long-weekend special offer: the key concepts of the discipline explained in one article. As many as I can fit, anyway. More than a year ago, the boss of the Australian Competition and Consumer Commission (ACCC) Rod Sims – surely the most experienced senior econocrat evading retirement in Canberra – began a speech by saying economics had become too mathematical and that to be a good economist all you needed was a deep intuitive feel for 10 or 15 concepts. He then rattled off what he regarded as the 15 most important concepts, “in no particular order”. From those I’ll explain, in order, the five I consider to be most significant.
1. Opportunity cost
The first is one you should have heard of: opportunity cost. Many economists consider “opp cost” to be the single most important and fundamental concept in economics, and the discipline’s most useful contribution to the betterment of mankind. Indeed, that’s the view Professor John Quiggin, of the University of Queensland, takes in his book Economics in Two Lessons, which I recommend as the best book to introduce you to economics. Quiggin says “the opportunity cost of anything of value is what you must give up to get it”. Our wants are almost infinite, but our resources are limited, so we have to make choices. Economists’ eternal message to individuals and to the community is: think carefully before you spend your money, make sure you’re spending it on what you really want because you can’t spend it twice. Really? That complicated, huh? Quiggin says “the lesson of opportunity cost is easy to state but hard to learn”. We keep forgetting to apply it. For instance, Prime Minister Scott Morrison is saying he’s not going to reduce our greenhouse gas emissions if the opportunity cost is to endanger jobs in the coal industry. Sounds fair enough until you realise he’s saying jobs in a particular industry matter more to him than us doing all we can to help reduce global warming (which will destroy jobs in many industries). We live in a market economy. We sell our labour in the jobs market, then use the money we earn to buy the goods and services we need in 101 product markets. Economics is the study of markets and, in particular, of how the prices set in markets work to bring supply and demand, sellers and buyers, into agreement (aka “equilibrium” or balance).
Prime Minister Scott Morrison is saying he’s not going to reduce our greenhouse gas emissions if the opportunity cost is to endanger jobs in the coal industry. CREDIT:MATT DAVIDSON
2. The Invisible Hand
The first of Quiggin’s two lessons is “market prices reflect and [also] determine the opportunity costs faced by consumers and producers” – which brings us to Sims’ next key concept, “the invisible hand”. In a market-based economy (as opposed to a feudal economy or a planned economy), the differing objectives of workers, employers, consumers and producers are co-ordinated (brought together) not by the government issuing orders to people, but by the “price mechanism” (prices going up or down until both sides are satisfied). That’s the invisible hand. And what motivates this invisible hand is the self-interest of workers, bosses, consumers and businesses. In the famous words of the father of modern economics, Adam Smith, in 1776, “it is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest”. It’s amazing to think of, but it holds much truth: the invisible hand of markets and prices takes the self-interest of all those competing players and turns it into a situation where most of us have our wants satisfied most of the time.
3. Imperfect Competition
But if that sounds a bit too pat – a bit too perfect – it is. It is, in fact, a description of what economists call “perfect markets” and “perfect competition”. And in real life, nothing’s ever perfect. The greatest female economist, Joan Robinson, was the first to formalise Sims’ third key concept, “imperfect competition” – the study of why markets and the price mechanism don’t always work as perfectly as the oversimplified “neo-classical” model of markets assumes they do.
4. Market Failure
From the subtitle of Quiggin’s book you see that lesson one is “why markets work so well”, but lesson two is “and why they can fail so badly”. This takes us straight to Sims’ fourth key concept “market failure”. Markets are said to fail when they deliver results that aren’t “allocatively efficient” – when they don’t lead to the particular distribution of economic resources that yields the maximum satisfaction of people’s wants. Economists have spent much time studying the various categories of factors that cause markets to fail. More recently they have turned to studying “government failure”, which is when governments’ attempts to correct market failures end up making things worse.
Sims’ final key concept is “externalities” – a major category of market failure. These occur when transactions between sellers and buyers generate costs (or benefits) for third parties – known as “social” costs or benefits – that aren’t reflected in the market or “private” prices paid and received by the buyers and sellers. These social costs or benefits are thus “external” to the private transaction and the private price mechanism. They constitute market failure because the market generates more costs (or fewer benefits) than is in the public’s interest. One example of an external benefit is the gain to the wider community (not just the particular individual) when a student graduates from university (which is why uni fees are set at only about half the cost of the course, so as to “internalise” the positive externality). As for external costs (“negative externalities”), Quiggin notes that the leading British economist Lord Nicholas Stern has described climate change as “the biggest market failure in history”. So now you know why so many of the nation’s economists are appalled by Morrison’s dereliction. Ross Gittins is the Herald and the Age's economics editor.
1. Write down the FIVE concepts in your workbook that Gittins outlines in this article. 2. Create a symbol for each one that depicts your interpretations of this concept's influence in your daily life. 3. Using your textbook, read p 15: Opportunity Cost between Welfare & Infrastructure. How do you think this trade-off is influenced by a government's economic objectives? Write around 100 words.