Sunday, February 14, 2010

Unit 1 - An economic way of thinking

Economics is the “science of choice. This unit covers microeconomics, macro economics, modelling of complex interactions and behaviour thinking. The major difference between microeconomics and macroeconomics is that micro focuses on individuals and firms while macro focuses on the economy as a whole.

The underlying cause of our economy is resources are scarce when compared to everyone’s wants and needs. Therefore, microeconomics is generally based on individuals trying to making rational self-interested choices. As resources are scarce people choose alternatives that provides them with the highest utility, which is traded off for utilities of lower satisfaction. Our modern economies in the developed world is based upon open markets with as little government regulations as possible. The principal is that governments will only regulate to stop situations like monopolies, property rights, human rights, market failures etc. However, it often governments can interfere with the open markets which creates inefficiencies within the market.

As micro economics is about interactions are generally between individuals and firms, the cost is what the minimum the seller will sell a product for, the value is the maximum a buyer will buy a product for and the price is the actual amount paid by the buyer. The price will fit in somewhere between the cost and value. A firms cost if using the economic way of thinking should be greater the explicit and implicit costs of a product. Firms will change this price (behave differently) depending on the amount of competition in the market. Generally if there are a lot of competition in the market in association with a product the price of the product will be lower, if there is less competition the price of the product will be greater. A buyers value will be influenced by their income, the product’s ability to satisfy their needs compared to other products.

Macroeconomics is concerned with the economy as a whole, which can be generally broken down into government, financial, household and business sectors. The analysis of macroeconomic level involves studying factors of total products and services produced in the economy, total income, productivity, price inflation, interest rates, exchange rates and national accounts. Countries with high productivities through skilled labour and/or infrastructure generally has good living standards because productivity increases the average income, giving people more buying power and governments have more taxation revenue to provide important social services and infrastructure. High inflation lessen the living standards as it affects people negativitly with fixed incomes or incomes that don’t keep pace with inflation. It also adds uncertainity to business and encourages excessive borrowing. Therefore, in most western countries it is the central banks role to keep inflation down. They do this by increasing or decreasing the official cash rate that affects the interest rates that many banks borrow or loan money at. If inflation is predicted to be high the banks will increase the OCR or if it is low they will low the OCR to try and stimulate growth within the economy, the central banks work independently of the governments and if government expenditure is high which puts upwards pressure on inflation the central bank may increase the OCR to counter the increase in inflation. Exchange rates are influenced by many things generally though trade between countries and relative interest rates. If a country is exporting more than they are importing to another country it puts pressure on lifting their exchange rate against the other country and ves versa. Economic policy with interest rates, taxtation and government expenditure tends to be complicated and is generally based around trades-off between inflation and economic growth.

Economics models attempt to model economies. They can hold a lot of assumptions which generally means they are modelling a more perfect economy, however the less assumptions a model has the more like reality it is. It is generally best to change only one variable to see what effects it has on the model, even though in the real world all variables are changing all the time.

People are generally focused on the losses and gains and not the final positions (covered under prospect theory). i.e. a loss of $400 000 is a bigger blow even though they may of gained $500 000 previously. People narrow themselves down with their framing, biases, sunk costs, negative comparisons and tend to ignore opportunity costs and lack self control.