INTRODUCTION TO ECONOMICS

1
LEARNING OBJECTIVES
By end of this chapter, student should be able to:

1. Define economics and the discipline of economics; Microeconomics and

Macroeconomics.
2. Explain the basic economic concept; scarcity, choices and opportunity cost
3. Describe the 3 basic economic problems
4. Explain basic economic concept, economic growth and technologies
advancement using the production possibilities curve (PPC).

DEFINITION OF ECONOMICS
1. Economics defined as a social science that studies how people use their
limited resources to fulfil their unlimited wants and adjust with the
available choices or alternatives.

DISCIPLINE OF ECONOMICS
1. Economics is subdivided into: a) microeconomics; b) macroeconomics.
2. ‘Micro’ is derived from Greek word meaning small, while ‘macro’ which
means large.
a) Microeconomics – is concerned with the choices made by the
individual decision-making units in the economy- typically households,
firms and government- and the impacts the choices have on individual
markets.
b) Macroeconomics- is concerned with the aggregate performance of
the entire economic system, such as national income, total
employment, price level and international trade.
 3. Table shows the differences between microeconomics and macroeconomics;

TYPES OF MICROECONOMICS ANALYSIS

Positive vs. Normative Analysis
1. Economic uses two types of analysis when examining social issues and
advising policymakers.
2. There are:
a) Positive analysis describes the world the way it is. It is based on
facts.
b) Normative analysis describes the world the way it should be. It is
based upon opinions.

Positive Statement Normative Statement

 A positive statement is to deal with the
question of ‘what is’ and no indication of
approval and disapproval.
 Focus on the facts and causes-and-effect
relationship. This analysis will predict the
changes in economic phenomena due to
changes in government policy.
 Examples:
 A negative statement is to deal with the
question of ‘what ought to be’.
 Incorporates value judgements about
what the economy should be or what
policy should be used to achieve
economic goals.
 Example:
BASIC ECONOMIC CONCEPTS
1. Scarcity
 Defined as the unlimited human wants are always exceeding the
available resources.
 The definition of scarcity replicates the definitions of economics, thus if no
scarcity there will be no economics – most important concept in
economics.
 The needs in unlimited but the world have only limited of resources of
factors of production.
 Factors of production are the basic resources that used in the production
process of economic goods and services, which is basically classified into 4:

a) Land: All natural resources, e.g. water, air, mineral and

others
b) Labour: All human resources, e.g skilled and unskilled
labour
c) Capital: Human made resources that are used in the
production process, e.g, Machinery, equipment, tools,
building and so on.
d) Entrepreneur: Human ability that combines land, labour and

2. Choices
 When scarcity exists, choices have to be made.
 The more good you choose to buy, the less money you will have to spent on
other goods.
 Thus, individuals, firms and government have to choose from available
alternatives or choice since they cannot have all their unlimited wants due to
the scarcity.

3. Opportunity Costs
 Defined as the second best alternative that has to be sacrifice for another
choice which gives more satisfaction.
 Opportunity cost is the cost of one choice in term of the best forgone
alternatives.
BASIC ECONOMIC PROBLEMS
There are three economic questions need to be answered when deciding how to
allocate the limited resources that use in producing the goods and services to satisfy
the needs of the people.

1. What to produce?
 This question depends on the types of goods and services as well as the
quantities needed by the country, especially the consumer.
 The economy should decide type of products to produce to satisfy the
needs of consumers depends on the limited resources the economy own.

2. How to produce?
 The question of how to produce is depends on the cost of production.
 Firm’s aim is to maximize profit with minimum cost. Thus, firms will choose
the cheapest method of production to use in producing goods and
services.
 There are alternatives of techniques of producing products, which are the
labour-intensive and capital-intensive.
 Firms have to decide which methods that efficient, cheapest and lowering
the costs of production yet can maximize profit.

3. For whom to produce?

 The question for whom to produce is depends on the distribution of
income.
 The economy will decide who should get the goods and services produced
by the firms.
 Incomes are used to purchased goods and services. Thus , the higher the
level of income, the more goods and services can be demanded.

PRODUCTION POSSIBILITIES CURVE (PPC)

1. The PPC is used to explain the basic economic concepts of scarcity, choices
and opportunity cost.
2. It shows the various possible combinations of goods and services produced
within the specified time period with given technology and resources that are
fully and efficiently employed.
3. 4 assumptions of PPC:

a) All resources are fully employed

b) Fixed resources
c) Technology constant
d) Assuming the country only producing two
goods.
 Figure and table show production possibilities for country X for
producing two goods, defence goods and consumer goods.
 Points A to F are the best possible combination of two goods
when resources are fully utilized and the country is at full
employment.
 Point inside the PPC (point Y) – These combinations is
attainable and can be produced. However it shows that
resources are not fully utilized and indicate inefficiency and
waste of resources since the production has not reached its
maximum level.
 Point outside the PPC (point Z) – These combinations is
unattainable. Due to limited resources and limited technology
this combination cannot be produced. When country wants to
produce more than the limited resources, scarcity happens.
 Point along the PPC – since country X cannot produce at Z, it
will choose any point along the PPC which is attainable and
efficient. Country X has to make its choice from various
combinations of defence goods and consumer goods, which
will maximize its satisfaction.
 Movement from one point to another point along PPC
(from point A to F) shows that producing more of one type of
good means other goods have to produce in lesser quantity. It
shows the concept of opportunity cost.
Factors that Influence the Shift of the PPC
1. The PPC will shift outwards when there are improvement in technologies,
expansion of resources and a growth in economic.

1. Economic growth
 Economic growth is the expansion of production possibilities.
 When a new resources are discovered or there is an expansion of resources,
the production capability will increase and the country are able to produce
more products. This lead to the growth of economy.
 Increasing in output will shift PPC outward from PPC1 to PPC2.
 When the growth of economy decline, let say when the country is struck by
the natural disaster, production of output decreases. PPC will shift to the left
from PPC1 to PPC3
 2. Technological advances
 Technology also plays a key role to the growth of an economy.
 As new technologies are developed, production capability of a country also
increases.
 Through a new innovations or applications of new and efficient techniques of
production, a country can produce more products with the same quantities of
resources and within the same period. Thus, PPC will shift to the right.

Example: Country X producing two products, defence goods and

consumer goods. Through innovation in the production of defence
goods, country X can produce more defence goods than before using
the same amount of resources. This will shift the production of defence
goods to the right from PPC 1 to PPC2, as shown in figure. The outward
shift of PPC only implies to the defence goods since the advancement
of technologies only implies to the production of defence goods.

The Shape of PPC

1. The shape of PPC is depends on the types of opportunity cost.
2. Basically, there are three types of opportunity cost: increasing opportunity
cost, decreasing opportunity cost and constant opportunity cost.
a) Increasing Opportunity Cost
 If a country produces more of one good, it
has forgone more amounts of another
goods.
 As more good X added, the number of
good Y forgone (opportunity cost of good X)
will also increase
 The PPC slope from left to right and
concave from origin
b) Decreasing Opportunity Cost
 If a country produces more of one good, it
has forgone lesser amounts of another
goods.
 As more good X added, the number of
good Y forgone (opportunity cost of good X)
will decreasing.
 The PPC slope from left to right and
convex from origin
c) Constant Opportunity Cost
 If a country produces more of one good, it
has forgone same amounts of another
goods.
 The number of good Y forgone is same for
every additional unit of good X
 The PPC is linear line.
Application- Gains from Specialization and Trade

1. Specialization is when individuals or countries concentrate on producing a

product that they good and efficient at, at the lowest opportunity cost.
2. With specialization, they can trade with others and end up with more than they
could have if they tried to produce everything themselves.
3. The possible gains from specialization such as;

a) Higher output: Raise total production of goods and services as well improve
the quality of product.
b) Variety: Consumers have a greater choices and variety of higher quality
products.
c) A bigger market: Specialisation and global trade increase the size of the
market offering opportunities for economies of scale
d) Competition and lower prices: Increased competition acts as an incentive to
minimise costs, keep prices down and therefore maintains low inflation

4. Specialization and trade are based on the concept of comparative advantage.

The Circular-Flow Diagram

1. One model that helps explain how a market economy works is a circular-flow
diagram - a visual model of the economy that illustrates how households and
businesses interact through markets for products and markets for resources.
2. This model will focus more on two specifics types of decision makers:
Households and Firms.
3. Firms/ entrepreneurs produce goods and services using inputs or factors of
production, such as labour, land and capital, that all were own by the households.
Whereas, households are the unit that consume all the goods and services that
produced by firms.
4. There are two markets involved: (a) market for factors of production, which the
households as the sellers while firms as the buyers; (b) market for goods and
services, where the firms are seller and households are buyers.

The red flow represents the flows of inputs and outputs, where at first households
sell the use of their labour, land and capital to the firms in the market of production.
Firms then use these factors of production to produce goods and services, which in
turn sold in the market for goods and services and later were bought by households.

The green flow represents the corresponding flow of money. The households spend
money to buy goods and services. Firms then use some of the revenue from sales to
pay for the factors of production (wages, rent etc.). The pay is also income in the
form of wages, rent and profit for households for offering the factors of production to
the firms.