Objectives for Chapter 1

At the end of Chapter 1, you will be able to answer the following:

1. What are the most important theories in the history of economic

thought?
2. What is scarcity?
3. Why do we need to study Economics?
4. What are the basic goals of the study of economics?
5. What are the four aspects of utilization?
6. What are the roles of the economist?
7. How do we understand the circular flow diagram and the
production possibilities frontier?
8. What are the 2 main branches and 2 main views in Economics?

Chapter 1
INTRODUCTION: Economics in General

He who will not economize will have to agonize.

-Confucius

Economics came from the Latin word “oikonomia” or “oikonomos” which

refers to someone who manages the household. It was coined by an
ancient philosopher called Xenophone. It may sound too simple, but
actually the economy is very similar to the household in terms of some
general aspects. Managing the national economy is not totally different
from managing a household. It requires almost the same values and
consideration. Both household and nation/country experience the
concept of scarcity.

A household faces many decisions. It must decide whether the members

of the household do which task and what each gets in return: Who cooks
dinner? Who does the laundry? Who gets the extra dessert at dinner?
Who gets to choose what TV show to watch? In short, the household
must allocate its scarce resources among its various members, taking into
account each member’s ability, efforts, and desires.

Like a household, a society faces many decisions. A society must find

some way to decide what jobs will be done and who will do them. It
needs some people to grow food, other people to make clothing, and still
others to design computer software. Once the society has allocated
people, as well as land, building, and machines, it must also allocate the
output of goods and services they produce. It must decide who will eat
the cake and who will eat the bread. It must decide who will drive a
Porsche and who will take the jeepney. The Management of the society’s
resources is important because resources are scarce. The economy
cannot produce all the goods and services people wish to have. Just as
each member of the household cannot get everything he or she wants,
each individual in the society cannot attain the highest standard of living
to which he or she might aspire.

The history of humanity has a rich history of economic theories. From

then till now, humanity has been trying to analyze, understand, and
explain the workings of the economy so that they could improve the
society’s status and living standard. In the next part, we would have a
brief survey of economic theories and their proponents who really
influenced the world through their ideas.

Brief History of Economic Thoughts

Economics only became an independent field during the modern period,

through the efforts of many thinkers specifically through the ideas and
writings of Adam Smith. His book, entitled An Inquiry into the Nature and
Causes of the Wealth of Nations, or simply The Wealth of Nations,
published in 1776 is one of the most important doctrines in the field of
economics. It can be considered as the bible of economics. It gave
emphasis on the concepts we now consider as the most basic in the field.

Having said this, I didn't mean that economics only became useful during
Adam Smith's time. The Wealth of Nation can actually be considered as a
by-product of the very rich though conflicting ideas prior to the 18 th
century. Economic theories can already be traced centuries before Adam
Smith. We have the Physiocrats, the mercantilist, even during the
Medieval period, scholars like St. Thomas Aquinas and St. Augustine,
though concentrated on theology, had theorized on how economies
works as well, same thing with great philosophers like Plato and Aristotle.

Plato (427-347 BCE) According to Plato in The Republic, money is used as

a medium of exchange in buying goods and services. During his time
people were using precious stones such as gold, silver, and copper in
exchanging goods and services. Market also, according to Plato is a place
where income and employment takes place. He said that market is not
capable of self-regulation; rather it requires administrative control to
eliminate usury, profit and interest. Money and trade must be subject to
administrative interest and control. Thus he proposed communism where
the state has absolute power. In this market theory, Plato proposed equal
or just distribution of opportunities to individuals because usury and
profit makes the rich becomes richer, and the poor becomes poorer.

Aristotle (384-322 BCE) Aristotle’s focus on personal ethics led him to

devise a notion of fairness that could be applied in exchange, but his most
important contribution to economics by initiating the study of economic
value. He did so by distinguishing the ways in which way a product can be
used. All articles of property have two possible uses. Both of these uses
belong to the article as such, but they do not belong to it in the same
manner, or to the same extent. One use is proper and peculiar to the
article concerned; the other is not. Take the shoe for example. It can be
used both for wearing and for exchange.

Implicit to these uses, according to Aristotle, there are two types of

values. Use value relates to a good’s intrinsic characteristics, whereas
exchange value relates to how much the good can fetch in return for
other goods.

Thomas Aquinas (1225-1274) St. Thomas Aquinas combined the ideas of

Aristotle with Christian laws, thereby laying the groundwork for the
religiously based medieval thought known as Scholasticism. Given the
breath of Aquinas’ interest, it is not surprising that his treatment of
worldly affairs included economics in particular. He attempted to define
fairness in monetary transactions and trade. Aquinas extended Plato and
Aristotle’s view that the proceeds of usury represent an unfair profit
made at the expense of the borrower. In Aquinas’ words from the Summa
Theologica: “To receive usury for money lent is, in itself, unjust, since it is
a sale of what does not exist”.

Adam Smith (1723-1790) It may only be a coincidence that Adam Smith’s

great book The Wealth of Nations was published in 1776, the exact year
that American revolutionaries signed the Declaration of Independence.
But the two documents share a point of view that was prevalent at the
time: Individuals are usually best left to their own devices, without the
heavy hand of government guiding their actions. This political philosophy
provides the intellectual basis for the market economy and for free
society more generally.

Why do decentralized economies work so well? It is because people can

be counted on to treat one another with love and kindness? Not at all.
Here is Adam Smith’s description of how people interact in a market
economy:

Man has almost constant occasion for the help of his brethren,
and it is in vain for him to expect it from their benevolence only.
He will be more likely to prevail if he can interest their self-love in
his favour, ans show them that it is for their own advantage to do
for him what he requires of them… Give me that which I want, and
you shall that this which you want, is the meaning of every such
offer; and it is in this manner that we obtain from one another the
far greater part of those good offices which we stand in need of.

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. We address ourselves, not to their humanity but to
their self-love, and never talk to them of our own necessities but of
their advantages. Nobody but a beggar chooses to depend chiefly
upon the benevolence of his fellow-citizens…

Every Individual… neither intends to promote their public interest,

nor knows how much he is promoting it… He intends only his own
gain, and he is in this, as in many other cases, led by an invisible
hand to promote an end which was no part of his intention. Nor is
it always the worse for the society that it was no part of it. By
pursuing his own interest he frequently promotes that of the
society more effectually than when he really intends to promote it.

Smith is saying that participants in the economy are motivated by self-

interest and that the “invisible hand” of the marketplace guides this self-
interest into promoting the general economic well-being. Many of Smith’s
insights remain at the center of modern economics.

David Ricardo (1772-1823) David Ricardo, a British political economist,

wrote The High Prices of Bullions (1809) and Principles of Political
Economy and Taxation (1817). In the former, he discussed a method of
determining the real price of bank notes, while on the latter, Ricardo
offered several theories based on his studies on the long range
distribution of wealth. Ricardo feared that increasing population would
lead to a shortage of productive land; his theory of rent is based on
relative land productivity.
He supported the classical theory of international trade, emphasizing
national specialization and freedom and competition. His labor theory of
value, states that wages are determined by the price of food which is
determined by the cost of production and the amount of labor required
to producing the food.

Thomas Robert Malthus Malthus used the idea of diminishing returns to

explain low living standards. Population, he argued, tended to increase
geometrically, outstripping the production of food, which increases only
arithmetically. The force of the rapidly growing population against the
limited amount of land meant diminishing returns to labor. The result, he
claimed, was chronically low wages, which prevented the standard of
living for most of the population from rising above the subsistence level.

John Stuart Mill (1806-1883) Coming at the end of the Classical Tradition,
John Stuart Mill parted company with the earlier classical economists on
the inevitability of the distribution of income produced in the marker
system. He discussed this in his magnum opus, A System of Logic (1845).
Mill pointed to a distinct difference between the market’s two roles:
Allocation of resources and distribution of income. The market might be
efficient in allocating resources but not in distributing income, he wrote,
making it necessary for the society to intervene.

Karl Marx (1818-1883) Marx is a German economist, philosopher,

sociologist, and revolutionist whose writings form the basis of the body of
ideas known as Marxist (Though Karl Marx himself said that he is not a
Marxist). With the aid of Friedrich Engels, Marx produced much of the
theory of Socialism and Communism.

Marx major works on political economy are best illustrated in his books,
Theories of Surplus Value (1860) and Das Capital (1867). In Das Capital,
Marx analyzed the capitalist process of production. He elaborated his
version of the labor theory of value and his conception of surplus value
and exploitation, which he said would lead to a falling, orate of profit and
ultimately the collapse of industrial capitalism.

John Maynard Keynes (1883-1946) John Maynard Keynes was born the
year Karl Marx died. Before Keynes, economist are mostly pessimists,
they are gloomy naysayers, “Nothing can be done”, “Do not interfere”, “It
will never work”. But Keynes was an unswerving optimist. He wrote,
“There is no reason to put up with recessions and depressions. The
economic problem is not- if we look into the future- the permanent
problem of the human race.”
His General Theory of Employment,
Some Important Thinkers
Interest, and Money (1936), is a response
and Schools of Thoughts in
to high rates of unemployment in Britain
Economics:
in the wake of the depression. His main
thesis was that full employment could be
Ancient Period
reached with the aid of government
- Plato
spending. He advocated active
- Aristotle
government management of the
- Kautilya
economy as a key responsibility of the
- Confucius
government to counteract the peaks and
- Lao Tzu
troughs of the business cycle.
Medieval Period
- St. Augustine
Keynes believed that laissez faire
- St. Thomas
capitalism did not offer appropriate
Modern Period
solutions for the economy of the 20th
 Mercantilism
century. Through the use of fiscal and
monetary policies, recessions can be  Physiocratic period
eliminated and economic prosperity can  Classical school
be controlled. This would help the - Adam Smith
smooth the boom/bust effect of the - David Ricardo
business cycle as he saw it. His theories - Thomas Robert Malthus
underpinned the fundamental - John Stuart Mill
relationships and ideas of - James Mill
macroeconomics and it is fair to say that - Jean Baptiste Say
Keynes was singularly responsible for the  Marginalist school
creation of the concept of  Marxist school
macroeconomics.  Institutionalist
 Keynesian School of
As you could see, a survey of just some Economics
of the major economic thoughts showed  Neo-Marxists
us how economic theories are constantly  Monetarism
changing. Keynesian theory, with its  Rational Expectations
emphasis on active government policies Theory
to promote high employment,  Contemporary
dominated the economic policy making Economics
in the early post-war period. But starting - Alfred Marshall
in the late 1960’s, troubling inflation and - Milton Friedman
lagging productivity prodded economists - Thorstein Veblen
to look for new solutions. A lot of - George Orwell
theories have emerged. We have the - Friedrich Von Hayek
Monetarism which updates the Quantity - Paul Samuelson
Theory. It reemphasizes the capital role - Paul Krugman
of money growth in determining - John Nash
inflation. Another is the Rational Expectations Theory, which provides a
contemporary rationale for the pre-Keynesian tradition of limited
government involvement in the economy. It argues that the market’s
ability to anticipate government policy actions limits their effectiveness.

There are many other contemporary theories in economics. These

theories has been and still are being debated and tested. Some were
accepted, some modified, others rejected. It is a continuous cycle as we
continue to answer basic economic problems. As for us, let us try first to
have a keener understanding of what Economics is all about.

What is Economics?

Economics is a social science that deals with the study of the proper
utilization of the available scarce resources to meet the insatiable needs
and wants of man and the society. It is the study of how economic
entities manage their scarce resources. In most societies, resources are
allocated not by an all-powered dictator but through the combined
actions of millions of households and firms. Economists therefore study
how people make decisions: how much they work, what they buy, how
much they save, and how they invest their savings. Economics also
studies how people interact with one another. Finally, economists analyze
forces and trends that affect the economy as a whole, including the
growth in average income, the fraction of the population that cannot find
work, and the rate at which prices are rising.

The study of economics has many facets, but it is unified by several

central ideas. One of which is the concept of scarcity.

What is Scarcity?

Scarcity is a situation where resources and/or condition which is

inevitable to all human beings wherein resources are always finite and
they are limited. All resources are said to be scarce. John Locke, in his Two
Treatises of the government said that nature is generous to man.
Everything that we are consuming came from nature and its derivatives.
In Economics, we consider three major economic resources. These are
land, labor and capital. There have been debates which is the most
important of the three. Some economists say its land, others labor, some
say capital. As for me, I would of course, the safest answer, and say all the
three are important, but I would say/add that the foremost, is land.
Land is the foremost important precisely because everything else, labor
and capital, are all dependent from land, they all come from nature. By
the way, it is important to note that land resources are also known as
natural resources.

Labor, also known as man power resources, cannot survive without gifts
of nature. All of our psychological needs, like food, water, clothing and
others cannot be produced by man on his/her own. It has to harvest
them from nature first. Unlike God, man cannot produce/create anything
out of nothing. A shirt is made in a factory with machines out of cotton
which comes from nature. A machine is created with metals and alloys
which again came from nature. With this example, we prove that
technology is also dependent but not just from land, but also from labor.
Technology is a product of how man ingeniously uses the resources
available to him.

Land, then, is the key to all other resources. It is a good thing that unlike
labor and technology. Land has the capacity to regenerate itself. A tree
can grow even in the absence to man and technology. Diamonds are
created by nature without participation of man, same thing with falls,
rivers, flowers, petroleum, and so on. However, scarcity still takes place.
The question is, why? Scarcity is an inevitable needs and wants. Man's
desire are unlimited, it is infinite, while the resources that we use to meet
these desires are limited.
FYI : WHO STUDIES ECONOMICS?

Locke disagree with this, he said George W. Bush- Former US

nature is abundant. There is more
than enough at any given time. The
problem is when man's needs and
wants now grows much faster than
what is required for nature to
regenerate itself. Thus, this situation
would lead to scarcity of resources,
which is a condition that we face
every day of our lives. But this is
where economics would make itself
useful to us. Economics is the study of
the proper utilization of our available
scarce resources to meet the
insatiable needs and wants of man
and society. Utilization of resources is
fragmented into four distinct aspects:
Allocation, production, distribution
President
Danny Glover- Actor
Kofi Annan- Former UN Secretary
General
Donald Trump- Real Estate/ TV Mogul
Lionel Richie- Singer
Cate Blanchett- Actress
Tiger Woods- Golfer
Steve Ballmer- CEO, Microsoft
Arnold Schwarzenegger- Actor,
Governor of California
Mick Jagger- Singer, Rolling Stones
LIST OF FILIPINO ECONOMIST
* Diosdado Macapagal 
* Gloria Macapagal-Arroyo 
* Solita Monsod (Mareng Winnie)
* Joey Salceda 
* Mar Roxas
and consumption.
Why Study Economics?

These are just some of the rationale why one needs to study economics:

Benefits of Knowledge

In today’s globalized world, actions in one economy affect all other

economies, at least to some extent. For example, a decrease in the
availability of oil in the Middle East can lead to an increase in the
unemployment rate in the Philippines. A decrease in oil availability leads
to an increase in the price of oil. This increase in the price of oil increases
business cost in the Philippines, which lead to a lower output. A lower
output leads to less employment, or ultimately higher unemployment. Do
not worry if these steps do not make sense right now; they will all be
explained throughout the term. By understanding how economic actions
affect one another, you will be able to better understand the world
around you.

Economics and Politics

Since the dawn of time, economics and politics have been intertwined in
every society across the globe. Every political action is in some way
affected by the society’s economy. Whether it is war over natural
resources or political re-election, all events are affected by some aspect
of an economy. Take a look back at all the Philippine Presidents.
Whenever, there is a tough economic time, majority of the time there is
political uncertainty. During political races, the economy is often the
major topic of debate. Views on taxes, spending, social programs, and
war are primarily shaped by the politician’s economic view.

Prevention of Ignorance

If everyone across the world understood the basics of economics, the

world would be a more stable place. Basic economics can tell us the do’s
and don’ts during times of instability. For example, during the “Great
Recession” in the United States which began in approximately 2008, many
Americans panicked and sold all stock holdings as values plummeted
across the board. While some Americans were using these stocks as
retirement holding they would soon be cashing out, many Americans held
stocks as additional sources of income. The theory of long-run economics
is based upon the idea that the economy eventually corrects itself. Had
many Americans simply held onto their stocks, prices would have
eventually returned to normal (as they did), and no losses would have
been taken. Instead, people panicked and decreased their financial
investments. The decrease in financial investments only hurt businesses
more, causing them to cut even more jobs, ultimately leading to higher
unemployment and less stable economy.

Soon you will be able to understand and appreciate these statements as

we go on in our term.

Economic Instinct

Whether you are taking this course as part of the general education
curriculum or as an introductory course to your bachelor’s degree in
Economics, it is essential to recognize that we are all instinctively
economist. It is a part of your daily routine to budget your allowance,
allocate your resources, produce a good or service, etc. Thus, in a natural
way, you are a practitioner of economics.

As an Economics practitioner, you should be familiar of the field’s

language and its way of thinking. As mathematicians talk about postulates
and axioms, integrals, limits. Philosophers talk about substance and
accidents, egoism, ulititarianism and phenomenology. Accountants talk
about assets, liabilities, T-accounts, and net worth.

One should be acquainted with the vocabulary of an economist. Supply

and demand, consumer surplus, indifference curves, production
possibility frontier, deadweight loss- these terms are part of an
economist’s language. Within the book, we would be encountering many
new terms and some familiar words that economists use in specialized
ways. At first this new language may seem needlessly arcane. But as you
will see, its value lies in its ability to provide you with a new and useful
way of thinking. Just as you cannot be a mathematician, or a philosopher,
or an accountant overnight, learning to think like an economist will take
some time. Yet with a combination of theory, case studies, and examples,
this book will give you an ample opportunity to develop and practice this
skill.

Fundamentals of Economics:
Circular Flow Diagram and the Production Possibilities
Frontier

The Economy is a complicated entity, yet with illustrations and diagrams,

we may be able to get a glimpse of how the economy works. The circular
flow diagram and the production possibilities frontier are two very useful
and ingenious ways of understanding the fundamentals of economic
activity.

The Circular Flow Diagram

Figure 1. The Circular Flow

The diagram is a schematic representation of the organization of the economy.

Decisions are made by households and firms. Households and firms interact in the
market for goods and services (where households are buyers and firms are sellers) and
in the market for the factors of production (where the firms are the buyers and the
households are the sellers). The outer set arrows shows the flow of money (pesos),
and the inner set of arrows shows the corresponding flow of inputs and outputs.

The economy consists of millions of people engaged in many activities-

buying, selling, working, hiring, manufacturing, and so on. To understand
how the economy works, we must find some way to simplify our thinking
about all the activities. In other words, we need a model that explains, in
general terms, how the economy is organized and how participants in the
economy interact with one another.

Figure 1 presents a visual model of the economy called a circular-flow

diagram. In this model, the economy is simplified to included only two
types of decision makers – firms and households. Firms produce goods
and services using inputs such as labor, land, and capital (buildings and
machines). These inputs are called the factors of production. Households
own the factors of production and consume all the goods and services
that the firms produce.

The circular flow diagram in figure 1 is one simple model of the economy.
It dispenses with details that, for some purposes, are significant. A more
complex and realistic circular flow model would include, for instance, the
roles of government and international trade.

Production Possibility Frontier

Figure 2.

The production possibilities frontier shows the combinations of output- in this case
Product A and Product B- that the economy can possibly produce. The economy
can produce any combination on or inside the frontier. Points outside the frontier
are not feasible given the economy’s resources.

The Production Possibility Frontier (PPF) also known as the

Transformation Curve is an economic model that shows the maximum
amounts of production that can be obtained by an economy, given its
technological knowledge and quantity of inputs available. Sometimes it is
also referred to as the PPC or the Production Possibilities Curve.

The PPF or PPC represents the menu of goods and services available to
society. Every point within the transformation curve is a situation called
Productive Efficiency, wherein you cannot produce more of a good
without curtailing the production of other goods. Along the Productive
Efficiency region, resources are optimally used. Examples are Point A, B,
 and C. Points at the left of the transformation curve are within the area of
inefficiency, where resources are mostly idle and not optimally used.
Example is Point X. Points at the right of the transformation curve are
within the non-feasible region, meaning the combination is not within the
productive capacity of the economy. No matter how resources are
allocated between the two products, the economy just cannot produce at
Point Y. Given all the technology, the economy does not have enough
factors of production to support that level of output.

The production possibilities frontier simplifies a complex economy to

highlight some basic but powerful ideas: scarcity, efficiency, trade-offs,
opportunity cost, and economic growth. As you study economics, these
ideas will recur in various forms. The PPF offers one simple way of
thinking about them.

In analyzing the PPF or PPC, we take several basic assumptions, these are:
1. Land, labor and capital are all fixed.
2. Technology is constant.
3. There is only a choice between 2 goods or services.

The analysis of the Production Possibilities Frontier will only be correct

assuming these three to be true. However, of course in reality, any
economy, or any nation can overcome these assumptions, thus we may
have shifts in our PPF as well.

Figure 4. A Shift in the PPF brought by a

biased technological change. The move
from point B to C was caused by an
Figure 3. A Shift in the PPF brought improvement in the technology used to
by overall economic growth. produce butter only.
The 2 Branches of Economics:
Microeconomics and Macroeconomics

Before we delve into the field of economics, we must first differentiate

between the two primary types of economics. Economics is studied on
various levels. We can study the decisions of the individual households
and firms. Or we can study the interaction of households and firms in the
market for specific goods and services. Or we can study the operation of
the economy as a whole, which is the sum of all the activities of all the
decision makers in the markets.

The field of economics is traditionally divided into two broad subfields.

Microeconomics is the study of how households and firms make
decisions and how they interact in specific markets. Macroeconomics is
the study of economy-wide phenomena. A microeconomist might study
the effects of rent control on housing in Manila, the impact of foreign
competition on the Philippine shoe industry, or the effects of compulsory
school attendance on worker’s earnings. A macroeconomist might study
the effects of borrowing by the central government, the changes over
time in the economy’s rate of employment, or alternative policies to
promote growth in national living standards.

Microeconomics and macroeconomics are closely intertwined. Because

changes in the overall economy arise from the decisions of millions of
individuals, it is impossible to understand macroeconomic developments
without considering the associated microeconomic decisions. For
example, a macroeconomist might study the effect of sin taxes on the
overall production of goods and services. But to analyze this issue, he or
she must consider how tax affects the decisions of households about how
much to spend on goods and services.

While both fields deal directly with economics, they have obvious
contrast. What may be true at one level of an economy may not be true
at another. Sometimes, there is a conflict between micro and
macroeconomics, as what’s good for one may not be good for the whole,
and vice versa.

2 Kinds of Economic Analysis:

Positive and Normative Analysis

There are two kinds of economic analysis, sometimes also referred to as

the two views in economics. Economists are often times asked to explain
the causes of certain economic events. Why, for example, is
unemployment tends to increase or decrease at specific times of the
year? On the other hand, sometimes economists are asked to
recommend policies or resolutions to improve economic situations. What,
for instance, should the government do to in order to decrease the
unemployment rate? When economists are trying to explain the world,
they are scientists, thus they are giving a positive view on the economy.
When they are trying to help improve it, suggesting and recommending
what steps can be taken by individuals, firms, government, etc., they are
policy advisers, thus they are making a normative claim about the
economy.

To help clarify the two roles that economists play, let’s examine the use of
language, and provide some examples. Because scientists and policy
advisers have different goals, they use language in different ways. For
example, suppose two people are discussing the trade-off between
inflation and unemployment. Here are the two statements one might
encounter:

Mang Pandoy: A low level of inflation leads to a rise in unemployment.

Aling Norma: The government should prefer unemployment to inflation.

Ignoring for now whether you agree or disagree with these statements,
notice that Mang Pandoy and Aling Norma differ in what they are trying
to do. Mang Pandoy is speaking like a scientist: He is making a claim
about how the economy works. Aling Norma is speaking like a policy
adviser: She is making a claim about how to change the economy.

In general, statements about the economy are of two types. One type,
such as Mang Pandoy’s, is positive. Positive statements are descriptive.
They make a claim about how the economy is. A second type of
statement, such as Aling Norma’s, is normative. Normative statements are
prescriptive. They make claims on how the economy ought to be.

A key difference between positive and normative statements is how we

judge their validity. We can, in principle, confirm or refute positive
statements by examining evidence. An economist might evaluate Mang
Pandoy’s statement by analyzing data on changes in minimum wages and
changes in unemployment over time. By contrast, evaluating normative
statements involves values as well as facts. Aling Norma’s statement
cannot be judged using data alone. Deciding what is good or bad policy is
not just a matter of science. It also involves our views on ethics, religion,
and political philosophy.
Now, the question is which is more important, is it the Positive analysis,
or the Normative analysis?

Answer: Both are important of course. Although at first it may seem like
normative analysis is more useful however imagine making a suggestion
on what we should do in the economy without understanding first the
nature and current state of the economy. Somehow, it can be compared
to a doctor prescribing medication without first observing the patient and
without looking at his/her laboratory results. It can lead to a tragedy.
Thus we can conclude that the positive and the normative economist
should work hand in hand in resolving the economic problem.

N. Gregory Mankiw’s Principles of Economics

Professor Mankiw is a professor of economics at Harvard University. He

studied at Princeton University and MIT. He developed the 10 Principles
of Economics as a summary of the unified central ideas of the many
facets of economics.

1. People face trade-offs.

2. The cost of something is what you give up to get it.
3. Rational people think at the margin.
4. People respond to incentives.
5. Trade can make everyone better off.
6. Markets are usually a good way to organize economic activity.
7. Government can sometimes improve market outcome.
8. A country’s standard of living depends on its ability to produce
goods and services.
9. Prices rise when the government prints too much money.
10. Society faces a short-run trade-off between inflation and
unemployment.
 Summary

 Economics is the social science that deals with the study of the
proper utilization of the scarce resources to meet the insatiable
needs and wants of man.

 Utilization of resources is fragmented into four distinct aspects:

Allocation, production, distribution and consumption. Their key
considerations are priority, quantity and quality, equity, and
utility, respectively.

 Economists try to address their subject with a scientist’s

objectivity. Like all scientists, they make appropriate
assumptions and build simplified models to understand the
world around them. Two simple economic models are the
circular flow diagram and the production possibilities frontier
(PPF).

 The circular-flow diagram is a simplified model which included

only two types of decision makers – firms and households. Firms
produce goods and services using inputs such as labor, land, and
capital (buildings and machines).

 The field of economics is divided into two subfields:

microeconomics and macroeconomics. Microeconomists study
the decision making by households and firms in the
marketplace. Macroeconomists study the forces and trends that
affect the economy as a whole.

 A positive statement is an assertion about how the world is. A

normative statement is an assertion about how the world ought
to be. When economists make normative statements, they are
acting more as policy makers than as scientists.

Questions for Review and Application:

1. Why do economists sometimes offer conflicting advice as policy
makers?

2. What is the difference between a positive and a normative

statement? Give an example of each.

3. Name one economic interaction that is not covered by the

simplified circular-flow-diagram.

4. Identify the major proponents of economic theories and give their

most important contribution in the field.

5. What are the two subfields into which economics is divided?

Explain what each subfield studied.