AAU-Minda T. CH1

Addis Ababa University
School of Economics
Introduction to Economics
Name of instructor: Minda Tsega
Addis Ababa University,
ETHIOPIA
11/18/2021 AAU, INTRODUCTION TO ECONOMICS, MINDA T. 1
INTRODUCTION TO ECONOMICS (Econ 1011);
Chapter One
AAU, INTRODUCTION TO ECONOMICS, MINDA T.

11/18/2021 2
Chapter One
Basics of Economics
WHAT IS ECONOMICS?
Economics – the study of
how individuals, societies and
government make decisions
about ways to use scarce
resources to fulfill wants and
needs.
AAU, INTRODUCTION TO ECONOMICS, MINDA T.

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Definition of economics
Economics is one of the most exciting
disciplines in social sciences.
The word economy comes from the Greek
phrase ―one who manages a household.
There is NO universally accepted definition of
economics (its definition is controversial).
11/18/2021 INTRODUCTION TO ECONOMICS, MINDA T. 4

Adam Smith (1723 – 1790)
O Known as father of modern economics
O Wrote the first and most important books on the subject of
economics, An Inquiry into the Nature and Causes of the
Wealth of Nations (1776)
O Smith believed in “free market”
(free market is one where consumers may buy what they like and
producers may produce what they like, with no government
interference)
Smith suggested that a laissez-faire (don ’ t interfere)
approach should be followed, leaving customers and
producers to make their own decisions

Definition (Cont…)
Definition of Economics
Economics can be defined in different way
Economics: is a branch of social science which
deals with efficient utilization/allocation of
scarce or limited resources to fulfill the
unlimited human wants
Economics is the study of how society
manages its scarce resources so as to
maximize their unlimited wants

Economics is the social science that
studies the choices that Economic agents
i.e., individuals, businesses, governments, and
entire societies make as they cope with
scarcity, the incentives that influence those
choices, and the arrangements that coordinate
them.
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INTRODUCTION TO ECONOMICS, MINDA T.
 Economics is a social study of
production, distribution, and
consumption of wealth or output.
 It emphasizes three major economic activities
 output must be produced (production);
 the product must be distributed to potential consumers (distribution); and
 consumers must choose from the available goods for consumption (consumption).
 Economics is the study of decision

making:
The following statements are derived from
the above definition.
Economics studies about scarce resources;
It studies about allocation of resources;
Allocation should be efficient;
Human needs are unlimited
The aim (objective) of economics is to study how to
satisfy the unlimited human needs up to the maximum
possible degree by allocating the resources efficiently.

1.2 The Foundation of Economics
THERE ARE TWO FUNDAMENTAL FACTS THAT
PROVIDE THE FOUNDATION FOR THE FIELD OF
ECONOMICS.
1) HUMAN (SOCIETY‘S) MATERIAL
WANTS ARE UNLIMITED.
2) ECONOMIC RESOURCES ARE
LIMITED (SCARCE).
OR IN SHORT
Unlimited Wants
Limited resources

1.2 The Foundation of Economics (Cont…)
Unlimited wants: Society's wants for material goods and

services are unlimited: Why? Because,
Wants are multiplicative
Wants multiply endlessly
Wants are recurrent
Human nature is accumulative
Human being will borrow wants from others
Because of these and other facts wants are unlimited

1.2 The Foundation of Economics (Cont…)
Limited-resources:-Economic resources
like, Land, labor, capital, and
entrepreneurial skill are limited to
produce all goods & services
Limited resource means
◦It is not possible to produce all goods
and services needed by the society.

1.3.1 Scope of Economics
Macroeconomics
◦ The big picture: growth,
employment, etc.
◦ Choices made by large groups (like
countries)
◦ Economy as a whole or Aggregate
level
Microeconomics
◦ How do individuals make economic
decisions i.e., HH, Firms, …

Microeconomics vs Macroeconomics
Microeconomics: The study of the choices that individuals
and businesses make.
It deals with the decision making behavior of individual
economic actors/agents such as individuals, households,
business firms, industries.
Macroeconomics: The study of the aggregate (or total)
effects on the national economy and the global economy of
the choices that individuals, businesses, and governments
make.
It is the study of the behavior of the economy as a whole

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(Cont….)

1.3.2 Explanation (Analysis) of Economics
Positive Economics Vs Normative Economics
Positive economics: it is concerned with
analysis of facts and attempts to describe the
world as it is..
It tries to answer the question “What?” as in
“What is the price of commodity X in market A?”
The answer may be 50 Birr per unit or 70 ETB per unit.
This shows that positive economics tries to
understand the existing economic situation.

1.3.2 Explanation (Analysis) of Economics
Positive Economics Vs Normative Economics
Normative Economics: It deals with value judgment on economic
situation.
It tries to answer questions like “What should be?”
“What should be done to increase employment and to reduce
price?”
The answer may be cutting wage rates or that the government
should increase expenditure on the construction of public
infrastructure so that the unemployed will be employed in the
project and that they in turn generate employment through spending
their increased income.

1.3.3 Inductive and deductive reasoning in
economics
The fundamental objective of economics, like any
science, is the establishment of valid generalizations
about certain aspects of human behavior. Those
generalizations are known as theories.
A theory is a simplified picture of reality. Economic
theory provides the basis for economic analysis
which uses logical reasoning. There are two methods
of logical reasoning: inductive and deductive.

Count…
Deductive Vs Inductive Methods of Analysis
Deductive method:- It is a logical way of arriving at a particular or specific
correct statement starting from a correct general statement. it is an abstract,
analytical or a priori approach that involves the principal
steps of:
Awareness of the problem and identify the significant variables and
interrelationships.
Specifying or making of assumptions
Deducing or formulating hypothesis: with the aid of words, symbolic
logic, graphic technique or formal mathematics.
Testing the validity of hypothesis: economics relies on uncontrolled
experiences and observations to verify hypothesis.

Cont…
Inductive Method:- it is the process of deriving a
principle or theory by moving from facts to theories and
from particular to general economic analysis.
◦ It is based on experience or observations.
The steps involved in the inductive approach include

1. Selecting problem for analysis
2. Collection, classification, and analysis of data
3. Establishing cause and effect relationship between economic phenomena.
The method of induction should be
 supported with theories developed by deductive logic,
 requires sufficient data and
 good knowledge of statistical methods.

The central aim of economics
All economic questions and problems arise because
human wants exceed the resources available to satisfy
them.
What do you think is the central aim of economics?
Efficient utilization of scarce resources
Goals of economics
◦Economic Growth
◦Full employment
◦Price stability
◦Equitable distribution of income

Scarcity
Scarcity is the condition that arises because wants
exceeds the ability of resources to satisfy them.
Faced with scarcity, we must make choices—we must
choose among the available alternatives.
Limited resource + Unlimited wants = Scarcity
Scarcity: refers to a physical condition
where the quantity desired of a particular
resource exceeds the quantity available
NB: scarcity doesn’t mean shortage

Count…

Economic resources.
They are usually classified into four categories
 Land resource includes land and other natural resources and its
reward is called rent
 labor refers to the physical or mental effort of people and its
reward is called wage
 Capital represents the set of goods produced for use in the
production other goods but not for direct consumption and its
reward is called interest
 Entrepreneur ability is a special talent of human beings to
organize, start and run business and its reward is called profit .

Production Process
Land
Goods
Labor
Production/Manufacturing
“Factory” Consumers
Capital
Services
Entrepreneurship

What are resources?
Definition: The things used to make other goods

BUT, there’s a
Fundamental Problem:
SCARCITY: unlimited wants and

needs but limited resources

Choices, Choices
Because ALL resources, goods,

and services are limited – WE
MUST MAKE CHOICES!!!!

Why Choices?
We make choices about how we spend our money, time,

and energy so we can fulfill our NEEDS and WANTS.
What are NEEDS and WANTS?

Wants and Needs,
Needs and Wants
NEEDS – “stuff” we MUST HAVE TO survive,
generally: food, shelter, clothing
WANTS – “stuff” WE WOULD REALLY LIKE to have (big

screen TVs, jewelry, conveniences . . . Also known as
LUXURIES

What is the difference between a
need and a want?
Needs: items for survival, Like water,
food, shelter
Wants: luxuries, fancy cars, vacations

VS.

TRADE-OFFS
You can’t have it all (SCARCITY –
remember) so you have to choose how to
spend your money, time, and energy.
These decisions involve picking one thing
over all the other possibilities – a TRADE-
OFF

Trade-Offs, cont.
What COULD you have done instead of come to school
today?

The result of your Trade-Off is the
OPPORTUNITY COST =
The Value of the Next Best Choice
(Ex: Sleeping is the opportunity cost of studying for a test)

“ T H E R E I S N O S U C H T H I N G A S A F R E E L U N C H .” I M A G I N E
T H AT T H E F R I E N D LY N E I G H B O R H O O D P I Z Z A R E S TA U R A N T
S E T U P A TA B L E F U L L O F P I Z Z A B O X E S O U T S I D E Y O U R
S C H O O L A B O U T L U N C H T I M E A N D P U T U P A S I G N T H AT
S A I D P I Z Z A A N D S O D A E T B 0 . 0 0 . W H Y W O U L D N ’ T T H AT
BE A FREE LUNCH? IT DIDN’T COST YOU ANYTHING
R I G H T ? W E L L , I T M AY N O T H A V E C O S T Y O U I N T E R M S
O F M O N E Y, B U T A N Y S I T U AT I O N W H I C H F O R C E S Y O U T O
M A K E A C H O I C E R E S U LT S I N A N O P P O R T U N I T Y C O S T.
Or consider this: you may spend several hours this evening tweeting
and texting friends at no additional monetary cost to your phone
plan. You may think of this as free, but there is a cost. What
opportunity did you give up? In his famous quote, Milton Friedman
was reminding us of the lessons we have learned today: because of
scarcity we must choose and choice means that there is an
opportunity
11/18/2021
cost INTRODUCTION TO ECONOMICS, MINDA T. 36
Opportunity Costs
This is really IMPORTANT – when you choose to do ONE
thing, its value (how much it is worth) is measured by
the value of the NEXT BEST CHOICE.
◦ This can be in time, energy, or even MONEY
If I buy a Then I
pizza… can’t afford
the
movies…
Q: What is the opportunity cost of buying pizza?

What is Opportunity
Cost?
THE COSTS OF THE CHOICE NOT TAKEN
WHEN YOU CHOOSE TO DO ONE THING, ITS VALUE
(HOW MUCH IT IS WORTH) IS MEASURED BY THE
VALUE OF THE NEXT BEST CHOICE. THIS CAN BE IN
TIME, ENERGY, OR EVEN MONEY

Production Possibilities Frontier
Production possibilities frontier is the
boundary between the combinations of goods
and services that can be produced and the
combinations that cannot be produced, given
the available factors of production and the
state of technology.
The PPF is a valuable tool for illustrating the
effects of scarcity and its consequences.

The PPF puts three features of production
possibilities in sharp focus:
◦ Attainable and unattainable combinations
◦ Efficient and inefficient production
◦ Tradeoffs and free lunches
Production efficiency is a situation in which

we cannot produce more of one good or
service without producing less of something
else.
A tradeoff is an exchange—giving up one thing
to get something else.

PPF /PPC
PPF Y
0 x

Cout…..

Cout…
The PPF describes three important concepts:

i) The concepts of scarcity: - the society cannot have
unlimited amount of outputs even if it employs all of its
resources and utilizes them in the best possible way.
ii) The concept of choice:
iii) The concept of opportunity cost: - when the economy
produces on the PPF, production of more of one good
requires sacrificing some of another product which is
reflected by the downward sloping PPF.

The opportunity cost

Cout…..
Example: Referring to table 1.1 above, if the economy is initially operating at point
B, what is the opportunity cost of producing one more unit of computer?
Solution: Moving from production alternative B to C we have:

Economic Growth and the PPF
Economic growth or an increase in the total output level
occurs when one or both of the following conditions occur.
1. Increase in the quantity or/and quality of economic resources.
2. Advances in technology

Capital Goods and Consumer Goods
Capital Goods: are used to make
other goods
Consumer Goods: final products

that are purchased directly by
the consumer

Economic System

1.5 Basic Economic Questions
Economic problems faced by an economic system due to
scarcity of resources; any human society should answer
the following basic economic questions.
a. What to produce :
 which product and in what quantity is profitable for producers
in terms of revenue or profit (Agricultural product,
manufactured good or service).
b. How to produce:
 what production method or technique to use and about what
inputs to use. This problem is also known as the problem of
choice of techniquelabour-intensive techniques and capital-
intensive techniques

1.5 Basic Economic Questions (Cont…)
c. For whom to produce:

 Identify our potential customers, whether farmers or students. This
problem is also known as the problem of distribution of national
product
d. Where to produce:
 It view the location of our production unit or distribution center
depends on the location of our potential customers.
e. When to produce:
 Determine the season of high demand for your product.

Economic Systems
These basic Economics problems are solved
differently in different Economic Systems
Economic System: The set of organizations
and institutions that are established to solve
the economic problems (What, How and for
whom?)
The economic system are different from
each other on the basis of,
The ownership of means of production
Who coordinate or lead the economic
activities

Economic System (Cont…)
Historically four forms of economic systems are observed
Traditional Economy
Command Economy
Free market economy system
Mixed Economic System
1. Traditional Economy
Economic Questions answered by custom and also Production and distribution
are coordinated by custom rule

Traditional Economies (Cont…)
Technological change and
innovation is constrained
by tradition
Economic activities are
considered secondary to
religion and cultural
values
Predominately Agricultural
Developing or “3rd World”
Trade and barter oriented
Low GDP & PCI (per capita income =
avg. inc.)
2. Command Economy system:
Resources are owned by the state
Economic activities are led by the central
government
Social welfare is a guiding factor for economic
activity
The role of Market and competition are eliminated
by law
Freedom of choice is curbed by what the society
afford for all.
Innovation, Quality of product are problems of
this system

11/18/2021 54
Command Economies
Def: Economic questions
answered by the government
Very little economic choice
No private ownership
Communism
Old Soviet Union, old
Communist China, Cuba and
North Korea

Karl Marx
19th century German economist
Author of “Communist
Manifesto” and “ Das Kapital”
◦ Government should control
economy and distribute goods and
services to the people
Founder of revolutionary
socialism and communism

Communism Falls
Market reforms in China in the mid
1970s.
Fall of the Berlin Wall in 1989.
Collapse of the Soviet Union 1991.
Free Market Capitalism (w/ some

Mixed Economies) the only show in
town.

3. Free market economy system
Resources are privately owned
The economic activities are led by
invisible hand
Self interest is the motivating factor
/ guiding force to carry out economic
activities
Competition is the regulating factor of
self interest
Freedom of choice
Government plays limited role.
The market economy is beloved to lead to
◦innovation and
◦quality of products
Public Goods, Externality, Market power are some of the problem of
this system
Laissez-faire - Government stays out of

business practices “hands off” to let the
market place determine production,
consumption and distribution.

Free Market (Capitalist) Economies
Economic questions answered
by producers and consumers
Limited-government
involvement
Private property rights
Wide variety of choices and
products
U.S., Japan

4. Mixed Economy System: It is the
hybrid of the Free and command
economy system
It supposed to combine the good
elements of both economy system

Mixed Economy/Socialism (Cont…)
Government involvement and
ownership and control of property,
of decision making, and
companies.
Government control of business
Social “safety net” for people
Socialism
Common in Europe, Latin America,
and Africa

1.7 Decision making units and THE CIRCULAR
FLOWS
Circular flow model is a model of the economy
that shows the circular flow of expenditures and
incomes that result from decision makers’ choices
Four Economic agents
◦ Households
◦ Business Firms
◦ Government
◦ Foreign sector

Elements of the two sector circular flow model
Households: are individuals or people living together
as decision-making units.
Firms: are institutions that organize production of
goods and services.
A market is any arrangement that brings buyers and
sellers together and enables them to get information
and do business with each other.
A market is a collection of buyer and sellers that
interact, resulting in the possibility for exchange

11/18/2021 64
The two sector circular flow con…
There are two flows in the economy:
a. real &
b. money/ financial/ flow
Money flows run in the opposite direction to the real flows.
1. In factor markets:
Households supply factors of production and firms hire or
buy factors of production.
2. In goods/service/product market:
Firms supply goods and services produced and households
buy goods and services.

The two sector Circular Flow.. The real flow
Households
Buy and consume goods and
services •Own and sell factors of
production
Factor Goods
Markets market
Firms •Produce
and sell goods and services
•Hire and use factors of
production
11/18/2021 66
The two sector Circular Flow.. The Financial flow
Households
Goods market Factor

Markets
Firms
11/18/2021 67
The Circular flow of economic activities
Birr Birr
Factor Goods
services
(3) (2)
P P Products
Factors S
market S
market
PF2
P2
PF1 P1
D2 D2
D1 D1
O QF1QF2 Q O Q1 Q 2 Q
Factor
services Goods
(4)
(1)
Factor
Birr Birr Consumer
supply
11/18/2021
demand
68 68
The Circular Flow Model
• Economic model illustrating the flow of
goods and services though the economy.
• In the model, producers are termed as "firms"
while consumers are referred to as
"households."
• Firms supply goods and services
Households consume these goods and
services.
• Factors of production (land, labor, capital) are
supplied by the household to firms and the
firms convert these into finished products for
household consumption
THANK YOU
Questions and Suggestions Welcome!!!!!!!
2014 E.C/2021 G.C
Addis Ababa University,

ETHIOPIA

AAU-Minda T. CH1

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Addis Ababa University

Name of instructor: Minda Tsega

Addis Ababa University,

AAU, INTRODUCTION TO ECONOMICS, MINDA T.

AAU, INTRODUCTION TO ECONOMICS, MINDA T.

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 Economics is the study of decision

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Unlimited wants: Society's wants for material goods and

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INTRODUCTION TO ECONOMICS, MINDA T.

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The steps involved in the inductive approach include

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SCARCITY: unlimited wants and

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Because ALL resources, goods,

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We make choices about how we spend our money, time,

What are NEEDS and WANTS?

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WANTS – “stuff” WE WOULD REALLY LIKE to have (big

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Wants: luxuries, fancy cars, vacations

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The Value of the Next Best Choice

(Ex: Sleeping is the opportunity cost of studying for a test)

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Q: What is the opportunity cost of buying pizza?

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Production efficiency is a situation in which

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The PPF describes three important concepts:

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Consumer Goods: final products

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c. For whom to produce:

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