CHAPTER ONE

Basics of Economics
Definition

Economics is a social science which studies about the efficient allocation of scarce resources so as to attain the
maximum fulfillment of unlimited human needs and wants.

Branches

• Microeconomics – deals with the decisions and interactions of households and firms in a specific market.
• Macroeconomics – deals with the effects of the aggregate behavior of all decision-making units in a certain
economy.

➢ Positive economics – is concerned with analysis of facts and attempts to describe the world as it is.
➢ Normative economics – evaluates the desirability of alternative outcomes based on one’s value judgement.

Reasoning

Inductive – logically reaches at a general correct statement based on independent and specific correct ones.

Deductive – logically arrives at a particular correct statement starting from a general correct one.

Basic Concepts

• Scarcity – A scarce/economic resource is when the amount available to a society is less than what people
want to have at zero price. Its four categories are land, labor, capital, and entrepreneurship.
Shortage is when people are unable to get the amount they want at the prevailing price. Shortage is a specific
and short-term problem while scarcity is a universal and everlasting problem.
• Choice – is the allocation/production of one resource/product over another due to scarcity.
• Opportunity cost – is the amount or value of the next best alternative that must be sacrificed in order to
obtain one more unit of a product.
• Production possible frontier/curve – shows the various possible combination of two goods or services that a
society can ideally produce given its fixed quality and quantity of resources and technology. Moving along
the curve obeys the law of increasing opportunity cost due to the specialization effect of economic resources.

Basic Questions

• What to produce? (The problem of allocation of resources)

• How to produce? (The problem of choice of technique, either labor-intensive or capital-intensive)
• For whom to produce? (The problem of distribution of national product)

Systems

Economic system – is a set of organizational and institutional arrangements established to answer the basic
economic questions.
 Capitalism (Free-Market/Market/Laissez-Faire)

Advantages Disadvantages

✓ Flexibility or adaptability ➢ Inequality of income

✓ The right to private property ➢ Unbalanced economic activity
✓ Consumer sovereignty ➢ Exploitation of labor
✓ Decentralization of economic power ➢ Negative externalities
✓ Increase in per-capita income
✓ New types of consumer goods
✓ Profit motive and competition
✓ Growth of entrepreneurship
✓ Optimum utilization of resources
✓ High rate of capital formation

Command (Socialistic)

Advantages Disadvantages

✓ Absence of wasteful competition ➢ Absence of price mechanism

✓ Balanced economic growth ➢ Absence of incentives for hard-work and
✓ Social welfare efficiency
✓ Elimination of private monopolies and ➢ Lack of economic freedom
inequalities ➢ Red tapes

Mixed

Advantages Disadvantages

✓ The right to private property ➢ Ineffectiveness and inefficiency

✓ Profit motive and price mechanism ➢ Economic fluctuations and unemployment
✓ Adequate freedom ➢ Corruption and black markets
✓ Rapid and planned economic development
✓ Social welfare

Decision-Making Units and the Circular Flow Model

• Households – are one or more persons who live under one roof and make joint financial decisions. They sell
their resources and buy goods and services.
• Firms – are production units that use economic resources to produce goods and services. They sell their
products/services and buy economic resources.
• Government – is an organization that has legal and political power to control or influence households, firms,
and markets. It buys economic resources and goods and services, and also provides public goods and services
for the society.

➢ Product market – is where firms sell their products/services to households and the government.
➢ Factor/Input market – is where households sell their resources to firms and the government.

Circular flow diagram – is a visual model of an economy that shows how money, economic resources, and goods
and services flow through markets among the decision-making units. It could be a two-sector model or three.