CHAPTER 1: introduction OF ECONOMICS

LEARNING OUTCOMES:

At the end of this chapter, you should be able to:

• Interpret the definition of economics and distinguish between micro and

macroeconomics
• Describe three basic economic problem:
- What and how much to produce
- How to produce
- For whom to produce
• Identify the three economic concepts: scarcity, choice and opportunity cost
• Discuss and illustrate the production possibilities curve (PPC)
• Differentiate the four types of economic system
a. Capitalism (free market)
b. Central planned
c. Mixed economic
d. Islamic economic
- Discuss the advantages and disadvantages of each world economic
system
- Describe how the world economic system solve basic economic problems

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DEFINATION OF ECONOMICS

 Economics is a field of social science

 studies the behavior of individuals and society
 in the distribution of limited factors of production
 to fulfill man’s unlimited wants and demands

FACTOR OF PRODUCTION (ECONOMIC RESOURCES / INPUT)

1) LAND 2) LABOUR
3) CAPITAL 4) ENTREPRENEUR

1) LAND
- All natural resource on surface of earth or within the earth
- The supply of land is fixed in location and geography
- The value of land is dependent on quality and location
- The payment for land is RENT

2) LABOUR
- Services contributed by people in the production process
- May be skilled or unskilled
- Contribute physical and mental energy
- Can moved from one location to another
- Differ in efficiency and productivity. The payment for labour is a WAGE

3) CAPITAL
- Consist of assets such as money, equipment, machinery and raw materials
which used in production process
- Capital can be moved from one location to another and can be increased
or decreased.
- The payment for capital is a DIVIDEND

4) ENTREPRENEUR
- Person with skills and ability to manage a firm efficiently and profitably
- Be as a leader, planner, coordinator and manager of the activities of a firm
- Bear to take risks
- The payment for the effort and risks of entrepreneurship is PROFIT.

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ECONOMIC GOODS

▪ To fulfill the wants of society

Divided into three categories:

i) Economics goods
ii) Free goods
iii) Public good

i) ECONOMICS GOODS
Divided into three => consumer goods, capital goods and intermediate goods

Consumer goods
▪ Are final goods (Finished goods)
▪ Directly give satisfaction to the consumer
▪ Classified into durable goods (radio, tv, computer) and perishable good
(food, seafood)

Capital goods
▪ Used to produce others good.
▪ Example: machinery and factories

Intermediate goods
▪ Also known as producer goods or semi products
▪ Used as input in production of other goods
▪ Example: sugar is final goods when sold in the supermarket and
intermediate goods when used to make candy
▪ Not counted in a country’s GDP – if happen mean will cause double
counting

ii) FREE GOODS

▪ Essential for life
▪ Unlimited supply – use without any cost
▪ Example: air and water
 Due to pollution clean air and water may no longer be free

iii) PUBLIC GOODS

▪ Funded by government through taxation
▪ Individuals and communities are not exempt from using public goods
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FIELDS OF ECONOMICS
- Divided into microeconomics and macroeconomics
MICROECONOMIC
Studies the behavior and decisions of
individual entities such as households, firms
and market
- specific economic units
Known as price theory:
Studies and discuss how the individuals,
household, firm and industry making decisions
on what to buy and how markets allocate
resources among alternative ends.
Analyzes the economic entity in detail
Examples:
a) Production
- Individual, firm and industry
- Analyze demand and supply
b) Prices
- Individual goods and services
c) Income
- Distribution among factors of
production
d) Employment
- Analyzes household demand supply
of labour in an industry
It sees and examines the “trees”.
MACROECONOMIC
Studies the aggregate behavior of the entire
economy as a whole
- Overall levels of economic activity
Known as the theory of income determination:
Looks at the gross domestic product, the
national income, public finance, income,
unemployment, output, inflation, business
cycles and international trade and others.
Analyzes the economic unit in general
a) Production
- Gross Domestic Product (GDP), Gross
National Product (GNP),
- Aggregate demand and aggregate
supply
b) Prices
- Average price, Consumer Price Index
(CPI) or inflation
c) Income
- Total national income, total profits
d) Employment
- Analyzes total employment and
unemployment in the economy
It sees and analyzes the “forest”.
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BASIC ECONOMIC PROBLEMS

1) What to produce

➢ The economy of every nation has to take a fundamental decision of what to produce
because of the limited resources.

➢ Every society must ensure the sufficient production of every type of goods to fulfill the wants
of economy as a whole. Should more clinics be built than schools? How many cars should be
produced? The problem of what to produce is solved in different ways in different economy
systems. In a capitalist economy, this problem is solved through the price mechanism, which
reflects consumers’ taste (determined by power of supply and demand)

2) How much to produce

➢ Every society must choose the type and the quantity of goods and services that it will
produce.

➢ Due to limited factors of production, producer must identify the quantity of demand in the
market to avoid wastage of factors of production

3) How to produce it

➢ This refers to the cheapest method of production.

Labour intensive and capital intensive.

➢ Should cars be produced by automatic machines or assembly line workers in India?

If the cost of labour is less than the cost of capital, the producer selects the labour intensive
production method vice versa

4) For whom to produce it

➢ Refers to distribution patterns of income, affordability and society’s purchasing power.

➢ Who will drive the latest model of an imported car? People with the higher income will
able to afford more goods, while people with lower income can afford fewer goods

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 ECONOMIC PROBLEMS

BACIC ECONOMIC CONCEPTS: SCARCITY, CHOICE, AND OPPORTUNITY COST

▪ In economics, society is faced with limited factors of production, which is the problem of scarcity.
Limited or scarce resources force individuals and societies make choices when trying to satisfy
their unlimited wants. Choices involve sacrifice. When peoples make a choice, opportunity cost
will occur. There are three basic economic concepts: scarcity, choice and opportunity cost.

1) PROBLEM OF SCARCITY

▪ Occur when goods and services are limited compared man’s unlimited want and desirers
 Individual
scarcity of time (study, entertainment) and money (pay fees, purchase food, drinks
and clothes)
 Firms
scarcity of capital by limited economic resources
 Government
scarcity of financial and source of revenue to build basic amenities (clinics, school, roads)

2) PROBLEM OF CHOICE

▪ When people faced with problems of scarcity – Society must make the best choice possible
after considering the available alternatives.
 Individual
need to make choices in order to maximize satisfaction
 Firms
need to make choices in order to maximize profits
 Government
need to make choices based on priorities to fulfill wants of society

3) PROBLEM OF OPPORTUNITY COST

▪ Refer to the second best option that will have to be forgone in order to select the best option.
 Individual
Example:
Dini has RM15 and she wants to buy shirt and a pair of shoes which cost RM 15 each.
If the Dini choose to purchase shoes, the shirt is the opportunity cost because it is the
second best alternative which she has to forgo.

 Firm
❖ Between new business or to takeover an existing business

 Government
❖ Constructing hospital and recreational park.
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 PRODUCTION POSSIBILITIES CURVE (PPC)

➢ The concepts of scarcity, choice and opportunity cost can be illustrated through a production
possibilities curve (PPC).

➢ This curve shows the:

Maximum production limits of two goods that an economy can produce simultaneously
(pada masa yang =) at a fixed technology level and with limited resources

There are FOUR (4) specific assumptions to explain the PPC:

1. The economy only produces two goods.

o Example: shoes and cloths

2. The economy achieves full efficiency.

- Economy is operating in full employment and full production capacity

3. The level of technology is fixed and unchanging.

- The state of technology does not change throughout production.

4. Economic resources are fixed in quantity and quality.

- The amount of resources available is fixed.

A numerical example can be shown as follow:

Table: 1.1 Production Possibilities Schedule
Combinations Food (units) Clothing (units)
A 0 10
B 1 9
C 2 7
D 3 4
E 4 0

EXPLAINATION:
1) Combinations A, B, C, D and E is the best possible combination of resource the country
can be produced.

2) The table show, when the production of food is increased, the production of clothing
must be decreased.
For example: The beginning using max resource the country can be produce 10 unit of
clothing and 0 qty for food. When the production of food is increased by 1 unit, the
production of clothing must be decreased by 1(10-9) units. When the production of food
is further increased to 2 units, the production of clothing must decrease by 2 (9-7) units.

3) The situation occurs due to scarcity of production in the economy

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 Clothing (units)

A Choice
B
• G (scarcity)
C
•F
(achievable but Opportunity cost
wastage & D
inefficiency)

E Food (units)

Figure 1.1 Production Possibilities Curve

EXPLAINATION:

1) A PPC shows all combination of output that could be produced

2) The points A, B, C, D and E indicate the level of production that can be achieved with
maximum efficiency of production.

3) Point F is an achievable level of production but wastage and inefficiency will occur.

4) Point G indicated an unattainable level of production where the combination

of goods and services cannot be achieved. When the country wants exceed output,
there is scarcity.

5) The problem of choice shown by any points (A, B, C, D and E)

- movement along PPC

6) The PPC slopes downward from left to right indicate the problem of opportunity cost.
- The amount of goods or services that must be forgone in order to increase
production of another good

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 SHAPES OF PRODUCTION POSSIBILITIES CURVES

Can be represented in three shapes:

ITEM TABLE CURVE EXPLAINATION

Shows the principle of
Good X Good Y Good Y Increasing opportunity
0 10 cost
1 9 1y for 1x
2 7 2y for 1x Means that in order to get
3 4 more unit of good X, more
Concave 3y for 1x
4 0 unit of another good
4y for 1x (good Y) would have been
sacrificed
Good X

Shows the principle of

Good X Good Y Good Y decreasing opportunity
0 10 cost
1 6 4y for 1x
2 3 3y for 1x Means that in order to
Convex 3 1 Obtain one more unit of
2y for 1x good X, less units
4 0
1y for 1x of another good (good Y)
Good X should be sacrificed

Shows the principle of

Good X Good Y Good Y constant opportunity
cost.
0 9 3y for 1x
1 6 Indicates that as more unit
2 3 3y for 1x of a good X is produced,
Linear 3 0 the same number of units
3y for 1x of another good (good Y)
Good X would have been sacrificed

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FACTOR THAT INFLUENCES THE SHIFT OF THE PPC
Four factors will shift the production possibilities curve (PPC) to the right or left and
may also shift outwards or inwards.
PPC shift to the right or outwards
1. Increased inputs and resources
- Happen when a country expansion through
investment.
- Labour force can also increase due to an
increase in labour productivity, as people
receive training and seek additional
education.
2. Improved level of technology
- Improvement in the level of technology
due to successful research and development
(R & D) will enhances efficiency.
- Output will increase due to new innovations,
new technique of production or development
of a better way of producing goods and services
3. Increased economic growth
- With economic growth, the production
capability of country increases as there is
an expansion of resources, such as land,
labour, capital and entrepreneurship.
- The increase in output is due to the
availability of new resources, machinery
and an increase in productivity.
4.Increased population
- A larger population will result in an
increase in production because the number
of people who willing to work increase.
- At the same time, the bigger the population
the higher the demand of goods and
services in the country.
Factors PPC shift to the left or inwards.
1. Reduced inputs and resources
- When amount of input or resources
reduces in the economy, a nation will not
able to produce more goods and services
2. Inferior technology
- When country is facing inferior
technology, a nation has less ability to
produce more goods and services.
3. Economic downturn or recession
- When a country is stuck by natural
disaster such as tsunami, a hurricane or
an earthquake, natural resources are
either exhausted or reduced.
- Recession reduces a nation’s income, and
the nation will not be able to increase
the number of inputs to produce more
good and services.
5. Decrease in population
- When the number of populations
reduces,
i) The number of people who willing to
work also decrease.
ii) The demand of goods and services will
less. Thus, resulting in less production
goods and services.
- As a result, will reduce the production
of goods and services.
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The PPC curve can shift to the right or to the left and shift outwards or inwards can be
illustrated as below:

Good Y

- The PPC will shifts to outwards

due to positive factors and will
shift inwards because of
negative factors

Good X
Figure 1.2
Good Y

- The PPC shifts outwards

and inwards towards
Good Y

Good X
Figure 1.3

Good Y

- The PPC shifts outwards

and inwards towards
Good X

Good X

Figure 1.4

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