LESSON #00B

INTRODUCTION TO ECONOMICS
COR2100 ECONOMICS AND SOCIETY
WONG FOT CHYI
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 Lesson Outline
 Introduction to Economics
➢ The Economic Problem of Scarcity and Choice
 Economic Perspectives
➢ Trade-Offs and Opportunity Cost
➢ Rational and Purposeful Behaviour
➢ Economic Cost of Resources
➢ Marginal Analysis
➢ Accounting Profit vs Economic Profit
➢ Individual’s Economising Problem

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 Lesson Outline
 Individual’s Economising Problem
➢ The Consumer’s Budget Line
 Society’s Economising Problem
➢ Production Possibility Frontier
➢ Specialization, Exchange, Comparative Advantage
 Organization of Economic Systems
 The Methods of Economics
➢ Theories and Models

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 Textbook’s Chapter Reference
 Daron Acemoglu, David Laibson, John A. List (2018) Economics, 2nd
Global Edition, Pearson ISBN-10: 1-292-21450-3

➢ Chapter 1: The Principles and Practice of Economics

➢ Chapter 2: Economic Methods and Economic Questions
➢ Chapter 3: Optimization: Doing the Best You Can

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 Introduction to Economics

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 What is Economics?
 Economics is the social science that studies the
choices made by individuals, businesses,
governments, and societies as a whole as they
cope with scarcity and the incentives that
influence and reconcile those choices.

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 The Economic Problem of Scarcity and Choice

 Scarcity and choice are the two central concepts

in economics:
➢ Goods are scarce because our unlimited wants far
outstrip their availability from nature.
➢ Scarcity forces us to choose among available
alternatives.
➢ Making choices in the face of scarcity involves trade-
off of one objective against another.

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 The Three Basic Questions

 Every society has some system or process that transforms its

scarce resources into useful goods and services.
 In doing so, it must decide (1) what gets produced, (2) how it is
produced, and (3) to whom it is distributed.
 The primary resources that must be allocated are land, labor,
and capital.
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 Economic Perspectives

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 Trade-Offs and Opportunity Cost
 Scarcity and choice
➢ Resources are scarce, but wants are unlimited
➢ Choices, involving trade-offs, must be made

➢ Making decisions requires comparing the costs and

benefits of alternative choices.
➢ The relevant cost for decision making is opportunity
cost.
❖Opportunity cost of any item is the highest-valued
alternative that must be given up to get it.
❖“There's no free lunch”
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 Trade-Offs and Opportunity Cost
 Guns or Butter
“Every gun that is made, every warship launched, every
rocket fired signifies, in the final sense, a theft from those
who hunger and are not fed, those who are cold and are
not clothed. This world in arms is not spending money alone.
It is spending the sweat of its laborers, the genius of its
scientists, the hopes of its children . . . This is not a way of
life at all in any sense. Under the cloud of threatening war,
it is humanity hanging from a cross of iron.”
– Dwight D. Eisenhower, 16 April, 1953

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 Trade-Offs and Opportunity Cost
 Some examples of trade-offs due to scarcity:
➢ Going to a party the night before your mid-term
leaves less time for studying.
➢ Having more money to buy stuff requires working
longer hours, which leaves less time for leisure.
➢ Protecting the environment requires resources that
could otherwise be used to produce consumer goods.

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 Rational and Purposeful Behaviour
 Purposeful behaviour
➢ Economic agents are rational and self-interested in
achieving their desired outcomes
➢ Rational consumers or individuals maximize their
utility or satisfaction from consumption
➢ Rational firms or producers maximize their profit by
producing and selling goods and services

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 Economic Cost of Resources
 Opportunity cost is:
➢ What firm owners must give up to use resources to
produce goods and services
 Market-supplied resources
➢ Owned by others and hired, rented, or leased
 Owner-supplied resources
➢ Owned and used by the firm

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 Total Economic Cost
 Total Economic Cost
➢ Sum of opportunity costs of both market-supplied
resources and owner-supplied resources
 Explicit Costs
➢ Monetary opportunity costs of using market-supplied
resources
 Implicit Costs
➢ Non-monetary opportunity costs of using owner-
supplied resources

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 Types of Implicit Costs
 Opportunity cost of cash provided by owners
➢ Equity capital (money provided to businesses by the
owners)
 Opportunity cost of using land or capital owned by
the firm
 Opportunity cost of owner’s time spent managing or
working for the firm

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 Economic Cost of Using Resources

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 Economic Profit vs Accounting Profit
Economic profit = Total revenue – Total economic cost
= Total revenue – Explicit costs – Implicit costs
Accounting profit = Total revenue – Explicit costs

 Accounting profit does not subtract implicit costs from

total revenue
 Firm owners must cover all costs of all resources used by
the firm
➢ Objective is to maximize economic profit

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 Implicit and Explicit Costs Example
Mo Tak Ting Pizzeria @ Toa Payoh
 You owned a shop in Toa Payoh that you used to run a small
pizzeria. An adjacent shop of similar size was being rented out for
$60,000 per year.
 To get the business started, you quit your job as an engineer which
paid you $80,000 a year, and withdrawn $10,000 from your
savings account for the initial set-up. The balance of your savings
in the bank account was earning interest at 5% per year.
 During the first year of operation, food supplies were the only
materials you needed and purchased.
 At the end of the year, your accountant informed you that these
supplies cost $20,000 and that your revenues were $100,000.
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 Implicit and Explicit Costs Example
Mo Tak Ting Pizzeria @ Toa Payoh
 Questions:
➢ What were your explicit costs and implicit costs?

➢ What were your accounting profit and economic profit?

➢ Should you continue with your pizzeria business?

Please see lesson video for answers.

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 Marginal Analysis
 Marginal Analysis
➢ A rational economic agent compares costs and benefits
to achieve the greatest benefit over cost for the choice
made.
➢ Decisions are based on comparison between marginal
benefit and marginal cost.
➢ Marginal benefit (MB) = the benefit from pursuing an
incremental increase in an activity.
➢ Marginal cost (MC) = the opportunity cost of pursuing an
incremental increase in an activity.
➢ If MB > MC, then do more of that activity
➢ If MB < MC, then do less of that activity
➢ If MB = MC, then the level of that activity is optimal
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 Marginal Analysis: Example #1
 Marginal Analysis
➢ SQ Flight from Singapore to Bangkok is ready to
depart. All passengers with ticket reservation are on
board. There are 5 empty seats in the Economy class.
There are some standby passengers hoping to catch
this flight. What is the marginal cost of filling up the
flight?

Please see lesson video for answers.

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 Marginal Analysis: Example #2
 Marginal Analysis
➢ Memorial Hospital’s CEO Memorial made 500 deliveries
conducted performance reviews originally
of the hospital departments (see Fixed cost: $1,000,000
Variable cost: $3,000/delivery
box). Total cost: $1,000,000 + ($3,000 x
➢ During this process, the chief of 500) = $2,500,000
obstetrics proposed an increase Average cost: $2,500,000 / 500 =
in the number of babies being $5,000/delivery
Fee charged per delivery: $4,500
delivered in his department.
➢ The CEO wondered why since
the cost of delivering babies Please see lesson video for answers.
was higher than the revenues
brought in.
Should Memorial increase the number of babies delivered?
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 Marginal Analysis: Relevant Costs
 In marginal analysis, sunk costs and fixed costs are
totally irrelevant in decision making:
➢ Sunk costs are costs that have previously been paid
and cannot be recovered
❖ Example: administrative expense of CEO office
➢ Fixed costs are costs that are constant and must be
paid no matter what level of an activity is chosen
❖ Example: medical equipment in the operating
theatre

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 Incentives
 Incentives
➢ Incentive: something that induces a person to act, i.e.
the prospect of a reward or punishment.
➢ Rational economic agents (people or firms) respond to
incentives or disincentives:
➢ When gas prices rise, consumers buy more hybrid cars and
fewer gas guzzling SUVs.
➢ When cigarette taxes increase, teen smoking falls.
➢ When US imposed import tariffs on steel, Harley-Davidson
planned to relocate its motorcycle manufacturing plant
overseas to reduce its cost of production.
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 Individual’s Economising Problem

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 The Economizing Problem

 The economizing problem

➢ Limited income and unlimited wants
 The budget line
a. Attainable and unattainable combinations
b. Trade-offs and opportunity costs

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 The Consumer’s Budget Line
❑ Consumer with income I = $120 to spend on DVDs and books.
❑ Price of a DVD, Pd = $20; Price of a book, Pb = $10
12 DVDs
The Budget Line: Combinations of DVDs and
Books Attainable with $120
10
Units of Units of Income = $120
DVDs Books Total =6
(Price = $20) (Price=$10) Expenditure
Pd = $20
8
6 0 $120 Unattainable
5 2 $120 6
4 4 $120
Income = $120
3 6 $120 4 = 12
Pb = $10
2 8 $120
2
Attainable
1 10 $120
0 12 $120
Books
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0
2 4 6 8 10 12 14
 Society’s Economising Problem

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 Society’s Economizing Problem
❑ For the economy as a whole, resources are scarce
❑ 4 categories of economic resources

➢ Land
➢ Labour

➢ Capital
➢ Investment [Note: this refers to spending on factory,
machinery and equipment, and NOT on financial
investments such as stocks and bonds.]
➢ Entrepreneurial ability

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 Production Possibility Frontier
 Production Possibility Frontier (PPF): shows different
combinations of goods and services that society can
produce in a fully employed economy, assuming a fixed
availability of supplies of resources and fixed
technology.
➢ Full employment
➢ Fixed resources
➢ Fixed technology
➢ 2-good economy, e.g.
✓ Consumer goods and capital goods

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 Production Possibility Frontier
 Weighing Present and Expected Future Costs and
Benefits
➢ We trade off present and future benefits in small
ways all the time.
 Capital Goods and Consumer Goods
➢ Consumer goods: goods produced for present
consumption.
➢ Capital goods: goods that are used in producing
other goods, rather than being bought by consumers.
✓ The process of using resources to produce new capital is
called investment.
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 Production Possibility Frontier
 The PPF illustrates a number of economic concepts. One of the most
important is opportunity cost.
 PPF separates region of

Capital Goods
attainable production from
region of unattainable Unattainable
production. PPF F
 Examples: A
➢ Point F is unattainable B
➢ Points A, B, C, D and E are
attainable C
➢ Points A, B, C and D are E
efficient, with full-employment
Attainable
of resources
➢ Point E is inefficient, with D
unemployed resources 0
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 Production Possibility Frontier
 The PPF illustrates a number of economic concepts. One of the most
important is opportunity cost.
 The opportunity cost of

Capital Goods
producing more consumer
goods is fewer capital goods,
and vice versa. PPF F
 Moving from A to B, the A
amount of consumer goods ΔY ABB
increases by ΔX, but the ΔX C
amount of capital goods E
decreases by ΔYAB.
➢ i.e. opportunity costs of
consumer goods = (ΔYAB/ΔX) D
of capital goods. 0
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 Production Possibility Frontier
 The PPF illustrates a number of economic concepts. One of the most
important is opportunity cost.
 Opportunity costs of one unit

Capital Goods
consumer goods in terms of
capital goods:
PPF F
➢ A to B: ΔYAB/ΔX
A
➢ B to C: ΔYBC/ΔX
ΔY AB B
➢ C to D: ΔYCD/ΔX
ΔX
 Note that for the same ΔX, ΔY BC C
E
ΔYCD > ΔYBC > ΔYAB: ΔX

Law of Increasing Opportunity Costs ΔYCD

D
0
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 Production Possibility Frontier
 The PPF illustrates a number of economic concepts. One of the most
important is opportunity cost.
 What is the opportunity cost to

Capital Goods
society of moving from Point E
to Point A or Point B or Point
C? PPF F
A
B

C
Please see lesson video for answers. E

D
0
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 Production Possibility Frontier
 Economic Growth is reflected in the outward shift of the PPF.
 An increase in the total output
of an economy. It occurs when

Good Y
a society acquires new
resources or when it learns to
produce more using existing PPF
resources.
➢ Land
➢ Labour
➢ Capital
➢ Entrepreneurial ability
➢ Improvement in technology

0
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 Production Possibility Frontier
 Economic Growth is reflected in the outward shift of the PPF.
 Question:
➢ What will cause the PPF to

Good Y
shift inward?

PPF

0
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 Organisation of Economic Systems

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 The Economic Problem
 Recall the three basic questions facing all economic
systems:
➢ What gets produced?

➢ How is it produced?

➢ Who gets it?

 Given scarce resources, how do large, complex

societies go about answering the three basic economic
questions?

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 Economic Systems and the Role of Government

Command Economies
 command economy An economy in which a central
government either directly or indirectly sets output
targets, incomes, and prices.
Laissez-Faire Economies: The Free Market
 laissez-faire economy Literally from the French:
“allow [them] to do.” An economy in which individual
people and firms pursue their own self-interest
without any central direction or regulation.

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 Economic Systems and the Role of Government

 Market: The institution through which buyers and

sellers interact and engage in exchange.
 Some markets are simple and others are complex,
but they all involve buyers and sellers engaging in
exchange.
 The behavior of buyers and sellers in a laissez-faire
economy determines what gets produced, how it is
produced, and who gets it.

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 Mixed Systems, Markets, and Governments

 The differences between command economies

and laissez-faire economies in their pure forms
are enormous.
 In fact, these pure forms do not exist in the
world.
 All real systems are in some sense “mixed.”

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 The Methods of Economics

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 The Method of Economics
 Economics deals with two kinds of questions: positive and
normative.
 Positive Economics: An approach to economics that seeks
to understand behaviour and the operation of systems
without making judgments. It describes what exists and
how it works.
➢ A positive statement can be tested by checking it against facts.
 Normative Economics: An approach to economics that
analyses outcomes of economic behaviour, evaluates them
as good or bad, and may prescribe courses of action. Also
called policy economics.
➢ A normative statement expresses an opinion and cannot be
tested.
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 The Method of Economics
Two Main Branches of Economics
 Microeconomics: The branch of economics that examines
the functioning of individual industries and the behaviour
of individual decision-making units—that is, firms and
households.
➢ looks at the individual unit—the household, the firm, the
industry. It sees and examines the “trees.”
 Macroeconomics: The branch of economics that examines
the economic behaviour of aggregates—income,
employment, output, and so on—on a national scale.
➢ looks at the whole, the aggregate. It sees and analyzes the
“forest.”
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 Theories and Models
 Model: A formal statement of a theory, or part of a
theory, usually a mathematical statement of a
presumed relationship between two or more
variables.
 Variable: A measure that can change from time to
time or from observation to observation.
 Ockham’s Razor: The principle that irrelevant detail
should be cut away.
➢ Abstraction from unimportant details = necessary to
understand the functioning of anything as complex as the
economy
➢ Proper degree of abstraction depends on the objective of

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the analysis: risk of over-simplification
 Theories and Models
Which of these 3 maps, Map 1, 2 or 3, is most useful for navigation from one place to another?

 Map1: Detailed Road Map of Los Angeles

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 Theories and Models
Which of these 3 maps, Map 1, 2 or 3, is most useful for navigation from one place to another?

 Map 2: Major Los Angeles Arteries and Freeways

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 Theories and Models
Which of these 3 maps, Map 1, 2 or 3, is most useful for navigation from one place to another?

 Map 3: Greater Los Angeles Freeways

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 Theories and Models
Which of these 3 maps, Map 1, 2 or 3, is most useful for navigation from one place to another?

 Map 3: Greater Los Angeles Freeways

There is no such thing as one “right”

degree of abstraction and
simplification for all analytic purposes.
The proper degree of abstraction
depends on the objective of the
analysis. A model that is a gross
oversimplification for one purpose
may be needlessly complicated for
another.”

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 Theories and Models
 ceteris paribus, or All Else Equal: A device used to
analyse the relationship between two variables while
the values of other variables are held unchanged.
 Using the device of ceteris paribus is one part of the
process of abstraction.
 In formulating economic theory, the concept helps us
simplify reality to focus on the relationships that
interest us.

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 Theories and Models
Expressing Models in Words, Graphs, and Equations
 Graphs and equations capture the quantitative side of

economic observations and predictions.

 Economists are interested in cause and effect, but sorting

out causality from correlation is not always easy: statistical

correlation need not imply causation
➢ post hoc, ergo propter hoc (or in short: post hoc fallacy): Literally,
“after this (in time), therefore because of this.” A common error
made in thinking about causation: If Event A happens before
Event B, it is not necessarily true that A caused B.
 Empirical Economics: The collection and use of data to
test economic theories.
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 End of Module

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