Rift Valley University

Harar campus

Introduction to Econonics

Chapter one
Introduction
 Contents of the Chapter
1.1 Meaning and Definition of Economics
1.2 Branches of Economics
1.3Economic Resources, Scarcity, Choice, Opportunity Cost and
Production Possibility Frontier
1.4 Basic Economic Problems
1.5Decision making units and the circular flow model

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 1.1.Meaning of the word ‘Economics

• The word ‘Economics’ originates from two Greek

words ‘Oikos' and ‘nomos’
–‘Oikos’ meaning ‘Home’
–‘Nomos’ meaning ‘Management’
Hence, Economics means ‘Home Management’
Economics is one of the most exciting disciplines
in social sciences.
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 Definition of Economics
 Economics is the study of how individuals and societies choose to allocate
and use scarce resources to satisfy unlimited wants.

 In the definition it embedded four key words:

 Scarcity- a situation where the amount of something available is
insufficient to satisfy the desire for it.
 choice-Scarcity implies choice

 Resources-The labor, capital, land and natural resources and entrepreneurship

that are used to produce goods and services.
 Unlimited wants – without limits, infinite

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Cont..

The core of economics is ‘Choices’

The fundamental economic activities are

production and consumption

The aim of economics is optimizing given resources

(both scarce and surplus) and achieving growth
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Cont.….

Generally ECONOMICS – is a social

science that deals with how people
organize themselves in order to
allocate scarce resources to
produce goods and services to satisfy
the unlimited wants and needs
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 1.2. Rationales of Economics
There are two fundamental facts that laid or provide the
foundation for the field economics (The rationales of
Economics).
I. Human wants are unlimited.
II. The available resources to satisfy these wants are
limited.
The imbalance between the unlimited wants and the
limited resources to satisfy these wants is called
Scarcity.
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 1.3.Scope of Economics
• There are two branches of economics
– Micro Economics
• It
is also called Price Theory
– Macro Economics
• It is also called Income Theory

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A. Microeconomics - is the study of economics at individual level.
 It is a branch of economics which is concerned with the behavior of
individual economic agents.
 It studies the behaviours of individual decision makers in a particular
market and the interaction among individual markets.
 Microeconomics studies about:-
 Consumers’ satisfaction
 Buying and selling decisions of the firm
 The determination of prices in markets
 The quantity, quality and variety of products
 Profits
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The central problem of microeconomics is price
determination and allocation of resources.
Its main tools are the demand and supply of particular
commodities and factors.
 It helps to solve the central problem of what, how and for
whom to produce‘ in an economy so as to maximize profits.
 Discusses how the equilibrium of a consumer, a producer or
an industry is attained.
 Examples: Individual income, individual savings, individual
prices, an individual firm‘s output, individual consumption,
etc.

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B. Macroeconomics is the study of the economy as a whole. i.e, it
studies economic variables at aggregate level.
 Macroeconomics studies about:-
 Economic growth
 National income
 Unemployment and inflation
 Aggregate demand and aggregate supply
 Economic policies – fiscal and monetary Policy
 International trade – exports and imports
 Money supply
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 The central problem of macroeconomics is the determination of
the level of income and employment.
 Its main tools are aggregate demand and aggregate supply
of an economy as a whole.
 Helps to solve the central problem of full employment of
resources in the economy.‘
 Concerned with the determination of equilibrium levels of
income and employment at aggregate level.
 Examples: national income, national savings, general price
level, national output, aggregate consumption, etc.
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1.4. Resource, Scarcity, Choice, Opportunity Cost and Production
Possibility curve
 Resources can be classified as : free and Scarce (economical)
resources.
 Free resources: A resource is said to be free if the amount
available to a society is greater than the amount people desire at
zero price. E.g. sunshine i.e Qs> Qd, at zero price
 Scarce (economic) resources: A resource is said to be scarce or
economic resource when the amount available to a society is
less than what people want to have at zero price. i.e Qd>Qs
 Economic resources, in economics, are Land, Capital, Labour
and Entrepreneurship.
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 Cont’d
Land :- the term Land is used to describe all the natural resources;
includes agricultural Land, forest, mineral deposits, fisheries,
rivers, lakes, oil deposits, etc.
The return for Land is called Rent.
Capital:- the term Capital refers to all man-made resources
which aid to production.
Thus, machinery, equipment, tools, factories, storage,
transportation, etc.., which are used in the production of new goods
and service are called Capital resources.
The return for capital is called rent.
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Labour:- in economics labour refers to human effort, both physical and
mental, which is directed to the production of goods and services.
For example, factory worker, clerk, typist, teacher, doctor, Judge,
Physicist, etc.,
The payment for labour is called Wage.
Entrepreneurial ability:- is the ability to take risks and organize or
bring other factors of production together to produce goods and services.
Entrepreneurship is the taking of production risks and business creation
An entrepreneur is a person who organizes the other resources of
production and undertakes the risks and uncertainties involved in
production.
The reward for entrepreneurship is profit.
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Note: Scarcity does not mean shortage.
Scarcity is a fundamental economic problem that any
human society faces (if the amount available is less than
the amount people wish to have at zero price).
Scarcity is a universal and everlasting problem
But Shortage is a specific and short-term problem
Shortage occurs when people are unable to get the amount
of goods and services they want at the prevailing or
ongoing price
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Choice
If resources are scarce, then the output will be limited.
If the output is limited, then we cannot satisfy all of our wants.
Thus, a choice must be made.
Due to the problem of scarcity, individuals, firms, and governments are
forced to choose as to what output to produce, in what quantity, and what
output not to produce.
In short, scarcity implies choice.
Choice in turn, implies a cost. That means whenever a choice is made, an
alternative opportunity is sacrificed.
This cost is known as opportunity cost.

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 Opportunity Cost
Opportunity Cost is the amount or value of the next best alternative that must
be sacrificed (forgone) in order to obtain one more unit of a product.

 Scarcity implies choice

 When we make a choice again, it has a cost. This is because once we choose to
use a resource for some purpose, it will no longer be available for other
purposes. In economics, such cost is termed as Opportunity Cost.
When we say opportunity cost, we mean that:
 It is measured in goods & services but not in money costs
 It should be in line with the principle of substitution.
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 1.5 Basic Economic Problems
The economic problem sometimes called the basic, Central, or
fundamental economic problems.
Three main economic questions arise from scarcity and implied
choice:
 what to produce is the problem of allocation of resources
 how to produce/ the problem of choice of technique
 for whom to produce/ the problem of distribution of national
product
These questions are answered differently according to the
economic system a country adopts.
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 Cont…

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 1.7 Decision making units and the circular flow model

There are three decision making units in a closed economy.

These are households, firms and the government.
a) Selling of their resources, and
1) Households make two decisions.
b) Buying of goods and services

2) Firms also make two decisions: a) Buying of economic resources

. b) Selling of their products

3) Government also provides some types of goods and services
known as public goods and services for the society.
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The three economic agents interact in two markets:
Product market: it is a market where goods and services are transacted/
exchanged.
That is, a market where households and governments buy goods and
services from business firms.

Factor market (input market): it is a market where economic units

transact/exchange factors of production (inputs).

In this market, owners of resources (households) sell their resources to

business firms and governments
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The circular-flow diagram is a visual model of the economy that
shows how money (Birr), economic resources and goods and
services flows through markets among the decision making units.

For simplicity, let‘s first see a two sector model where we have only
households and business firms. In this case, therefore, we see the
flow of goods and services from producers to households and a
flow of resources from households to business firms.

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