Introduction to

Applied Economics
Economics has been
defined as a social
science that deals
with the allocation Defining
Economics
of scarce resources
to meet unlimited
human wants.
5 Dimensions In the Development of the
Definition of Economics

Social
Allocation Scarcity
Science

Human
Resources
Wants
Economics as a
Social Science
 The earlier definition of economics is the science
Economics as a study of wealth-getting and wealth-using

It deals with production and consumption

of wealth:

Economics is all about wealth and how this

wealth is being used by individuals and society at
large for material survival, stability, and
development.
 Economics is the
Defining science of making
Economics choices.
 • The more current
definition of economics is
a science of making
Economics as a choices.
Study of • Whether it is wealth-
Making Choices getting or wealth-using,
we make decisions.
• Opportunity Cost - Costs
or sacrifices for each
decision
Economics as a Social
Science
• Economics is primarily a social
science.
• The systematic or scientific method
is being used in the study of society
and its components.
• Economics pertains to the study on
how society creates its material
wealth, how it makes this wealth
available, and how it expands its
wealth.
Resources and the
Study of Economics
• Natural Resources – water,
trees, gas (used as inputs)

• Human Resources – labor,

intelligence, creativity,
talents, etc.
• Physical Resources – man-
made resources, buildings,
equipment, technology,
Resources and the
Study of Economics
• Resources are limited
• Resources can be used in
various productive and
distributive activities.
• The concept of
opportunity cost
becomes prominent
Human Wants

• Resources are used to

answer human wants.
• Society must respond to
the ever expanding and
multiplying human
wants considering the
limited wealth of
society.
Scarcity
• Limitation of resources
to answer the
expanding human
wants.

• Society has to survive

materially, but
resources are limited.
 • It is a social science that
Economics deals with the study of
as a Study of allocation of scarce
Allocation resources to answer the
unlimited human wants.
Allocation

• Social mechanism used

to respond to the
economic problem of
scarcity.

• How society deals with

scarcity.
Allocation

• Market system – buyers and

sellers

• Command system –
government takes charge

• Traditional system – social

structure, norms, beliefs
Economics as an
Applied Science
• Many of the principles,
laws, and theories in
economics can be
applied to various
fields.
Understanding Decisions Using
Economic Analysis
Cost-Benefit
Analysis
• In any decision-making
process, an individual is
motivated by benefits.
• Benefits can be returns,
profit, satisfaction,
depending on the
decision maker.
Cost-Benefit
Analysis
• Costs can be money, time,
resources or other goods.

• In making any decisions,

we must weigh and
compare the benefits
derived and the costs
incurred.
 • What is important is not the absolute
value of benefits and costs but the
additional or marginal benefits and
costs.
Marginal
Analysis • It is an examination of the additional
benefits of an activity compared to the
additional costs incurred by that same
activity.
Marginal Analysis

• Marginal analysis refers to the focus on the cost or

benefit of the next unit or individual.

• For example, the profit of producing one more product

vs the cost of hiring an additional worker.
Short Run • In the short run, capital is fixed
Production • Only changes in the variable
labor input can change the
level of output
• Short run production function:
Q = f (L, K) = f (L)
• When discussing
production in the
short run, three Production in
definitions are
important. the Short Run
• Total Product
• Marginal Product
• Average Product
AVERAGE PRODUCT (AP)
• The average product (AP) of an input is the total product divided by the level of the
input.

• Average product tells us, on average, how many units of output are produced per
unit of input used.

Output Q
AP  
Labor Input L
MARGINAL PRODUCT (MP)

 The marginal product (MP) of a variable input is the change in output (or TP)
resulting from a one unit change in the input.

 Marginal product tells us how output changes as we change the level of the
input by one unit.

Output Q
MPL  
Labor Input L

Slide 25
 Total, Average, & Marginal Products of Labor, K = 2
(Table 8.2)

Number of Total product (Q) Average product Marginal product

workers (L) (AP=Q/L) (MP=Q/L)
0 0 -- --
1 52 52 52

2 112 56 60
56.7 58
3 170
55 50
4 220
51.6 38
5 258
47.7 28
6 286 43.4 18
7 304 39.3 10
8 314 35.3 4
9 318 31.4 -4

10 314
Total, Average, & Marginal Products K = 2
Total, Average, & Marginal Product Curves

Q2

Q1 Total product

Panel A
Q0

L0 L1 L2

Panel B

Average product

L0 L1 L2
Marginal product
 Stage I
Stage I • From zero units of the variable input to where
AP is maximized

The Three
Stages of
Stage II Stage II
Production • From the maximum AP to where MP=0

Stage III Stage III

• From where MP=0
 • In the short run, rational firms should only be
operating in Stage II.
• Why not Stage III?
• Firm uses more variable inputs to
The Three produce less output!
Stages of • Why not Stage I?
• Underutilizing fixed capacity.
Production • Can increase output per unit by
increasing the amount of the variable
input.
 • Average product of labor
• AP = Q/L
• Marginal product of labor
• MP = Q/L

Average & • When AP is rising, MP is greater than AP

• When AP is falling, MP is less than AP
Marginal
• When AP reaches it maximum, AP = MP
Products • Law of diminishing marginal product
• As usage of a variable input increases, a point is
reached beyond which its marginal product
decreases