Lecture 1

Introduction to
Economics

Reading:
Sloman and
Garratt,
chapter 1

Prepared by:
Dr. Bawani
ECN1014 Lelchumanan
INTRODUCTORY (DEF, SBS)
ECONOMICS
 LEARNING OUTCOMES
(LO)
After this lecture, you should be able to:
LO1: Identify scarcity as the central problems of
economics
LO2: Explain basic economic ideas
LO3: Apply production possibilities analysis to
illustrate:
 Various production combinations
 Relationship between scarcity, choice and opportunity cost
 The law of increasing and constant opportunity cost
 Unemployment and economic inefficiency
 Economic growth
LO4: Explain how, and assess the desirability of,
different economic systems in allocating scarce
resources
MICROECONO
MICS VERSUS
MACROECON
OMICS
THE ECONOMIC PROBLEM

What is economics about?

choices involving production and consumption
the problem of scarcity: the central economic problem
scarcity and the factors of production
• labour
• land and raw materials
• capital
• entrepreneur
scarcity and demand and supply
• importance of reconciling demand and supply
• actual and potential demand and supply
SCARCITY, CHOICE AND
OPPORTUNITY COST

Economics is concerned with how individuals,

institutions, and society allocate limited resources under
conditions of scarcity.
Scarcity means limited resources (labour, land, capital
and entrepreneurs) relative to unlimited needs and wants.
As such, we cannot have everything, therefore we must
make choices in what we will have and decide what we
must forgo or sacrifice.
What we forgo is called opportunity costs.
 MICROECONOMICS IS
CONCERNED WITH ...

INDIVIDUAL
BEHAVIOURS
and small-scale economic factors

Decision Carried debts Spending habits

making
 MACROECONOMICS IS
CONCERNED WITH ...

GROUP BEHAVIOURS
and large-scale economic factors

Economic National Global

growth productivity Economy
MICROECONOMICS:
CHOICES TO MAKE
Because resources are scarce, choices
have to be made in relation to the
following aspects:
 What to produce
 How to produce
 For whom to produce

Remember that as a choice implies that

the second-best option must be sacrificed,
therefore there is always an opportunity
cost.
MICROECONOMICS: RATIONAL
CHOICES

Economics assumes that human behaviour reflects

“rational self-interest”.
 Consumption decisions are driven by a desire for increasing
utility (or satisfaction).
 Production decisions are driven by a desire for increasing
profit.

Some issues:

 Do individuals always behave rationally?

 Is rational self-interest the same as selfishness?
 Are individuals’ decisions necessarily leave those around
them unaffected?
 In economics studies,
“marginal” means “extra” or
“additional”.
MICROECON Rational decision-making
OMICS: involves comparing marginal
MARGINAL benefit and marginal cost.
ANALYSIS
A rational decision-maker
takes an action only if
marginal benefit exceeds
marginal cost.
 MICROECONOMI
CS: EFFICIENCY
AND EQUITY
As microeconomics are
concerned with the allocation
of scarce resources, there are
implications on:
Efficiency
 Productive efficiency: production at the
minimum cost
 Allocative efficiency: production which gives
consumers maximum satisfaction
Equity
 Are resources fairly allocated and distributed?
 Are certain parties unfairly excluded?
MACROECONOMICS

Because of scarcity, societies must ensure that

• Resources must be fully utilized

• National output should grow over time

Macroeconomic problems are related to imbalance between

aggregate demand and aggregate supply.

• Inflation
• Balance of trade
• Recession
• Unemployment
ECONOMIC STATEMENTS
Positive Normative
• Focuses on facts and cause-and- • Incorporates value judgments about
effect relationships. what the economy should be like or
what particular policy actions should
• Includes description, theory be recommended to achieve a
development, and theory testing. desirable goal.
• Tries to establish scientific • Looks at the desirability of certain
statements about economic behavior aspects of the economy.
and deals with what the economy is
actually like. • “what ought to be”
• “what is” • E.g. Your opinion that the
government should spend more
• E.g. Increase in demand will money on health service compared
increase price and government to defence or that the government
spending will lead to growth. should cut taxes on profit even if it
has to cut spending.
• Will this subsidy removal increase
the price of other related goods?

13
PRODUCTIO
N
POSSIBILITI
ES CURVE
 ASSUMPTIONS OF
PRODUCTION
POSSIBILITIES CURVE

Society uses its scarce resources to

produce different goods and services.
In a condition of scarcity, society
faces many production alternatives
and needs to make choices.
Such decisions can be illustrated by
production possibilities, which
assumes the following:
 Full employment
 Fixed resources
 Constant technology

A production possibilities curve (PPC)
shows different combinations of
maximum goods and services a society
can produce with a fixed number of
resources and constant technology.
 A production possibility curve

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)
4
8 0.0
3 7 2.2
6 4.0
5 5.0
2
4 5.6
3 6.0
1 2 6.4
1 6.7
0 0 7.0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
 A production possibility curve

8
a
7

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)
4
a 8 0.0
3 7 2.2
6 4.0
2 5 5.0
4 5.6
3 6.0
1 2 6.4
1 6.7
0 0 7.0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
 A production possibility curve

7 b

6
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)
4
8 0.0
3 b 7 2.2
6 4.0
5 5.0
2
4 5.6
3 6.0
1 2 6.4
1 6.7
0 0 7.0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
 A production possibility curve

6 c
Units of food (millions)

5 Units of food Units of clothing

(millions) (millions)
4
8 0.0
3 7 2.2
c 6 4.0
5 5.0
2
4 5.6
3 6.0
1 2 6.4
1 6.7
0 0 7.0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
 A production possibility curve
8

7 w
6 x
Units of food (millions)

0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
 The PPC is concave towards the
PPC: origin, a property which reflects
INCREASING the law of increasing opportunity
OPPORTUNI cost.
TY COST Opportunity cost increases because
resources are not equally adaptable
to alternative productions.

 As production of cars expands, additional

workers which are more suited for producing
computers may have to be transferred to the
production of cars.
 But these workers are less productive in
producing cars.
 Therefore, an ever-larger number of computers
must be sacrificed for the sake of raising the
production of cars by an equal amount.
 Increasing opportunity costs
8

6 x
Units of food (millions)

1 y
5
1
4
2
3
z
1
2

0
000000000011111111112222222222333333333344444444445555555555666666666677777777778
......... ......... ......... ......... ......... ......... ......... .........
123456789123456789123456789123456789123456789123456789123456789123456789
Units of clothing (millions)
PPC: SCARCITY, CHOICE AND
OPPORTUNITY COST

Scarcity Choices Opportunity cost

• The amount of • An economy can at • When production
goods and services most maximise moves from B to C,
an economy can production by fully production of
produce is defined utilising all computers must be
by the production existing resources, reduced in order to
possibilities curve. as indicated by raise the
• Point A represents point B and C. production of cars.
a higher but
unattainable
production due to
scarcity of
resources.
 PPC: Scarcity, Choice and Opportunity Cost
Computers
Scarcity:
Point A – beyond the curve
Any output combination outside the
curve is impossible.

O Cars
 PPC: Scarcity, Choice and Opportunity Cost
Computers Choice:
Point B or C – on the curve
A country’s can only choose any
B output combination (either B or C,
10 but not both) which can be afforded
by its maximum potential.
A

3 C

O 5 10 Cars
 PPC: Scarcity, Choice and Opportunity Cost
Computers

B
10 A

–7

3 C
+5

O 5 10 Cars
 PPC: Law of Increasing Opportunity Cost
Computers When the economy moves from A to D, it
must give up successively larger amounts
of computers (1, 3 and 4) to acquire equal
A increment in cars (1, 1 and 1).
10
-1 B
9
+1
-3
6 C
+1
-4

2 D
+1

O 7 8 9 10 Cars
 Recap: PPC shows the various
combinations of two goods which
PPC: can be produced with a given
UNEMPLOYMENT
AND ECONOMIC number of resources and constant
INEFFICIENCY technology when the economy is
at full employment.
With unemployment, the economy
would produce less than the
maximum potential, as represented
by any point which falls within the
PPC.
Full employment or economic
efficiency takes place with an
economy operating along the PPC,
stretching itself to the maximum
potential.
 PPC: Unemployment and Economic Inefficiency
Computers
Full employment or economic
efficiency is achieved when an
economy operates along the PPC,
B as represented by point B and C.

A
Any point inside the PPC,
such as point A, represents
unemployment or economic
inefficiency for failing to fully
utilise existing resources.

O Cars
 Making a fuller use of resources

x
Production inside
Food

the production y
possibility curve

PP

O
Clothing
 Resources and technology are
likely to evolve over time,
PPC: thereby shifting the position of
ECONOMIC PPC and changing the potential
maximum output of the
GROWTH economy.

Consider the impact on PPC of

the following events:
 An increase in or discovery of resource
supplies
 Improvement in resource qualities
 Technological advancement

When PPC shifts outwards, the

production of both goods can be
increased simultaneously.
 Growth in potential output

Growth in potential output

shown by outward shift in the
PP curve.
Food

Now

PP1

O
Clothing
 Growth in potential output

5 years’ time
Food

Now

PP2
PP1

O
Clothing
 Growth in potential and actual output

Growth in actual output

y shown by movement from
x to y
x
Food

PP2
PP1

O
Clothing
 PPC: Economic Growth
Computers
Economic growth takes place when
the PPC shifts outward. Production
of one output can be increased
without reducing the other.

O Cars
ECONOMIC
SYSTEMS
AND
RESOURCE
ALLOCATIO
N
 SCARCITY, ECONOMIC
DECISIONS AND
SYSTEMS
Due to scarcity, each economy
must decide:
• What should be produced
• How to produce
• For whom to produce
Different economic systems are
featured by different extent to
which the government decides
how resources should be
allocated to deal with scarcity.
• Planned or command
economy
• Free-market economy
• Mixed economy
 Usually associated with a
socialist or communist state,
in a command economy
PLANNE virtually all economic
decisions are taken by the
D OR central authority.
COMMA Planning can be studied from
ND three angles:
ECONO Resource allocation between current
consumption and future investment (i.e.
MY what should be produced)
Output determination (i.e. how to
produce)
Output distribution (i.e. for whom to
produce)
 ECONOMIC SYSTEMS

The command economy

features of a command economy
planning
• consumption and investment
• matching of inputs and outputs
• distribution of output

Advantages of a command economy

high investment, high and stable growth
social goals pursued
low unemployment
ECONOMIC
SYSTEMS

Problems of a command economy

problems of gathering information
expensive to administer
inefficient allocation of resources
• inappropriate incentives
• no system of prices
o shortages and surpluses
o lack of response to consumer demand
FREE-MARKET
ECONOMY
In a free-market economy, virtually all
economic decisions are taken by individual
households and firms and the government plays
very minimal role.
Main features of a free-market economy:
Individual liberty in making economic decisions
Importance of the price system as a rationing mechanism
Reflective of spontaneous changes in demand and supply
Constant interaction between goods market and factor
market
ECONOMIC
SYSTEMS

The mixed market economy

Economic reasons for government
intervention
allocative role

distributive role

macroeconomic role