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What do Economists Study?

Economics studies people at work,
producing the goods
Its studies people as a consumer, buying
the goods
It studies government influencing the level
& pattern of production and consumption
Licensing, tax, subsidy.

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What we will cover in this course?

Consumption and consumer

Production and producer
Price and Costs
Market and consumer behavior.
Market and producer behaviour
Price level and Inflation
Investment and Savings
Factors of Production
Fundamentals of Macroeconomics
National Income Accounting
International Trade and Foreign exchange

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Chapter 1
Economic Issues and
Concepts

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Learning Outcomes
Modern market economy uses price signals to
solve the complex problems involved in using
resources to produce goods and services that
people want
How Economics studies the choice between
competing demands for scarce resources
Interaction between production, employment and
consumption decisions
The Market economy generally delivers outcomes
desired by consumers
Governments step in when markets fail to
produce results that are regarded as successful

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The Complexity of the modern economy

Self Organization
The great insight of the early economists was that an economy
based on free market transaction is self organizing

Efficient Organization
Efficiency is initiated due to scarcity. So resources are organized to
produce efficiently with maximum total output.

A Planned Alternative
Command economy communism, in which the govt. plans all of
the economic transaction vs. Market economy.

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Main characteristics of market economies

Individuals pursue their own self-interest, buying and

selling what seems best for themselves.

People respond to the incentives. Other things being
equal, sellers seek higher price and buyer seek lower
prices.
Prices are set in open markets.
People earn their income by selling their services to
those who wish to use them.
All of these activities are governed by a legal framework
largely created by the state.

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Resources and Scarcity

Kinds of Resources:
(a) Land, (b) Labour,
(c ) Capital and (d) Entrepreneurs

Ownership of Resources:
Private ownership

Kinds of Production:
Goods and Services
production, consumption

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Choice and Opportunity Cost

The concept of opportunity cost highlights the
choices that must be made by measuring the
cost of anything that is chosen in terms of the
alternative that could have been chosen instead.

The production Possibility Boundary

(PPF, PPC)
Choice, Scarcity and Opportunity cost
illustrated.

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Production Possibility Frontier

A Curve/Frontier showing all the possible
combinations of two goods that a country
can produce within a specified time period
with all its resources fully and efficiently
employed.
A single PPF illustrates three concepts
Scarcity, Choice and Opportunity cost.

A Production-Possibility Boundary

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Unattainable combinations

Production possibility
boundary
Attainable
combinations

0
Quantity of public sector goods

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Scarcity, Choice and Opportunity cost.

Scarcity Shown by unattainable
combination beyond the boundary d
Choice arises as we have to select one of
the point on or inside the PPF
Opportunity cost shown by the negative
slope of the PPF

A Production-Possibility Boundary

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c0

Unattainable combinations

Production possibility
boundary
Attainable
combinations

g0
Quantity of public sector goods

A Production-Possibility Boundary

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c0

Unattainable combinations
d

Production possibility
boundary
Attainable
combinations
c1

b
c

g0

g1

Quantity of public sector goods

A Production-Possibility Boundary

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Unattainable combinations

c0

Production possibility
boundary

C
Attainable
combinations
c1

b
c

g0

g1

Quantity of public sector goods

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A production-possibility boundary
The quantity of public sector goods produced is
measured along the horizontal axis.
The quantity of private sector goods is measured along
the vertical axis.
Any point on the diagram indicates some amount of
each kind of good produced.
The production-possibility boundary separates the
attainable combinations, such as a, b, and c, from
unattainable combinations, such as d.
Points a and b represent efficient uses of societys
resources.
Point c represents either an inefficient use of resources
or a failure to use all the resources that are available.

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A production-possibility boundary
The boundary is negatively sloped because in a fully
employed economy more of one good can be produced
only if resources are freed by producing less of other
goods.
Moving from point a (with coordinates c0 and g0) to point
b (with coordinates c1 and g1) implies producing an
additional amount of public sector goods, indicated by
G in the figure
The opportunity cost of this increase in G is a reduction
in private sector goods by the amount indicated by C.

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Three Key Issues

What should be produced?
which point on the PPF?

Efficient Production not inside the PPF.

Economic Growth Shift in the PPF

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The effect of economic growth on the production possibility boundary

Economic growth shifts the boundary outwards.

Some combinations of goods that were
previously unattainable become attainable.

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The Effect of Economic Growth on the Production-Possibility Boundary

Production possibility
boundary before growth

0
Quantity of public sector goods

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The Effect of Economic Growth on the Production-Possibility Boundary

Production possibility
boundary before growth
Production possibility
boundary after growth

0
Quantity of public sector goods

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Who makes the choice and how

The Flow of income and
expenditure

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The Circular Flow of Income and Expenditure

Goods
Market

Individuals
(consumers)

Firms
(producers)

Factor
Market

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The Circular Flow of Income and Expenditure

Goods
Market

Individuals
(consumers)

Firms
(producers)

Factor
Market

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The circular flow of income and expenditure

The yellow line shows the flows of goods and
services while the red line shows the payments
made to purchase these.
Factor services flow from individuals who own the
factors (including their own labour) through factor
markets to firms who use them to make goods and
services (yellow arrow).
The goods and services then flow through goods
markets to those who consume them (yellow arrow).
Money payments flow through factor markets from
firms to individuals (red arrow).
When individuals spend this income buying goods and
services, money flows through goods markets back
to producers (red arrow).

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CHAPTER 1: ECONOMIC ISSUES AND CONCEPTS

The Complexity of the Modern Economy

A market economy is self-organising in the sense that when
individuals act independently to pursue their own self-interest,
responding to prices set on open markets, they produce coordinated and relatively efficient economic activity.

Resources and Scarcity

Scarcity is a fundamental problem faced by all economies because
not enough resources - land, labour, capital, and entrepreneurship are available to produce all the goods and services that people
would like to consume.
Scarcity makes it necessary to choose among alternative
possibilities: what products will be produced and in what quantities
and how these products to be produced.

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CHAPTER 1: ECONOMIC ISSUES AND CONCEPTS

The concept of opportunity cost emphasises scarcity and

choice by measuring the cost of obtaining a unit of one
product in terms of the number of units of other products
that could have been obtained instead.
A production-possibility boundary shows all of the
combinations of goods that can be produced by an
economy whose resources are fully employed.
Movement from one point to another on the boundary
shows a shift in the amounts of goods being produced,
which requires a reallocation of resources.

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CHAPTER 1: ECONOMIC ISSUES AND CONCEPTS

Who Makes the Choices and How

Modern economies are based on the specialisation
and division of labour, which necessitate the
exchange of goods and services.
Exchange takes place in markets and is facilitated by the use
of money.

Much of economics is devoted to a study of how markets work

to co-ordinate millions of individual, decentralised decisions.

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Practical Alternative to Market

economy
Three pure types of economy can be distinguished: traditional,
command and free market.
Traditional System: the behaviour primarily depend on the tradition,
custom and habit. Production is based on the traditional techniques,
distribution based on the long established tradition.
Command System: Some central authority decided the economic
behaviour. It makes most of the decision on what to produce, how to
produce and for whom to produce.
Pure Market System: The decisions of buyers and sellers,
production and consumption all are determined with the help of
market forces.
In practice, all economies are mixed economies in that their
economic behaviour responds to mixes of tradition, government
command, and price incentives.

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CHAPTER 1: ECONOMIC ISSUES AND CONCEPTS

Governments play an important part in modern mixed

economies.
They create and enforce important background
institutions such as private property.
They intervene to increase economic efficiency by
correcting situations where markets do not effectively
perform their co-ordinating functions.
They also redistribute income and wealth in the
interests of equity.

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Role of the Government in the modern

economy
Regulate the Prices of Goods and Commodities taxing,
subsidizing
Regulate Income Income tax, welfare benefits,
unemployment benefits
Regulate the pattern of production and consumption
legislation for producing illegal goods, provision of
education and defense
Solving the macroeconomic problem such as
unemployment, inflation, balance of payment crisis,
control of bank lending and interest rates.