THE FUNDAMENTALS OF ECONOMICS ECONOMICS from the Greek word oikonomia (oikos household; nomos to manage) which means

ns management of a household. is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people (Samuelson and Nordhaus: 1998) Two key ideas: 1. goods are scarce (SCARCITY) economic goods goods that are scarce or limited in supply Imagine, if infinite quantities of every good could be produced or if human desires were fully satisfied, what would be the consequences? o People would not worry about stretching out their limited incomes. o Businesses would not need to fret over the cost of labor. o Governments would not need to struggle over taxes, because nobody would care. o All goods would be free. Prices would be irrelevant. But, goods are limited. While wants are limitless. 2. society must use its resources efficiently (EFFICIENCY) Human wants are insatiable. Given unlimited wants, it is important that an economy makes the best use of its limited resources. Efficiency denotes the MOST EFFECTIVE USE of a societys resources in satisfying peoples wants and needs. The essence of economics is to acknowledge the reality of scarcity and then figure out how to organize society in a way which produces the most efficient use of resources. Adam Smith Scottish and is father of modern economics An Inquiry into the Nature and Causes of the Wealth of Nations (1776) the invisible hand theory

Why study economics? As part of the society, we make economic decisions or choices that actually have an impact on the society as a whole: 1. When we buy goods, we add up to the total consumption and subsequently, to the national income. 2. As voters, we are actually making decisions that will soon address or worsen issues such as government deficit, taxes, free trade, inflation, unemployment. 3. Choosing your occupation is the most important economic decision that you will make. Choice and Opportunity Cost 1. Making a choice normally involves a tradeoff. In simple terms, choosing more of one thing means giving up something else in exchange. Because wants are unlimited but resources are finite, choice is an unavoidable issue in economics. 2. Opportunity Cost There is no such thing as a free lunch. The cost of the forgone alternative. When we produce something out of scarce resources, there is an opportunity cost involved. MICROECONOMICS vs MACROECONOMICS 1. Microeconomics branch of economics which is concerned with the behavior of individual entities such as firms (producers or sellers), households (consumers or buyers), and markets. Alfred Marshall the Father of Microeconomic theory; first to develop the standard graphical representation of supply and demand curves. 2. Macroeconomics is the branch of economics which is concerned with the over-all performance of the economy. did not even exist in its modern form until 1935, when John Maynard Keynes published his revolutionary General Theory of Employment, Interest, and Money. Great Depression of the 1930s one-quarter of the American labor force were unemployed Keynes developed an analysis of what causes unemployment and economic downturns, how investment and consumption are determined,

how central banks manage money and interest rates, and why some nations thrive while others stagnate. Keynes also argued that governments have an important role in smoothing out the ups and downs of the economy. THREE FUNDAMENTAL ECONOMIC PROBLEMS 1. What commodities are produced and in what quantities? A society must determine how much of each of the many possible goods and services it will make and when they will be produced. Eg. Will we produce pizzas or t-shirts today? 2. How are goods produced? A society must determine who will do the production, with what resources, and what production techniques they will use. Eg. Who farms and who teaches? Will we use natural resource or alternative use of electricity? What techniques will we use? 3. For whom are goods produced? Who gets to eat the fruit of economic activity? How is the national product divided among different households? Are many people are poor and a few rich? Do high incomes go to managers or athletes, workers or landlords? Will society provide minimal consumption to the poor or must they work if they are to survive? POSITIVE ECONOMICS vs NORMATIVE ECONOMICS Positive Economics describes the facts of an economy; answers questions such as: o Why do doctors earn more than janitors? o Does free trade raise of lower wages? o What is the economic impact of raising taxes? o can be resolved by reference to analysis and empirical evidence Normative Economics involves value judgment; involves ethical precepts and norms of fairness; answers questions such as: o Should the poor be required to work if they are to get government assistance?

o o

Should the US penalize China because it is pirating US books and CDs? There are no right or wrong answers because they involve ethics and values rather than facts. They can be resolved only by political debate and decisions, not by economic analysis alone.

TYPES OF ECONOMIC SYSTEMS 1. Traditional Economy o An economy that is based on agriculture, fishing, hunting, gathering or some combination of the above. o Guided by traditions of the community, family, or religion. o Examples: Inuit or Eskimos in Northern Canada Barter system and the harvest season in the ancient Philippines usually located in Africa, Asia, Latin America and the Middle East 2. Market Economy o An economy in which individuals and private firms make the major decisions about production and consumption (i.e., what, how and for whom) o Consumption is determined by individuals decisions about how to spend their wages and property incomes generated by their labor and property ownership (the for whom). o Also known as the laissez-faire economy or the free market economy in which the government keeps its hands off economic decisions. o There has never been a 100% market economy, although 19th century England came close. 3. Command Economy o Also known as planned economy o An economy in which the government makes all important decisions about production and distribution. o Examples: Soviet Union (1922 and 1991) People's Republic of China (1949 to 1978) o The government answers the economic questions through its ownership of the countrys resources and its power to enforce decisions.

4. Mixed Economies o No contemporary society falls COMPLETELY into either market or command economy. o An economy with elements of market and command. SOCIETYS TECHNOLOGICAL POSSIBILITIES Inputs are commodities or services that are used to produce goods and services. Outputs various useful goods or services that result from the production process and are either consumed or employed in further production. Example 1. Production of pizza INPUTS: Eggs, flour, heat, pizza oven, chefs skilled labor OUPUT: pizza Example 2. Education INPUTS: time of the faculty, laboratories, classrooms, textbooks OUTPUTS: educated and informed citizens

could be bought or sold through the slave trade on the open market. In ancient Greece and Rome, 80% of the people were slaves. The slaves did all the manual work and even much of the clerical, bureaucratic and artistic work. On each agricultural plantation, the slave owner was king and lived in splendid luxury. Slave women were sexually exploited. All work was demeaning. Little technological advance and the economy stagnated. The Roman Empire was focused too much on conquering lands depleting their populations for slavery and tribute marked by population decline 3. Feudalism Feudalism in Western Europe grew out of the slave economy of the Roman Empire. The vacuum was filled by the creation of feudal hierarchy: 1. Kings 2. Nobility (barons) 3. knights 4. Serf or peasant tilled the land fief hereditary right to use land This was also an age during which the religious teaching of the Church had a very strong and pervasive influence throughout Western Europe. The Catholic Church was the largest owner of land during the Middle Ages. Ruling classes: 1. Religious lords; 2. Secular lords In return for very onerous appropriations of the serfs labor, produce, and money, the nobility provided military protection, and the church provided spiritual aid. Transition: The feudal class distinctions largely remained, but the manorial system began to break up. Trade expanded First Crusade (1905): people broke loose from their feudal ties and became traveling merchants. The Enclosure Movement much of the land that has been opened was fenced in (enclosed); a push in the 18th and 19th centuries to take land that had formerly been owned in common

HISTORY OF ECONOMICS 1. Primitive Society first socio-economic formation or structure in human history From the standpoint of archaeology, this period basically coincides with the Stone Age. All resources are held in common. There was no private ownership. predominance of custom, authority, respect, the power enjoyed by the elders of the clan Activities: hunting, gathering, tool-making Level of technology is so low; subsistence (the condition of managing to stay alive) is only marginal or very small in scale. "tragedy of the commons the depletion of a shared resource by individuals, acting independently and rationally according to each one's self-interest, despite their understanding that depleting the common resource is contrary to the group's long-term best interests 2. Slave Society Anyone might have become a slave through capture in war, piracy, or breaking the law. They

by all members of a village, or at least available to the public for grazing animals and growing food, and change it to privately owned land, usually with walls, fences or hedges around it. The Reformation began as a religious movement within the church aimed at correcting (reforming) certain specific abuses of spiritual power, particularly the sale of indulgences (certificates for partial remission of the punishment for sins already confessed and repented) Mercantilism for a country to become prosperous, it should rely more on trade, external relations and conquest; the development of a country will not occur unless it engages in international trade. Physiocracy an economic ideology that favors agriculture over international trade and believes that growth should start internally by developing agriculture; Physiocrats were actually concentrated in France and their ideology was supported by the monarchs. Industrial Revolution By 1750, over a century of successful exploration, slave trading, merchandising, piracy, and territorial conquest had made Great Britain one of the worlds wealthiest, most powerful nations. Considered to be the most fundamental transformation of human life in history. Textile industry was the most important in the early Industrial Revolution. Most important innovation was the development of steam engine Transformed England into a country of large urban manufacturing centers, where the factory system was dominant. Advantages Centre of economic life shifted from the villages to cities and towns where the factories were situated. Urban (cities) and rural (villages) life became dependent upon one another. Isolated life of selfsufficient villages came to an end. Men became free to develop their capabilities in areas other than farming. It brought countries and people together. There was an international awareness among people

because developments in one country influenced the others. The aristocracy and nobility with their feudal ideas were replaced by the newly rich middle class capitalists (bourgeoisie) who also became politically powerful. Better transport, communications and mechanized goods made life comfortable for man. Disadvantages Cities became crowded, smoky, with problems of slums, housing, sanitation, accidents and epidemics. Women and child labour was badly exploited. Workers suffered from long working hours, low wages, and unemployment, unsafe conditions of work, with no rights to vote strike or form trade unions. Society, became divided into rich and poor, the 'Haves' and the 'Have- Nots'. It led to wars of imperialism and colonization. 4. Capitalism economic system, dominant in the Western world since the breakup of feudalism, in which most of the means of production are privately owned and production is guided and income distributed largely through the operation of markets. 5. Socialism an economic system characterized by social ownership of the means of production and cooperative management of the economy "from each according to his ability, to each according to his contribution" government controls all means of production During the 1960s the Soviet Union became the first industrial country in history to suffer a prolonged peacetime fall in average life expectancy, a symptom of its disastrous misallocation of resources. Mikhail Gorbachev (perestroika and glasnost) 6. Communism is a revolutionary socialist movement to create a classless, moneyless and stateless social order structured upon common ownership of the means of production, as well as a social,

political and economic ideology that aims at the establishment of this social order. proletariat is that class in society which lives entirely from the sale of its labor and does not draw profit from any kind of capital "from each according to his ability, to each according to his needs

The most familiar and the most crucial input for an advanced industrial economy. 3. Capital o Durable goods of an economy which are produced in order to produce yet other goods. o Capital goods machines, roads, computers, automobiles. Farm fertilizer, seed, land, and labor and use them to produce wheat or corn Factories energy, raw materials, computerized machinery, and labor and use them to produce tractors, TVs, or tubes of toothpaste Airline takes planes, fuel, labor, and computerized reservation systems and provides passengers with the ability to travel quickly through its network of routes. Assume that the farm, factory, and airline always strive to produce efficiently, that is, maximum output at the lowest cost. Production Function Shows the relationship between the amount of input required and the amount of output that can be obtained. PROPERTIES OF THE PRODUCTION FUNCTION i. Monotonic a. Increasing the amounts of at least one input makes it possible to produce more output. b. Implies that the production function is positively sloped. ii. Concavity a. Concave means increasing at a decreasing rate THREE MEASURES OF PRODUCTION Total product designates the total amount of output produced Average product total output divided by the total units of input Marginal product of an input is the extra output produced by 1 additional unit of that input while other inputs are held constant; additional output obtained from adding a small amount of

PRICE ELASTICITY Price Elasticity of Demand or Supply measures the responsiveness of the quantity demanded / quantity supplied of a good or service to changes in its price. 5 LEVELS/CRITERIA: 1. perfectly inelastic: if Ed/Es is equal to 0 2. relatively inelastic: 0 < Ed/Es < 1 3. unit-elastic: Ed/Es is exactly equal to 1 4. relatively elastic: Ed/Es > 1 5. perfectly elastic: Ed/Es =

FORMULA Q2 Q1 Ed/Es = ______ Q1 + Q2 P1 + P2

________ P2 P1

PRODUCTION FACTORS OF PRODUCTION Another term for inputs Classified into THREE CATEGORIES: 1. Land o More generally, natural resources o Represents the gift of nature to our productive processes o Energy (oil, heat, etc) and nonenergy resources (copper, iron ore, sand) o Must include environmental resources such as clean air and drinkable water 2. Labor o Also known as the human resources o Human time spent in production o Eg. Baking pizza, teaching

2. Increasing returns to scale also called economies of scale; arise when an increase in all inputs leads to a more-than-proportional increase in the level of output.

3. Decreasing returns to scale occur when a balanced increase of all inputs leads to a lessthan-proportional increase in total output. In many processes, scaling up may eventually reach a point beyond which inefficiencies set in.

MARKET STRUCTURES Market Structure the selling environment in which a firm produces and sells its product Defined by three characteristics (determinants): Number of firms in the market Degree of product differentiation Ease of entry and exit of firms Short-run Production o A period in which firms can adjust production by changing variable factors such as materials and labor but cannot change fixed factors such as capital o Period too short to allow changes in the quantity of all inputs o fixed inputs: machines, building, land o variable inputs: quantity can be changed such as labor and raw materials Four Basic Market Structures 1. Perfect Competition (or Pure Competition) a. happens when numerous small firms compete against each other. Firms in a competitive industry produce the socially optimal output level at the minimum possible cost per unit. b. A perfectly competitive market has the following characteristics: i. There are many buyers and sellers in the market ii. The goods offered by the various sellers are largely the same iii. Firms can freely enter or exit the market c. Refers to a market in which no firm or consumer is large enough to affect the market place. Each buyer and seller takes the market price as given. Thus, each buyer and seller is a price taker. 2. Monopoly a. A market structure in which a commodity or service is supplied by a single firm. b. A monopoly firm has no competitors in its industry. It reduces output to drive up prices and increase profits. By doing so, it produces less than the socially optimal

Long-run Production o Period long enough to allow changes in the quantity of all inputs o all factors of production are variable including capital o How the output of a business responds to a change in factor inputs is called returns to scale Returns to Scale the effects of scale increases in inputs on the quantity produced. Three important cases 1. Constant returns to scale denote a case where a change in all inputs leads to a proportional change in output.

output level and produces at higher costs than competitive firms. c. Example: MERALCO Electric Company (Consumers have no choice on who they want to provide service for their electricity) d. In the long-run, no monopoly is completely secure from attack by competitors. 3. Oligopoly a. an industry with only a few firms. If they collude, they reduce output and drive up profits the way a monopoly does. However, because of strong incentives to cheat on collusive agreements, oligopoly firms often end up competing against each other. b. Examples of oligopolists: oil cartel - a cartel of companies or nations formed to control the production and distribution of oil Cell phone companies (Nokia, Samsung, Apple); Four music companies control 80% of the market - Universal Music Group, Sony Music Entertainment, Warner Music Group and EMI Group Automobile industry (Toyota, Mitsubishi, Ford), telecommunications (Smart, Globe) 4. Monopolistic Competition a. an industry contains many competing firms, each of which has a similar but at least slightly different product b. occurs when a large number of sellers produce differentiated products c. differs from perfect competition in that the products sold by different firms are not identical d. Examples: Restaurants all serve food but of different types and in different locations Companies producing hair products like Sunsilk (Unilever), or Head & Shoulders (Procter and Gamble); milk products like Nido (Nestle) and Alaska Milk (Alaska Milk Corporation)

BUSINESS ORGANIZATIONS Business firms are specialized organizations devoted to managing the process of production. Important functions: Exploiting economies of mass production o Efficient production requires specialized machinery and factories, assembly lines, and the division of labor into many small operations. Raising resources for large-scale production o In a private-enterprise economy, most funds for production must come from company profits or from money borrowed in financial markets. Organizing factors of production o Production cannot organize itself. Someone has to supervise the construction of a new factory, negotiate with labor unions, and purchase materials and supplies. TYPES OF BUSINESS ORGANIZATIONS Individual proprietorship o This type of business is large in number, but small in total sales. o Simplest business form run by one person Partnership o Any two or more people can get together and form a partnership. Each agrees to provide some fraction of the work and capital, to share some percentage of the profits, and losses or debts. Corporation o A form of business organization owned by a number of individual stockholders. o Shareholders control the companies they own. They collect dividends in proportion to the fraction of the shares they own and they elect directors and vote on many important issues.