Principles of Economics.

Production possibility frontier (PPF)

The word ‘Economics’ was derived from Greek word (aikonomos), where by oikos (a  Branches of Economics
house) and nomos (to manage) which would mean ‘managing the household’ (household
management) using the limited funds available, in the most satisfactory manner possible The branches of economics are divided into two units these are “Microeconomics &
Macroeconomics.”
 Definition of economics
Microeconomics
Economics refers to the study of human behaviour on how to allocate scarce resources so
as to produce goods and services in order to satisfy human wants. Micro means small. Micro economics refers to a branch of economics which studies the
Economics analyses how human beings make choices in an effort to maximize utility. It behaviour of individual economic units such as; price determination of a commodity
also analyses how a society seeks to allocate their limited resources in other to achieve (goods), behaviour of consumers or producers (firms) etc.
growth.
Microeconomics analyses the economic behaviour of any particular decision-making unit
IMPORTANCE OF STUDYING ECONOMICS. such as a household or a firm. Microeconomics studies the flow of economic resources or
factors of production from the households or resource owners to business firms and flow of
i. It helps to build up a body of principle and furnish the economist with lots of goods and services from business firms to households. It studies the behaviour of
economic analysing that will enable students to understand current economic problem individual decision-making unit with regard to fixation of price and output and its reactions
and to see the economics consequence of perusing a particular time of policy. to the changes in demand and supply conditions. Hence, microeconomics is also called
ii. It helps in interpreting economic issues rising from government and non-government price theory. Or What is Microeconomics? Micro means too small. Microeconomics is the
policies. branch of economics which deals with the choice and decision-making behaviour of the
iii. It helps in managing personal life and that of the society. individual household, firms and industries, and the relationship between prices and
iv. It helps to distinguish various economic systems such as capitalist, socialist and mixed quantities of individual goods and services. It is concerned on how individual firm decide
economy. how to allocate scarce resources (how they answer three basic economic problems/
v. It explains economic theories and shows how they apply to a particular economy. questions) to minimize costs of production. It studies economic behaviour of individual
Economic theories are simplified representation of the real word that we use to economic entities like household, firm/industry and economic variables, e.g. individual
understand, explain and predict economic phenomena in the real world. They can be prices, individual incomes, individual wages etc
inform of statements or graphs.
vi. Helps in discussion and analysis of international economic issues and dealing. Macroeconomics
vii. It helps students to use the terminologies, language and symbolism of the subject
clearly and communicate economic ideals. Macroeconomics studies the behaviour of the economic system as a whole or all the
decisionmaking units put together. Macroeconomics deals with the behaviour of aggregates
The Scope of Economics like total employment, gross national product (GNP), national income, general price level,
etc. So, macroeconomics is also known as income theory. Microeconomics cannot give an
This covers the following: idea of the functioning of the economy as a whole. Similarly, macroeconomics ignores the
individual’s preference and welfare. What is true of a part or individual may not be true of
The branches of economics
the whole and what is true of the whole may not apply to the parts or individual decision-
The nature of economics
making units. By studying about a single small-farmer, generalization cannot be made
Basic problem of economics
about all small farmers, say in Tamil Nadu state. Similarly, the general nature of all small
Fundamental problem of economics
farmers in the state need not be true in case of a particular small farmer. Hence, the study
Economic systems
of both micro and macroeconomics is essential to understand the whole system of
 economic activities. Or What is macroeconomics? macro means too large. Economics as a body of systematised knowledge is concerned with both the question, what
Macroeconomics Is the branch of economics which is chiefly concerned with the is and what ought to be. Economics science is concerned with both what is and what out to
behaviour of and relationship between aggregate variables which affect the economy as a be. Economics is thus both a positive and normative science.
whole, e.g. national income, total output, total consumption, total savings, total
investment, total money supply, total employment, general price level etc
 Fundamental problem of economics
The difference between microeconomics and macroeconomics
The main central economic problem is the scarcity of resources in relation to unlimited
The main differences between microeconomics and economics are:
wants
i. Microeconomics deals with individual units of the economy e.g. firm’s output
Scarcity:. The scarcity implies limitlessness in supply therefore; when we say the
consume behaviour etc while macroeconomics deals with economic variables which
resources of a country are scarce it means that the resources are limited in supply
affect the whole economy.eg national income
ii. Microeconomics works under ceteris paribus (assume full employment) while  Basic problem of economics
macroeconomics doesn’t work under ceteris paribus condition because changes have
wide spread effects What to produce. It is related with the types (ranges) and quantity of goods to produce.
iii. It gives explanation about the performance of single firm or consumer while Since resources are scarce, we must choose between different alternative collection of
macroeconomics gives explanation of the performance of aggregate variable of the goods and services that may be produced. It also involves the allocation of resources
economy such as growth of national output between different types of goods. For example, consumer goods and producer goods. The
iv. Microeconomics deals with formulation of policies which are effective in solving decision to this question is unanswered. Differently under capitalist economy it is answered
problem which affects individual firm while macroeconomics is applied only to by price mechanism while in planned socialist t is determined by central planning authority
problems which affect the whole economy such as inflation, national income etc and also by mixed economy.
v. Microeconomics is effective in development of individual firms while
How to produce. This question arises from the basic economic problem that since
macroeconomics is effective in development of all economic variable in nation
resources are scarce in relation to unlimited wants, we need to consider how resources are
used that the best outcome may arise. The question requires the determination of the
method or techniques, the choice of the techniques of production will depend on the
 Nature of economics Efficiency and the price of factors of production i.e. the cost of production.

Economics as a Positive and Normative Science For whom to produce. Since we cannot satisfy all the wants of all the population,
decisions have to be taken concerning how many of each person’s want are to be satisfied
A positive science may be defined as a body of systematized knowledge concerning what i.e. it involves who should get how much. However, the distribution will depend on the
it is, was or will be and hence depends on facts. Positive science describes how the economic system of socialist, capitalist economic system.
circumstances occur.
Scarcity, Scale of Preference, Choice and Opportunity Cost.
Normative science or regulatory science is a body of systematized knowledge relating to Scarcity
criteria of what ought to be and hence depend on the value judgement as to what is good or Something which is limited in supply or less than requirement/
bad. It concerned therefore with ideal as distinguished from actual. It states how the insufficient
circumstances should occur.
Scale of preference
A list of alternative human wants arranged in the order of preferences

Choice
Selecting from the scale of preference some wants to be
 v. There is equality among the members in a command economy. Majority of people
have access to the national output as the state ensures equality in the distribution of
wealth.
vi. Low quantity and quality of outputs due to lack of competition.
vii. Production is mainly gearing at maximizing utility of the society

Economic systems

Economic system, is that an institutional arranged where by human and natural resources
of an economy cooperate with each other to produce goods and service. II. CAPITALIST ECONOMIC SYSTEM

TYPES OF ECONOMIC SYSTEM Capitalist economic market itself through forces of demand and supply make decision on
how to allocate the resources, its also called price mechanism.
There are three main types of economics system;.
The system is also known as market economy, unplanned or free enterprise economy.
i. Socialist economic system. Capitalist economic system refers to the type of economic system in which all major means
ii. Capitalist economic system. of production are owned by individuals and privates’ companies, with little government
iii. Mixed economic system intervention. Examples of the countries which practice this system are USA, UK,
Germany, France etc.

FEATURES OF CAPITALIST SYSTEM

I. SOCIALIST ECONOMIC SYSTEM
i. There is private ownership of the major means of production such as land and capital.
Command or socialist economic system is a type of economic system in which all major
ii. There is freedom of choice. That is producers and consumers can make decisions on
means of production are owned by the state.
what, where and for whom to produce and consume.
FEATURES OF THE SOCIALIST OR COMMAND ECONOMY iii. Production is aimed at profit maximization i.e. for self interest resources.
iv. Reliance and price mechanism as a means of allocating resources. Under capitalist
i. Collective ownership. All major means of production such as factories, banks, school’s economy all problems of what is to be produced where to produce and for whom to
hospital, and farms etc. are owned by state. produce are answered by the price mechanism.
ii. All economic decisions are made by the state. Economic decisions about what to v. There is limited role by the government. i.e. the government has little intervention
produce, how to produce and to whom to produce are made by the country planning over the allocation of the economic resources.
authority. vi. Competition. Under capitalist economy there is free entry of firms in production.
iii. Exploitation is minimized and classes are not in extent. Profit is shared equally among These firms compete for resources and market. Such competition results to the
the members and classes do not exist because wealth in the socialist economy is increase in efficiency in production.
owned equally by all members. vii. There is existence of classes. Under this system the society is divided into classes.
iv. Lack of freedom. In command economy producers are not free to make decisions on That is the class of haves and have not i.e. the haves been those who own the major
the allocation of scarce resources. What is to be produced is determined by the state means of production and they have not been those who do not own the major means of
consumers; likewise, producers are not free on what goods and services to produce to production.
the consumers.

III. MIXED ECONOMIC SYSTEM

 Mixed economic system refers to the type of economic system which involves both public 3. In a mixed economy the government can redistribute incomes which results due to
and private ownership of the major means of production like capital, land and other related uneven ownership of resources by helping the lower income groups through tax
means of production. Therefore, decisions on important economic issues involve some relief’s and subsidies.
forms of planning by private as well as public enterprises and interaction between the 4. Mixed economic system involves some kind of planning in this case it can control
government business and labour through market mechanism. wastages in allocation of resources and control some economic crises such as
inflation and unemployment also by allowing private sector to enjoy some kind of
FEATURES OF MIXED ECONOMIC SYSTEM
economic freedom in allocation of resources, it builds an element of competition
i. Some resources are owned by individuals and some are owned by government. which usually increases efficiency in production.
ii. Decisions regarding production. The production of commodities is partly made by 5. The merit goods which can not efficiently be provided by the private sector can be
individuals and partly by the government. provided by the government.
iii. There is joint venture in the ownership of business firm. The government tends to have 6. The government can fix incomes to factors of production in order to stabilize
shares with the private investors in running businesses. e.g. TBL in Tanzania. 4. The incomes in a society.
role of the government is to regulate the private sector to work for national interests
What is production?
and not for their personal interests.
iv. There is a system of price mechanism and planning authority. All are important in Production is any activity which results into the creation of goods and services in order to
economic decisions and planning. satisfy human wants.
v. There is a relative high freedom of choice for both consumers and producers.
In economics, sense, production is for exchange while in the general meaning production
Why is the mixed economy more preferred than other economic systems? The mixed may mean the creation of goods and services for personal consumption. Production is not
economic system is a type of economic system which has both the public and private complete without consumption. Therefore production involves activities which facilitate
sectors existing and functioning side by side in various economic activities. Due to the fact transfer of goods and services from the areas where they are produced to where they are
that no country in the real world is practicing either pure capitalism or pure socialism, most demanded for consumption. Examples of such activities which facilitate transfer of goods
Economies are mixed. and services are:-. Transportation. Communication. Ware-housing. Banking. Advertising.
Insurance. Marketing etc
The reasons as to why most countries nowadays prefer mixed economic system than other
systems are as follows. Factors of Production

1. Pure free markets can not provide all the goods and services that people want and These are the economic resources, which assist the process of production. Factors of
are willing to pay for, there are some public goods which by their nature can not production are also known as input, tools of production and agents of production.
be efficiently produced by the individuals producers and therefore need to be Categories of factors of production There are four major categories of factors of
produced by the government, likewise in a command economy the government production:-
can fail to anticipate the actual needs of the consumers and lead to shortages, the
1. Land.
government in a mixed economy control this problem by allowing individual
2. Labour.
producers to respond to the needs of the consumers which are expressed through
3. Capital.
their demand in the market, on the other hand the government is able to correct
4. Entrepreneurship.
the weaknesses of the private sector of failing to produce public goods by
engaging in supplying essential public goods. Land
2. Government intervention is necessary to prevent social cost of production such as
pollution; in a mixed economy the government takes measures which control Land includes all kinds of natural resources, that is, things which are not made by man like
social costs such as pollution. soil, farmland, minerals, playgrounds, fishing grounds, forest, oceans, rivers etc.
Features of Land  Demand for labour is a derived demand.
 Labour differ in efficiency.
Land has the following features:
 Labour psychologically prefers leisure to work.
 It is a gift of nature. It has been provided freely by nature. It is non-man made,  The payment for labour is wage.
that is, man did nothing to bring land into existence unlike other factors such as  The supply of labour increases with the increase in wages, that is, when wages
capital, which is accumulated or made by human beings. – increase then supply of labour also increases.
 Unlike other factors of production, land is limited in quantity or fixed in supply so
that even in the long period its supply cannot be increased. –
 Location of land is fixed. –
 Each plot of land has unique natural characteristics –
Capital
 Demand for land is a derived demand. –
 Land provides site/place where production can take place like schools, industries, Capital is the wealth or an asset that is used to produce other wealth (assets). Capital
roads are built on land. includes all types of producer goods like machinery, tools, buildings, raw materials, means
 Land lack geographical mobility, that is, it can not be moved or transported from of transport, telephone wire etc.
one place to another. However land is mobile in occupational sense, that is, land
can be changed from one use to another use for example a piece of land can be Features of Capital Capital has the following features:.
used as a farmland, playground or site for building industries. –  Capital is a factor of production which increases efficiency of other factors
 It is subjected to the law of diminishing returns. because it simplifies work. –
Labour  Unlike land, capital is made by human beings. It is not provided freely by nature
and it is a factor, which increases efficiency of other factors. –
Labour means any mental or physical efforts made by human being in the process of  Supply of fixed capital cannot be increased in the short run because they take a
production or any mental or physical efforts of human beings for any beneficial activity long time to be produced. –
(productive activity). Example of labour is the work of a doctor of treating people, a  Capital can depreciate or become obsolete. –
teacher of teaching, a farmer of cultivating land, a carpenter of making furniture etc.  It is less subjected to the law of diminishing returns as compared to land. –
NB: Any human effort which is not made for any material benefit or any payment cannot  Most capital forms cannot work alone without combination with other factors like
be regarded as labour, for example, if a mother (at home) looks after her baby without any labour. –
payment from the husband her work cannot be regarded as labour or if a person play music  It has an element of time Capital renders its services over a certain period of time
just for recreation then playing music in this situation cannot be regarded as labour. and its payments depends on the length of time in which it is used in the process
of
Features of Labour Labour has the following features:
Entrepreneurship
 Labour is the most mobile factor in both geographical and occupational sense, that
is, labour can easily move from one geographical area to another to work or An entrepreneur is the owner of a business. It is a factor of production, which organizes
change from one kind of job to another kind of job. For instance, a doctor may other factors of production in the production process, and establishes the business.
become a politician; a teacher may become a business consultant etc.
Characteristics of Entrepreneurship Entrepreneurship has the following features:.
 Any labour must be aimed for production.
 Without labour other factors cannot produce.  An entrepreneur does not work alone he must employ other factors. –
 Labour cannot be separated from laborers.  The supply of entrepreneurship skills is scarce and cannot be developed easily. –
  The reward of an entrepreneur depends on efficiency of other factors.

PRODUCTION POSSIBILITY FRONTIER OR CURVE (PPF OR PPC)

A production possibility curve is a curve representing all possible combinations of total

output that could be produced by the economy when its resources were fully and efficiently
utilized under a given state of technology. Or This is a locus of points which showing two
combinations of commodities that may be produced when all resources are fully utilized.

The production possibility curve is also known to other economist as production possibility
frontier or Boundary. Also known as marginal rate of transmission, it measures the
opportunity cost of one product.

The concept of production possibility curve helps to explain the concept of scarcity and
opportunity cost.

The following are the assumptions of the production possibility curve;

1. The resources are fully and efficiently utilized.

2. There is a constant state of technology.
3. Only two commodities are being produced.
4. The amount of resources is fixed.
5. full employment and productive efficiency
From the graph, we learn that the shape of the production possibility curve is concave to
Given that the resources and technology are fixed, we can produce more of every the origin. Because there must be the decrease in output of guns in order to add more unit
commodity from the resources which can be used to produce more of another commodity. of butter e.g. To produce one unit of butter we have to foregot one unit of gun i.e from A to
In the production possibility curve, since the resources are scarce, we are forced to choose B.
between production of capital goods and consumer goods. Sacrificing the production of This is called the marginal rate of technique substitution of butter for gun and it goes on
consumer goods. Thus, the opportunity cost of more capital goods is the consumer goods increasing.
that we have to sacrifice.
If the economy devoted all its resources to the production of gun it can produce 15
thousand guns but the production of butter will be zero.
GRAPH OF PRODUCTION POSSIBILITY CURVE Therefore, if we decide to produce 1unit of butter we have to produce 14 units of guns.

From the graph therefore we learn that if butter we want to produce more butter, we have
to reduce the output of guns and vice verse i.e. we can transform guns into butter or butter
into guns.

The point on the boundary of PPC i.e. A, B, C, D, E and F represents the combination of
goods that can be produced using the country’s available resources and technology.
Any point inside the boundary say K is one from the diagram it shows inefficiency of
which may be under utilization or unemployment of the countries resources.

From point A to point F, it indicates the increase in the production capacity of the
economy. The new graph tells us that economy can now produce large quantity of output.

Point H on the graph indicates unattained point of which it is outside the PPC. point K will
be attained when the economy increases its production leading to the shift of the PPC from
its original position to point K.

How choice, opportunity cost and scarcity are shown on the PPC.

Choice is indicated by selecting any point on the PPF. When resources are fully utilized i.e.
a, b, c, d, e and f.

Opportunity cost is indicated by movement along the PPF i.e. a, b, c, d, e and f. e.g.

The opportunity cost of producing 15 units of guns is the 0 unit of butter that you forego at
full employment of the resources.

Scarcity is indicated by point H which has not been attained. It will depend on the
expansion of the production in the economy.

In order to move the economy from the current production possibility curve to the outer
production possibility curve, the economy has to;.

i. Increase in the stock of its resources. i.e. To increase the quality of labour, land,
capital and entrepreneurship.
ii. Improve the state of the technology to more advanced methods in order to find
move output of maximum cost of production of capital.

DIAGRAM FOR INNOVATION OF NEW RESOURCES

In some other cases the PPC curve tends to shift inwards, this signifies the decline of the
economy which may be due to;.

i. Exhaustion of the economy’s natural resources such as land.

ii. Working population is falling.
iii. Technology available was changed.
iv. Underemployment of the resources of a country of which some of the resources
are left idle.
 THE CONCEPT OF DEMAND AND SUPPLY
THEORY OF DEMAND

Demand can be defined as the willingness and ability of consumer to purchase (or pay for)
a certain amount of goods and services at different prices during a specified period of time.
Demand is always at a price. The demand for anything at a given price is that amount
which will be purchased for a specific period at that price. Without the reference of price, it
is meaningless to say that demand is this much.
Features of a demand curve
Demand schedule
i. The demand curves slope downwards from left to right implying that at higher prices
This is the table which shows different quantities of goods and services which a consumer lower quantities will be bought and at lower prices more quantities will be bought.
is willing and able to purchase at different prices during a specific period of time. Example ii. It has a negative slope, due to inverse relationship between prices and quantity
of demand schedule demanded. That is, when price increases then the quantity demanded decreases and
Price per Kg (TZS) Quantity demanded when price is low more quantities are bought.
500 10 Why a Demand Curve has a Negative Slope

400 20 Demand curve slopes downwards from left to right due to the following factors:

300 30 The law of diminishing marginal utility: According to this law as someone consumes more
and more units of a commodity, the marginal utility derived from each successful unit
200 40 added tends to decline. Therefore, as the consumers purchase more units of a commodity
marginal utility from each additional unit bought tends to decline. Also, as the price of a
100 50
commodity increases the marginal utility of a commodity tends to decline hence decline in
demand.

Income effect: As the price of a commodity falls, real income of the consumers increases
Demand curve
and consumers can buy more units of the commodity with the same amount of money
It’s the geometrical representation of demand schedule. This is a graphical depiction or income. On the other hand, an increase in the price of a commodity reduces real income of
representation of the relationship between price and quantity of goods and services that a consumers hence reduces quantity of the commodity demanded.
consumer is willing and able to purchase. Demand curve usually slopes downward from
Substitution effect: As the price of a commodity falls, assuming that prices of substitutes
left to right i.e. it has a negative slope except two cases (Veblen goods and giffen goods).
remain constant consumers buy more of it and less of substitutes and vice versa.
The negative slope is referred to as the law of demand.
The price effect: This is the combination of income and of substitution effect. When the
price of a commodity falls consumers buy more of it because of the income and
substitution effect and vice versa.

Change in number of consumers: When the price of a commodity decreases the number of
consumers increases because even poor people start buying the commodity. When the price
increases the number of consumers decreases hence decline in demand.
Demand function

A mathematical expression of the relationship between price and the quantity of goods and
services that a consumer is willing and able to purchase. Demand function postulates that
demand is always at prices. Therefore, ceteris paribus;

X = f (Px)

The following are some examples of demand functions with different slopes;

Qty = 2- P

Qdd = 7 – 3P

Qdd = 10 – ½P

DD = 3 – 8P

The law of demand

The law of demand explains the relationship between quantity demanded and their pieces.
It is empirically tested that there is inverse relationship between the two variables. The law
states that

Ceteris paribus (other things remain constant) as price falls, the quantity demanded rise
and as price increases the quantity demanded falls for most type of goods and services.

The law of demand states that “The higher the price the lower the demand, the lower the
price the higher the demand, other factors remaining constant.

Other things remain equal, the amount of products that consumers are willing and able to
buy during some period of time changes inversely with the price of those goods (products).
It means at a lower price more quantities of a commodity are bought and at a higher price
small quantities of a commodity are bought.

Note: this is true for normal goods, inferior goods etc., but not for all types of goods,
example for giffen and luxurious goods demand law is violated