What is

Economics?
Economics can be defined as the Social
Science concerned with the Problem of
administering or using Scarce Resources so
as to attain the greatest or maximum
fulfillment of society’s Unlimited Wants.
SOCIAL SCIENCE
PROBLEM
RESOURCES
WANTS
ECONOMICS as SOCIAL
SCIENCE
ECONOMIC PROBLEMS
Economic Resources
 used to produce goods / services to
satisfy human wants

 limited in supply

 scarce: i.e. their quantities are

insufficient to satisfy all human wants
 Goods and Services
The ice cream is a good. A good is something you
can feel, or any kind of merchandise.
A service is any kind of work performed for others.
 Goods

 Services
 Factors of Production

 Natural Resources: land, minerals, water, forests,

etc.;
 Labor: both physical and mental;
 Physical Capital: machines, tools, buildings, trucks,
etc.;
 Human Capital: knowledge, education; know how;
and
 Entrepreneurship: the ability to organize a
production process and take risks.
 Three Types of Resources
work together in our economy

Natural Resources Human Resources

Capital Resources
Scarcity

 Meaning: Resources are insufficient to

satisfy ALL human wants

 A relative concept: we want more than

we have

 Basic economic problem in human

societies
Needs vs. Wants

 Needs – what  Wants – the

people must have things we would
to live. like to have, but
Food can live without.
Clothing
Shelter
Do they face scarcity problem?

 United States

 Hong Kong

 North Korea

 Africa
Is sea water scarce?

 Is it fixed in supply?

 Do we want more sea water than we

have?

 Sea water is not scarce

Are they scarce?

 Sunshine in Thailand
 A free sample of candies given at a
shopping centre
 Fresh air in a café with many smokers
 Sand in the desert
Are they scarce?

 Sunshine in Thailand 
 A free sample of candies given at a
shopping centre 
 Fresh air in a café with many smokers

 Sand in the desert 
Making choices

 Which restaurant will you go for lunch?

 What would you like to study at
university?
 What will you buy with $100? CD or
dress ?
 Which girl (boy) will you marry?
 OPPORTUNITY
COST
The opportunity cost of any item is
whatever must be given up to obtain it.
It is the relevant cost for decision
making.
The opportunity cost of…
…going to college for a year is not
just the tuition, books, and fees,
but also the foregone wages.
…seeing a movie is not just the
price of the ticket, but the value
of the time you spend in the
theater.
 Human wants are unlimited but the
resources through which goods and
services are produced to satisfy these
wants is limited or scarce.
This involves the problem how to use
scarce resources for the achievement of
maximum possible satisfaction of the
people.
 Scarcity of resources is the
root cause of all economic
problems. Resources are scarce in
relation to what we demand. In
view of this scarcity of resources, a
society cannot produce unlimited
quantities of goods and services.
 Scarcity of resources gives
rises to four central problems
which every economy has to solve
them.
1. What to produce
2. How to produce
3. For whom to produce
4. How much to grow
 The community has to decide which
goods and in what quantities are to be
produced.
The society has to choose among
numerous consumer goods and decide
about allocation of resources between
them. The society has to make a choice
between necessities and luxuries.
How to produce

After the society has decided

what to produce the next problem
arises as how to produce.
This means which technique of
production is to be used. The society
is to decide what combination of
resources is too applied for the
production of goods.
 For whom to Produce

For whom to produce means how the

national product is to be distributed among
the members of the society.
In view of the scarce resources and
output, the society has to decide who
should get how much from the total national
output.
How much to grow

The scarce resources should not

be spent for consumption goods only.
Resources should be allocated for the
production of capital goods. If the
resources are not allocated for
investment future production will suffer
a serious setback.
Decision Makers

 Households: the principal owners of

factors of production;
 Business Firms: the principal users of
factors of production; and
 Central Authorities: the federal, state,
and local governments and their
agencies.
Types of Economic Problems

 What goods and services are being produced

and in what quantities?
 By what methods are goods and services
produced?
 How is the supply of goods and services
allocated among the members of the society?
 Are the society’s resources being fully
employed, or are some lying idle?
 Is purchasing power being eroded by inflation?
 Is the economy’s capacity to produce goods
and services growing over time?
 BRANCHES

MICROECONOMICS

MACROECONOMICS
 MICROECONOMICS

It involves the study of the individual units

in the economy.
It is the branch of economics that focuses
on how human behavior affects the
conduct of affairs within narrowly defined
units, such as individual household or
firms.
 MICROECONOMICS

It is more focused on the choices

made by individual actors in the
economy (individual consumers or
firms, for instance)
 MACROECONOMICS

It is the branch of economics that

focuses on how human behavior
affects outcomes in highly aggregated
markets such as the markets for labor
or consumer products.
 MACROECONOMICS
It involves the study of economic
aggregates and an overview of the
economy, including the levels of national
income, economic growth, employment,
prices business cycles and the effects of
monetary and fiscal policies
 MACROECONOMICS
It is the branch of economics that
concerns itself with market systems
that operate on a large scale.
It deals with the performance,
structure and behavior of the entire
economy.
from the Greek prefix makro-
meaning "large" and economics
 Microeconomics and
Macroeconomics
 Microeconomics is the study of how households
and firms make decisions and how they interact in
markets.
 Macroeconomics is the study of economy-wide
phenomena, including inflation, unemployment, and
economic growth.
 These two branches of economics are closely
intertwined, yet distinct – they address different
questions.
THINKING LIKE AN ECONOMIST 36
POSITIVE
ECONOMICS AND
NORMATIVE
ECONOMICS
 As scientists, economists make
positive statements, which attempt to
describe the world as it is.
 As policy advisors, economists make
normative statements, which attempt
to prescribe how the world should be.
 Positive statements can be confirmed
or refuted, normative statements
cannot.
 Government employs many economists
for policy advice.
38
 Identifying positive vs. normative
Which of these statements are “positive” and
which are “normative”? How can you tell the
difference?
a. Prices rise when the government increases the
quantity of money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of burritos will cause
an increase in consumer demand for video
rentals. 39
 ANSWER

a. Prices rise when the government

increases the quantity of money.
Positive – describes a relationship, could
use data to confirm or refute.
b. The government should print less money.
Normative – this is a value judgment,
cannot be confirmed or refuted.
40
 ANSWER
c. A tax cut is needed to stimulate the
economy.
Normative – another value judgment.
d. An increase in the price of burritos will
cause an increase in consumer demand
for video rentals.
Positive – describes a relationship.
Note that a statement need not be true to
be positive. 41
 Why Economists Disagree

 Economists often give conflicting policy advice.

 They sometimes disagree about the validity of
alternative positive theories about the world.
 They may have different values and, therefore,
different normative views about what policy
should try to accomplish.
 Yet, there are many propositions about which
most economists agree.

THINKING LIKE AN ECONOMIST 42

 SCIENTIFIC APPROACH IN THE
EMPIRICAL TESTING OF AN ECONOMIC
THEORY
STEPS:
1.State the propositions or conditions
2.Observe facts in connection with the activity
3.Apply the rules of LOGIC
4.Establish a set of principles such that
formulated hypotheses may be tested as to
whether they are valid or not.
5.Use statistics and econometrics as empirical
proof in testing the hypothesis
 TYPES OF ECONOMIC
SYSTEMS

TRADITIONAL
COMMAND
MARKET
 TRADITIONAL ECONOMY

 Decisions are based on traditions and

practices upheld over the years and
passed on from generation to
generation.
 Methods are stagnant and therefore not
progressive.
 Traditional societies exist in primitive
and backward civilization.
 COMMAND ECONOMY

 This is authoritative system wherein

decision-making is centralized in the
government or a planning committee.
 Decisions are imposed on the people
who do not have a say in what goods
are to be produced.
 This economy holds true in dictatorial,
socialist, and communist nations.
 MARKET ECONOMY
 This is the most democratic form of economic
system.
 Based on the workings of demand and supply,
decisions are made on what goods and
services to produce.
 People’s references are reflected in the prices
they are willing to pay in the market and are
therefore the basis of the producer’s decisions
on what goods to produce.
 Is a schedule in which consist quantity
supply.
 Economists describe supply as the
relationship between the quantity of
good or service consumers will offer for
sale and the price charged for that
good.
 FACTORS
AFFECTING SUPPLY
 The Price of Inputs
 The price of the product is the main factor
as stated in the law of supply. Producing a
goods or services involves taking inputs
and applying a process to them to
produce an output. Inputs are raw
materials, labor, utilities, licensing fees, or
even other goods.
 The Current State of
Production Technology

The level of production

technology can make the process
more efficient.
 The Producers
Expectations
It doesn’t just matter what is currently going on – one’s
expectation can also affect how much of a product one is
willing and able to sell. For example, if your firm produces
mp3 players and you hear that Apple will soon introduce a
new iPod that has more memory and longer battery life, you
(and other produces) may decide to hurry up and sell your
players to stores before the new iPod comes out. When
people decide to increase production/sales today, they are
increasing the current supply for mp3 players because of
what they EXPECT to happen in the future.
 The Number of Producers in the
Prices
As more or fewer producers enter the market this
has a direct effect on the amount of a product
that producers (in general) are willing and able to
sell. More competition usually means a reduction
in supply, while less competition gives the
producer an opportunity to have a bigger market
share with a larger supply.
 Law of Supply
States that as the price of a
commodity is raised, the quantity
of the product that sellers or
producers are able and willing to
sell also increases.
THEORIES OF
CONSUMER
BEHAVIOR
 TWO TYPES OF
CONSUMER BEHAVIOR
CardinalistApproach or
Marginal Utility (Jevon 1835-
1882)
 OrdinalistApproach theory
(J.R. Hicks and RGD Allen 1928)
 THE CONCEPT OF
UTILITY
 Jevon (1835-1882) was the first economist who
introduced the concept of utility in economics.
According to him ‘utility’ is the basis on which
the demand of an individual for a commodity
depends ‘Utility’ is defined as the power of a
commodity or service to satisfy human want.
Utility thus is the satisfaction which is
derived by the consumer by consuming the
goods.
Example:

cloth has a utility for us

because we can wear it.
Pen has a utility for a
person who can write
with it.
utility

 The utility is subjective in .nature. It differs from

person to person. The utility of a bottle of wine is zero
for a person who is non drinker while it has a very high
utility for a drinker. Here it may be noted that the term
‘utility’ may not be confused with pleasure or
unfulLness which a commodity gives to an individual.
Utility is a subjective satisfaction which consumer gets
from consuming any good or service. For example,.
poison is injurious to health but it gives subjective
satisfaction to a person who wishes to die. We can say
that utility is value neutral.
 CARDINALIST APPROACH

 Human wants are unlimited and they are of

different intensity. The means at the disposal of
a man are not only scarce but they have
alternative uses. As a result of scarcity of
resources, the consumer cannot satisfy all his
wants. He has to choose as to which want is to
be satisfied first and which afterward if the
resources permit. The consumer is confronted
in making a choice.
 Example:

A man’ is thirsty. He goes to the market

and satisfies his thirst by purchasing
coca’-cola instead of tea.
 It goes this way .

 The consumer buys a commodity because it

gives him satisfaction. In technical term, a
consumer purchases a commodity because it
has utility” for him.
 Total utility (TU): Total utility is the total
satisfaction which a consumer derives from the
consumption of a. particular good over a period of
time. For example, a person consumes five units of
a commodity and derives Ul; U2, U3, U4, U5 utility
from the successive, units of a good, his total utility
will be,
 Tu = U1+ U2 ± U3 + U4 4” U5
 Marginal Utility (MU) .
 It can also be described as the extra, satisfaction
which a consumer gets from consuming additional
unit of a good. More precisely, it is defined as the
addition to the total utility obtained from the
consumption of one more unit. For example, the
marginal utility of second glass of water is the
change in total utility resulting from ATu consuming
the second glass of water.
 THE CONCEPT OF ORDINAL
UTILITY
 Was first introduced by Slustsky, a Russian
economist in 1915. Later on it was developed
by J.R. Hicks and R.G.D. Allen in the year
1928.
 Ordinal utility

 These economist are of the view that it is

wrong to base the theory of consumption on
two assumptions; (i) that there is only one
commodity which a person will buy at one
time, and (ii) the utility can be measured.
Their point of view is that utility is purely
subjective and is immeasurable.
 Moreover an individual is interested in a
combination of related goods and not in the
purchase of one commodity at one time. So
they base the theory of consumption on the
scale of preference. According to the ordinal
theorists, a consumer simply ranks or orders his
preferences. It is only an expression of the.
consumer’s preference for one commodity over
another.
The ordinal utility theory or the
indifference curve analysis is
based the following main
assumptions:
 (1) Rational behavior of the
consumer. It is assumed that
individuals are rational in making
decisions from their expenditures on
consumer goods.
 (2) Utility is ordinal. Utility cannot be
measured cardinally. It can be, however,
expressed ordinally. In other words, the
consumer can rank his various combination
of goods according to the satisfaction or
utility of each basket.
(3) Diminishing marginal rate of
substitution. In the indifference curve
analysis, the principle of diminishing
marginal rate of substitution is
assumed.
 (4) Consistency in choice: The consumer,
it is assumed, is consistent in his behavior
during a period of time. For instance, if the
consumer prefers combination of A of goods
to combination B of goods, he then remains
consistent in his choice. His preference,
during another period of time does not
change. Symbolically, it can be
expressed as: If A > B, then B > A
 (5) Consumer’s preferences not self
contradictory. The consumer’s preferences
are not self contradictory. It means that if
combination A is ‘preferred over combination
B and combination B is preferred over C,
then combination A is preferred over C.
Symbolically it can be expressed, If A > .B
and B > C, then A > C.
 (6)Goods Consumed are substitutable. The
goods consumed by the consumer are
substitutable. The utility can be maintained at
the same level by consuming more of some
goods and less of the other. There are many
combinations of the , two commodities which
are equally preferred by a consumer and he is
indifferent as to which of the two he receives.