Introduction To Economics: By: Tewolde G

Introduction to Economics
By: TEWOLDE G.
Lecture Note on Introduction to

Economics By Tewolde G..
Questions to consider:
• Why learning economics is needed?

• What do we mean by ‘Economise’? Why it
is needed?
• what are objectives of economics are?
• List the fundamental economic problem?
• What is opportunity cost?
• What are alternative economic systems?

1.What is Economics?
• Definitions of Economics
– Mankiw’s definition
• …is the study of how society manages its scarce
resources
– Hedrick’s definition
• …is how society chooses to allocate its scarce
resources among competing demands to improve
human welfare
– Alternative definitions
* what economists do.
* is the study of choice.. Why choice???
Cnt’d
-Economics is a social science that studies:
• How individuals, governments, and
businesses make decisions
• Choices of how to get the most from limited
resources.

Activity 1:
• Can we have everything we want? Why not?
• Scarcity – a basic human dilemma
– Limited resources vs. unlimited human wants
– The human condition requires making choices
– Scarcity is not necessarily related to poverty
– it occurs when people want more than what the
economy can provide at zero price.

The Economic Problem
Unlimited Limited
Needs & Resources
Wants of
human
Scarcity
Choices
WHAT HOW FOR

to to WHOM
produc produc
Lecture Note on Introduction to to
e e produce
1.2. Scope of Economics
are two major divisions of Economics:

namely microeconomics and macroeconomics
Microeconomics: also called Price theory
looks at specific economic units like house
holds, firms
Macroeconomics (forest) = Aggregate
economics

Goals of Economics
 Economic growth: produce more and better
services, or, more simply, develop a
higher standard of living
 Full Employment: Provide suitable jobs far
all citizens who are willing and able to
work
• Economic efficiency productive vs.
allocative :Achieve the maximum
fulfillment of wants using the available
productive resources
price level stability Avoid large upswings
and downswings in the general price level that
is avoid inflation and deflation
Trade balance seek a reasonable overall
balance with the rest of the word in
international trade and financial transactions.
Equity : Ensure that no group of citizens
faces stark absolute poverty while others enjoy
luxury.
1.4. Methods of Economic Analysis
Economics ask and attempt to answer two
kinds of questions
Positive and normative Economics
 Normative Economics : answers what ought
to be (focuses on facts and avoids value
judgments) also called as policy economics.
 Positive economics: deals with what the
economy is actually like

• It makes statements of the “if ..,.. then”
type that can be supported or rejected by
empirical evidence. example
• Should poor people be required to work if
they are to get aid? N
• The African economy should grow at 10%. N
• What is the economic impact of raising
taxes? P
• The unemployment rate in nation A is 15%. P

Activity 2
• Given scarcity of resources, how
government realize them?
Answer: Scarcity requires all societies to answer the
following questions:
– What is to be produced?
– How is to be produced?
– For whom will it be produced?

The Fundamental Economic Problems
1. What goods and services should an economy
produce?
– should the emphasis be on agriculture,
manufacturing or services, should it be on
education, or housing?
2. How should goods and services be produced?
– labor intensive, land intensive, capital intensive?
Efficiency?
3. Who should get the goods and services produced?
– Even distribution? more for the rich? more for those
who work hard?

Opportunity Cost
• Definition – the cost expressed in terms of the
next best alternative sacrificed (tradeoffs)
• The cost of using an economic good is the cost
of foregoing the
• next best alternative to which that resource
could have been put
• It is a way of putting a cost on our economic
decisions
Why is it referred to as a cost?
Example: A plot of land could have several possible uses:

• develop shopping centre
• develop office block
• develop private housing estate
Suppose that after doing an initial feasibility analysis, the land
owner estimates that he can make the following profit from
each option:
• shopping centre = $10 million
• office block = $5 million
• housing estate = $8 million
Q: What is the best economic use for the land?
Q: What is the opportunity cost associated with this use?

Cnt’d
• Computed as :opp.cost=sacrifice/  gain
• Helps us view the true cost of decision
making
• Implies valuing different choices
• Model with Production Possibilities
Frontier(PPF)

Type of
Products Production alternatives
A B C D E
Wheat
0 1 2 3 4
Machinery
10 9 7 4 0
• find the opportunity cost of

moving from B to C? OC=
Sacrifice/ Benefit =7-9/2-1=-2

Activity 3
• What do we mean by PPF?
• What are the basic features of PPF?
PPF:-Shows the different combinations of goods and services
that can be produced with a given amount of resources.
- An economic tool/diagram with two purposes:
– illustrates opportunity cost
– shows whether resources are being used efficiently

BASIC ASSUMPTIONS OF PPF
• A) Fixed resources: - the quantity and quality of the factors of

production (labor and capital) are fixed during a given period of time,
such as a given year. But with some limits, they can be shifted or
reallocated (see the assumption of homogeneity).
• B) Homogeneity of resources: - the available factors of production
are homogenous in the sense that they can be employed anywhere in
the production of goods and services.
• C) Specialization: - some inputs are better adapted to the production
of one good than to the production of the other.
• D) Fixed technology: - technology is fixed and does not advance
during the period under consideration.

Cnt’d
• E) Two goods: - the economy is producing only two goods, say
capital goods(Y) and consumer goods(X).
• F) Full employment and productive efficiency: -the economy is
employing all its available resources (full employment) and producing
goods and services at least cost (productive efficiency-the production
of any particular mix of goods and services in the least costly way.
When we produce at the lowest achievable per unit cost, we are
expending the smallest amount of resources and therefore making
available the largest amount of resources to produce other desired
products)
N.B. The assumption of fixed resources and fixed technology imply that
we are looking at an economy at a very short period of time.

Production Possibility
Capital goods
Ym
Frontiers(PPF)
Yo
A
.X .Y
• Y1 B
Consumer goods
Xo X1 Xm

Assume----
• Assume a country can produce two types of

goods with its resources : capital goods(Y) and
consumer goods(X)
• If the country is at point A ,on the PPF, it can
produce the combination of Yo capital goods
and Xo consumer goods

Cnt’d
• If it reallocates its resources (moving down on the PPF
from A to B) it can produce more consumer goods but only
at the expense of fewer capital goods.
• That is, Moving from point A to point B involves
sacrificing some capital goods to gain more consumer
goods and thus demonstrates the opportunity cost
involved.
• The more of a product which is produced, the greater is its
opportunity cost (“marginal” being implied). This is what
we call the law of increasing opportunity cost .
Cnt’d
• The opportunity cost of producing an extra X1 – X0 consumer goods is
Yo – Y1 capital goods
• If it devotes all resources to capital goods it could produce a maximum
of Ym.
• If it devotes all its resources to consumer goods it could produce a
maximum of Xm
• Any point inside the curve(eg. Point X) – attainable but resources are
not being utilised efficiently
• Production inside the PPF means the country is not
using all its resources
• Any point outside the curve(eg. Point Y) – not attainable with the
current level of resources.

Activity 4
• Can the country produce outside PPF? If yes, under what condition?
Answer:It can only produce at points outside the PPF if it

finds
 a way of expanding its resources or improves the
productivity of those resources it already has.
 An advance in technology
 If the total amount of resources in the economy increased
This will push the PPF further outwards(Out ward shift of
PPF).
(see on the next slide)
Shift of PPF:Inward and outward
y1
y2
a) out ward shift x o x1 b) in ward shift x1 x0

The PPF: What We Know So Far
• The Production Possibilities Frontier (PPF): A graph that shows the combinations of
two goods the economy can possibly produce given the available resources and the
available technology.
• Points on the PPF
– possible
– efficient: all resources are fully utilized
• Points under the PPF
– possible
– not efficient: some resources underutilized
(e.g., workers unemployed, factories idle)
• Points above the PPF
– not possible
•

Summary….
• The opportunity cost of an item is what must be given up
to obtain that item
 Moving along a PPF involves shifting resources from the
production of one good to the other.
 Society faces a tradeoff: Getting more of one good
requires sacrificing some of the other.
 The slope of the PPF tells you the opportunity cost of one
good in terms of the other
 The PPF could be a straight line, or bow-shaped
Summary….
• Depends on what happens to opportunity cost as economy shifts resources
from one industry to the other.
– If opp. cost remains constant, PPF is a straight line.
- -If opp. cost of a good rises as the economy produces more of the good,
PPF is bow-shaped
- Question: Why the PPF Might Be Bow-Shaped?
• PPF is bow-shaped when different workers have different skills, different
opportunity costs of producing one good in terms of the other.
• The PPF would also be bow-shaped when there is some other resource, or mix
of resources with varying opportunity costs.
– E.g., different types of land suited for
different uses
– Therefore, bow-shaped PPF illustrates the concept of increasing
opportunity cost

Summary…..
• PPF illustrates four basic concepts:
• Scarcity of resources: - this is reflected by the negative slope of the
PPF. Moreover, points outside the curve are unattainable because of
the scarcity of resources.
• Choice: - this is reflected in the need for the society to select among
the various attainable goods on the curve. Substitution is a rule rather
than exception in full employed economy and the PPF depicts the
menu of society’s choices.
• Downward slope of the PPF: - this indicates the trade-offs that exist
in the real world, i.e. opportunity cost.
• Law of increasing opportunity cost: - this is reflected by the
concavity of the PPF

Activity 5
Question:State the law of increasing opportunity cost
• States that the opportunity cost of each additional
unit of output of a good over a period increases as
more of that good is produced.
• Meaning: In order to get more of something one
must give up ever increasing quantities of
something else.
• The economic rational for this law is that
economic resources are not completely adaptable
to alternative uses

Decision – Making Units and Circular Flow of economic Activities
• Market systems now dominate the world economy

• our focus: how nations use markets to respond to the
economizing problem.
• Our goal: to identify the major groups of decision makers
and the major markets in the market system.
• Our tool of analysis: circular flow model (CFM).
 CFM: A visual model of the economy, shows how dollars
flow through markets among households and firms.
• The three most important decisions – making units:
Households, Business firms, and Governments

Households
• units that provide an economy with the resources they
sell in the factor market
• use the money paid for them to buy goods& services
from the product market
• They are owners of resources (land, labor, capital and
entrepreneurship) and
• They make decisions on how to sell their resources to
firms and governments.
• They also make decision on what and how much of the
commodities they can buy from business firms.

Business firms
• production units that use resources to
produce goods & services and sell them to
other firms, households and governments.
• make economic decisions on buying
resources from households in order to
produce goods & services and selling their
products to households and governments.

Governments
• refers to an organization that has a legal &
political power to exert control over individuals,
business firms and markets.
• provide social goods & services, such as defense
road, justice, education, public health, and other
infrastructure facilities.
• The major source of government revenue to
finance social goods & services comes from the
collection of taxes
The Circular-Flow Diagram
• Revenue • Spending
• Product
• G&S market • G&S
sold bought
• Firms • Households
• Factors of • Labor, land,

production • Factor market capital
• Wages, rent, profit • Income

Cnt’d
• In the two sector model circular flow of economic
activities, we set the flow of goods & services from
producers to households and a flow of resources from
households to business firms.
• The model suggests a complex, interrelated web of
decision making and economic activities.
• Note that households and business firms participate in both
basic markets, but on different sides of each, firms are on
the buying or demand side of resource markets, and
households (as resource owners and suppliers) are on the
selling or supply side.

Cnt’d
• In the product market, these positions are reversed
households are on the demand side, and firms on the
supply side. Each group of economic units both buys and
sells.
• In the factor market firms purchase or hire economic
resources to produce goods& services which are demanded
by households. The households, in turn, use the income
they earn from the sale of the resources (rent, wages,
interest and profit) to purchase goods & services which are
supplied by the firms and thus the circular flow of
economic activities is complete.

Cnt’d
• The problem of scarcity challenges these economic

activities & exchanges.
• Because households have only limited amounts of
resources to supply to firms, consumers’ money incomes
are limited, which means that each consumer’s income
will go only so far.
• A limited amount of money income clearly will not
permit the purchase of all the goods & services the
consumer might like to buy.
• Similarly, because resources are scarce, the output of
finished goods and services is also necessarily limited.

Sum-up
In a monetary economy: households, as resource
owners, sell their resource to businesses /firms and
as consumers, spend the resource income by
buying goods & services.
Firms must buy resources to produce goods &
services, their finished products are then sold to
households in exchange for consumption
expenditures or, as firms see it, revenues.

Cnt’d
• These revenues are used to purchase additional resources
to maintain the circular flow.
• The net result is, a counter clock wise real flow of
economic resources and finished goods & services, and a
clock wise money flow of income and consumption
expenditures.
• Those flows are simultaneous & repetitive.
• N.B: Real flow – the flow of resources and finished
goods & services.
• Money flow – the flow of income and consumption
expenditures.

Alternative Economic systems
• A country must decided which economic system it will
employ in order to utilise its finite resources.
• The functions of an economic system:
 choose which goods & services will be produced
 ensure, as far as possible, that wastage of resources does
not occur
 to push out the production possibility curve

Cnt’d
• When allocating resources, the society must consider 3
questions:
1. What is to be produced?
2. How are the goods to be produced?
3. For whom to produce?
Society’s answers to these questions will determine which
economic system they adopt: Capitalist, Mixed or
Socialist

Capitalist Economic System – Key Words
• free enterprise system
• price mechanism
• privately owned resources
• profit motive
• consumer sovereignty

Advantages of Capitalist System
• encourages most efficient methods of production by
private
• businesses (profit motive) encourages innovation in
production techniques
• allows economic freedom
• ensures scarce resources are used carefully

Disadvantages of Capitalist System
• inequality in distribution of goods & services

• some essential goods & services (those consumed on
collective basis) will not be provided by private sector, e.g.
defense, police etc.
• monopoly situations can arise, which may lead to unfair
practices
• fluctuating demand is characteristic, which leads to
periods of high unemployment and high inflation
• Existence of externalities

Mixed Economic System – Key Words
• Government intervention
• Government role supports/facilitates free market
enterprise in the following ways:
 establishing monetary system & legal system
 controlling monopolies
 provision of essential goods & services not provided by
the market
 regulating undesirable business practices
 alleviate inequality in society (progressive tax, social
welfare)
 attempting to provide stable economy

Socialist Economic System – Key Words
• This is a form of economic system in which the means of
production except labor are owned by the sate. The state,
in fact, owns the resources on behalf of the society as a
whole
• Central Planning Authority (CPA)
• command system
• central planning and ownership of resources
• production targets (5 year plans) to plan resource
allocation
• production techniques/income levels decided by CPA
• no consumer sovereignty (although consumers can choose)
• no profit motive as businesses are socially owned
• workers encouraged by incentives & patriotic loyalty
Cnt’d
• distribution through market, but price not determined by
market
– amount an individual receives depends on the proportion of
wealth they receive (income level)
• CPA set wage levels for different jobs/professions
according to perceived value
• central authority price fixing, rationing of scarce G&S
• essential G&S are provided free of charge
• there is greater welfare due to wider job opportunity and
lesser inequality of distribution.
• Prices are stable for a long period of time and business
fluctuations are rare.
• Absence of private monopolistic practice

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Introduction to Economics

Lecture Note on Introduction to

• Why learning economics is needed?

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

WHAT HOW FOR

are two major divisions of Economics:

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Example: A plot of land could have several possible uses:

Lecture Note on Introduction to

Lecture Note on Introduction to

• find the opportunity cost of

Lecture Note on Introduction to

Lecture Note on Introduction to

• A) Fixed resources: - the quantity and quality of the factors of

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

• Assume a country can produce two types of

Lecture Note on Introduction to

Lecture Note on Introduction to

Answer:It can only produce at points outside the PPF if it

a) out ward shift x o x1 b) in ward shift x1 x0

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

• Market systems now dominate the world economy

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

• Factors of • Labor, land,

• Wages, rent, profit • Income

Lecture Note on Introduction to

Lecture Note on Introduction to

• The problem of scarcity challenges these economic

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

Lecture Note on Introduction to

• inequality in distribution of goods & services

Lecture Note on Introduction to

Lecture Note on Introduction to

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