Kwame Nkrumah University of

Science & Technology, Kumasi, Ghana

ECON 151:
ELEMENTS OF ECONOMICS

Paul Owusu Takyi (Ph.D)

Department of Economics
KNUST
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

LECTURE ONE
INTRODUCING ECONOMICS
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Welcome to economics lectures

 The things you learn in this class will probably help
you see the world in a different way.
 Economics is not just about money, as you may have
incorrectly assumed.
 On the contrary, as you will learn in this course,
economics is about how society distributes scarce
resources.
 Since almost anything in the world is a scarce
resource, from fossil fuels to nice guys, or nice ladies,
we can apply the rules of economics to pretty much
anything.
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Welcome to economics lectures

 My main goal is to show you the way economists
think and how to use this analytical system to
answer questions related not only to these and other
important human issues, but to anything you end up
doing with your life after this class.

 After all, as you will quickly find out, I believe that

everything is economics!
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Definition of Economics
• Economics is a science that studies how society uses
limited resources, which have alternative uses in an
attempt to satisfy unlimited human wants

• Human wants are the things, goods, services and

circumstances the people desire.

• Economic recourses are the inputs used in the

production of goods and services to satisfy human
wants. These are called factors of production (land,
labour, capital, and entrepreneurship)
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Definition of Economics
• Economic recourses are scarce (limited in quantity
and therefore cannot to used to produce infinite
quantity of goods and services.

• Scarcity means limited in supply (the major

economic problem).

• Since recourses for production are there are not

enough goods to satisfy unlimited human wants,
choice must be made.
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Definition of Economics
• Choice refers to the act of making economic decision or
selecting from alternatives.
• In making choices, economic agents usually draw scale
of preference.
• In making choices opportunity costs are encountered
• Scale of preference is an arrangement of wants in order
of importance or priority.
• Opportunity cost is cost of an item or alternative chosen
or decision taken in terms of the alternative sacrifices.
That is, opportunity cost is the next best alternative
forgone.
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Definition of Economics

• Economics is thus, the study of how economic

agents choose to allocate scarce resources and how
those choices affect society.
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Economic Agents and Economic Resources

 An economic agent is an individual or a group that
makes choices.
 An economic agent can be an individual like:
 Consumer
 Boss
 Kid, student, lecturer, ….
 Parent
 Thief
 Prostitute, carpenter, etc.
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Economic Agents and Economic Resources

 An economic agent can be a group like:
 A household
 a government
 an army
 a firm,
 a university (KNUST)
 a political party (NPP, NDC)
 a labor union, a sports team, a street gang, students union..
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Resource and resource allocation

An important concept of interest in the study of
economics is the issues of scarcity of resources.

Scarce resources are things that people want, where

the quantity that people want exceeds the quantity that
is available
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Resource and resource allocation

Scarcity is the situation of having unlimited
wants in a world of limited resources.
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Positive Economics and Normative Economics

As indicated, economics is all about Peoples’ choice…
 Understanding people’s choices is practically useful
for two key reasons.
Economic analysis:
1.Describes what people actually do (positive
economics).

2.Recommends what people ought to do (normative

economics).
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Positive Economics and Normative Economics

– Positive Statement
Positive statement is a statement of fact. It may be right or wrong,
but its accuracy can be tested by appealing to the facts. Eg. Ghana’s
economy is bigger than that of USA; KNUST is older than UDS

– Normative Statement

Normative statement is a statement based on an individual’s value

judgement. Eg. It is inappropriate for university students to pay
fees. The price of the Bible/Quran should be very low;
government ought to scrap sitting allowances for
parliamentarians
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Positive Economics and Normative Economics

 positive economics: An approach to economics
that seeks to understand behavior and the
operation of systems without making judgments.
It describes what exists and how it works.

 normative economics An approach to economics

that analyzes outcomes of economic behavior,
evaluates them as good or bad, and may
prescribe courses of action. Also called policy
economics.
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Positive Economics
 ….Describes what people actually do
 ….Descriptions of what people actually do are
objective statements about the world….
 Such factual statements can be confirmed or tested
with data.
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Normative Economics
 .....analysis that prescribes what an individual or
society ought to do.
 advises individuals and society on their choices.
 Normative economics is almost always dependent on
subjective judgments, which means that normative
analysis depends at least in part on
personal feelings
tastes,
or opinions.
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Positive Economics and Normative Economics

 Positive Economics
 *******Some people took more than one
and not everyone got a piece

Normative economics
********Each student should just take one
so that everyone gets a piece
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Trial Question
 Which of the following is an example of a normative
economic statement?
 A) A cut in the tax rate will lead to an increase in
consumption.
 B) Relaxation of import duties will encourage imports.
 C) An increase in subsidies to farmers will boost
agricultural production.
 D) Commercial Banks should cut their interest rate for
people to borrow more.
 Ans: D
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Trial Question
 Which of the following is an example of a normative
economic statement?
 A) The government ought to reduce prices of fuel.
 B) An increase in the money supply will lead to an
increase in the inflation rate.
 C) An increase in income is accompanied by an
increase in savings.
 D) An increase in income is accompanied by an
increase in consumption.
 Answer: A
 Q Which one of the following is a
normative statement?
20% 20% 20% 20% 20%
A. Unemployment is higher
this year than last.
B. Unemployment will rise.
C. Economists predict that
unemployment will rise.
D. Raising taxes will cause
unemployment to rise.
E. The government should cut A. B. C. D. E.

taxes and therefore reduce

unemployment.
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Normative analysis and Public Policy

 Since policies normally affect some people
positively and others negatively, its evaluation
involves normative analysis…

 Deciding whether the costs experienced by the

losers are justified by the benefits experienced by
the winners is partly an ethical judgment.
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Normative analysis and Public Policy

 For instance to protect the environment, some
forests must be left untouched and this policy will
not be welcomed by farmers who need the land to
farm on.

 in Brazil
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The Scope of Economics

Microeconomics Macroeconomics
The study of how The study of the whole
individuals, firms, and
governments make choices… economy
Studies Economic Agents Studies economic
aggregates
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The Scope of Economics: Macroeconomic issues

 Macroeconomics is concerned with the economy
as a whole.
 Growth
 Employment or unemployment
 Inflation
 balance of payments problems
 cyclical fluctuations
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The Scope of Economics: Microeconomic issues

 Microeconomic is concerned with individual
economic agent choices.
– Choices
Choice refers to the act of choosing from
among alternatives of goods and services.

The three main categories of choice are

• What to produce
• How to produce and
• For whom to produce
 Examples of microeconomic and
macroeconomic concerns
Production Prices Income Employment

Microeconomics Production/Output Price of Individual Distribution of Employment by

in Individual Goods and Services Income and Wealth Individual
Industries and     Businesses &
Businesses Price of medical care Wages in the auto Industries
  Price of gasoline industry Jobs in the steel
How much steel Food prices Minimum wages industry
How many offices Apartment rents Executive salaries Number of
How many cars Poverty employees in a firm

Macroeconomics National Aggregate Price National Income Employment and

Production/Output Level Total wages and Unemployment in
    salaries   the Economy
Total Industrial Consumer prices  
Output Producer Prices Total corporate Total number of jobs
Gross Domestic Rate of Inflation profits Unemployment rate
Product
Growth of Output

27 of 33
 Q Which one of the following is
a microeconomic issue?
20% 20% 20% 20% 20%
A. The government spends
more than it receives in
tax revenue.
B. House prices rise more
rapidly.
C. Unemployment rises.
D. The Bank of England A. B. C. D. E.
raises interest rates.
E. Imports exceed exports.
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Key Ideas: The Three Principles of Economics

1. Optimization = making the best choice possible

with given information.

2. Equilibrium = a situation in which nobody would

benefit by changing his or her own behavior.

3. Empiricism = using data to figure out answers to

interesting questions
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Optimization, Trade-offs and Budget Constraints

An economic agent faces a trade-off when the

agent needs to give up one thing to get something
else.

That is trade-offs arise when some benefits must

be given up in order to gain others
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Optimization, Trade-offs and Budget Constraints

 Economists use budget constraints to describe

trade-offs.

 A budget constraint is the set of things that a

person can choose to do (or buy) without
breaking her budget.
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Optimization, Trade-offs and Budget Constraints

Examples…
Assume that Christabel has GH¢20 which she can
use to buy kenkey and fish. Assume that the price
of kenkey is GH¢1 and the price of fish is GH¢2.
Her budget constraint can be written as:
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Optimization, Trade-offs and Budget Constraints

Suppose that you have 5 free hours in a day (once we

take away necessities like sleeping, eating, bathing,
attending classes, doing problem sets, and studying for
exams).

Think of these 5 free hours as your budget of free time.

Then your budget constraint would be:

5 hours = Hours on social media + Hours working at

part-time job.
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Opportunity Cost

The other important tool in the analysis of optimization

is Opportunity Cost..
Opportunity cost is the best alternative use of a resource.
It is defined as the next best alternative forgone.
Opportunity cost is what an optimizer is effectively
giving up when she undertakes an activity.

*****The concept of opportunity cost applies to all

resources****
Budget Hours Surfing Social Hours at Part-Time
Media Job
5 hours 0 hours 5 hours
5 hours 1 hours 4 hours
5 hours 2 hours 3 hours
5 hours 3 hours 2 hours
5 hours 4 hours 1 hours
5 hours 5 hours 0 hours
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Cost Benefit Analysis

 Cost-benefit analysis is a calculation that adds
up costs and benefits using a common unit of
measurement, like Ghana Cedis.

 It is used to identify the alternative that has the

greatest net benefit, which is equivalent to
benefits minus costs.
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Cost Benefit Analysis: Example

 Should I cook or Buy Food: (Assuming same
Quality).

 Assume a plate of fried rice and chicken cost 15

Ghana Cedis…..

 An agent who wants to optimize will calculate

the alternative to buying, like ingredients, time,
gas, etc, and put monetary value on it…….
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Cost Benefit Analysis

COSTS BENEFITS
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The Second Principle of Economics: Equilibrium

 A situation in which no one benefits by changing

his/her behavior.

 Thus equilibrium is the special situation in which

everyone is optimizing in the society, so nobody would
benefit personally by changing his or her own
behavior.
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What Does Equilibrium Really Mean?

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Equilibrium: An Illustration
 To illustrate the concept of equilibrium, consider the
length of the regular checkout lines at a supermarket.

 If any line has a shorter wait than the others, optimizers

will choose that line.

 If any line has a longer wait than the others, optimizers

will avoid that line. So the short lines will attract
shoppers, and the long lines will drive them away. And
it’s not just the length of the lines that matters.
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Equilibrium: An Illustration
 You pick your line by estimating which line will
move the fastest, which incorporates everything
that you can see, including the number of items
in each person’s shopping cart.

 Economists say that “in equilibrium” all of the

checkout lines will have roughly the same wait
time.
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Equilibrium: The Free Rider Problem

The Free Rider Problem exists when an individual

or group is able to enjoy the benefits of a situation
without incurring the costs
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Equilibrium: The Free Rider Problem

1. Group needs to decide what is fair.

2. Some sort of pressure needs to be put on the

free rider to get him to conform

Markets have no mechanism for deciding what is

fair
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The Third Principle of Economics: Empiricism

 Economists test their ideas with data.

 We call such evidence-based analysis, empirical
analysis or empiricism.

 Economists use data to determine whether our

theories about human behavior—like
optimization and equilibrium—match up with
actual human behavior.
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Why Study Economics?

1. To Learn a Way of Thinking

 In order to do this, we must understand Three

fundamental concepts:

 Opportunity cost
 Marginalism
 Efficient markets
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Why Study Economics?

2. To Understand Society

 The study of economics is an essential part of

the study of society. One thing that is very
important about our modern society is the
industrial revolution
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Why Study Economics?

3. To Understand Global Affairs

 An understanding of economics is essential to

an understanding of global affairs. The fracas
(quarrel) between USA and china concerning
exchange rates could only be understood if one
is well vexed in the subject of economics.
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Why Study Economics?

4. To Be an Informed Citizen

 To be an informed citizen requires a basic

understanding of economics.
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Economic Policy
Criteria for judging economic outcomes:
1. Efficiency
2. Equity
3. Growth
4. Stability
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Economic Policy
Efficiency: An efficient economy is one that
produces what people want at the least possible
cost.

equity means Fairness. This is highly normative

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Economic Policy
economic growth: An increase in the total output
of an economy

Stability: A condition in which national output is

growing steadily, with low inflation and full
employment of resources.
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The Economic Problem:

Scarcity and Choice
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The Problem of Scarcity

 There is a central economic problem that
everyone faces. This central economic problem
is the problem of scarcity.

 Scarcity is the excess of human wants over what

can actually be produced to fulfill these wants.
 (Limited in supply of resources)

 The resources or factors of production are

limited but human needs or wants are unlimited
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The Problem of Scarcity

 The the reason for scarcity is thus:

 Human wants are virtually unlimited, whereas

the resources available to satisfy these wants are
limited.

 Because of scarcity, various choices have to be

made between alternatives.
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The Problem of Scarcity

 One thing you must understand is that we do
not all face the problem of scarcity to the same
degree. For instance, a poor person unable to
afford enough to eat or a decent place to live
will hardly see it as a ‘problem’ that a rich
person cannot afford a second BMW.
 But given that people, both rich and poor, want
more than they can have, this makes them
behave in certain ways.

 Economics studies that behaviour.

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The Problem of Scarcity

In short, Economics studies anything to do with

the process of satisfying human wants using
available resources.
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The Ten facts of Economics

1. PEOPLE FACE TRADEOFFS (there is nothing
like free lunch)

 Individuals as well as societies face tradeoff….. For

something to be done, we must always sacrifice
something.
 For individual…. Learn or club, education or work.
 For societies…. “Guns and butter.”
 One tradeoff society faces is between efficiency
and equity.
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The Ten facts of Economics

2. THE COST OF SOMETHING IS WHAT
YOU GIVE UP TO GET IT

 Because people face tradeoffs, making decisions

requires comparing the costs and benefits of alternative
courses of action.

 In many cases, however, the cost of some action is not

as obvious as it might first appear. For university
education, the benefit is intellectual enrichment but the
cost goes beyond fee and time spent in school
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The Ten facts of Economics

3. RATIONAL PEOPLE THINK AT THE
MARGIN

4. PEOPLE RESPOND TO INCENTIVES….

Because people make decisions by comparing
costs and benefits, their behavior may change
when the costs or benefits change.
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The Ten facts of Economics

5. TRADE CAN MAKE EVERYONE BETTER
OFF

6. MARKETS ARE USUALLY A GOOD WAY

TO ORGANIZE ECONOMIC ACTIVITY

7. GOVERNMENTS CAN SOMETIMES

IMPROVE MARKET OUTCOMES
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The Ten facts of Economics

8. A COUNTRY’S STANDARD OF LIVING
DEPENDS ON ITS ABILITY TO PRODUCE
GOODS AND SERVICES

9. PRICES RISE WHEN THE GOVERNMENT

PRINTS TOO MUCH MONEY

10. SOCIETY FACES A SHORT-RUN TRADEOFF

BETWEEN INFLATION AND UNEMPLOYMENT
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What do Economists Study?

– Production and consumption

 Production has to do with the transformation of

inputs into outputs by firms in order to earn
profit (or meet some other objective).

 Consumption is the act of using goods and

services to satisfy wants. This will normally
involve purchasing the goods and services.
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Factors
 As indicated, of production
Production is the process by which
resources are transformed into useful forms.
 For firms to produce, they need resources or factors of
production.
 Resources, or inputs, refer to anything provided by nature
or previous generations that can be used directly or
indirectly to satisfy human wants.

 There are four factors of production:

• Capital resources……… Capital
• Human resources..... Labour
• Natural resources….Land
• Entrepreneur…..Enterprise
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Factors of production
Labour
 Labour refers to all forms of human input, both
physical and mental that goes into current
production. The reward for labour is Wages

Land and raw materials

 Inputs into production that are provided by nature:
e.g. unimproved land and mineral deposits in the
ground. The reward for land is Rent
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Factors of production
Capital
 All inputs into production that have themselves
been produced: e.g. factories, machines and tools.
The reward for capital is Interest

 Entrepreneur uses his skill to combine the

other three factors of production for production
and sales.
The reward for entrepreneur is Profit
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Three basic questions must be answered in

order to understand an economic system
 The mechanics of decision making in a larger economy
are more complex, but the type of decisions that must
be made are nearly identical.

 All societies must decide:

– What will be produced?
– How will it be produced?
– Who will get what is produced?
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The production possibility curve

– The curve shows all the combinations of the
two goods that can be produced with all the
nation’s resources fully and efficiently
employed.
 The production possibility curve
8
A
7 B

6 C
D
Capital Goods

3 E
2

0
F
0 1 2 3 4 5 6 7 8

Consumer Goods
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The production possibility curve

The production possibility frontier (PPF) curve
has a negative slope that indicates the trade-off
that a society faces between two goods.
The slope of the PPF is also called the marginal rate of
transformation (MRT).
The marginal rate of transformation describes
numerically the rate at which output of one good can be
transformed (by re-allocation of production resources)
into output of the other
The production possibility curve

• Points inside of the

curve are inefficient.

• At point H, resources are

either unemployed, or are
used inefficiently.
The production possibility curve

• Points outside the PPF are

unattainable.

• Point F is desirable
because it yields more of
both goods, but it is not
attainable given the
amount of resources
available in the economy.
The production possibility curve
• Points on the PPF
represent full and
efficient allocation of
resources.

• Point C is one of the

possible combinations of
goods produced when
resources are fully and
efficiently employed.
The production possibility curve
• A move along the curve
illustrates the concept
of opportunity cost.
• In order to increase the
production of capital
goods, the amount of
consumer goods will
have to decrease.
The production possibility curve
• The concave shape of the
production possibility frontier
curve reflects the law of
increasing opportunity
cost.

• As we increase the
production of one good,
we sacrifice
progressively more of
the other.
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Economic Growth
The outward shift of the PPF represent economic
growth
Economic growth is an increase in the total output
of the economy. It occurs when a society acquires
new resources, or when it learns to produce more
using existing resources.
The main sources of economic growth are capital
accumulation and technological advances.
Food Economic Growth

Now

O
Clothing
 Economic Growth

Future
Food

Now

O
Clothing
Economic Growth
• To increase the
production of one good
without decreasing the
production of the other,
the PPF curve must
shift outward.

• From point D, the

economy can choose any
combination of output
between F and G.
Q Which of the following would shift the
P.P.F curve outwards?
A. An increase in the population 20% 20% 20% 20% 20%

of working age
B. A reduction in
unemployment
C. A reduction in VAT
D. An increase in the general
level of prices
A. B. C. D. E.

E. A reduction in expenditure on
education
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Economic Systems
An economic system refers to the particular way in
which economic activities takes place in an
economy.
In other words, an economic system refers to the
particular set of institutional arrangement or
mechanism by which ownership and use of
resources in an economy are determined.
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Economic Systems
There are basically three classifications of economic
systems. These are;
Centrally planned or command economy
Free-market economy
Mixed economy
 Classifying economic systems

Mid 1980s

N. Korea China UK Hong

Cuba Poland France USA Kong
Totally Totally
planned free-market
economy economy
N. Korea Cuba China Poland France USA
UK China
(Hong
Kong)

Late 2000s
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Economic Systems: The command economy

A command economy is an economy
where all economic decisions are taken by
the central authorities.
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Features of a command economy

 The state plans the output of each industry
and firm.
 It plans the distribution of output between
consumers.
 It plans the allocation of resources between
current consumption and investment for the
future.
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Advantages of a command economy

 high investment, high growth
 stable growth
 social goals pursued
 low unemployment
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Problems of a command economy

 problems of gathering information
 expensive to administer
 inappropriate incentives
 shortages and surpluses
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The free-market economy

 A free market economy is an economy
where all economic decisions are taken by
individual households and firms and with
no government intervention.
 demand and supply decisions
 the price mechanism
 the interdependence of markets
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Advantages of a free-market economy

 transmits information between buyers and
sellers
 no need for costly bureaucracy
 incentives to be efficient
 competitive markets responsive to
consumers
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Problems of a free-market economy

 Competition may be limited: problem of
market power
 Inequality
 The environment and other social goals
may be ignored
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The mixed economy

 An economy where economic decisions are
made partly by the government and partly
through the market.
 Because of the problems of both free-
market and command economies, all real-
world economies are a mixture of the two
systems.
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Methods of Economic Studies:

Theories and Models

 Model: A formal statement of a theory,

usually a mathematical statement of a
presumed relationship between two or more
variables.
 Examples are Demand Models, Consumption
Model. etc. it is an abstraction of reality
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

Methods of Economic Studies:

Theories and Models

 Variable: A measure that can change from

time to time or from observation to
observation. For Example, Price, income,
Quantity of Yam, Etc.
 Ockham’s razor: The principle that
irrelevant detail should be cut away
 Kwame Nkrumah University of
Science & Technology, Kumasi, Ghana

The Principles of All Else Equal: Ceteris

Paribus
 Ceteris paribus, or all else equal (all other
things being equal): A device/an assumption
used to analyze the relationship between two
variables while the values of other variables are
held unchanged.
 Using the device of ceteris paribus is one part of
the process of abstraction. In formulating
economic theory, the concept helps us simplify
reality to focus on the relationships that interest
us.