CONTENTS

1. Chapter One: Nature of Economics

2. Chapter Two: Theory of Demand and Supply
3. Chapter Three: Theory of Consumer Behavior
4. Chapter Four: The Theory of Production and
Cost
5. Chapter Five: Market Structure
6. Chapter Six: Fundamental Concepts of
Macroeconomics
1
KANENUS COLLEGE
INTRODUCTION TO ECONOMICS

CHAPTER ONE

NATURE OF
ECONOMICS
LECTURE NOTES
Course Instructor: Assefa D.
2022
 PRE-TEST

•What are resources?

•What does efficient allocation of resources
mean?
•What are human needs?
•What is economics?

3
 1.1. DEFINATION OF ECONOMICS

• The word economy comes from the Greek phrase

―one who manages a household.
• The science of economics in its current form is
about two hundred years old.
• Adam Smith – generally known as the father of
economics – brought out his famous book, ―An
Inquiry into the Nature and Causes of Wealth of
Nations, in the year 1776.
• However there were economic thoughts since antiquity 4
 1.1. DEFINATION OF ECONOMICS

• There is no universally accepted definition of

economics (its definition is controversial).
• This is because different economists defined
economics from different perspectives
• More generally it can be defined as:

• ‘A social science dealing with the efficient

allocation and wise use of scarce resources to
attain the maximum fulfillment of unlimited wants’
5
 1.1. DEFINATION OF ECONOMICS

• Economics is a science of choice

• It studies how people choose to use scarce or

limited productive resources (land, labor,
equipment, technical knowledge and the like)
• to produce various commodities

• to distribute these goods to various members of

society for their consumption.

6
1.2. THE RATIONALE FOR ECONOMICS

• The two fundamental facts provide the

foundation for the field of economics are:
i. Human wants are unlimited
ii. Resources are limited/scarce
• Thus, the imbalance between unlimited ends
and scarce means provides a foundation for the
field of economics.
• Scarcity forces people to make choice and
choice involves sacrifice
7
1.2. THE RATIONALE FOR ECONOMICS

There are three fundamental choices to be

made by economic agents:
1.What to produce:
•what kind of goods and services should be produced
and how much in each category.
1.How to produce:
• refers to the method of production to be adopted.
2.For whom to produce:
• the concern of distribution
8
1.2. THE RATIONALE FOR ECONOMICS

• Economic agents (HHs, Firms, Gov’t) need to

balance their resource use with the resources
available
• They do so to meet their desired objectives.

• The objectives of economic agents:

• Maximization of satisfaction for consumers,
• Maximizing profit for firms
• Maximizing social welfare for the
government 9
1.3. SCOPE AND METHOD OF ANALYSIS IN
ECONOMICS
1.3.1. SCOPE OF ECONOMICS
1. MICROECONOMICS:
• Considered to be the basic economics.
• May be defined as:
• that branch of economic analysis which studies
the economic behavior of individual decision
making units such as households, firms,
markets and industries.
• In other words, it deals with how households and
firms make decisions and how they interact in
specific markets. 10
SCOPE OF ECONOMICS
2. MACROECONOMICS:
• May be defined as:
• that branch of economic analysis that deals
with the effects and consequences of the
aggregate behavior of all decision making
units in a certain economy.
• It is an aggregative economics that examines
the interrelations among various aggregates,
their determination and the causes of
fluctuations in them.
11
Microeconomics Macroeconomics
Studies individual economic units of Studies an economy as a whole and
an economy. its aggregates.
Deals with individual income, Deals with national income and output
individual prices, individual outputs, and general price level
etc.
Its central problem is price Its central problem is determination of
determination and allocation of level of income and employment
resources.
Its main tools are the demand and Its main tools are aggregate demand
supply of particular commodities and and aggregate supply of an economy
factors. as a whole.
It helps to solve the central problem of Helps to solve the central problem of
what, how and for whom to produce‘ full employment of resources in the
in an economy so as to maximize economy.‘
profits
Discusses how the equilibrium of a Concerned with the determination of
consumer, a producer or an industry equilibrium levels of income and 12
is attained employment at aggregate level.
SCOPE OF ECONOMICS
EXAMPLES OF ISSUES ANALAYSED AT
MICROECONOMIC LEVEL:
•Individual income, individual savings, individual
prices, an individual firm‘s output, individual
consumption, etc
EXAMPLES OF ISSUES ANALAYSED AT
MACROECONOMIC LEVEL
•national income, national savings, general price
level, national output, aggregate consumption, etc.
13
1.3.2. POSITIVE AND NORMATIVE
ANALYSIS
• Positive economics: it is concerned with analysis of facts
and attempts to describe the world as it is.
• It tries to answer the questions what was; what is; or what
will be?
• It does not judge a system as good or bad
• Any disagreement on positive statements can be checked
by looking in to facts.
Example:
• The current inflation rate in Ethiopia is 12 percent.
• Poverty and unemployment are the biggest problems in
Ethiopia.
• The life expectancy at birth in Ethiopia is rising. 14
1.3.2. POSITIVE AND NORMATIVE
ANALYSIS
• Normative economics: It deals with the questions like,
what ought to be? Or what the economy should be?
• It evaluates the desirability of alternative outcomes based
on one‘s value judgments about what is good or what is
bad.
• Normative analysis is subjective in nature
• Any disagreement on a normative statement can be
solved by voting.
Example:
• The poor should pay no taxes.
• Females ought to be given job opportunities.
15
1.4 SCARCITY, CHOICE, OPPORTUNITY COST AND
PRODUCTION POSSIBILITIES FRONTIER

SCARCITY
•The excess of wants resulting from having limited
resources (land, labor, capital and entrepreneurs) in
satisfying the endless wants of people.
•It is a universal problem for societies – it is not limited to
poor countries
•Scarcity is not synonym with shortage
•To the economist, all goods and services that have a price
are relatively scarce.
•This means that they are scarce relative to people’s
16
demand for them
1.4 SCARCITY, CHOICE, OPPORTUNITY COST AND
PRODUCTION POSSIBILITIES FRONTIER

RESOURCES
•Free resources: A resource is said to be free if the
amount available to a society is greater than the
amount people desire at zero price.
• E.g. Sunshine
•Scarce (economic) resources: A resource is said to
be scarce or economic resource when the amount
available to a society is less than what people want
to have at zero price.
• E.g. labor , land, capital, entrepreneurship 17
ECONOMIC RESOURCES

18
CHOICES
• Scarcity means that choices are necessary.
• When you can’t have all you want of everything,
you must make choices.
• Economics is the study of how to make the best
possible ( or the optimal) choice under the
constraint of limited resources.
• Choices always involve tradeoffs
• Because of the scarcity of resources, we can
have more of one thing only if we are willing to do
with less of another (Opportunity Cost) 19
OPPORTUNITY COST

• In a world of scarcity, a decision to have more of

one thing, at the same time, means a decision to
have less of another thing.
• Opportunity cost is that which we give up or
forgo, when we make a decision or a choice.
• It is the cost expressed in terms of the next best
alternative sacrificed
• Helps us view the true cost of decision making

• Implies valuing different choices 20

OPPORTUNITY COST

• For example, suppose the country spends all of

its limited resources on the production of cloth or
computer.
• If a given amount of resources can produce either
one meter of cloth or 20 units of computer,
• then the cost of one meter of cloth is the 20 units
of computer that must be sacrificed in order to
produce a meter of cloth.
• when opportunity cost of an activity increases
people substitute other activities in its place. 21
1.5. PRODUCTION POSSIBILITY CURVE
(FRONTIER) OR PPF

• Production – output of goods and services

• Possibility – maximum attainable amount

• Frontier – border or boundary

• PPF shows the boundary of what is possible

• It is used as an illustration in economics to show

the choices facing all countries in producing
goods which use limited factors of
production. 22
PRODUCTION POSSIBILITY CURVE

• Show the different combinations of goods and

services that can be produced with a given
amount of resources
• Any point inside the curve – suggests
resources are not being utilised efficiently
• Any point outside the curve – not attainable
with the current level of resources
• Useful to demonstrate economic growth and
opportunity cost 23
PRODUCTION POSSIBILITY CURVE

Assumptions in using PPC

i.Fixed resources: factors of production are not changed.
ii.Efficiency: there is state of full employment and no idle
resource is left.
iii.Two products: there are only two goods to be produced.
iv.Fixed technology: there is no advancement/change in
technology.
v.Specialization: Some inputs are better adapted to the
production of one good than to the production of the other.
24
Table 1.1. Alternative production
possibilities of a certain nation

Types of Unit Production

products alternatives
A B C D E

Food 500 420 320 180 0

Metric

tons
Computer 0 500 1000 1500 2000
Number

25
PRODUCTION POSSIBILITY CURVE

26
PRODUCTION POSSIBILITY CURVE

• Opportunity cost is the amount of other

products which must be forgone (give up) to
obtain a units if any given products.
• In equation form:

• Opportunity cost=

27
PRODUCTION POSSIBILITY CURVE

• Example: Referring to table 1.1, if the economy

is initially operating at point B, what is the
opportunity cost of producing one more unit of
computer?
• Solution: Moving from production alternative B to
C we have:

28
PRODUCTION POSSIBILITY CURVE
The PPF illustrates the three basic concepts:
scarcity, choice and opportunity cost.
1.There is a limit to the amount we can produce in
a given time period with available resources and
technology (Scarcity).
2.Shows the combination of goods that can be
produced when the factors of productions are utilized
to their full potentials (Choice)
3.We can obtain additional quantities of any
desired good by reducing the potential production of
another good (Opportunity Cost)
29
ECONOMIC GROWTH AND THE PPF

• Economic growth or an increase in the total

output level occurs when one or both of the
following conditions occur.

1. Increase in the quantity or/and quality of

economic resources.

2. Advances in technology.
• Economic growth is represented by outward shift
of the PPF.
30
ECONOMIC GROWTH AND THE PPF

31
ECONOMIC GROWTH AND THE PPF

• An economy can grow because of an increase

in productivity in one sector of the economy.
• For example, an improvement in technology
applied to either food or computer would be
illustrated by a shift of the PPF along the Y- axis
or X-axis.
• This is called asymmetric growth (figure 1.3)

32
ECONOMIC GROWTH AND THE PPF

33
SHAPE OF PPF

• PPF is shaped concave to the origin due to law

of Increasing opportunity Costs
• This means that resources are not equally
adaptable to alternative uses
• Or due to lack of perfect flexibility on the part of
resources and this is called specificity of
resources.
• This specifically means that inputs are more
productive in some uses than in others.
34
Why PPC is concave to the origin?

35
 1.6. THE ECONOMIC PROBLEM

1. What goods and services should an economy

produce? (What to produce)
• should the emphasis be on agriculture, manufacturing or
services, should it be on sport and leisure or housing?
• This problem is also known as the problem of allocation
of resources.
• This problem arises mainly for two reasons.
i. Scarcity of resources does not permit production of all
the goods and services that people would like to
consume.
ii. All the goods and services are not equally valued in
36
terms of their utility by the consumers
 THE ECONOMIC PROBLEM

2. How should goods and services be produced?

(How to Produce)
• This problem is also known as the problem of
choice of technique
• Should produce: labour intensive, land intensive,
capital intensive?
• Here, the problem is how to determine an
optimum combination of inputs.
• This problem mainly arises mainly because of
scarcity of resources. 37
 THE ECONOMIC PROBLEM

3. Who should get the goods and services

produced? (For Whom to produce) –
• This problem is also known as the problem of
distribution of national product.
• even distribution? more for the rich? for those
who work hard?
• identifying the market or the users of the
commodity what you produce using a certain
technical means
38
1.7. ALTERNATIVE ECONOMIC SYSTEMS

• The way a society tries to answer the above

fundamental questions is summarized by a
concept known as economic system.
• Economic systems are
• sets of organizational arrangements and
institutions that are established to solve
economic problems.
• Today there exists an array of economic systems
in the world
39
1.7.1 MARKET (CAPITALIST) ECONOMY

• This system is also called free market economy

or market system or laissez faire.
• All production is in private hands
• Few cases of surpluses and shortages
• If there are changes in the pattern of demand,
then there will be changes in the pattern of
supply in order to meet the new demand pattern
• Is a self-righting system
• Government intervention in the economy is minimal 40
MARKET (CAPITALIST) ECONOMY

• In such a system, the three fundamental

economic problems are addressed in such a
manner that
• firms produce those goods and services that
give the highest profit (the what),
• by the techniques of production that are least
costly (the how), and
• incomes are distributed based on the
ownership of means of production (the for
whom).
41
FEATURES OF CAPITALISTIC ECONOMY

• The right to private property

• Freedom of choice by consumers
• Profit motive
• Competition
• Price mechanism
• Minor role of government
• Self-interest
• Inequalities of income
• Existence of negative externalities 42
ADVANTAGES OF CAPITALISTIC
ECONOMY
• Flexibility or adaptability
• Decentralization of economic power
• Increase in per-capita income and standard of
living
• New types of consumer goods
• Growth of entrepreneurship
• Optimum utilization of productive resources
• High rate of capital formation
43
DISADVANTAGES OF CAPITALISTIC
ECONOMY
• Inequality of income
• Unbalanced economic activity
• Exploitation of labor
• Negative externalities
• Monopolies

44
1.7.2 COMMAND (SOCIALIST) ECONOMY

• Sometimes called a centrally planned economy

• Decisions as what to produce, how to produce,
and who to produce for, are made by a central
body, the state.
• All resources all collectively owned.
• Unlike the capitalist economy, in the socialist
economy the prime motive is public interest
(social welfare) rather than profit
• In the recent past, socialism has lost its popularity
and most of the socialist countries are trying free
market economies
45
MAIN FEATURES OF COMMAND ECONOMY

• Collective ownership
• Central economic planning
• Strong government role
• Maximum social welfare
• Relative equality of incomes

46
COMMAND (SOCIALIST) ECONOMY

Advantages of Command Economy

•Absence of wasteful competition
•Balanced economic growth
•Elimination of private monopolies and inequalities

Disadvantages of Command Economy

•Absence of automatic price determination
•Absence of incentives for hard work and efficiency
•Lack of economic freedom
•Red-tapism 47
1.7.3 MIXED ECONOMIES

• In reality, all economies are mixed economies

• Some countries have high levels of planning and

government involvement in the economy (eg.
China)
• It is an attempt to combine the advantages of
both the capitalistic economy and the command
economy.
• It incorporates some of the features of both and
allows private and public sectors to co-exist
48
MIXED ECONOMIES

• The basic economic problems are resolved by a

mixture of government decisions and market
forces of demand and supply.
• The private sector (where decisions are made
mainly by firms and households) functions
through the price mechanism and
• the public sector is planned and controlled by the
state.

49
MAIN FEATURES OF MIXED ECONOMY

• Co-existence of public and private sectors

• Economic welfare
• Economic planning
• Price mechanism
• Economic equality

50
MIXED ECONOMY

Advantages
•Private property, profit motive and price mechanism
•Adequate freedom
•Rapid and planned economic development
•Social welfare and fewer economic inequalities
Disadvantages
•Ineffectiveness and inefficiency
•Economic fluctuations
•Corruption and black markets 51
1.11. MAJOR DECISION MAKING UNITS AND THE
CIRCULAR FLOW OF ECONOMIC ACTIVITIES

• Market is an institution or mechanism which

brings together buyers (Households) and
suppliers (Firms) of particular goods & services
or resources.
• The three most important decisions – making
units are:
1. Households: - these are units that provide an
economy with the resources they sell in the
factor market and use the money paid for them to
buy goods and services from the product market.
52
MAJOR DECISION MAKING UNITS AND THE
CIRCULAR FLOW OF ECONOMIC ACTIVITIES

2. Business firms: - these are production units that

use resources to produce goods and services
and sell them to other firms, households and
governments.

3. Governments: - this refers to an organization

that has a legal and political power to exert
control over individuals, business firms and
markets.

53
MAJOR DECISION MAKING UNITS AND THE
CIRCULAR FLOW OF ECONOMIC ACTIVITIES

The three economic agents interact in two

markets
1. Product market: it is a market where goods and
services are transacted/ exchanged.
• That is, a market where households and governments
buy goods and services from business firms.
2. Factor market (input market): it is a market
where economic units transact/exchange factors
of production (inputs).
• In this market, owners of resources (households) sell
their resources to business firms and governments. 54
55
`

56