Wollo University

College of Business and Economics

Department of Economics

Introduction to Economics (PPT)

 For Business student 2012/2013

 P.By Temeselew W.
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May , 2013
 CHAPTER ONE

BASICS OF ECONOMICS

Have you ever heard anything about Economics?

 understand the concept and nature of economics;
 analyze how resources are efficiently used in producing output;
 identify the different methods of economic analysis ;
 distinguish and appreciate the different economic systems;
 understand the basic economic problems and how they can be solved; and
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 identify the different decision making units and how they interact with each other
1.1. DEFINITION AND NATURE OF
ECONOMICS
 The word economics comes from the ancient Greek word
oikonomia.
oikos=>house
nomos =>rule or custom
So oikonomia means rule of house(household) or management of
household administration
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.
There is no universally accepted definition of economics
Wealth , scarcity, economic growth , and welfare definitions are
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some of the common definitions of economics.
 However, we can condense the definition f economics as
 DEFINITIONS OF ECONOMICS

 “ efficient and effective allocation and utilization of scarce

resources so as to attain the maximum fulfillment of unlimited
human needs.

 Two fundamental facts together provide a foundation for

Economics (rationales for Economics)
1. Society’s material want are unlimited.
2. Economic resources are limited in supply or scarce

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CONT…
 These two contradictory facts lay the foundation for the field of
Economics
 Economics is a science which studies the allocation of scarce
resources in production, consumption and distribution of goods
and services to attain the maximum fulfillment of society’s
material wants.
 Economics is concerned with “doing the best with what we
have”.

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 THE SCOPE OF ECONOMICS
 From the point of view of elements of analysis, economics has
two major branches: microeconomics and macroeconomics
A. Microeconomics
 Deals with economic behaviors of individual economic
units such as consumers, producers, business firms and
other economic decision making units
 Deals with how the market of individual commodities
function

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CONT…
 It is concerned also with interaction among the economic units
B. Macroeconomics
 Is branch of economic analysis
concerned with the economy as a whole
and sub aggregates of the economy.
Macroeconomics deals with aggregate
units of national economy such as
national output or Gross National
Product (GDP), general price level, 7

inflation and national employment.

CONT…
 Like macroeconomics ,microeconomics also uses aggregates.
 But in microeconomics we aggregate over the homogeneous
product but in macroeconomics the aggregation is at the
economy level

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BASIC CLASSIFICATIONS OF ECONOMICS

Macroeconomics Microeconomics
The big picture. Study of the “A small-scale study”. Focuses
operation of the economy as a on individual entities of the
whole. It looks at aggregate economy, such as households and
data. firms.

Focuses more at focuses at the

the policy and firm level
regulatory levels.

 Both areas offer valuable outlook on the economy.

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TABLE 1. COMPARISON BETWEEN MICROECONOMICS
AND MACROECONOMICS

Microeconomics Macroeconomics

Households’ and/or firms’ National economy

economic behavior
Price of individual items or General price level
firms
Price of a consumption Consumer price index
good (CPI)
An increase in price of a Inflation
commodity 10

Output of a factory or a firm National output or GDP

CONT…

Microeconomics Macroeconomics

Output of a factory or a National output or

firm GDP
Wage rate in an National wage rate
enterprise
Investment of National Investment
individual firm
Consumption of National Consumption
households or 11
individuals
Firm’s expense or Government
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DEDUCTIVE AND INDUCTIVE METHODS

Deductive Method
• Deductive method proceeds from general to
particular.
• It involves reasoning from certain principles to the
analysis of specific facts.
• Then conclusions are drawn which are verified
against observed facts.
Steps involved in deductive method:
1. Selection of economic phenomenon to be explained,
i.e. identification of the problem
2. Formulation of assumptions
3. Making logical inferences/conclusions 13

4. Verification of conclusions/inferences
 …
DEDUCTIVE AND INDUCTIVE METHODS

Inductive Method
This method involves reasoning from particular facts to
general principles. It involves four steps:
 Observation
 Formulation of hypothesis
 Generalization
 Verification
Example: One may observe that the prices of grains fall
during harvest period. This may be connected with an
increase in the supply of grain at that time of the year.
From this observation a generalization can be made: “An
increase in supply leads to a fall in prices, keeping other
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factors constant”.
Deductive Vs Inductive Method

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 The Method of Economics:
Positive v. Normative Economics…
 Normative economics. - Studies the way the world
should be.
 Statements about what ought to be.
 The poor should pay no taxes.
 There is a need for intervention of government in the
economy.
 Females ought to be given job opportunities.

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POSITIVE VS NORMATIVE ECONOMICS
 Positive economics-statements about what is.
 It studies the way the world is.

 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.

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 CONT…

 Besides technical knowledge, engineers are also required to

control the budget of a project, or decide if invest in an
infrastructure development.
 Engineers are strong in mathematics and quantitative analysis -
the core element in finance are mostly mathematics
 Many banks and financial firm hire engineering graduates as
financial analysts.

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1.2. SCARCITY AND CHOICE
Scarcity –refers to all economic resources, that a society needs
to produce goods and resources, are finite or limited in supply
 It refers to the imbalance between our wants and a means to
satisfy these wants.
 Resources can be classified as free and economic resources
 A resource is said to be free if the amount available to society is
greater than the amount people desire at zero price.

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CONT…

 A resource is said to be scarce or economic resource if the

amount available to society is less than the amount people desire
at zero price
 Economic resource can also be divided into four categories

i. Labor iii. Capital

ii. Land iv. Entrepreneurship

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CONT…

i. Labor
 refers to the physical as well as mental effort of human
beings in production and distribution of goods
 This includes both the skilled and unskilled labor
 The reward for labor is called wage

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CONT…

ii. Land
 refers to the natural resources or all the free gifts of nature

 It doesn’t include those resources that are transformed, altered

or improved by human beings
 The reward/payment for land is called rent

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CONT…
iii. Capital
 refers to all manufactured inputs that can be used to produce
other goods and services
 it refers to physical capital only.

 It doesn’t take in to account financial capital

 The reward for capital is called interest

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CONT…

iv. Entrepreneurship
 refers to a special type of human talent that helps to organize,
manage factors of production to produce goods and services
 Takes risk of making losses
 The reward for an entrepreneur is profit

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 CONT…

 The same logic(definition of scarce or free resource ) is

applicable for goods and services
 A good is said to be scarce or economic good if the amount
available to society is less than the amount people desire at zero
price
 A good is said to be free good if the amount available to society
is greater than the amount people desire at zero price

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CONT…
NB:scarcity doesn’t mean shortage

Shortage Scarcity

Specific problem Universal problem

Short term Everlasting

phenomena phenomena

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CONT…
2. Choice
 Scarcity implies choice
 Choice in turn implies cost(scarification)
 The cost is the forgone opportunity

3. Opportunity cost: is the value of the next best alternative that

must be given up in order to obtain one more unit of a product

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4. PRODUCTION POSSIBILITY FRONTIER(PPF)

 PPF is a graph that shows the various combinations of output

that the economy can possibly produce given the available

factors of production and the available production technology

Assumptions to draw the PPC/PPF

i. Efficiency

ii. Fixed resource

iii. Two products iv. Fixed technology

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CONT…
Behaviors of points in/on/out of the PPF
 Points on PPF (A, B,C, D and E ) are attainable and efficient

 Points inside the PPF (Q) are (attainable but inefficient)

 Points outside the PPF are (R) (Unattainable)

Three concepts described by the PPF

 The concept of scarcity

 The concept of choice

 The concept of opportunity cost ( the law of increasing

opportunity cost)
 the law of increasing opportunity cost leads to Concave to the
origin
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CONT…
Opportunity = The amount of the good scarified
The amount of the good gained

 Law of Increasing Opportunity Cost – For each additional unit

of a good produced the opportunity cost increases. Why?
 Because the most efficient use of the resource in production
of a good is used first.

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 symmetrical  Asymmetrical

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1.6.THE BASIC ECONOMIC QUESTIONS AND
ALTERNATIVE ECONOMIC SYSTEMS
There are three basic economic problems that any economic unit
needs to answer:
A. What to produce: (problem of allocation of resources)
Types and amounts of commodities to be produced
B. How to produce: (problem of choice of techniques)
determine what production method or technique to use and what
input to use.
C. For whom to produce: ( problem of distribution of output )
This question helps us to identify potential customers

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 ALTERNATIVE ECONOMIC SYSTEMS
Economic system is a set of organizational and institutional
arrangements Established to answer the basic economic
questions There are three types of economic systems
A. Market Economy (Capitalism or Free Market )

B. Command economy( communism or socialism)

C. Mixed economy

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A. MARKET ECONOMY
 The private ownership of resources and the use of markets and
prices to coordinate and direct economic activity characterize
the market system, or capitalism.
 In this system each participant acts in his or her own self-
interest; each individual or business seeks to maximize its
satisfaction or profit through its own decisions regarding
consumption or production.

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 B. COMMAND ECONOMIC SYSTEM
 The alternative to the market system is the command system,
also known as socialism or communism.
 In this system, the government owns most property resources
and economic decision making occurs through a central
economic plan.
 A central planning board appointed by the government makes
nearly all the major decisions concerning the use of resources,
the composition and distribution of output, and the organization
of production
 Pure capitalism and command economy are the two extreme
types of economic systems

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C. MIXED ECONOMIC SYSTEMS( BOTH)
 The mixed economic system takes the strong elements of
the two economic systems

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 1.7. Decision making unit and circular flow of economic
activities
 There are three decision-making units in closed economy.( HH,
Firm , and Government )
Households-A household can be one person or more who live
under one roof and make
joint financial decisions. Households make two decisions.
a) Selling of their resources, and

b) Buying of goods and services.

Firm: A firm is a production unit that uses economic resources to

produce goods and
services. Firms also make two decisions:
c) Buying of economic resources

d) Selling of their products.

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Government: A government is an organization that has legal and
political power to control
or influence households, firms and markets. Government also
provides some types of goods
and services known as public goods and services forth society.
The three economic agents interact in two markets:
Product market( Output market)
 goods and services are transacted/ exchanged.

Factor market (input market) (Resource Market )

 a market where economic units transact/exchange
factors of production (inputs).

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 CIRCULAR-FLOW DIAGRAM (TWO SECTOR CIRCULAR FLOW MODEL)

 Two sector circular flow model

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CIRCULAR-FLOW DIAGRAM (THREE SECTOR CIRCULAR FLOW MODEL

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Thank you!

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