ECONOMICS

CHAPTER ONE
DEFINITION OF ECONOMICS
is the study of efficient allocation of
scarce resources to attain the maximum
fulfillment of unlimited human wants or
needs.

key phrases in this definition are unlimited

1 human wants, scarce resources,
Unlimited wants and resource
scarcity
Human beings;
 want its basic needs like food, clothes,
shelter and other variety of goods and services
for their survival.
 These human wants are unlimited and
increase from time to time;
 however, the availability of economic
resources that include Land, Labor, Capital
and Entrepreneurship are scarce by their
nature.
Thus, economics describes various sets of
tools that enable societies to use their
scarce resources efficiently in order to
2
achieve the highest possible standard of
 THE RATIONALES OF
ECONOMICS
 fundamental facts that provide
the foundation for economics;
 Human material wants are
unlimited.
 Economic resources are
limited (scarce).

Thus, economics is the study of

how human beings make
choices to use scarce resources
Opportunity cost and making
choice

An opportunity cost: is the best

alternative forgone. It is the most
important concept for making optimizing
choices.

To make economic choices, compare

marginal costs (the additional
opportunity cost that can be incurred) and
marginal benefits (the additional benefit
that can be obtained);
SCOPE OF ECONOMICS
Economics can be analyzed at
micro and macro level.
Microeconomics
 deals with the economic
behavior of individual
decision making units such
as households and business
firms;
Macroeconomics
 deals with the effects of the
Microeconomics Macroeconomi
cs
 Studies behavior of  Studies an economy as
individual economic units a whole and its
in the economy. aggregates.
 Its main tools are the  Its main tools are
demand and supply of aggregate demand and
particular commodities and aggregate supply of an
factors. economy as a whole.
 It helps to solve the central Helps to solve the central
problem of what, how and for problem of full
whom to produce in an employment of resources
economy so as to maximize in the economy.
profits
Examples: Individual income, Examples: national income,
individual savings, individual national savings, general
prices, an individual firm‘s price level, national output,
output, individual aggregate consumption,
 METHOD OF ANALYSIS IN
ECONOMICS
Economics can be analyzed from two
perspectives: positive economics and
normative economics.
Positive Economics
 is analysis of facts and attempts to
describe the world as it is.
 tries to answer the questions what was;
what is; or what will be?
Example:
• Poverty and unemployment are the biggest
problems in Ethiopia.
Normative economics
 is loaded with judgments, what is
good for one may not be the case for
the other.
 deals with the questions like, what
ought to be? or what the economy
should be?

Example:
• The poor should pay no taxes.
• Females ought to be given job
opportunities.
 Any disagreement on a normative
 Inductive and deductive
reasoning in economics
 A theory is a simplified picture of reality
 Economic theory provides the basis for economic
analysis which uses logical reasoning
 There are two methods of logical reasoning:
inductive and deductive.

a. Inductive reasoning
 is the process of deriving a principle or theory by
moving from facts to theories and from
particular to general economic analysis.
 It involves the following steps.
i. Selecting problem for analysis
ii. Collection, classification, and analysis of data
iii. Establishing cause and effect relationship
between economic phenomena.
b. Deductive reasoning
 It checks the validity of the
theory to facts by moving from
general to particular.
 Major steps in the deductive
approach include:
i. Problem identification
ii. Specification of the
assumptions
iii. Formulating hypotheses
iv. Testing the validity of the
hypotheses
 THE PRODUCTION POSSIBILITIES
FRONTIER OR CURVE (PPF/ PPC)
PPF/PPC
 is a curve that shows the various
possible combinations of goods and
services that the society can produce given
its resources and technology.
 To draw the PPF we need the following
assumptions.
 Fixed quantity as well as quality of
economic resource available for use
during the year (L, K)
 Two types of output to be produced over
the year
 The economy is operating at full
Table 1.1: Alternative production possibilities of a certain nation

Types of products Unit Production alternatives

A B C D E
Food metric tons 500 420 320 180 0

Computer number 0 500 1000 1500 2000

We can also display the above information with a graph.

Food 500 A All points on the PPF are

420
attainable and efficient
B
Point Q is attainable but
inefficient
320 C .R - Point R is unattainable

180 Q D

E
0 500 1000 1500 2000 Computer
Figure 1.1: Production Possibilities Frontier
 1.5 BASIC ECONOMIC QUESTIONS
The scarcity of resources created three major
problems that every society faces.
1. What to produce
 refers;
 to types of those goods and services
to be produced;
 the quantity of each goods that the
economy should produce
 an economy cannot produce as much of
every good and service as desired;
 b/c resources are scarce (more of one
good means less of others).
 Thus, society must choose exactly which
14 goods and services to produce and
consume
2. How to produce
It refers to ;
 choosing efficient production
techniques used (labor intensive,
capital intensive)
 the combination of factors and the
particular technique ;

3. For whom to produce

 refers;
 about the distribution way of goods
& services among end users;
15
 choose how to distribute the
 1.6 ECONOMIC SYSTEMS
 are established to answer the basic
economic questions
 are three types: capitalism, command
and mixed

a. Capitalist Economy (Capitalism)

 it is also called free market economy or
market system or laissez faire
 here, all means of production are
privately owned,
 minimum government intervention in
the economy
 Features of Capitalistic
Economy

 Full right to own private

property (factors of
production)
 Profit motive
 Minor role of government
 High inequalities of
income
b. Command Economy (socialistic
economy)

all means of production are owned and

controlled by the state.

Main Features
 collective ownership
 strong government intervention
 maximum social welfare
 relative equality of income
 c. Mixed Economy
incorporates features of capitalistic
economy and the command
allows private and public sectors to co-
exist.

Main Features
 co-existence of public and private
sectors
 high economic welfare
 high economic equality (through re-
distribution of income in the form
 1.7 Circular Flow of Economic
Activity
It is a model showing the basic economic
relationships within different sectors of market
economy.
It includes
o households
o business firms
o government sectors
The model shows where money goes and what it is
exchanged for
Goods and services flow through the economy in one
20 WSU, CBE, Department of Economics 11/15/2024
direction while money flows in the opposite direction
Product or Output market
is the markets in which goods and
services produced by businesses are
sold to households

Flow of money income (revenue) to

business firms from the sell of G & S
to households

21 WSU, CBE, Department of Economics 11/15/2024

 Input or Factor market
is a market in which households who own
economic resources supply resources to
firms

here, business firms are demanders of

resources, but households are the suppliers

firms pay for resources(expenditure of firms)

and Hhs earn money payment (income of
hhs)
23 WSU, CBE, Department of Economics 11/15/2024
 Economics Individual Assignment
1. WHY WE STUDY ECONOMICS? HAVE YOU GAINED
ANYTHING FROM THIS CHAPTER? WOULD YOU
DISCUSS THEM PLEASE?
2. DEFINE SCARCITY, CHOICE AND OPPORTUNITY COST
3. WHAT DO YOU UNDERSTAND BY POSITIVE
ECONOMICS AND NORMATIVE ECONOMICS?
4. EXPLAIN WHY ECONOMICS DEALS WITH
ALLOCATION AND EFFICIENT UTILIZATION OF
SCARCE RESOURCES ONLY?
5. DESCRIBE THE FOUR CATEGORIES OF ECONOMIC
RESOURCES. WHICH CATEGORY OF RESOURCES YOU
AND YOUR FAMILY OWNED?
6. DISCUSS THE ECONOMIC SYSTEM IN ETHIOPIA
OVER THE RECENT THREE REGIMES (PROSPERITY
PARTY, EPRDF AND DERG REGIME)
END!
25 WSU, CBE, Department of Economics 11/15/2024