Hello Everyone

Economics
The science that deals with the production,
distribution, and consumption of goods and
services, or the material welfare of
humankind.
Definition :

“Economics is the study of how
people choose to use resources.
Resources include the time and talent
people have available, the land, buildings,
equipment, and other tools on hand, and
the knowledge of how to combine them
to create useful products and services.
Society (we) must figure out
WHAT to produce (make)

HOW MUCH to produce (quantity)

HOW to Produce it (manufacture)

FOR WHOM to Produce (who gets what)

WHO gets to make these decisions?

What are Resources?

▪ The things used to make other goods

BUT, There’s a Fundamental Problem:

▪ SCARCITY: unlimited wants and needs but limited

resources
Why Choices?

▪ We make choices about how we spend our money, time,

and energy so we can fulfill our NEEDS and WANTS.

▪ What are NEEDS and WANTS?

 Wants and Needs
Needs and Wants
▪ NEEDS – “stuff” we must have to
survive, generally: food, shelter,
clothing
▪ WANTS – “stuff” we would really like
to have (Fancy food, shelter, clothing,
big screen TVs, jewelry, conveniences
. . . Also known as LUXURIES
 TRADE-OFFS

You can’t have it all (SCARCITY –

remember?)so you have to

▪choose how to spend your money,

time, and energy. These decisions

involve picking one thing over all the
other possibilities –a TRADE-OFF!
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 TRADE-OFFS

▪ What COULD you have done instead of come to

class today? All of these are trade-off.

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WHAT IS ECONOMICS?

The subject has two parts:

▪ Microeconomics
▪ Macroeconomics
Microeconomics is the study of the choices that individuals and
businesses make, the way these choices interact in markets, and
the influence of governments
Macroeconomics is the study of the performance of the national
economy and the global economy.

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—“Microeconomics is the study of the
economic actions of individuals and
well defined groups of individuals.”
Microeconomics
Microeconomics is the study of the choices that individuals and businesses
make, the way these choices interact in markets and the influence of
governments.

Some examples of microeconomic questions are: Why are people buying

more mobile phones?
 Macroeconomics (from the Greek
prefix makro- meaning "large" and
economics) is the study of the
macroeconomy. It is a branch of
economics dealing with the
performance, structure, behavior, and
decision-making of an economy as a
whole, rather than individual markets.
 "Macroeconomics is the branch of economics
concerned with aggregates, such as national
income, consumption, and investment “

 Macroeconomics is the study of the performance of the

national economy and the global economy.
 Some examples of macroeconomic questions are: Why did
production and jobs shrink in 2001? Why has Japan’s
economy stagnated?
Microeconomics vs macro economics

1.Microeconomics is the study of particular markets,

and segments of the economy.
Macro economics is the study of the whole economy.
2. Micro economics looks at issues such as
consumer behaviour, individual labour markets,
and the theory of firms.
Macro economics looks at ‘aggregate’ variables,
such as aggregate demand, national output and
inflation.
3. The word “Micro” has come from a Greek word
“Mikros” which means millions of parts.
The word “Macro” comes from a Greek word “Makros”
which means large.

4. Microeconomics is also called price theory. macro

economics is called income theory.
5. Micro economics provides a microscopic view .
Macro economics provides a bird view of the whole
economy.
Micro economics is concerned with:
 Supply and demand in individual markets
Individual consumer behaviour .
e.g. Consumer choice theory.
Individual labour markets – e.g.
demand for labour , wage
determination.
Externalities arising from production
Macro economics is concerned with
Monetary / fiscal policy. e.g. what
effect does interest rates have on
whole economy?
Reasons for inflation,
and unemployment
Economic Growth
International trade and globalisation
Interactions between Micro and
Macro Economics

Microeconomics and macroeconomics

are inter-related because their fields of
interest are bound together and cannot
be separated. The decisions of
individuals make up the economies
studied in macroeconomics
A microeconomist cannot possibly study
the investment policies of businesses
without understanding the impact of
macroeconomic trends such as economic
growth and taxation policies.

Similarly, a macroeconomist cannot study

the components of output in a nation’s
economy without understanding the
Functions of Economic System
Economic system refers to the means
by which decisions involving
economic variables are made in a
society.

In this light, a society’s economic system determines how t h e society answers

its fu n d amen tal economic questions of what to be produce, how t h e o u t p u t is
to be produced, who is to get this o u t p u t a n d how future growth will be
facilitated, if a t all.
Economic systems everywhere may perform similar
functions. These functions may be traditional or
non- traditional.

The traditional functions include the following:

 a. What to produce
 b. How to produce in order to maximize the use of
the resources
 c. For whom to produce
 d. How to distribute the goods and services
 Traditional functions

The traditional functions of every economic

system include the following:
 a. In deciding on what goods to produce, an
economic system also decides in what not
to produce.
For example, if the system wants to provide roads and recreational
facilities, it may have problems since it may lack enough resources
to do so at the same time. It will be necessary that it chooses
between the two. It may for instance have to choose roads.
 b. Economic systems also function to decide on
the particular technique to be used in production.

 Here, the economic system decides what method of

factor combination to be employed in order to maximize
the use of the scarce resources, by minimizing cost and
increasing productivity.
 c. Another problem the economic
system is faced with is for whom to
produce.

To get maximum use from the scarce resources, the

commodity must be produced in an area where it
would be demanded and where costs will be minimized.
The production unit may be sited near the source of
raw material or the market center depending on the
nature of the product.
Non-traditional Functions

•Owing to scarcity of resources, the society must

know whether its capacity to produce goods and
services is expanding or decreasing.
• Some of the major ways to promote economic growth
are ensuring:
adequate rate of growth of per capita income; improvement in
technology through the adoption of superior techniques of
production; better and more extensive education and training of
the labor force and others .
e. Society must also ensure full employment. It is the
task of economic systems to ensure that resources are
not idle or unemployed, since resources are scarce.

 In the market economy, full employment is

achieved by stimulating demand.
 Input and Output

 In economics,factors of production are the inputs to

the production process. Finished goods are the
output.
 In puts : are commodities or services that are used to produce goods
and services. An economy uses its existing technology to combine inputs
to produce outputs.
 Outputs: are the various useful goods or services that result from
the production process and are either consumed or employed in
further production.

 Consider the production of “pizza”. The eggs , flour , heat, pizza oven and
chef’s labor are the inputs. The tasty pizza is the output.
 Inputs are factors of production (land, labour, capital
and entreprenuership)
Factors of production :
 Resources required for generation of goods or services, generally
classified into four major groups:
 Land (including all natural resources), Land includes not only the
site of production but natural resources above or below the soil.
 Labor (including all human resources),
 Capital (including all man-made resources), and
 Enterprise (which brings all the previous resources
together for production).
Two big economic question?

Two big questions summarize the scope of economics:

■ How do choices end up determining what, how, and for whom goods and
services are produced?

■ Can the choices that people make in the pursuit of their own self-interest
also promote the broader social interest?

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Two big economic question?
What, How, and For Whom?

Goods and services are the objects that people value and produce to satisfy
human wants. Goods are physical objects such as cell phones and automobiles.

Services are tasks performed for people such as cell- phone service and auto-
repair service.

What?

What we produce varies across countries and changes over time. What determines
these patterns of production? How do choices end up determining the quantities of cell
phones, automobiles, cell-phone service, auto- repair service, and the millions of other
items that are produced in the United States and around the world? 31
Two big economic question?
How?
Goods and services are produced by using productive resources that economists call
factors of production. Factors of production are grouped into four categories:
▪ Land
▪ Labor
▪ Capital
▪ Entrepreneurship
Land The “gifts of nature” that we use to produce goods and services are called land. In
economics, land is what in everyday language we call natural resources. It includes land
in the everyday sense together with minerals, oil, gas, coal, water, air, forests, and fish.

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Two big economic question?

Labor The work time and work effort that people devote to producing goods and services is called
labor. Labor includes the physical and mental efforts of all the people who work on farms and
construction sites and in factories, shops, and offices.
Capital The tools, instruments, machines, buildings, and other constructions that businesses use to
produce goods and services are called capital.
Entrepreneurship The human resource that organizes labor, land, and capital is called
entrepreneurship. Entrepreneurs come up with new ideas about what and how to produce, make
business decisions, and bear the risks that arise from these decisions.

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Two big economic question?
For Whom?
Who consumes the goods and services that are produced depends on the incomes
that people earn.
▪ People with large incomes can buy a wide range of goods and services.
▪ People with small incomes have fewer options and can afford a smaller range of
goods and services.
People earn their incomes by selling the services of the factors of production they
own:
■ Land earns rent.
■ Labor earns wages.
■ Capital earns interest.
■ Entrepreneurship earns profit. 34
Two big economic question?
Can the Pursuit of Self-Interest Promote the Social Interest?
Self-Interest
A choice is in your self-interest if you think that choice is the best one available for you. You make
most of your choices in your self-interest.
▪ You use your time and other resources in the ways that make the most sense to you, and you
don’t think too much about how your choices affect other people.
▪ You order a home delivery pizza because you’re hungry and want to eat. You don’t order it
thinking that the delivery person needs an income. And when the pizza delivery person shows
up at your door, he’s not doing you a favor. He’s pursuing his self-interest and hoping for a
good tip

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Two big economic question?
Social Interest
A choice is in the social interest if it leads to an outcome that is the best for society as a whole. The social interest
has two dimensions: efficiency and equity (or fairness). What is best for society is an efficient and fair use of
resources.

▪ Economists say that efficiency is achieved when the available resources are used to produce
goods and services at the lowest possible cost and in the quantities that give the greatest
possible value or benefit.

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The Economic Way of Thinking
The questions that economics tries to answer tell us about the scope of economics, but they don’t tell us
how economists think and go about seeking answers to these questions. You’re now going to see how
economists go about their work.
We’re going to look at six key ideas that define the economic way of thinking. These ideas
are

■ A choice is a tradeoff.

■ People make rational choices by comparing benefits and costs.

■ Benefit is what you gain from something.

■ Cost is what you must give up to get something.

■ Most choices are “how-much” choices made at the margin.

■ Choices respond to incentives.

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The Economic Way of Thinking
A Choice Is a Tradeoff
Because we face scarcity, we must make choices.
▪ And when we make a choice, we select from the available alternatives.
▪ For example, you can spend Saturday night studying for your next economics test or having fun
with your friends, but you can’t do both of these activities at the same time. You must choose how
much time to devote to each.
▪ Whatever choice you make, you could have chosen something else.
▪ You can think about your choices as tradeoffs.

A tradeoff is an exchange—giving up one thing to get something else. When you choose how
to spend your Saturday night, you face a tradeoff between studying and hanging out with your friends.

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The Economic Way of Thinking

Making a Rational Choice

▪ Economists view the choices that people make as rational.
▪ A rational choice is one that compares costs and benefits and achieves the
greatest benefit over cost for the person making the choice. (Benefit > Cost)
▪ Only the wants of the person making a choice are relevant to determine its
rationality. For example, you might like your coffee black and strong but your
friend prefers his milky and sweet. So it is rational for you to choose espresso
and for your friend to choose cappuccino.

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The Economic Way of Thinking

Benefit: What You Gain

▪ The benefit of something is the gain or pleasure that it brings and is determined by
preferences—by what a person likes and dislikes and the intensity of those feelings.
▪ Some benefits are large and easy to identify, such as the benefit that you get from being
in school. A big piece of that benefit is the goods and services that you will be able to
enjoy with the boost to your earning power when you graduate.
▪ Some benefits are small, such as the benefit you get from a slice of pizza.
▪ Economists measure benefit as the most that a person is willing to give up to get
something. You are willing to give up a lot to be in school. But you would give up only an
iTunes download for a slice of pizza.

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The Economic Way of Thinking
Cost: What You Must Give Up
The opportunity cost of something is the highest- valued alternative that must be given up to get it.

▪ To make the idea of opportunity cost concrete, think about your opportunity cost of being in school. It has two
components: the things you can’t afford to buy and the things you can’t do with your time.

▪ Start with the things you can’t afford to buy. You’ve spent all your income on tuition, residence fees, books,
and a laptop. If you weren’t in school, you would have spent this money on tickets to ball games and movies
and all the other things that you enjoy. But that’s only the start of your opportunity cost.

▪ You’ve also given up the opportunity to get a job. Suppose that the best job you could get if you weren’t in
school is working at Citibank as a teller earning $25,000 a year. Another part of your opportunity cost of being
in school is all the things that you could buy with the extra $25,000 you would have.

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The Economic Way of Thinking
How Much? Choosing at the Margin
▪ You can allocate the next hour between studying and instant messaging your friends, but the choice is not all or
nothing. You must decide how many minutes to allocate to each activity. To make this decision, you compare the
benefit of a little bit more study time with its cost—you make your choice at the margin.

▪ The benefit that arises from an increase in an activity is called marginal benefit. For example, your marginal
benefit from one more night of study before a test is the boost it gives to your grade. Your marginal benefit doesn’t
include the grade you’re already achieving without that extra night of work.

▪ The opportunity cost of an increase in an activity is called marginal cost. For you, the marginal cost of studying
one more night is the cost of not spending that night on your favorite leisure activity.

▪ To make your decisions, you compare marginal benefit and marginal cost. If the marginal benefit
from an extra night of study exceeds its marginal cost, you study the extra night. If the marginal
cost exceeds the marginal benefit, you don’t study the extra night
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The Economic Way of Thinking
Choices Respond to Incentives
▪ Economists take human nature as given and view people as acting in their self-interest. All people— you,
other consumers, producers, politicians, and public servants—pursue their self-interest.

▪ Self-interested actions are not necessarily selfish actions. You might decide to use your resources in ways
that bring pleasure to others as well as to your- self. But a self-interested act gets the most benefit for you
based on your view about benefit.

▪ The central idea of economics is that we can predict the self-interested choices that people make by looking
at the incentives they face. People undertake those activities for which marginal benefit exceeds marginal
cost; and they reject options for which marginal cost exceeds marginal benefit.

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The Economic Way of Thinking
Choices Respond to Incentives
For example, your economics instructor gives you a problem set and tells you these problems will be on
the next test. Your marginal benefit from working these problems is large, so you diligently work them. In
contrast, your math instructor gives you a problem set on a topic that she says will never be on a test.

You get little marginal benefit from working these problems, so you decide to skip most of them.

Ceteris Paribus
Ceteris paribus (often shortened to cet par) means “if all other relevant things remain the same.” To
isolate the relationship of interest in a laboratory experiment a scientist holds everything constant
except for the variable whose effect is being studied.

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Thank you for
listening