Introduction to Economics

Basics of Economics

• Economics studies the efficient allocation of scarce resources to fulfill unlimited human needs.
• Economics analyzes how people use limited resources (land, labor, equipment, knowledge) to produce commodities.
• Economics studies the allocation of resources and how to make the allocation efficient.
• Economics studies how to satisfy unlimited human needs by allocating resources efficiently.
• Economics studies scarce resources

Rationales for Economics

• Economics is founded on two fundamental facts: human material wants are unlimited and economic resources are limited (scarce).
• The basic economic problem involves scarcity and choice.
• Economics examines how humans make choices to use scarce resources to satisfy unlimited wants.

Scope and Method of Analysis in Economics

• Microeconomics concerns the economic behavior of individual units like households, firms, and markets.
• Microeconomics deals with decisions of households and firms and their interaction in specific markets.
• Microeconomics studies individual income, prices, and outputs. The central problem is price determination and allocation of resources.
• Microeconomics main tools include the demand and supply of particular commodities and factors.
• Macroeconomics addresses the effects and consequences of the aggregate behavior of all decision-making units in an economy.
• Macroeconomics is an aggregative economics that examines interrelations and fluctuations among aggregates.
• Macroeconomics considers the economy as a whole and discusses economy-wide phenomena.
• Macroeconomics studies national income and output, and the general price level.
• Determination of the level of income and employment is the central problem in Macroeconomics.
• Macroeconomics main tools include the aggregate demand and aggregate supply of an economy as a whole.
• Both microeconomics and macroeconomics are complementary and that macroeconomics cannot be studied in isolation from microeconomics.

Positive and Normative Analysis

• Positive economics analyzes facts and describes the world as it is, without judging a system as good or bad.
• Positive economics answers questions about what was, what is, or what will be.
• Normative economics deals with what the economy should be.
• Normative economics evaluates alternative outcomes based on value judgments about what is good or bad.

Inductive and Deductive Reasoning in Economics

• Economics aims to establish valid generalizations about human behavior, known as theories which is a simplified picture of reality.
• Inductive reasoning involves deriving a general statement or theory from specific observations, moving from facts to theories.
• Steps in the inductive method include problem selection, data collection and analysis, and establishing cause-and-effect relationships.
• Deductive reasoning arrives at specific statements from a general statement, drawing conclusions about economic phenomena. The theory is checked against reality.
• Steps in the deductive approach include problem identification, assumption specification, hypothesis formulation, and hypothesis testing.

Scarcity, Choice, Opportunity Cost, and Production Possibilities Frontier

• Scarcity is the fundamental economic problem concerning the finite nature of resources, expressed in relation to human wants.
• Free resources are abundant with enough available to satisfy people's needs at zero price, like sunshine.
• Scarce or economic resources have limited availability and are lower than the demand at zero price.
• Manual, intellectual, skilled and specialized labor represents all types of human resources
• Essential natural resources like land, minerals, clean water, and forests are examples of scarce resources
• Capital resources include machines and infrastructure, intermediate goods
• Special human talent helps to organize and manage other factors of production to produce goods and services and this is called entreprenuership
• A good is said to be scarce if the amount available is less than the amount people wish to have at zero price.
• Shortage refers to goods and services that people cannot obtain at the prevailing price.

Choice and Opportunity Cost

• Scarcity leads to limited output, which therefore demands that choices must be made.
• Individuals, firms, and governments must decide what and how much to produce given resource constraints.
• Scarcity implies choice, and choice implies cost, that means whenever a choice is made, an opportunity will be sacrificed.
• Opportunity cost is the value of the next best alternative that must be sacrificed to obtain one more unit of a product.
• Opportunity cost is measured in goods and services and should be in line with the principle of substitution.

Production Possibilities Frontier

• The production possibilities frontier (PPF) illustrates the possible combinations of goods and services an economy can produce with its resources and technology.
• PPF assumes fixed quantity and quality of resources and production is operating at full employment.
• PPF also assumes that technology remains unchanged during the year.
• The PPF describes scarcity.
• All points on the PPF are attainable and efficient.
• The PPF describes choice.
• Any movement along the PPF curve indicates a change in the choices made.
• The PPF describes opportunity cost.
• When the economy produces on the PPF, producing more of one good requires sacrificing some of another product which is reflected by the shape of the PPF.
• Economic growth (increased output) occurs with increased quantity/quality of resources or advances in technology.
• Growth is represented by an outward shift of the PPF.

Basic Economic Questions

• Economic problems due to scarcity are common to all economic systems, also known as central problems.
• Every human society must answer the following three basic questions: What to Produce? How to Produce? For Whom to Produce?
• Deciding which goods to produce and in what quantities is the problem of allocation of resources.
• The economy must choose between consumer goods versus capital goods, civil goods versus military goods, and necessity goods versus luxury goods.
• Once an economy has decided which types of goods to produce and the quantities, decisions need to be made on how these goods will be produced.
• Various production techniques can be classified into labour-intensive and capital-intensive methods.
• The problem of distribution of national product relates to how a material product gets divided among the members of a society.

Economic Systems

• The way a society tries to answer the basic economic questions summarizes the concept of its economic system.
• Capitalistic, command, and mixed economies are three primary economic systems.
• Capitalism is the oldest formal economic system and features privately owned means of production.
• All production takes place at the initiative of individual private entrepreneurs who work primarily for private profit.
• Capitalistic economies operates with minimal government intervention.
• A capitalist economy features the importance of the right to private property, freedom of consumer choice, the motive of profit, and the function of competition.

Command and Mixed Economies

• A command economy is also known as socialistic economy.
• In a command economic system, the economic institutions engaged in production and distribution are owned and controlled by the state.
• A command economy features collective ownership, central economic planning, a strong government role, maximal social welfare, and relative equality of incomes.
• Mixed economy attempts to combine the advantages of both capitalistic and command economies.
• Co-existence of public and private sectors, economic welfare, economic planning, and the price mechanism are the main features of a mixed economy.

Decision-Making Units and the Circular Flow Model

• In a closed economy, three decision-making units include households, firms, and the government.
• Households make financial decisions, sell resources, and buy goods / services
• Firms use financial resources to produce goods/ services and make decisions for buying / selling economic resources
• Governments control households, firms, and markets through legal / political power, while providing public goods and services.
• Economic agents interact in the product market (goods/ services exchanged) and the factor market (factors of production inputs exchanged).
• A circular flow diagram is a visual representation showing how money (Birr), economic resources, goods, and services flow.

Theory of Demand and Supply

• Theory of demand and theory of supply are the two fundamental tools of economics, which determine equilibrium price and quantity.
• Demand relates to consumer consumption. The theory of demand seeks to figure what factors effect demand.
• More specifically, demand refers to quantities of a commodity that a consumer would purchase at varying prices in a market, other aspects unchanged (ceteris paribus).
• Quantity demanded of a commodity depends on price stated in the law of demand.
• The law of demand states there is an inverse relationship between the price and its quantity demanded, ceteris paribus
• Law of demand: As price of a commodity increases (decreases) quantity demanded for that commodity decreases (increases), ceteris paribus

Demand Schedule, Demand Curve, and Demand Function

• The relationship between price and amount of a commodity purchased can be shown by a table (schedule), a curve, or an equation.
• A demand schedule is a list of prices and quantities.
• An individual demand schedule lists the quantities of a commodity that an individual consumer would purchase as the prices changes.
• A demand curve is a graph showing the varying amounts of a commodity that one person demands at differing prices per time period.
• A demand function is a mathematical relationship between price and quantity demanded, assuming other things remain the same.
• The market demand schedule, curve, or function gets derived as a horizontal sum of everybody's quantity demanded for the product at each price.

Determinants of demand

• Demand for a product relies on price of the product, taste/preference of consumers, consumer income, price of related goods, expectation of income/price, number of buyers in the market
• Changes in demand shift the demand curve from the original location, due to the mentioned variables rather than a products own price.
• An increase in demand will shift the demand curve to the right.
• A decrease in demand cause the demand curve to shift to the left.
• When the consumer favors a good then demand for the good incereases.
• Income of the consumer is important, normal goods increase in demand as income increases. Inferior goods decrease in demand as income increases.
• Substitution and compliments of goods will influence demand.
• High expectation of goods will increase demand.
• Low expectation of goods will decrease demand.

Elasticity of Demand

• Elasticity analyzes prices and the quantity purchased or sold. It is used to analyze quatitative relationships between dependent and independent variables.
• Degree of responsiveness of quantity demanded of a good to a change in its price, or its income, or change in prices related goods is demand elasticity.
• Price elasticity, income elasticity, and cross elasticity are three kinds of demand elasticity.
• The percentage change in quantity demanded divided by the percentage change in price is the price elasticity of demand, which indicates how consumers react to price changes.
• The price elasticity of demand can be calculated in ways, i.e. through the point price and arc elasticity.

Point and Arc

• In measuring using the point elasticity of demand is calculated using a strait line to measure elasticity between two point which should be intiimately close to each other.
• Arc price elasticity of demand: measures a mid point of the old and new values of both price and quantity demanded, this is used when there are differences of price in quantity as well.

Elasticity nots

• Unit free demand because it is a ratio of percentage change.
• Elasticity of demand is negative due to the law of demand.
• If |8| > 1, demand is elastic and the product is luxury.
• If 0 ≤ |8| <1, demand is inelastic and the product is necessity.
• If |8| = 1, demand is unitary elastic.
• If s = 0, demand is perfectly inelastic.
• If 8 = ∞, demand is perfectly elastic.
• More substitutes available for a product, then the more elastic is price elasticity of demand. Tendency for demand to be elastic over time, and people tend to adjust their spending patterns as well.

Income Elasticity of Demand

• This refers to the change of responsiveness to demand change in income,
• If &>1, the good is luxury good.
• If &<1(and positive), the good is necessity good,
• If &<0, (negative), the good is inferior good.

Cross price Elasticity of Demand

• Measures how much the demand for a product is affected by a change in price of another good. The cross – price elasticity of demand for substitute goods is positive. for complementary goods is negative and otherwise zero

Theory of Supply

• Supply shows various quantities of a product that sellers are willing to provide at different prices in a period, with other aspects remaining unchanged
• Law of supply: As the price a product increase, the quantity supplied increases, and vise versa.
• There is a positive relationship btw product price and quantity supplied.
• A supply schedule is a tabular statement that identifies the amount of the product offered for sale at different prices
• The quantities of oranges and their prices on the Y axis shows the supply curve
• Market supply is found through horizontally adding the quantity supplied of the product of all sellers at each price

Determinants of supply

• Other than price which causes a change in quantity demanded, supply depends on: price of inputs (cost of inputs) technology prices of related goods, expectation of product price, taxes & subsidies market sellers & weather, etc.
• Supply is affected by input price, as input price is low then a left shift will occur on curve
• Supply curve shifts out when technology improves.
• Weather condition can affect supply as well
• Elasticity of supply may be defined as the percentage change in quantity supplied divided by the percentage change in quantity supplied, and shows how responsive supply is to price change
• Elasticity is measured similar to demand

Market Equilibrium

• A price that leads to marked demand equals mkt supply
• equilibrium point is a point at which the market demand equals market supply (equilibrium point)

Theory of Consumer Behaviour

• Consumer can can derive satisfaction as they utilize a g/s
• consumer decision making process is bases on what people like and we inter the g/s that they like from the choices that they make
• Steps to unterstand customers by; examining preference, customer faces budget constraints, put customer preference to deterring customer choice.