Introduction to Economics

• Economics is an exciting discipline in social sciences.
• The word "economy" originates from the Greek term meaning "one who manages a household."
• Economics in its current form is around two centuries old.
• Adam Smith is known as the father of economics
• Adam Smith published “An Inquiry into the Nature and Causes of Wealth of Nations" in 1776.
• Economics began as a distinct subject with Adam Smith's book.
• There isn't one universal definition, economists define it from different perspectives

Four definitions of economics

• Wealth definition
• Welfare definition
• Scarcity definition
• Growth definition
• Since the subject evolves, its definition changes over time.

Economics

• Social science about the efficient allocation of scarce resources to maximize fulfillment of unlimited human wants.
• Studies how people use limited productive resources like land, labor, equipment, and technical knowledge to produce commodities.
• It studies scarce resources, allocation of resources, and the efficiency of allocation.
• Aims to satisfy unlimited human wants as much as possible by allocating resources efficiently.
• Economics looks at human behavior in relation to satisfying needs and wants.
• Economics is a science because economists develop and test theories like scientists.
• There are two fundamental facts that provide the foundation for economics
• Human (society’s) material wants are unlimited.
• Economic resources are limited (scarce).
• The basic economic problem involves scarcity and choice
• Limited resources are available to produce the unlimited goods and services desired.
• Economics is the study of how humans make choices to use scarce resources to satisfy unlimited wants.
• Choice is central to decision-making, as individuals, families, and nations face decisions on using limited resources. Economists study how choices are made, evaluate them on efficiency, equity, and stability
• Economists also search for ways to improve living standards and material well-being.
• Economics is expanding rapidly to include many topics and issues.
• New branches include development, industrial, transport, welfare, and environmental economics.

Core of modern economics features

• Microeconomics
• Macroeconomics
• Microeconomics deals with individual parts of the economy, consumer behavior, households, firms, markets and industries
• Macroeconomics deals with the entire economy, aggregate demand, aggregate supply and factors such as, national output, unemployment, inflation, and balance of payments
• Positive economics deals with facts and is verifiable
• Normative economics focuses on opinions and value judgments, and can't be tested.
• Positive economics tries to describe the world: what was, what is, and what will be?
• Disagreements can be settled by appealing to facts.
• Normative economics tells what should be or ought to be, evaluates outcomes based on value judgments, and involves ethics, religion, and political philosophy.
• Economic theory provides the basis for economic analysis using logical reasoning using inductive or deductive reasoning.
• The fundamental objective of economics is to establish valid generalizations about certain aspects of human behavior.

Two methods to derive laws/generalizations through economic theory

Inductive Method/Empirical method (bottom-up approach)

• Logical method of reaching a correct general statement or theory based on several independent and specific correct statements
• Involves deriving a principle or theory by moving from facts to theories and from particular to general economic analysis.
• The theory of population - human population grows more rapidly than the food supply until famines, war or disease reduces the population is an example of this
• Involves selecting a problem for analysis, collecting, classifying, analyzing data, and determining cause and effect relationships between economic phenomena.

Deductive Method (top-down approach)

• Logical way of arriving at a particular/specific correct statement starting from a correct general statement
• Deals with conclusions about economic phenomenon from certain fundamental assumptions or truths or axioms through a process of logical arguments.
• Any supply and demand analysis is an application of general principles about demand and supply
• Both methods are complementary and have weaknesses and cannot be relied upon exclusively.
• Scarcity, choice, opportunity cost, and the Production Possibilities Frontier are all related

Major steps in the deductive approach include

• Problem identification
• Specification of the assumptions
• Formulating hypotheses
• Testing the validity of the hypotheses
• The fundamental economic problem for any human society is scarcity- limited economic resources.

Scarcity

• Economic resources that a society needs to produce goods and services are finite or limited in supply
• Scarcity reflects the imbalance between people’s wants and the means to satisfy them.
• Scarcity results from limited resources like land, labor, capital and entrepreneurs, in satisfying people's endless wants
• Scarcity is a universal problem, not just for poor countries.
• All goods and services with a price are relatively scarce due to people’s demand.

Free resources

• Resource is free if the amount available is greater than what people desire

Scarce Resources

• Resource is said to be scarce or economic if it the amount available is less than what people want

Examples of scarce resources

• Human resource, natural resources; land, minerals, clean water, forests and wild animals, capital and entrepreneurial resources

Economic resources

• Classified into four categories: labor, land, capital, and entrepreneurship.
• Labor is the physical and mental effort of humans used to produce goods and services, with wages paid as a reward.
• Land refers to natural resources usable for production, with rent as the reward.
• Capital, as a reward for the services, refers to manufactured inputs to produce goods and services with interest as the reward
• Entrepreneurship represents a special type of human talent that manages other factors of production, with profit as the reward.
• Scarcity is the fundamental economic constant.
• Scarcity refers to a state when a resource is available in a finite quantity, and is permanent.
• Shortage is a market phenomenon when quantity demanded exceeds quantity supplied, and its is temporary.
• All economic questions and problems stem from scarcity.
• Economics assumes that people do not have the resources to satisfy all their wants.
• Choices must be made about resources are allocated, spending money / time.
• Scarcity leads to limited resources and output,
• The inability to satisfy all wants, necessitating choices, and ultimately choice involves costs.
• In a world of scarcity, choosing more of one thing means having less of another.
• Decisions involve tradeoffs, with the value of the next best alternative sacrificed.

Opportunity Cost

• Opportunity cost is the value of the next best alternative forgone to obtain one more unit of a product.
• Production Possibilities Frontier (PPF/PPC shows combinations of output an economy can produce with available factors and technology.
• The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce
• The car industry and the computer industry together use all of the economy's factors of Production in this example

Assumptions of the PPF needed to draw the PPF

• The quantity and quality of economic resources are fixed.
• There are two broad classes of output.
• The economy operates at full employment and efficiency.
• Technology is constant during the year.
• Some inputs are better suited for producing one good over another (specialization).
• The PPF demonstrates four concepts: scarcity, choice, efficiency, and opportunity cost.
• Scarcity means society cannot produce unlimited outputs with available resources.
• Choice is indicated by any movement along the PPF curve.
• Efficiency is represented by all points on the PPF.
• Opportunity cost is sacrificing one good for another on the PPF.
• The law of increasing opportunity cost states the opportunity cost per unit increases as more of a product is produced. This makes the PPF concave to the origin.
• Economic growth or an increase in the total output level occurs when and only when the following conditions occur
• Increase in the quantity or/and quality of economic resources.
• Advances in technology lead to economic growth
• Economic growth is represented by outward shift of the PPF.
• An economy can grow via productivity in the Y or X axes

Basic economic questions

• What to Produce? - the problem of allocation of resources.
• How to Produce? - the problem of choice of technique.
• For Whom to Produce? - the problem of distribution of national product.
• Economies must decide what and how much to produce
• The economy must make a choice civil goods versus military goods
• The economy must make a choice necessity goods versus luxury goods
• the available supplies of different factors and production and their relative prices depends on

Broadly the techniques of production can be classified into

• labor-intensive techniques
• capital-intensive techniques
• Making good choices is essential for making the best possible use of limited resources to produce maximum amounts of goods and services.
• For Whom to Produce relates to how a material product is to be distributed among the members of a society.
• An economy aiming to benefit the most number of people should try to produce the necessities of the whole population and then luxury goods.
• Economic systems determine how societies answer fundamental questions.
• Three types of economic system based on resource allocation mechanisms / ownership of means of production

Economic Systems Types

• Capitalism/Free market economy/laissez faire
• Command/Socialistic/Planned economy
• Mixed economy
• Capitalism features private ownership of production means and individual entrepreneurs work mainly for private profit.
• In capitalism, government intervention is minimal.
• Resource allocation decisions are driven by the market.
• Resources are allocated by demand and supply via the market mechanism.

Capitalist Economy Features include

• The right to private property
• Freedom of choice by consumers
• Productive activity is guided by the motive of profit-making and self-interest
• Competition among economic agents prevail
• All basic economic problems are solved through the market or price mechanism
• Minor role of government
• Inequalities of income
• Features of capitalistic economy include the Existence of negative externalities

Capitalist Economy has advantages

• Flexibility/adaptability
• Decentralized economic power
• Increase in per-capita income
• Diversified types of consumer goods and services
• High rate of capital formation

The disadvantages include

• Merit goods are underprovoded
• Demerit goods are overprovoded
• Unbalanced economic activity
• Inequality of income
• Exploitation of labor
• Negative externalities
• Excessive market power
• Command economy is also socialistic, and involves state-owned and controlled economic institutions engaged in production and distribution.
• The government has a central position in all decisions.

Main Features of Command Economy

• Economic planning: Planning for resource allocation is performed by the controlling authority according to given socio- economic goals
• Strong government role Government has complete control over all economic activities
• social welfare Command economy aims at maximizing social welfare and does not allow the exploitation of labor.
• Relative equality of incomes Private property does not exist in a command economy, the profit motive is absent, and there are no opportunities for accumulation of wealth greater income distribution, in comparison with capitalism

Command Economy Disadvantages

• Absence of automatic price determination
• Absence of incentives for hard work and efficiency
• Economic planning making use of both private and public sectors
• Red-tape

Mixed economy

• Incorporates some features of both capitalist & command economy
• Co-existence of public and private sectors
• Economic welfare where public sector tries to remove regional imbalances
• Price mechanism

Mixed Economy Advantages

Disadvantages

• Adequate freedom
• Rapid and planned economic development
• Social welfare and fewer economic inequalities
• Corruption and black markets
• Decision-making units are households (who make financial decisions), firms/businesses, and the government
• Households sell resources to firms and buy goods/services.
• Firms use economic resources to produce goods and sell their products.
• The government controls or influences households, firms, and markets through laws.
• These laws provide public goods and services and regulation.
• Product markets are where households/governments buy goods/services from firms.
• Factor markets are where economic units exchange factors of production (resources) sold by households to firms/governments.