Introduction to Economics PDF

ECON01 Principles of Economics I Introduction to Economics Overview  Most people have a general idea of what Economics is.  They live with it, they practice it.  Some will even be able to define it.  Economics is concerned with the production, distribution, and use o...

ECON01 Principles of Economics I Introduction to Economics Overview  Most people have a general idea of what Economics is.  They live with it, they practice it.  Some will even be able to define it.  Economics is concerned with the production, distribution, and use of material goods and services.  Adam Smith, the recognized father of Economics, stated that Economics is “an inquiry into the nature and causes of wealth of nations. What is Economics?  The two Greek roots of the word economics are oikos – meaning household – and nomus – meaning system or management. Oikonomia or oikonomus therefore means the management of household. Economics defined  a social science concerned with man’s problem of using scarce resources to satisfy unlimited human wants. – Walstad and Bingham  the study of how societies use scarce resources to produce valuable commodities and distribute them among different people – Samuelson and Nordhaus  The study of production, distribution, selling, and use of goods and services – Collin  A social science concerned with using scarce resources to obtain the maximum satisfaction of the unlimited material wants of society – McConnel and Brue  The study of how people use their limited resources to try to satisfy unlimited wants  The efficient allocation of the scarce means of production toward the satisfaction of human needs and wants. 2 Factors in the Definition of Economics 1. Scarce resources 2. Unlimited human wants Scarcity – the condition wherein most things that people want are available only in limited supply. These things, called economic goods, are generally scarce and must somehow be rations whether by price or by some other means. Unlimited wants – a person’s desires or preferences for specific ways of satisfying basic needs. To satisfy an unsatisfied need, a person wants particular products or services. Goods – a good is anything which yields satisfaction to someone.  2 Types of goods 1. Tangible goods – when they are in the form of material goods or commodities 2. Intangible g3oods – they are in form of services. Goods classification according to uses: 1. Consumer goods – goods which yield direct satisfaction e.g. soft drinks, food. 2. Capital goods – goods used in production or other goods and services. E.g. buildings, machineries, equipment. 3. Essentials or essential goods – goods used to satisfy the basic needs of man. 4. Luxury goods – goods man may do without but are used to contribute to his comfort and well being. Other classifications:  Economic good – good which is both useful and scarce. It has a value attached to it and price has to be paid for its use.  Free good – if a good is too abundant that there is enough of it to satisfy everyone’s needs without anybody paying for it. How are goods produced ?  Goods are created by means of production. It may involve the physical transformation of a commodity such as conversion of leather into shoes. This type of production takes place in the factory and referred to as manufacturing or industry.  Production may also take place in the farm. Planting and harvesting of rice, corn, coconuts and sugar are agriculture production.  Even exploration for oil, mineral, and precious metals is production. All these activities are carried out to provide goods and services for use in the satisfaction of man’s wants and needs. Economic Resources  Things that are needed to carry on the production of goods are called economic resources or factors of production.  They are the basic resources because they constitute the basic needs in production.  They are the most basic tools used in the production of goods and services. 4 Economic Resources 1. Land 2. Labor 3. Capital  4. Entrepreneur Land  Strictly speaking, land refers to all natural resources, which are given by and found in nature, and are therefore, not man-made.  Land is an economic good because it is scarce and a price has to paid for it.  People who own land and offer it to others for their use earn an income called rent. The less the supply of land available for man’s use, the higher is the rent that has to be paid for it. Labor  Labor is any form of human effort exerted in the production of goods and services. It covers a wide range of skills, abilities and characteristics.  The supply of labor in a country is dependent on its production and on the percentage of its population that is willing to join the labor force.  The country’s supply of labor is also affected by the migratory tendencies of its population and by the influx of workers from other countries.  Payment for labor is called salary or wage. Capital  Refers to man-made goods used in the production of goods and services.  It does not only include money, it includes buildings, machinery, raw materials, and other physical necessities for the use in production.  A nation’s capital is dependent on its level of savings.  Savings refer to the part of a person’s income which is not spent on consumption.  Capital is an economic good and the owner of capital earns income for its use. This income is called interest. Entrepreneur  The one who combines the other economic resources for use in the production of goods and services.  Entrepreneurship is an economic good that commands a price. This price is the income earned by the entrepreneur and is called profit.  Profit is the amount left behind after all allocations to the other economic resources have been made. Functions of the entrepreneur: 1. Organizes production by combining land, labor and capital to make goods and services. 2. He makes business decisions by determining what goods or services to produce and how to produce them. 3. He bears the risk of his business decisions. He must suffer the consequence of losses if he fails, but in the same light, he must reap the profits as a reward if he succeeds.  4. He innovates by introducing new products, new technology, and new ways of organizing the business. THE NEED TO CHOOSE  Scarcity is the reason why people economize.  Scarcity refers to the limitations that exist in obtaining all the goods and services that people want.  It gives rise to economic problems and it is the reason why man has to make a choice.  If all goods were as free as air, there would be no need to economize.  Because of scarcity, any society must confront four fundamental and inter dependent economic problems. 4 Fundamental Economic Problem 1. What goods and services must be produced? 2. How shall these goods and services be produced? 3. How much is to be produced? 4. For whom shall goods be produced? What to produce?  An economy must identify what are the goods and services needed to be produced for the utilization of the society in the everyday life of man.  A society must also take into account the resources tat it possesses before deciding what goods or services to produce.  In a market economy, what gets produced in the society is driven by prices. Resources are allocated to the production of goods and services that have high prices and low input prices relative to one another How to produce?  There is a need to identify the different methods and techniques in order to produce goods and services.  The decision of what form of technology is to be employed depends more on the availability of cheaper resources and less of more expensive inputs.  If there is abundant supply of labor then this resource will be cheaper and will cost less so production will be labor intensive. How much to produce?  Identifies the number of goods and services needed to be produced in order to answer the demand of man and society.  The optimum amount of production must be approximated by producers.  Underproduction (shortage) results to a failure to meet the needs and wants of the society.  Overproduction results to excess (surplus) goods and services going to waste. For whom to produce?  Identifies the people or sectors who demand the commodities produced in a society.  Economists must determine the “target market” of the goods and services which are to be produced to understand their consumption behaviors and patterns  An understanding of these results to higher sales of goods, and ultimately to increased profits.  For those who can pay the highest price is for whom goods and services are produced. The 3 E’s of Economics 1. Efficiency - productivity and proper allocation of economic resources. Being efficient in production allocation of goods and services saves time, money and increases a firms output. 2. Effectiveness – attainment of goals and objectives. Economics therefore is an important and functional tool that can be utilized by other fields. 3. Equity – justice and fairness. While technological advancement may increase production, it can also bear disadvantages to employment of workers. Types of Economic System 1. The Traditional Economy. 2. The Command Economy. 3. The Market Economy 4. The Mixed Economy The Traditional System  Basically a subsistence economy. A family produces everything that it consumes.  Decisions on what, how, and for whom to produce are made by referring to the traditional manner of doing things.  Production is carried on in the methos used by the forefathers, and is therefore very primitive.  This system is very backward since it does not allow for change.  A traditional economy is a system that relies on customs, history, and time-honored beliefs.  Tradition guides economic decisions such as production and distribution.  Traditional economies depend on agriculture, fishing, hunting, gathering, or some combination of the above.  They use barter instead of money.  Most traditional economies operate in emerging markets and developing countries.  They are often in Africa, Asia, Latin America, and the Middle East.   But you can find pockets of traditional economies scattered throughout the world. The Command Economy  Production are owned by the government.  Its decisions are arrived at by planners or government men who dictate what, how and for whom to produce.  In a command economy (also known as a centrally planned economy), the central government controls all major aspects of a nation's economy and production. The government, mandates which goods and services will be produced and how they will be distributed and sold.  The theory of a command economy was defined by Karl Marx in the Communist Manifesto as “common ownership of the means of production,” and it became a typical characteristic of communist governments. The Market Economy  Characteristic of this economy is that resources are privately owned and decisions are made by the people themselves.  Since every consumer arrives at his own decision, the system is coordinated through an interlocking network of markets and prices.  The system depends on prices set by the conditions of demand and supply.  Competition is supreme; there is consumer sovereignty, and the price of the good is the guiding factor for producers to know what and how much to produce. Mixed Economy  It is seldom that an economic system exists in pure form. The US economy is predominantly market, but it cannot be denied that there exists some form of government control.  Cuba can be best described as command since its decision are planned by the government, however, the price system is also used, even if only minimally. Opportunity Cost When one makes a choice, there is always an alternative that has to be given up. A producer who decides to produce shoes, gives up other goods that could be produced with the same resources.  A student who buys a book with his limited allowance, gives up the chance of eating out or watching a movie.  An M.A. graduate who decides to teach, gives up the salary he would have earned had he worked in a big firm like San Miguel Corporation.  The values of these alternatives given up are referred to as opportunity costs.  Opportunity cost maybe defined as “the cost choosing to use resources for one purpose measured by the sacrifice of the next best alternative for using those resources.”  - costs or benefits foregone in the alternative use of a resource Example:   If a farmer chooses to send his child to college rather than expanding his farm’s output by 100% his opportunity cost is the additional output of the farm.  If a person is considering sleeping rather than choosing the next best alternative, like meeting a friend, then the opportunity cost of sleeping is meeting a friend. Society’s Technological Possibilities Since a nation has limited resources, it has to cope by choosing different potential bundles of goods. It also has to choose among the different production techniques and who will consume the goods and services it decides to produce. These decisions involve choices on inputs to be used and the outputs to be produced.  Inputs refer to the commodities of services used to produce the good or services.  Existing technology is used to combine these different inputs. Inputs consist of land labor and capital.  Land refers to gifts of nature to our productive process. It is a term that covers natural resources including minerals, forests, oceans, and soil.  Labor refers to the human resource used in production. Labor includes farmers, doctors, factory workers, drivers, or teachers  Capital consists of man-made durable goods which are used to produce other goods. They include machinery, equipment and other tools.  Outputs refer to useful goods and services resulting from the production process. There are goods that are either consumed like shoes, or used in further production like machines. Technology - is the body of knowledge applied to how goods are produced. In other words, technology is the production process employed by the firms in creating goods and services. 2 Broad Categories 1. Labor intensive technology 2. Capital intensive technology 3. Labor intensive technology – utilizes more labor resources than capital resources. It is usually employed by economies where labor resources are abundant and cheap.  In the case of the Philippines, industries that are considered intensive include agriculture sector and some manufacturing sub-sectors like garments 2. Capital intensive technology – utilizes more capital resources than labor resources in the production process. It is employed by industrialized economies since capital resources in these economies are cheaper than labor.  Countries such as Germany, Japan, Korea, the US are considered capital intensive economies The Tools of Economics  Economics is a positive science that means it deals with what it is. This in contrast to normative economics which deals with what should be.  Economics, therefore, is a study that attempts to explain how an economy operates.  To be able to understand and explain economic events and economic theories, the student of economics must learn how to use the basic tools of Economics; logic, mathematics, and statistics. Positive and Normative Economics  Positive economics is an economic analysis that considers economic conditions “as they are”, or considers economics “as it is”.  It uses objective or scientific explanation in analyzing the different transactions in the economy.  It simply answers the question ‘what is.’ Example of Positive statements:  The economy is now experiencing a slowdown because of too much politicking and corruption in the government  The economy is no on a slowdown because the world is experiencing a financial and economic crisis.  On the other hand, normative economics is an economic analysis which judges economic conditions “as it should be”.  It is that aspect of economics that is concerned with human welfare.  It deals with ethics, personal value judgments and obligations analyzing economic phenomena.  It answers the question ‘what should be’.  It is also referred to as “policy economics” because it deals with the formulation of policies to regulate economic activities. Example of normative statements:  The Philippine government should initiate political reforms in order to regain investor confidence, and consequently uplift the economy.  In order to minimize the effect of global recession, the Philippine government should release a stimulus package geared towards encouraging economic productivity. How to use the basic tools of economics:  Learn how to apply logic in order to enable him to reason out properly and to draw conclusions.  The use of mathematics will enable him to conceptualize and quantify economic principle  Use statistics to describe quantitavely human behaviors and to serve as empirical evidence in the testing of hypothesis Divisions of Economics 1. Microeconomics 2. Macroeconomics Microeconomics  Microeconomics studies the economy in parts. It is the study of the price system, the individual consumer, the individual firm. It deals with the question: What determines the breakdown of national income aggregates into various types goods and services.  Examples are the determination of the price of a single product, or the behavior of a single consumer or business firm. Macroeconomics  deals with the aggregates.  It presents pictures of the totals: income, output, employment, spending, price level. It studies economy as a whole.  It views all consumers as a unit e.g. consumer sector, all businesses as an aggregate unit e.g. the business sector, and all the various government agencies as a unit.  The purpose is to explain and predict the structure and functioning of whole economies. Important Economics Terms  Wealth – anything that has a functional value (usually in money), which can be traded for goods and services  Consumption – the direct utilization or usage of the available goods and services by the buyer (individual) or the consumer (household) sector.  Production – the formation or creation by firms of an output. It is basically the process which land, labor and capital are combined in order to produce outputs of goods and services  Exchange – the process of trading or buying and selling of goods and/or services for money and/or its equivalent. It also includes the buying of goods and services either in the form of barter or through market  Distribution – The process of allocating or apportioning scarce resources to be utilized by the household, the business sector, and the rest of the world. It also refers to the process of storing and moving products to customers often through intermediaries such as wholesalers and retailers.