Chapter 1: Principle of Economics PDF

CHAPTER 1: PRINCIPLE OF ECONOMICS CHAPTER OUTLINE 1.1 Why Study Economics? 1.2 Economics Defined 1.3 The Scope of Economics 1.4 Scarcity, Choices & Opportunity cost 1.5 Basic Economic Problems 1.6 Production Possibility Frontier (PPF) 1.7 Economic System  1.1 WHY STUDY ECONOMICS?...

CHAPTER 1: PRINCIPLE OF ECONOMICS CHAPTER OUTLINE 1.1 Why Study Economics? 1.2 Economics Defined 1.3 The Scope of Economics 1.4 Scarcity, Choices & Opportunity cost 1.5 Basic Economic Problems 1.6 Production Possibility Frontier (PPF) 1.7 Economic System  1.1 WHY STUDY ECONOMICS? To an und To r s t er s d e dg ta n un t he lo b d e t y affa al i irs soc th y o a To orm r in f o t e wa rn in k f in g be ed lea v an To 1.2 ECONOMIC DEFINED K.E. Case and R. C. Fair view that economics is a study of how people use their limited resources to try to fulfill unlimited wants and involves alternatives or choices. David N. Hyman defined economics as a study of how scarce resources are allocated among alternative uses Economics is a science that studies human behavior as a relationship between ends and scarce, which have alternative uses, according to L. Robbins Basically, economics deals mainly with how to efficiently utilize scarce resources that are limited in relation to human wants in the society.  1.3 The Scope of Economics Microeconomics Macroeconomics Deals with individual units; a household, a Looks at the economy firm and an industry. as a whole. Its deal Studies the with the economic interrelationship behavior of between these units aggregates; national to determine the output, overall price pattern of distribution level, inflation, of goods and unemployment. services.  1.4 Scarcity, Choices & Opportunity cost Human wants are always Faced with scarcity, Economists use the term of greater than the available people must make opportunity cost to emphasize resources. choices – cannot get that making choices in the all. face of scarcity implies a cost. Society has limited (scarce) 45 resources (factors of Choice involves The opportunity cost of any production), and therefore sacrifice action is the second best cannot produce all the goods (opportunity costs). alternatives that has to forgo and services people wish to Choices made by for another choice which have. any society to gives more satisfaction. Economist has classified the decide on what to factors of production into four produce, how to groups namely Labour, Capital, produce and for Land and Entrepreneur. whom to produce.  1.4 Scarcity, Choices & Opportunity cost e cont… pl x am Scarcity: The core problem E Alex has RM25 and he would like to buy two things; a book and a pen which cost RM25 each (unlimited wants and limited resources). Choice Alex has to choose either to purchase book or a pen which would satisfy his needs (choices). Opportunity cost If Alex choose the book, then the pen is the opportunity cost.  1.5 Basic Economic Problems Every society has to take a There are This it relates to where the goods fundamental decision of what alternatives produced will end up, as such goods and services to produce techniques of goods and services will be used because of the limited resources. producing by consumers in the society or goods and exported to other countries. Since resources are not sufficiently services, and available – focus on the production firm will choose This refers to distribution. of commodities which give it a cost the cheapest Distribution of economic benefits advantage over other products. method of depends on the distribution of production- income. What to produce is an important minimizing question in every economy, cost. Who gets the goods and services because it involves where the depends on the incomes that economy will focus most in its people earn. specializations.  1.6 Production Possibility Frontier (PPF) Refers to the boundary between the combinations of goods and services that can be produced with given available resources and those that cannot be produced. Full employment Fixed resources Technology constant 1.6 Production Possibility Frontier (PPF) cont…. The curve that shows all of the possible combinations of 2 goods (products) or services that can be produced within a specified time with all its resources fully and efficiently employed. The economy ________________at any combination _____or ________ the curve (C and H). Point ________ the curve is ______________(F).  Inside, On, or Outside the PPF: (i) Point on the curve (C): ________________________ Because all resources are fully and efficiently employed. (ii) Point inside the curve (H): __________________________ Because resources are not fully and efficiently employed. (iii) Point outside the curve (F): _________________ Because of limited resources. Calculating the Opportunity Cost Movement along the PPF represent the opportunity cost That mean __________ in producing a particular product can only possible with _________ production of another product.  Opportunity Cost = (∆ Quantity forgone / ∆ Quantity increased) Point on PPF Opportunity cost (units of computers) A to B (650 – 700) / (200-100) = -0.50 B to C (510 – 650) / (380-200) = -0.78 C to D (400 – 510) / (500-380) = -0.92 D to E (300 – 400) / (550-500) = -2.00 The opportunity cost from point (A to B), (B to C), (C to D) and (D to E) are increasing, implying the law of increasing opportunity cost. It also represented in the increasing steepness of the slope and the concave shape of PPF. 13  Constant opportuni ty cost Increasin Decreasin g g opportuni opportuni ty cost ty cost The Shap e of PPF *The shape of PPF depends on the opportunity cos Increasing Opportunity Cost: As we move along the production possibility curve with increasing computer, ______________food must be forgone. PPF is ______________ INCREASING OPPORTUNITY COST: Q to R = [(11 – 10)/(5-6)] = -1 T to V = [(8 – 5) /(9-10)] = -3  Constant Opportunity Cost: Food As we move along the 125 production possibility curve with increasing computer, constant ______ of food 100 A must be forgone PPF 75 B PPF is _________ 50 C CONSTANT OPPORTUNITY COST: 25 D A to B = [(75 – 100)/(10 – 5)] = -5 C to D = [(25 – 50) /(20 – 15)] = -5 0 5 10 15 20 Computer  Decreasing Opportunity Cost Food As we move along the production possibility curve with increasing computer, ___________food must be 15 A forgone. B PPF PPF is ________________ 10 C 7 DECREASING OPPORTUNITY COST: A to B = [(10 – 15) / (10 – 2) ] = -0.625 0 2 10 30 Computer B to C = [(7 – 10) / (30 – 10) ] = -0.15  Changes in the PPF: (i) Movement along the (same) PPF: Moving down (up) along the PPF – more (less) computers and less (more) foods are produced “trade-off”. E.g: Transfer resources (ii) Rotate/pivot the PPF: Changes in the factor(s) that will only affect production of 1 good E.g: Increases/decreases in the resources that will be used to produce computer (only) E.g: Improvement in technology for production of food (only) (iii) Shift the PPF: Changes in the factor(s) that will affect production of both goods E.g: Increases/decreases in the resources that will be used to produce both goods. E.g: Increase in the number of population. Changes in the PPF: 1.6 ECONOMIC SYSTEMS ECONOMIC SYSTEMS Free Market Mixed Planned Economy Economy Economy Economic Systems Free Market Planned Economy Mixed Economy Economy Private ownership of Public ownership of Public and private resources ownership of resources Central planning resources Price mechanism authority Price mechanism and Freedom of economic plans Price mechanism of enterprise and choice less importance Selective government intervention Consumer’s Central control and Government control power ownership of monopolies Laissez-faire No competition Free competition Free competition Refresh Your Mind!!! 22  Example of PPF analysis Figure 1 illustrated the Production Possibility Frontier (PPF) for the allocation of resources in Malaysian banking sector. Assumed that the Malaysian banking sector only consist of two types of banking product/services that are the conventional banking and Islamic banking. Question (i): Calculate opportunity cost from A to B, B to C and C to D. 23 Question (ii): Malaysian is currently producing at Point B. The government is encouraging the development of Islamic banking, thus, advising all the banks in Malaysia to divert more resources to Islamic banking from conventional banking. If all the banks follow the government’s advice, sketch a PPF diagram to illustrate this scenario. Mark a possible new production combination (point) as “E”. Give your explanation. 24 Question (iii): The government successfully invites foreign Islamic banks to invest in Malaysia by opening branches here. What happen to the PPF? Mark a new possible production point as “F”. Give your explanation. 26 28