Fundamentals of Economics - Chapter 1 PDF

All Rights Reserved 1– 1 CHAPTER 1 INTRODUCTION TO ECONOMICS  OBJECTIVES At the end of the chapter, you should be able to:  Interpret the definition of economics and distinguish between microeconomics and macroeconomics.  Describe the three economic conce...

All Rights Reserved 1– 1 CHAPTER 1 INTRODUCTION TO ECONOMICS  OBJECTIVES At the end of the chapter, you should be able to:  Interpret the definition of economics and distinguish between microeconomics and macroeconomics.  Describe the three economic concept; scarcity, choice and opportunity cost.  Discussand illustratethe production possibility curve (PPC).  Describe the three economic problems. 1– 3  INTRODUCTION  Economics is the most important aspect in human life.  The desire of human beings is unlimited and they will try as hard as possible to fulfill their demand to maximize satisfactions.  However, economics faces limited resources or factors of production.  Economics study how people fulfill their unlimited desire with the limited resources. 1– 4  DEFINITION OF ECONOMICS  Economics can be defined as the study of how to allocate scarce recourses to satisfy unlimited wants.  Economics is the study of how people, institutions, and society make choices under conditions of scarcity.  Economics is study of the allocation of scarce resources among alternative uses.  Economics is defined as ‘a social science that studies how people and society organize scarce and limited resources to satisfy unlimited human wants’ All Rights Reserved 1– 5  ECONOMIC RESOURCES FACTORS OF PRODUCTION  FOP are resources or inputs used to produce goods and services. (1) Land — Land is the primary source from which all resources are derived — Includes all natural resources which are derived from the earth and land itself — Examples: timber, oil, coal, soil and water — ‘Rent’ is the return to land 1– 6  DEFINITION OF ECONOMICS (cont.) (2) Labour — Labour or workers are defined as people who contribute their energy mentally and physically to earn wages or salaries. — Refers to the human effort, skills, abilities, and expertise contributed to the production process — Labour can be categorized into: (a) Skilled labour (b) Semi-skilled labour (c) Unskilled labour — ‘Wages/salaries’ are the returns to labour 1– 7  DEFINITION OF ECONOMICS (cont.) (3) Capital — Capital refers to the stock of goods created by society to help them in the production of goods and services. — In other words, it is man-made goods used to produce other goods and services. — For example, machinery, tools and equipment, building, factories and so on. — Interest is the return to capital. 1– 8  DEFINITION OF ECONOMICS (cont.) (4) Entrepreneur — Refers to a person who has the ability of planning, organizing, directing and controlling. — Entrepreneur is a person who organizes the other FOP to produce goods and services. — The difference between a labour and an entrepreneur is that, entrepreneur takes risk in setting up his own business. — On the other hand, labour works for an entrepreneur and does not take risks. — ‘Profit’ is the return to the entrepreneur.  FOPs are limited and society will try to use them efficiently to produce goods and services which later satisfy their unlimited wants. 1– 9  DEFINITION OF ECONOMICS (cont.) Limited resources vs unlimited wants  The Limited resource:  The unlimited wants : (1) Land (1) Goods (2) Labour (2) Services (3) Capital (4) Entrepreneur 1– 10  Goods (1) Goods: are physical goods that human made  Can be seen and touched  E.g.: books, cars and computers All Rights Reserved 1– 11  Services (1) Services are actions that a person performs.  Intangible things  E.g.: transportation, education, etc All Rights Reserved 1– 12  DEFINITION OF ECONOMICS (cont.) Limited resources vs unlimited wants Society must make a choice on how to use the FOP to minimize wastage 1– 13 BRANCHES OF ECONOMICS 1– 14  BASIC ECONOMIC PROBLEMS What to produce Refers to the type of product to produce Decision must be made about what to produce with the limited resources available. E.g.: whether to produce food crops or TV  BASIC ECONOMIC PROBLEMS How much to produce Refers to the quantity of goods and services to be produced. It depends on the demand from consumers. Societies must decide what to produce and how much to produce to ensure that scarce resources are utilized properly and efficiently.  BASIC ECONOMIC PROBLEMS How to produce Refers to the technique or method of production: who will be producing the goods and services using what resources and technology? The method of production could be either labour intensive or capital intensive. It involves the cheapest method of production to minimize possible COP and maximize profit.  BASIC ECONOMIC PROBLEMS For whom to produce Refers to the group of people in the society who will buy the goods and services. It depends on the society’s income level.  BASIC ECONOMICS CONCEPTS The Basic Economic Concept Opportunity Cost Choices Scarcity 1– 19  BASIC ECONOMICS CONCEPTS (cont.) (1)SCARCITY  Scarcity refers to the condition where resources are limited or insufficient to satisfy all human wants and needs.  Therefore, society is faced with scarcity. (2)CHOICE  Due to unlimited wants and limited resources, society has to make choices.  Society must make the best choice possible.  Consumersmake choices to maximize satisfaction  Producersminimize cost and maximize profit  Governmentmaximize society’s welfare 1– 20  BASIC ECONOMICS CONCEPTS (cont.) (3) OPPORTUNITY COST  Every choice is associated with opportunity cost.  Opportunity cost refers to the value of the next best alternative forgone when a decision is made.  It is defined as ‘the number of goods forgone to make the best choice or the best alternative forgone’.  The second-best alternative. Omar’s Decision-making Grid Alternatives Sleep late Wake up early to study Enjoy more sleep Better grade on test Benefits Have more energy during the day Teacher and parental approval Personal satisfaction Decision Sleep late Wake up early to study for test Opportunity cost Extra study time Extra sleep time Better grade on test Enjoy more sleep 1– 21 Benefits forgone Teacher and parental approval Have more energy during the day  PRODUCTION POSSIBILITIES CURVE (PPC)  A production possibilities curve shows the alternative combinations of two goods which can be produced with the existing resources and the current level of technology.  Assumptions: (1) Only two goods are produced in a nation. (2) There is fixed level of technology. (3) Fixed and limited FOP (4) Full level of employment (the FOP are used efficiently no waste of resources and unemployment). 1– 22 PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) All Rights Reserved 1– 23  PRODUCTION POSSIBILITIES CURVE (PPC) (cont.)  Point A implies that Japan will allocate all its resources to produce only TV and non radio.  Point F shows that Japan will produce radio entirely and zero TV by utilize  At point B, Japan produces combination of all its resources. 80 units TV and 20 units of radio given available resources.  Point C indicates the combination of 60 units of TV and 30 units of radio produce by Japan. 1– 24 PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) 1– 25 PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) All Rights Reserved 1– 26 PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) All Rights Reserved 1– 27 PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) All Rights Reserved 1– 28  PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) Factors that Influence the Shift of the Production Possibilities Curve Shift OutwardsIncrease in PPC Increase in the level of technology Increase in Economic Growth Increase population All Rights Reserved 1– 29  PRODUCTION POSSIBILITIES CURVE (PPC) (cont.) Recession 1 Decline in Economic Growth 2 Natural Disaster 3 All Rights Reserved 1– 30  Positive and Normative Economics  Positive economics deals with issues that can be observed or it deals with scientific explanations of the working of the economy.  It looks at the world as it is not as it should be.  Normative economics offers recommendations based on personal value judgment. It tries to explain how the world would be.  It does not involve scientific proof or research. For instance a statement such as “an income tax is a good thing” is a normative stated. 1– 31  Theories, Principles and Models  Theories, Principles and Models Like the physical and life sciences, as well as other social sciences, economics relies on the scientific method.  Economists develop theories of the behavior of individuals (consumers, workers) and institutions (business, governments) engaged in production, exchange, and consumption of goods and services.  Economic principles and models are highly useful in analyzing economic behavior and understanding how the economy operates. They are the tools of ascertaining cause and effect within the economic system 1– 32  Theories, Principles and Models  A theory is a simplified representation of how two or more variables interact with each other. The purpose of a theory is to take a complex, real-world issue and simplify it down to its essentials  Model is more applied or empirical representation. Models are used to test theories,  Model is a simplified version of reality that allows us to observe, understand, and make predictions about economic behavior  All Rights Reserved 1– 33  TRY IT 1. Define Economics 2. List and discuss factor of production? 3. Differentiate and discuss Microeconomics and macroeconomics? 4. Differentiate and discuss Positive economics and normative economics? 5. Discuss the fundamental problems that economics addresses? 6. Explain the concepts of scarcity, choice and opportunity cost and show how the three concepts are related by using production possibilities curve? 1– 34