Topic One Introduction PDF

**TOPIC ONE: INTRODUCTION** **[MEANING OF ECONOMICS ]** Economics is a social science which studies the human behavior as individuals undertake economic activities using scarce resources and means in order to satisfy the unlimited wants. **[SCOPE OF ECONOMICS ]** The Scope of economics refers to...

**TOPIC ONE: INTRODUCTION** **[MEANING OF ECONOMICS ]** Economics is a social science which studies the human behavior as individuals undertake economic activities using scarce resources and means in order to satisfy the unlimited wants. **[SCOPE OF ECONOMICS ]** The Scope of economics refers to the area and extent of study. Economics involves the study of the problems of production, consumption, exchange and distribution of wealth as well as the determination of the value of goods and services.it further makes inquiry into the possible causes and remedies of poverty, inflation, unemployment etc. Questions: \(i) Is economics a study of man or it is a study of human behavior as a member of a society? \(ii) is economics a science or an art? Economics is both a science and an art. It is a science because in economic study rules, laws, approaches and theories that have been proven through a scientific process are used. It is an art because economic situations and problems can be represented or analyzed using graphs and diagrams. In economics Mathematical concepts are also applied. \(iii) How does the society deal with scarcity of resources? **[BRANCHES OF ECONOMICS ]** There are two major branches of economics: Microeconomics and Macroeconomics \(a) Micro Economics -- studies the behavior of individual decision making units such as consumers, resource owners and business firms as well as individual markets in a free market economy. \(b) Macro Economics -- study the behavior of the economy as a whole whereby the relationship is considered between broad economic aggregates like national income, employment and prices. **[CONCEPTS/TERMINOLOGIES]** **1. Human wants** -- the things individuals desire to have in life. Human wants may either be primary or secondary. a\) Primary -- the things individuals need to live i.e. they cannot do without them e.g. food, shelter, clothing, basic healthcare and basic education. b\) Secondary -- the things one can do without but whose satisfaction provide more comfort and prestige in life e.g. TV, car, computer etc. **Features of human wants** i. Some are universal esp. basic needs. ii. They are competitive due to scarcity of resources. iii. They are unlimited. iv. Some are complimentary. v. Some are habitual. vi. They are recurrent. vii. Cannot be fully satisfied. viii. They vary in terms of urgency and intensity. **2. Utility** It is the ability of a product to satisfy human wants. It is the amount of satisfaction desired by a consumer from the consumption of a unit of good or service. i. Time utility -- the satisfaction derived when goods and services are stored at a place convenient to the consumer to access when need arise. ii. Form utility -- derived when a product is transformed from one state to another better one to provide a consumer with better satisfaction. iii. Place utility -- satisfaction derived when goods are moved to consumers through transport. iv. Possession utility -- satisfaction derived when individuals or parties own property or skills in society. It is created through the process of exchange. **3. Scarcity, Choice and Opportunity cost.** **a) Scarcity** -- it refers to the limited nature of economic resources in relation to the satisfaction of the unlimited human wants. **b) Choice** -- this is the action of selecting a possible option from many alternatives as a result of scarcity. **i. Consumers** To make good choices consumers need to prepare a list of preference upon which he chose upon which want to satisfy and which ones to forgo. He needs to make the choice that gives him the greatest satisfaction or utility. **ii. Producer** ♣ To make a good choice a producer should address these concerns ♣ What to produce and in what quantities ♣ How to produce -- define the techniques to be applied in production so as to minimize costs and maximize profits. The producer defines in what proportions he will combine the various factors of production at the least cost possible. Decides on either capital intensive or labor intensive production methods. ♣ For whom to produce -- he needs to incorporate the tastes and preferences of the consumers in his production so as to maintain the demand of his product in the market **c) Opportunity cost** This is the value of the benefit forgone from the second next best alternative. This arises due to scarcity of resources which can be put to alternative uses. The choice of one action often implies that an alternative will be forgone. Uses of Opportunity cost - A consumer will always choose to consume that commodity whose opportunity cost is low i.e. a product that has maximum satisfaction or utility. - A producer will have to forgo a production whose opportunity cost is high because this would imply loss of more profit. - The government should consider undertaking those projects whose opportunity cost is low as this would mean more benefit to members of the society. - Opportunity cost analysis can also apply to student where more time is devoted to those course units that are hard and little time to those that are easy. - Opportunity cost defines the gradient of production possibility frontier (PPF) and production possibility curve (PPF). **Production Possibility Frontier (PPF)** This is a graphical representation of five feasible productions that are possible in an economy given fixed amount of resources and constant technology. Considering that in an economy we have two productions i.e. agricultural and industrial a.) At points A, B and C the economy is engaging fixed amount of resources and constant technology in the production of agricultural and industrial products therefore the curve joining points A, B, and C is called a PPF. b.) At point X inside the PPF the economy is producing a lower output of both industrial and agricultural products and this can be attributed to either underemployment of available resources or employment of poor technology. c.) It is not possible for a country at fixed amount of resources and constant technology to produce an output of both industrial and agricultural products at point Y because the resources and technology may not be enough to produce such an output. To produce at 'Y', the country needs to either discover other new resources or improve its technology. N/B: - - At a fixed amount of resources and constant technology if the economy is to produce more of a given production it must forgo some output of the other production. This defines the opportunity cost which becomes the gradient of the ppf. - If there is a possibility that a country can produce at point Y with the new level of resources and technology this would mean that the ppf will shift upwards to the right. - Changes in Resource availability - Increases in capital stock - Technological change (Resources are used more efficiently) - Increases in the size and skills of the labour force **4. Economic resources** These are the ingredients that are required in the production of goods and services which satisfy the human wants in a society. The resources enhance economic activities. Categories a\) Natural resources -- provided by nature e.g. land, minerals, water bodies, mountains etc. b\) Man-made -- are those created or modified by man from the natural resources e.g. electricity, dams, roads etc. c\) Human resources -- the human effort both physical and mental as applied in the production of goods and services in a society. d\) Wealth -- the stock of resources that a country or an individual has. Wealth can be personal (things and knowledge one has in society), business (assets of a business) and social (resources shared by all in society e.g. schools, hospital etc.) **5. Welfare** This is the level of satisfaction realized by individuals in their life. The welfare of the citizens is defined by their standards of living which indicate how the human wants are satisfied in society. **6. Goods** A good is anything tangible and having an economic value which can satisfy a human need. Goods can be either perishable or durable, or consumer or producer. **7. Service** A service is anything intangible and having an economic value used to satisfy human wants. **[TOOLS OF ECONOMIC ANALYSIS]** Tools used to analyze real life phenomena i. **Models and theories** Economists observe real-life economic phenomena over a period of time and develop a theory or model to grasp or understand the essence of the issue/problem at hand. **Theory:** A reasoned assumption intended to explain an occurrence or a phenomenon **Model**: A mathematical representation based on the economic theory. - Using Graphs to Illustrate Relationships Visual representation of the relationship between two or more variables - Holding All Other Things Constant (Ceteris Paribus) - The Slope of a Linear Curve - Variables (Real and Nominal): any measurement that helps to determine how an economy functions - Total, Averages and Marginal Values - Marginal Changes: "change in the total value as a result of a unit change in the quantity of another variable ii. **Positive and Normative Economics** There are two approaches to the study of economics namely **positive and normative** analysis. **Positive analysis (deductive):** is more central to micro-economics and it is concerned with what is, what was, and what will be. That is, it is more specific and objective. It employs economic theory in explaining and predicting circumstances. The economic theories are tested against observations and are used to construct models from which prediction are made. A theory therefore is a reasoned assumption intended to explain an occurrence or a phenomenon. A model on the other hand is a mathematical representation based on the economic theory. In case of controversies in positive analysis, we refer to economic theories that have been proven through empirical observations. **Normative analysis (inductive):** goes beyond theory to ask questions like "what is best, what ought to be" etc. it is subjective meaning that it depends on value judgment on what is desirable. In case of controversies, individual policy choices will rule. It is concerned with alternative policy actions that help in illuminating and sharpening debates. **Example to help distinguish between positive and normative economics** Government imposes tax on a good; effect of this would be - - - **[ECONOMIC SYSTEMS]** These are the means through which economies addresses the three fundamental questions. Therefore, they are the means through which economies defines how economic resources are to be distributed and allocated. There are three economic systems namely: Free market system/ capitalist economies Centrally planned/ governed/ command socialist/ communism Mixed economy like Kenya 1. **Free Market Economy** This is a system whereby decision regarding resource allocation and distribution are made by people of the nation as guided by the prices generated by forces of demand and supply. Its characteristics include: 1.) Prices and wages are determined by forces of demand and supply. 2.) There is ownership of private properties. 3.) There is no government intervention such that no taxes, subsidies, price control, quota system, licenses. 4.) There is no matching of demand and supply as forces of demand and supply dominate in this market. 5.) There is free entry and exit such that there are many buyers and sellers. **Merits** 1.) Due to the ownership of private properties, individuals are entitled to enjoy the incomes from such properties. Also workers are entitled to enjoy the incomes generated from services they are offering. 2.) Due to free entry and exit, there are many buyers and sellers in the system hence better qualities are produced. 3.) There is matching of demand and supply hence no over or under production. This helps to minimize wastage of resources. 4.) Due to the presence of many producers in the system, there will be a wide variety of goods and services to choose from, thus consumer sovereignty can be exercised in this system (in this system, there is freedom of choice to the economy. 5.) There is no government intervention thus freedom of choice toe enterprise where the producers can produce whatever commodity they want. 6.) The prices are controlled by forces of demand and supply hence minimizing the disadvantages of price controls. 7.) There is much production hence creation of employment opportunities to the society. **Demerits** 1.) Merit goods such as education and health may be provided at higher prices thus not affordable by most people in the society. 2.) Public goods such as defense or security and street lighting may not be provided. 3.) Negative externalities such as pollution may not be controlled in this system. 4.) In this system such production requiring heavy capital outlay may not be taken. 5.) In this system only those who have the capital will be able to start business which will mean a few monopolies may arise in the system thus exploiting consumers. 6.) There is uneven distribution of income and wealth thus the gap between the poor and rich is wide. 7.) Development projects may not be undertaken. 8.) Essential services such as electricity may be provided at high prices. 9.) There is production of harmful goods e.g. harmful drugs. 2. **Centrally Planned/ Command/Governed Economy** This is a system where by decision regarding resource allocations and distribution are made by a planning body appointed by the government. Its features include: 1.) Resources are owned and controlled by state. 2.) Wages and prices are fixed and controlled by the government. 3.) There is no ownership of private properties hence properties are for the whole community since projects undertaken by the government are to benefit the whole society. 4.) Occasionally there exist restricted labor markets. 5.) Government undertakes the production by fixing production targets to various sectors of the economy. **Merits of planned economy** 1.) Merit goods such as education and health are provided for at affordable prices. 2.) Public goods such as defense and street lighting are provided for. 3.) Monopolies arising in the economy are controlled through either instituting anti-monopoly rules or the government operating this monopoly acts as parastatals. 4.) Since the government is not profit motivated as it produces, it will consider maintaining a production even when losses are incurred e.g. Kenya Railways. 5.) Essential services such as water and electricity are provided at affordable prices. 6.) Development projects are able undertaken for the sake of the whole community. 7.) Production requiring heavy capital outlay will be undertaken in the economy e.g. generation of power. 8.) Negative externalities will be controlled in this system, 9.) Inflation and unemployment are controlled through monetary and fiscal policies. **Demerits** 1.) No consumer sovereignty in this system are forced to consume what has been produced by the government. 2.) In this system there is a lot of planning which may mean wastage of resources. 3.) The implementation of the plans in this system is associated by delays and lags. 4.) Due to lack of matching demand to supply there may be either an under or over production. 5.) There exists a restricted labor market where workers are forced to train and take such jobs as offered from the production that are undertaken by the government. 6.) In this system there is no ownership of properties. **3.) Mixed Economy** This system has both the features of both free market and planned system economy i.e. is an economy where individuals are able to make decision regarding resource allocation and distribution because the government takes control. It may be a better economy than a free market system or a planned economy. In the world no economy that is 100% free or 100% planned and most economies tend to be mixed economy. [**CONSUMER SOVEREIGNTY** ] Refers to the sole power or the freedom that the consumer has such that he can spend his income the way he would want. **Limitations of consumer sovereignty** 1.) Availability of the commodity, if the commodity is available in the market the consumer will be more sovereign and vice versa. 2.) Nature of the economic system, in the free market system there are wide variety of goods and services to choose thus the consumer is more sovereignty than in planned where they is forced to consume what has been produced by the government. 3.) Consumers' level of income, demand must be backed or supported by ability to buy therefore the more income a consumer has the more sovereign he will be and vice versa. 4.) Tastes and preference of an individual, if an individual or consumer can only go for a particular test, this would mean he cannot exercise his freedom of choice over the availability of goods and services in the market. 5.) Consumer\'s own habits, some individuals in society are not able to part from the ways they have chosen to live their lives therefore they are not able to see other commodities available in the market because they are limited in their choices. 6.) Believes, customs and rules set by a society, some individuals are not able to consume some commodities which are against their family, religion and society rules. 7.) Individual's health, once health dictates what to be consumed such that the consumer may be limited only after commodity to choose from. 8.) Presence of monopoly, if there is a monopoly this will mean no production of a variety of goods and services to choose from, consumers may be forced to consume what has been produced by a monopoly. 9.) Presences of standardized goods, sometimes goods are standardized but not unlike the tastes and preference of the consumer and thus may limit the freedom of choice of an individual.