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Lifetime Learning… Building Success… Towards Globalization

Economics -Chapter 1The Nature of Economics

Lifetime Learning… Building Success… Towards Globalization

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Economics - Definition

• Economics is the;• science which studies human behavior;• as a relationship;• between ends and scarce means;• which have alternative uses

– Lord Robbins.

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Definition Explained

a. Economics is a social science in that it uses scientific methods to study human behaviour.

b. Human needs are unlimited whereas resources are in limited supply, hence the problem of scarcity.

c. The resources can be put to alternative uses in order to meet certain ends. (needs)

Note: Choices have to be made to utilize scarce resources

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Scarcity and choice

• Wants unlimited• Means (resources) limited• Choice between alternatives• Opportunity cost.

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Reading Graph

• Vertical and horizontal axis • Price → vertical axis

• Quantity demanded → Horizontal axis

• Price is shown in units, Quantity demanded in time

period• The relationship between the two variables is inverse;

negative.

Economists make assumption of ceteris paribus ‘meaning other things being equal’

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The Nature of Economic Problem

• Economics studies the;– allocation– distribution– utilization of resources

– to meet human needs.

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Economic Problem cont…

• Main economic problem can be summarized as:• Allocation of Resources: What gets produced.• Distribution of Resources between different groups in

the society. (who gets what is produced)• Utilization of resources: All the available resources

are used effectively.

• Since the resources are limited in supply (scarce) and the wants are unlimited choice has to be made.

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The Nature of Economic Problem Cont…..

• The resources an economy has at its disposal to satisfy the unlimited wants are termed by economists as inputs or factors of production and divided into the following categories:a. Land; Natural resourcesb. Labour: Human resources:c. Capital: Physical resources

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Opportunity Cost Production Possibilities Frontier (PPF)

• Opportunity cost of producing more of one good is less of the other.

• Opportunity cost can be defined as the best alternative forgone or sacrificed.

• A production possibilities frontier (PPF) represents the combinations of the two products that the country can produce if it fully utilizes all of its resources.

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Production Possibilities Frontier (PPF)

• An economy should produce at any point on the

PPF.• Points inside PPF (G in the

diagram) an economy is underutilizing its resources.

• Points outside the frontier (H in the diagram) are unattainable. (production not possible with available resources).

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• A shift outwards in the PPF represents the ability to produce more goods and services with the same inputs.

• This may be the result of technological change or other productive improvements.

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PPF and Opportunity Cost

• The PPF can be viewed in terms of opportunity cost since to produce more units of one product needs resources to be taken from production of the other. A straight line opportunity

cost curve shows constant opportunity cost at each point.

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Economic Systems

• Economic system refers to the approach taken when dealing with the economic problem of;– allocating, – distributing‘, and;– utilizing recourses.

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• Three main types of economic systems are:• A Market Economy:• A Planned Economy• A Mixed Economy

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Market economy

• What is a market economy?• A market economy allocates resources through the price

mechanism; and prices are determined by demand and supply.

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Advantages of the

• Resources are allocated without government intervention.

• The consumer dictates to the producers, what is produced.

• Producers produce those goods and services which gives most profit.

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Market Economy

Advantages• Resources allocation

without government intervention.

• The consumer dictates to the producers, what is produced.

• Producers produce those goods which gives most profit.

Disadvantages• Based on the ‘ability to pay’

and not on need. • Generates competition

between producers. • Pollution, noise, traffic

congestions etc.• Certain public goods (health

education, defence) may be not provided

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The Planned Economy

• In a planned economy the government decides; – what to produce; – how to allocate the resources and;– distribute the goods and services

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Planned Economy

Advantagesa. No wasteful

competition.b. more equal distribution

of income and wealth.c. price control.

Disadvantagesa. Overproduction/

underproduction of certain goods and services.

b. lack of motivation for work.

c. lack of competition between the companies

d.misuse of resources.

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The Mixed Economy

• A mixed economic system combines merits of both the market and planned economies.

• The mixed economy aims to allow the market to operate, with government intervening in the economy only where the market fails.

• Providing those goods and services such as;– law and order, education and health services which would have been

under-provided if left to the market.

– Most economies throughout the world are mixed economies

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Why Mixed Economy?

• The free market economy can cause:a.Up and down in the economic activity.b.Monopoly powerc.Inequalitiesd.Environment problem

So government intervention and control is required

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Positive and Normative Economics

• Positive economics deal with what is or what will be— statements that can be empirically tested. – Example: If the government increase the income tax it will

lead to a fall in the level of consumer expenditure.

• Normative economics deals with should or ought —statements that cannot be tested empirically.– Example: Income should be distributed more equally.

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Micro and Macroeconomics

• Microeconomics deals with the decision making of individuals and firms and how particular market works.

• Macroeconomics studies the operation of the economy as a whole covering such areas as; unemployment, inflation and aggregate demand.