Lectured By: Mr. Phorn Much, MBA 1-1

C H A P T E R

1 NATURE OF ECONOMICS

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Lectured By: Mr. Phorn Much, MBA 1-2

CHAPTER OBJECTIVES

After studying this chapter, you should be able:• To give the definition of economics• To know economics perspective and its goals• To identify the three major questions for proper

use• To understand macro- and micro-economic• To explain the economic system• To define the Circular Flow of economic Activity

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ics The word economy comes from the

Greek word for “one who manages a household”• The management of society’s

resources is important because resources are scarce.

• Understanding economics helps us make sense of the world we live in.

• Economics studies how people make decisions.

Nature and importance of Economics

Lectured By: Mr. Phorn Much, MBA 1-4

• The social science concerned with the efficient use of limited or scarce resources to achieve maximum satisfaction of human materials wants.

• Human wants are unlimited, but the means to satisfy the wants are limited.• Economics is the study of how society manages

its scarce resources.

DefinitionC

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The Economics Perspective

Economists view things through a unique perspective.• Scarcity and choice.– Resources can only be used for one

purpose at a time.– Scarcity requires that choices be made.– The cost of any good, service, or

activity is the value of what must be given up to obtain it.C

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The Economics Perspective

• Rational Behavior.– Rational self-interest entails making

decisions to achieve maximum utility.– Different preferences and circumstances

lead to different choices.

• Marginalism: benefits and costs– Most decisions concern a change in current

conditions– Weighs the marginal benefit against the

marginal cost– The marginal cost of an action should not

exceed its marginal benefits

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Economic Goals

Economic policies are designed to achieve certain economic goals.– Economic growth– Full employment– Economic Efficiency– Price-level Stability– Economic freedom– Equitable Distribution of Income– Economic Security– Balance of Trade

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Fundamental of Economic ProblemSocieties do not have enough productive resources to satisfy everyone’s wants and needs.• If each of us were to make a list of all the

things we want, it would most likely include more things than we could ever hope to obtain.– Scarcity : the fundamental economic

problem facing all societies.– Needs and Wants: needs for survival, but

wants is more much broader than the term of needs.

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Three Basic questions

Unlimited

wants

Limited resourc

es

Scarcity

Choices

How to produce

For Whom to

produce

What to produceC

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Macroeconomics and MicroeconomicsMacroeconomics examines the economy as a whole– It includes measures of total output,

total employment, total income, aggregate expenditures, and the general price level.

– It is a general overview examining the forest, not the trees

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Macroeconomics and MicroeconomicsMicroeconomics looks at specific economic units.– It is concerned with the individual

industry, firm or household and the price of specific products and resources.

– It is an examination of trees, and not the forest.

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Positive versus Normative Analysis• Positive economics describes the

economy as it actually is, avoiding value judgments and trying to establish scientific statements about economic behavior (Absolute Facts)

•Normative economics involves value judgments about what the economy should be like and the desirability of the policy options available (What Ought to be)

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The factors of Production

The four factors of production must be presented to produce goods and services.– land: includes gifts of nature, or natural

resources not man- made.– Capital: includes the tools, equipment,

and factories used in production– Labor: includes people with all their

efforts and abilities.– Entrepreneurs: individuals who starts a

new Business or bring a product market.

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Economic System

When companies want to do business in other countries, they need to adjust their business plans to meet local customs.– Economic System_ an organized way of

providing for the wants and needs of their people

• There are three major kinds of economics systems

• Traditional• Command• Market economies

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Economic System

• Traditional EconomiesMany of our actions spring from habit and custom.

– Characteristics: • ritual, habit, or custom

– Advantages: • everyone knows which role to play. Only little

uncertainty exists over “What to produce, How to produce, For Whom to produce”

– Disadvantages: • tends to discourage new ideas and new ways of

doing things, • The lack of progress leads to economic stagnation

(stop working) and low standard of living than in other economic systems.

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Economic System

• Command EconomiesA central authority makes the major decisions about “What, How, for Whom to produce”

– Characteristics: • The government makes the major economic

decisions.– Advantages:

• It can change direction drastically• Many health and public services are available to

everyone at little or no cost (represented by the former Soviet Union)

– Disadvantages: • One is that they ignore the basic wants and needs

of consumers.

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Economic System

• Command EconomiesA central authority makes the major decisions about “What, How, for Whom to produce”

– Disadvantages: • The system gives people the incentive to fill

quotas instead of producing a good product• A command economy requires a large

decision making bureaucracy.• The planning bureaucracy lacks the flexibility

to deal with minor day-to-day problems.• Rewards for individual initiative are rare.

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Economic System

• Market EconomiesPeople make decisions in their own best interest,

– Characteristics: • Characterized by a great deal of freedom• Feature the private ownership of resources, based

on Capitalism.– Advantages:

• High degree of individual freedom.• Adjusts gradually to change over time.• The relatively small degree of government

interference• Decision making is decentralized• The variety of goods and services• High degree of consumer satisfaction

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Economic System

• Market EconomiesPeople make decisions in their own best interest, – Disadvantages: • Does not provide for everyone, some people

may be too young, too old, or sick to earn a living or to care for themselves.• May not provide enough of some basic

goods and services.• High degree of uncertainty

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Economic System

• Mixed EconomiesSystems that combine elements of all three types, traditional, command, and Market economies.

– Characteristics: • Tradition as well as market, answer some of the

questions of “What, How, for Whom to produce”• Some governments intervene only in certain key

sectors or industries and leave the rest to markets– Advantages:

• Provides assistance for some people who might otherwise be left out.

• Still share certain benefits to people who are not fortunate.

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Economic System

• Mixed EconomiesSystems that combine elements of all three types, traditional, command, and Market economies.

– Disadvantages: • Tend to provide more services, the costs for

these benefits can mean higher costs for overall citizens.

• the availability of services may be limited or the quality may deteriorate (miserable) over time.

• Because socialism has proved to be inefficient, many socialistic countries today allow more capitalist development.

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Circular Flow of Economic Activity• The economic activity in markets

connects individuals and businesses.• The wealth that an economy

generates is made possible by circular flow of economic activity.– Factor Markets

Individuals earn their incomes in factor markets, where the factor of production are bought and sold.

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Circular Flow of Economic Activity– Product Markets

After individuals receive their income from the resources they sell in a factor market, they spend it in Product Markets. These are the markets where producers sell their goods and services.

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Circular Flow of Economic Activity

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