Principles of Economics

Class 1Introduction to Economics

State and MarketSupply and Demand

Prerequisites 1: Graphs

• A Graph is a picture that shows a relationship between 2 or more variables.

• 2D graphs – linear or nonlinear.• The slope of the curve shows by how much y

changes if x changes by 1 small unit. The sign of the slope tells whether an increase in x causes an increase in y (+), or a decrease (-).

x

y

a

1

0

Inverse relation

x

y

a1

0

Direct relation

Linear function(y = ax + b)

Nonlinear functions-slope changes = slope at point and slope on segment is different

x

y

y*

Δx

0

Δy

x*

α

β

Draw the following graphs:y = 2x - 3y = -0.5x +1y = -x2 +4Then find slopes for x = 0, 1 and 2.

Exercise 1a

Prerequisites 2: Indices and growth rates

year production Base index (2012 = 100)

Chain index Growth rate (%)

2012 2500 100,0 - -2013 2750 110,0 110,0 10,02014 2900 116,0 105,5 5,52015 3000 120,0 103,4 3,4

×100

×100

Exercise 1b: Inflation rate and CPI

Year Trade union basket cost

CPI (2011 = 100) Chain index Inflation rate

2011 4500

2012 4575

2013 4450

2014 4500

×100 ×100

Exercise 1b: Inflation rate and CPI

Year Trade union basket cost

CPI (2011 = 100) Chain index Inflation rate

2011 4500 =4500×100/4500 = 100 - -

2012 4575 =4575×100/4500 = 101.7 =4575×100/4500=101.7 101.7-100=1.7

2013 4450 =4450×100/4500 = 98.9 =4450×100/4575=97.3 97.3-100=-2.7

2014 4500 =4500×100/4500 = 100 =4500×100/4450=101.1 101.1-100=1.1

PRINCIPLES OF ECONOMICS

• ECONOMICS is a science which investigates how societies use scarce resources in order to produce useful goods and how they are distributed among them.

• ECONOMY is the overall economic activity in a country (region)

• If resources were not scarce, there would have been no economics -> scarcity is the main trait of ECONOMIC GOODS.

• Resources are used efficiently if no additional unit of any good can be produced without reducing production of the other good.

MICROECONOMICS AND MACROECONOMICS

• MICROECONIMICS is a branch of economics which analyses the behaviour of individual entities (companies, consumers) and their interaction on the market.

• Found in 1776 (Adam Smith – Wealth of the Nations)• MACROECONOMICS is a branch of economics which

analyses the sum of economic activity.• Found in 1936 (John Maynard Keynes – General Theory

of Employment, Interest Rate and Employment).

ECONOMY TYPES

• MARKET ECONOMY is an economy where consumers and producers freely set prices and quantities. It boosts efficiency, but fails to solve situations like monopoly and lacks justice.

• PLANNED ECONOMY is an economy where consumption and production is commanded by the state (e.g. communistic economies)

• MIXED ECONOMY is the most common type where majority of the market is self-regulated, but state interferes when it is needed to provide justice.

Positive vs. Normative economy

POSITIVE ECONOMY – description of economic phenomena – the answer provided by economic analysis

Example: Why housekeepers earn less than doctors?NORMATIVE ECONOMY –value or normative

judgments about economic fairness or what the outcome of the economy or goals of public policy ought to be – the answer provided by political discussion and political decisions.

Example: Should production of some arms and drugs be made illegal?

INPUTS AND PRODUCTS

INPUTS are the goods used in production of the other goods and services. Basic inputs are labour, capital and land.

PRODUCTS are useful goods and services that are either consumed or used for production of other goods.

The three basic economic questions

1. What goods and services should be produced? Those that bring producers the most profit.

2. How should the goods and services be produced? To stay competitive, one has to minimize costs and produce efficiently.

3. For whom should the goods and services be produced? It depends on the input market – the product of all factors and its prices define the income of consumers

Production possibility frontier

• PPF shows the maximum amount of production that a country can produce using a given technology and avaialble inputs.

0 q1

q2

0 q1

q2

A

InefficiencyEconomic Growth

B

Efficiency

Capital & Consumer goods

0 Capital goods

•Economic growth depends on the choice between consumer goods and capital goods.

A

B

Cons

umer

goo

ds

PPF 2013

PPF2018

PPF2018

case coconut fish

A 0 8

B 1 6

C 2 4

D 3 2

E 4 0

0 2 4 6 8 fish

coconut

4

3

2

1

PPF – production possibility frontier

Exercise 2: PPF curve

Exercise 3

• Country can produce the following combination of goods using all the inputs:

– a) Draw PPF.– b) Is country efficiently using its inputs if it produces X = 70, Y = 90– c) Due to technological advances a production of X is doubled and the

production of Y increases by 50%. Draw new PPF curve.

Option X Y

A 100 0

B 80 100C 50 200D 0 300

Solution

c) New PPF

Option X Y

A 100*2=200 0

B 80*2=160 100×1,5=150C 50*2=100 200×1,5=300D 0 300×1,5=450

Market and State

• Market is a system in which sellers and buyers interact in order to determine prices and quantities of goods and services.

• Price is the value of a good or service in money.

• Market equilibrium is a situation in which sellers are willing to sell just as much consumers are willing to buy at certain price.

Market system

Labour, savings, land

Goods and services

Households Companies

money

money

Exchange, money and capital

• Exchange of goods is based on the specialisation and money is the mean for exchange.

• Specialization and division of labour increases productivity of labour which increases the amount of goods and thus the welfare of consumers.

• Capital is an input which is an accumulation of investments. Capital is made by sacrificing current consumption.

• Ownership of capital is protected – it is the foundation of capitalism.

Economic role of the state

• Laissez-faire (Fr.) – “let it be” – classical economics, today revised.

1. EFFICIENCY – best in perfect competition (invisible hand) but sometimes regulation of market competition needed:

• Imperfect competition appear – antitrust laws needed

• Externalities - levying costs or benefits to others.• Public goods – financed by the state.• Taxes – price of the public goods.

2. JUSTICE• Unregulated markets can lead to the unjust

differences between the incomes.3. MACROECONOMIC GROWTH AND STABILITY• Fiscal policy (public spending, taxes) and

monetary policy (supply of money) affect the employment, GDP growth rate, inflation, etc.

4. PROTECTION OF INDIVIDUAL AND PROPERTY RIGHTS