1. Introduction to Economics

What is Economics?

What is Economics?

Economics is a social science which studies the relationship between scarce resources with alternative uses and unlimited wants

importance of studying economics?

Economists provide information and forecasting to inform decisions within companies and government

To have an idea about politics and politicians decisions

To choose the right job and enhance personal internal values throughout that job

To live as a rational person and take right decisions at the right times

What is microeconomics?

Microeconomics studies the behavior of economic variables such as individuals, households, business firms and government separately

macroeconomics

Macroeconomics studies the economy as a whole, focusing on factors like inflation, unemployment, economic growth, and government policies.

positive statements

These are statements that answer the questions of what happened, what is happening, and what will happen. They can be tested using real-world facts and proven true or false. Positive statements do not involve value judgments or opinions.

nomative statements

statements that answer the question of what should happen. These statements are unverifiable and cannot be tested using real-world facts.

wants

wants are various ways to satisfy needs

characteristics of wants

unlimited

differ from person to person

combined with traditions and values and culture

change with time

secondary

need

needs are basic necessities needed to sustain human life

characteristics of needs

limited

common to all

related with biological sources

do not change with time

primary

goods

anything that has a positive useful and tangible

services

anything that has a positive utility and is intangible

economic bad

anything that has a negative utility and a cost of disposal

economic goods

all the goods that have a limited/ scarce supply

characteristics of economic goods

having a scarce supply

positive opportunity cost

have to make choices among alternatives

has an ownership

has a price

non economic goods

goods with unlimited supply at zero price level

characteristics of non economic goods/ free goods

unlimited supply

zero price level

There is no need to make choices among alternatives

zero opportunity cost

no ownership

Can non-economic goods become economic goods?

Yes, non-economic goods can become economic goods when they are scarce and have a market value assigned to them.

Eg oxygen being used by a diver when diving

oxygen given to patients

solar panels produced with solar power

bottled water

production factors

all the inputs and factors that can be used for the production of goods and services can be known as production factors

production resources classification

economic resources

noneconomic resources

economic resources

all the resources that have a scarce supply and positive opportunity cost

non economic resources

all the resources that have an unlimited supply at zero price. also known as free resources and has zero opportunity cost

production resources

property resources

• land

• capital

human resources

• labour

• entrepreneurship

Land

Natural resources gifted from nature that are used in the production of goods and services

This is also known as natural capital

•Being a gift of nature

•Supply being inelastic

•Immobility

•Possibility to improve the productivity

•Heterogeneity

Labour

The mental and physical efforts rendered in the production of goods and services

Being a live factor

Perishability

Heterogeneity

Mobility

Possibility to improve productivity

Capital

All the man made aids used in the production of goods and services

Being a real factor

Being a man made factor

Being a stock factor

Mobility

Possibility to depreciate

Possibility to be used in the production process again and again

entrepreneurship

combining all factors of productions, analysing product activities, operation and policy making while bearing risks

•Being a human factor

•Being a generating force

•leadership quality

.identifying of opportunities

renewable resources

resources that generate again and do not get used up with consumption

Non renewable resources

Resources that get used up with consumption and do not generate again

Eg; Diamonds, Gas,Gold

Division of Labour

Is an economic concept which state the dividing the production into different stages which enables workers to focus on specific tasks

This will lead employees to specialization as the employees will be specialized in one area of work

Specialization

Individuals or businesses focus on a specific area of expertise or product to increase efficiency and productivity

specialization is the existing skills and ability of an individual to complete a task quickly and effectively through division of labor

Production firms can increase their productivity and efficiency through division of labor

Fixed capital

Durable capital that are used in the production process continuously such as factories, machineries and stores

Throughout the period where fixed capital is used the resource owner will recieve a flow of benefit

Circulating capital

Stock of raw materials, stock of goods being produced, stock of semi finished goods, stock ready for sale and finished goods are circulating capital

Economic overhead capital

Capital goods which facilitate the production of goods and services and the distribution process of an economy

Eg; ports, airports, highways

Economic Infrastructure

Hard infrastructure

Roads, Highways, bridges, airports

Soft infrastructure

Operational training programmed, research and development facilities

Social overhead capital/social infrastructure

Capital goods which help to produce services to fulfill basic human needs. They improve social welfare

SOCIAL INFRASTRUCTURE

Hard infrastructure

Hospitals, schools, housing, child protection

Soft Infrastructure

Social protection, community service

Human Capital

Skills of Labor, which consist of education, training, research, experience and favorable health, help to improve the productivity of laborers and professionals

Through human capital, the productivity of labor can be improved and quality and quantity of production can be increased

Natural Capital

All the natural resources gifted by nature

Social capital

Institutions which improve social interrelationships qualitatively and quantitatively. Social networks and traditions, membership of clubs

Functions performed by an entrepreneur

Risk bearing

Mobilizing factors of production engaged in policy decision making

Organization of production activities

Introduction of innovations

Factor income

Land- Rent

Labour- wages

Capital- interest

Entrepreneur- profit

Capital Stock

Capital stock of a country is generated through investments. Investments arise with savings. Therefore, there’s a relationship among capital, investments and savings

Savings of an economy

Savings of an economy exists in various forms. it can be classified as :

Domestic savings

Foreign savings

Business firms savings

Public savings

What is savings

Proportion of household income not used for daily consumption is savings

Business savings

Part of firms profits is kept as retained earnings and is called business savings. It will be used for future investments

Public savings

The balance obtained by deducting current expenditure from total government revenue

Differences between an entrepreneur and a manager

Entrepreneur	Manager
Entrepreneur is visonary and bears all financial risks.	Manager works for salary, and does not have to bear any risks
Focuses on starting and expanding the business ideas	Focus on daily smooth functioning of business
Key motivation for entrepreneurs is achievements	Managers motivation comes from the power of their position
Reward for all the efforts is profit that is earned from the enterprise	Remuneration is the salary he draws from the company
Entrepreneur can be informal and casual	Managers approach to every problem is formal

Why is money not considered as capital in economics?

Investments and capital are not the same

Capital is the man-made resources used for production	Investment is the process of deriving capital
Stock concept	Flow concept
Stock is defined as a variable that is measured at a particular point in time, eg: buildings and raw materials	Flow is defined as a variable which is measurable over a period of time, e.g., expenditure, change in money supply
Capital gets depreciated	Investment can increase stock capital. Can reform the value of capital depreciation

Capital is a factor of production that can produce goods and services.

Money cannot produce a good or service by itself. Rather, money is used as an intermediary to hire other factors of production, such as capital.

how various countries in the world utilize capital

•Countries like Australia and New Zealand have a lot of land resources. Therefore, they mainly use land for their production.

•Countries like China and India use mainly labor in their production, as these countries have world’s largest population.

•Countries like the United States of America and Japan use capital mainly in their production, as these countries are rich with capital.

•Although there is less land, labor, and capital, Singapore has achieved a high level of development with the factor of entrepreneurship.

Productivity

Output per unit of input is called factor productivity

Factor productivity = Total Output

Total input

Factors affecting productivity

• Technology

• Human capital

• Management

• Division of Labour and specialization

Scarcity

• Scarcity is the basic economic problem that arises due to the availability of limited resources but presence unlimited wants of human beings

• Scarcity is a central economic problem common to every economy and is a relative concept

• Scarcity does not mean the total absence of resources

Scarcity arises due to two main characteristics

• Human wants being unlimited at a given period of time

• Resources used to produce goods and services to fulfill human needs and wants being unlimited at a given period of time

Shortage of goods and scarcity

If the stock is not available to satisfy wants then it is not scarcity as it could be satisfied once the stock arrives

Goods produced with these limited resources are called as economic goods and the supply of these goods are limited

Scarcity and poverty

Scarcity	Poverty
Scarcity is the basic economic problem that arises due to the availability of limited resources but presence unlimited wants of human beings	Poverty is the inability of an individual or a family to command sufficient resources to satisfy basic human needs
Scarcity arises because of lack of resources relative to unlimited human wants	Poverty arises because of the total absence of resources to fulfill basic needs
Scarcity cannot be eliminated through government policies	Poverty can be eliminated through governmental policies eg: samurdhi, Gala neguma, gemidiriya

Scarcity is considered as the central problem of economics due to

• Common to every society

• As any society would commonly face the problems of what to produce in what quantity, how to produce and whom to produce

Choice

Since scare resources have alternative uses instead of selecting many, people have to choose one alternative

Problem of Choice arises due to

• Scarcity of resources

• Based on alternative uses- scarce resources

Basic economic problems

1. What to produce in what quantity

2. How to produce

3. Whom to produce

What to produce in what quantity? (Resource allocation problem)

• Due to scarcity of resources and alternative uses, economic agents should make the choice of what to produce in what quantity.

• resources should be allocated after deciding what goods to be produce in what quantity. This also means how much of resources should be used for present and are available for future

• This is also defined as resource allocation problem

How to produce? (Problem of production)

The basic problem of how to produce means which production technique or which technology should be used in producing goods and services?

Two production techniques can be used to produce goods and services

Labour intensive Production technique

• Labour intensive Production technique uses more of Labour and less of capital in production

Capital intensive Production technique

• Capital intensive Production technique uses more of capital and less of Labour in production

This economic problem is also known as problem of production

For whom to produce (problem of distribution)

• The question looks at what basis the product would be distributed amongst the economy. This could be whether the goods are to be given to everyone, given to those who could afford or to different age categories etc

• A solution to the problem of whom to produce is determined upon the person’s income

• The income gained by each person differs on factor ownership and factor price

• The person who has more factor income will have the chance to consume more goods produced and the person who owns less factor income will have less chance of consuming the goods produced

Opportunity cost

When selecting one alternatives among all the other alternatives, the value of the next best alternative forgone can be known as opportunity cost

Production possibility frontier or production possibility curve (PPF/PPC)

The PPC is the line or a curve that is drawn by connecting all maximum possible output combinations of two products that an economy can produce using all available resources fully at a given state of technology at a given period of time

Factors that determine the PPC of an economy

Resources Endownmemt

• Land ( Natural Capital)

• Labour (Human Capital)

• Capital (physical capital)

• Entrepreneurship (social capital)

Factor Productivity

• Technology

• Human capital

• Management

• Division of Labour and specialization

Assumptions used when drawing PPC

1. Production of only two goods

2. Resource stock remains constant

3. Technology remains constant during the concerned period

4. Fully utilization of resources with maximum efficiency

Slope

When moving along a PPC the ratio between forgone amount of the other goods when increasing the fixed amount of goods is identified as the slope or ratio. Slope shows the marginal opportunity cost.

Increasing opportunity cost

• When moving along the production possibility curve by increasing the fixed amount of a certain good, the situation of increasing the amount of the forgone good is known as increasing opportunity cost.

• Shape of the ppc is concave to origin

Reasons for increasing opportunity cost

1. Non homogenous of resource [one type of resources is not perfectly substitutable to another]

2. Resources efficient for one industry are not efficient for the other industry

3. Production technology used to produce one products productivity is totally different from the technology used in the other product

Constant opportunity cost

• When moving along the production possibility curve by increasing the fixed amount of a certain good, the situation of the amount of the foregone good remaining unchanged is identified as constant opportunity cost

• The shape of the PPC is linear

Reasons for constant opportunity cost

1. Homogenous resources

2. The resources efficient for one industry are the same for the other industry

Increasing opportunity cost vs constant opportunity cost

Increasing opportunity cost	Constant opportunity cost
When moving along the PPC by increasing the fixed amount of a certain good, the situation of increasing the amount of the foregone good is identified as increasing opportunity cost	When moving along the PPC by increasing the fixed amount of a certain good, the situation of the amount of the foregone good remaining unchanged is identified as constant opportunity cost
Shape of the PPC is concave to origin	Shape of the PPC is linear

Zero opportunity cost

A point moves from inside the PPC towards the PPC

Zero opportunity cost situations

• With non economic goods the opportunity cost is zero. Eg sunlight, rain

• When having only one alternative use. Eg; coffee, military weapons

• When converting unemployed resources to employed resources. Eg: recruiting an unemployed person in a job

Decreasing opportunity cost

• When moving along the PPC by increasing the fixed amount of a certain good, the situation of decreasing the amount of the foregone good is identified as decreasing opportunity cost

• The shape of the PPC is convex to origin

Opportunity cost calculation

Opportunity Cost = decreased units

Increased units

Macro and micro economic concepts that could be represented by PPC

Microeconomic	Macroeconomic
Scarcity	Employment
Opportunity cost	Unemployment
Choice	Economic growth
Utilization	Economic recession
Production	Imposing of sanctions

Scarcity and PPC

Scarcity is the lack of resources relative to unlimited humans wants

Can be represented by a point outside the PPC

Points located OUTSIDE the PPC are Unattainable and cannot be produced with the current available resources and technology

Alternative uses in PPC analysis

• Alternative uses are all possible output combinations that an economy could produce with its available resource and technology

• Alternative uses are shown either by points ON or INSIDE the PPC

  • ON- productive efficient

  • INSIDE- productive inefficient

Choice

• Choice is the selection of one of the alternatives and allocate and use resources to that alternative

• Is shown by a point on the PPC

Utilization

The act of using something in an effective way

concepts that can be represented by using points ON or INSIDE the PPC

ON THE PPC	INSIDE THE PPC
Full employment	Unemployment
Full production	Under production
Full efffiency	Inefficiency
Production efficiency	Production Inefficiency

Zero utilization

Represented by a point on the origin

Economic efficiency

economic efficiency is the form of efficiency that is at tainted when an economy simultaneously achieves both productive efficiency and allocative efficiency

Economic efficiency

Production efficiency	Allocative efficiency
Production efficiency means achieving all maximum output from all resources of an economy	Allocative efficiency means distribution of limited resources of an economy based on society’s preference
Two main conditions necessary for production efficiency Full Employment Full production	Conditions for allocative efficiency Price = Marginal Cost (P=MC) OR Marginal Cost= Marginal Benefit (MC=MB) Allocative efficiency can only be shown by one point on the PPC

Economic efficiency (production efficiency and allocative efficiency)

Full employment

Productive employment of all resources of an economy within a production process is called full employment

Shown by a point on PPC

Underemployment

Employing of resources in a way which does not provide maximum productivity

Economic recession

• Decreasing of production due to decrease in demand for goods and services of an economy

• Can be shown by a movement of production

Economic depression

• Long term situation of economic recession is economic depression

• PPC will shift to the left

Economic growth

• Continuous increase in real output of an economy throughout a long period

• PPC will shit to the right

Sectorial Growth

Increasing the output of one good due to the technological development

Factors that affect the PPC shiftment

PPC to the Right	PPC to the left
Resource stock ↑	Resource Stock ↓
Land ↑	Land ↓
Labour ↑	Labour ↓
Capital ↑	Capital ↓
Entrepreneurship ↑	Entrepreneurship ↓
Productivity ↑	Productivity ↓
Technology ↑	Technology ↓
Management ↑	Management ↓
Infrastructure ↑	Infrastructure ↓
Investment ↑	Investment ↓
Innovations ↑	Innovations ↓
Development ↑	Development ↓
Production capacity	Production capacity ↓
	Civil war and conflicts
	Natural Disasters

Factors that affect the replacement of a point

Right	Left
Utilization ↑	Utilization ↓
Employment ↑	Employment ↓
Unemployment ↓	Unemployment ↑
Efficiency ↑	Efficiency ↓
Inefficiency ↓	Inefficiency ↑
Production ↑	Production ↓
Factor price ↓	Factor price ↑

Economic Systems

Institutional framework made by the people who live within a society to solve basic economic problems

Elements of an Economic System

• Households

• Government

• Business firms

• Non governmental organizations

• Markets

• Incentives

Criteria used to classify Economic Systems

1. Ownership of property

2. Decision coordination mechasinsm

3. Nature of incentives

Property Ownership

• Property ownership is simply who owns the production resources of an economy

  Property owned by the government->	Socialist economic system
  Property owned by the private sector->	Capitalist economic system
  Property owned by a group of people or a tribe ->	Traditional economic system
  Property owned by government and private sector ->	Mixed economic System

Decision coordination Mechanism

• Decision coordination method is how an economy solves basic economic problems

  Planning Mechanism	Planned Economic System
  Price Mechanism	Market economic system
  Customs and Traditions	Traditional Economic Systems
  Planning and Price mechanism	Mixed Economic System

Incentives

• Factors that encourage or discourage people’s behavior in an economy are called Incentives

  Coercive incentives	Command economic System
  Material incentives (self interest)	Market economic system
  Moral incentives	Traditional Economic systems
  Coercive and material incentives	Mixed economic system

Capitalist Market/ Free Market Economic System

Market economic system is the economics system which solves basic economic problems based on price determined by the market demand and supply