principles of economics

economics

scientific study of how individuals, firms, and society allocate scarce resources ,which have alternative resources, to satisfy unlimited wants

why study eco

• aim of teaching eco is to give students grasp of main issues that less developed countries are faced with

eco as a social science

• it deals with activities of society by studying human behavior, decision making and societal trends therefore making it a social science

eco as a science

• it uses scientific methodology

• Economics like all sciences has certain laws which are true under certain conditions. These laws can be verified.

economic theory

• set of ideas and principles about how the economy works based on logical thinking. it provides tools necessary for analyzing and explaining behavior in the economic system

• the theories are developed to understand economic concepts even if they don’t have immediate real world use

main economic problem.

scarcity- created as humans have unlimited wants but there is limited resources to produce them

• demand exceeds supply

economic problem 2

• 2 HOW ARE THESE GOODS TO BE PRODUCED?

  • production process

  • question arises whenever there is more than one technically efficient / possible way in which goods can be made.

  • labor intensive method or capital intensive method

economic problem 3

• 3 FOR WHOM ARE THE GOODS PRODUCED? 

  • distribution of the national produce among various individuals and groups in the economy is of great general interest.

  • everyone in economy is a consumer

  • ultimate objective of production is to satisfy the wants of the consumer

    • production is not complete until the produced goods and services reached the final consumer.

  • Our contribution to production determines what each one of us gets from the goods and services produced.

economic problem 4

• 4 ECONOMIC GROWTH:

  • How much of current output should be saved for future use / growth? 

  • economy that consumes all what it produces will stagnate.

  •  All economies make effort to expand their productive capacity and so increase output of goods and services. Any economy that saves will grow.

economic problem 5

• 5 THE USE OF A COUNTRY’S RESOURCES

  • Are the country’s resources being fully utilized? Or are some of them lying idle?

  • there are many human wants abut the resources to satisfy them are not sufficient

    • yet under this condition, some resources are lying idle or are underutilized. Thus most economies face the problem of less than full employment of available resources.

economic problem 6

• 6 HOW EFFICIENTLY ARE THE RESOURCES BEING USED: Splits into 2 questions

  • is production efficient?-  Production is inefficient if it’s possible, simply by reallocating resources to produce more of at least one good without simultaneously producing less of another good.

    • - if you still have some resources leftover and you are able to produce other products with those leftover resources then the resources where used inefficiently therefore production was inefficient

  • efficient allocation of output- Good are said to be inefficiently allocated if it would be possible to redistribute them among the individuals in the society and make at least one person better off without simultaneously making anyone worse off

    • if you can remove a quantity of something from one group and give it to another group and the first group is not lacking in anything because they had excess supply to begin with then it means that the goods were inefficiently distributed in the first place as the second group gained something without making the first group worse of

economic problem 1

• 1. WHAT GOODS ARE TO BE PRODUCED AND IN WHAT QUANTITY?

  • arises because goods are produces by factors of production. These factors of production are scarce

    • When there is full employment of resources, the decision to use more resources to produce more of one thing necessitates producing less of something else. Hence, not all the goods the society desire will be produced.

  • producers need to be aware of- government policies, consumer demand, resource availability

microeconomics

• looks at the economic actions/functioning of individual or groups of individuals in the economy

  • individual consumers, firms, resource owners

• major concern is on how a specific price is established within

  the economy.

• major importance of microeconomics is that it helps us to understand the functioning of individual economic units.

macroeconomics

• refers to the combined behavior of all individuals businesses or sectors of the economy. how the economy functions as a whole

• the study of the aggregate behavior of all individuals in the economy.

  • aggregate- total or overall sum of many individual parts

• looks at the economy as one functioning unit because different sectors of the economy are interrelated and, certain institutions cover the entire economy. 

• main problems macroeconomics are economic growth, unemployment, inflation and balance of payments. 

• major importance of macroeconomics is that it helps us to understand the functioning of the economy

in microeconomics we study

• price of a single product

• decision of individual consumer, individual firm

• market for individual good

in macroeconomics we study

• consumer price index

  • tracks average change in price, measuring inflation

• total output of all goods in the economy

• combined outcome of decisions of all consumers in the economy

• total supply of labor in the economy

• total exports and imports in the economy

positive economics

• the study of how the economic system actually functions. 

• describe economic facts/ factual evidence of how economic system actually functions

• Positive statements are about facts, what is or has happened, or how certain conditions are related to each other.

normative economics

• suggests policies based on opinions and values rather than factual evidence

• it is concerned with what ought to be. it is about value judgements

• actual performance of the economy is compared with what will be the ideal performance and differences between the two will lead to economic policy proposals for improving the performance of the economy. 

  • economist can use this knowledge of reality to analyze the problem and suggest effective means for attaining the desired end.

free good

• exists in natural abundance that one’s desire can be satisfied at zero price

• example- air, sunlight

economic good characteristics

• arises out of scarcity and choice.

• must provide satisfaction, be relatively scarce and marketable(have value)

• example- clothing, phone

private good

• good enjoyed exclusively by a single individual

• example- personal computer, phone

public good

• good that is publicly owned. they are non appropriability/ non-excludability therefore they are equally available to all

  • non appropriability- can’t be exclusively owned or controlled by a single individual or firm

  • non excludability- no feasible way of excluding anyone from gaining the benefits of a public good.

• public goods are made available; they are equally available to everyone. so if one individual uses it/consumes it it does not reduce its availability to others

•  public good is non rivalry and non excludability character of consumption.

• example- public transprt, public park, public health

giffen goods

• non luxury goods needed for survival therefore they generate higher demand when prices rise as other alternatives cant be bought due to lack of income

  • if price rise, demand rises cause other alternatives cant be bought and they are needed for survival creating an upward sloping demand curve

• example- bread, rice

luxury good

• good for which demand increases more than what is proportional as income rises so that expenditures on the good become a more significant proportion of overall spending

  • That means luxury goods take up a larger share of a person’s spending when they get richer.

• example- jewerly, luxury vehicles

NECESSITY GOOD or a necessary good

• type of normal good

• consumers will buy regardless of the changes in their income levels, therefore making these products less sensitive to income change.

  • example- food, clothing

• If people's income falls, then they will buy less of these goods. And, if the prices of these goods rise, people will buy less of them.

conspicuous consumption

when people buy expensive goods or services mainly to show off their wealth or social status, rather than for practical needs.

Merit goods 

• goods or services that are considered to be beneficial to individuals and society as a whole, but are often under-consumed in a free market economy. 

  • have positive effects on health, education, or the environment, but are not consumed in optimal quantities

• goods for which the social benefits of consumption outweigh private benefits

  • example- education, healthcare, renewable energy

The classification of merit and demerit goods is based on value judgments.

•  idea of merit good was coined by economist Richard Musgrave in the 1950s- He defined merit goods as commodities that individuals and society should be able to benefit from, regardless of their willingness and ability to pay.

private benefit

direct advantage or gain an individual or business gets- personal benefit

positive externalities 

• goods or services that provide benefits to third parties who aren’t directly involved in the economic transaction.

• In the free market economy, the positive externalities of merit goods often go unnoticed, so consumption and production are under the socially optimal level.

socially optimal level

private and social benefits are maximized while cost to maximize them are balanced

 privately optimal level 

amount of good or service that maximize private benefit based on their own costs

PRODUCTS (goods and services)

• Products are the outcome of all production activity. 

• products are either tangible(goods) or intangible (services)

  • Final Goods and Services are consumed by the ultimate user, the consumer.

• Goods- are also classified by their expected life time:

  • durable goods- have a long life. example- furniture, equipment

  • semi-durable goods- which have a short life-time. example- clothing, shoes, bags

  • non-durable goods- which disappear at the moment of consumption. example- food and drinks

• Services- are products of intangible nature

  • banking, entertainment, insurance

Intermediate Goods and Services

• products destined for further processing or assemble before their sale to the final consumer. 

MARKET CONCEPT:

refers to the idea that a market is a system where buyers and sellers interact to exchange goods and services

• buyers- consumers who purchase goods and services, and firms who buy labour, capital and raw material that are used to produce goods and services

• sellers- firms which sell their goods and services; workers who sell their labour services; and resource owners who rent land or sell resources to firms

market

organization in which buyers and sellers come into close contact. its function is to enable an exchange of goods and services to take place

• interaction of buyers and sellers in a free competitive system is a result of price

  • in a free market the interaction between buyers and sellers is dependent on price which is determined by market clearing price which is price when supply=demand

RESOURCES

• means of producing goods and services that will satisfy human wants.

• Resources possess the following characteristics:

  • They are limited in supply in relation to the quantity of them needed.

  • They are versatile – i.e. can be put to different uses

  • They can be combined in varying proportions to produce output. To produce the same output different proportion of resources can be used, one combination can be more labour intensive while another is capital intensive.

    The resource of the economy can be grouped under four broad categories:

    • Land: All free gift of nature.- agricultural land, commercial real estate, resources available from a particular piece of land.

    • Labor: Human, mental and physical effort in production.

      • refers to the effort expended by an individual to bring a product or service to the market. 

      • Within the software industry, labor refers to the work done by project managers and developers in building the final product.

      • for early political economists, labor was the primary driver of economic value.

    • Capital: Man made goods used in further production.

      • money is not a factor of production because it is not directly involved in producing. Instead, it facilitates the processes used in production by enabling entrepreneurs and company owners to purchase capital goods or land or to pay wages.

      • for modern mainstream economists, capital is the primary driver of value.

    • Entrepreneurship: The organizer of the production

      • combines all the other factors of production into a product or service for the consumer market.

the physiocrats

French economists who predated the classical political economists, land was responsible for generating economic value.

THE ECONOMY

• way, manner, place and environment in which economic activities take place 

  • also called the economic system

• includes the set of organizational arrangements and institutions that are established to solve the economic problems.

WANTS

• economic goods desired by human beings to improve their welfare

• characteristics of human wants:

  • various and varied

  • human wants are insatiable

• More wants are generated in the process of satisfying existing ones.

SCARCITY

• means limited in supply

• demand exceeds supply

• it means that people may not have enough factors of production to satisfy all their needs and not that the factors are not available at all.

choice

• Because resources are scarce, choice has to be made. The choice of what will be done and what will be left undone.

• the decision to have more of one thing implies the decision to have less of

  something else.

• decision making process when selecting among many alternatives

SCALE OF PREFERENCE

• ranking or ordering or arrangement of the things we need in order of priority or importance to us 

• Because we have to make choice, there is need to arrange the things we need in order of priority to us.This represents an ordering or ranking of our needs.

• essence of scale of preference is to ensure that we attend to our needs in order of our priority.

OPPORTUNITY COST:

• value of the next best alternative that is forgone when a choice is made

• If we choose more of one thing then we must have less of another. What we left is the opportunity cost of what we chose.

• concept of opportunity cost emphasizes the problem of choice by measuring the cost of obtaining a quantity of one commodity in terms of the quantity of other commodities that could have been obtained instead.

PRODUCTION

• process of transforming raw and semi-finished material resources into products with the aid of human resources, capital goods and technology.

• Production is an all-encompassing activity which includes extraction, primary production, processing, manufacturing, assembly, construction, communication, transportation, storage, distribution, and marketing, financing and servicing.

  • These are stages through which the transformation process traverses before the product is placed at the disposal of the consumer.

WEALTH AND WELFARE:

• nation’s wealth consists of its stock and services

• Welfare refers to the satisfaction that the individual or society derives from wealth.

STOCKS AND FLOWS

• stocks refers to the resources that are available at a particular moment

  • example- capital

• flow measure relates to an amount during a specified interval, or period of time.

  • processes or values occurring during a period of time

  • example- gdp

TECHNOLOGY

•  application of knowledge in human activity such as work, distribution, exchange, consumption which results in rendering an activity more efficient.

  • reduces the amount of inputs required to produce a unit of output and simultaneously improves the quality and usefulness of the output.

WHY ECONOMISTS DISAGREE

• They might make different value judgements.

  • when economists agree on the facts, they may differ because they have different views about what ought to be.

•  might not agree on the facts

  • there can be uncertainty about actual performance of economy at a particular time

• might be biased

  • They might be forced to reach conclusions that serve the interests of their employers.

• might hold different views about how the economy operates.

• might have different time perspectives. 

  • Some economists may be more concerned with short-term prospects while others might tend to focus on the long-run.

THE STRUCTURE OF A NATIONAL ECONOMY

• Four major sectors plus its interaction with foreign economies called foreign sector

  • household

  • firms(producers)

  • Financial sector

  • Government

  • foreign sector

household

• Consists of the entire population of the country as they are arranged into micro units (individuals or families)

FIRMS (PRODUCERS)

• organizational units set up and managed by households whose sole objective is to acquire and transform raw resources into finished goods which are then sold to consumer of other firms for a profit. 

incorporated business

• business that has a separate legal identity from its owners therefore they have continuity and liability is limited to the amount they invested

unincorporated business

• business that does not have a separate legal identity from its owners therefore have no continuity and unlimited liability so owners are personally liable for their debts

FINANCIAL SECTOR

• include all non-industrial firms whose sole purpose is financial intermediation and financial services (deposits, lending, payments and investment services). 

• example- banks, investment bankers, trust companies

GOVERNMENT:

• three broad areas of activity:

  • Care Taking: This includes overall administration and coordination, provision of justice, national defence, foreign relation;

  • Provision of Services: includes public health, public education, police and fire protection, public roads, parks, facilities; transportation and communication services;

  • Social Protection: This includes old age pensions, unemployment insurance, welfare payment and family allowances.

• it is financed in through taxes- two types of taxes

  • Direct Taxes: Individual income tax, Corporation income tax, Capital gains tax.

  • Indirect Taxes: Value Added Tax (VAT), Goods and Services tax, Excise tax, Import duties, Property taxes.

FOREIGN SECTOR

• includes all economic agents outside a country's borders, engaging in trade, investment, and financial transactions with domestic entities. It plays a crucial role in the economy through exports, imports, and foreign investments.

economic system

• nature of life as a whole with a particular reference to the ownership and use of resources. 

economic system performs the following functions:

• determines what should be produce and in what amount

• decide on the technique of producing the selected commodities 

• for whom to produce?

• makes provision for the maintenance and possible expansion of production

  capacity

THE SUBSISTENCE ECONOMY

• each family produces everything it consumes

• each village produces everything that it consumes. 

THE SOCIAL ECONOMY – PLANNED ECONOMY

• is that means of production are government property. 

• resources are owned and controlled by the government they decide what should be produced, when, how and for who to produce

  • While production is controlled, consumers and workers are left relatively free. and consumers are free to soend as much as they wish but they can only choose among the goods government decided to supply

Advantages of a social economy(planned economy):

• Distribution of wealth and income: There is a greater equality in the

  distribution of wealth and income in social economy. 

• Provision of public and merit goods: Since production is not undertaken for

  profit purposes, there is greater likelihood of the provision of both public

  goods and merit goods

• Prevention of demerit goods: The production and consumption of demerit goods can be prevented.

• Relatively stable economies: The social economies are generally stable

  because economic management is entirely in the hands of the government

Disadvantages of a social economy(planned economy)

• Reduction of consumer sovereignty:The state decides what is to be produced, and consumers hardly influence production

• Inefficiency: less incentive to increase efficiency due to the absence

  of profit motive.

• Absence of competition:

• Bureaucratic structures: There are bureaucratic structures in social economy

  which result into inefficiency.

THE MARKET ECONOMY (FREE ENTERPRISE/LAISSEZ-FAIRE)

• productive resources are privately owned and economic decisions are highly decentralized

• resources are owned and controlled by various private individuals

Characteristics of the Market Economy(free market)

• Limited role of the state: The market economy is not planned, controlled, or

  regulated by the government.

• Use of price mechanism:there is reliance on price mechanism to allocate resources.

• The right to own and dispose off private property:

• The existence of the profit motive:entrepreneurs are often guided by profit motive. Entrepreneurs produce what often give them greatest profit.

invisible hand

• way individual decisions made in self interest result in overall efficient outcomes for the market

THE MIXED ECONOMY

• All economic systems are a mixture of traditional behavior, central control

  and market determination.

• private property, private initiative, self-interest and the market mechanism all play an important role. However, it is also characterized by a substantial degree of government intervention.

THEORY OF DEMAND

• quantity or amount of commodities consumers are willing and able to buy at a given price and in a stated period of time.

Effective demand

willingness to buy backed by the ability to pay.

Wants

unlimited desire or wishes that people have for goods and services

TYPES OF DEMAND

• Joint / Complementary Demand

• Derived Demand:

• Composite Demand:

• Competitive Demand:

Joint / Complementary Demand

•  When two or more commodities are jointly demanded.

  • toothbrush and toothpaste

Derived Demand

• Things demanded not for direct consumption but for what they can help to produce.

Composite Demand

•  Demand for a commodity that can be used for more than one purpose.

Competitive Demand

•  Demand for goods which are fairly close substitutes for one another.

DEMAND SCHEDULE

tabular indication of quantity demanded at different prices.

• shows the amount of a commodity that will be demanded at various prices in the same state of demand.

INDIVIDUAL DEMAND SCHEDULE

it shows the quantity demanded by a particular individual at different prices

MARKET DEMAND SCHEDULE

tabular indication of the quantity demanded by everybody who demands that commodity at different prices during a given time. 

DEMAND CURVE

• graphical representation of the quantity demanded at difference prices.

• The demand curve shows the relationship between quantity demanded of a good and its price

• drawn on the assumption that the quantity demanded depends on the price of the commodity

ceteris paribus

• the assumption that all other variables remain constant while analyzing the effect of one variable.

MARKET DEMAND CURVE

• horizontal summation of the demand curve of everybody who purchases that commodity

• can also be got by adding the quantities demanded of the commodity as in market demand schedule and plotting a graph of this sum with the prices.

THE LAW OF DEMAND

• quantity of a commodity demanded decreases when its price rises and increase when its price falls, ceteris paribus.

  • When price goes down, demand goes up. When price goes up, demand goes down, ceteris paribus

MAJOR CAUSES OF DOWNWARD SLOPING (negative slope) DEMAND CURVE

1. Law of Diminishing Marginal Utility

   1. the more units consumed the less additional satisfaction is gained

2.  Price Effect

   1. the demand curve slopes downward when consumers consume more or less of the commodity.

3.  Income Effect

   1. When the price of a commodity decreases, the real income of the consumer increases.  On the contrary, When the price of a commodity increases, the real income of the consumer decreases.

   2. a fall in price, the consumer will buy more units of that commodity and also spend a portion of income in buying other commodities.

4. Income Group

   1. Ordinary people buy more when the price of the commodity falls whereas they buy less when the price rises.

5. Different Uses of Certain Goods

   1. With the increase in the price of such goods, they will be used only for more important uses and accordingly the demand for such goods will fall. 

   2. Some goods have multiple uses. When the price is high, people use them only for the most important purposes, so demand is low. When the price drops, people start using them for other purposes too, so demand increases. This helps explain why the demand curve slopes downward.

6. Substitution Effect

   1. a fall in the price of the commodity, and the price of its substitutes remaining the same, the consumer will buy more units of that commodity. As a result, demand will increase

   2. a rise in the price of the commodity, and the price of its substitutes

      remaining the same, the consumer will buy fewer units of that commodity. As a result, demand will decrease.

7. Tendency To Satisfy Unsatisfied Wants.

   1. when the price of goods, falls, the consumer will buy more of that commodity as he wants to satisfy his unsatisfied wants.

diminishing marginal utility

the principle stating that as a person consumes more units of a good or service, the additional satisfaction or utility gained from each additional unit decreases.

EXCEPTIONS TO THE LAW OF DEMAND

• situations where demand does not decrease as price increases, such as Giffen goods or Veblen goods.

price elasticity of demand

how sensitive quantity demand is when price chnages

veblen goods

are luxury items for which demand increases as the price rises, due to their status symbol appeal.

conspicuous consumption

purchasing a good to show off status and wealth

experience goods

goods thst cant be fully evaluated until it has been experienced or consumed

responsiveness to price changes of ordinary goods

• normal goods

  • elasticity is greater than 0- means that when income increases, demand also increases

• luxury good

  • elasticity >1 - means that demand changes a lot when price changes

    • elastic

• necessary goods

  • elasticity <1- means that demand changes a little with price changes.

    • inelastic

normal goods

• one which demand increases when income increases

responsiveness to price changes of inferior goods and giffen goods

• inferior good & giffen good

  • elasticity is less than 0- means that demand decreases when income increases

inferior good

one which consumers are no longer interested in once their income increases as they can buy better alternatives

three necessary preconditions for a (upsloping)positive slope demand curve

• must be an inferior good

• must be a lack of close substitutes

• good must constitute a substantial percentage of the buyer's income, but

  not such a substantial percentage of the buyer's income that none of the

  associated normal goods are consumed.

  • basically the good must be important in the budget but not so important that normal goods are not purchased.

additional causes for a positive slope demand curve

• When consumers expect a rise in the price of a durable commodity, they buy more of it despite its increase in price. They do so with a view to avoiding the pitch of high prices in the future.

• Similarly, when consumers anticipate a considerable decrease in the future, they postpone their purchases and wait for the price to fall to the expected level rather than to buy the commodity when its price initially falls.

FACTOR AFFECTING THE LAW OF DEMAND

• price of the product

•  price of related products:

  • Complements- goods that are used jointly.

  • Substitutes- goods which can be used instead of the good in question.

• income of the consumer

•  taste (or preference) of the consumer:

  • The higher the taste of that commodity, the higher the quantity demanded of him and vice versa.

• size of the household:

  • a bigger household will bur more than a household containing 2 people

CHANGES IN QUANTITY DEMANDED IN THE MARKET VERSUS CHANGE IN DEMAND

• Demand can vary in two possible ways

  1. Change in quantity demanded that is movement along same curve

  2. Change in demand which is shift on the demand curve.

• What decides which of the two that is being discussed are:

  • The price of the commodity (whether it changed or remained constant)

  • The number of demand curve(s) involved (whether it is only one curve involved or more the one).

CHANGE IN QUANTITY DEMANDED

• movement on the same demand curve. There is a change in price. Only one demand curve is involved.

• price is the determinant factor so demand changes due to changes in price

CHANGE IN DEMAND (SHIFT OF THE DEMAND CURVE)

• no change in price (1 price)

• More than one demand curve is involved due to a shift of the original curve.

• demand curve can shift outwards(to the right) to show an increase in the demand at the same price. 

change in demand occurs when a greater (for increase in demand) or smaller (for

decrease in demand) in quantity of commodity without any change in price

CHANGES IN DEMAND (DECREASE)

• demand curve can shift inwards(to the left) to show a decrease in the demand at the same price. 

REASONS FOR CHANGE IN DEMAND (A SHIFT OF THE DEMAND CURVE)

• change in the price of a related good- substitutes and complements

• change in the income of the consumer

  • increase in income will normally lead to increase in demand, vice versa

  • demand curve shifts upwards as income rises and downwards as income falls

• change in consumers’ taste or preferences

• change in population:

  • the larger the population the greater will be the demand for the product, and the smaller the population, the smaller the demand will be for the product

• change in expected future prices

• distribution of income

  • Redistributing income from rich to poor will likely increase demand bought by the lower income households and decrease demand from higher income households.

• Government policy

  • Taxation reduces demand while subsidization increases the demand.