Introduction to Economics

INTRODUCTION TO ECONOMICS

ECON 1011
  • Institution: Addis Ababa University
  • Department: College of Business and Economics
  • Date: July, 2021

Chapter One: Basics of Economics

1.1 Definition of Economics

  • Origin of the word "Economics": Greek word "oeconomicus" meaning household management.
  • Lack of a universally accepted definition; definitions vary among economists.
1.1.1 Wealth Definition (Adam Smith)
  • Adam Smith (1723-90): Father of economics.
  • Key Work: "An Inquiry into the Nature and Causes of Wealth of Nations" (1776).
  • Concept: Economics as a science of wealth - studies production, distribution, consumption, and accumulation of wealth.
    • Objective: Increase the riches and power of a country.
    • Mechanism: Smithian 'invisible hand' (price system) guides production and distribution.
  • Critiques of Wealth Definition:
    • Too narrow, ignores societal issues; labeled as "bread-and-butter science."
    • Focus on material wealth ignores non-material aspects; promotes selfishness.
    • Lacks consideration of scarcity and choice (fundamental economic problems).
1.1.2 Welfare Definition (Alfred Marshall)
  • Alfred Marshall (1842-1924): Book "Principles of Economics" (1890).
  • Concept: Focused on human welfare rather than wealth.
  • Definition: Economics as the study of people's actions to achieve welfare; encompasses the ordinary business of life.
    • Wealth as a Means: Not an end; primary aim is human welfare.
    • Critiques:
    • Focus on material welfare, neglecting the non-material aspects.
    • Lack of clear link between economic activity and human welfare.
    • Normative perspective; economics should avoid value judgments.
1.1.3 Scarcity Definition (Lionel Robbins)
  • Lionel Robbins (1898-1984): Defined economics based on scarcity in his 1932 work.
  • Definition: Economics studies human behavior concerning ends and scarce means with alternative uses.
    • Highlights scarcity and its implications on opportunity cost and optimization.
    • Well-accepted as a positive definition, but criticized for neglecting wealth and welfare.
1.1.4 Growth Definition (Paul A. Samuelson)
  • Paul Samuelson (1915-2009): Defined economics emphasizing societal choices with scarce resources.
  • Concept: How societies allocate resources over time for future consumption.
  • Emphasis on macroeconomic aspects and the importance of cost-benefit analysis.
1.1.5 Commonly Accepted Definition
  • Definition: Economics is the social science studying the efficient allocation of scarce resources to satisfy human needs.
  • Implications:
    • Studies scarce resources and efficient allocation.
    • Addresses unlimited human needs and aims to meet these needs to maximum possible degree.

1.2 Rationales of Economics

  • Two fundamental facts:
    • Human material wants are unlimited and multiply.
    • Economic resources are limited (scarcity is a fundamental problem).
  • Scarcity leads to the economic problem of choice as limited resources cannot satisfy unlimited wants.
  • Key Focus: How individuals, families, and nations confront choices and the outcomes evaluated concerning efficiency, equity, and stability.

1.3 Scope and Method of Analysis

1.3.1 Scope of Economics
  • Rapid expansion, including various branches like development economics, industrial economics, etc.
  • Core divisions:
    • Microeconomics: Examines individual decision-making units such as households and firms.
    • Macroeconomics: Focuses on aggregate behavior in economies.
1.3.2 Method of Analysis: Positive and Normative Economics
  • Positive Economics: Analyzes facts without value judgments (e.g., inflation rates, unemployment).
  • Normative Economics: Questions on what the economy ought to be; subjective opinions cannot be definitively proven.
1.3.3 Inductive and Deductive Reasoning
  • Inductive Reasoning: Derives generalizations from specific observations through logical processes.
    • Steps: Problem selection, data collection/analysis.
  • Deductive Reasoning: Draws specific conclusions based on general axioms or premises.
    • Steps: Problem identification, specification of assumptions, formulation/testing hypotheses.

1.4 Scarcity, Choice, Opportunity Cost, and Production Possibilities Frontier (PPF/PPC)

A) Scarcity
  • Fundamental economic problem: unlimited wants vs. limited resources.
  • Scarcity necessitates choices; every choice involves an opportunity cost—the value of the next best alternative.
B) Opportunity Cost
  • Defined as the value of the next best alternative sacrificed to obtain another good.
C) The Production Possibilities Frontier (PPF/PPC)
  • Depicts various possible combinations of goods produced given resources and technology.
  • Reflects concepts of scarcity (only so much resource) and choice (trade-offs between products).
  • Law of Increasing Opportunity Cost: As production of one good increases, the opportunity cost of producing additional units rises, resulting in a concave PPF shape.
D) Economic Growth
  • Achieved through an increase in resource quantity/quality or advancements in technology, illustrated by shifts in the PPF.

1.5 Basic Economic Questions

  1. What to Produce? - Allocation of resources decisions.
  2. How to Produce? - Choices regarding production methods and techniques.
  3. For Whom to Produce? - Distribution of goods among consumers.

1.6 Economic Systems

  • Describes how societies answer basic economic questions through organizational arrangements, typically classified into:
    • Capitalism: Profit-driven, individual ownership.
    • Command Economy: Central planning and control.
    • Mixed Economy: Combination of private and governmental roles.
1.7 Decision Making Units and Circular Flow Model
  1. Households: Make decisions on selling resources and purchasing goods.
  2. Firms: Produce goods, making decisions about resource acquisition and product sales.
  3. Government: Controls economic activities via regulations and serves public goods.
  • Markets: Two types exist:
    • Product Market: Where goods/services are bought/sold.
    • Factor Market: Where resources (inputs) are transacted.

Key Diagrams: Circular flow model illustrating economic exchanges between households, firms, and government.

Chapter Two: Theory of Demand and Supply

2.1 Theory of Demand

  • Definition: Demand is the quantity of a good that buyers are willing and able to purchase at different prices.
    • Distinguished from mere desire.
  • Law of Demand: Inversely related between price and quantity demanded, ceteris paribus.
A) Demand Schedule, Curve, and Function
  • Demand Schedule: Tabular form showing relationship between price and quantity demanded.
  • Demand Curve: Graphical representation of the demand schedule.
  • Demand Function: Mathematical representation where price affects quantity demanded.
B) Market Demand
  • Calculated by horizontally summing individual demands across all consumers.
  • Formed through market demand schedule, curve, and function.
C) Determinants of Demand

Factors affecting demand include:

  1. Price of the Commodity: Changes lead to movements along the demand curve.
  2. Consumer Income: Changes in income affect demand depending on whether goods are normal or inferior.
  3. Prices of Related Goods: Influences through substitution and complementary goods.
  4. Tastes and Preferences: Altering consumer preferences affect demand.
  5. Future Price Expectations: Influence current demand based on anticipated price changes.
  6. Number of Buyers in Market: Population studies affect aggregate demand.
  7. Climate/Weather: Seasonal changes affect demand patterns for certain goods.

Changes in Demand vs. Quantity Demanded

  • Change in Demand: Shift in overall demand due to determinant changes other than the product price.
  • Change in Quantity Demanded: Movement along the same demand curve due to price changes.

2.1.3 Elasticity of Demand

  • Measure of responsiveness in demand to changes in its determinants, primarily price.
Types:
  1. Price Elasticity of Demand: Responsiveness of quantity demanded to price changes, calculated as a ratio of percentage changes.
  2. Income Elasticity of Demand: Responsiveness to income changes; determines whether goods are normal, inferior, or luxury.
  3. Cross Elasticity of Demand: Responsiveness to price changes in related goods - signifies substitute vs. complementary relationships.

Theory of Supply

2.2 Supply

  • Represents quantities sellers are willing to provide at different prices over a time period.
  • Law of Supply: Directly related: a price increase leads to increased supply.
Supply Schedule, Curve, and Function
  • Supply Schedule: Table depicting quantities supplied at various prices.
  • Supply Curve: Graphical representation showing the relationship between price and quantity supplied.
  • Supply Function: Mathematical expression showing reliance of quantity supplied on price.
Determinants of Supply

Factors that influence supply include:

  1. Input Prices: Increases cause supply decrease.
  2. State of Technology: Advancements can increase supply.
  3. Prices of Related Goods: Affecting transitions based on complementary/substitutable goods.
  4. Firm Objectives: Firms’ individual goals for production can influence supply.
  5. Weather Conditions: Impacts particularly on agriculture.
  6. Number of Sellers: Affects market supply.
Elasticity of Supply
  • Measure of responsiveness in supply to price changes, depending on various factors including production methods and time periods.

Supply and Demand Equilibrium

Market equilibrium occurs when demand equals supply.

Short-Run Market Dynamics
  1. Shifts in demand impact equilibrium price and quantity.
  2. Supply shifts similarly, affecting market conditions.
Quiz and Practical Applications
  • Students are given scenarios to determine market dynamics through derived equations and analyses.

Chapter Three: Theory of Consumer Behaviour

Consumer Preferences and Utility

1. Consumer Preferences
  • Choices reflect preferences between goods.
2. Utility Measurement
  • Utility describes satisfaction levels from goods.
3. Indifference Curves
  • Graphical representation facilitates understanding of consumer preferences in differing scenarios.

Chapter Four: Theory of Production and Cost

Production Concepts

  1. Production as a transformation of inputs into outputs.
  2. Relationships between total, average, and marginal products.
  3. Variable proportions and correlations across short-run production functions.
Cost Concepts
  1. Definition and types of cost (explicit vs. implicit).
  2. Total fixed cost and total variable cost dynamics.
  3. Average cost relationships, marginal cost calculus and implications.

Chapter Five: Market Structure

Types of Markets

  • Perfect Competition: Large number of firms selling identical products without influence over price.
  • Monopoly: Single firm controlling the market without substitutes.
  • Oligopoly: Few firms with market power, interdependencies exist among competitors.
  • Monopolistic Competition: Many sellers with differentiated products, combining features of monopoly and competition.
Key Market Dynamics
  • Transitioning between market types based on supply, demand, and competitive conditions.