01

FUNDAMENTALS OF
ECONOMICS

PAGE 0
INTRODUCTION TO ECONOMICS
Economics is a social science which examines how people
choose to use scarce resources to satisfy their unlimited wants

Economics is defined as the study of the administration of

scarce resources and of the determinants of income and
employment – Keynesian

Economics is a social science that studies

 Human behavior between unlimited wants & limited resources with
their alternative uses
 How we can make best use of what we have in order to satisfy our
needs & wants

PAGE 1
BRANCHES OF ECONOMICS

Micro Economics Macro Economics

• Micro economics studies • The field of economics that

the behavior of individual studies the behavior of the
decision making units such aggregate economy.
as consumers, resource Macroeconomics examines
owners, and business firms economy-wide phenomena
such as changes in
unemployment, national
income, rate of growth,
gross domestic product,
inflation and price levels

PAGE 2
IMPORTANCE OF MICRO AND MACRO ECONOMICS

Micro Economics Macro Economics

 It explains the functioning of a free
enterprise economy
 It tells us how millions of individuals
take decisions about the allocation
of resources
 It explains how goods and services
are distributed
 It helps form policies that promote
efficient allocation of resources
 It helps determine how the prices of
goods and factors of production are
determined
 It helps explain the conditions of
efficiency in consumption,
distribution, and production
 It is helpful in understanding the
functioning of a complicated
economic system
 It gives a complete view of the
economy
 Helpful in the formulation of
economic policies
 Useful in regulating employment
and national income
 Assists in solving economic
problems
PAGE 3
SCARCITY AND CHOICES
 Scarcity means that people want more than is available
 Scarcity limits us both as individuals and as a society
 As individuals, limited income (and time and ability) keep us from
doing and having all that we might like
 As a society, limited resources (such as manpower, machinery, and
natural resources) fix a maximum on the amount of goods and
services that can be produced

PAGE 4
THREE ECONOMIC PROBLEMS

For Whom to
What to Produce? How to Produce?
Produce?
• The society has to • The society has to • Who gets to enjoy the
decide and determine determine who will benefits of economic
how much of each produce and what activities?
good they will make resources and • Is the distribution of
• Will we produce pizzas techniques they will income and wealth is
or shirts today, few use fair and equitable?
high quality shirts or • Who farms and who • How is the national
many cheap shirts? teaches? product divided among
• Or will we produce • Is electricity generated different household?
fewer consumer goods from oil, from coal or • Do high wages go to
and more investment from the sun? teachers or farmers?
goods? • Will factories be run by • Will society provide
people or robots? minimal consumption
• Will we use the labor to the poor? Or must
intensive or capital people work if they are
intensive technique? to eat?

PAGE 5
MARKET, COMMAND & MIXED ECONOMIES

Market Economy /
Capitalism / • A market economy is one in which
individuals and private firms make the major
Free Enterprise decisions about production and consumption
Economy
Command • A command economy is one in which the
Economy / government makes all important decisions
Socialism about production and distribution

• All societies are mixed economies with

Mixed Economy elements of market and command economy

PAGE 6
FACTORS OF PRODUCTION

Land

Management
Factors of Labor
Production

Capital

PAGE 7
POSITIVE VS NORMATIVE ECONOMICS
Positive economics studies economic behavior without making
judgments. It describes what exists and how it works. It is objective
and based on facts and explains “what is”
Example: Why do doctors earn more than janitors?
Although this is a difficult question to answer, it can be answered with
reference to evidences
Normative economics, also called policy economics, analyzes
outcomes of economic behavior, evaluates them as good or bad, and
may prescribe courses of action. It is based on opinions and explains
“what ought to be”
Example: Should the poor be made to work if they are to receive
government support
There are no right or wrong answers for such questions and can only
be resolved through debate

PAGE 8
ECONOMICS – AN ART OR SCIENCE
Economics is a positive science because:
 Economists collect the facts
 They analyze them and derive result
 They determine the relationship between facts and results
 They give a title to the relationship

Economics is normative science because:

 Economists points out different economic problems
 They analyze them in the light of statistics or facts and figures
 They advise policies, laws, theories to solve the problems

Economics is an art because:

 Economists suggest policies along with their implementation
procedures to solve the economic problem
PAGE 9
ECONOMICS – AN ART OR SCIENCE (CONT.)
Economics is an applied science because:
 It is typically characterized by the application of the core, i.e.
economic theory and econometrics, to address practical issues in a
range of fields including demographic economics, labor
economics, agricultural economics, development
economics, education economics, monetary economics, public
economics

Economics is a social science because:

 It is the study of human behavior
 It analyzes the behavior of humans and predicts possible outcomes
to situations

PAGE 10
PRODUCTION POSSIBILITY FRONTIER (PPF)
The PPF shows the maximum amounts of production that can be
obtained by an economy, given its technological knowledge and
quantity of inputs available
 Because of the scarcity of resources, there is always a limit to how
much can be produced in the country
 For example, if a country produces only guns and butter, there will
be a maximum quantity of guns that can be produced
 In order to increase the production of butter, the country will have to
reduce the number of guns being produced

PAGE 11
ALTERNATIVE PRODUCTION POSSIBILITIES
 In the example below, it can be seen that if a country is producing
12 thousand guns, it can only produce 2 millions pounds of butter
 In order to increase the production of guns to 14 thousand, the
quantity of butter being produced will have to be reduced to 1 million
pounds

Possibilities Butter (millions of Guns (thousands)

pounds)
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0

PAGE 12
PPF CURVE
 A country can only produce on
a point that lies on the PPF
curve
 Any point inside the curve
signifies that the country is not
utilizing all of its resources
 A country cannot produce at a
point outside the curve as the
curve shows the maximum
limits of production

PAGE 13
SHIFTS IN THE PPF
 Economic growth shifts the PPF curve outwards which shows that
the country can now produce more goods
 Developing and under developed countries usually spend more on
basic necessities and less of luxury goods
 However, as the economy develops, the basic needs of the
economy are fulfilled and the country thus begins to spend more on
luxury goods

PAGE 14
INVESTMENT FOR THE FUTURE
 In order to shift the PPF curve outwards, the country will have to
invest today so that returns may be higher in the future
 Countries that invest more today will witness a greater shift in the
PPF thus enabling it to produce more goods and services in the
future

PAGE 15
OPPORTUNITY COST
If we have several options but are restricted to choose only one,
the opportunity cost is the cost of the next best alternative
forgone
Examples:
 Someone gives up going to see a movie to study for a test in order
to get a good grade. The opportunity cost is the cost of the movie
and the enjoyment of seeing it.
 When a student completes his BBA, he decided to do his MBA. The
opportunity cost of the MBA degree is the salary he gave up working
full time for the number of years he was in university
 For a farmer choosing to grow corn, the opportunity cost would be
any other crop he may have planted, like wheat or cotton

PAGE 16