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CHAPTER ONE

INTRODUCTION TO ECONOMICS

1. Definition and Scope of Economics

 The word ‘economy’ comes from the Greek word for ‘one who
manages a household’. Economy and households have much in common,
particularly in allocating the tasks of production and consumption (that is, the
production and distribution of goods to its members).

What is Economics?
There is no single definition for it. Generally, the definition of Economics can be
classified into three broad categories;

1. Adam Smith (1723 –1790)

“ Economics can be defined as an inquiry into the nature and causes of
the wealth of nations”
2. Alfred Marshall (1824-1924)
“Economics is the study of man’s actions in the ordinary business life, it
enquires how he gets income and how he uses it.”
3. Lionel Charles Robbins (1898-)
“ Economics is a science which studies human behaviour as a
relationship between ends and scarce means which have alternative
uses.”

The above list is not exhaustive. Perhaps the definition given by Paul
A.Samuelson can give us a compromising definition of Economics;

“ Economics is the study of how societies use scarce resources to

produce valuable commodities and distribute them among
different groups”
.
B) Divisions in Economics
The study of Economics is divided into two major areas; Microeconomics and
Macroeconomics.

 Economics is the study of how society manages its scarce

resources in order to satisfy its wants efficiently, that is, it is the study of how
society maximizes its welfare/utility given its resource constraint.

 Economics addresses the issues of:

o what goods and services to produce
o how to produce the goods and services (as fully)
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o how much of each goods and services to produce

o for whom to produce, that is, what share of these goods and services
to be given to each individual household.

These are the ‘what’, ‘how’, ‘how much’ and ‘for whom’ problems or the three
basic economic problems.

2. Scope of economics: Microeconomics and Macroeconomics

 Since the 1930s, the study of Economics have been divided into
Microeconomics and Macroeconomics.

 Microeconomics
‘ Micro’ comes from the Greek word meaning small. It studies the
behaviour of individual decision making units such as consumers,
resource owners and business firms. For example, how does an
individual household decide to spend its income? How does an
individual firm decide what volume of output to produce? How is the price
of an individual product be determined? How are wage levels determined
in a particular industry?

 Macroecomics

 Macroeconomics comes from the word ‘makros’ meaning large. It

focuses on the economy as a whole rather than on individual units. It is
concerned with aggregates e.g. unemployment rate, national output/income,
economic growth and economic cycles, inflation rate and governmental
intervention in the economic system (government policy measures). It deals
with how an economy grows. It analyses the chief determinants of economic
development and the various stages and processes of economic growth.

In other words, it is that part of Economics which is primarily concerned with
the study of relationships between broad economics aggregates, the most
important of which are nation income, aggregate saving and consumers’
expenditure, investment,aggregate employment, the quantity of money, the
average price level and the balance of payments. For example, what
economic policies a government can pursue to influence the condition of the
national economy. What is the total output of the agricultural sector in
Malaysia in the year 2000? What is the economic growth rate in this year?
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Comparison Between Microeconomics and Macroeconomics

Microeconomics Macroeconomics

Study smaller scope of economic activity. Study bigger scope of economic activity.

Examines the functioning of individual Focuses on the determinants of total

industries and behaviour of individual national output and aggregate decision
decision making units. making.

Deals with household income. Deals with the national income.

Focuses on the factors that influence the Focuses on the determinants of national
production of a particular product and the output.
behaviour of individual industries.

Analyses individual prices of goods and Analyses the general price level.
services.

Focuses on the specific units making up Concerns with an overview of the structure
the various aggregates. of the economy and the relationship among
the major aggregates which constitute the
economy.

3. Basic Economic Concepts- Scarcity, Choice and

Opportunity Cost
 Scarcity arises because the available economic resources
are insufficient to produce all the goods and services required to satisfy all
human wants. A want refers to man’s desire to possess/consume goods and
services. Man’s wants are unlimited, that is, his desire to possess/consume
goods and services are unlimited. The resources available in the world is
insufficient to produce all the goods and services to satisfy all of man’s
wants.

 Due to the insufficient resources available to satisfy all of

man’s wants, man need to make choices. In choosing to consume or
produce a certain good, society have to forego (give up) the consumption or
production of other goods. For example, if society wants to build more
hospitals, it will have to build less schools because there is insufficient
resources to build more of both hospitals and schools.
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 Each time society makes a choice, the consumption of

certain goods which will provide satisfaction is foregone. Opportunity cost
refers to the next best alternative foregone when making a choice.
It is defined as the amount of goods or services that need to be given up in
order to produce something else

 For example, if more hospitals are built, less schools can

be built. The opportunity cost of building hospitals is schools.

4. Basic Economic Problems

 Due to the scarcity of resources which arise because of
man’s unlimited wants, 4 basic economic problems arise. These are:
- What to produce
- How to produce
- How much to produce and
- For whom to produce

 What to produce: Economic resources have alternative uses, that is, they
can be used to produce different types of goods and services. However,
because there is insufficient resources to produce all the goods and services
that man wants, there is a need to decide what goods and services to
produce. The goods and services to be produced must be those that are
most desired by society, i.e. those goods and services which will provide
the maximum utility/satisfaction. For example, land can be used either to
grow vegetables, fruits, paddy, oil palm, rubber etc. Society need to decide
which crops are to be produced. If society thinks that paddy will provide the
maximum satisfaction, then it will decide to produce paddy with the land
available.

 The problem of what to produce is solved in different ways in different

economic systems. In a capitalist economy, this problem is solved through
price mechanism which reflects consumers’ preferences. Consumers
express their preference through the amount of money they are willing to
spend on different products. If they spend more on a product, demand would
go up which in turn would cause price to rise. The rising price acts as a
signal to the producer to produce more of the product. Price mechanism
works through the forces of supply and demand and decides how resources
are allocated in an economy.

 How to produce: The method of production must be the one that is

most efficient, i.e. it will result in the lowest cost. This means that the
method of production selected must take into account the available
technology, the availability of resources and the cost of the resources. In the
above example, society will choose the method of producing paddy which
involve the lowest cost.
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 How much to produce: How much of a good or

service to produce will be dependent on the amount desired to be
consumed by society. When more of a good or service is produced, less of
other goods or services can be produced since less resources will be
available for their production. Continuing the above example, society will
produce the quantity of paddy which it desires to consume.

 For whom to produce: Once a good have been

produced, there is the need to decide who shall get to consume the good.
This will be determined largely by the distribution of income in society. Goods
and services will be produced for and consumed by those who have the
ability and willingness to pay for them. The paddy that is produced will be
consumed by those consumers who have the money and are willing to pay
for it.