LECTURE NUMBER 1 & 2 : ECONOMICS AND IT’s FOUNDATIONS

Economics :
× Economics is a social science concerned with the production, distribution and
consumption of goods and services.
× Economics is about the allocation of resources available to fulfill people's needs and
wants for goods and services.
× Economics is the study of how people allocate their limited resources (income and time)
to satisfy their unlimited wants and how firms use limited resources (raw materials) to
meet consumer demand.

× Economics is about making choices.

Economics is the study of how people seek to satisfy their needs and wants by making choices. It
is important because it allows people and businesses to make smart decisions in the economy.

Examples :
 The management of financial matters for a community, business or family.
 Like Stock Market.

The fundamental concepts on which economic models (decision-making) are based:

1. Incentives :

× Economic incentives are the things that motivate you to engage in certain
behavior because they are the path towards achieving your preferences, such as
wealth or social status.

× In economics are the benefits that motivate a decision maker in favor of a

particular choice.

× Incentives are factors that motivate people to act.

2. Trade-Off :

× In economics, the term trade-off is often expressed as an opportunity cost, which

is the most preferred possible alternative.

× Daily life example: you have to choose between either eating a burger or a
sandwich for lunch.

× If you decided to eat the burger, then you have made a trade off, and the sandwich
in this case is your opportunity cost.
 o Opportunity Cost :
It is the opportunity cost, also known as alternative cost while making a
decision.

o Marginal thinking :
 In economics, the term marginal is used to indicate the change in some benefit or
cost when an additional unit is produced.
 Marginal thinking is at the heart of economic thinking.

o Trade creates value :

 Trade is the voluntary exchange of goods and services. People engaging in
trade must be willing to bear a cost (give up something). Therefore, we
know that people will only participate voluntarily when they expect to
gain from the exchange. If even one of the trading partners believes he
cannot gain, the exchange will not take place.
 When people buy something, they value it more than it costs them; when
people sell something, they value it less than the payment they receive.
When individuals engage in voluntary exchange, both parties are made
better off. It is a positive sum game. By channeling goods and resources to
those who value them most, trade creates value and increases wealth
created by the society’s resources.

How People Make Decisions :

Principle 1: People face trade-offs
Making decisions requires trading off one item against another. In economics, the term trade-
off is often expressed as an opportunity cost, which is the most preferred possible alternative.
A trade-off involves a sacrifice that must be made to get a certain product or experience.

Production Possibilities Frontier : Model

A model is a simplified representation of a real situation that is used to better understand real-life
situations. Models allow economists to see the effects of only one change at a time.
 In production, we would like to have productive efficiency – achieving as much output as
possible from a given amount of inputs or resources.
A production possibilities graph shows alternative ways that an economy can use its resources.
Efficiency means using resources in such a way as to maximize the production of goods and
services. Growth If more resources become available, or if technology improves, an economy
can increase its level of output and grow. When this happens, the entire production possibilities
curve “shifts to the right.”
Scarcity : - Choice between producing 2 goods
A resource is considered scarce when there is not enough to satisfy everyone’s wants at a zero
price.
The production possibilities model is the comparison between two goods that a nation can
produce - either guns or butter - and it must choose between these two goods. The production
possibilities model is a visual model of scarcity and efficiency. It simplifies the concept of how
an economy can produce things using only two goods as an example. It's going to show us all the
production possibilities we have between these two goods. It takes the concept of opportunity
cost, which we already explored, and helps us make the best economic decision we can make,
which is to say, the most efficient decision.
The maximum combinations of goods and services that can be produced.

The production possibility frontier (PPF) is a curve depicting all maximum

output possibilities for two goods or services an economy can achieve when all resources
are fully and efficiently employed. The PPF indicates the production possibilities of two
commodities when resources are fixed. This means that the production of one commodity
can only increase when the production of the other commodity is reduced, due to the
availability of resources. A production possibility frontier shows how much an economy
can produce given existing resources.

For Example :

A country produces pizza and sugar. If the country decides to ramp up its sugar
production, using the existing fixed resources, it has to lower its pizza production. Hence,
at points A, B, and C, the economy achieves the maximum production possibilities
between pizza and sugar. Point D is inside the PPF line and is inefficient because all the
resources are not being used properly. Point E is simply beyond the amount of production
attainable with the current level of resources.
Hence, the production of one good or service increases when the production of the other good or
service decreases. The PPF measures the efficiency in which the two goods or services are
produced together. Typically, opportunity cost occurs when a manager chooses between two
alternative ways of allocating business resources. In other words, if one action is chosen, the
other action is foregone or given up. There is a trade off. Hence, the production possibility
frontier provides an accurate tool to illustrate the effects of making an economic choice. At any
given point of a PPF, the company produces at maximum efficiency by fully using its resources.
The PPF means a graphical representation of the possible production combinations a company
could produce if it used all of its resources to produce only two goods or services.

Factors Of Production Diagram :

Definition :

The production possibility curve indicates the combinations of any two goods or services that
are attainable when the society's resources are fully and efficiently employed. The production
possibility curve is also known as the production possibility frontier and is a very useful tool to
illustrate the economic problem of scarcity and choice.

Important things to notice about the definition of the production possibility curve are:

 It indicates all possible combinations of the production of two goods or services.

 It is assumed that all the resources of a society are used fully and efficiently.

It can be represented in a table and /or graphical format.

 A Production Possibilities Curve : P.P.C

× A production possibility curve measures the maximum combination of outputs

that can be achieved from a given number of inputs.

× It slopes downward from left to right.

× The production possibility curve not only represents the opportunity cost concept,
it also measures the opportunity cost.

× The curve is used to describe a society’s choice between two different goods.
× The P.P.C is used to measure the efficiency of a production system when two
products are being produced together. The graph shows the maximum number of
units that a company can produce if it uses all of its resources efficiently.
× This downward sloping line represents the trade off between producing product A
and product B. As the company diverts more resources to producing product B,
the production of product A will decrease.
 × One key assumption the PPC makes is that all resources for production are fixed.
This means that the output of product A can only increase if the output of product
B decreases. Another assumption is that technological advances and production
improvements are fixed.

× P.P.C is a graphical representation of the number of products a company can

produce if it uses all of its resources to produce two products.

× A production possibilities curve (PPC) is a curve that shows the maximum

amounts of two different goods or services that an economy can produce at a
given time. It is useful for a couple of reasons. First, it can illustrate the idea of
opportunity cost. Second, it can help us to understand the ideas of efficiency and
inefficiency in an economy as a whole.

Principle 2: Each decision has an opportunity cost

Opportunity cost is a key concept in economics, and has been described as expressing "the
basic relationship between scarcity and choice." Therefore, every decision involves trade-offs.
... Opportunity cost is the most desirable alternative given up as the result of a decision. It is
important because it creates opportunities and variation in the economy.

Principle 3: Rational people think at the margin

 Systematically and purposefully doing the best you can to achieve your objectives.
 Economists assume all people are rational.
 Firms want to produce the level of output that maximizes the profits.
 Generally, rational decisions are influenced by incentives, opportunity cost, and trade-
offs !

Principle 4: People respond to incentives

Marginal changes in costs or benefits motivate people to respond.

Best Example:
Seat belt laws. The direct effect is that the driver is more likely to survive an accident, so seat
belts save lives.

Principle 5: Trade can make everyone better off

Don't think of trade as having one side win and the other side lose. No one is forcing people to
trade, so both sides think they benefit. Trade involves competition.

Economic Paradigm :
× A paradigm is an intellectual framework consisting of a set of key questions to be
addressed.
× The basic way that an economy works.
× A new economic paradigm has emerged with the growth of e-commerce.
A basic principle that describes how an economy works.
 A paradigm is a logical framework consisting of a set of key questions to be addressed,
a set of core assumptions and a set of standard methodologies.
 The economic paradigm is widely accepted as the framework for understanding the
economy and for making economic decisions. For example, interest rate, investment,
inflation, unemployment etc.
 The ideas and concepts of the economic paradigm have major impact on public policy,
business and finance. For example, Causes and consequences of monetary policy, Fiscal
policy, trade policy.

Example :
The knowledge that the Earth is round is a paradigm.

Assumptions About Individual Economic Behavior

The set of assumptions that a firm will make about the upcoming economic situation. A firm will
often make assumptions about what the economic environment will be like during a certain time,
in order to predict how this will affect or influence an upcoming project or other plan.

Examples :
1. For each person, some goods are scarce -> choices
2. Each person desires many goods and goals -> tradeoffs
3. Each person is willing to give up some of one economic good to get more of another
economic good -> basis for trade
4. The more one has of a good, the lower is its personal marginal value -> diminishing
marginal value
5. Not all people have identical tastes and preferences
6. People are innovative and rational

Economics Systems :
Economists generally recognize four basic types of economic systems—traditional, command,
market, and mixed. Each of these kinds of economies answers the three basic economic
questions (What to produce, how to produce it, for whom to produce it) in different ways. An
economic system is a system of production, resource allocation and distribution of goods and
services within a society or a given geographic area.

1. Traditional Economies :
Traditional economy is an original economic system in which traditions, customs, and
beliefs help shape the goods and the services the economy produces, as well as the rules
 and manner of their distribution. Countries that use this type of economic system are
often rural and farm-based. An economic system that relies on customs and traditions
to make decisions. A traditional economic system focuses exclusively on goods and
services that are directly related to its beliefs, customs, and traditions. The oldest form of
an economic system is the traditional approach. It follows guidelines created by social
customs, religion and morals. Males and females work in occupations deemed suitable
for their gender. Sons tend to follow the occupations of their fathers. Resources are
allocated based on traditional criteria of age, sex and birthrights.

2. Command / Planned Economies :

The government controls the economy. The state decides how to use and distribute
resources. The classic (failed) example of a command economy was the communist
Soviet Union. The collapse of the communist bloc in the late 1980s led to the demise of
many command economies around the world; Cuba continues to hold on to its planned
economy even today. The most notable feature of a command economy is that a large
part of the economic system is controlled by a centralized power; often, a federal
government. In a command economic system, a large part of the economic system is
controlled by a centralized power. For example, in the USSR the central government
made most decisions. This type of economy was the core of the communist philosophy.
Since the government is such a central feature of the economy, it is often involved in
everything from planning to redistributing resources. A command economy is capable of
creating a healthy supply of its resources, and it rewards its people with affordable prices.
This capability also means that the government usually owns all the significant industries
like utilities, aviation, and railroad. In a command economy, it is theoretically possible
for the government to create enough jobs and provide goods and services at an affordable
rate. However, in reality, most command economies tend to focus on the most valuable
resources like oil. An economic system in which decisions are made by a strong
central power such as the government.
3. Market Economies :
Individuals choose how to invest their personal resources—what training to pursue, what
jobs to take, what goods or services to produce. In addition, individuals decide what to
consume. A market economy is very similar to a free market. The government does not
control vital resources, valuable goods or any other major segment of the economy. In
this way, organizations run by the people determine how the economy runs, how supply
is generated, what demands are necessary, etc….There is no government
intervention….In this type of economy, there is a separation of the government and the
market. This separation prevents the government from becoming too powerful and keeps
their interests aligned with that of the markets. An economic system in which individuals
are free to make decisions. An economic system that is a market based economy that
incorporates government involvement.
4. Mixed Economies :
All of Economic systems rely on a different set of assumptions and conditions. They all
have their own strengths and weaknesses. A mixed economic system combines elements
 of the market and command economy. Individuals make many economic decisions in the
market. However, the government also plays a role in the allocation and distribution of
resources. The United States today, like most advanced nations, is a mixed economy. A
mixed economic system (also known as a Dual Economy) is just as if it sounds (a
combination of economic systems), but it primarily refers to a mixture of a market and
command economy.

Goals of an Economy :
i. Economic Efficiency :

× Production of goods is at its lowest cost.

× The situation in which it is impossible to generate a larger welfare total from the
available resources. In other words, the situation where some people cannot be made
better off by reallocating the resources.
× Efficiency is concerned with the optimal production and distribution of these scarce
resources.
× This occurs when the maximum number of goods and services are produced with a
given amount of inputs. This will occur on the production possibility frontier.
× When every resource is optimally used and a change in production of one product
would affect the production of other products.

ii. Economic freedom :

Freedom from government intervention in the production and distribution of goods and
services. Economic freedom is the fundamental right of every human to control his or her
own labor and property. In an economically free society, individuals are free to work,
produce, consume, and invest in any way they please. In economically free societies,
governments allow labor, capital, and goods to move freely.

iii. Economic security and predictability :

Assurance that goods and services will be available, payments will be made on time.
Economic stability is the absence of excessive fluctuations in the macroeconomic.
An economy with constant output growth and low and stable inflation would be
considered economically stable. On the other side, An economy with frequent
large recessions, a pronounced business cycle, very high or variable inflation, or
frequent financial crises would be considered economically unstable.

iv. Safety Net :

Government programs that protect people during bad economic times. Actions by a
government to help companies and financial institutions with financial difficulties.

v. Economic Equity :

Equity or economic equality is the concept or idea of fairness in economics.

 The situation in an economy in which the apportionment of resources or goods among the
people is considered fair.

vi. Economic Growth And Innovation :

Innovation leads to economic growth, and economic growth leads to a higher standard of
living. Economic growth is usually brought about by technological innovation and
positive external forces.

In economic terms, innovation describes the development and application of ideas and
technologies that improve goods and services or make their production more efficient.

vii. Value Goals :

a. The full employment of factors of production.
b. Price stability and economic growth.
c. Societies pursue additional goals, such as environmental protection,
universal medical care, etc…

Branches Of Economics :
1. Microeconomics :

 It focuses on how individual consumers and producers make their decisions.

 This includes a single person, a household, a business or a governmental
organization.
 Microeconomics includes concepts such as supply and demand, price elasticity,
quantity demanded, and quantity supplied.
 It studies small-scale economies. That is, from the individual level on up to the
industry level.
 It usually addresses individual agents.
 The branch of economics that studies how households and businesses reach
decisions about purchasing, savings, setting prices, competition in business, etc. It
focuses at the individual level.
Examples :
× Market Failure.
× The demand for labor and other factors of production.
2. Macroeconomics :
 It studies the how overall economy works.
 This can include a distinct geographical region, a country, a continent or even the
whole world.
 It is the study of the performance and structure of the whole economy rather than
individual markets. Macroeconomics includes concepts such as inflation,
international trade, unemployment, and national consumption and production.
 It deals with the behavior of economies on a large scale.
 The branch studies large-scale economies.
  The branch of economics that studies the overall working of a national economy.
It is more focused on the big picture and analyzing things such as growth,
inflation, interest rates, unemployment, and taxes.

Examples :
Unemployment, interest rates, inflation, GDP, national products, demand, and production.

Economic Policies versus Public Policies :

Economic Policy’s:
• The effectiveness of economic policies can be assessed in one of two ways, known
as positive and normative economics.

Public Policy :
Public policy is the principled guide to action taken by the administrative executive branches of
the state with regard to ( a class of ) issues, in a manner consistent with law and institutional
customs. The foundation of public policy is composed of national constitutional laws and
regulations. Government actions and process Public policy making can be characterized as a
dynamic and complex in nature. Public policy making is a continuous process that has many
feedback loops. The public problems that influence public policy making can be of economic,
social, or political nature. The large set of actors in the public policy process, such as politicians,
civil servants, lobbyists, domain experts, and industry or sector representatives. Many actors can
be important in the public policy process, but government officials ultimately choose public
policy in response to the public issue or problem at hand.

Purposes :
Public policy is the means by which a government maintains order or addresses the needs of its
citizens through actions defined by its constitution.

Key Attributes Of Public Policy :

 The policy is made in response to some sort problem that requires attention.
 Ultimately, made by governments.
 Towards a goal or desired state.
 Policy is made on behalf of the "public."
 Policymaking is part of an ongoing process that does not always have a clear beginning
or end.
 No doubt, there are many problems in our communities that need to be solved.
 Policy making process is a part of politics and political action.
A good policy is one that solves problems without creating a political rift. Whenever it is
believed that it can solve a problem without one party disagreeing with its inception, it can go
forward without issue. This policy should solve a public problem without violating the legal
boundaries set down by federal, state, and local laws. It must encourage an active citizenry,
furthermore, as well as the democratic process. Public Policy Making is a Very Complex
Process; it involves many components, which are interconnected with each other’s.
 • Public authorities make up public policies.

Fig. Public Policy

Public policy is a set of objectives set by the government relating to the general health and
welfare of the public and actions taken to accomplish it. The public policy process is the
manner in which public policy is formed, implemented and evaluated. Public policy decisions
are primarily made to improve the health, safety and well-being of citizens, and may seat
standards for educational institutions, transportation operations and housing facilities.

Figure. Public Policy Making Process

Economic Policy :
The economic policy of governments covers the systems for setting levels of taxation,
government budgets, the money supply and interest rates as well as the labor market, national
ownership, and many other areas of government interventions into the economy. Economic
policies are typically implemented and administered by the government. Examples of economic
policies include decisions made about government spending and taxation, about the
redistribution of income from rich to poor, and about the supply of money. The effectiveness of
economic policies can be assessed in one of two ways, known
as positive and normative economics.
A government policy for maintaining economic growth and tax revenues
The actions taken by a government to influence its economy. Some examples of these actions
include setting tax rates, setting interest rates, and government expenditures. Such policies are
often influenced by international institutions like the International Monetary Fund or World
Bank.
• Economic policies are typically implemented and administered by the government and
are related to the behavior of economy.
• Examples of economic policies include decisions made about government spending and
taxation, about the redistribution of income from rich to poor, and about the supply of
money.

Key Objective :
One of the key objectives of the government’s economic policy is the prosperity and stability of
the economy.

Economists distinguish between the as follows’: Social Science

 Normative Statements :
 The normative economics is subjective and value based.
 Positive statements are verifiable statements.
 It is used to judge whether the economic events are desirable or not.
 Statements cannot be tested.
 It provides solution for the economic issue, based on value.

 Although people often disagree about positive statements, such disagreements can
ultimately be resolved through investigation.
Example :

The statement, "government should provide basic healthcare to all citizens" is a

normative economic statement.

 Positive Statements :
× Positive economics is objective and fact based.
 × It must be able to be tested and proved or disproved.
× These are the opinion based, so they cannot be proved or disproved.
× Positive statements are verifiable statements.
× Statements can be tested using scientific methods.
× It clearly describes economic issue.

Example :
An increase in the minimum wage increases unemployment among teenagers.

Goals Of Economic Policy :

 Economic Growth:

Economic growth is an increase in the capacity of an economy to produce goods and

services, compared from one period to another. Economic growth is an increase in the
production of goods and services over a specific period. Economic Growth refers to the
rise in the value of everything produced in the economy. It implies the yearly increase in
the country’s GDP or GNP, in percentage terms. Economic Growth is often contrasted
with Economic Development, which is defined as the increase in the economic wealth of
a country or a particular area, for the welfare of its residents.

 Full Employment:

Full employment is an economic situation in which all available labor resources are
being used in the most efficient way possible. The full employment is when the economy
is operating at an output level considered to be at full capacity.

 Price Stability :

Price stability in an economy means that the general price level in an economy does not
change much over time. In other words, prices neither go up or down; there is no
significant degree of inflation or deflation. ... Monetary policy can be used to try to keep
prices stable.

The monetary policy refers to the decisions that a government makes concerning interest
rates and the supply of money in an economy. Monetary policy can be used to try to keep
prices stable.