1.1 Introduction 1.2 Economics Defined 1.3 The Scope of Economics 1.4 Scarcity, Choices & Opportunity cost 1.5 Basic Economic Problems 1.6 Production Possibility Frontier (PPF) 1.6 Economic System CHAPTER OUTLINE
WHY STUDY ECONOMICS?
To learn a way of thinking
To understand the society
To understand global affairs
To be an informed voter
1.2 ECONOMIC DEFINED Economics: a) K.E. Case and R. C. Fair view that economics is a study of how people use their limited resources to try to fulfill unlimited wants and involves alternatives or choices. b) David N. Hyman defined economics as a study of how scarce resources are allocated among alternative uses c) Economics is a science that studies human behavior as a relationship between ends and scarce , which have alternative uses, according to L. Robbins
1.3 THE SCOPE OF ECONOMICS
Microeconomics deals with individual units; a household, a firm and an industry. Studies the interrelationship between these units to determine the pattern of distribution of goods and services.
Macroeconomics looks at the economy as a whole. Its deal with the economic behavior of aggregates; national output, overall price level, inflation, unemployment.
Scarcity : The core problem Choice Opportunity cost Danny has RM5 and he would like to buy two things; a book and a pen which cost RM5 each (unlimited wants and limited resources). Danny has to choose either to purchase book or a pen which would satisfy his needs (choices) . If Danny choose the book, then the pen is the opportunity cost . 1.4 SCARCITY, CHOICES AND OPPORTUNITY COST
Human wants are always greater than the available resources.
Society has limited (scarce) resources (factors of production), and therefore cannot produce all the goods and services people wish to have .
Economist has classified the factors of production into four groups namely Labour, Capital, Land and Entreprenuer.
Consists of the mental process of thinking involved with the process of judging the merits of multiple options and selecting one of them from action.
Choice involves sacrifice.
Economists use the term of opportunity cost to emphasize that making choices in the face of scarcity implies a cost.
The opportunity cost of any action is the second best alternatives that has to forgo for another choice which gives more satisfaction.
The higher the opportunity cost, the less likely to do it.
What to Produce
- Type of goods and services
How to Produce
- Method of production
For Whom to Produce (Distribution Theory)
- Distribution of income
1.5 BASIC ECONOMIC PROBLEMS
1.6 PRODUCTION POSSIBILITIES FRONTIER (PPF)
The curve that shows all of the possible combinations of 2 goods (products) or services that can be produced within a specified time with all its resources fully and efficiently employed.
The economy can produce at any combination on or inside the curve (C and H). Point outside the curve is not attainable (F).
Assumptions for PPF
Production Possibilities: Inside , On , or Outside the Frontier
Point on the curve (C): Attainable and Efficient because all resources are fully and efficiently employed.
Point inside the curve (H): Attainable and Inefficient because resources are not fully and efficiently employed.
Point outside the curve (F): Unattainable because of limited resources.
Production Possibilities Frontier (PPF)
Butter (thousand kg) Sewing machines (thousands units)
Attainable Unattainable 0 1 2 3 4 5
Point A, B, C, D, E and F is attainable and efficient
Point Y is attainable and inefficient
Point Z is unattainable
Movement along the PPF represent the opportunity cost
That mean increase in producing a particular product can only possible with reduce production of another product.
Calculating the Opportunity Cost
Table 1.2: Opportunity Cost (per bushels of extra wheat per year)
The opportunity cost from point A to B, B to C, C to D and D to E are increasing, implying the law of increasing opportunity cost.
It also represented in the increasing steepness of the slope and the concave shape of PPF.
End Point on PPF Opportunity cost (bushels of corn) A to B (700 – 650) / (200 – 100) = 0.50 B to C (650 – 510) / (380 – 200) = 0.78 C to D (510 – 400) / (500 – 380) = 0.92 D to E (400 – 300) / (550 – 500) = 2.00
Shifts in the Economy’s Production Possibilities Frontier
The shape of PPF depends on the opportunity costs :
Increasing opportunity cost (PPF is concave)
Constant opportunity cost ( PPF is linear)
Decreasing opportunity cost (PPF is convex)
The Shape of PPF
Increasing Opportunity Cost (PPF is concave)
As we move along the production possibility curve with increasing computer, more and more food must be forgone
INCREASING OPPORTUNITY COST : Q to R = [(11 – 10)/(6 – 5)] = 1 T to V = [(8 – 5) /(10 – 9)] = 3
Constant Opportunity Cost
(PPF is linear):
Computer - As we move along the production possibility curve with increasing computer, constant unit of food must be forgone 0 5 10 15 20 30 20 15 10 5 PPF A B Food C D CONSTANT OPPORTUNITY COST : A to B = [(20 – 15)/(10 – 5)] = 1 C to D = [(10 – 5) /(20 – 150)] = 1
Decreasing Opportunity Cost
(PPF is convex):
Computer -As we move along the production possibility curve with increasing computer, less and less food must be forgone 0 PPF 15 10 7 2 10 30 B A Food C DECREASING OPPORTUNITY COST : A to B = [(15 – 10)/(10 – 2)] = 0.625 C to C = [(10 – 7) /(30 – 10)] = 0.15
1.7 ECONOMIC SYSTEMS Free Market Economy Mixed Economy Planned Economy ECONOMIC SYSTEMS
Economic Systems Free Market Economy Planned Economy Mixed Economy
Private ownership of
enterprise and choice
Public ownership of
Price mechanism of
Central control and
Public and private ownership of resources
Price mechanism and economic plans
Selective government intervention
Government control of monopolies
Refresh Your Mind!!!
Figure 1 illustrated the Production Possibility Frontier (PPF) for the allocation of resources in Malaysian banking sector. Assumed that the Malaysian banking sector only consist of two types of banking product/services that are the conventional banking and Islamic banking. Example of PPF analysis
Example of PPF analysis End Point on PPF Opportunity cost (Ringgit of conventional outputs per one Ringgit of Islamic banking output) (i) A to B (ii) B to C (iii) C to D
Scenario A : Malaysian is currently producing at Point B. The government is encouraging the development of Islamic banking , thus, advising all the banks in Malaysia to divert more resources to Islamic banking from conventional banking. If all the banks follow the government’s advice, sketch a PPF diagram to illustrate this scenario. Mark a possible new production combination (point) as “E”. Give your explanation.
Scenario B : The government successfully invites foreign Islamic banks to invest in Malaysia by opening branches here. What happen to the PPF? Mark a new possible production point as “F”. Give your explanation.