1.1 WHAT IS ECONOMICS ?
- is a social science concerned with the production,
distribution, and consumption of goods and services. It
studies how individuals, businesses, governments, and
nations make choices about how to allocate resources.
- Economics focuses on the actions of human beings,
based on assumptions that humans act with rational
behaviour, seeking the most optimal level of benefit or
WHAT IS ECONOMICS ?
- is the proper allocation and efficient use if available resources
for maximum satisfaction of human wants. It is the study of how
we manage our scarce resources. It is concerned with
production, distribution and use of material goods and services,
and the study of human efforts to satisfy unlimited wants with
THE FATHER OF ECONOMICS
Adam Smith was an 18th-century Scottish
economist, philosopher, and author, and is
considered the father of modern economics.
Smith is most famous for his 1776 book, "The
Wealth of Nations."
Smith's ideas–the importance of free markets,
assembly-line production methods, and gross
domestic product (GDP)–formed the basis for
theories of classical economics.
ECONOMICS – is classified as a social science because it deals with the
study of man/s life and how he lives with other men. It is interdependent
with other sciences like sociology, geography, history, physics, and
SCARCITY – arises from the assumption of unlimited wants and desires
and the fact that resources to obtain goods and services are limited. It
implies that we cannot have all want we want. Hence, we need to
make the best use of scarce resources to satisfy our wants as much as
possible. Scarcity limits our options and forces us to make hard choices
which means that in order to get something we have to give up of
Nature of Economics
Production – simply means the process of transforming raw materials
(inputs) to a finished product (output). It brings about the creation or
addition of utility by getting things that give them pleasure and avoiding
the things that give them pain.
Distribution – refers to the physical apportion of goods and services from
the producers to the consumers or it is imply called as marketing
distribution of trade (barter)
Consumption – is the process of using goods and services in the direct
satisfaction of human wants. It is regarded as the most important function
in economics because it is the ultimate end of economic activity. Without
consumption there would be no need for production and distribution.
Exchange - is the transfer of ownership over goods and services from one
person to another. This is anchored on the use of money or credit. Activities
of buying and selling are involved.
Fundamental Economic Activities
Positive economics deals with what is or the scientific analysis of economic
behavior while normative economics deals with what should be or suggests
what ought to be.
Goods refer to things that are produced, traded, sold, bought, and utilized
which satisfy a person’s wants and desires. Goods are tangible when they are
in the form of material goods or commodities like shoes, books, umbrellas, etc.
They are intangible goods when they are in the form of services, rendered by
doctors, teachers, and others, which also satisfy human needs and wants.
Aside from services, copyrights, franchises, or patents are also intangible goods.
Goods may also be classified according to use. Consumer goods are
goods that are intended for final use by the consumer, like milk, soft drinks, and
food. Capital goods are goods that bare used in the creation or production of
other goods and services like building, machinery, and equipment.
Basic Terms in Economics
Essential or necessity goods are goods that are used to satisfy the basic
needs of man such as food, clothing, shelter, and medicine. Luxury goods
are goods that man may do without, but are used to contribute to his
comfort and well-being, such as chocolates, perfumes, expensive cars and
Durable goods are goods that last more than three (3) three years when
used on a regular basis. Non-durable goods are goods that last less than
three (3) years when used on a regular basis. Examples of durable goods
are appliances, vehicles and machineries. Non-durable goods include
food, medicine and clothing, among others.
Consumers are people who use goods and service. Services are the
efforts rendered by someone for a price such as haircuts, doctor’s visits, or
Value is an assignment of worth basically expressed in terms of price.
The assignment is usually based on the usefulness or scarcity of the item.
Wants are means of expressing a perceived need or desire for goods
and services. Such wants are unlimited and numerous. It does not mean
that we have the ability to pay for the goods and services desired.
Needs are basic requirements for survival like food, water, and
shelter. In recent tears we have seen a perceived shift of certain items
from wants to needs. Telephone service, motor vehicles and education
- it is the study of what is likely to happen (tendencies) when
individuals make choices in response to changes in incentives,
prices, resources, and/or methods of production. Individual actors
are often grouped into microeconomic subgroups, such as
buyers, sellers, and business owners. These groups create the supply
and demand for resources, using money and interest rates as a
pricing mechanism for coordination.
- Microeconomics studies the decisions of individuals and firms to
allocate resources of production, exchange, and consumption.
- Microeconomics deals with prices and production in single markets
and the interaction between different markets but leaves the study
of economy-wide aggregates to macroeconomics.
Theories of Microeconomics
Consumer demand theory relates preferences for the consumption
of both goods and services to the consumption expenditures;
ultimately, this relationship between preferences and consumption
expenditures is used to relate preferences to consumer demand
curve. The link between personal preferences, consumption and
the demand is one of the most closely studied relations in
economics. It is a way of analyzing how consumers may
achieve equilibrium between preferences and expenditures by
maximizing utility subject to consumer budget constraints.
Production theory is the study of production, or the economic
process of converting inputs into outputs. Production uses resources
to create a good or service that is suitable for use, gift-giving in a gift
economy, or exchange in a market economy. This can
include manufacturing, storing, shipping, and packaging. Some
economists define production broadly as all economic activity other
than consumption. They see every commercial activity other than
the final purchase as some form of production.
Cost-of-production theory of value states that the price of an object
or condition is determined by the sum of the cost of the resources
that went into making it. The cost can comprise any of the factors of
production (including land, labour and capital) and taxation.
Technology can be viewed either as a form of fixed (e.g.
an industrial plant) or circulating capital (e.g. intermediate goods).
In the mathematical model for the cost of production, the short-run
total cost is equal to fixed cost plus total variable cost. The fixed cost
refers to the cost that is incurred regardless of how much the firm
produces. The variable cost is a function of the quantity of an
object being produced.
Land includes all natural resources, including mineral deposits, water,
air, trees, poultry, livestock, and all other forms of these raw materials
used in production. Natural resources inputs have to be paid for by
firms upon using them in their production processes.
Labor is nay form of human effort like physical or mental, which is
exerted in the production of goods. The physical labor includes
those that extract raw materials and process these into finished
goods or capital goods, transport and sell finished products. The
mental labor includes the teachers, lawyers, doctors, nurses,
scientists and others who provide services.
and risk taker.
Factors of Production
Capital refers to the machinery, tools, equipment, and structures
used in the production of goods into finished goods or products.
Capital has to be produced and is valuable to firms because it
contributes to the generation of revenue. Financial capital
represents all the money received from or retained for use in
Entrepreneurship is the ability of an individual to provide the right
kind of good or service at the right place and time, to the right
people at the right price. A person who puts together or organizes
the other factors or production to generate goods and services
which can satisfy the needs of man is an entrepreneur. Innovative
and risk taker.
Opportunity cost is closely related to the idea of time constraints.
One can do only one thing at a time, which means that, inevitably,
one is always giving up other things. The opportunity cost of any
activity is the value of the next-best alternative thing one may have
done instead. Opportunity cost depends only on the value of the
next-best alternative. It doesn't matter whether one has five
alternatives or 5,000.
is the value of benefits foregone from alternative uses if resources.
Price theory is a field of economics that uses the supply and
demand framework to explain and predict human behaviour. Price
theory focuses on how agents respond to prices, but its framework
can be applied to a wide variety of socioeconomic issues that might
not seem to involve prices at first glance. Price theorists have
influenced several other fields including developing public choice
theory and law and economics. Price theory has been applied to
issues previously thought of as outside the purview of economics
such as criminal justice, marriage, and addiction.
- is a branch of economics that studies how an overall economy—the
market or other systems that operate on a large scale—behaves.
Macroeconomics studies economy-wide phenomena such
as inflation, price levels, rate of economic growth, national income,
growth domestic product (GDP) and changes in unemployment.
- is the branch of economics that deals with the structure,
performance, behaviour, and decision-making of the whole, or
- Unlike microeconomics—which studies how individual economic
actors, such as consumers and firms, make decisions—
macroeconomics concerns itself with the aggregate outcomes of
those decisions. For that reason, in addition to using the tools of
microeconomics, such as supply and demand analysis,
macroeconomists also utilize aggregate measures such as gross
domestic product (GDP), unemployment rates, and the consumer
price index (CPI) to study the large-scale repercussion of micro-level
Basic Macroeconomics Concept
Output and income
National output is the total amount of everything a country
produces in a given period of time. Everything that is produced and
sold generates an equal amount of income. The total output of the
economy is measured GDP per person. The output and income are
usually considered equivalent and the two terms are often used
interchangeably, output changes into income. Output can be
measured or it can be viewed from the production side and measured
as the total value of final goods and services or the sum of all value
added in the economy.
The amount of unemployment in an economy is measured by the
unemployment rate, i.e. the percentage of workers without jobs in
the labour force. The unemployment rate in the labour force only
includes workers actively looking for jobs. People who are retired,
pursuing education, or discouraged from seeking work by a lack of job
prospects are excluded.
The interrelationship Between the
Household Sector and Business Sector
Economic activities take place within economy. These include
production, consumption, employment, and income generation. They
take place through the interrelationship that exists between two
economic units. The household unit which is the basic consuming unit,
and the firm, which is the basic producing unit. Economic activities refer
primarily to production that employs resources such as land, labor, and
capital, and entrepreneurship. The basic processes therefore, can be
described as a process of change and transformation of economic
resources into actual goods and services.
Production is the use of economic resources in the creation of goods
and services for the satisfaction of human wants. The use of these
economic resources in production is employment. Whenever resources
are used in production, a price is paid to the resource owners.
The Circular Flow Model
Circular flow of an economy is only a model, a simplification of a
complex reality. However, it is necessary for it to be understood in order to
have a clear understanding of the complexities that are encountered in
the economic activities of a nation.
The circular-flow diagram (or circular-flow model) is a graphical representation
of the flows of goods and money between two distinct parts of the
• -market for goods and services, where households purchase goods and services from
firms in exchange for money;
• -market for factors of production (such as labour or capital), where firms purchase
factors of production from households in exchange for money.
The market for goods and services is the place where households spend their
money buying goods and services produced by firms. In other words, is the
place where firms sell the goods and services they have produced, receiving
a revenue paid by households.
This market represents the place where money and goods are exchanged. In
this case, the flow of money (green arrow in the diagram below) goes from
households to firms, in exchange for finished products, which flow from firms
to households (red arrow).
The market for factors of production is the place where households offer their
labour, capital and other factors such as land, receiving an income for their
use. Firms use these factors in their production.
In this case, money flows from firms to households (green arrow in the diagram
below) in the form of wages in exchange for labour, interests for capital and
rent for the use of land. Factors of production flow form households (red
arrow) to firms, so they can produce more goods and services.
When we combine both diagrams, we get the circular-flow diagram, as
shown below. The exchanges made in the economy imply a redistribution of
rent according to the diagram, and the creation of value makes the