In This Lecture…..
 Goods and Bads
 Resources
 Scarcity
 Opportunity Costs
 Costs and Benefits
In This Lecture…..
Decisions Made at the Margin
Efficiency
Unintended Effects
Exchange
In This Lecture…..

 Microeconomics & Macroeconomics
 Positive & Normative Economics
What does an Economist do?
• Economists look at the world and ask questions.
• Their questions give us insight into the
ec...
Five Basic Questions of Economics
• What is Economics?
• What do Economics study?
• Is there an economic way of thinking?
...
What is Economics?
• Economics is about choices that an
individual and society make.
• Why do people and society make choi...
What do Economics study?
• Everything in the world that attracts the
curiosity is studied using economic
analysis.
• Econo...
Is there an economic way of thinking?
• It means how the economists view,
interpret and analyze the world.
• Economists ca...
Why study Economics?
• To solve the real world problems
• Because of its explanatory and predictive
power – economics can ...
Can the study of Economics help us
understand our world?
• Economics matters in people’s everyday
life.
• Global events af...
RECAP – What is economics?
• Economics is about choices that an
individual and society make.
• Why do people and society m...
Scarcity
The condition in
which our wants
are greater than the
limited resources
available to satisfy
those wants
Effects of Scarcity
• Need to make choice
• Need for a rationing device
• Competition
Need to make Choice
• Scarcity = wants > limited resources
• What is wants?
* Anything that provides utility
• What is uti...
Contd.
What is good and what is bad?
Good - Anything from which individuals
receive utility or satisfaction
Bad - Anything...
Contd.
• Goods can be tangible or intangible
• Goods do not appear with the snap of
your finger.
• It takes factors of pro...
Factors of Production
~ Resources ~
Land - All natural
resources, such as
minerals, forests,
water, and
unimproved land
Factors of Production
~ Resources ~
Labor - The
physical and mental
talents people
contribute to the
production process
Factors of Production
~ Resources ~
Capital - Produced goods
that can be used as inputs
for further production,
such as fa...
Factors of Production
~ Resources ~
Entrepreneurship - The particular
talent that some people have for:
organizing the re...
Characteristics of Resources
• Resources are scarce
• Resources have alternative uses
This leads to economic problem – the...
Economic Problem/Resource Allocation
• Economic problem or Problem of choice
• There are three critical issues
1. what to ...
What to Produce + How much to
produce?
• To make a choice of wants which are
important for the economy as a whole on
the b...
How to produce?
• Choice of technique of production that
maximizes output or minimizes costs or
by choosing the efficient ...
QUESTIONS!!!
• In a country like Nepal which technique of
production should be used?
Labor intensive as labor is in
abunda...
For whom to Produce?
• It is concerned with the distribution aspect
of product among various sections of the
society.
• It...
Institutions for Allocation Resources
• Institutions, including laws and customs,
define a society’s procedures for alloca...
The Market Economy
* Private Ownership of Property

* Freedom of Enterprises
* Profit Motive of Production
* Price Mechani...
Communist/Command/Centrally
Planned Economy
• In such an economy:
– Economic decisions are highly
centralized
– The state ...
The Centrally Planned Economy
* Public ownership of property or factors
of production
* No freedom of enterprise
* Social ...
No economy is
completely centralized
or decentralized; all
economies are a
combination of both.
Mixed Economy
* Ownership of property both by
private and public sector.
* Freedom of enterprise in private
sector but no ...
* Competition exists only in private sector
* Consumer sovereignty exists
* Freedom of occupation exists
* Considerable in...
Economics- REDIFINED
Economics is the science that studies human
behavior in regards to the allocation of
scarce resources...
Need for Rationing Device
A means for
deciding who gets
what of available
resources and
goods

If you are willing and able...
Competition
• It’s the result of scarcity of resources
• Competition takes the form of people
trying to get more of the ra...
Self Test Questions
1.
2.
3.
4.

What are the three effects of scarcity?
Define utility and disutility.
State how economis...
Self Test Questions
1. How does competition arise out of
scarcity?
2. How does choice arise out of scarcity?
Opportunity Costs
The most highly valued opportunity
or alternative forfeited when a choice
is made
Study or ???
Cost

Benefit
Contd.
The higher the opportunity cost of doing
something, the less likely it will be done.
• Why young rock stars, movie ...
Economics, the Science of Scarcity
The science of how individuals and
societies deal with the fact that wants are
greater ...
Production Possibilities Frontier
Represents the possible combinations
of two goods that can be produced in
a certain peri...
• Since scarcity is the fact of economic life,
we need to use our resources as efficiently
as possible. If we succeed we a...
Production Possibility Curve
Assumptions – Economy produces only
two goods.
- Economic resources are
constant
- Resources ...
Tabular and Graphical Presentation of
PPC – when MRT is constant
• What is marginal opportunity cost or MRT
(marginal rate...
Production Possibilities Frontier
Constant Opportunity Costs
Tabular and Graphical Presentation of
PPC – when MRT is not constant
• When MRT is not constant in fact,
increasing - PPC ...
Production Possibilities Frontier
Increasing Opportunity Costs
Production Possibility Frontier
Framework for Understanding
Scarcity and Choice
• All the points on PPC shows what to
produce and how much to produce.
• All points on the curve are e...
Productive Efficiency and
Inefficiency
Productive Efficiency
The condition where the maximum output is
produced with given...
Unemployment
• Any point inside PPC shows that
resources are unemployed or
underemployed or are lying idle.
• By increasin...
Attainable and Unattainable Regions
and Productive Efficiency
Economic Growth within
a PPF Framework
An increase in resources or an advance in
technology can increase the production
ca...
PPF and Economic Growth
Economic Growth and Shift in PPC
• PPC will shift to the right when
- New stock of resources are discovered
- There is an ...
Advance in Technology
An advance in
technology commonly
refers to the ability to
produce more output
with a fixed amount
o...
PPC – Technological Change
P1
P

P1
P

P

O

O
P

P1

Fig A
Advancement in technology
Of both Good X and Good Y

O
P P1

F...
Positive vs. Normative Economics
Positive - The study of “what is” in
economic matters.
Cause
Effect
• Deals with actual o...
Positive vs. Normative Economics
Normative - The study of “what should
be” in economic matters
Judgment and Opinion (ethic...
Microeconomics
Microeconomics deals with human
behavior and choices as they relate to
relatively small units—an individual...
Microeconomic Questions
~
• How does a market work?
• What level of output does a firm produce?
• What price does a firm c...
Microeconomic Questions
(continued)

• How does a consumer determine how
much of a good he or she will buy?
• Can governme...
Macroeconomics
Macroeconomics deals with human
behavior and choices as they relate to
highly aggregate markets (e.g., the
...
Macroeconomic Questions
• How does the economy work?

• Why is the unemployment rate
sometimes high and sometimes low?
• W...
Macroeconomic Questions
(continued)

• What might cause interest rates to be
low one year and high the next?
• How do chan...
Difference between Micro and Macro Economics

Microeconomics

Macroeconomics

* It studies individual economic
units.

* I...
Need for integration of Micro and Macro
Economics

• Why integration?
To get correct solutions of our main
economic proble...
Economic Theory / Model
• It is an abstract representation of the real
world designed with the intent to better
understand...
Models and Mathematics
• Economists use models to provide an
account of cause and effect, to help us
understand how the wo...
Simplifying Assumptions
• All scientists build models based on
assumptions, so do economists
• This allows the model to fo...
Data Analysis
• Scientific method requires models to be tested
with data, e.g., from:
– Records (financial accounts, custo...
Judging a Theory
• On the basis of how well they predict
• Common mistake – theories judged on the
basis of its assumption...
Laws of Economics
• They are set of generalizations that explain
economic activities.
• They are statement of uniformities...
Contd.
• The economic laws lack definiteness found in the
laws of sciences like Physics. They are more like
laws of tides ...
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2 what is economics

  1. 1. In This Lecture…..  Goods and Bads  Resources  Scarcity  Opportunity Costs  Costs and Benefits
  2. 2. In This Lecture….. Decisions Made at the Margin Efficiency Unintended Effects Exchange
  3. 3. In This Lecture…..  Microeconomics & Macroeconomics  Positive & Normative Economics
  4. 4. What does an Economist do? • Economists look at the world and ask questions. • Their questions give us insight into the economic way of thinking. Benefit Cost
  5. 5. Five Basic Questions of Economics • What is Economics? • What do Economics study? • Is there an economic way of thinking? • Why study Economics? • Can the study of Economics help us understand our world?
  6. 6. What is Economics? • Economics is about choices that an individual and society make. • Why do people and society make choices? • Why can’t a society and a person have everything they want? • Economics is the science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.
  7. 7. What do Economics study? • Everything in the world that attracts the curiosity is studied using economic analysis. • Economic analysis : process of using economic tools and economic way of thinking to real world problems. • However, economics cannot explain everything about the world but believe it can explain much.
  8. 8. Is there an economic way of thinking? • It means how the economists view, interpret and analyze the world. • Economists can see things that other people cannot. • Economic way of thinking cannot be pinned down. • It is more about watch- economists do economics, think-what economists are doing and how and identify- what is essential to economic problem solving.
  9. 9. Why study Economics? • To solve the real world problems • Because of its explanatory and predictive power – economics can explain why things are as they are and predict what is likely to happen under certain conditions. • Because it explains certain ideas that have shaped the world – helps us to judge whether they are right or wrong.
  10. 10. Can the study of Economics help us understand our world? • Economics matters in people’s everyday life. • Global events affect and impact everyone’s life. • The universal language for twenty first century is the language of Economics.
  11. 11. RECAP – What is economics? • Economics is about choices that an individual and society make. • Why do people and society make choices? • Why can’t a society and a person have everything they want? • Economics is the science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.
  12. 12. Scarcity The condition in which our wants are greater than the limited resources available to satisfy those wants
  13. 13. Effects of Scarcity • Need to make choice • Need for a rationing device • Competition
  14. 14. Need to make Choice • Scarcity = wants > limited resources • What is wants? * Anything that provides utility • What is utility? * The satisfaction one receives from a good
  15. 15. Contd. What is good and what is bad? Good - Anything from which individuals receive utility or satisfaction Bad - Anything from which individuals receive disutility or dissatisfaction Disutility - The dissatisfaction one receives from a bad PEOPLE WANT GOODS NOT BADS.
  16. 16. Contd. • Goods can be tangible or intangible • Goods do not appear with the snap of your finger. • It takes factors of production or resources to produce them. • Factors of Production : Land, Labor, Capital, Entrepreneurship.
  17. 17. Factors of Production ~ Resources ~ Land - All natural resources, such as minerals, forests, water, and unimproved land
  18. 18. Factors of Production ~ Resources ~ Labor - The physical and mental talents people contribute to the production process
  19. 19. Factors of Production ~ Resources ~ Capital - Produced goods that can be used as inputs for further production, such as factories, machinery, tools, computers, and buildings
  20. 20. Factors of Production ~ Resources ~ Entrepreneurship - The particular talent that some people have for: organizing the resources of land, labor, and capital to produce goods seeking new business opportunities  developing new ways of doing things
  21. 21. Characteristics of Resources • Resources are scarce • Resources have alternative uses This leads to economic problem – the problem of choice. What is the motive of making choice? - Welfare at individual, producer and government level.
  22. 22. Economic Problem/Resource Allocation • Economic problem or Problem of choice • There are three critical issues 1. what to produce + How much to produce 2. how to produce 3. for whom to produce • Economics examines how societies address these three issues: allocation of scarce resources
  23. 23. What to Produce + How much to produce? • To make a choice of wants which are important for the economy as a whole on the basis of the technology available, cost of production, demand for the commodity. It is studied under Price Theory. • How much to produce is the problem of determining the quantity for each good to be produced on the basis of the technology available, cost of production, demand for the commodity
  24. 24. How to produce? • Choice of technique of production that maximizes output or minimizes costs or by choosing the efficient technique of production • Labor Intensive – more labor and less capital used • Capital Intensive – more capital less labor is used
  25. 25. QUESTIONS!!! • In a country like Nepal which technique of production should be used? Labor intensive as labor is in abundance so as to raise the standard of living of the people. • In USA which technique of production should be used? Capital Intensive as capital is in abundance
  26. 26. For whom to Produce? • It is concerned with the distribution aspect of product among various sections of the society. • It is related to the buying capacity of the consumers in the market. • Buying capacity is dependent on his purchasing power / income • Production will be carried out for those consumers who can pay.
  27. 27. Institutions for Allocation Resources • Institutions, including laws and customs, define a society’s procedures for allocating resources • In a capitalist economy: – Means of production are owned and controlled by and for the benefit of private individuals – Resources are allocated by voluntary trading among businesses and consumers
  28. 28. The Market Economy * Private Ownership of Property * Freedom of Enterprises * Profit Motive of Production * Price Mechanism guides production decisions * Existence of competition * Consumers are supreme * Very unequal distribution of Income * Absence of role of Government
  29. 29. Communist/Command/Centrally Planned Economy • In such an economy: – Economic decisions are highly centralized – The state owns and controls the means of production and distribution
  30. 30. The Centrally Planned Economy * Public ownership of property or factors of production * No freedom of enterprise * Social welfare motive * Planning mechanism guides production * No competition * Absence of consumer’s sovereignty * Restriction of freedom of occupation * Inequalities of income greatly reduced * Complete role of government
  31. 31. No economy is completely centralized or decentralized; all economies are a combination of both.
  32. 32. Mixed Economy * Ownership of property both by private and public sector. * Freedom of enterprise in private sector but no freedom in public sector. * Private sector – profit motivated; public sector – welfare motivated * Private Sector – Price mechanism Public Sector - Government
  33. 33. * Competition exists only in private sector * Consumer sovereignty exists * Freedom of occupation exists * Considerable inequality of income exists * Full role of government in public sector and limited role in private sector. * Price mechanism resolves the central problems of economy in private sector while central planning authority decides in public sector
  34. 34. Economics- REDIFINED Economics is the science that studies human behavior in regards to the allocation of scarce resources so that consumers attains the maximum level of satisfaction, producers attains the maximum level of profit and the nation attains the maximum level of social welfare.
  35. 35. Need for Rationing Device A means for deciding who gets what of available resources and goods If you are willing and able to pay the price the good is yours.
  36. 36. Competition • It’s the result of scarcity of resources • Competition takes the form of people trying to get more of the rationing device. • If dollar price is the rationing device people would compete to earn dollars.
  37. 37. Self Test Questions 1. 2. 3. 4. What are the three effects of scarcity? Define utility and disutility. State how economists divide utility. State the function of rationing device and give an example. 5. Scarcity is the condition of finite resources. True or false? Explain your answer.
  38. 38. Self Test Questions 1. How does competition arise out of scarcity? 2. How does choice arise out of scarcity?
  39. 39. Opportunity Costs The most highly valued opportunity or alternative forfeited when a choice is made
  40. 40. Study or ??? Cost Benefit
  41. 41. Contd. The higher the opportunity cost of doing something, the less likely it will be done. • Why young rock stars, movie stars, and fashion models rarely go to college? BECAUSE the opportunity cost are sufficiently high for the individual that the benefits of attending college are outweighed by the cost.
  42. 42. Economics, the Science of Scarcity The science of how individuals and societies deal with the fact that wants are greater than the limited resources available to satisfy those wants.
  43. 43. Production Possibilities Frontier Represents the possible combinations of two goods that can be produced in a certain period of time with a given state of technology and fully employed resources. • It is a hypothetical model of an economy that produces only two products.
  44. 44. • Since scarcity is the fact of economic life, we need to use our resources as efficiently as possible. If we succeed we are operating on full economic capacity. Usually, there are some economic slack, but every so often we do manage to operate at peak efficiency. • When this happens, we are on our production possibilities frontier. • When at PPF, 4-6% labor unemployment rate and 85-90% use of plant and machinery is an accepted norm.
  45. 45. Production Possibility Curve Assumptions – Economy produces only two goods. - Economic resources are constant - Resources are not specific - Resources are fully employed - Technology is constant - Resources are efficiently employed
  46. 46. Tabular and Graphical Presentation of PPC – when MRT is constant • What is marginal opportunity cost or MRT (marginal rate of transformation)? It means the sacrifices made in terms of units of Y to produce an additional unit of X. • When MRT is constant PPC will be a downward sloping straight line.
  47. 47. Production Possibilities Frontier Constant Opportunity Costs
  48. 48. Tabular and Graphical Presentation of PPC – when MRT is not constant • When MRT is not constant in fact, increasing - PPC will be a downward sloping curve concave to the origin
  49. 49. Production Possibilities Frontier Increasing Opportunity Costs
  50. 50. Production Possibility Frontier Framework for Understanding
  51. 51. Scarcity and Choice • All the points on PPC shows what to produce and how much to produce. • All points on the curve are efficient and attainable. • Depending on nation’s policy it can choose any point on the curve • All points on PPC imply that most efficient technology is employed
  52. 52. Productive Efficiency and Inefficiency Productive Efficiency The condition where the maximum output is produced with given resources and technology Productive Inefficiency The condition where less than the maximum output is produced with given resources and technology. Productive inefficiency implies that more of one good can be produced without any less of another good being produced.
  53. 53. Unemployment • Any point inside PPC shows that resources are unemployed or underemployed or are lying idle. • By increasing the use of resources production can be increased
  54. 54. Attainable and Unattainable Regions and Productive Efficiency
  55. 55. Economic Growth within a PPF Framework An increase in resources or an advance in technology can increase the production capabilities of an economy, leading to economic growth and shift outward in the production possibilities frontier.
  56. 56. PPF and Economic Growth
  57. 57. Economic Growth and Shift in PPC • PPC will shift to the right when - New stock of resources are discovered - There is an advancement in technology • PPC will shift to the left when - Resources are destroyed because of national calamity like earthquake, fir, war etc. - There is the use of outdated technology
  58. 58. Advance in Technology An advance in technology commonly refers to the ability to produce more output with a fixed amount of resources or the ability to produce the same output with fewer resources.
  59. 59. PPC – Technological Change P1 P P1 P P O O P P1 Fig A Advancement in technology Of both Good X and Good Y O P P1 Fig B Advancement in technology of Good X only P Fig C Advancement in technology of Good Y only
  60. 60. Positive vs. Normative Economics Positive - The study of “what is” in economic matters. Cause Effect • Deals with actual or realistic situation • eg. What determines the price rise? Govt has adopted policies to reduce unemployment. Rate of inflation is 6% in Nepal.
  61. 61. Positive vs. Normative Economics Normative - The study of “what should be” in economic matters Judgment and Opinion (ethics) • Deals with idealistic situation • Eg – What is a fair price rise? Unemployment is worse that poverty. Rate of inflation should not be more than 6%.
  62. 62. Microeconomics Microeconomics deals with human behavior and choices as they relate to relatively small units—an individual, a business firm, an industry, a single market.
  63. 63. Microeconomic Questions ~ • How does a market work? • What level of output does a firm produce? • What price does a firm charge for the good it produces?
  64. 64. Microeconomic Questions (continued) • How does a consumer determine how much of a good he or she will buy? • Can government policy affect business behavior? • Can government policy affect consumer behavior?
  65. 65. Macroeconomics Macroeconomics deals with human behavior and choices as they relate to highly aggregate markets (e.g., the goods and services market) or the entire economy.
  66. 66. Macroeconomic Questions • How does the economy work? • Why is the unemployment rate sometimes high and sometimes low? • What causes inflation? • Why do some national economies grow faster than other national economies?
  67. 67. Macroeconomic Questions (continued) • What might cause interest rates to be low one year and high the next? • How do changes in the money supply affect the economy? • How do changes in government spending and taxes affect the economy?
  68. 68. Difference between Micro and Macro Economics Microeconomics Macroeconomics * It studies individual economic units. * It studies aggregate economic units. * It deals with determination of price and output in individual markets. * Its basic parameter is price, i.e. consumers and producers take economic decision on the basis of price. * It uses partial equilibrium method given by Alfred Marshall. * It aims at optimal allocation of resources. * It deals with determination of general price level and national output in the economy. * Its basic parameter is income, i.e. economic decision relating to consumption, saving, investment etc. are made on the basis of national income * It uses general equilibrium method given by Walras. * eg. Individual demand * It aims at determination of aggregate output, national income, price level and employment level in the economy. * eg. Aggregate demand, national income
  69. 69. Need for integration of Micro and Macro Economics • Why integration? To get correct solutions of our main economic problems
  70. 70. Economic Theory / Model • It is an abstract representation of the real world designed with the intent to better understand that world. • Abstract means to omit certain variables to understand something. • In theory only those variables are emphasized that are critical to explain/predict an activity or event.
  71. 71. Models and Mathematics • Economists use models to provide an account of cause and effect, to help us understand how the world works • Some economic models are quantitative (mathematical) so that they are more precise
  72. 72. Simplifying Assumptions • All scientists build models based on assumptions, so do economists • This allows the model to focus on the most important explanations for a particular phenomenon • No economic model is literally true • Some assumptions are easy to criticize • The test of a model is its usefulness
  73. 73. Data Analysis • Scientific method requires models to be tested with data, e.g., from: – Records (financial accounts, customer databases) – Surveys (Consumer Expenditure Survey, other government or private sources) – Experiments • Econometrics: application of statistical methods to empirical questions in economics
  74. 74. Judging a Theory • On the basis of how well they predict • Common mistake – theories judged on the basis of its assumptions • If the theory works, if the evidence supports the theory, then it is a good and useful theory, and the assumptions of the theory, no matter what anyone might think of them, are a sufficiently good approximation for the purpose in hand.
  75. 75. Laws of Economics • They are set of generalizations that explain economic activities. • They are statement of uniformities which shows human behavior concerning the utilization of limited resources for the achievements of the ultimate ends. (Robbins) • The nature of economic laws are indicated by the phrase “ other things being equal” (ceteris paribus) • Some economic laws are axiomatic in character i.e. greater gain is preferred to smaller gain • Some economic laws are of the nature of physical laws eg. Law of Diminishing Returns
  76. 76. Contd. • The economic laws lack definiteness found in the laws of sciences like Physics. They are more like laws of tides (Marshall). • Economic laws are hypothetical or conditional as their validity depends on the fulfillment of certain conditions. • Economic laws are statements of tendencies of statistical probabilities. They can only say what is likely to happen eg. If demand increases price tends to rise. Actually it may or may not rise. It will also depend on the supply condition.
  77. 77. Next !

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