Nature and Scope of Economics

BACHELOR OF ARTS IN ECONOMICS SOC SCI 104 – BASIC ECONOMICS W/ TAR
Pangasinan State University
Social Science Department – PSU Lingayen
CHAPTER 1
NATURE AND SCOPE OF ECONOMICS
1st Semester, S.Y 2014 – 2015
JAMESON ESTRADA

A. Definition of Economics
B. Importance of Economics
C. Microeconomics vs. Macroeconomics
D. Nature of Economic Choice (Scarcity and Opportunity Cost)
E. Economic Activities
F. Economic Resources
G. Economic Goals
H. Fundamental Economic Problems / Questions
I. Types of Economic System
J. Economic Models
K. Ceteris Paribus
L. Normative and Positive Economics
M. Scientific Method
N. Circular Flow Model
O. The Production Possibility Frontier
P. Graphs
Q. Linear Relationship
Chapter Outline

What is Economics?
 The study of how individuals and societies
choose to allocate and use scarce resources to
satisfy unlimited wants.
 Embedded in the definition are four key words:
 Choice
 Resource Allocation
 Scarcity
 Unlimited Wants

Economics involves
 Examining how individuals, businesses,
governments, and societies choose to use scarce
resources to satisfy their wants.
 Organizing, analyzing, and interpreting data about
those economic behaviors.
 Developing theories and economic laws that
explain how the economy works and to predict
what might happen in the future.
What is Economics?

A good understanding of this subject will not only help us learn
economics as an academic discipline but would also help us
understand the world and the reality that we are in. Specifically, a
study of this course will help us:
1. Appreciate events in economic history and understand
how the present-day system of economics came to be.
2. Learn the ways in which economics explain the activities
of man through its tools, models, principles and
standards.
3. Make use of production and consumption concepts in
business endeavors or simply in understanding people’s
economic behavior.
Why Study Economics?

4. Manage economic and financial affairs; thereby,
achieving a good standard of living for ourselves, our
families and our nation.
5. Understand government’s functions in economics and
choose leaders who are economically sensible.
6. Understand what is happening in the economy of the
Philippines and the world and know how nationwide and
worldwide economic policies and events affect us all.
Why Study Economics?

Microeconomics
 A branch of economics which is concerned
with the behavior of individual entities such as
markets, firms, and households.
Macroeconomics
 A branch of economics which is concerned
with the overall behavior and performance of
the economy as whole.
Two Branches of Economics

Scope of Microeconomics
Microeconomics studies
 Buying decisions of the individual
 Consumers’ satisfaction
 Buying and selling decisions of the firm
 The determination of prices and in markets
 The quantity, quality and variety of products
 Profits

Macroeconomics studies
 Economic growth
 Unemployment and inflation
 Aggregate demand and aggregate supply
 Economic policies – fiscal and monetary
 International trade – exports and imports
 Money supply
Scope of Microeconomics

Which of the following questions involve microeconomics, and which
involve macroeconomics? In each case, explain your answer.
1. Why did consumers switch to using Smart TVs in 2013?
2. Why did overall consumer spending slow down in 2013?
3. Why did the standard of living rise more rapidly in the
current administration compared to previous
administration?
4. Why have starting salaries for students with geology
degrees risen sharply of late?
5. What determines the choice between rail and road
transportation?
6. Why did the computers get cheaper over the past 5
years?
Let’s Check Your Understanding!

Concept of Scarcity
 Scarcity exists because individuals want more than
can be produced. It implies that there are not
enough resources to satisfy human wants.
 The condition in which our wants are greater than
the resources available to satisfy them.
 Scarcity means making choices. Wants are
unlimited and resources are limited. Therefore,
scarcity exists, and people must make choices.

Wants versus Needs
Wants are desires that can be satisfied by
consuming a good or service.
Needs are things, such as food, clothing, and
shelter, that are necessary for survival.
Necessities are few but our wants are endless.

Let’s Check Your Understanding
Determine whether each of the following is a want or a
need.
1. Fruits and Vegetables
2. Education
3. Medicine
4. Luxurious car
5. Jewelry

Goods versus Services
Good is something that is intended to satisfy some
wants or needs of a consumer and thus has economic
utility. It is normally used to denote tangible
commodities such as products and materials that can
be purchased and consumed.
Goods can be categorized as:
 Economic Good and Free Good
 Durable Good and Nondurable Good
 Intermediate Good and Final Good
 Consumer Good and Capital Goods
.

Service is an intangible commodity. More
specifically, services are an intangible equivalent
of economic goods. These are tasks that you pay
other people to perform for you.
Services are work that one person performs for
another for payment. Services include the work of
sales clerks, technical support representatives,
teachers, nurses, doctors, lawyers, etc.
Goods versus Services

Determine whether each of the following is a good or a
service.
1. Beauty shop or barbershop.
2. Furniture
3. Pineapples
4. Legal counsel
5. Books

 This is a key concept in economics, and has been
described as expressing "the basic relationship
between scarcity and choice“.
 It is the cost of any activity measured in terms of the
value of the best alternative that is not chosen (that
is foregone).
 It is the sacrifice related to the second best choice
available to someone, or group, who has picked
among several mutually exclusive choices.
Opportunity Cost

Opportunity Cost Examples
What to Do
What you
have Done Opportunity Cost
Watch a
television Read a book
The opportunity cost of watching television
is reading a book.
Going to college Having a job
The opportunity cost of going to college is
having a job
Buy good A Buy good B
The opportunity cost of buying good A is
buying good B.
Produce tablet
Produce
laptop
The opportunity cost of producing tablet is
producing laptop
Spend on
infrastructure
Spend on
national
defense
The opportunity cost of spending
infrastracture is spending on national
defense
Opportunity Costs

Individuals do make their choices randomly. Rather,
they carefully looked at the benefits they would gain
and the opportunity costs they would incur from their
decisions. This practice of examining the costs and
the expected benefits of a choice as an aid to decision
making is called cost-benefit analysis. It is an
approach that weighs the benefits of an action against
its costs. Cost-benefit analysis is one of the most
useful tools for individuals, businesses, and
governments when they need to evaluate the relative
worth of economic choices.
Cost-Benefit Analysis

Economic Activities
1. Production. The process of transforming inputs into
outputs.
2. Distribution. The way total output, income, or
wealth is distributed among individuals or among the
factors of production
3. Exchange. The process of trading goods between
buyers and sellers in a particular market.
4. Consumption. The process of how goods and
services are utilized that give satisfaction to the
consumers.

Land includes all natural resources, such as minerals,
timber, and water, as well as the land itself.
Labor refers to the physical and intellectual services of
people and includes the training, education, and abilities
of the individuals in a society.
Capital refers to products such as machinery and
buildings that are used to produce other goods and
services
Entrepreneurship is a human resource that combines
these factors of production creatively and efficiently.
Categories of Economic Resources

 The entrepreneur takes the initiative in combining the
resources of land, labor, and capital to produce a
good or a service.
 The entrepreneur makes the strategic business
decisions that set the course of an enterprise.
 The entrepreneur is an innovator.
 The entrepreneur is a risk bearer.
Functions of an Entrepreneur

Determine what category of economic resources each of
these belongs.
1. Factory worker
2. Company’s CEO
3. Assembly plant
4. Industrial robots
5. Mineral deposits

Economic Resources (also called factors of production
or productive inputs) are what people use to produce
goods and services. These are inputs used by the firm
to produce a good or service. These inputs include the
following:
 Land
 Labor
 Capital
 Entrepreneurship
Economic Resources

1. Economic efficiency
2. Economic growth and economic development
3. Economic freedom
4. Economic security
5. Equitable distribution of income
6. Full employment
7. Price level stability
8. Reasonable balance of trade
Economic Goals

Economic System is the way in which a society decides
what goods to produce, how to produce them, and for
whom goods will be produced. Whether rich or poor, every
nation must answer the same three fundamental economic
questions:
1. What to produce?
2. How to produce?
3. For whom to produce?
Three Economic Questions

What to Produce?
To answer the first fundamental economic question, a society
must decide the mix of goods and services it will produce. Will
it produce mainly food, or will it also produce automobiles,
televisions, computers, furniture, and shoes? The goods and
services a society chooses to produce depend, in part, on the
natural resources it possesses.
Because of scarcity, no country can produce every good it
wants in the quantity it would like. More of one good (say,
television sets) leaves fewer resources to produce other
goods (such as cars). No matter what nation we are talking
about—the United States, China, Japan, India, Russia, Cuba,
or Brazil—each must decide what goods will be produced.

How to Produce?
The next question every society has to answer deals with
the ways in which people produce the goods. Will farmers
using modern tractors produce food, or will farmers using
primitive tools produce it? Will the food be produced on
private farms, where production decisions are made by
individual farmers, or will it be produced on collective farms,
where production decisions are made by people in the
government?
Answering this second question involves using scarce
resources in the most efficient way to satisfy society’s wants.
Again, decisions on methods of production are influenced, in
part, by the natural resources society possesses.

For Whom to Produce?
This answers how goods and services are distributed among
people in society. This actually involves two questions.
Exactly how much should people get and how should their
share be delivered to them? Should everyone get an equal
share of the goods and services? Or should a person’s
share be determined by how much he or she is willing to
pay? Once the question of how much has been decided,
societies must then decide exactly how they are going to get
these goods to people. To do this, societies develop
distribution systems, which include road and rail systems,
seaports, airports, trains, ships, airplanes, computer
networks—anything that helps move goods and services
from producers to consumers in an efficient manner.

Economic System
 An economic system is a set of economic
institutions that dominates a given economy.
 a particular set of institutional arrangements and a
coordinating mechanism—to respond to the
economizing problem. It is a society decides what
goods to produce, how to produce them, and for
whom goods will be produced.
 The way a society uses its scarce resources to
satisfy its people’s unlimited wants.

1. To produce the goods for consumption of the
population
2. To utilize the resources in efficient method of
production
3. To employ the labor force in occupations where
productivity is at optimum
4. To apportion the wealth and income available to
everyone in an equitable manner
5. To encourage innovation and technology in order to
maximize efficiency, optimize satisfaction and minimize
waste
Salient Functions of an Economic
System

1. Traditional Economy
2. Market Economy
3. Command Economy
4. Mixed Economy
Classification of Economic System

 Traditional economy is an economic system
in which the society produces what best
ensures its survival.
 Resources are allocated according to long-lived
practices from the past.
 People make economic decisions based on
customs and beliefs that have been handed
down from generation to generation.
Traditional Economy

 Market economy is characterized by the private
ownership of resources and the use of a system of
markets and prices to coordinate and direct
economic activity.
 Private individuals own most, if not all, the resources
and control their use.
 The prices of goods and services are determined in a
free price system .
 Market economy or capitalism is sometimes called
laissez-faire; translated from the French, this phrase
means “to let do,” or to let people do as they choose
without government intervention.
Market Economy

Characteristics of a Market Economy
1. Private Property
2. Freedom of Enterprise or Choice
3. Self-interest
4. Competition
5. Markets and Prices
6. Technology and Capital Goods
7. Specialization
8. Use of Money
9. Active, but Limited, Government

 an economy characterized by public ownership of
virtually all property resources and the rendering of
economic decisions through central economic
planning.
 Government owns most of the businesses and
makes all economic decisions.
 There is no free competition because the
government is the only seller.
 Countries using mainly the command system include
Turkmenistan, Laos, Belarus, Libya, Myanmar, Iran,
North Korea and the former Soviet Union.
Command Economy

Flaws of Command Economy
1. Running an economy is so complicated that some
resources are used inefficiently.
2. Because nobody in particular owns resources, each
person has less incentive to employ them in their highest-
valued use, so some resources are wasted.
3. Central plans may reflect more the preferences of central
planners than those of society.
4. Because government is responsible for all production, the
variety of products tends to be more limited than in a
capitalist economy.
5. Each individual has less personal freedom in making
economic choices.
In practice, the pure command system also has flaws, most notably:

 Mixed Economy is a blend of market system and
some form of government regulation and control.
Private ownership of resources exists side by side
with substantial public ownership of resources and
government participation in economic activities.
 This involves a degree of private economic
freedom mixed with a degree of government
regulation of markets.
 The major and strategic industries are owned and
managed by the state while the minor industries
belong to the private sector.
Mixed Economy

Consumption goods and services
 Goods and services that are bought by individuals and used
to provide personal enjoyment and contribute to a person’s
quality of life.
Capital goods
 Goods that are bought by businesses to increase their
productive resources.
Government goods and services
 Goods and services that are bought by governments.
Export goods and services
 Goods and services that are produced in one country and
sold in other countries.
Categories of Goods and Services

 A simplified representation of economic forces.
It is a simplified representations of complex
economic activities, systems, or problems—to
clarify trade-offs.
 It is also a simplified description of reality used
to understand and predict the relationship
between variables.
Economic Model

Forms of Economic Model
 Descriptive economic model (words,
statements)
 Assumption
 Mathematical model (Equations and
Functions)
 Graphs

Ceteris Paribus Assumption
Ceteris paribus assumption is a Latin phrase
that means while certain variables change, “all
other things remain unchanged.”
This assumption allows analysis of the effect of a
change in one factor by holding all other relevant
factors unchanged.

Positive Economics
 It is concerned with “what is”.
 A statement that can be proved or disproved by reference to
facts
 A way of describing and explaining economics as it is, not as
it should be.
Normative Economics
 It is concerned with what should be.
 A statement that reflects an opinion, which cannot be proved
or disproved by reference to the facts.
 a way of describing and explaining what economic behavior
ought to be, not what it actually is. It does involve value
judgments because it seeks to make recommendations for
actions
Positive and Normative Economics

Determine whether each of the following statements is normative or
positive.
1. The inflation rate in this country is too high.
2. The government should increase the minimum wage in Metro
Manila.
3. Increasing the minimum wage results in more unemployment.
4. What government policies should be adopted to make it
easier for low-income students to attend college?
5. How many people are employed in the economy as a whole
this year?

To study economic problems, economists employ a
process of theoretical investigation called the
scientific method. Scientific method consists of four
steps.
1. Step One: Identify the Question and Define
Relevant Variables
2. Step Two: Specify Assumptions
3. Step Three: Formulate a Hypothesis
4. Step Four: Test the Hypothesis
Scientific Method

The Circular-Flow of Income Diagram
Circular-flow diagram is a visual model of the
economy that shows how income flows through
markets among households and firms.

The Circular-Flow Diagram

Households are individuals or groups of people
living together and considered the consuming-unit of
the economy. They sell economic resources and buy
goods and services
Firms are the institutions that organize the
production of goods and services and are
considered the producing-unit of the economy. They
buy economic resources and they sell goods and
services.
Components of the Circular-Flow Model:
Households and Firms

Market is a place or any arrangement that brings
buyers and sellers together and enables them to get
information and do business with each other. The
circular flow model has two classifications of market.
Resource Market is a market in which a resource
(land, labor and capital) is bought and sold.
 Land market, capital market, labor market
Product Market is a market in which a good or
service is bought and sold.
Resource Market and Product Market

Real Flows (input-output flows) depicts the
flows of the economic resources (inputs) that go
from households through resource markets to
firms and of the goods and services that go from
firms through goods markets to households.
Money Flows indicates the flows of payments
made in exchange for the services of factors of
production and of expenditures on goods and
services.
Resource Market and Product Market

When households choose the quantities of services of land,
labor, capital, and entrepreneurship to offer in resource
markets, they respond to the incomes they receive—rent for
land, wages for labor, interest for capital, and profit for
entrepreneurship. When firms choose the quantities of
factor services to hire, they respond to the rent, wages,
interest, and profits they must pay to households. Similarly,
when firms choose the quantities of goods and services to
produce and offer for sale in goods markets, they respond to
the amounts that they receive from the expenditures that
households make. And when households choose the
quantities of goods and services to buy, they respond to the
amounts they must pay to firms
Real Flows and Money Flows

The production-possibility frontier (or PPF )
shows or measures the maximum quantity of goods
that can be efficiently produced by an economy,
given its technological knowledge and the quantity of
available inputs.
Production Possibility Frontier

Like all other economic models, the PPC is based on
assumptions that simplify the economic interactions. For the
PPC these assumptions are:
1. Resources are fixed. There is no way to increase the
availability of land, labor, capital, and entrepreneurship.
2. All resources are fully employed. There is no waste of
any of the factors of production. In other words, the
economy.
3. Only two things can be produced. This assumption
simplifies the situation and suits the graphic format, with
one variable on each axis.
4. Technology is fixed. There are no technological
breakthroughs to improve methods of production.

The PPF model demonstrates the following economic principles:
 The economy is said to be operating efficiently if it is
operating on the production possibilities frontier (e.g. Point
A or B) because it is producing a mix of output that is the
maximum possible from the resources available.
 Points inside the curve (e.g. Point C) are therefore
inefficient while points outside the curve (e.g. Point D) are
currently unattainable.
 If the economy is operating on the production possibilities
frontier, we can see the tradeoffs society faces. To produce
more of one good, it must produce less of the other. The
amount of one good given up when producing more of
another good is the opportunity cost of the additional
production.
PPF: An Analysis

 The production possibilities frontier is bowed outward
because the opportunity cost of producing more of a
good increases as we near maximum production of that
good. This is because we use resources better suited
toward production of the other good in order to continue
to expand production of the first good.
 A technological advance in production shifts the
production possibilities frontier outward. This is a
demonstration of economic growth.
PPF: An Analysis

Combination
Capital
Goods
Consumer
Goods
A 160 0
B 140 40
C 80 80
D 0 100

One way to express the relationship between
variables is with a graph.
Graphs serve two purposes:
1. Graphs offer a way to visually express
ideas that might be less clear if described
with equations or words.
2. When analyzing economic data, graphs
provide a way of finding how variables are
related in the world.
Graphs in Economic Analysis

Pie graph
 is a circular chart divided into sectors illustrating proportion. It is a
convenient way to represent the different parts of something that
when added together equal the whole.
Bar graph
 is a chart with rectangular bars with lengths proportional to the
values that they represent. The bars can be plotted vertically or
horizontally. It is used for marking clear data which has learned
value.
Line Graph
 is a type of graph, which displays information as a series of data
points connected by straight line segments. It is an extension of a
scatter graph, and is created by connecting a series of points that
represent individual measurements with line segments.
Forms of Graphs

88, 10%
76, 9%
100, 12%
67, 8%
55, 6%
60, 7%
40, 5%
45, 5%
56, 6%
68, 8%
78, 9%
125, 15%
Number of Android Tablets Sold in 2013
January February March April May June
July August September October November December
Month
Number of
Android Tablets
Sold
January 88
February 76
March 100
April 67
May 55
June 60
July 40
August 45
September 56
October 68
November 78
December 125
Pie Graph

88
76
100
67
55
60
40
45
56
68
78
125
0
20
40
60
80
100
120
140
No.ofAndroidTabletsSold(inthousands)
Month
Bar Graph
Month
Number of
Android Tablets
Sold
January 88
February 76
March 100
April 67
May 55
June 60
July 40
August 45
September 56
October 68
November 78
December 125

88
76
100
67
55
60
40
45
56
68
78
125
0
20
40
60
80
100
120
140
NumberofAndroidTabletsSold(inthousands)
Month
Month
Number of
Android Tablets
Sold
January 88
February 76
March 100
April 67
May 55
June 60
July 40
August 45
September 56
October 68
November 78
December 125
Line Graph

Graphs of Two Variables:
The Coordinate System
Economists are often
concerned with the
relationships between
variables. Thus, they
need to display two
variables on a single
graph. The coordinate
system makes this
possible.

Variable and Constant
Variable is q quantity that assumes different values in a
particular problem. It is a value that may change within
the scope of a given problem or set of operations.
Constant is a quantity whose value remains unchanged
throughout a particular problem.
 Numerical Constant – has the same value in all
problems
 Parametric Constant (Parameter) – has the same
value throughout the problem but may assume
different values in different problems
Ex: 𝑅 = 10𝑥 (Revenue ) , 𝑇𝐶 = 𝑎 + 𝑏𝑋 (Cost) , 𝑄𝑑 = 𝑎 – 𝑏𝑌 (Demand)

Dependent and Independent Variables
Function is a relationship between two or more variables
such that a unique value of one variable is determined by
the values taken by the other variables in the function.
These variables can be:
Independent Variable – the variable representing the value
being manipulated or changed.
Dependent Variable – observed result of the independent
variable being manipulated
If every value of x is associated with exactly one value of y,
then y is said to be a function of x.
In the function, 𝑦 = 𝑓 𝑥 , 𝑦 is the dependent variable and
𝑥 is the independent variable.

Direct Relationship is a positive relationship between
two variables in which change in one variable is
associated with a change in the other variable in the
same direction.
Ex. Price and Quantity Supplied
Inverse Relationship is a negative relationship
between two variables in which change in one variable
is associated with a change in the other variable in the
opposite direction.
Ex. Price and Quantity Demanded
Direct vs. Inverse Relationship

Inverse and Direct Relationship
Inverse Relationship has a downward sloping curve.
Direct relationship has an upward sloping curve.
Inverse Relationship Direct Relationship

The slope of the line represents the change in one
variable that occurs when another variable changes.
It is an exact numerical measure of the relationship
between the change in 𝑌 and the change in 𝑋.
Slope measures the rate of change. It is expressed
as:
Slope
𝑚 =
𝑟𝑖𝑠𝑒
𝑟𝑢𝑛
=
∆𝑌
∆𝑋
=
𝑌2 − 𝑌1
𝑋2 − 𝑋1

Slope of a Line
 Slope is negative if the
line slopes downward
to the right
 Slope is positive if the
line slopes upward to
the right
 Slope of the x-axis or
horizontal line is zero
 The slope of the y-axis
or vertical line is
undefined.

Study the four accompanying diagrams. Consider the following statements and indicate
which diagram matches each statement. In each of these statements, is the slope positive,
negative, zero, or infinity?
1. If the price of movies increases, fewer consumers go to see movies.
2. Whatever the temperature outside, people consume the same number of
hotdogs per day.
3. Consumers buy more frozen yogurt when the price of ice cream goes up.
4. Research finds no relationship between the number of diet books purchased
and the number of pounds lost by the average dieter.
5. Regardless of its price, consumers in Lingayen buy the same quantity of salt.
Let’s Check Your Understanding

Linear Equation to Economic Analysis
Linear Equation is an algebraic equation which expresses
a relationship between two or more variables.
 𝑌 = 𝑓 (𝑋) says the value of 𝑌 is determined by the value
of 𝑋; 𝑌 is a “function of 𝑋.”
 𝑌 is the dependent variable
 𝑋 is the independent variable
A linear relationship may be in the common form:
𝑦 = 𝑚𝑥 + 𝑏
where 𝑥 and 𝑦 are variables, 𝑚 is slope, 𝑏 is y-intercept

X and Y – Intercepts
The x-intercept is the point where a line crosses
the x-axis. The general form of the x-intercept is (x,
0). The y-coordinate will always be zero.
The y-intercept is the point where a line crosses
the y-axis. The general form of the y-intercept is (0,
y). The x-coordinate will always be zero.

Given the equation: 𝑦 = −3𝑥 + 9
1. What is the Y intercept? The slope?
2. What is the X intercept? Is this a positive (direct)
relationship or negative (inverse)?
Given the equation 𝑦 = 2𝑥 + 10
1. What is the Y intercept? The slope?
2. What is the X intercept? Is this a positive (direct)
relationship or negative (inverse)?

Nature and Scope of Economics