WHAT ECONOMICS IS ABOUT

1
 A Definition of Economics

Economics is a social science that deals with the

allocation of scarce resources

Resources / inputs / factors of production: are the

things that are used to produce output (goods do not
appear out of thin air).
Resources

▪ Land: all things found in nature (wood, coal, fish,

unimproved land etc)
▪ Labor: physical and mental talent of people used to
produce output
▪ Capital: produced goods that are used as inputs for
further production (factories, machinery, computers,
etc)
▪ Entrepreneurship: talent that people have to bring
the other factors of production (as mentioned
above) to produce goods, seek new business
opportunities, and develop new ways of doing things
Scarcity
▪ The condition where human wants far exceed the limited
resources that are available to fulfill them.

You cannot have your cake and eat it too! (you cannot
have it all)
Scarcity has its effects:
1) The need to make choices: given our wants far exceed the
limited resources that are available to fulfill them, some wants
must go unsatisfied.
2) Need for a rationing device: a means for deciding who gets
what of the available resources and goods. Ex. The taka price
for a new houses. People who pay the take price ends up with
a new house
3) Competition: competition exists because of scarcity. People will
try to get more of the rationing device. Ex, if taka price is the
rationing device, then people will compete to earn taka.
Opportunity Cost

The highest-valued alternative that we give up to get

something is the opportunity cost of the activity chosen.
There Is No Such Thing As A Free Lunch!
Opportunity Cost

Consider people who speak about free housing, free

bridges (“no charge to cross it”), and free parks. None of
these things are actually free. The resources that provide
housing, bridges, and parks could have been used in
other ways.
Opportunity Cost & behavior

A change in opportunity cost can change a person’s

behavior.

The higher the opportunity cost of doing some, the less

likely it is that it will be done

Ex: Assume that you are a full time student, and you give
up earning Tk 20, 000 / month working full time
What if you have to give up …
Tk 40, 000/ month
Tk 80, 000
Tk 200, 000 …
Benefits and Costs

Every choice that we make has benefits and costs.

Ex: Coming to class…

has its benefits: we learn new things that, say, makes us

more productive in the work place and ultimately leads to
higher earnings

has its costs: I have to wake up early in the morning,

travel to uni, and miss out on adda…
Decisions are made at the margin

We make decisions in terms of additional / marginal costs

and benefits, and not total costs and benefits.

This is because for most decisions we think in terms of

small additional / marginal changes. Think about it…

Ex: you just had 1 packet of biriyani for lunch. You are still
a little hungry. In deciding whether to eat the second
packet of biriyani, you are going to compare the
additional/ marginal benefit of eating this second packet
with the additional/marginal cost
Decisions are made at the margin

Ex: you just had 1 packet of biriyani for lunch. You are still
a little hungry. In deciding whether to eat the second
packet of biriyani, you are going to compare the
additional/ marginal benefit of eating this second packet
with the additional/marginal cost

If the marginal benefit (MB) of eating the second biriyani is

greater than the marginal cost (MC) of eating it: eat it!

If the marginal benefit (MB) of eating the second biriyani is

smaller than the marginal cost (MC) of eating it: do not eat
it!
Decisions are made at the margin

Marginal benefit (MB) : additional benefit derived from

consuming an additional unit of a good or undertaking one
more unit of an activity.

Marginal cost (MC) : additional cost for consuming an

additional unit of a good or undertaking one more unit of
an activity.
Economics is about incentives

Incentive: something that motivates or encourages a

person to undertake an action.

Without proper incentives in place, it’s hard to motivate

anyone to do anything. People respond to incentives!
The Economist as Scientist

Economists play two roles:

1. Scientists: try to explain the world
2. Policy advisors: try to improve it

In the first, economists employ the

scientific method, the unemotional development and
testing of theories/models about how the world works.
Assumptions & Models /Theory

Assumptions simplify the complex world, make it

easier to understand.

Example: To study international trade, assume two

countries and two goods. Unrealistic, but simple to
learn and gives useful insights about the real world.

Model: a highly simplified representation of a more

complicated reality. Economists use models to study
economic issues.
Some Familiar Models

A road map
 Some Familiar Models

A model of human
anatomy from high
school biology class
 Ceteris Paribus
All other things equal / constant.

Economists cannot easily do experiments and most economic behavior has

many simultaneous causes.

To isolate the effect of interest, economists use the logical device called ceteris
paribus or “other things being equal”

Economists try to isolate cause-and-effect relationships by changing only one

variable at a time, holding all other relevant factors unchanged.
 Positive and Normative Statements
Economists distinguish between two types of statements:
▪What is — positive statements. They describe the world as it is
▪What ought to be — normative statements. They prescribe how the
world aught to be.

A positive statement can be tested by checking it against facts – if it is

false, data will show it to be false. E.g all else equal, if the price of a
good increases, then quantity demanded will fall. (we can collect data to
test this statement!)

A normative statement cannot be tested – it involves opinion or value

judgments E.g we should cut taxes, or we aught to increase minimum
wage, or …