CHAPTER 1: INTRODUCTION TO ECONOMIC THEORY Variable

A factor that is subject to change or variations.

Terms to REMEMBER!!!
Macroeconomics
ECONOMICS The branch of Economics that studies the economy as a
A social science concerned with man’s problem issuing scarce whole, also known as National Economy Analysis.
resources to satisfy unlimited wants.
Microeconomics
Basic needs The branch of Economics that deals with parts of the
Man’s needs required for his survival. economy such as household and the business firm, also
known as Price Theory.
Luxury Goods
Goods that can do without. Market
Context in which buyers and sellers buy and sell goods,
ECONOMIC RESOURCES
services, and resources.
Inputs used in the production of goods and services.
Economic System
Land
The framework in which a society decides and needs of
Natural resources, not man-made, covering anything found
consumers that have to be satisfied.
on or under land, including water, forests, minerals and
water Wants
The various desires/needs of consumers that have to be
Labor
satisfied through the use of goods & services.
Human effort expanded in production regarding basic
economic problem Function
Depicts the relationship between two or more variables. It
Normative Economics
shows how one variable depends on another variable or
An analysis of economics which deals with what should be.
variables, called the independent variables. For example, the
Positive Economics demand function shows how demand, the dependent
An analysis of economics which deals with what actually is. variable, varies according to a change in price, the
independent variable.
Empirical Validation
The us of statistics evidence to prove the validity of the ECONOMIC ENTITY
hypothesis.
“Man’s Best Economic Activity”
Economic System
Consists of efforts to satisfy human wants with the use of
The means by which an economy reaches decisions.
goods and services.
Free Enterprise System
Three elements are involved in this objective of satisfaction.
A system in which all economic resources are privately
owned. Individuals are free to engage in a business of their 1. The human wants which are unlimited.
choice.
2. The use of resources which are available in limited
Right to Private Property amounts.
The right of private individuals and enterprises to own things
of value. 3. The technique of production which shows how
resources are used and combined in production.
Entrepreneur
Organizes all other factors of production to be used in the CONSUMPTION
creation of goods and services.

Capital “household”
Materials used in the production of goods and services For example:
including money.
✘ A student budgeting his
Theory/Hypothesis or her allowance for a
An unproven proposition tentatively accepted to explain “basic week.
certain facts or to provide a basis for further investigation. consuming unit”
Opportunity Cost
Refers to what you have to give up to buy what you want in
terms of other goods or services
SATISFY
HUMAN
WANTS
WITH GOOD
BUSINESS FIRM PRODUCING UNIT & SERVICES
For example:
A shoemart selling shoes.
✘ WORKERS – Get paid
✘ RESOURCES – Get profit from entrepreneurs
✘ CONSUMERS – Get their want shoes.
GOALS OF ECONOMIC ACTIVITY
 Unemployment
Leads to existence of idle resourcces.
 Economic Instability
Makes nation’s producers difficult to make accurate
forecasts on demand and consumption levels.
 Low Level of growth & development
Make it more difficult for underdeveloped and
developing nations to rise from their low levels of income
and employment.
 Inequality in Income Distribution
Resulting in the concentration of the nation’s wealth
in the hands of a few.
 Determination of the type of economic system
To adopt to fit the country’s peculiar conditions and
needs.
ECONOMICS ANALYSIS AND ECONOMIC POLICY
✘ Economic analysis is the process of directing
economic relationships by examining economic
behaviour and events, and determining the causal
relationships among the data and activities observed.
✘ The third tool of economics is the mathematics which
enables the analyst to conceptualize and quantify a
hypothesis for empirical validation.
PURPOSES OF ECONOMIC ANALYSIS
✘ Economic analysis is an aid in understanding how an
economy operates because it explains how economic
variables are related to one another.
✘ It permits prediction of the results of changes in the
economic variables.
✘ Its serves as basis of policy formulation.
ECONOMIC POLICY
✘ Economic policy consists of intervention or courses
of action takes by the government or other private
institutions to manipulate the results of economic
activity. The economic policy adopted by the
government may be monetary, fiscal or trade for the
purpose of achieving economic welfare.
METHODOLOGY
✘ Like the theory of any other science, it consists of
sets of principles or causal relationships among the
important “facts "or variables that surround and
permeate economic activity.
THE CONSTRUCTION OF ECONOMIC THEORY
✘ In economics we may build a theory of consumer
behaviour on the postulate of consumer rationality,
defined as the general desire of consumers to secure
as much satisfaction as they can in spending their
incomes.
Our process is easy
STEP 1
Then in the construction of a theory is the specification of its
functions and postulates.
STEP 2
The observation of “facts” concerning the activity about
which we want to theorize.
STEP 3
The application of the rules of logic to the observed facts in
an attempt to establish causal relationship among them and
to eliminate as many irrelevant and insignificant facts as
possible.
STEP 4
The process of establishing a set of principles is a crucial one.
The Functions of Economic Theory
The principal functions of economic theory fall into two
categories:
✘ (1)to explain the nature of economic activity
✘ (2)to predict what will happen to the economy as
facts change.
POSITIVE ECONOMICS is supposed to be completely
objective, limited to the cause-and-effect relationships of
economic activity; it is concerned with the way economic
relationship are.
NORMATIVE ECONOMICS is concerned with what ought to
be. Value judgments must necessarily be made; that is,
possible objectives to be achieved must be ranked, and
choices must be made among those objectives.
Price and Economic Theory
Price theory (microeconomic theory) and the theory of the
economy as a whole (microeconomic theory) constitute the
basic analytical tool kit of he discipline of economics.
✘ MICROECONOMICS is concerned primarily with the
market activities on individual economic units such as
consumers, resource owners, and business firms.
✘ MACROECONOMICS treats the economic system as a
whole rather than treating the individual economic units
of which it is composed.
Characteristics of Microeconomics
1 Microeconomics looks at the decisions of individual units.
2 Microeconomics looks at how prices are determined.
3 Microeconomics is concerned with social welfare.
4 Microeconomics has a limited focus.
5 Microeconomics develops skills.
 Logical Reasoning
 Construction and use of models
 Decision-Making techinuques
 Personal resource allocation
Economic Models
Economic models are composed of a series of statements of
assumptions or given and statements or implications or
deductions.
MODELS ARE ABSTRACTION
A common feature of all models is that they focus only on
the essential elements of an object or process.
Models that consistently predict a broad range of real-world
phenomena are classified as theories.
“Not all models are theories.”
When there is a correspondence between the conditions
described in the assumptions of a model & the conditions in
the economy, the model maybe applied to predict or forecast
events in the economy. The test of the theory is the
consistency of its prediction.
We can say that microeconomics is concerned with three
types of models: There are models to explain;
1. The resource allocation or choice decisions of
individual household, procedures, & firms.
2. How prices & quantities exchanged are determined
in various types of market structures.
3. To examine the market economy as an interrelated
system.
An example of a Model
Intervention in the energy industry has been practised by
government in at least 4 forms; price & tax admnistration,
licensing, rationing, and corporate participation in the
industry.
Assume a peroluem product demand function that can be
expressed as;
(1) Qt = a – bP
Where;
Qt is total industry sales
P represents the selling price of the private firms acting
jointly
a & b are positive coefficients
Profit will be maximized when;
(2) P = (a + bk)/2
Then the results sales would be;
Q = (a - bk)/2
In turn, private firms can follow any of 3 price strategies, in
reaction to the price set by the government firm;
Strategy A
Select a price level that will maximize joint monopoly
profits after allowing the government firm to sell all
it can at the price that it selects. Private firms will
end up pricing above the government’s price level.
Strategy B
Price the government firm’s price level & sell all that
the market will clear up to the extent of their
capacity..
Strategy C
Match the government price in cooperative fashion
& share the market proportionately.
COMPARATIVE STATISTICS
Focuses on the shift in equilibrium positions for an individual
decision unit, market or economic system.
VS
DYNAMIC ANALYSIS
Focuses on the pattern & rate of change for some variable
between points in time.
For example;
In a competitive market, supply & demand for a commodity
reaches at the price of equilibrium at the price of P20 per
unit.
PARTIAL EQUILIBRIUM
Analysis compared equilibrium changes for one decision unit
or one make independent of related changes in the economic
system. Assumes that the other factor will remain the
same(ceteris paribus assumption).
Qd = f(P)
VS
GENERAL EQUILIBRIUM
Analysis recognizes the interdependence of all decision units
& all markets in the economic system. Examines changes
w/in the context of the entire system. All variables are
allowed to adjust to response to the initial change, then the
change incorporated into the calculation.
Qd=f(P, Y, Po, Pe, Ad)
AN OVERVIEW TO THE ECONOMY
The Circular Flow of the Economy
Within the economy, the basic activties of producton unit,
consumption, employment & income generation take place
through the interrelationship existing between the basic
consuming unit, w/c is the houseold & the bsic producing
unit, w/c is the firm.
Basic Economic Problems
All nations, big or small, developed or undeveloped, have to
find answers to the following economic problems:
1 What to produce?
2 How much to produce?
3 How to produce?
4 For whom to produce?
ECONOMIC SYSTEMS
Traditional Economic System
Command Economic System
Market Economic System
The Market System and the Enterprise
The market system is the best described as characterized by
free enterprise where individuals enjoy the right of private
property.
Under free enterprise system, the individual is free to do any
of the following:
1. Purchase goods and services of his choice within the
limits of income.
2. Offer sale for sale his economic resources in
exchange for a financial remuneration.
3. Establish a business enterprise of his choice for the
production and sale of a desired product.
The Mixed Economy
It is seldom that an economic system exists in its pure
form. In a mixed economy, the question of what to produce
and how to produce, answered predominantly through the
price mechanism, are modified through government
intervention in the form of direct controls, taxes and
subsidies.
The problem of for whom to produce is also solved
by the price-mechanism coupled with different forms of
government regulation. The economy will produce those
commodities that will satisfy the wants of those people who
have the money to pay for them.