Year of Study: 1st

Module Code: PEC 100110

Module Name: Principles of Economics
Faculty: Economics and Management Sciences
University: UNILAK
Instructor: Albert O. Maake, PhD

Class Notes: Unit 1

Unit I:
NATURE OF ECONOMICS ANALYSIS

1.1 General Introduction

For the more understanding the nature of any subject, it is essential to examine its definition. So
to define a dynamically changing science like economics, however, is not an easy job. Normally
a good definition must have two prerequisites:
a) It must reveal the key ideas relating to the different elements and issues concerned
with the field of investigation;
b) It must delineate the scope of the subject.

Following the chronological order various schools of economic thoughts, the most widely
acclaimed definitions of economic science may be grouped as: i) the classical or wealth
definitions, ii) the neo-classical or welfare definitions, and iii) the modern definitions- a) scarcity
definition, and b) growth definition.

1.2 The classical or wealth definitions

Economists like Adam Smith, J.B. Say and J.S. Mill formulated their definitions in terms of
wealth, which are described as classical definitions.

 Adam Smith, in his celebrated book, “The Wealth of Nations” he defines economics in
the following words: “Political economy considered as a branch of science of statesmen
or legislators, proposes two distinct objects: 1st, to provide a plentiful revenue or
subsistence for themselves, and 2nd to supply the State or Commonwealth with the
revenue sufficient for the public services. It proposes to enrich both the people and the

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 sovereign.” For the sake of brevity, we may reduce the words in that definition saying
that is “science of wealth”, because he was interesting on the way of earning and
spending the wealth.

 J.S. Mill also defines economics thus: “Political economy professes to teach or
investigate the nature of wealth and the laws of its production and its distribution.”

 J.B. Say also affirmed that the aim of Political economy is to show the way in which
wealth is produced, distributed and consumed.

 F.A. Walker defined too economics thus: “Political economy or economics is the name of
that part of knowledge which relates to wealth.”

Criticism
The various wealth definitions formulated by the classical economists have been criticized on
several grounds. One of these is that too much importance attached to the wealth, while
completely ignoring man, for whose welfare, in actual fact, wealth is supposed to be a means.

1.3 The Neo-classical or Welfare definitions

Neo-classical economists like Professors Marshall, Cannan and Pigou have defined economics
in terms of welfare. Therefore their definitions are described as “welfare definitions”.
 In defining economics, Prof. Marshall puts emphasis on man rather than wealth. He also
gives importance to the ethical aspect of economic activities, and thus, in the sense,
“humanizes” the so-called “dismal science”. According to him, “Political economics or
economy is a study of mankind in the ordinary business of life”.
It examines that part of individual and social action which is most closely connected with
the attainment and use of material requisites of well-being. Thus, it is, on the one side, a
study of wealth and, on the other hand and more important side, a part of the study of
man.
 Prof. Pigou also lays stress on the welfare aspect of economics when he asserts that
economics is a science of welfare-oriented economic activities of people in the

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 community; in other words he said that the range of our inquiry becomes restricted to that
part of social welfare that can be brought directly or indirectly into relation with the
measuring rod of money.
 Prof. Cannan defines economics in terms of welfare. According to him, the aim of
political economics is the explanation of the general causes on which the material welfare
of human beings depends.

Robbins’s Criticisms

Lionel Robbbins is an ardent critic of the welfare definitions. The following are the major
criticisms:
a) The definitions are not analytical, are just classificatory and narrow. They are
classificatory because they divide economic activities into two parts: those which
contribute to the material welfare and those which do not contribute; and they are narrow
because they exclude from the economic scope all those activities which do not
contribute to the material welfare.
b) In the opinion of many economists, the concept of “welfare” is subjective.

1.4 The Modern definitions

In modern literature, some economists stress the scarcity aspect of man’s economic life, while
others emphasize the growth phenomenon in defining economics.

The scarcity definition

In his book, An Essay on the Nature and Significance of Economic Science, Lionel Robbins
sought to delimit the subject matter of economics by stating that: “Economics is concerned with
that aspect of man’s behavior which arises from the scarcity of means to achieve given ends.”

According to Prof. Robbins, human life exhibits four characteristics:

 Innumerability or multiplicity of wants;
 Arranging wants according to their importance;
 Scarcity of means;
 Means have more than one use.

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Criticisms
a) He emphasized only on the phenomenon of scarcity forgetting that the economic
problems do not arise only under conditions of scarcity but even under the conditions of
abundance. For eg: when there is overproduction, etc.
b) He has not taken into account the social aspect of the economic problems;
c) His definition disregards the ethical aspect and lacks human touch. According to Prof.
Robbins, economics is not concerned with the nature of ends.

The Growth definition

Modern economics is growth oriented. According to Professor Samuelson furnishes a growth-

oriented definition thus: “economics is the study of how people and society end up choosing,
with or without the use of money, to employ scarce productive resources that could have
alternative uses, to produce various commodities, and distribute them for consumption, now or in
the future, among various persons and groups in the society.” It analyses the costs and benefits of
improving patterns of resource allocation.

In short, economics is a science which teaches how to strive against scarcity through
economizing and advancement of resources for the benefit of the society at large. Or, it can be
defined as a social science that studies the means by which scarce resources are used to satisfy
the competing ends, needs.

Please note that word economy comes from the Greek word for “one who manages a
household.” Words are: Oikos: house and Nomos: law. At first, this origin might seem peculiar.
But, in fact, households and economies have much in common.

All economists who have contributed to the economic science such as: Karl Marx, John Maynard
Keynes, etc. are not quoted here, but their contribution is powerful to this wonderful field.

1.5 Economic problems

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Economics is the science which is fundamentally concerned with the economic problems of
every economic society. Most economic problems arise out of the fact that human wants are
many unlimited while the productive resources available to satisfy them are relatively scarce or
limited. Because of imbalance of wants and means we have to economize.
The economic problems originate from the following 4 facts of our economic life:
 The wants are unlimited;
 The means for satisfying the wants are limited;

 The wants are gradable according to their intensity and urgent;

 The resources or means are versatile, i.e they can be used for one purpose or the other.

Because of the above 4 facts, reason why we make a choice for deciding what to do and what to
let. It is the core of an economic problem. Making a choice of wants and resources is described
as an economic decision. Each choice has to be made with a view to disposing of the resources to
obtain the best result, i.e to satisfy maximum possible wants. This aspect of economizing is
technically known as the optimum allocation of resources.

Scarcity forces us to make a choice. Economics, as such, is nothing but a study of scarcity and
choice. J.R. Hicks, thus, described economics as, “the logic of choice.”

1.6 Economic questions

1. What to produce? Which goods get produced?

2. How to produce? Which method of production gets chosen?
3. For whom to produce? Distribution question. Who gets output? How to split up/allocate
output? Equal shares for everyone, highest bidder, according to political influence,
according to need, etc.

All societies have to have some form of economic organization to answer these three questions.
Two extreme forms of econ organization are:
 Market mechanism/Capitalism/Free Market/Decentralized;
 Command economy/Central Planning/Communism/Socialism/ Collectivism.

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1.7 Principles of economics

These principles recur throughout this syllabus and are introduced here to give you an overview
of what economics is all about. You can think of this point as a “preview of coming attractions.”
Please remember that these principles are more than the following:
 Scarcity
 Choice
 Opportunity costs: Because people face tradeoffs, making decisions requires comparing
the costs and benefits of alternative courses of action. In many cases, however, the cost of
some action is not as obvious as it might first appear. The opportunity cost of an item is
what you give up to get that item. In other words, the cost of something is what you give
up to get it (opportunity cost).


1.8 Factors of Production

According to Jean Baptiste Say, there are three factors of production, such as:
 Capital

Capital consists of all goods produced by human labor (with other resources) and used in the
production of still more goods and services; in other words, produced means of production.
Some examples are: machinery, houses and other buildings, grapevines, fruit trees and hogs on
the hoof, and human capital.
 Labor

But, from several points of view, labor is the most important resource. From the point of view of
cost, it is quite important. Labor is also important to most of us because it is the resource from
which we expect to get our living. It is the totality of mental and physical energy employed in
producing goods and services. It is either skilled or unskilled.

 Land

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By convention, economists include the category of land both the original and indestructible
powers of the soil, and natural resources such as: Coal, Oil, and Metallic ores.

There are, of course, some important differences. Coal and oil, once they are dug out or the
ground and burned, are gone forever. In other words, they are "wasting resources." On the other
hand, the fertility of the soil does not have to be a wasting resource, if the farmer uses farming
methods, which maintain fertility. But this difference is not absolute. Copper ores, for example,
may be used and then recycled
One way to increase production is to increase the quantity of resources available. Of these three
resources, the supply of labor and capital can be increased. By contrast, the quantity of land and
natural resources on the planet cannot be increased. It is true that we can discover more natural
resources -- even if we cannot, like Columbus, discover a new supply of agricultural land on this
planet. Discovery is not quite the same thing as creation, though; we can discover, but cannot
create, more land and natural resources. We can create more capital and give birth to more labor.
An increase in the population increases the supply of labor, but, as the saying goes, every
additional person is also an additional mouth to feed. So increase of the population will not lead
to a higher standard of living, a wealthier nation , in and of itself. It may lead to a declining
standard of living instead.
On the other hand, an increase in the supply of capital means that each worker has more tools to
work with, and can be more productive. That can lead to a higher standard of living -- to
economic growth.

In our days, information, technology, time, etc have been added on the list of factors of
production.

1.9 Economic Models

Economists also use models to learn about the world, they are most often composed of diagrams
and equations. Like a biology teacher’s plastic model, economic models omit many details to
allow us to see what is truly important. Just as the biology teacher’s model does not include all of

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the body’s muscles and capillaries, an economist’s model does not include every feature of the
economy.

As we use models to examine various economic issues throughout this book, you will see that all
the models are built with assumptions. Just as a physicist begins the analysis of a falling marble
by assuming away the existence of friction, economists assume away many of the details of the
economy that are irrelevant for studying the question at hand. All models in physics, biology, or
economics simplify reality in order to improve our understanding of it.

a) Our First Model: The Circular-Flow Diagram

The economy consists of millions of people engaged in many activities buying, selling, working,
hiring, manufacturing, and so on. To understand how the economy works, we must find some
way to simplify our thinking about all these activities. In other words, we need a model that
explains, in general terms, how the economy is organized and how participants in the economy
interact with one another.

In this model, the economy has two types of decision makers: households and firms. Firms
produce goods and services using inputs, such as labor, land, and capital (buildings and
machines). These inputs are called the factors of production. Households own the factors of
production and consume all the goods and services that the firms produce. Households and firms
interact in two types of markets. In the markets for goods and services, households are buyers
and firms are sellers. In particular, households buy the output of goods and services that firms
produce. In the markets for the factors of production, households are sellers and firms are buyers.
In these markets, households provide firms the inputs that the firms use to produce goods and
services.

The circular-flow diagram offers a simple way of organizing all the economic transactions that
occur between households and firms in the economy. The inner loop of the circular-flow diagram
represents the flows of goods and services between households and firms. The households sell
the use of their labor, land, and capital to the firms in the markets for the factors of production.

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The firms then use these factors to produce goods and services, which in turn are sold to
households in the markets for goods and services. Hence, the factors of production flow from
households to firms, and goods and services flow from firms to households. The outer loop of the
circular-flow diagram represents the corresponding flow of dollars. The households spend money
to buy goods and services from the firms. The firms use some of the revenue from these sales to
pay for the factors of circular-flow diagram a visual model of the economy that shows how a
given currency flows through markets among households and firms production, such as the
wages of their workers.

It looks like:

Or,

b) Our Second Model: The Production Possibilities Frontier

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Most economic models, unlike the circular-flow diagram, are built using the tools of
mathematics. Here we consider one of the simplest such models, called the production
possibilities frontier, and see how this model illustrates some basic economic ideas.

In economics, a production–possibility frontier (PPF), sometimes called a production–

possibility curve, production-possibility boundary or product transformation curve, is a
graph that shows the various combinations of amounts of two commodities that could be
produced using the same fixed total amount of each of the factors of production. Graphically
bounding the production set for fixed input quantities, the PPF curve shows the maximum
possible production level of one commodity for any given production level of the other, given
the existing state of technology. By doing so, it defines productive efficiency in the context of
that production set: a point on the frontier indicates efficient use of the available inputs, while a
point beneath the curve indicates inefficiency. A period of time is specified as well as the
production technologies and amounts of inputs available. The commodities compared can either
be goods or services.

There are different forms of it, as they are here below:

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A common A common PPF: increasing opportunity cost A straight line PPF: constant opportunity cost

The fourth one demonstrates the unbiased expansion in the position of a PPF; and please know
that the two main determinants of the position of the PPF at any given time are the state of
technology and management expertise (which are reflected in the available production functions)
and the available quantities of factors of production. Only points on or within a PPF are actually
possible to achieve in the short run. In the long run, if technology improves or if the supply of

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factors of production increases, the economy's capacity to produce both goods increases; if this
potential is realized, economic growth occurs.

1.10 Positive and Normative Economics

Positive economics is an unbiased, objective, scientific approach to issues. It is the positive

science because is after all a search for truth and, therefore, it should study the truth as it is and
not as it ought to be.

Normative economics involves a specific policy alternative, because it uses subjective, ethical,
or moral judgments in addition to positive approach. Normative economics is about "what ought
to be." It should be able to suggest policy measures to the politicians and prescribing guidelines
for the conduct of economic activities.

1.11 Definition of Microeconomics

Etymologically, the term “micro-economics” has been derived from the Greek word micros, i.e
small. In other words, micro means individualistic.

It is the branch of economics that analyzes the market behavior of individual consumers and
firms in an attempt to understand the decision-making process of firms and households.

Again we can say that it looks at the smaller picture and focuses more on basic theories of
supply and demand and how individual businesses decide how much of something to produce
and how much to charge for it.

It is concerned with the interaction between individual buyers and sellers and the factors that
influence the choices made by buyers and sellers. In particular, microeconomics focuses on
patterns of supply and demand and the determination of price and output in individual markets
(e.g. coffee industry).

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