BASIC MICROECONOMICS

CHAPTER I
INTRODUCTION

Lesson 1
BASIC ECONOMIC CONCEPTS

OBJECTIVES:
1. To define economics.
2. To discuss the importance of economics.
3. To discuss why we study economics.
4. To identify the fundamental economic activities and factors of production.
5. To compare the divisions of economics.

A. Nature and Scope of Economics and Microeconomics

Introductory Part
Economics is everywhere. When you turn on the TV, you will be faced with a variety of news
headlines concerning economic activities. The same goes with reading a printed newspaper or
online news, topics are mainly about economics—price fluctuations, healthcare, environmental
issues, employment, trade, globalization, and so on. In real-life situations, consumers are buying
a plethora of goods or services. Companies are always busy doing business. The government
makes so many decisions pertaining to issues and the state of the economy. Countries across the
world trade with one another to sustain every nation’s needs. These members of the economy
have something in common—economics affects their interactions. In fact, economics dictates
how they live and function. They face economic problems and they make economic decisions.

B. Basic Terms
 Needs – basic requirements for survival like food, water, and shelter. In recent years, we
have seen a shift of certain items from wants to needs like telephone services, motor
vehicles, and education.
 Moslow’s Hierarchy of Needs

 Wants – the various desires of man that must be satisfied with goods and services. Wants
are defined as something that a person would like to possess; either immediately or at later
time. Wants are not as important as needs, because a person can live without wants.
Goods versus
 Goods – things (tangible or intangible) that are produced, sold, bought, and utilized which
satisfy a person’s needs and wants.
 BASIC MICROECONOMICS

 Services – the efforts rendered by someone for a price such as haircuts, doctor’s visits, legal
consulting, etc. which also satisfy human needs and wants. Non-physical, intangible parts of
the economy, as opposed to goods which we can touch or handle.
 Consumer Goods – goods that are intended for final use by the consumer like milk, soft
drinks, and food.
 Capital Goods – goods that are used in the creation or production of other goods like
buildings, machinery, and equipment.
 Essential or Necessity Goods – goods that are used to satisfy the basic needs of man such as
food, clothing, shelter, and medicine.
 Luxury Goods – goods that man may do without but are used to contribute to his comfort
and well-being, such as chocolates, perfumes, and expensive cars.
 Durable Goods – goods that last more than 3 years when used on a regular basis.
 Non-durable Goods – goods that last less than 3 years when used on a regular basis.

C. Four Core Principles of Economic Way of Thinking

People are engaged in various activities—selling, distributing, exchanging, consuming, and so
on. These activities, at any rate, involve individual choice.
According to Krugman (2008), four economic principles describe the economic way of
thinking and underlie the economics of individual choice. These are:
1. Rational choice. Choices are necessary because resources are scarce
2. Opportunity cost. The true value of something is its opportunity cost.
3. Choosing at the margin. “How much” decisions require making trade-offs at the margin:
comparing the costs and benefits of doing a little bit more of activity versus doing a little bit less
4. Responding to incentives. People usually respond to incentives, exploiting opportunities
to make themselves better off. These four principles will be more covered in detail in the
following topics.

D. Scarcity and Choice

 Scarce – means very small in amount.
 Scarcity – a situation that arises from the assumption of unlimited needs and wants and the
fact that resources to obtain goods and services are limited.
o It implies that we cannot have all that we want; hence, we need to make the best
use of scarce resources to satisfy our wants as much as possible.
o It limits our options and forces us to make hard choices which mean that in order to
get something, we must give up something else. There is always a trade-off to be
able to satisfy unlimited wants with limited resources.
o Scarcity is the reason why people must “economize”.
 Economics is a study of decision-making. It studies what choices people make, how they are
made, and what happens as a result. The choice is the ability of an individual to make a
decision. Thus, choice always involves decision making.
 An old adage that can sum up somehow the matter of choice in economics is “There is no
such thing as a free lunch.”. It means that whatever goods and services are given, they must
be paid for by someone— that is, one cannot get something for nothing. This also implies
that every choice entails costs. These costs may take in the form of time, money, or
something that is valued.
 Since resources are scarce and a choice has to be made, one has to give up something he
already has to get something he desires. In economics literature, the act of giving up one
thing in order to get something else is called trade-off. It is the alternative a person gives up
when he makes a decision.
 BASIC MICROECONOMICS

E. Opportunity Cost
 The concept of opportunity cost is one of the core ideas in the economic way of thinking and
is vital to understanding individual choice. If an individual chooses something, he gives up
the other thing.
 This is the opportunity cost of a decision. Boyes (2008) defined opportunity cost as the
highest-valued alternative that must be forgone when a choice is made.
 For example, a student chooses to review his lessons in Economics today. This means he
gives up doing other activities—he chooses not to watch a series, do household chores, or
surf the internet. If reviewing lessons in Economics is his best alternative to a full day of
other activities, then the opportunity cost of doing activities like watching a series or surfing
the internet is the value of reviewing his Economics lessons. It’s the cost of the lost
opportunity.

F. Marginal Analysis
 Choices are not instantly made. Rational people always decide by carefully analyzing the
benefits they would get and the cost they would incur from their decisions. To put it another
way, they compare their marginal benefits and marginal costs. Marginal cost is the extra cost
of using one more unit of a good or service. In comparison, a marginal benefit is an
additional satisfaction derived from consuming one more unit of a good or service. The study
of weighing the benefits and costs usually for decision making is called cost-benefit or
marginal analysis.

G. Incentives
 Scarcity requires everyone to choose and one thing that drives one person to make a
decision involves incentives. In the most general terms, incentive is a benefit or reward that
encourages someone to behave in certain ways. Salary increase and bonuses paid to
workers, recognition awards for students, price discounts given to customers, and tax
deductions to businesses are all forms of incentives.
 Krugman (2008) points out that people usually respond to incentives, exploiting
opportunities to make themselves better off.

H. Economics as a Social Science

The discipline of Economics is social science as it seeks to explain the relationships between
people and societies. As a matter of fact, it is the “queen of the social sciences,” as cited by Paul
Samuelson. Like other social sciences such as sociology, psychology, and political science,
economics is also concerned about human behavior.
Although economics has similarities with other fields, it is viewed from a different
perspective. Economics is unique in analyzing various areas of human behavior. Economists
answer different questions and solve problems using tools and methodologies, which are far-
reaching that other social scientists find overwhelming.

I. Economics: Defined
Etymologically, the word economics comes from the ancient Greek word ‘oikonomia’—
which literally means the management of a family or a household. A household has inadequate
resources, and managing these resources will require certain decision-making skills.
There are numerous definitions of economics. Different economists have advanced more or
less the meaning of the term. Some of the commonly used specific and general definitions are as
follows:
1. Wealth definition. Adam Smith, a Scottish economist, regarded as the father of
economics, laid out in his magnum opus, “Wealth of Nations,” the definition of economics
 BASIC MICROECONOMICS

focused on wealth creation. Smith defined economics as an inquiry into the nature and causes of
the wealth of the nation.
2. Welfare definition. This definition of Economics was explained in the influential book of
Alfred Marshall, “Principles of Economics,” which focused on welfare and human activities
instead of wealth accumulation. To Marshall, economics is the 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 with the use of material required for well-being.
3. Scarcity definition. This definition is credited to Lionel Robbins, a British Economist, and
emphasized scarcity, which is central in the definition of economics. According to his book, “An
Essay on the Nature and Significance of Economic Science,” economics is the science which
studies human behavior as a relationship between ends and scarce means which have
alternative uses. His famous definition was the most accepted definition of economics and still
generally used today.
4. Growth-Oriented Definition. The definition was credited to Paul Samuelson, called by the
New York Times as the "foremost academic economist of the 20th century". According to him,
“economics is a study of how people and society choose, with or without the use of money to
employ scarce productive resources which could have alternative uses, to produce various
commodities over time and distribute them for consumption now and in the future among
various persons and groups of society.”
The meaning of the word economics has developed over time. Today, many books and other
reference materials define economics in similar ways—a science that deals with the allocation of
limited resources to satisfy unlimited human wants. Mankiw (2010) defined economics as a
science that studies how society manages its scarce resources. Krugman (2008) defined
economics as the study of the production, distribution, and consumption of goods and services.

J. Reasons for Studying Economics

Economics governs many aspects of life. Individuals whether rich or poor are always faced with
making choices because scarcity indeed exists. It is where proper knowledge in Economics is of
greater importance. Studying economics will not only help us become wiser in making everyday
life decisions but will also make us aware of our interconnectedness with other people,
organizations, and the environment we live in to contribute to society and the economy.
Basically, the following are the reasons why there is a need to study Economics.
1. Understand how goods or resources are produced and properly allocated to society.
2. Understand the behavior and roles of the different individual decision-makers: the
households, firms, and the government.
3. Explain how the national or global economy operates.
4. Know the forces that affect the dynamics of any market.
5. Understand economic issues and trends.

K. Fundamental Economic Activities

1. Production – the process of transforming raw materials to a finished product.
2. Distribution – the physical apportionment of goods and services from the producers to the
consumers; it is simply called marketing distribution or trade.
3. Exchange – the transfer of ownership over goods and services from one person to another
and this is usually accomplished using money or credit.
4. Consumption – the process of using goods and services in the direct satisfaction of human
needs and wants; it is regarded as the most important function in economics because it is
the ultimate end of economic activity; without consumption, there would be no need for
production and distribution.
 BASIC MICROECONOMICS

L. Factors of Production
1. Land – includes all the natural resources, including mineral deposits, water, air, trees,
poultry, livestock, and all other forms of these raw materials used in production of goods
and services.
2. Labor – any form of human effort like physical or mental, which is exerted in the production
of goods and services.
3. Capital – refers to the machinery, tools, equipment, and structures used in the production of
goods and services.
4. Entrepreneurship – the ability of an individual to provide the right kind of good or service at
the right place and time, to the right people at the right price.
 Entrepreneur – the person who puts together or organizes the other factors of
production (land, labor, capital) to create goods and services which can satisfy the
needs and wants of man. He is innovative and a risk taker.

M. Divisions of Economics
Economists develop economic principles and models at two levels. These two levels are the
branches of Economics: Microeconomics and Macroeconomics. Microeconomics is concerned
with the behavior and decision-making of the individual players in the economy, such as the
consumers, businesses, and the government. Microeconomics studies the prices, markets,
buying decisions of consumers, selling decisions of firms, costs of production, profit
maximization, market failure, etc. On the contrary, macroeconomics is focused on the overall
structure and performance of the national or global economy. It is concerned with the analysis
of aggregates. Macroeconomics studies the determination of national income, price level,
employment, economic growth, money, economic policies, international trade, among others.
The comparison of topics of interest for microeconomics and macroeconomics is depicted in
Table 1.1.

Table 1.1 – Matrix of Comparison of Topics between Microeconomics and Macroeconomics

Microeconomics (Topics of Interest) Macroeconomics (Topics of Interest)
Supply and demand for goods and services in Aggregate demand and aggregate supply
the market
Worker’s decision, employment in an Employment and unemployment
industry
Price of a product General price level and inflation
Commodity market, labor market, etc. Financial market, Stock exchange
Domestic trade International trade
Firm’s profit, household income National Income, GDP
Mortgage loan interest General Interest rate
Government regulations, government failure Government economic policies – fiscal
monetary policies