Econ 1 | Lesson 1

Economics
Prepared by:
Mariel Montalba, LPT
Lesson 1

Introduction
Why do we need to study economics?
THE ESSENCE OF ECONOMICS
Economics is a social science essential for managing
scarce resources to satisfy unlimited human wants and
needs.
Factors of production – resources; contribute to the
production of people’s varying needs and wants.
1. Land
2. Labor
3. Capital
4. Entrepreneurship

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 1. Land
– the factor of production which covers all
natural resources that exist without man’s
intervention.
Factors of It encompasses all things derived from the
Production forces of nature such as air, water, forests,
vegetation, and other forms beyond the
earth’s surface, like minerals.
These resources are not man’s creation
and are simply irreproducible.

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 2. Labor
– refers to human inputs, such as manpower and
skills that are used in transforming resources into
different products that meet our needs.
3. Capital
Factors of - The man-made factor of production used to
create another product.
Production
- Examples of capital resources are the machinery
and equipment commonly used in manufacturing
companies.
4. Entrepreneurship
- Integrates land, labor, and capital to create new
products.
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 The four (4) factors of production
are scarce, that is, they are either
improperly allocated or limited.

The finite nature of land, labor,

capital, and entrepreneurship
consequently makes the
existence of scarcity, on top of
our unlimited wants and needs, a
universal and perpetual
phenomenon.

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 NEEDS VS WANTS
things we cannot live non-essential things we
without can live without
 Scope of Economics
Microeconomics
- deals with the economics of the firms. It focuses on the behavior
of a particular unit of the economy such as the consumers,
producers, and specific markets.

Macroeconomics
- deals with the aggregates. Its scope is wider as it studies the entirety
of an economy, whether national or international, and attempts to
determine economic changes.

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 The Method of Economics

Positive Analysis & Describes what exists and how things work. It has a more objective
orientation that distinguishes it from normative economic analysis
Normative Economic which looks at the outcome of economic behavior through judgments
Analysis and prescriptions for our courses of action.

Positive statement: “Taxes provide government services to the people.” (it only describes the
existence of something; they only tell what is)
Normative statement: “Government should levy more taxes to provide more services to the people.”
(simply add an expression of an opinion or value judgment)

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 Theories and Models
Propositions about certain related variables
that scientifically explain a certain
phenomena.
Population Theory of Thomas Malthus
– scrutinizing food and population
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Used to illustrate, demonstrate, and
represent a theory or parts of it. Models
simplify an explanation or description of a
certain economic phenomenon, often
employing graphs, diagrams, or
mathematical formulae.
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Fallacies in Making Models and Theories

1. The post hoc fallacy – The post hoc ergo propter hoc fallacy relates two events as if the
first event causes the second one to happen. It is commonly constructed in this form:

A occurred immediately before B. Therefore, A caused B.

Suppose a particular economy experienced an oil price hike as a result of an increase of fuel
prices in the world market. Subsequently, inflation occurred. Some may deduce that the
increase in fuel prices is the reason for inflation. However, in reality, even without an increase
in fuel prices, inflation may occur as a result of several other factor like an excessive supply of
money or a depreciation in exchange rates.

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Fallacies in Making Models and Theories
2. Failure to hold other things constant under the ceteris paribus assumption

– When you are generalizing events as if they were all the same and all the results were
predictable, you are actually committing this second fallacy. The Latin phrase, ceteris
paribus, meaning “all things being equal or held constant,” is one of the frequent
assumptions in economics. This is commonly applied in building economic models which rely
on the principle that in order to explain a specific economic phenomenon, each of its
variables should be studied one at a time. However, it is of course difficult to hold everything
constant because in reality, an event cannot simply be free from the influence of other
variables.

For example when the price of a particular brand of soda drink goes down, we can assume
that more consumers will buy the said commodity. But what if a new and cheaper brand of
soda drink is sold in the market? Or what if the reduced price is still beyond the purchasing
power of the consumers? The fallacy is committed because we draw the conclusion of this
event under the ceteris paribus assumption.

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Fallacies in Making Models and Theories
3. The fallacy of composition

– The fallacy of composition states that what is true for a component is also true for the entire
thing. Suppose the claim, “Mr. A wins the lottery and becomes a good businessman;
therefore, all lottery winners will become good businessmen.” In this statement, the fallacy is
committed since we cannot assume that all lottery winners have the capabilities of Mr. A to
become a good businessman.

4. Sweeping generalization fallacy

– The sweeping generalization fallacy is committed when a statement wraps up everything

with no exemptions to the rule, as if making it a general statute. An example is the sentence:
“There is no treatment for AIDS and if a person gets this disease, he/she will never be cured.”
This statement generalizes that all those who got the disease cannot be healed. However, it
does not take into account cases such as that of former NBA star Magic Johnson who got
the disease a long time ago but until now shows no signs of deteriorating health.

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The Economic Systems and the Basic Economic Questions
The existence of scarcity is central to the study of economics. Scarcity necessitates the proper
allocation of resources to meet people’s unlimited wants. This process of allocation answers three
economic questions:

What to produce? How to produce? For whom to produce?

A society determines the
kind and quantity of
products it will produce
depending on what the
consumers want to buy or
are willing to pay for.
A society decides who will
produce goods and what
process of production will
be used. Goods may be
produced by corporations,
small business-owners, or the
government itself. The
process of producing goods
may be addressed
depending on the costs and
the availability of resources
needed.
The question revolves
around the issue of who will
benefit from the good and
services produced. This
depends on the distribution
of wealth in a particular
society. Therefore, a
consumer who has the
capacity to pay for certain
goods and services is more
likely to benefit than one
who could not afford them.

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 ECONOMIC SYSTEM
characterized by the type of institutions responsible for the
management and allocation of resources used in the
production of goods and services.

THREE (3) KNOWN ECONOMIC SYSTEMS

1. Market Economic System – these three questions are respectively answered by: producing
goods that yield high profits; producing at “constant returns to scale” with minimum costs;
and distributing the goods to those who can afford to buy them

2. Command Economic System – where all resources are owned by the government. The
question “What to produce?” is answered by producing more public goods like roads, public
schools, and public hospitals. The question “How to produce?” is answered by employing all
possible laborers and using the available machinery and equipment. The government
answers the final questions by producing for the public.

3. Mixed Economic System – where all three questions are answered by both the
government and private entities in consideration of their mutual benefit. Today, most
countries apply this type of economy but in different proportions--some with more of
command than of market or vice versa.
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 OPPORTUNITY COST AND TRADE-OFF
One of the pervasive effects of scarcity is opportunity cost. This
refers to the cost of giving up an alternative by selecting the
next best choice. When resources are scarce or limited,
consumers are compelled to choose how to manage them
efficiently and decide how much of their wants or needs will be
satisfied and how much of them will be left unsatisfied. Hence,
when a particular need is pursued, all the other alternatives are
forgone. And the more we have of this good, the more we
sacrifice those other things.

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 OPPORTUNITY COST AND TRADE-OFF
For instance, the cost of a soda drink today is PHP 25. The
opportunity cost of buying it corresponds to all other items that
can be bought with the same amount. When a consumer
pursues to purchase two soda drinks, he will be giving up a PHP
50 worth for other things. It is important because we can identify
the good points we have to give up in order to get another. This
is what economists call a trade-off. In our example, the good
points a consumer got from losing the PHP 50 are the possession
and consumption of the soda drink, his thirst being quenched,
and his wants being satisfied.

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Production Possibility Frontier and
Opportunity Cost
The concept of trade-off is illustrated in economics by the production possibility
frontier (PPF). It is a graph which shows the greatest sum of output given the
accessible inputs, or factors of production, in an economy.

For example, a firm needs to produce two types of soda drinks. Table 1.1 shows
all possible production combinations of two kinds of soda drinks manufacturer
can produce in a given time. Using a fixed amount of inputs (resources), a
manufacturer can produce 40 units of orange soda and none of the cola drinks
in one hour, 30 units of orange sodas and 20 units of cola in two hours, and so
on. The trade-off is illustrated here by showing how much of the cola drinks is
not produced as the manufacturer chooses to spend more time producing
orange sodas.
Production Possibility Frontier and
Opportunity Cost
From the combination in Table 1.1, we can obtain the production possibilities
frontier. Figure 1.1 shows the graphical representation derived from the table.

TABLE 1.1 Trade-off Between Orange Soda and Cola

Point Number of Hours Orange Soda Cola
A 1 40 0
B 2 30 20
C 3 25 25
D 4 10 35
E 5 0 40
Production Possibility Frontier and
Opportunity Cost
From this figure, we can observe
that at point A, 40 units of orange
sodas but none of the cola drinks
will be produced. At point B, two
hours will be consumed to make
30 units of orange sodas and 20
units of cola. At point C, three
hours will yield 25 orange sodas
and 25 colas. This goes on for five
hours, when no orange soda but
40 colas will be manufactured
(point E).
Production Possibility Frontier and
Opportunity Cost

Therefore, the opportunity cost of

producing cola drinks is the
amount of orange soda that the
manufacturer had to give up in
order to produce the cola. To
produce 20 units of cola (from
point A to point B), 10 units of
orange soda had to be given up.
Opportunity Cost and Comparative Advantage
Opportunity cost can also be used and analyzed on a wider scale such as in the
international trade. In international trade, the comparative advantage is a
principle which states that if a nation decides to specialize in the production of a
certain good in which it has the largest advantage over other nations, the
amount of the output will increase.

Consider for example two countries, Country A and Country B, manufacturing

both agricultural and technological products using 100 units of resources for
each. Table 1.2 shows that both countries yield 150 units of these products.
However, Country A’s strength is in producing agricultural goals while country B
has more advantage in producing technological goods.
TABLE 1.2 Production of Country A and Country B (no trade)
Country Agricultural Products Technological Products Total
A 100 50 150
B 50 100 150

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Opportunity Cost and Comparative Advantage
If countries A and B do not trade, both countries need to produce both goods. However, if
Country A decides to specialize in agricultural production, that is, to allocate all its
resources in producing agricultural goods, its output will increase. Table 1.3 shows that
when Country A uses all its resources on the products it specializes in, its output increases
by 50 units. The same happens to Country B. When Country B focuses its production to
technological goods, its total output becomes 200 units. If the two countries start to trade,
opportunity cost is eliminated because the forgone units for specializing in a product will be
compensated by more of it from the other country. In the final analysis, after trade, both
countries will have 100 units of each product amounting to 200 units in all.

TABLE 1.3 Production of Country A and Country B (with trade)

Country Agricultural Products Technological Products Total
A 100 + 100 200
B 100 + 100 200

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That ends for
Lesson 1! ☺