Poornima Weerasinghe

1. Introduction
Definition
• The subject that analyses how resources of a society are allocated to satisfy their
wants through production, distribution and consumption of goods and services
-Britannica Encyclopedia-

Production Distribution Consumption

Economics is the study of the relationship between scarce resources with alternative uses and
human wants.

1. Human Needs and Wants

 Needs- The basic necessities humans require to ensure survival (Eg: Food, Shelter)
 Wants- The different ways of fulfilling needs (Eg: Food- rice, tea, biscuits, pizza)

Needs

Physical Mental
Needs Needs
Needs fulfilled by consuming Needs that cannot be fulfilled directly
goods and services. by consuming goods and services
Eg: Food, Shelter, Clothing Eg: Love, Companionship, Spirituality

 These human needs and wants are unlimited.

2. Scarce Resources
 Humans have unlimited needs and wants. They can never be completely fulfilled.
 But the resources we have, to fulfill these needs and wants are limited. Therefore,
they are called scarce resources.

3. Alternative Uses
 However, these scarce resources can have different uses at a given time. i.e, there
are different options in which we can invest these resources.
Eg: Water- Drinking, Cleaning, Cooking, Watering plants.. and many other uses

*Because of the unlimited nature of human needs and the limited nature of resources available to
fulfill those needs, people have to behave economically.
 Poornima Weerasinghe

The activities performed by people to fulfill physical needs and wants of a society using limited
resources amounts to their economic behaviour.

Social Science
Since Economics study the behaviour of people in a society, there is a social aspect to
Economics.

Since economic theories and principles that we study are derived using the scientific method, there
is a scientific aspect to Economics as well.

Identify the problem

Formulate question

Formulate hypothesis

Collect Data

Test the hypothesis

Draw conclusions

Therefore, Economics could be identified as a “social science”

Sciences

Natural Social
Sciences Sciences
*Economics differ from natural sciences because they:

 Examine behaviour of people

 Theories developed cannot be proved in laboratories
 Theories formulated aren’t rigid as human behaviour changes over time, regions and social
environments

Economics in particular studies the human behaviour related to production, exchange and
consumption

Economics is considered as the “queen of social sciences” because it represents a broad aspect of
human society and most of the social issues arise from economic problems faced by humans.
 Poornima Weerasinghe

Natural
Production
Sciences
Sciences Behaviour in a
Social social setting
Distribution
Sciences

Consumption

Scientific
method

Importance of studying economics

 Important to rule the country
 Important to be a successful citizen
 Ability to understand economic phenomenon well
 For efficient decision making as an investor, consumer and producer
 When making voting decisions
 As students to make logical decisions
 To select a better job

Classifications of study of Economics

Microeconomics Vs Macroeconomics

Microeconomics Macroeconomics
Studies small units of an economy Studies the economy as a whole
Studies variables at individual level Studies variables at aggregate level
Has a comparatively narrow scope Has a broader scope
Studies how government intervention affects Studies how government intervention affects
individual units the entire economy
Eg: Demand and supply for particular products Eg: Aggregate output/ income level
Production function of firms Economic fluctuations and depression
Scarcity Inflation
Employment level
Investments

Positive Economics Vs Normative Economics

Positive Normative
Objective statements that can be verified Subjective statements that may not be verified

Answers the questions what was? What is? And
What will happen?
Consists of most of the economic theories that
could be accepted or rejected based on real
world facts and data
Used to explain economic behaviour and
phenomenon
Eg: There is a negative relationship between
price and quantity demanded
The unemployment level of Sri Lanka in 2013%
was 44%
Needs and Wants
Needs
Basic necessities required to sustain life
Arise from biological sources
Needs do not change overtime
Common to all
Limited
Represents necessity
Essential for survival
Eg: Food, Shelter, Clothing
Poornima Weerasinghe
Answers the question of what should happen?
It is difficult to test the correctness using real
world data
Used for economic policy analysis
Eg: The monthly salary of Government workers
should be increase by Rs. 5000
Every citizen should be given medical supplies
for free
Economic growth rate should be maintained at
8%
Wants
Different forms of fulfilling needs
Arise from traditions, values and culture
Change overtime
Changes from person to person
Unlimited
Represents desire
Not essential for survival
Eg: Food- Rice, pizza, tacos, cake
Shelter- Apartments, Flats, 1 story house
Clothing- Denims, frocks, crop tops
 Poornima Weerasinghe

Goods
Anything that provides positive satisfaction/ utility is termed as a good

Goods

Economic Non- Economic

Goods Goods

Goods with scarce supply Unlimited supply

There is a resource cost and No resource cost or

opportunity cost opportunity cost

Consumes scarce resources No scarce resources

for production therefore, consumed in production
they demand a price therefore do not demand a
price
Problem of choice can occur
No problem of choice
No room to become a non-
economic good Can become an economic
good
Eg: Books, Pens, Smart
phones, Wifi, Solar energy Eg: Air, Sunlight
produced by solar panels,
Bottled water, Oxygen for
divers/patients

Resources
Economic Resources Vs Non- Economic Resources

Resources

Economic Non- Economic

Resources Resources

Resources with limited Resources with unlimited

supply supply and gifted by nature

There is an opportunity cost No opportunity cost in

when consuming consuming

Eg: Land, fuel Eg: Sunlight, Air, Rain water

 Poornima Weerasinghe

Resources gifted by nature are also called as natural resources. These could be further divided as
renewable and non- renewable resources.

Renewable Vs Non- Renewable Resources

Natural
Resources

Renewable Non- Renewable

Resources Resources

Resources that do not get Resources which are used up

used up with consumption in consumption

Eg: Forestry, Fisheries Eg: Gas, Gold, Coal

However, natural resources need to be preserved to ensure sustainable development.

Over-consumption of natural resources could cause complications such as:

 Global warming
 Liquidation of glaziers
 Damage to ozone layer
 Water shortage
 Natural disasters

Factors of Production
The resources that are used in the production process are called factors of production. They are
namely:

 Land
 Labour
 Capital
 Entrepreneurship
FOP Definition Characteristics
Land Natural resources that can productively Gift of nature
be used in the production process. Inelastic supply
Eg: Forests, minerals, oceans, animals Immobility
Possibility to improve
Payment for land is called rent productivity
Non uniformity
Labour Mental and physical efforts used to Being a live factor
produce goods Mobility
Heterogeneity
Payment is called wages Possibility to improve
productivity through
Size of labour force is affected by: education and training
 Size of population and age Decision making and
structure organizing ability
 Poornima Weerasinghe

 Health
 Level of education and skills
Capital Man made aids used in production Being a man made factor
process Being a real factor
Being a stock factor
Payment is called interest Consists of productivity
Ability to be reused in
Types of capital: production
 Fixed/ real capital Possibility to depreciate
 Circulating capital
 Economic overhead capital
 Social overhead capital
 Human capital
 Natural capital
 Social capital
Entrepreneurship The factor that combines all other Being a human factor
factors of production, organizes Being a generating force
production activities, operating and Successfully facing
making policies while bearing risks. challenges
Leadership
Payment is called as profit Futuristic vision
Belief in self
Functions performed: Room for training
 Mobilizing FOP’s Creativity
 Organizing production activities Identifying opportunities
 Introducing innovations Positive thinking
 Risk bearing Flexibility

Factor Productivity
Average output obtained by a unit of input.

Total Output
Factor Productivity = Total Input

Determinants of factor productivity

 Technology
 Human capital
 Management
 Division of labour and specialization

Scarcity
Scarcity is known as the central economic problem

It simply means the limitedness of resources compared to human wants

Scarcity is a relative concept as it holds that resources are limited relative to human wants
 Poornima Weerasinghe

Problem of scarcity arise due to:

 Unlimitedness of human wants at a given period

 Limitedness of resources used to produce unlimited wants at a given period

Efficient utilization of resources cannot solve the problem of scarcity as wants will remain unlimited

Scarcity is the central economic problem because:

 It is common to everyone
 Every society will face the problems of what to produce in what quantity, how to produce
and for whom to produce

Choice
Although resources are scarce, they have alternative uses. This gives rise to the problem of choice.

Choices have to be made by households, business firms and government in various ways

Scarcity gives rise to the 3 choices in any economy. Namely:

 What to produce in what quantity?

 How to produce?
 For whom to produce?

Opportunity Cost
When making choices, the value of the next best alternative forgone is called opportunity cost

Also called as real cost and economic cost

There will always be an OC for economic goods

OC is not a financial cost. It shows the real value of the next best alternative forgone

OC is subjective, and differs from person to person

There is an external cost associated with OC

OC can be 0 when:

 There are unlimited resources (non- economic goods)

 Absence of alternative uses
 When there are unemployed resources (under-utilized resources)

Basic Economic Problems

Scarcity gives rise to 3 choices in an economy. These are identified as the basic economic problems.
They are namely:

 What to produce in what quantity?

 How to produce?
 For whom to produce?

What to Produce in What Quantity? (Resource Allocation Problem)

 Poornima Weerasinghe

An economy needs to decide what goods will be produced using its scarce resources and in what
quantities should these goods be produced. Resources will be allocated based on these decisions.
Therefore, this problem is also known as resource allocation problem.

Further, it should also be decided how much of goods will be used at present and how much goods
to be kept for future use. i.e, of the available resources, how much will be used and present and how
much will be kept for future use.

How to Produce? (The Problem of Production)

This is deciding which production technique to be used.

Also gives the idea of which resources to be used in which proportions

How to
produce?

Labour Capital
intensive intensive

Since problem is related to production technique, it is also called as the problem of production

For Whom to Produce? (Problem of Distribution)

This is deciding how the produced stock of goods would be distributed. i.e, who will own the limited
amount of goods produced using scarce resources.

The distribution depends on the income of a person’s income. And the income here means the
factor income by owning factors (Land- rent, Labour- wages, Capital- interest, Entrepreneurship-
profit).

More the factors owned by a person, more the income he/she gets and more the goods that could
be purchased by that person.

Since this problem decides upon the distribution of the total product of an economy based on the
income, it is also called as the problem of distribution.