Introduction to

Economics
 Objectives
At the end of the lesson the learners will be able to:
a. Define Economics as a social science
b. Apply the concept of opportunity cost when evaluating options and making
economic decisions;
c. Make decisions based on how man can satisfy most of his wants given limited
resources;
d. Differentiate macroeconomics and microeconomics; e. Describe and state the
importance of economic resources;
f. Analyse basic economic problems and propose solutions to the problems using
the principles of applied economics; and
g. Describe the various economic systems
 Scarcity
Scarcity is a condition where there are insufficient
resources to satisfy needs and wants of a
population. It is the result of people having
"Unlimited Wants and Needs," or always wanting
something new, and having "Limited Resources."
Limited Resources means that there are never
enough resources, or materials, to satisfy, or fulfil, the
wants and needs that every person have. Scarcity
may be Relative or Absolute.
 Types of Scarcity
 Absolute scarcity: First, it may be that there are simply insufficient quantities of a
resource to meet human needs or wants. We call this absolute scarcity. No matter
how much we look or try to find additional sources, there are none to be had. Lack of
food leads to starvation, lack of water leads to drought, thirst, and crop failure – and
starvation. There simply is no food or water to be had, at least in that particular area.
 Relative scarcity: Second, there may be physical quantities of a resource present but
scarcity exists because of problems about supply or distribution. Meeting the demand
for that resource might mean exploiting lower quality resources. For example, food
production may require cultivating lands that are poorly suited to farming, such as on
steep slopes or in very arid areas, requiring a greater effort (more labour) and other
inputs (chemical fertilizers, irrigation) in order to meet the demand. Another example
concerns the exploitation of fossil fuels. When the most accessible and best quality
fuels are fully exploited (e.g., sweet crude from the Middle East or other areas) we
may turn to lower quality fuels (tar sands) to meet our needs.
Economics
 Economics helps us understand the decisions that
individuals, families, businesses, or societies make, given
the fact that there are never enough resources to
address all needs and desires. Economics, as a study is
the social science that involves the use of scarce
resources to satisfy unlimited wants. Part of human
behaviour is the tendency of man to want to have as
many goods and services as he can.
 However, his ability to buy goods and services is limited
by his income and purchasing power. It is therefore in
this context that man has to practice economics.
Alfred Marshall

Well-known economist Alfred Marshall

described economics as a study of mankind
in the ordinary business of life. It examines part
of the individual and social action that is most
closely connected with the attainment and
use of material requisites of well-being.
CHOICE AND DECISION-MAKING
The process of making a choice is not always easy. Because
resources are scarce, consumers need to make wise
choices. One must know to identify the problem and then
analyse the alternatives. There are alternatives and costs to
everything we do. Because economist studies how people
satisfy unlimited wants with the use of scarce resources, they
are also concerned with strategies that will help us make
the best choices. Every time a choice is made something is
given up. The world of economics is complex and the road
ahead is bumpy. Studying and understanding economics is
vital to our understanding of how the world works.
Economic decisions

Economic decisions are those decisions in which

people (or families or countries) have to choose
what to do in a condition of scarcity. Scarcity occurs
because people have unlimited wants but only have
limited resources with which to fulfil these wants. This
means that people have to make economic
decisions because they want more things than they
can actually get. Therefore, they have to choose
between various options.
 Economic Decisions
 An individual person has to make economic decisions. You might have to
decide which pair of jeans to buy, or how many pairs of jeans to buy as
opposed to how many shirts. You may have to decide whether you will go
to a university or whether you will go straight into the labour force. You may
have to decide whether you should buy the newest mobile phone or keep
your old one a while longer.
 Families have to make essentially the same kinds of decisions. A family
might have to decide how many pants and shirts their children need. They
might have to decide how often (if at all) they can go on vacation. If they
decide they can go on vacation, they will have to decide where they
want to go and how much they want to spend on souvenirs while they are
there. They may have to decide what car they can afford and when to
replace it with a new one.
 Countries have to make bigger decisions. They have to decide what level
of taxation they will impose on various types of economic activities. They
have to decide how much they will spend on their military as opposed to
domestic programs. They may have to decide what economic activities
they want to subsidize.
What is Opportunity cost?

Opportunity Cost refers to the cost of the next

best alternative use of money, time, or
resources when one choice is made rather
than another. For example, you spend your
money on ten new CDs, instead of saving the
money for a new car. The cost of the CDs is
not just the price of them, but also the car
you could have had.
ECONOMIC RESOURCES

Economic Resources, also known as Factors

of production, are the resources people use
to produce goods and services; they are
the building blocks of the economy.
Economists divide the factors of production
into four categories: land, labour, capital,
and entrepreneurship.
Four Categories of Economic Resources

 The first factor of production is land, but this includes any natural resource used
to produce goods and services. This includes not just land, but anything that
comes from the land. Some common land or natural resources are water, oil,
copper, natural gas, coal, and forests. Land resources are the raw materials in
the production process. These resources can be renewable, such as forests, or
non renewable such as oil or natural gas. The income that resource owners earn
in return for land resources is called rent.
 The second factor of production is labor. Labor is the effort that people
contribute to the production of goods and services. Labour resources include
the work done by the waiter who brings your food at a local restaurant as well
as the engineer who designed the bus that transports you to school. It includes
an artist's creation of a painting as well as the work of the pilot flying the
airplane overhead. If you have ever been paid for a job, you have contributed
labor resources to the production of goods or services. The income earned by
labor resources is called wages and is the largest source of income for most
people.
Four Categories of Economic Resources
 The third factor of production is capital. Think of capital as the
machinery, tools and buildings humans use to produce goods and
services. Some common examples of capital include hammers, forklifts,
conveyer belts, computers, and delivery vans. Capital differs based on
the worker and the type of work being done.
 The Fourth factor of production is entrepreneurship. An entrepreneur is a
person who combines the other factors of production - land, labor, and
capital - to earn a profit. The most successful entrepreneurs are
innovators who find new ways produce goods and services or who
develop new goods and services to bring to market. Without the
entrepreneur combining land, labor, and capital in new ways, many of
the innovations we see around us would not exist. Think of the
entrepreneurship of Henry Ford or Bill Gates. Entrepreneurs are a vital
engine of economic growth helping to build some of the largest firms in
the world as well as some of the small businesses in your
neighbourhood. Entrepreneurs thrive in economies where they have
the freedom to start businesses and buy resources freely. The payment
to entrepreneurship is profit.
ECONOMICS AS A SOCIAL SCIENCE

 Economics is regarded as a social science because it uses

scientific methods to build theories that can help explain the
behaviour of individuals, groups and organizations.
Economics attempts to explain economic behaviour, which
arises when scarce resources are exchanged. A social
science is, broadly speaking, the study of society and how
people behave and influence the world around them. As a
social science, economics studies how individuals make
choices in allocating scarce resources to satisfy their
unlimited wants.
MACROECONOMICS AND MICROECONOMICS

Economics is concerned with the well-being of all

people, including those with jobs and those without
jobs, as well as those with high incomes and those
with low incomes. Economics acknowledges that
production of useful goods and services can create
problems of environmental pollution. It explores the
question of how investing in education helps to
develop workers’ skills.
MACROECONOMICS

Macroeconomics looks at the economy as a

whole. It focuses on broad issues such as growth
of production, the number of unemployed
people, the inflationary increase in prices,
government deficits, and levels of exports and
imports. Microeconomics and macroeconomics
are not separate subjects, but rather
complementary perspectives on the overall
subject of the economy.
Microeconomics

It should be clear by now that economics

covers a lot of ground. That ground can be
divided into two parts: Microeconomics
focuses on the actions of individual agents
within the economy, like households, workers,
and businesses;
Two types of Macroeconomics

Monetary Policy refers to the policy that involves

altering the level of interest rates, the availability
of credit in the economy, and the extent of
borrowing.

Fiscal policy is the economic policies that

involve government spending and taxes.
 BASIC ECONOMIC PROBLEMS OF SOCIETY

 If there is a central economic problem that is present across all

countries, without any exception, then it is the problem of
scarcity. This problem arises because the resources of all types
are limited and have alternative uses.

 If the resources were unlimited or if a resource only had one

single use, then the economic problem would probably not
arise. However, be it natural productive resources or man-
made capital/consumer goods or money or time, scarcity of
resources is the central problem. This central problem gives rise
to four basic problems of an economy. These are the following:
Four basic problems of an economy
1. What to Produce?
What does a society do when the resources are limited? It decides which
goods/service it wants to produce. Further, it also determines the quantity required.
For example, should we produce more guns or more butter? Do we opt for capital
goods like machines, equipment, etc. or consumer goods like cell phones, etc.? While
it sounds elementary, society must decide the type and quantity of every single
good/service to be produced.
2. How to Produce?
The production of a good is possible by various methods. For example, you
can produce cotton cloth using handlooms, power looms or automatic looms. While
handlooms require more labour, automatic looms need higher power and capital
investment. Hence, society must choose between the techniques to produce the
commodity. Similarly, for all goods and/or services, similar decisions are necessary.
Further, the choice depends on the availability of different factors of production and
their prices. Usually, a society opts for a technique that optimally utilizes its available
resources.
 Four basic problems of an economy

3. For whom to Produce?

Think about it – can a society satisfy each and every human wants?
Certainly not. Therefore, it has to decide on who gets what share of the total output
of goods and services produced. In other words, society decides on the distribution
of the goods and services among the members of society.
4. What provision should be made for economic growth?
Can a society use all its resources for current consumption? Yes, it can.
However, it is not likely to do so. The reason is simple. If a society uses all its resources
for current consumption, then its production capacity would never increase.
ECONOMIC SYSTEMS
An economic system is an organized way in which a
country allocates resources and distributes goods and services
across the whole nation or a given geographic area. It includes
the combination of several institutions, entities, agencies,
decision-making processes and patterns of consumption that
make up the economic structure of a specific community.
Hence it is a type of social system. An economic system defines
how all the entities in an economy interact. Defining them
today is much more complicated than it used to be. Ancient
systems were relatively simple –trade was carried out using
barter and there were very few treaties and rules of
engagement.
 Three main types of economic systems
 1. Market Economy: Prices are determined by levels of supply and demand, instead of central
and or local government. Market forces determine what is produced, how much is produced,
how it is distributed, plus the prices of goods and services. All decisions regarding investment and
salaries are also driven by market forces in a market economy. In a market economy, the
government plays a minor role and only lays down the rules so that businesses can thrive. An
outdated word for this type of economy is Capitalism.
 2. Planned Economy: all decisions regarding production, distribution, salaries, investment and
prices are made by a central authority – usually the government. The closest examples to this
type of economy today are North Korea and Cuba (to a lesser extent). In a planned economy,
also known as a centralized economy, controlled economy or command economy, central
government has planners who make all the decisions. According to economists, the most
fundamental difference between a market and planned economy is the existence of private
property, i.e. it exists in the free market and does not in the command economy.
 3. Mixed Economy: Market economies sometimes get into trouble, at which point the
government feels compelled to intervene. Sometimes, when lawmakers believe some players are
being exploited unfairly, or the level playing field for business is under threat, the government may
become involved. Similarly, the leaders of a command economy may decide that more
investment is required, and the only way to accomplish this is by allowing more freedom. The
moment the government of a command economy loosens its grip, or that of a market economy
begins to intervene, they integrate some aspects of the other.
WHY ECONOMICS IS IMPORTANT?

 You may have asked yourself, “What is the importance of

economics?” and “What's the meaning of the economy?”
In a nutshell, an economy refers to a region or country’s
resources and wealth, especially as it pertains to producing
and consuming goods and services.
 Economics is important because it helps people
understand how a variety of factors work with and against
each other to control how resources such as labor and
capital get used, and how inflation, supply, demand,
interest rates and other factors determine how much you
pay for goods and services.
 SCIENTIFIC APPROACH IN THE EMPIRICAL
TESTING OF AN ECONOMIC THEORY

Economics is a study that attempts to explain how

an economy operates and how the consumer
attempts to maximize his/her wants within limited
means. Using tools such as logic, mathematics, and
statistics, the student needs to approach the
empirical testing of an economic theory in a
scientific manner. This scientific approach involves
the following steps:
POSITIVE ECONOMICS V.S NORMATIVE
ECONOMICS

 Most economic decisions and policy are influenced by

value judgements, which vary from person to person,
resulting in fierce debate between competing political
parties. Positive economics and Normative economics are
two standard branches of modern economics.
 Positive economics is objective and fact based, while
normative economics is subjective and value based.
Positive economic statements must be able to be tested
and proved or disproved. Normative economic statements
are opinion based, so they cannot be proved or disproved
MEASURING THE ECONOMY
 Formulating economic policy is impossible if we don’t
know what the economy looks like and how it’s doing.
Once we have a basic idea in our heads of how the
economy works, we need to figure out where it is at the
moment before we tinker. That requires measuring key
variables such as output, employment and inflation.
Perhaps the most commonly cited economic measure is
Gross Domestic Product (GDP). GDP is considered one
of the best measures of economic performance
because it is a good barometer of the economy’s ups
and downs.
What is GDP?
 GDP is the country’s total income: if we add everyone’s income, from household
wages to business profits and government surpluses we get GDP. GDP can also be
measured as the value of all the goods and services produced in the economy. In
New Zealand this is the preferred the measure of economic activity.
 To measure the value of goods and services we can calculate the total
expenditure on consumption, investment and exports, less the spending on
imports. This is probably the most intuitive
Strengths and weaknesses
 GDP is an excellent measure of how much we produce, but
it is important to remember that production and spending
are all it measures. It is not a measure of the standard of
living, although it is often used as such. Standards of living
also depend upon the amount of leisure time we have and
the wage rate. In addition, GDP tells us nothing about how
the incomes are distributed: it may be that most of it goes
to only a few people.
 These are not reasons to ignore GDP, which is a vital
economic measurement, but it is important to realize that
the state of the economy is too complex to be summed up
with a single number.
 GNP/GDP: EXPENDITURE and INCOME
APPROACH
 The income approach to measuring gross domestic product is based on the accounting
reality that all expenditures in an economy should equal the total income generated by
the production of all economic goods and services. It also assumes that there are four
major factors of production in an economy and that all revenues must go to one of these
four sources.
 Therefore, by adding all of the sources of income together, a quick estimate can be made
of the total productive value of economic activity over a period. Adjustments must then be
made for taxes, depreciation, and foreign factor payments.
 The expenditure method is a system for calculating gross domestic product (GDP) that
combines consumption, investment, government spending and net exports. It is the most
common way to estimate GDP, and it says everything that the private sector, including
consumers and private firms, and government spend within the borders of a particular
country, must add up to the total value of all finished goods and services produced over a
certain period of time. This method produces nominal GDP, which must then be adjusted
for inflation to result in the real GDP.
 GNP/GDP: EXPENDITURE and INCOME
APPROACH
The Formula for Expenditure GDP is: GDP=C+I+G+(X−M)
where:
C=Consumer spending on goods and services
I=Investor spending on business capital goods
G=Government spending on public goods and services
X=exports
M=imports
 Main Components Under Expenditure Method
 The most dominant component in the calculations of GDP under the expenditure method is
consumer spending, which accounts for the majority of the country’s GDP. Consumption is
typically broken down into purchases of durable goods (such as cars and computers),
nondurable goods (such as clothing and food) and services.
 The second component is government spending, which represents expenditures by state,
local and federal authorities on defence and nondefense goods and services, such as
weaponry, health care and education.
 Business investment is one of the most volatile components that goes into calculating GDP. It
includes capital expenditures by firms on assets with useful lives of more than one year each,
such as real estate, equipment, production facilities and plants.
 GNP is calculated by adding the personal consumption expenditures, government
expenditures, private domestic investments, net exports and all income earned by residents in
foreign countries, minus the income earned by foreign residents within the domestic
economy. The net exports are calculated by subtracting the value of imports from the value
of the country’s exports.
 The official formula for calculating GNP is: Y = C + I + G + X + Z
Where:
C – Consumption Expenditure
I – Investment
G – Government Expenditure
X – Net Export (Value of imports minus value of exports)
Z – Net Income (Net income inflow from abroad minus net income outflow to foreign
countries)

 Alternatively, Gross National Product can also be calculated as follows:

GNP = GDP + Net Income Inflow from Oversees – Net Income Outflow to Foreign Countries
Where:
GDP = Consumption + Investment + Government Expenditure + Exports – Imports
 Importance of GNP

 Policy makers rely on Gross National Product as one of the important economic
indicators. GNP produces crucial information on manufacturing, savings, investments,
employment, production outputs of major companies and other economic variables.
Policymakers use this information in preparing policy papers that legislators use to
make laws. The government applies the GNP information in determining the resident’s
total income and making policies about savings and policies. Economists rely on the
GNP data to solve national problems such as inflation and poverty.
 When calculating the amount of income earned by a country’s residents regardless of
their location, GNP becomes a more reliable indicator than GDP. In the globalized
economy, individuals enjoy many opportunities to earn an income, both from
domestic and foreign sources. When measuring such broad data, GNP provides
information that other productivity measures cannot produce. If residents of a country
would only be limited to domestic sources of income, GNP would be equal to GDP,
and it would be less valuable to the government and policymakers
GROSS NATIONAL PRODUCT vs. GROSS DOMESTIC PRODUCT

 Both the Gross National Product (GNP) and Gross Domestic Product (GDP) measure
the market value of products and services produced in the economy. The terms differ
in what constitutes an economy since GDP measures the domestic levels of production
while GNP measures the level of the output of a country’s residents regardless of their
location.
 The difference comes from the fact that there may be many domestic companies that
produce goods for the rest of the world, and there may be foreign-owned companies
that produce products within the country. If the income earned by domestic firms in
overseas countries exceeds the income earned by foreign firms within the country,
GNP is higher than the GDP. For example, the GNP of the United States is $250 billion
higher than its GDP due to the high number of production activities by U.S. citizens in
overseas countries.
Limitation of GDP Measure
GDP, which can be calculated using numerous
methods, including the expenditure approach, is
supposed to measure a country's standard of living
and economic health. Critics such as the Nobel
Prizewinning economist Joseph Stieglitz caution that
GDP should not be taken as an all-encompassing
indicator of a society's well-being, since it ignores
important factors that make people happy. For
example, while GDP includes monetary spending by
private and government sectors, it does not consider
work-life balance or the quality of interpersonal
relationships in a given country.
REFERENCES:

Case, Karl E. and Fair Ray C. 2007. An Introduction

to Principles of Economics. Pearson 6th Edition.
Education International
Rosemary P. Dinio, PhD and George A. Villasis.
Applied Economics. First Edition. Kto12 Program
Bautista, Germelino. Economics and Society.
(Quezon City: Ateneo de Manila University Press,
2013).
www.investopedia.com