ECO 120

Principles of Economics

CHAPTER 1
Introduction to Economics
 What is Economics?
Definition: Study of Economics
how people use their
limited resources to
fulfill unlimited wants
and need.

Microeconomics Macroeconomics
 Differences between Microecomics
and Macroeconomics
Microeconomics
studies decision making by a single
individual, household, firm, industry
Analyzes DD for and SS of labor
Deals with households and firm
decisions
Studies individual prices
Analyzes demand and supply of goods
Macroeconomics
studies decision making for the
economy as a whole
Analyzes total employment in the
economy
Deals with aggregate decisions
Studies overall price level
Analyzes aggregate demand and
aggregate supply.
 Factors of Production
• Land –Inputs into production that are provided by nature such as raw
materials from the surface of earth, mineral and oil deposits. The reward is
rent.

• Labor – All forms of human input, both physical and mental, into current
production. The reward is wage.

• Capital – All inputs into production that have themselves been produced such
as factories, machineries, equipments and tools. The reward is interest.

• Entrepreneur – The person who has the capability to combine all resources
into the production of goods and services. The reward is profit.
 Economic Concepts
SCARCITY  CHOICES  OPPORTUNITY COST

Scarcity
• scarce – impossible to satisfy our unlimited
wants due to limited resources
• wants always exceeding limited resources
• Peoples’ wants are greater than the economy’s
ability to produce desirable goods & services
• Because of our resources are limited, we must
choose and sacrifice one thing for another.
 Choices
• because of scarcity, choose from the available
alternatives. Choices can be made by comparing
cost or benefits from available alternatives.
Opportunity Cost
• the second best alternative that has to be
forgone for another choice which gives more
satisfaction.
• the opportunity cost of an action is the
next best foregone alternative.
 Example
• These three basic economic concepts are related to
each other.

Ikhwan has RM100 and he want to buy two things,

bag and jeans which cost RM100 each (limited
resources but unlimited wants).

Because of limited resources (scarcity), Ikhwan

has to choose either to buy bag or jeans (choice).

If Ikhwan choose to buy bag, then he has to forgo

jeans (opportunity cost).
 Basic Economic Problems
• What to produce?
– types of goods the society wants to produce given limited factors
of production (eg: radios or televisions)

• How much to produce?

– Quantity of goods to be produced

• How to produce?
– Methods of production (labor or capital intensive)
– The cheapest method of production – minimum cost of production

• For whom to produce?

– Target group (rich, poor, working people, etc)
 Production Possibilities Curve
(PPC)
• A curve that shows the maximum combinations of
two outputs that an economy can produce, by using
all its available resources efficiently.

Assumption of PPC
1) Producing 2 goods 3) Fixed resources
2) Fixed technology 4) Producing at full
employment
 PPC - Example
Clothes
a
15
14 b
Combination Food Clothes
12 c
a 0 15
b 1 14 9 d
c 2 12
d 3 9 e
5
e 4 5
f 5 0
f
1 2 3 4 5 food
PPC and Basic Economics Concepts
CLOTHES
scarcity choices
 Without more resources,  Refer to any point along
points outside PPC are PPC.
20 unattainable (Point E)
 Example: At point A, society
A
19 can produce 19 units of
clothes & 4 units of Foods.
B
18 •E  At B, can produce 18 unit of
clothes and 7 unit of foods.
•D
9 C
Opportunity cost
• Movement from one point to
another – point A to B

0 4 7 14 15 FOODS

Points “inside” the PPC are inefficient – waste of resources or unemployment (Point D).
 Production Possibility
Curve
Good Y  opportunity cost of good X
Opportunity cost of rises so that it is much higher
Good X = 1 unit of good Y (10 - 9) at point B (1 unit of good X
A costs 2 unit of good Y).
10
9  Opportunity costs of
economic action not
constant, but vary along PPC

B
4 Opportunity cost of
Good X = 2 unit of good Y (4 - 2)
2

Good X
0 3 4 12 13
Combination of Radios (R) Televisions (TV) Opp. cost of radio
goods (unit) (unit) (Total)

A 0 10 -

B 4 9 1 TV

C 7 7 2 TV

D 9 4 3 TV

E 10 0 4 TV

Increasing opp. cost

Combination of Radios (R) Televisions (TV) Opp. cost of radio
goods (unit) (unit) (Total)

A 0 12 -

B 2 10 2 TV

C 4 8 2 TV

D 6 6 2 TV

E 8 4 2 TV

F 10 2 2 TV

g 12 0 2 TV

Constant opp. cost

 Shape of The PPC
Good Y
Increasing Opportunity Costs
(PPC concave)

Constant Opportunity Costs

(PPC linear)

Decreasing Opportunity
Costs (PPC convex)

Good X
 Shift of PPC
- PPC depends on the availability of the factors of
production (resources) and technology.
Good X

Increase

Decrease

0 Good Y
Why would the PPF shift outward?
-- more resources: land, labor, capital, and human capital (economic
growth)
-- technological progress – improvement in technology
-- larger population – increase in number of labor

Good Y

New PPF

Initial PPF

Good X
 Production Possibilities Curve
Increase in Resources or Technology
70
Improvement that benefits
both products. PPC shifts
Production of Clothing

60 outward (to the right), from

50 PPC1 to PPC2.

40
PPC2
30 PPC1
20
10
0
0 10 20 30 40 50 60 70

Production of Food
Production Possibilities Curve
Improvement that benefits Food
production only – from PPC1 to
60 PPC2
Production of Clothing

e.g: there is improvement in

50 technology of producing Food.

40

30
PPC2
PPC1
20

10

0
0 10 20 30 40 50 60 70

Production of Food
 Production Possibilities Curve
Improvement that benefits clothing
70 production only – from PPC1 to
PPC2
Production of Clothing

60
50
40
PPC2
30 PPC1
20
10
0
0 10 20 30 40 50 60 70

Production of Food