Chapter 1:

Overview

1. What is economics?
2. Three fundamental questions
3. Market coordination
Definition of economics
Let think about your situation
 Do you have enough time to do anything you
wish?
 Do you have enough money to buy anything
you want?
Your answer is…
Everyone wants more of something
Definition of economics
This problem also applies to society
Most societies would prefer to
 Better health care
 Higher quality education
 Less poverty
 A cleaner environment

But, there are not enough resource…

Definition of economics
 The fundamental economic problem is
scarcity.
 Individuals and societies must choose
among available alternatives.

“Economics is defined as the study of how

individuals and societies use limited
resources to satisfy unlimited wants.”
Definition of economics
Wants Resources

Choices

Economics

Microeconomics Macroeconomics

Slide 5
Microeconomics vs. Macroeconomics
 Microeconomics is study on the choices
of individuals, firm, their interaction in
the markets, and the influence of
government.
 Macroeconomics is study on the
performance of the national economy
and the global economy.
Microeconomic policy vs.
Macroeconomic policy
 Microeconomic policy involves policies designed
to correct for
 Imperfect information
 Externalities
 Public goods
 Absence of property rights
 Monopoly
 Macroeconomic policy involves policies
designed to enhance
 Economic growth
 Macroeconomics stability
Positive and normative analysis
 Positive economics
 attempt to describe how the economy
functions
 relies on testable hypotheses
 Normative economics
 relies on value judgments to evaluate or
recommend alternative policies.
For example, free trade policy
Logical fallacies
 Fallacy of composition
 occurs when it is incorrectly assumed that
what is true for each and every individual
in isolation is true for an entire group.
 Post hoc, ergo propter hoc fallacy
(association as causation)
 occurs when one incorrectly assumes that
one event is the cause of another because
it precedes the other.
Economic methodology
 Economists attempt to reply on the
scientific method
 Observe a phenomenon,
 Make assumptions and formulate a

hypothesis,
 Generate predictions, and

 Test the hypothesis.

Test can never prove that a model is true

Law vs. Principle
 A law is a tested and proven theory that
is true in everywhere in the world.
 A principle is only tested to be
applicable on somewhere in the world.
For example, law of demand
A law has also some exception!
Verify vs. Validate
A model is not a reality!
 Verify is used to check a model is correct
or not?
 Validate is used to check a model is
applicable or not?

The assumption of ceteris paribus is

used to simplify reality
Three fundamental questions:
 All countries must address three
fundamental questions
 What?
 How?
 For whom?

 Let’s examine each of these question

What?
 The first question is what mix of goods
and services will be produced?
 Society’s wants
 Foods
 Clothes
 Gasoline
 Weapon
 …
Comparative advantage vs.
absolute advantages
 Comparative advantage refers to the ability of
a person or a country to produce a particular
good or service at a lower marginal and
opportunity cost over another.
 Absolute advantage refers to a person or a
country to be more efficient in production of
all goods.

Countries will gain by trading with each other.

Consumer sovereignty?
 The interaction of self-interest buyer and seller
determines the mix of goods and services that
are produced.
 Competition among firms forces them to produce
goods and services that satisfy customer wants.
 This lead to a condition of customer sovereignty,
in which the customer determine what mix of
goods and services will be produced.
How?
 The second question is stated as how is
output produced?
Economic Resource Resource payment
land rent
labor wages
capital interest
entrepreneurial ability profit
For Whom?
 The third question deals with the issue of
who get what?
 This is determined by the interaction of buyer
and seller in both product and resource
markets.
 Price and Income determine who get what.

For example, real estate

Market economy vs.
Command economy
 Market economy is driven by a invisible hand.
 Command economy is driven by a central
planning board.
 In real world economies, markets do not
make all of these decisions. In all societies,
governments influence what will be produced,
how output will be produced and who
receives this output.
Government and
the three fundamental questions
 Government influences the responses to each of the
three fundamental questions. Examples:
 What?
 government spending
 product safety and consumer protection laws
 How?
 safety regulations
 minimum wage laws
 environmental protection
 For whom?
 tax structure
 welfare programs
Market coordination
 The word market means a place where
people buy and sell goods such as fish, meat,
vegetable, etc.
 In economics, a market has a more general
meaning. A market is any arrangement that
enables buyers and sellers to get information
and to do business each other.
Product market vs. Resource market
 Product market is where goods and services are
produced by firm and bought by customers. Firm
get profit that allows them to buy production
resource to produce more products.
 Resource market is where production resource
are bought and sold. Households provides
resources and receive income that allow them to
buy more products.
Household, Firm, and Government
 A household consists one or more individuals that
share living units.
 A firm is an entity that is formed by single owner
or multiple owners. There are three types of firm:
 Sole proprietorship
 Partnership
 Corporation
 A government consists of the legislators,
administrators of the country
Circular flows