INTRODUCTION TO ECONOMICS (Econ-1011)

By: Urgessa June, 2021

Lecture -1:- INTRODUCTION
Outline:-
1.1 Mining and Definition of Economics
1.2 Rationale of Economics
1.3 Branches of Economics (Scope of Economics) and
Methods of Economic Analysis
1.4 Economic Resources,Scarcity,choice, Opportunity
Cost and Production Possibility Frontier
1.5 Basic Economic Problems
1.6 Economic Systems
01/27/2024 1.7 Decision making units and the circular flow model
2
 Lecture-1 :
1.1.Definition of
INTRODU Economics
CTION
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 1.1.Meaning of the word ‘Economics’

• The word ‘Economics’ originates from a Greek word

‘Oikonomos’
• This Greek word has two parts:
–‘Oikos’ meaning ‘Home’
–‘Nomos’ meaning ‘Management’
Hence, Economics means ‘Home Management’

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Economics is one of the most exciting disciplines in social
sciencesThere is no universally accepted definition of
Economics ( its definition is controversial) This is because
different economists defined economics from different
perspectives; here the evolution in the definitions of
economics was given as follows:-
• A. Wealth Definition (1776) by Adam Smith
• B. Welfare Definition (1890) by Alfred Marshall
• C. Scarcity Definition (1932) by Lionel Robbins
• D. Growth Definition (1948) by Paul Samuelson
• E. Modern Definition (2011) by A.C. Dhas
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 Wealth Definition (1776)
 Adam Smith, who is regarded as Father of Economics, published a
book titled ‘An Inquiry into the Nature and Causes of the Wealth of
Nations’ in 1776.
 He defined economics as “a science which inquires into the nature
and cause of wealth of nations”.
 He defined Economics as it is a practical science of production and
distribution of the wealth
 He emphasized the production and growth of wealth as the subject
matter of economics.
 Though many other writers expressed important economic ideas
before Adam Smith, but economics as a distinct subject started with
his book
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 ADAM SMITH

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Wealth of Nations (1776) 7
 Welfare Definition (1890):
 In 1890, Alfred Marshall stated that “Economics is a
study of mankind in the ordinary business of life;
 It examines that part of individual and social action
which is most closely connected with the attainment
and with the use of material requisites of wellbeing”.
 It is on one side a study of wealth; and on the other
side, a study of human welfare based on wealth

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 ALFRED MARSHALL

01/27/2024 Principles of Economics (1890) 9

 Scarcity Definition (1932)
 According to Lionel Robbins: “Economics is the science
which studies human behavior as a relationship between
ends and scarce means which have alternative uses.”
 He emphasized on ‘choice under scarcity’.
 In his own words, “Economics ,,, is concerned with that
aspect of behavior which arises from the scarcity of means
to achieve given ends.”
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 LIONEL ROBBINS

An Essay on the Nature and Significance

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of Economic Science (1932) 11
Growth Definition (1948)
 According to Prof. Paul A Samuelson “Economics is the
study of how men and society choose with or without the use
of money, to employ the scarce productive resources which
have alternative uses, to produce various commodities over
time and distribute them for consumption now and in future
among various people and groups of society.
 It analyses the costs and benefits of improving pattern of
resource allocation”.
 This definition introduced the dimension of growth under
scarce situation.
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 PAUL A SAMUELSON

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Economics: An Introductory Analysis (1948) 13
 Modern Definition of Economics (2011)
 According to Prof.A.C.Dhas, “Economics is the study of
choice making by individuals, institutions, societies,
nations and globe under conditions of scarcity and surplus
towards maximizing benefits and satisfying their unlimited
needs at present and future”.
 In short, the subject Economics is defined as the “Study of
choices by all in maximizing production and
consumption benefits with the given resources of scarce
and surplus, for present and future needs.”
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 Prof A. C. DHAS

Modern Definition of Economics (2011)

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The common definition of Economics
 Economics is the study of how individuals and societies choose to
allocate and use scarce resources to satisfy unlimited wants.
 In the definition it embedded four key words:
 Scarcity- a situation where the amount of something available is
insufficient to satisfy the desire for it.
 choice-Scarcity implies choice
 Resources-The labor, capital, land and natural resources and
entrepreneurship that are used to produce goods and services.
 Unlimited wants – without limits, infinite
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Cont..

The core of economics is ‘Choices’

The fundamental economic activities are

production and consumption

The aim of economics is optimizing given resources

(both scarce and surplus) and achieving growth
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Cont.….

Generally ECONOMICS – is a social

science that deals with how people
organize themselves in order to
allocate scarce resources to produce
goods and services for satisfy the
unlimited wants and needs
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 1.2. Rationales of Economics
There are two fundamental facts that laid or provide the
foundation for the field economics (The rationales of
Economics).
I. Human wants are unlimited.
II. The available resources to satisfy these wants are
limited.
The imbalance between the unlimited wants and the
limited resources to satisfy these wants is called Scarcity.
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 1.3.Scope of Economics and Method of
Economic Analysis
• The study of Economics is divided into two parts on
the basis of looking the system as whole or in terms
of its innumerable decision- making units
– Micro Economics
• It is also called Price Theory

– Macro Economics
• It is also called Income Theory

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A. Microeconomics - is the study of economics at individual level.
 It is a branch of economics which is concerned with the behavior of
individual entities such as markets, firms, and households.
 It studies the behaviours of individual decision makers in a particular
market and the interaction among individual markets.
 Microeconomics studies about:-
 Consumers’ satisfaction
 Buying and selling decisions of the firm
 The determination of prices in markets
 The quantity, quality and variety of products
 Profits
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The central problem of microeconomics is price
determination and allocation of resources.
Its main tools are the demand and supply of particular
commodities and factors.
 It helps to solve the central problem of what, how and for
whom to produce‘ in an economy so as to maximize profits.
 Discusses how the equilibrium of a consumer, a producer or
an industry is attained.
Examples: Individual income, individual savings, individual
prices, an individual firm‘s output, individual consumption,
etc.
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B. Macroeconomics is the study of the economy as a whole. i.e, it
studies economic variables at aggregate level.
Macroeconomics studies about:-
 Economic growth
 National income
 Unemployment and inflation
 Aggregate demand and aggregate supply
 Economic policies – fiscal and monetary Policy
 International trade – exports and imports
 Money supply
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 The central problem of macroeconomics is the determination of
level of income and employment.
 Its main tools are aggregate demand and aggregate supply
of an economy as a whole.
 Helps to solve the central problem of full employment of
resources in the economy.‘
 Concerned with the determination of equilibrium levels of
income and employment at aggregate level.
Examples: national income, national savings, general
price level, national output, aggregate consumption, etc.
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1.3.1 Methodology of Economic Analysis and Reasoning
Economists often distinguish between positive
economics and normative economics.
Positive economics is concerned with facts.
 It tells us what was, what is or what will be.
It does not involve value judgment.
Disagreement over positive economics can be settled
by an appeal to facts.
In other words, positive economics is verifiable.
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 Cont’d
Normative economics is concerned with value judgments.
It tells us what should be or ought to be
A statement that reflects an opinion, which cannot be
proved or disproved by reference to the facts
Disagreement over normative economics cannot be settled by
an appeal to facts.
In other words, normative economics is not verifiable.
Normative economics deals heavily on value judgment and
theoretical scenarios.
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 Activity:-Identifying positive vs. normative
Which of these statements are “positive” and which are
“normative”? How can you tell the difference?
a. Prices rise when the government increases the quantity of
money.
b. The government should print less money.
c. A tax cut is needed to stimulate the economy.
d. An increase in the price of gasoline will cause an increase in
consumer demand for video rentals.

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 Answers
a) Prices rise when the government increases the quantity of money.
Positive, describes a relationship, could use data to confirm or refute.
b. The government should print less money.
Normative, this is a value judgment, cannot be confirmed or refuted.
c. A tax cut is needed to stimulate the economy.
Normative, another value judgment.
d. An increase in the price of gasoline will cause an increase in consumer
demand for video rentals.
Positive, describes a relationship.
Note that a statement need not be true to be positive

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 Methods of economics reasoning
Like other sciences, Economics also uses scientific methods
• These methods are:-Deductive Method and Inductive Method
 Method of Inductive reasoning is a logical method of
reaching at a correct general statement or theory based on
several independent and specific correct statements
 Method of Deductive reasoning is a logical way of arriving
at a particular or specific correct statement starting from a
correct general statement.

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1.4. Resource, Scarcity, Choice, Opportunity Cost and Production
Possibility curve
Resources can be classified as : free and Scarce (economical)
resources.
Free resources: A resource is said to be free if the amount available to
a society is greater than the amount people desire at zero price. E.g.
sunshine i.e Qs> Qd, at zero price
Scarce (economic) resources: A resource is said to be scarce or
economic resource when the amount available to a society is less than
what people want to have at zero price. i.e Qd>Qs
Economic resources, in economics, are Land, Capital, Labour and
Entrepreneurship.
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 Cont’d
Land :-the term Land is used to describe all the natural resources;
includes agricultural Land, forest, mineral deposits, fisheries,
rivers, lakes, oil deposits, etc.
The return for Land is called Rent.
Capital:- the term Capital refers to all man-made resources
which aid to production.
Thus, machinery, equipment, tools, factories, storage,
transportation, etc.., which are used in the production of new
goods and service are called Capital resources.
The return for capital is called Interest.
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Labour:- in economics labour refers to human effort, both physical and
mental, which is directed to the production of goods and services.
For example, factory worker, clerk, typist, teacher, doctor, Judge, Physicist,
etc.,
The payment for labour is called Wage.
Entrepreneurial ability:- is the ability to take risks and organize or bring
other factors of production together to produce goods and services.
Entrepreneurship is the taking of production risks and business creation
An entrepreneur is a person who organizes the other resources of
production and undertakes the risks and uncertainties involved in
production.
The reward for entrepreneurship is profit.
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Note: Scarcity does not mean shortage.
Scarcity is a fundamental economic problem that any
human society faces (if the amount available is less than the
amount people wish to have at zero price).
Scarcity is a universal and everlasting problem
But Shortage is a specific and short-term problem
Shortage occurs when people are unable to get the amount
of goods and services they want at the prevailing or
ongoing price
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Choice
If resources are scarce, then the output will be limited.
If the output is limited, then we cannot satisfy all of our wants.
Thus, a choice must be made.
Due to the problem of scarcity, individuals, firms, and governments are forced to
choose as to what output to produce, in what quantity, and what output not to
produce.
In short, scarcity implies choice.
Choice in turn, implies a cost. That means whenever a choice is made, an
alternative opportunity is sacrificed.
This cost is known as opportunity cost.

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Note:
Scarcity → limited resource
→ limited output → we might
not satisfy all our wants
→choice involves costs →
opportunity cost
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 Opportunity Cost
Opportunity Cost is the amount or value of the next best alternative that must be
sacrificed (forgone) in order to obtain one more unit of a product.

 Scarcity implies choice

When we make a choice again, it has a cost. This is because once we choose to

use a resource for some purpose, it will no longer be available for other
purposes. In economics, such cost is termed as Opportunity Cost.

When we say opportunity cost, we mean that:

 It is measured in goods & services but not in money costs

 It01/27/2024
should be in line with the principle of substitution . 36
 Production Possibility Frontier (PPC)

Production Possibility Frontier (PPC) is a curve or a boundary which

shows the combinations of two or more goods and services that an
economy/ society can produce using all the available or a given
resources and technology efficiently.
 The production-possibility frontier (or PPF ) shows or measures
the maximum quantity of goods that can be efficiently produced by an
economy, given its technological knowledge and the quantity of
available inputs

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Cont.….
The PPF describes three important concepts:
The concepts of scarcity
The concept of choice
The concept of opportunity

Related to the opportunity cost we have a law known as the law of

increasing opportunity cost.

This law states that as we produce more and more of a product, the

opportunity cost per unit of the additional output increases

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 Cont’d
PPF Y (Teff)

.C
. B

Production Possibility Frontier (PPF)

. A

X (Cotton)

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The PPF is concave to the origin.

The Points below the PPF are inefficient (point A)

The Points above the PPF are not attainable for the given level of
resource endowment and level of technology (point B)
 But production on point C is both efficient and attainable.

Technological innovation or identification of new resource base

would shift the PPF outwards to the right showing the possibility of
producing more goods and services. The broken PPF.
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 1.5 Basic Economic Problems
The economic problem sometimes called the basic, Central, or
fundamental economic problems.
Three main economic questions arise from scarcity and implied
choice:
 what to produce is the problem of allocation of resources
 how to produce/ the problem of choice of technique
 for whom to produce/ the problem of distribution of national
product
These questions are answered differently according to the
economic system a country adopts .
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 Cont…

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 1.6 Economic Systems
The manner or the structure through which the economy of a
country operates is known as Economic System
The way a society tries to answer the above fundamental questions
is summarized by a concept known as economic system.
An economic system is a set of organizational and institutional
arrangements established to answer the basic economic questions.
 We can identify three types of economic system.
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A.

A)

Command economy is also known as socialistic economy.

A) Command Economic System

 Under this economic system, the economic institutions

that are engaged in production and distribution are owned
and controlled by the state.
Derived from the idea of socialism, this economic system
argues that all major economic choice (i.e. economic
questions) should be answered through central planning by
the government.
Old Soviet Union, Communist China, Cuba and North
Korea are typical examples
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 B) Capitalism Economic System
Capitalism is the oldest formal economic system in the world.

Is also called free market economy or market system or laissez faire

It became widespread in the middle of the 19th century.

In this economic system, all means of production are privately owned, and

production takes place by individual private mainly for private profit.

Government intervention in the economy is minimal/no gov.t role

Private individuals (producers and consumers) are the main actors in this

system..
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 C) Mixed Economic System
This is a system where economic questions are answered partly
by the government as in the case of command economy and
partly by the market forces as in free market economic
system and some elements of traditional economic system.
Practically, most countries follow mixed economic system
even though there are wide differences in the roles played
by the market and the state.

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 Cont..

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 1.7 Decision making units and the circular flow model

There are three decision making units in a closed economy.

These are households, firms and the government.

a) Selling of their resources, and
1) Households make two decisions. b) Buying of goods and services

a) Buying of economic resources

2) Firms also make two decisions:
b) Selling of their products
.
3) Government also provides some types of goods and services
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The three economic agents interact in two markets:

Product market: it is a market where goods and services are transacted/

exchanged.
That is, a market where households and governments buy goods and
services from business firms.
Factor market (input market): it is a market where economic units
transact/exchange factors of production (inputs).
In this market, owners of resources (households) sell their resources to
business firms and governments
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The circular-flow diagram is a visual model of the economy that
shows how money (Birr), economic resources and goods and
services flows through markets among the decision making units.

For simplicity, let‘s first see a two sector model where we have only
households and business firms. In this case, therefore, we see the
flow of goods and services from producers to households and a
flow of resources from households to business firms.

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 Cont…
Two economic agents
Households (owners of resources)and
Business firms (owners of goods and services)
 The two markets
 Product market (supplied by firms)
 Resource market (supplied by households)
 Two flows
 Real flow (resources, goods & services)
 Financial flow (payments)
Let us assume income & revenue that all the income
received by the households is consumed.
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 The Circular-Flow Diagram in two sector model

Pangasinan State University

Social Science Department – PSU Lingayen
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Three sector model ( in closed economy model);
Government in the Circular Flow
Households and
firms pay taxes
and receive
transfers
●.
payment from
gov.t and
Government
both provide and
buy goods and
services
 __END OF CH -1___

THANKS
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