APPLIED ECONOMICS

ECONOMICS AS AN
APPLIED
SCIENCE
L E S S O N 2
 Explain the basic economic
problems

Discuss why Economics is an WHAT YOU Understand how Applied

Applied Science Economics work
NEED TO
KNOW
Analyze the solution to
economic problems
APPLIED
ECONOMICS
Applied Economics is the study of observing how
economic theories work in real world-situations. It is
the application of economic principles and theories to
real situations and trying to predict what the outcomes
might be. Applying economics to the status of the
economy of a country, household or company helps
eliminate all attempts to dress up a situation so that it
will seem better or worse than it really is.

Applied Economics deals on the application of

economic theories and principles to real-world
situations with the desired aim to analytically review
potential outcomes.
 APPLIED ECONOMIC
APPLICATION
FIRST
Applying economics to the
status of the economy of a
company, a household or a
country helps to sweep
aside all attempts to dress
up the situation so that it
will appear to be worse or
better than it actually is.
SECOND THIRD
Applying economics acts as a Applying economics can
mechanism to determine teach valuable lesson s on
what steps can reasonably be how to avoid the recurrence
taken to improve the current of a negative situation, or at
economic situation. Each least minimize the impact.
Perspective
element that is relevant to the Process Applied economics is all
contemporary
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ECONOMETRICS
Econometrics is the application of statistical and mathematical
theories to economics for the purpose of testing hypotheses
and forecasting future trends. Econometrics takes economic
models and test them through statistical trials. The results are
then compared against real-life examples.

An example of a real-life application of econometrics would be to study

the hypothesis that as a person’s income increases, spending increases.
10 PRINCIPLES OF ECONOMICS

PRINCIPLES OF
ECONOMICS
10 PRINCIPLES OF ECONOMICS
 BASIC ECONOMIC PROBLEMS
In today’s world, it is commonly believed that scarcity is
the root cause of all economic problems. Scarcity of means
for satisfying various needs is the central problem of our
economic life and it is scarcity that creates the need to SCARCITY
make a choice. All the problems like poverty,
unemployment, inflation, balance of payments, slow
growth, etc. that a modern economy faces originates from
the scarcity of resources. It is because of scarcity, people
and economies must make decisions over how to allocate
their resources.
DUE TO SCARCITY OF RESOURCES, EVERY ECONOMIC SYSTEM IS
FACED WITH THE FOLLOWING PROBLEMS:
What to produce? (Microeconomics)
• Availability of resources
• Physical Environment
• Customs and Traditions of people
How to produce? (Microeconomics)
• Proper combination of economic resources in producing the right amount of output.
• Quality of output must come first before quantity.

For whom shall goods and services be produced? (Microeconomics)

• How goods will be distributed?
• Pattern of income distribution c can be changed through government policies.

Are the country’s resources being utilized, or some of them are lying idle and unemployed?
(Macroeconomics)
• When resources are scarce, it is not in the rightness of things to keep some of the available resources
idle.
Is the economy’s capacity to produce goods growing or remaining the same overtime? (Macroeconomics)
• To achieve a growth in productive capacity is a universal objective.
ECONOMIC MODELS
CIRCULAR FLOW
DIAGRAM
The inner loop of the circular-flow diagram represents
the flows of goods and services between households and
firms. The households sell the use of their labor, land,
and capital to the firms in the markets for the factors of
production. The firms then use these factors to produce CIRCULAR FLOW
goods and services, which in turn are sold to households DIAGRAM
in the markets for goods and services. Hence, the factors
of production flow from households to firms, and goods
and services flow from firms to households.
The outer loop of the circular-flow diagram represents
the corresponding flow of dollars. The households spend
money to buy goods and services from the firms. The
firms use some of the revenue from these sales to pay for
CIRCULAR FLOW
the factors of production, such as the wages of their
DIAGRAM
workers. What’s left is the profit of the firm owners, who
themselves are members of households. Hence, spending
on goods and services flows from households to firms,
and income in the form of wages, rent, and profit flows
from firms to households.
The Production Possibilities Frontier is a graph that
shows the various combinations of output that the
economy can possibly produce given the available
factors of production and the available production
PRODUCTION
technology that firms can use to turn these factors into POSSIBILITY FRONTEIR
output.

An outcome is said to be efficient if the economy is

getting all it can from the scarce resources it has
available. Points on (rather than inside) the production
possibilities frontier represent efficient levels of
production.
 PRODUCTION
POSSIBILITY FRONTEIR
 • If all resources were used in the car industry, the economy
would produce 1,000 cars and no computers.
• If all resources were used in the computer industry, the economy
would produce 3,000 computers and no cars. The two end points
of the production possibilities frontier represent these extreme
possibilities. PRODUCTION
• If the economy were to divide its resources between the two
POSSIBILITY FRONTEIR
industries, it could produce 700 cars and 2,000 computers.
• By contrast, the outcome at point D is not possible because
resources are scarce: The economy does not have enough of the
factors of production to support that level of output.

In other words, the economy can produce at any point on or inside

the production possibilities frontier, but it cannot produce at points
outside the frontier.
 • When the economy is producing at such a point, say point
A, there is no way to produce more of one good without
producing less of the other.
• Point B represents an inefficient outcome. For some reason,
perhaps widespread unemployment, the economy is
producing less than it could from the resources it has PRODUCTION
available: It is producing only 300 cars and 1,000 POSSIBILITY FRONTEIR
computers.
• If the source of the inefficiency were eliminated, the
economy could move from point B to point A, increasing
production of both cars (to 700) and computers (to 2,000).

Notice as we move from point to point, trade off between

production quantities differ. This is due to the law of increasing
opportunity cost.
OPPORTUNITY
COST
The opportunity cost of any choice is what we
must forego when we make a choice.

When making any decision, such as whether to

attend college, decisionmakers should be aware
of the opportunity costs that accompany each
possible action.
LAW OF INCREASING
OPPORTUNITY
The principle of increasingCOST
opportunity cost applies to most of
society’s production choices, not just between computers and
cars. If we look at society’s choice between food and oil, we
would find that some land is better suited at growing food and
other land best suited for drilling oil. As we continue to drill for
more oil, we would find ourselves drilling on land that is less and
less suited to producing oil, but better and better for producing
food. The opportunity cost of producing additional oil will
therefore increase

The law of increasing opportunity cost states that the more of something
we produce, the greater the opportunity cost of producing even more of it
THANK
YOU