Economics Analysis

Basic Concepts

1
 Dr. Sadaf Zahoor
(Faculty Member and Researcher)
Experience :
• Assistant Professor: University of Engineering and Technology, Pakistan
• Post-Doctoral Fellow: MAME, University of Windsor, Canada
• Sessional Faculty: MAME, University of Windsor, Canada, IB&M, UET, University of
Lahore
PHD Manufacturing Engineering:
• University of Engineering and Technology, Pakistan
International Collaboration In Technical Research:
• Faculty advisor of IEOM-IME-UET Chapter, USA
Member Of Technical Committee:
• ICAMM Guangzhou, China
• IEOM, USA (China Chapter)

2
 Agenda
• Basic Economic Concepts
 Economics
 Scarcity
 Concerns of Economics
 Division of Economics
o Microeconomics
o Macroeconomics
 Types of Economics
 Ten Principle of Economics

3
 Definition of Economics
How would you define Economics?

4
Economics as defined

5
 Economics as defined
• The study of how individuals and societies
choose to allocate and use scarce resources
to satisfy unlimited wants.
• Economics is about economizing; that is,
about choice among alternative uses of
scarce resources. Choices are made by
millions of individuals, businesses, and
government units. Economics examines how
these choices add up to an economic system,
and how this system operates. (L.G.
Reynolds).
6
 Economics as defined by
authors of Economics books
Paul Samuelson (Economics)
“The study of how people and society end up
choosing, with or
without use of money, to employ scarce resources
that could have alternative uses to produce various
commodities among various persons and groups in
society.”

Roger Le Roy Miller (Economics, Today and

Tomorrow)
“Economics concerns with the situations in which
choices must be made about how to use limited
resources, when to use them and for what purposes.
Resources can be defined as the things people use
to make the commodities they want.”
7
 Common words among
definitions…
• Scarcity- a situation wherein the amount of
something available is insufficient to satisfy the desire
for it.
 The degree of scarcity is constantly changing
 The quantity of goods, services and usable
resources depends on technology and human
action
• Resources-The labor, capital, land and natural
resources and entrepreneurship that are used to
produce goods and services.
• Unlimited – without limits, infinite
• Wants –desires

8
 Concerns of Economics
• Economics is concerned with PRODUCTION
Production is the use of inputs to produce outputs.
Inputs are commodities or services that are used to
produce goods and services.
Outputs are the different goods and services which
come out of production process.

Factor of Production:
 Land
 Labor
 Investment (consumer goods, capital goods,
human capital)

9
 Concerns of Economics……
• Economics is concerned with DISTRIBUTION
Distribution is the allocation of the total product among members of
society. It is related to the problem of for whom goods and services are to
be produced.
• Economics is concerned with CONSUMPTION
Consumption is the use of a good or service. Consumption is the ultimate
end of economic activity. WHEN THERE IS NO CONSUMPTION, THERE WILL
BE NO NEED FOR PRODUCTION AND DISTRIBUTION.
• Economics deals with PUBLIC FINANCE
Public Finance is concerned with government expenditures and revenues.
Economics studies how the government raises money through taxation and
borrowing.

10
DIVISIONS OF ECONOMICS

11
Microeconomics vs Macroeconomics
• Microeconomics focuses on the individual parts
of the economy.
 How households and firms make decisions
and how they interact in specific markets

• Macroeconomics looks at the economy as a

whole.
 Economy-wide phenomena, including
inflation, unemployment, and economic
growth
12
 Scope of Microeconomics
Microeconomics studies:
• Buying decisions of the individual
• Consumers’ satisfaction
• Buying and selling decisions of the firm
• The determination of prices in markets
• The quantity, quality and variety of
products
• Profits

13
 Scope of Macroeconomics
Macroeconomics studies:

• Economic growth
• Unemployment and inflation
• Aggregate demand and aggregate supply
• Economic policies – fiscal and monetary
• International trade – exports and imports
• Money supply

14
Microeconomics vs. Macroeconomic
Questions
Should I go to Engineering school or take a job right now?
How many people are employed in the economy as a whole this year?

What determines the salary offered by UET fresh hiring?

What determines the overall salary levels paid to workers in a given year?

What determines the cost to a university or college of offering a new course?

What determines the overall level of prices in the economy as a whole?

What government policies should be adopted to make it easier for low-income

students to attend college?

What government policies should be adopted to promote employment and

growth in the economy as a whole?

What determines the overall trade in goods, services, and financial assets between the
Pakistan and the rest of the world

15
Let’s Check Your Understanding!
A. Why did consumers switch to smaller cars in recent
years?
B. Why did the standard of living rise more rapidly in the
current years compared to past?
C. Why have starting salaries for students with computer
science degrees risen sharply of late?
D. What determines the choice between rail and road
transportation?
E. Why did inflation fall in the 1990s?

16
Let’s Check Your Understanding!
Answers
A. This is a microeconomic question because it addresses
decisions made by consumers about a particular product.
B. This is a macroeconomic question because it addresses
changes in the overall economy.
C. This is a microeconomic question because it addresses
changes in a particular market, in this case the market for
computerscience.
D. This is a microeconomic question because it addresses
choices made by consumers and producers about which
mode of transportation to use.
E. This is a macroeconomic question because it addresses
changes in a measure of the economy’s overall price level.

17
A Household and an Economy……
face many decisions:
• Who will work?
• What goods and how many of them
should be produced?
• What resources should be used in
production?
• At what price should the goods be
sold?

18
How people make decisions ……
 People face tradeoffs.
 The cost of something is what you
give up to get it.
 Rational people think at the margin.
 People respond to incentives.

19
How people interact with each
other ……
 Trade can make everyone better off.
 Markets are usually a good way to organize
economic activity.
 Governments can sometimes improve
economic outcomes.

20
The forces and trends that affect how the economy as a whole
works……..

 The standard of living depends on a country’s

production.
 Prices rise when the government prints too much
money.
 Society faces a short-run tradeoff between inflation
and unemployment.

21
Ten Principles of Economics

22
Principle #1: People Face Tradeoffs

“There is no such thing as a free lunch!”

Principle #1: People Face Tradeoffs
 To get one thing, we usually have to give up
another thing.
– Guns vs butter
– Food vs clothing
– Leisure time vs work
– Efficiency vs equity

Making decisions requires trading

off one goal against another.
Principle #1: People Face Tradeoffs

 Efficiency vs Equity
– Efficiency means society gets the most that it can
from its scarce resources.
– Equity means the benefits of those resources are
distributed fairly among the members of society.
Principle #2: The Cost of Something
Is What You Give Up to Get It.
 Decisions require comparing costs and
benefits of alternatives.
– Whether to go to college or to work?
– Whether to study or go out on a date?
– Whether to go to class or sleep in?
 The opportunity cost of an item is what you
give up to obtain that item.
 Opportunity Cost

 Opportunity cost is the benefit forgone of the

next-best alternative to the activity you have
chosen
 Opportunity cost should always be less than the
benefit of what you have chosen
 Opportunity cost is the basis of cost/benefit economic
reasoning
 Opportunity Cost

Examples of opportunity cost:

1. Individual decisions
• The opportunity cost of college includes:
• Items you could have purchased with the
money spent for tuition and books
• Loss of the income from a full-time job

2. Government decisions
• The opportunity cost of money spent on the war
on terrorism is less spending on health care or
education
 Principle #2: The Cost of Something
Is What You Give Up to Get It….

1.Opportunity Cost – Most

Desirable

29
Principle #3: Rational People Think
at the Margin.
• Marginal changes are small, incremental
adjustments to an existing plan of action.

People make decisions by comparing

costs and benefits at the margin.
 Marginal Costs and Marginal Benefits
 Using economic reasoning, decisions are often made by
comparing marginal costs and marginal benefits

 Marginal cost is the additional cost or sacrifice

one makes of participating in an activity or
purchasing a additional product.

 Marginal benefit is the additional satisfaction

or value one obtains from an activity or product.
Principle #4: People Respond to
Incentives.
• Marginal changes in costs or benefits motivate
people to respond.
• The decision to choose one alternative over
another occurs when that alternative’s
marginal benefits exceed its marginal costs!
Principle #5: Trade Can Make
Everyone Better Off.
• People gain from their ability to trade with
one another.
• Competition results in gains from trading.
• Trade allows people to specialize in what they
do best.
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity
 A market economy is an economy that
allocates resources through the decentralized
decisions of many firms and households as
they interact in markets for goods and
services.
– Households decide what to buy and who to work
for.
– Firms decide who to hire and what to produce.
Principle #6: Markets Are Usually a Good
Way to Organize Economic Activity
• Adam Smith made the observation that
households and firms interacting in markets act
as if guided by an “invisible hand.”
– Because households and firms look at prices when
deciding what to buy and sell, they unknowingly
take into account the social costs of their actions.
– As a result, prices guide decision makers to reach
outcomes that tend to maximize the welfare of
society as a whole.
Principle #7: Governments Can
Sometimes Improve Market Outcomes
• Market failure occurs when the market fails to
allocate resources efficiently.
• When the market fails (breaks down)
government can intervene to promote
efficiency and equity.
Principle #7: Governments Can
Sometimes Improve Market Outcomes
• Market failure may be caused by
– an externality, which is the impact of one person or
firm’s actions on the well-being of a bystander.
– market power, which is the ability of a single
person or firm to unduly influence market prices.
Principle #8: The Standard of Living Depends on
a Country’s Production

 Standard of living may be measured in

different ways:
– By comparing personal incomes.
– By comparing the total market value of a nation’s
production.
Principle #8: The Standard of Living Depends on
a Country’s Production
• Almost all variations in living standards are
explained by differences in countries’
productivities.
• Productivity is the amount of goods and
services produced from each hour of a worker’s
time.
 Principle #9: Prices Rise When the Government
Prints Too Much Money
 Inflation is an increase in the overall level of
prices in the economy.
 One cause of inflation is the growth in the
quantity of money.
 When the government creates large
quantities of money, the value of the money
falls.
Principle #10: Society Faces a Short-run
Tradeoff Bet. Inflation and Unemployment

• The Phillips Curve illustrates the tradeoff

between inflation and unemployment:
òInflation ð ñUnemployment
It’s a short-run tradeoff!
 Thinking Like an Economist

• Economics trains you to. . . .

– Think in terms of alternatives.
– Evaluate the cost of individual and social choices.
– Examine and understand how certain events and
issues are related.
 The Economist As a Scientist

• The economic way of thinking . . .

– Involves thinking analytically and objectively.
– Makes use of the scientific method.
 Economic Model

 This is a simple analytic frame which shows the

relationship between the main factors, and explains the
behavior of an economic theory or phenomenon.

 Economists use economic models to simplify reality and

to facilitate the understanding of the actual world
economic inconveniences.
 Types of Economic Model

 Descriptive
– Like the Circular Flow
 Analytical
– Assumptions
– Mathematical model ( functions and equations)
– Graphical analysis
First Model: The Circular-Flow Diagram

• The circular-flow diagram is a visual model of the

economy that shows how income flows
through markets among households and firms.
First Model: The Circular-Flow Diagram
Wages, rent, MARKETS
and profit FOR Income
FACTORS OF PRODUCTION
•Households sell
Factors of •Firms buy Labor, land,
production and capital

HOUSEHOLDS FIRMS
•Buy and consume •Produce and sell
goods and services goods and services
•Own and sell factors •Hire and use factors
of production of production

Goods Goods and

and services services
MARKETS
bought sold
FOR
GOODS AND SERVICES
•Firms sell
Spending •Households buy Income
= Flow of inputs
and outputs
= Flow of Money
 General Features of Economic Model

 All economic models incorporate three common

elements:
1. The ceteris paribus (other things the same)
assumption;
2. The supposition that economic decision makers
seek to optimize something;
3. A careful distinction between “positive” and
“normative” questions.
 Ceteris Paribus Assumption

 The ceteris paribus (other things the same)

assumption – which allows analysis of the effect of
a change in one factor by holding all other relevant
factors unchanged.
 Optimization Assumption

2. The supposition that economic decision makers seek

to optimize something;
 Many economic models start from the assumption that the
economic actors being studied are rationally pursuing some goal.
 Positive versus Normative Analysis

 Positive economics are statements that attempt

to describe how the economy functions and the
the world as it is.
– Called descriptive analysis
 Normative economics are statements about how
the economy or world should be which relies on
value judgments to evaluate or recommend
alternative policies.
– Called prescriptive analysis
 Positive versus Normative Analysis

Positive or Normative Statements?

 If the minimum wage increases, then firms’ cost of
production rises.
POSITIVE
 Higher budget deficits will cause interest rates to
increase.
POSITIVE
 Positive versus Normative Analysis

 Positive or Normative Statements?

 The minimum wage in manufacturing industry should
increase to Rs. 30,000/-.
NORMATIVE
 The government should be allowed to collect from
tobacco companies the costs of treating smoking-
related illnesses among the poor.
NORMATIVE
 Let’s Check You Understanding!

Which of the following statements is a positive

statement? Which is a normative statement?

A. Society should take measures to prevent people

from engaging in dangerous personal behavior.
B. People who engage in dangerous personal behavior
impose higher costs on society through higher medical
costs.
 Economics System
1 Centrally Planned Economy
2 Free Market Economy
(Capitalism) by Adam smith 1776
3 Mixed Economy

55
 Types of Economics
1. Household Economics – most common use of economics is for the family.
At this level, anyone who knows the economic principles will be able to
improve the running of the household.
2. Business Economics – when a person or group of persons begins to work,
they come under the system of business economics in their workplace.
In this type, you deal with the rent, salary, profits and others.
3. National Economics – Economic factors of problems affecting the whole
nation. Deals with the management of income, expenditures, wealth or
resources of a nation.
4. International Economics – The highest stage of economic activities
involving the business of one country with other countries like trade,
tourism, exchange rates.

56
57
 Economics as a Science
• Is a science because it is an organized body of truth,
coordinated, arranged and systematized with
reference to certain general laws and principles
(Observation, Formulation of theories, Gathering of data, Experimentation,
Conclusion, Generalization)
• Economic analysis seeks to explain economic events
using some kind of logic based set of systematic
relations.
• It is a social science because the subject matter of
economics is people or societies and their behavior,
unpredictable in nature.

58
Relations of Economics to
other Sciences

59
 Benefits of Economics
• To understand the world better
• To gain self-confidence and become
wise decisions makers
• To achieve social change and contribute
to National Development
• To help prepare for other careers

60
61