UNIT 1: INTRODUCTION TO

ECONOMICS
1.1 WHAT IS ECONOMICS

Economics as the study of how society allocates scarce resources to satisfy human wants.

Economics is a social science because it studies human behaviour in relation to the economy. Its
concepts, principles and laws are based on empirical (past) evidence.

1.1.1 CETERIS PARIBUS

Ceteris paribus (other things remaining constant) applies when considering how one economic variable
affects another.

If, for example, the price of cinema tickets increases, the quantity demanded for them is expected to
decrease, assuming consumer incomes and tastes remain the same. Ceteris paribus is important in
economic analysis because it allows us to understand how a change in one economic variable causes
changes in other variables by excluding other factors that might also affect the change.

1.1.2 MACRO AND MICROECONOMICS

MICROECONOMICS
Microeconomics is the study of the behaviour of individual markets within the economy, particularly the
interaction of consumers and producers. We would, for example, study the growth of the market for
electric vehicles or the decline of the coal industry in microeconomic terms.

MACROECONOMICS
Macroeconomics is the study of the behaviour of the whole economy at a national level. It involves the
study of economic issues such as economic growth, inflation, equity, and unemployment. Hyperinflation
in Venezuela, low unemployment in the United States or high economic growth in Tanzania would all be
looked at in macroeconomic terms.

It is important to understand the crossover between macroeconomics and microeconomics. Negative

economic growth in Argentina last year is a macroeconomic topic that will have microeconomic
implications, such as a fall in demand for products in the luxury goods market.

1.1.3 THE ECONOMIC PROBLEM

SCARCITY
All the resources used to produce goods and services are in limited supply. This means unlimited human
wants are chasing too few resources, which is the central economic problem of scarcity.

HUMAN WANTS
Human wants are people’s desire to consume goods and services to derive satisfaction from their
consumption. Human wants can be expressed as consumer demand in markets. For example, consumers
who buy the music streaming service Spotify want to experience the pleasure of listening to music. A
want is a complex mixture of reasons why people buy different products.

SUSTAINABILITY IN THE ECONOMIC PROBLEM

Key issues of the economic problem: how the use of scarce resources to produce goods and services in
the present impacts their availability in the future, as well as the wider implications for the
environment.

1.1.4 FACTORS OF PRODUCTION

Resources are the factors of production used to produce goods and services. Resources are often
expressed as the factors that determine supply in markets. They include:

LAND
Land provides the raw materials used in production, such as oil, timber, copper, etc. In car
manufacturing, for example, the plastic, metal, and glass used to make a car are made up of different
raw materials that come from the land.

LABOUR
Labour are the workers used in the production of goods and services. An airline, for example, employs
pilots, cabin crew, and ground staff, in addition to people who work in marketing, finance and
administrative roles.

CAPITAL
Capital is the machinery and equipment used in the production of goods and services. A solar energy
provider, for example, utilises solar panels, batteries and transmission infrastructure that provides
electricity to its consumers.

ENTREPRENEURSHIP
An entrepreneur is a person or people who bring together and manage the factors of production (land,
labour, and capital) to produce goods or services to make a profit.

ALLOCATION OF RESOURCES
The allocation of resources means the distribution of the factors of production to produce different
goods and services in an economy.

1.1.5 ECONOMIC AND FREE GOODS

ECONOMIC GOODS
Economic goods are products produced using scarce resources.

FREE GOODS
Free goods arise because some resources in certain situations are not scarce. Economists consider the
air we breathe, sunlight and wind as free goods.

1.1.6 OPPORTUNITY COST

OPPORTUNITY COST
Opportunity cost is the highest value alternative foregone for the option chosen in a decision-making
situation. It arises because of scarcity which forces individuals, firms, and governments to choose
between alternatives.

OPPORTUNITY COST AND DIFFERENT STAKEHOLDERS

INDIVIDUALS
This could be where people choose to use their limited income to buy a good rather than spending their
money on something else.

Example: If someone spends $9 a month on a Netflix subscription, then the opportunity cost might be
choosing not to use that money to go to the cinema.

BUSINESSES
When businesses use their funds to invest in a project there will be an opportunity cost in terms of an
alternative use of the funds.

Example: For example, the car manufacturer, Volkswagen, plans to spend 30 billion Euros on developing
electric vehicles. The opportunity cost of this might be using this money to develop petrol or diesel cars.

GOVERNMENTS
Governments face an opportunity cost when they are deciding between different items of public
expenditure.

Example: The Saudi Arabian government is currently planning a city construction project called 'The
Line' that costs $1 trillion to build. The opportunity cost of this $1 trillion could be the funds the Saudi
Arabian government might spend on health and education.

SOCIETY
When resources are allocated in an economy, there is an opportunity cost in terms of what else the
resources could be used to produce.

Example: Japan, for example, plans to increase its provision of electricity generated by renewable
sources. The opportunity cost of this might be less electricity being generated using fossil fuels.

IMPORTANCE OF OPPORTUNITY COST

Opportunity cost allows consumers, producers, and governments to assess the implications of the
decisions they make in terms of what they are prepared to sacrifice when a choice is made. Opportunity
cost allows us to put a value on things.

1.1.7 ECONOMIC SYSTEMS

An economic system is how society is organised and governed, and how this affects the resource
allocation in the economy.

THE ALLOCATION OF RESOURCES BY AN ECONOMIC SYSTEM IS CONSIDERED IN TERMS OF

3 QUESTIONS:

WHAT GOODS AND SERVICES ARE PRODUCED?

This means what goods and services are available to a country’s population such as consumer goods
like cars and mobile phones, to wider services such as health and education.

HOW ARE GOODS AND SERVICES PRODUCED?

This question is about ownership of the factors of production used to produce goods and services in
the economy. This is normally looked at in terms of private businesses and state-managed enterprises.

WHO THE GOODS AND SERVICES PRODUCED ARE DISTRIBUTED TO?

The distribution of goods and services is often related to income distribution in terms of the income
individuals receive. For example, the households that earn the highest incomes in society can afford to
buy (get distributed) the most goods and services.

QUESTIONS FREE MARKET ECONOMY PLANNED ECONOMY MIXED ECONOMY

What goods and Consumer sovereignty The government or In mixed economies,
services are decides what goods and
planning authority governments are
produced? services are produced. If
consumers demand a determines what is normally involved in
particular good resource will produced based on the provision of public
be allocated to produce the what they believe the goods (police, defence
product as entrepreneurs people of their country and infrastructure) and
see the opportunity to make want. The planners public services like
a profit from selling it to
would decide what to health and education.
consumers.
produce based on
household needs.

How are goods Firms are owned by State-managed Private firms make up
and services individuals (known as organisations produce the other commercial
produced? private capital) who look to goods and services in a sectors of the
make a profit by producing command economy. economy. It should be
those goods or services. Producers were not noted, however, that
Competition between incentivised by profit those private
private firms means that but by the desire to companies are still
consumers get a wider satisfy the planners. involved in public
choice of goods at lower services such as
prices relative to more healthcare and
state-controlled economic education.
systems.

Who are the G and S are distributed in A primary aim for

goods and the economy through the these societies was
services produced price mechanism (rationing equality in the
to? system). People who are distribution of goods
willing and able to pay the and services (income
 price for the products will equality). Everyone, for
obtain them. In a free example, in the USSR
market economy, an should have a place to
individual’s income is live, and access to
determined by the demand necessities such as
and supply for the work food and clothing,
they do. along with the
provision of education
and healthcare for all.
Weaknesses Externalities Difficult for a NO
Merit and demerit goods government to
Public goods efficiently plan all of
Common pool/access resource allocation
resources decisions that take
Asymmetric information place every day in an
Monopoly economy.
Inequity Without the incentive
to earn high incomes
and profits individuals
(no motivation)
Considerable
bureaucracy in the
management of state-
run enterprises which
reduces their
efficiency.
The decisions taken do
not result in the most
efficient economic
outcomes.

1.1.8 PRODUCTION POSSIBILITY CURVE

DEFINITION OF PRODUCTION POSSIBILITY CURVE

A production possibility curve is a model that shows the maximum relative amounts of two goods a
country can produce with a given availability of resources at a point in time.

Economic models are used by economists to help them understand how the economy works. Production
possibility curves are a very simple model that can be used to illustrate the basic economic concepts of
scarcity and opportunity cost.

THE PRODUCTION POSSIBILITY CURVE DIAGRAM

General markets, such as capital goods and consumer goods, can be used, or more specific markets such
as sugary soft drinks and bottled water. The key purpose of the model is to show the relative output of
the two goods produced using scarce resources.

PRODUCTION POSSIBILITY CURVES, SCARCITY AND OPPORTUNITY COST

The PPC curve shows how the output of 2 goods is limited by the scarcity of available factors of
production in an economy at a certain point in time. Scarcity means producing more of one good on the
PPC leads to an opportunity cost in terms of the other good
produced.

In diagram 1.1, if the economy produces 200 units of wine it forgoes

the production 100 units of sugar. Producing 100 units of sugar
would mean giving up the production of 200 units of wine. By
producing at point F on the PPC the country produces 160 units of
wine with an opportunity cost of 30 units (100 units – 70 units) of
sugar.

THE SHAPE OF THE PRODUCTION POSSIBILITY CURVE

INCREASING COST PPCS

A curved outwards means more resources are allocated to the production of a
good, the opportunity cost in terms of the other good foregone increases. This is
because some resources are better suited to the production of one good than
they are to another.

CONSTANT COST PPCS

For some aspects of economic analysis, it is easier to use the constant cost PPC curve, where the PPC is a
straight line, and the opportunity cost stays the same as the output of one good increase and the other
decreases.

PRODUCTION POSSIBILITY CURVES AND ECONOMIC EFFICIENCY

Productive efficiency occurs in an economy when all available
resources are being used and they are achieving the highest possible
output. All points on the production possibility curve represent a
productively efficient use of resources.

GROWTH IN PRODUCTION POSSIBILITIES

One of the key applications of the PPC model is to illustrate growth in production possibilities where the
potential output of an economy grows over time. As potential output increases, the PPC shifts outwards
and the economy can now produce more of both goods in the PPC diagram.
The growth in production possibilities often occurs because of an
increase in available resources or because existing resources become
more productive. This could be because of greater use of capital,
improvements in technology and a more educated labour force...

1.2 HOW DO ECONOMISTS APPROACH THE WORLD

Economists test their theories, laws, and ideas by using empirical evidence. This is evidence gathered by
observing how people behave and by using data. For example, we might expect a decrease in the price
of Coca-Cola to lead to a rise in the quantity demanded for it. We can test this by looking at a situation
where Coca-Cola reduced the price of its product and by looking at data from past price reductions by
the company.

1.1.2 POSITIVE ECONOMICS

Positive economic statements are objective statements that can be proven true or false based on
empirical evidence.

Here are some examples of positive economic statements:

- ‘If interest rates are reduced economic growth rises’.

- ‘As the price of a personal computer falls its quantity demanded will increase’.
- ‘As the value of the US dollar falls US exports get cheaper’.
- ‘Economic growth leads to rising income inequality’.

HYPOTHESIS
For the claim: ‘If interest rates are reduced economic growth rises’, an economist might hypothesise
that reducing interest rates will increase consumer spending, which will increase aggregate demand,
thus leading to increased economic growth. The circular flow of income model can be used to support
this hypothesis, along with the theory that there is a negative relationship between interest rates and
consumption spending.

1.2.2 NORMATIVE ECONOMICS

Normative economic statements are value judgements that cannot be proved to be true or false based
on empirical evidence. They often form the basis of economic policymaking.

Here are some examples of normative economic statements:

- ‘Healthcare should be provided by the state’.

- ‘Professional footballers are paid too much’.
- ‘The governments ought to reduce interest rates to combat a recession’.
- ‘Increased consumption of alcohol is bad for society’.

1.2.3 ECONOMIC THOUGHTS

KARL MARX ADAM SMITH JOHN MAYNARD KEYNES
Wrote the book, An Inquiry into
the Nature and Causes of the
Wealth of Nations (1776)
(over-regulated and controlled
Economic systems hinders
economic development and
prevents the gains from
economic activity from
benefiting the wider
population.

Smith believed that allowing a

free exchange of goods and
services (laissez-faire markets),
both within countries and
through international trade,
benefited buyers and sellers
and increase incomes
throughout the population.