Topic 1 - Definition & Scope

PSCI 1500:
Introduction to Economics
Economics :
Definition & Scope

 WHAT IS ECONOMICS
A social science that studies:
• human behaviors on how they make optimal
choices under conditions of ‘scarcity’.
• how limited resources are used to satisfy
people’s unlimited wants and needs.
INTRODUCTION

BASIC ECONOMIC
CONCEPTS
SCARCITY
OPPORTUNITY COST
CHOICE

 SCARCITY
• Central economic problem - conventional view
• Refers to : when human wants are unlimited,
but the means to satisfy it are limited
• Thus, scarcity is a result of insufficient resources
to satisfy wants and needs.
 CHOICE
• Scarcity requires choice to be made, since
resources can only be used for one purpose at
a time.
SCARCITY, CHOICE & OPPORTUNITY COST

 OPPORTUNITY COST
The concept of opportunity cost explains that
everything has a cost associated with it.
Opportunity cost refers to the desired goods or
services that are foregone or given up in order
to obtain something else.
The opportunity cost of a decision (for example,
a production, or a purchase) measured in terms
of the foregone alternative.
In other words, opportunity cost is the next best
alternative that you didn’t choose.
SCARCITY, CHOICE & OPPORTUNITY COST

Resources used to produce goods and services,
and which are classified into four categories:
• Labor – includes all effort, both physical and
mental; receives wages
• Capital – includes warehouses, machinery,
and equipment; receives interest
• Land – includes all nature-originating
production inputs; receives rent
• Entrepreneurship – performance of a number
of critical tasks that are carried out in all
productive processes; receives profit
FACTORS OF PRODUCTION

RELATIONSHIP BETWEEN RESOURCES &
WANTS AND NEEDS

EFFICIENCY VS. EQUITY
 EFFICIENCY
• Producing the largest attainable output of a
desired quality from a given set of resources;
occurs when goods and services are produced
at the lowest possible cost.
• If goods and services are produced efficiently,
society would experience the greatest possible
lessening of the scarcity problem.
 EQUITY
The concept of just and equitable distribution
of goods and services. It is controversial as it’s
based on people’s value judgments.

ECONOMIC THEORY VS. POLICY
 ECONOMIC THEORY
Formal explanation of the relationship between
economic variables; provides a reason why
something happens, offers a cause-and-effect
interpretation for a set of events, or shows the
effect on one variable when another changes.
 ECONOMIC POLICY
 Action taken to change or remedy an
economic condition, which is often a result of
a decision made by a policymaker.

WHY ECONOMISTS DISAGREE?
• They may disagree about the validity of
alternative positive theories about how the
world works.
• They may have different values and, therefore,
different normative views about what policy
should try to accomplish.

POSITIVE VS. NORMATIVE ECONOMICS
• POSITIVE economic statement describes the
economy as it actually is, avoiding value
judgments and attempting to establish
scientific statements about economic behavior.
• NORMATIVE economics statement involves
value judgments about what the economy
should be like and the desirability of the policy
options available. Most disagreements among
economists involve normative, value-based
questions.

POSITIVE VS. NORMATIVE ECONOMICS
In short,
• Positive statements are statements that attempt
to describe the world as it is.
• Called descriptive analysis
• Normative statements are statements about
how the world should be.
• Called prescriptive analysis

MICROECONOMICS VS. MACROECONOMICS
 MACROECONOMICS
• Focuses on the operation of the economy as a
whole; interactions of household, business,
government & foreign sectors in the economy.
• Includes such topics as inflation, unemployment,
taxes, government spending and money.
 MICROECONOMICS
• Focuses on behavior of individual businesses &
households; specific product & resource markets.
• Includes such topics as consumer behavior, cost-
benefit analysis, determination of business profits,
determination of prices in specific markets.

PRODUCTION POSSIBILITIES
 All economies are subject to a trade-off
between the production of capital goods and
consumer goods.
 Capital Goods
Goods, such as machinery and equipment, that
are used to produce other goods and services.
 Consumer Goods
Goods, such as food and household furniture,
that are produced for final buyers.
SCARCITY : PRODUCTION POSSIBILITIES

 PRODUCTION POSSIBILITIES TABLE
 Lists the possible levels of production in an economy
 In the following model, assume that all of the economy’s
resources will be used to produce only two goods

• PRODUCTION POSSIBILITIES CURVE (PPC)
• Plotting the data from the production possibilities table
• Point A (outside the curve) is unattainable due to the
problem of scarcity
• Point B (inside the curve) is attainable but inefficient, due to
underutilization of resources/ resources not utilized to its full
potential (i.e. unemployment)
• The economy should produce at any point on the PPC to
achieve the most efficient condition

ECONOMIC GROWTH
Growing economic results in larger total output and is
shown by an outward shift of PPC
Among the factors for economic growth:
• Increases in the quantity of resources supplied
• Increases or improvements in the quality of resources supplied.
• Advances in technology employed in the production or
distribution process.

Assume in an economy with full employment and fixed
resources and technology, the following amounts of
consumer and capital goods can be produced.
1. Construct a production possibilities curve.
2. Demonstrate the outcome of new technology created
for producing both goods.
Consumer Goods Capital Goods
0 45
10 40
20 32
30 20
40 0

TEST YOUR UNDERSTANDING :
On the graph, illustrate the effect of a small amount of
unemployment with a point labelled A, and a large
amount of unemployment with a point labelled B.
Point A is slightly to the left of the production
possibilities curve, and point B is further to the left than
point A.

FROM THE TABLE:
1. The opportunity cost of increasing the
production of consumer goods from 20
million to 30 million units is 12 million units
of capital goods (capital goods
decreased from 32 to 20 million units)
2. The opportunity cost of increasing the
production of capital goods from 40 million
to 45 million unit is 10 million units of
consumer goods (consumer goods
decreased from 10 million units to zero).

 The circular-flow model is a simple way to
visually show the economic transactions that
occur between households and firms in the
economy.
THE CIRCULAR-FLOW MODEL

Firms
Households
Market for
Factors
of Production
Market for
Goods
and Services
SpendingRevenue
Wages, rent,
and profit
Income
Goods &
Services sold
Goods &
Services
bought
Labor, land,
and capital
Inputs for
production

Households
 Buy and consume goods and services
 Own and sell factors of production
Firms
 Produce and sell goods and services
 Hire and use factors of production

Markets for Factors of Production
 Households sell
 Firms buy
Markets for Goods & Services
 Firms sell
 Households buy

Topic 1 - Definition & Scope

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