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CHAPTER 1: CHAPTER 1:

PRINCIPLE PRINCIPLE

OF OF

ECONOMICSECONOMICS

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1.1 Introduction1.2 Economics Defined

1.3 The Scope of Economics1.4 Scarcity, Choices & Opportunity cost

1.5 Basic Economic Problems1.6 Production Possibility Frontier (PPF)

1.6 Economic System

CHAPTER OUTLINE

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1.1 INTRODUCTION1.1 INTRODUCTION

WHY STUDY ECONOMICS?

• To learn a way of thinking

• To understand the society

• To understand global affairs

• To be an informed voter

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1.2 ECONOMIC DEFINED1.2 ECONOMIC DEFINED

Economics:

a) K.E. Case and R. C. Fair view that economics is a study of how people use their limited resources to try to fulfill unlimited wants and involves alternatives or choices.

b) David N. Hyman defined economics as a study of how scarce resources are allocated among alternative uses

c) Economics is a science that studies human behavior as a relationship between ends and scarce, which have alternative uses, according to L. Robbins

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1.3 THE SCOPE OF ECONOMICS1.3 THE SCOPE OF ECONOMICS

• Microeconomics deals with individual units; a household, a firm and an industry. Studies the interrelationship between these units to determine the pattern of distribution of goods and services.

• Macroeconomics looks at the economy as a whole. Its deal with the economic behavior of aggregates; national output, overall price level, inflation, unemployment.

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Scarcity: The core problem

Choice

Opportunity cost

Danny has RM5 and he would like to buy two things; a book and a pen which cost RM5 each (unlimited wants and limited resources). Danny has to choose either to purchase book or a pen which would satisfy his needs (choices). If Danny choose the book, then the pen is the opportunity cost.

1.4 SCARCITY, CHOICES AND1.4 SCARCITY, CHOICES AND OPPORTUNITY COSTOPPORTUNITY COST

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Scarcity

• Human wants are always greater than the available resources.

• Society has limited (scarce) resources (factors of production), and therefore cannot produce all the goods and services people wish to have.

• Economist has classified the factors of production into four groups namely Labour, Capital, Land and Entreprenuer.

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Choice

• Consists of the mental process of thinking involved with the process of judging the merits of multiple options and selecting one of them from action.

• Choice involves sacrifice.

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Opportunity cost

• Economists use the term of opportunity cost to emphasize that making choices in the face of scarcity implies a cost.

• The opportunity cost of any action is the second best alternatives that has to forgo for another choice which gives more satisfaction.

• The higher the opportunity cost, the less likely to do it.

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• What to Produce- Type of goods and services

• How to Produce

- Method of production

• For Whom to Produce (Distribution Theory)- Distribution of income

1.5 BASIC ECONOMIC PROBLEMS1.5 BASIC ECONOMIC PROBLEMS

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1.6 PRODUCTION POSSIBILITIES FRONTIER (PPF)

The curve that shows all of the possible combinations of 2 goods (products) or services that can be produced within a specified time with all its resources fully and efficiently employed.

The economy can produce at any combination on or inside

the curve (C and H).

Point outside the curve is not attainable (F).

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Assumptions for PPF

• Full employment

• Fixed resources

• Technology constant

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Production Possibilities: Inside, On, orOutside the Frontier

• Point on the curve (C): Attainable and Efficient because all resources are fully and efficiently employed.

• Point inside the curve (H): Attainable and Inefficient because resources are not fully and efficiently employed.

• Point outside the curve (F): Unattainable because of limited resources.

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Butter (thousand kg)

Production Possibilities Frontier (PPF)Sewing machines (thousands units)

•A•B

•C

•D

•E

•F

•Y

Attainable

Unattainable

0 1 2 3 4 5

•Z•Point A, B, C, D, E and F is attainable and efficient

•Point Y is attainable and inefficient

•Point Z is unattainable

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Movement along the PPF represent the opportunity cost

That mean increase in producing a particular product can only possible with reduce production of another product.

Calculating the Opportunity Cost

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Point on PPF Opportunity cost (bushels of corn)

A to B (700 – 650) / (200 – 100) = 0.50

B to C (650 – 510) / (380 – 200) = 0.78

C to D (510 – 400) / (500 – 380) = 0.92

D to E (400 – 300) / (550 – 500) = 2.00

Table 1.2: Opportunity Cost (per bushels of extra wheat per year)

The opportunity cost from point A to B, B to C, C to D and D to E are increasing, implying the law of increasing opportunity cost.

It also represented in the increasing steepness of the slope and the concave shape of PPF.

End

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Shifts in the Economy’s Production Possibilities Frontier

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• The shape of PPF depends on the opportunity costs:

Increasing opportunity cost (PPF is concave)

Constant opportunity cost ( PPF is linear)

Decreasing opportunity cost (PPF is convex)

The Shape of PPF

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Increasing Opportunity Cost(PPF is concave)

• As we move along the production possibility curve with increasing computer, more and more food must be forgone

INCREASING OPPORTUNITY COST:

Q to R = [(11 – 10)/(6 – 5)] = 1

T to V = [(8 – 5) /(10 – 9)] = 3

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Constant Opportunity Cost(PPF is linear):

Computer

-As we move along the production possibility curve with increasing computer, constant unit of food must be forgone

0 5 10 15 20

30

20

15

10

5

PPF

A

B

Food

C

D CONSTANT OPPORTUNITY COST:

A to B = [(20 – 15)/(10 – 5)] = 1

C to D = [(10 – 5) /(20 – 150)] = 1

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Decreasing Opportunity Cost(PPF is convex):

Computer

-As we move along the production possibility curve with increasing computer, less and less food must be forgone

0

PPF

15

10

7

2 10 30

B

A

Food

C

DECREASING OPPORTUNITY COST:

A to B = [(15 – 10)/(10 – 2)] = 0.625

C to C = [(10 – 7) /(30 – 10)] = 0.15

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1.7 ECONOMIC SYSTEMS1.7 ECONOMIC SYSTEMS

Free Market Economy

Mixed Economy

Planned Economy

ECONOMIC SYSTEMS

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Economic Systems

Free Market Economy

Planned Economy Mixed Economy

•Private ownership of

resources•Price mechanism•Freedom of

enterprise and choice•Consumer’s

sovereignty•Laissez-faire•Free competition

•Public ownership of

resources•Central planning

authority•Price mechanism of

less importance•Central control and

ownership•No competition

•Public and private ownership of resources•Price mechanism and economic plans •Selective government intervention•Government control of monopolies•Free competition

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Refresh Your Mind!!!

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Figure 1 illustrated the Production Possibility Frontier (PPF) for the allocation of resources in Malaysian banking sector. Assumed that the Malaysian banking sector only consist of two types of banking product/services that are the conventional banking and Islamic banking.

Example of PPF analysis

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Example of PPF analysis

Point on PPF

Opportunity cost (Ringgit of conventional outputs per one Ringgit of Islamic banking output)

(i) A to B

(ii) B to C

(iii) C to D

End

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Scenario A:Malaysian is currently producing at Point B. The government is encouraging the development of Islamic banking, thus, advising all the banks in Malaysia to divert more resources to Islamic banking from conventional banking. If all the banks follow the government’s advice, sketch a PPF diagram to illustrate this scenario. Mark a possible new production combination (point) as “E”. Give your explanation.

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Scenario B:The government successfully invites foreign Islamic banks to invest in Malaysia by opening branches here. What happen to the PPF? Mark a new possible production point as “F”. Give your explanation.

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