Lesson 1. fundamentals

Introduction to the Principles of Economics

Lesson 1. Fundamentals of Economics

Prepared by: R.A. Liwanag

What is Economics?

• Economics is a social science that deals with the proper utilization of the available scarce resources, through allocation, production, distribution, and consumption, to meet the insatiable needs and wants of man and the society.

• 4 aspects of UTILIZATION:– Allocation- priority– Production- quality and quantity– Distribution- equity– Consumption- utility

2 branches of Economics:

Microeconomics is the branch of economics that deals with the personal decisions of consumers and entrepreneurs. Its primary concern is to help consumers and investors make their lives better by increasing their earnings and satisfying their needs despite limited resources. Also included in its study are the consumers' decisions on what products to buy and how the cost of commodities is determined.– Microeconomics- deals with the study of the fragmented

units of the economy like: • individual demand and supply, • price of g/s, • costs of production, etc.

2 branches of Economics:Macroeconomics deals with the larger aspects of a nation's economy, such as the sectors of agriculture, industry, and service. It aims to (a) speed up the economy's growth rate and increase total production; (b) increase the rate of employment; (c) keep the prices of commodities stable so that they remain affordable; and (d) have sufficient reserves for foreign exchange for importing goods and paying off loans. Economists help in solving problems like unfair wages, rapid population growth, people migration to city centers,

high crime incidence, and loss of human resources due to overseas migration.

– Macroeconomics- deals with the study of the economy as a whole. Macroeconomic issues are:

• inflation, • unemployment, • aggregate demand and supply, • GNP, • GDP, etc.

Problem can arise between Microeconomics and

Macroeconomics:

• Both branches of economics can help members of the society make better economic decisions, however, there are instances that a microeconomic decision can be in conflict with the rest of the economy, and vice versa.

• Sometimes what is good for one, may not be good for the entire society, and at times, what is good for the majority, may entail a sacrifice on some of the members of the economy.

2 Views in Economics:

• Positive View- also known as descriptive economics. Positive economics is the branch of economics that concerns the description and explanation of economic phenomena. It focuses on facts and cause-and-effect behavioral relationships and includes the development and testing of economics theories.– Make good use of statistics and other mathematical tools in

describing the workings of a certain economy. It tells us if an economy is sick or it is well through the different economic indicators such as:

• poverty rate • Unemployment rate• Income per capita• GNP/GDP growth rate, etc.

2 Views in Economics:

• Normative economics is that part of economics that expresses value judgments (normative judgments) about economic fairness or what the economy ought to be like or what goals of public policy ought to be. – Normative View- also known as prescriptive economics. Through

the aid provided by the positive view, Normative economics would be able to provide for resolution on how to answer economic problems. It is like prescribing medication to a sick economy. Medication that is based from an understanding of what the economy is undergoing. Prescriptions will be in terms of ECONOMIC POLICIES such as:

• Fiscal policies• Monetary policies

Assumptions in the study of Economics:

• Indeed our resources are limited, or at least those which are referred as ECONOMIC RESOURCES.

• Indeed our needs and wants are unlimited, or at least those which are referred as ECONOMIC WANTS.

• All economic decisions entails TRADE-OFFS.• What are non-economic resources?

– Free-goods (air, sunlight, family, friendship, health)

• What are non-economic wants?– Security needs, Esteem needs, need for love and belongingness, self-

actualization

A Brief History of Economic Theory

• Ancient Period– Plato.

• Theory of Money. Money is anything that is used as a medium of exchange.

• Theory of Market. Market is a place where income and employment takes place.

– Aristotle.• The difference between use value and exchange value.

– Xenophon.• He wrote the book Oikonomikos, where the term

economics was coined from.


• Medieval Period– St. Thomas Aquinas. Theorized on lending and interest. He

does not approve of putting interest in lending money. He called it USURY.

• Classical Period– Mercantilist Theory.

• A set of economist who proposed that the measure of economic wealth is the accumulation of gold and silver. They proposed that the government, as much as possible should limit importation of goods to limit the outflow of gold and silver in the economy.

– Physiocrats.• Agriculture is an important basis of economic wealth.

A Brief History of Economic Theory• Classical School of Economics.

• Adam Smith. An Inquiry into the Nature and Causes of The Wealth of Nations.– Father of Modern Economics– Emphasizes the natural economic order in is concept of the a Laissez

Faire (CAPITALISM or FREE MARKET)– INVISIBLE HAND – the aggregate of individual self-interest.

• Jean-Baptiste Say – Say’s Law : “SUPPLY CREATES ITS OWN DEMAND”.

• David Ricardo . Principles of Political Economy and Taxation.– He focused on the trade-off between rent and prices of corn in the

market.– He coined the term COMPARATIVE ADVANTAGE


• Thomas Robert Malthus. – Population Theory. He suggested that there is no need for

government intervention in terms of regulating the population, stating that nature has its own capacity to regulate itself.

• John Stuart Mill. – 2 Roles of the Market.

» Allocation of resources» Distribution of income

In summary the Classical School suggest this Main Theorem:P = f(COP)

A Brief History of Economic Theory• Neo-Classical School/ Marginalist School

– Suggested that Price is not only affected by the Costs of Production, but also the utility provided by the commodity, as well as the quantity demand.

• Marxist School– Turned away from capitalism as the best type of economic system and

suggested a Command Economy (COMMUNISM)– According to the Marxists, capitalism leads to economic alienation,

especially of the working class or the laborers. “Man is alienated by his own production, by private property”.

– In a COMMAND ECONOMY, all aspect of allocation, production, and distribution is controlled by the state or the government.

– No private property, everything is communally owned, with the government as the guardian of this communal property.


• Institutionalist School– The Circular Flow of Economic Activity

MARKETS FOR FACTORS OF PRODUCTION

MARKETS FOR GOODS AND SERVICES

FIRMS HOUSEHOLDS

Good and services bought

Good and services sold

Revenue (=GDP)

Spending (=GDP)

Inputs for Production

Land, labor and capital

Wages, rent, interest and profit (=GDP)

Flow of goods & services

Flow of money: pesos

Income (=GDP)

THE CIRCULAR FLOW DIAGRAM


• Keynesian School of Economics– John Maynard Keynes. The General Theory of

Employment, Interest, and Money.• One of the economic advisers of the then US president

Franklin Delano Roosevelt. He was behind the economic policy that was labelled as “the New Deal”.

• The West, at that time was experiencing a very long recession period, history refer to it as the Great Depression.

• He suggested a new type of economic system called the MIXED ECONOMY.

The Three Basic Economic Problems

• What goods and services should be produced and in what quantity?– Allocation

• How should these goods and services be produced?– Production

• For whom should these goods and services be produced?– Distribution

• These all leads to Consumption of the goods and services towards attainment of Utility or satisfaction.

Economic Wants

• Economic wants- goods that require trade off or sacrifice before they can be attained.

• Non-Economic wants- also known as free goods.– such as air, family, time.

• Basic wants- goods that are necessary for our basic survival.– Air, water, food, clothing, shelter.

• Created wants– Toothpaste, cars, cellphones.

• Public wants – goods that are non-rival and non exclusive.– Roads, bridges, park, schools.

• Private wants– Clothes, houses.

Society’s Technological Possibilities

Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed.

- Pres. Eisenhower

Inputs and Outputs

• Inputs- are commodities or services that are used to produced goods and services.Also known as factors of production.

• Outputs- are the various useful goods and services that result from the production process and are either consumed or employed further in production.

3 Major Economic Resources:RESOURCES are anything that can be used to satisfy a need or want.

• Land- also known as natural resources. Resources that are provided to us by nature such as woods from trees, cotton, minerals, such as gold, lead, copper, etc. Animals are also considered as land resources.

• Labor- also known as manpower or human resources. Labor refers to the time spend by man for work. Land resources are made available by nature, but they still need to be processed to be useful, and that will be the role of labor as a resource. – Labor Supply– Labor Force– Manpower

• Capital- capital refers to any man-made good that can produce other goods, or that can help man become more productive. Capital can be in the form of technology such as computers, cellphones, or fixed capital such as buildings, infrastructures, vehicles, etc.

The Entrepreneur• The entrepreneur is a special type of resource. It can be under Labor as a

capital, however because of the very important role of the entrepreneur in the production process, we are going to give it special attention.

• The entrepreneur serves as the brains of the production process. • Characteristics of a SUCCESSFUL entrepreneur:

– INITIATIVE. He initiates the production process. He brings together all the major factors of production, Land, labor, and capital.

– IDEALIST. He is the origin of ideas for production. He thinks of strategies and solutions to problems. Remember that all great things started as ideas.

– INNOVATIVE. Non-traditional & non-conventional. Thinks out of the box. – RISK-TAKER. You have to spend money to earn money, better, YOU HAVE

TO SPEND BIG MONEY, TO EARN BIG MONEY. But with risk, it entails good strategies, and great and innovative ideas.

• Examples of great entrepreneurs are STEVE JOBS, MARK ZUCKERBERG, HENRY SY.

TRADE-OFFs

• Due to the law of Scarcity, all Economic Decision entails a TRADE-OFF, every decision has a opportunity cost.

• TRADE-OFF is the condition of attaining things, but requiring a sacrifice at the same time.

• OPPORTUNITY COSTS is the value of the alternative that is lost

The PPF The Transformation Curve

Production-Possibility Frontier -shows the maximum amounts of production that can be obtained by an economy, given its technological knowledge and quantity of inputs available.The PPF represents the menu of goods and services available to society.

Alternative Production Possibilities

Possibilities Butter (millions of pounds) Guns (Thousands)

A 0 15

B 1 14

C 2 12

D 3 9

E 4 5

F 5 0

Table 1. Limitation of scarece resources implies the Guns-Butter tradeoff

The Production-Possibility Frontier

0

2

4

6

8

10

12

14

16

0 1 2 3 4 5 6

Butter (million of pounds)

Gu

ns

(Th

ou

san

ds)

Series1

Points within the transformation curve is a situation called Productive Efficiency, wherein you can not produce more of a good without curtailing the production of other goods. Examples are Point A, B, and C.

Points at the left of the transformation curve are within the area of inefficiency, where resources are mostly idle and not optimally used.Example is Point X.

Points at the right of the transformation curve are within the non-feasible region, meaning the combination is not within the productive capacity of the economy.Example is Point Y

Opportunity Cost and Efficiency

In a world of scarcity, choosing one thing means giving up something else. The opportunity cost of a decision is the value of the good or service forgone.

Productive Efficiency occurs when an economy cannot produce more of one good without producing less of another good; this implies that the economy is on its production-possibility frontier.

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Lesson 1. fundamentals