Introduction to Economics
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How Economics Originated?
Economics and Government
How do we define it?
What are its branches?
What is Opportunity cost?
What is GDP?
The three basic questions for any
The Theory of Social Contract
Thomas Hobbes
Nature is always in a state of conflict
John Locke
Nature is in a state of harmony
Thomas Hobbes (1651)
Hobbes was the supporter of absolutism.
In the opinion of Hobbes, “law is dependent
upon the sanction of the sovereign.
Government without sword are but words
and of no strength to secure a man at all ”.
According to Locke,
The purpose of Government and law is to uphold and
protect the natural rights of men. When it ceases to
fulfilil this purpose, the Government can be thrown
out of power.
In Locke’s view, unlimited sovereignty is contrary to
natural law
Adam Smith
• 18th century Scottish
economist
• Published “The Wealth
of Nations” in 1776
• Explained the workings
of the free market
within capitalist
economies
• Invisible hand of the
market
Adam Smith
• Laissez-faire - Government stays out
of business
• practices “hands off” to let the
market determine production,
consumption and distribution.
• Individual freedom and choice
emphasized.
The Foundation of Economics
-Lionel Robbins
-What is Economics?
Economics is the study of what
constitutes rational human behavior in the
endeavor to coordinate between limited
resources (that have alternative uses) and
unlimited wants.
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• William Baumol says, let the subject matter
speak for itself.
• The Basic Function:
• To observe, explain and predict how people
(individuals, households, firms and the
Government) make choice about resources
(land, labour, capital, etc.)
ECONOMICS
MICRO
MACRO
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The Study of Economics
• Macroeconomics
– The big picture: growth,
employment, etc.
– Choices made by large
groups (like countries)
• Microeconomics
– How do individuals make
economic decisions
Micro Economics
• Micro Economics studies how the individual parts of the
economy make decisions to allocate limited resources
• Microeconomics studies:
– how individuals use limited resources to meet
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unlimited needs
the consequences of their decisions
the behaviour of individual components like industries,
firms and households.
how individual prices are set
what determines the price of land, labour and capital
inquire into the strengths and weaknesses of the
market mechanism.
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Macro Economics
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Macroeconomics studies about the functioning of the
economy as a whole
It examines the economy through wide-lens.
Macroeconomics studies about
• the total output of a nation
• the way the nation allocates its limited resources of
land, labor and capital
• the ways to maximize production levels
• the techniques to promote trade
After observing the society as a whole, Adam Smith
noted that there was an "invisible hand" turning the
wheels of the economy: a market force that keeps the
economy functioning.
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PRODUCTION
• A measure of the production of an entire
country in one year is
GDP
The total money value of ALL final Goods and
Services produced in a country in a year.
(GROSS DOMESTIC PRODUCT)
The three basic questions
• What to produce?
(what not to produce)
• How to produce?
(refers to choice of technique)
• How much to produce?
(determination of quantity)
There is a fourth question:
• For whom to produce?
Market Economies
In a pure market economy
there is no government
intervention
in
economic
decisions.
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Contd….
The Government lets the market answer the
following three basic economic questions:
1. What ?
Consumers decide what should be produced in a
market economy through the purchases they make.
2.How ?
Production is left entirely up to businesses.
Businesses must be competitive in such an economy
and produce quality products at lower prices than
their competitors.
3.For whom ?
In a market economy, the people who have more
money are able to buy more goods and services.
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Karl Marx
• 19th century German
economist
• Author of “Communist
Manifesto” and “ Das
Kapital”
– Government should
control economy and
distribute goods and
services to the people
Command Economies
In a command economy the
Government takes economic
decisions.
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Command Economies
In a command economy the Government answers
the three basic economic questions.
1.What?
A central planning committee decides what
products are needed.
2.How?
Since the Government owns all means of
production in a command economy, it decides how
goods and services will be produced.
3. For Whom ?
The Government decides who will get what is
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produced in a command economy.
Mixed Economies
In the Mixed economies the
Government and the Market work
together in decision making
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John Maynard Keynes
• The Invisible Hand
doesn’t always work.
• “The long run is a
misleading guide to
current affairs. In the
long run we are all
dead.” or . . . the
trouble is people eat in
the short run.
Keynesian Economics
• Government should intervene in economic
emergencies through tax and spending (Fiscal
Policy) and changing the money supply
(Monetary Policy).
• This is done to smooth out the business cycle
(expansion and recession) and keep inflation
low.
Opportunity Cost
 Definition – the cost expressed in terms of the
next best alternative sacrificed
 The cost of anything in terms of other things
given up or sacrificed.
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Production Possibility Frontiers
• PPF Shows the different combinations of goods
and services that can be produced with a given
amount of resources
• No ‘ideal’ point on the curve
• Any point inside the curve – suggests resources
are not being utilised efficiently
• Any point outside the curve – not attainable with
the current level of resources
• Useful to demonstrate economic growth and
opportunity cost
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Production Possibility Frontiers
If it devotes all
Assume a country
to its
capital
Ifresources
it reallocates
can
produce
two
resources
goods it (moving
could round
types
ofagoods
the
PPF from
A to B) it can
produce
maximum
produce
more
consumer
with
resources
of Ym.its
Capital Goods
Ym
Yo
A
Y1
Xo
goods
but only
at the
– capital
goods
expense
of fewer
If it devotes
allcapital
its
and
consumer
goods.
The opportunity
resources
to
goods
cost
of
proIf
the
country
consumer goods
itis at
point A on the PPF It can produce
could produce a
the combination of Yo capital
maximum
of Xm
goods
and Xo consumer
goodsducing an extra Xo –
BX1 consumer goods is Yo
– Y1 capital goods.
X1 Xm Consumer Goods
Production Possibility
Frontiers
Production
Capital Goods
C
Y1
Yo
.
A
It can only produce at
points outside the PPF
inside the PPF
if it finds a way of
– e.g. point
B
expanding
its
resources
improves
means or
the
the
productivity
of
country
is not
those resources it
usinghas.
all This
its will
already
resources
push
the PPF further
outwards.
B
Xo X1
Consumer Goods
Vilfredo Pareto (1848-1923)
• Founder of modern welfare economics
• Most famous contribution:
“Pareto Optimality”
– Maximum welfare = no change could make anyone better
off without making someone worse off.
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Allocative Efficiency or Pareto optimality.
• Pareto improvement
Given a set of alternative allocations and a set of individuals,
a movement from one allocation to another
that can make at least one individual better off
without making any other individual worse off
is called a Pareto improvement.
• Pareto efficient or Pareto optimal
An allocation of resources is Pareto efficient or Pareto optimal
when no further Pareto improvements can be made.
If an economic system is not Pareto efficient,
then it is the case that some individual can be made better off
without anyone being made worse off.
Equity and efficiency
• Horizontal equity – the identical
treatment of identical people
• Vertical equity – the different
treatment of different people in
order to reduce the consequences
of their innate differences
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