Fundamentals of Economics - Chapter 1

CHAPTER

1

INTRODUCTION TO ECONOMICS

LEARNING OUTCOMES

At the end of the chapter, you should be able to:











Interpret the definition of economics and distinguish between microeconomics and macroeconomics.

Describe the three economic concept; scarcity, choice and opportunity cost.

Discuss and illustrate the production possibility curve

(PPC).

Describe the three economic problems.

Differentiate the four types of economic systems.

Fundamental of Economics

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INTRODUCTION









Economics is the most important aspect in human life.

The desire of human beings is unlimited and they will try as hard as possible to fulfill their demand to maximize satisfactions.

However, economics faces limited resources or factors of production.

Economics study how people fulfill their unlimited desire with the limited resources.




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DEFINITION OF ECONOMICS





Economics is defined as ‘a social science that studies how people and society organize scarce and limited resources to satisfy unlimited human wants’

FOP are resources or inputs used to produce goods and services.

(1) Land

─ Includes all natural resources which are derived from the earth and land itself

─

─

Examples: timber, oil, coal, soil and water

‘Rent’ is the return to land




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DEFINITION OF ECONOMICS (cont.)

(2) Labour

─ Labour or workers are defined as people who contribute their energy mentally and physically to earn wages or salaries.

─ Labour can be categorized into:

─

(a)

(b)

Skilled labour

Semi-skilled labour

(c) Unskilled labour

‘Wages/salaries’ are the returns to labour




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(3) Capital

─ Capital refers to the stock of goods created by society to help them in the production of goods and services.

─ In other words, it is man-made goods used to produce other goods and services.

─ For example, machinery, tools and equipment, building, factories and so on.

─ Interest is the return to capital.




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(4) Entrepreneur

─ Refers to a person who has the ability of planning, organizing, directing and controlling.

─ Entrepreneur is a person who organizes the other FOP to produce goods and services.



─ The difference between a labour and an entrepreneur is that, entrepreneur takes risk in setting up his own business.

─

─

On the other hand, labour works for an entrepreneur and does not take risks.

‘Profit’ is the return to the entrepreneur.

FOPs are limited and society will try to use them efficiently to produce goods and services which later satisfy their unlimited wants.




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 The unlimited wants :

(1) Goods

 Can be seen and touched

 E.g.: books, cars and computers

(2) Services





Intangible things

E.g.: transportation, education, etc.




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Limited resources vs unlimited wants

Society must make a choice on how to use the FOP to minimize wastage




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BRANCHES OF ECONOMICS




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BASIC ECONOMICS CONCEPTS

The Basic Economic Concept

Opportunity

Cost

Choices

Scarcity




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(cont.)

(1) SCARCITY



Therefore, society is faced with scarcity.

(2) CHOICE

 Due to unlimited wants and limited resources, society has to make choices.









Society must make the best choice possible.

Consumers

 make choices to maximize satisfaction

Producers

 minimize cost and maximize profit

Government

 maximize society’s welfare




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(cont.)

(3) OPPORTUNITY COST





Every choice is associated with opportunity cost.

It is defined as ‘the number of goods forgone to make the best choice or the best alternative forgone’.

 The second-best alternative.




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PRODUCTION POSSIBILITIES CURVE

(PPC)





A production possibilities curve shows the alternative combinations of two goods which can be produced with the existing resources and the current level of technology.

Assumptions:

(1) Only two goods are produced in a nation.

(2)

(3)

(4)

There is fixed level of technology.

Fixed and limited FOP

Full level of employment (the FOP are used efficiently

 no waste of resources and unemployment).




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(PPC) (cont.)

 Point A implies that Japan will allocate all its resources to produce only TV and non radio.

 Point F shows that

Japan will produce radio entirely and zero TV by utilize all its resources.

 At point B, Japan produces combination of

80 units TV and 20 units of radio given available resources.

 Point C indicates the combination of

60 units of TV and 30 units of radio produce by Japan.




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(PPC) (cont.)




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(PPC) (cont.)




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(PPC) (cont.)




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(PPC) (cont.)




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(PPC) (cont.)

Factors that Influence the Shift of the Production Possibilities Curve

Shift Outwards



Increase in PPC

Increase in the level of technology

Increase in Economic

Growth

Increase population




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(PPC) (cont.)

1

• Recession

2

• Decline in Economic Growth

3

• Natural Disaster




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(PPC) (cont.)

Factors That Influence The Shift Of The Production Possibilities Curve




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(PPC) (cont.)

Factors That Influence The Shift Of The Production Possibilities Curve




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BASIC ECONOMIC PROBLEMS

What to produce

• Refers to the type of product to produce.

• Decision must be made about what to produce with the limited resources available.

• E.g.: whether to produce radio or TV

How much to produce

• Refers to the quantity of goods and services to be produced.

• It depends on the demand from consumers.

• Societies must decide what to produce and how much to produce to ensure that scarce resources are utilized properly and efficiently.




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(cont.)

How to produce

• Refers to the technique or method of production: who will be producing the goods and services using what resources and technology?

• The method of production could be either labour intensive or capital intensive.

• It involves the cheapest method of production to minimize possible COP and maximize profit.

For whom to produce

• Refers to the group of people in the society who will buy the goods and services.

• It depends on the society’s income level.




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(cont.)

1.

Capitalist Economy System

Free market economy/free enterprise/laissez-faire

E.g.: USA, Canada, Japan and Germany

Characteristics

(a) The resources are owned by private sectors.

(b) No government intervention in making economic decisions.

(c) Individual firms are free to make the economic decisions.

(d) Price mechanism is used as an indicator.

(e) Producer objective – maximize profit

Consumer objective – maximize satisfaction

Advantages

(a) Freedom of choice

(b) People have right to own wealth.

(c) The harder people work, the more they will receive.

(d) There is mobility of labour.

(e) Competition leads to the production of quality goods and services.



Disadvantages

(a) Wide disparity between the rich and the poor

(b) Misallocation of resources

(c) Human welfare is ignored

(d) Social cost and negative externalities


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(cont.)

Economic Decisions in the Capitalist Economic System

What and how much?

Depends on consumers’ demand

Called as consumer’s sovereignty

For whom?

Depends on the society’s purchasing power

Higher income will get more goods and services because of higher purchasing power than the lower income people

How?

Depends on the cheapest method of production

The objective is to achieve efficiency and maximum profit




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(cont.)

2. Socialist Economy System

Command Economy/Central planning

E.g.: North Korea and Cuba

Advantages

Characteristics

(a) Government makes all economic decisions

(a) Equal distribution of income among society

(b) Government owns all resources and allocated through central planning according to society’s need.

(c) Society’s have no right to make

(b) Low unemployment problems

(c) Government provides public goods and services for society’s benefit.

(d) Inequality of income and wealth are minimized.

decisions.

(d) Equal distribution of income

(e) Government directs nations resources to produce desirable goods and services.

Disadvantages

(a) Consumers have no freedom of choice

(b) Workers have no incentive to work hard because they receive almost an equal income.

(c) Absence of competition will result in fewer FDI

(d) Technology inferior

(e) Price system does not operate and it is hard to estimate the demand for goods




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(cont.)

Economic Decisions in the Socialist Economic System

What/How/How much/For whom to produce?

Everything is controlled by the government through central planning.

Government itself will decide on methods of production which least cost methods.

Government will serve basic needs first and luxury goods later.




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(cont.)

The Mixed Economy System

Characteristics

Advantages

• Resources are owned by both the government and the private sectors

• Government will provide public goods and merit goods which private sectors are unwilling to produce.

• Individuals and firms are free to own wealth and need to pay tax to the government.

• Individuals and firms can make economic decisions.

• There is a variety of goods and services produced by private sectors and the government provides public goods at affordable prices.

• The economic activities are more stable and organized.

• There would be a narrow gap between the rich and the poor.

• The social costs are minimized.




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(cont.)

Economic Decisions in the Mixed Economic System

What and how much to produce?

Determined by market demand and supply.

The public sectors provide public goods at affordable price and private sectors produce variety of goods and services to maximize their profits.

How to produce?

The producer will choose the most efficient and cost-effective method.

Government will enact laws to combat inefficiencies from negative externalities.

For whom to producer?

Depend on the society’s needs and income distribution.




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(cont.)

The Islamic Economy System

Tauhid

Believing there is no God to be worshiped except

Allah

Habluminallah

(relationship between man and Allah)

Habluminannas

(relationship among mankind )

Ukhuwwah

Concept of brotherhood

Love and respect each other

Rububiyyah

Believe that Allah alone is the Creator and the Most

Powerful

Khalifah

Refers to the ’steward’ or leader of a caliphate.

We are created as trustees and always to be in servitude to Allah

SWT set by

Sharia’h



Tazkiyyah

Purification of man’s wealth

Zakat and sadaqah

Aims to help poor


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(cont.)

Economic Decisions in the Islamic Economic System

What and How

Much to Produce

• Through principles of Shari’ah in the Qur’an and Sunnah

• Produce permissible (halal) goods and services only.

• The production of goods and services according to classification of goods and services in Islam.

How to produce

• Choose the most efficient and cost effective method

• E.g.: producer will not produce goods which are not permissible (haram) in Islam and bring harm to society and environment.

For whom to produce

• The need of the poor should come first

• Not ignore the need of rich

• Produce basic/essential goods then only produce luxury goods




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Fundamentals of Economics - Chapter 1

INTRODUCTION TO ECONOMICS

Capitalist Economy System

2. Socialist Economy System

Characteristics

Advantages

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Fundamentals of Economics - Chapter 1

INTRODUCTION TO ECONOMICS

Capitalist Economy System

2. Socialist Economy System

Characteristics

Advantages

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