FE 1101 - Economics I for Finance
Name:
Ms. Chehara Dias Amaratunga
Bsc. Economics and Management, University of London, LSE
and Msc. Accounting and Finance, University of Adelaide.
FE 1101 - Economics I for Finance
Syllabus: An Introduction to Economics ( Microeconomics).Demand, supply and the market.
Elasticity(Price, Cross and Income).The theory of
Consumer Choice. Firms and their behaviour. The
Cost of Production. Market structure and Perfect
Competition and
Imperfect competition. Factor
market. Public Goods and Externalities.
Assessment: Assignments (In-class examination
/take home assignment) 40% and end of semester
written examination- 60%.
Assessment
 There will be In class quizzes, take home assignments, mid
term tests that would all add up to the 40% of total marks.
 The final examination will take 60% of the total mark.
The Learning Management System ( LMS)
All quizzes, lecture material and information about the course
will be uploaded on the LMS.
Learning Outcome
At the completion of this course unit in the First Year,
students are expected to:
 Be able to orient to the essential principles of
microeconomics.
 Be able to see how microeconomics concepts are
applied in the different theories of consumer behavior,
producer behavior, factor markets and firms.
 Be able to use a range of key techniques of economic
analysis
in
problem-solving,
including
simple
mathematical techniques.
Recommended textbook
Essential Reading : Richard Lipsey and Alec Chrystal (2015), Economics,
Thirteenth Edition, Oxford University Press.
Other text:
Parkin Michael (2010), Microeconomics, Tenth Edition, Prentice Hall.
Pindyck, R.S, Rubinfeld, (2005), “Microeconomics”, Pearson Education.
Lesson One
Introduction to Microeconomics
What is Economics?
“Economics is the study of people in
the ordinary business of life”
- Alfred Marshall
“Economics is the science which studies
human behavior as a relationship
between given ends and scarce means
which have alternative uses”
- Lionel Robbins
“Economics is the study of how societies use
scarce resources to produce valuable
commodities and distribute them among
different people”
- Paul A. Samuelson
What is Economics?
Economics is about choice and it is at the heart of all
decision making.
It is a social science as are psychology and anthropology and
it is the study of how a society manages its scarce resources.
It is about how people choose to use resources.
Social sciences examine and explain human interaction.
Economics explains how people interact within markets to
get what they want to accomplish certain goals.
•
It is often described as the study of how we use our limited resources to satisfy our
unlimited material wants.
Scarcity and Choice
Scarcity- It is a situation that arises when people have unlimited wants in the
face of limited resources ( Non-renewable resources).
Scarcity is a fundamental problem faced by all economies because not
enough resources - land, labour, capital, and entrepreneurship - are available
to produce all the goods and services that people would like to consume.
Scarcity makes it necessary to choose among alternative possibilities: what
products will be produced and in what quantities.
 As a result Economists are now trying to use Renewable resources.
Sustainable development- The needs of the present are met without
compromising the need’ s of future generations
Choices-Involve how much time is devoted to work, to school, and to leisure.
They also involve how many rupees are spent and saved, and how to
combine resources to produce goods and services. The government should
make choices with regard to expenditure with the utilization of tax revenue.
Individuals, businesses and governments are all faced with making choices
in situations where resources are scarce. More formally, economics is
concerned with the material well-being of human societies.
R
Factors of production/Resource and
Resource allocation
These are resources that are used in the production process to make goods
Land- Gifts of nature ( Reward- Rent)
Labour- Human resources ( Reward- Wage)
Capital- All man made aids for further production ( Reward- Interest)
Entrepreneurs- Manage and take risks in the business when introducing a
new product ( Reward- Profit).
Resource allocation
Resources are limited and it is impossible to produce goods and services to
satisfy all needs and wants of people.
Economists have to decide the ways in which resources are allocated to
different industries and occupations.
The three questions in Economics, Marginal Analysis
and Opportunity costs
All Economic choices could be arrived at succinctly by asking three big
questions about the goods and services we produce.
1. What to produce?
2. How to produce?
3. For whom to produce?
The manner in which the basic problems of an economy are solved depends
on the nature of the economic system or the economy ( Free market
economy, Planned or Mixed economy).
The opportunity cost in decision making is the value of the next best
alternative that is foregone.
Marginal Analysis is used in order to choose the best alternative from the
alternatives available. Choices are made by evaluating the costs and benefits
of each alternative.
Economic Systems
A Free Market Economy- Is one in which market forces are
allowed to guide the allocation of resources within a society.
A Centrally Planned Economy- Is an economy in which decisions
on resource allocations are guided by the state.
Mixed Economies- These are economies in which resources are
allocated partly through price signals and partly on the basis of
intervention by the State.
The Role of Economics in the real world?
Economics provides a framework for understanding consumer
behavior, government policies, and business developments
within a country and abroad. It provides a rich context for
making decisions in our business, professional, and financial life is
applicable in a wide range of fields.
Government policies•
Economics enables us to get a better understanding of the objectives,
methods and limitations of government economic policy.
e.g.
• How does government policy help reduce environmental pollution?
• How does the tax system affect the incentives for people to work, for
families to spend and save, and for firms to invest?
•
How do government budget deficits and debt affect the economy?
• The effects of free international trade on Sri Lankans’ standard of living.
• How do the actions and policies of the Central Bank of Sri Lanka affect
interest rates and the money supply, and thence the rate of price
inflation, the external value of the Sri Lankan Rupee, and international
capital flows?
•
Why we need to study Economics as a
subject?
Economics is essential to understand the world in which we live and
work and helps us to answer questions like:
1.
What determines the prices of the goods and services
on
which we spend our income, and the prices of the stocks and
bonds in which we invest our savings?
2.
How does
people?
3.
4.
Why do some people earn so much and others so little?
Why do some jobs pay high wages while other jobs pay
low wages?
How do firms operating in different market environments,
decide what quantities to produce of their product’s
outputs.
What prices to charge for these outputs, and what
quantities of labour and capital inputs to employ?
5.
6.
education
affect
the
lifetime
earnings
of
Why Economics Analysis helps
Macro level
• It helps determine the level of National Income and aggregate employment,
the rate of price inflation, the rate of unemployment, the rate of growth of
aggregate output and productivity, and the International value of the Sri
Lankan Rupee.
• It enables us to calculate the average standards of living which vary so widely
among and within countries.
Micro level
• It provides in-depth analysis of firms’ decision-making in a variety of market
settings.
• It helps business managers and executives make better production,
employment and investment decisions.
• Economic analysis helps us understand and solve the problems of environmental pollution and
resource depletion.
The more we know about this environment, the better we will function as
a manager, analyst, and decision-maker.
Thinking like an Economist
People who study economics are called economists. Economists seek to answer
important questions about how people, industries, and countries can maximize their
productivity, create wealth, and maintain financial stability .
Economics trains you to….
Think in terms of alternatives.
Evaluate the cost of individual and social choices .
Examine and understand how certain events and issues are related.
The economic way of thinking…
-Involves thinking analytically and objectively
-Makes use of the scientific method
When economists try to explain the world, they are scientists.
When economists try to change the world, they become policy advisors.
Since the study of economics encompasses many factors that interact in complex
ways, economists have different theories as to how people and governments should
behave within markets
In order to get a handle on such big issues, economists have
developed ways of setting out and testing their theories
They also seek to use what they have learned in order to
provide advice on how things could be improved
Positive and Normative statement and
the different methods of reasoning
Economists give advice on a wide variety of topics. Advice comes in two
broad types:
Positive statements
:are statements about what is ( about facts). These statements can be tested by
reference to the facts. The ultimate goal of a positive statement is to develop a
scientific model. Positive Economics is value free and addresses only what is
really happening, has happened or will happen .It analyses the effects of changes
in conditions or policies on observable economic variables. It is a way to
forecast the impact of changes on the economy and the reasons
Normative statements- These are value judgment statements :One which
cannot be tested properly by reference to the facts. Normative advice depends
upon a value judgement and it tells others what they ought to do.
Positive and Normative statement and
the different methods of reasoning
 In order to address the problems that we face economists
have developed an approach that involves developing
theories and building models.
 These help the economist to understand problems and find
realistic and practical solutions where possible
 Theories: Theories are constructed to explain things!
These theories are built around definitions, assumptions, and
predictions. They simplify the problem in hand and allow the
economist to observe the problem first hand.
Model-A model means a specific quantitative formulation of a
theory.
The Scientific Method: Observation and
Theory
Models
Use abstract models to help explain how a complex, real world
operates.
Develop theories, collects and analyses data to evaluate the theory.
Assumptions
Assumptions used to make the world easier to understand.
The Art of scientific thinking is deciding on which assumptions to
make.
Major Areas of Economics
The field of economics is divided into two
major
parts:
Microeconomics
and
macroeconomics.
Microeconomics: Microeconomics comes from
the Greek word mikros, meaning “small. It
looks at the small picture.
Microeconomics analyses the behavior of the
individual consumers, business firms and
governments that make up the economy, and
investigates the workings of individual markets.
It provides basic theory to economic activity. It
looks at the choices that are made, and how
they interact with each other when they come
together to trade specific goods and services.
Microeconomics basically covers two sections of
the society: consumers and producers.
Major Areas of Economics
Macroeconomics:
Macroeconomics
also
comes from the Greek word makros,
meaning large, take an overall view of the
economy.
It looks at the big picture. Macroeconomics
analyzes the performances of the economy
as a whole.
It attempts to explain the behavior of the
economy as a whole, looking at such issues
as inflation, unemployment and growth. It
provides the foundation for government
intervention in the economy.
Importance of Micro Economics
Micro economics plays a vital role in the study of modern
economic theory. It is important in the following ways :
It helps to understand the working of the economy:
It helps us in understanding the working of a free
enterprise
economy. It gives us an idea about how major
economic
decisions are taken in a market economy.
Helpful in the efficient employment of resources:
It suggests economizing, that is how efficiently the scarce
available resources can be utilized in production process
in
an economy.
Helps in International Trade:
Micro economics is used to explain gains from internal
trade, external trade, foreign exchange, balance of payment,
disequilibrium and in the determination of exchange rate.
Importance of Micro Economics
Basis of welfare economics:
The entire structure of micro economics has been built on the
basis of price theory which is an important constituent of
micro economics.
It suggests the conditions of efficiency and
it can be achieved. It helps in improving the
living of the population.
explains how
standard
of
Helpful in understanding the consequences of taxation:
Imposition of tax leads to reallocation of resources from one
place to another.
Micro economics explains how imposition of
different
types of direct and indirect taxes lead to attainment
of
social welfare.
Importance of Micro Economics
Tool for evaluating economic policies:
It helps the states and Central government to frame economic policies
like price policy, taxation policy etc.
It also explains
consumption.
the
condition
of
efficiency
in
production
and
Construction and use of models:
Micro economics constructs and uses simple models in order to
understand the actual economic phenomenon.
It uses abstract models to explain the economic
phenomenon.
Opportunity Cost- The foregone
alternative
The concept of opportunity cost emphasises scarcity and choice
by measuring the cost of obtaining a unit of one product in
terms of the number of units of other products that could have
been obtained instead. The best alternative sacrificed for a
chosen alternative
Think : “ next best”
Opportunity Cost

How should I spend my money ?

How should I spend my time ?

Opportunity cost is always measured by how much
you give up of the next best alternative to get what
you want.
???
??
Every Choice Has a Cost
Opportunity Cost
Can opportunity cost be something other than money?
Yes, that next most desired activity or opportunity that you
have to sacrifice may not be always money
A correct way to measure the cost of a choice is its opportunity
cost.
Every Choice has a cost
The Production Possibility Curve
The Production Possibility Frontier/ Curve
A production-possibility boundary shows all of the combinations of
goods that can be produced by an economy whose resources are
fully / efficiently employed under a given technology.
Movement from one point to another on the boundary shows a shift
in the amounts of goods being produced, which requires a
reallocation of resources.
Assumptions :
1.
Maximum goods and services that can be produced
2.
Two goods world (Easy to understand ).
3.
Available resources are fixed and fully employed ( land, labor,
capital, entrepreneurship)
4.
Technology, education, and training are fixed
The Production Possibility Frontier
The Production Possibility Curve






The quantity of public sector goods produced is measured along the
horizontal axis.
The quantity of private sector goods is measured along the vertical axis.
Any point on the diagram indicates some amount of each kind of good
produced.
The production-possibility boundary separates the attainable
combinations, such as a, b, and c, from unattainable combinations, such
as d.
Points a and b represent efficient uses of society’s resources.
Point c represents either an inefficient use of resources or a failure to
use all the resources that are available.



The boundary is negatively sloped because in a fully
employed economy more of one good can be produced only
if resources are freed by producing less of other goods.
Moving from point a (with coordinates c0 and g0) to point b
(with coordinates c1 and g1) implies producing an additional
amount of public sector goods, indicated by G in the figure
The opportunity cost of this increase in G is a reduction in
private sector goods by the amount indicated by C.
Opportunity Cost - Calculation
Opportunity Cost:
• Give up/ Gain
Opportunity Cost
Fishing
Calculate the opportunity
Cost of producing 60 units of
Fishing?
100
A
60
Tourism
80
200
Opportunity Cost
Calculate the opportunity cost
If an individual wants to move
From point A to B?
Fishing
100
A
60
B
40
80
160
200
Tourism
Shapes of the Production Possibility
Curve
If PPF is a straight line, there is a constant opportunity cost
If PPF concave, there is an increasing opportunity cost
If the PPF is convex, there is a decreasing opportunity cost
Increasing Opportunity Cost- Concave
curve
The law of increasing
Opportunity cost states
that: The opportunity
cost of producing a good
increases as more of
the good is produced
This is because resources
are not perfectly adaptable
to all products
The effect of economic growth on the
production possibility curve



Economic growth indicates an increase in the total
output of an economy.
Economic growth shifts the boundary outwards.
Some combinations of goods that were previously
unattainable become attainable.

Causes of an shift in PPC?
Increase in resources
Increased productivity
Improved technology
Causes of an shift in PPC
The production possibilities curve will shift as a result
of:
An increase in the economy’s production factor
Natural resources
Labor
Physical capital
Human capital
Entrepreneurship
Technological innovation that increases output from
a given amount of resources.
The effect of economic growth on the
production possibility curve
The effect of economic growth on the
Production Possibility Curve
The effect of economic growth on the
Production Possibility Curve
Question- Production Possibility Curve
Can the Production Possibility
Curve Shift Inwards?
Growth in One Sector: PPF
The PPF
Shows that
there is growth
only in the
Agricultural
sector.
Division of Labour and specialisation
The division of labor generates “the greatest improvement in the
productive powers of labor”
“the division of labor is limited by the extent of the market”
So, greater trade means more opportunities for greater
productivity
Absolute advantage and Comparative
advantage
Absolute advantage: A country’s ability to produce a good using fewer
resources than the country with which it trades.
Comparative advantage: A country’s ability to produce a good at a lower
opportunity cost than the country which it trades
What to produce? Cars or clothing?
Comparative Advantage asks which country is relatively better at cars than
clothing in comparison with the other country
A country should focus more on cars than clothing if transferring resources
at the margin from clothing to cars will yield greater returns than doing so in
the other country
Correspondingly, the other country should focus more on clothing
(transferring some resources from cars to clothing)
There are some costs of transferring resources and adjusting production