INTRODUCTION TO ECONOMICS
LESSON ONE
1.1
INTRODUCTION
This lesson introduces you to basic concepts economics upon which the
subsequent topics will build upon.
1.2 LECTURE OBJECTIVES
At the end of the lesson the student should be able to:
 Distinguish between economics and other social sciences like sociology, ethics
etc
 Understand the meaning of scarcity as used in economics
 See how scarcity is at the centre of all economic problems
1.2
Meaning of economics
Economics is a social science that has been in existence for about two centuries.
Various economists have tried to define it differently. Three types of definition can be
identified.
a) Wealth definition b) Welfare definition c) Scarcity definition
a) Wealth definition
Adam smith and his discipline J.B. Say, Walker, J.S. Mill defined economics as an inquiry
into the nature and courses of wealth of nations. Such a definition has been criticized
as follows.
(i)
The definition is very selfish: it restricts economics to the study of wealth
alone. The definition does not state clearly how man comes into the
study.
(ii)
Since economics is defined in terms of material commodity, it doesn’t
consider service e.g. services offered by doctors, teachers, Agricultural
Consultancy etc.
b) Material welfare definition of economics
Alfred Marshall and his discipline, Pigou and Cannon defined economics as the study
of man’s activities in the ordinary business of life. It tries to study how man acquires
and uses his resources aimed at improving the welfare of mankind. In this definition,
it can be noted that on the one hand, economics is the study of wealth and on the
other hand, and more important, a study of man.
Critism of the definition
(i)
This definition excludes the study of services, since it only takes into
account human material welfare.
(ii)
It addresses the study of man’s activities during ordinary business of life.
This begs the question, how about during extra ordinary business life?
c) Scarcity definition of economics
Leonel Robbin (1933) improved upon the above definition and explained
economics as the study of human behavior (as a relationship between scarce
resources which have alternative uses)
This this definition has fundamental characteristics that are addressed in economics.
They include;



Limited/scarce resources
Alternative uses
Unlimited wants
1.3
The Scope of Economics
The study of economics begins with understanding of human “wants”. Scarcity forces
us to economize. We weigh up the various alternatives and select that particular
assortment of goods which yields the highest return from our limited resources.
Modern economists use this idea to define the scope of their studies.
Although economics is closely connected with social sciences like ethics, politics,
sociology, psychology and anthropology, it is distinguished from them by its
concentration on one particular aspect of human behaviour i.e choosing between
alternatives in order to obtain the maximum satisfaction from limited resources.
Question; how does economics differ from other subjects? Economics involve the study
of the problem of production, consumption, exchange and distribution of wealth as
well as the determination of the values of goods and services. Besides, economic
investigates an inquiry into the possible causes and remedies of poverty,
unemployment, underdevelopment, inflation etc.
The subject consists of a body of general principles and theories which may be applied
to the interpretation of all economic problems, post and present. The fundamental
economic problem of all nations seeks to address the following issues.



What goods and services to produce
How to produce them
For whom to produce
1.4 Scarcity
According to economists all things are said to be scarce, since by “scarce” they
mean simply “that there are not enough to fill everyone’s wants to the point of satiety”.
Most people would probably like to have more of many things or goods of better
quality than they possess at present: larger houses perhaps in which to live in, better
furnished with the latest labour-saving devices, such as electric washers, cookers,
refrigeration etc; more visits to theatre or the concert hall; more travel; the latest models
in motor vehicles; radios and television sets; and most women exhibit an apparently
insatiable desire for clothes. People’s wants are many, but the resources for making the
things they want – labour, land, raw materials, factory buildings, machinery – are
themselves limited in supply. There are insufficient productive resources in the world,
therefore, to produce the amount of goods and services that would be required to
satisfy everyone‟s wants fully. Consequently, to the economist all things are at all times
said to be “scarce”.
1.5 Choice and Opportunity Cost
Due to scarcity, there are not enough resources to produce everything we want
(human wants are insatiable), a choice must be made about which of the wants to
satisfy. In economics, it is assumed that people always choose the alternative that will
yield them the greatest satisfaction.
Choice involves sacrifice. If there is a choice between having cement and having butter,
and a country chooses to have cement, it will be giving up butter to the cement. The
cost of having guns can therefore be regarded as the sacrifice of not being able to have
butter i.e The cost of an item measured in terms of the alternative forgone is called its
opportunity cost.
1.6 The concept of scarcity and opportunity cost
Limitations of the total resources capable of producing different commodities
forces society to choose between relatively scarce commodities. This can be
illustrated quantitatively by arithmetic examples and geometrical diagrams.
Suppose, we take an example, that a society can spend money on two
products, maize and beans. The society's resources are limited; therefore there
are restrictions on the amount of maize and beans that can be made, which can
be shown by a "production possibility" or "transformation curve". Here we shall
illustrate how two goods would be produced using the available scarce
resources.
Beans (Bags)
A
O1
A1
*N
PPF
*M
0
Maize (Bags)
B
B1
The slope is marginal rate of transformation
The straight line is drawn for constant opportunity cost
Beans (bags)
C
D
Maize (bags)

For simplicity assume that a country has same resources to enable her produce only
two goods, namely beans and maize. If all resources are used to produce beans, OA
units will be realized worth zero (0) units of maize. On the other hand, if all
resources are used to produce maize, OB units will be produced with zero (0) units
of beans. Thus the line joining point A and B is the production possibility frontier
(PPF) or curve. The frontier joins together different combinations of goods (beans
and maize) which a country can produce efficiently using all available resources and
efficiently.




All points inside PPF like M are attainable though they reflect under utilization or
inefficiency in the use of resources.
All points outside PPF like N are unattainable because resources are scarce.
Thus points along AB are attainable and reflect efficient production.
Suppose initially production was at point A, then only beans would be produced,
to produce OB, units of maize would thus require AA1 units of beans be sacrificed.
Quantity AA1, units of beans which has to be forgone to produce OB units of maize
is the opportunity cost of producing the maize. Sacrificing the production of one
good for the other results from scarcity of resources.
1.7 Other Concepts
1.7.1 Rationality
One of the most important assumptions in economics and on which much
economic theory is based, is the rationality of human behaviour. In order to
make predictions about human behaviour, economists assume that human
behaviour is "rational" and that consumers and producers act rationally e.g. in
what they will decide to buy or produce at any given price.
1.7.2 Ceteris Paribus
The economic world is extremely complicated. There are millions of people
and firms; thousands of prices and industries. One possible way of figuring out
economic laws in such a setting is by controlled experiments. A controlled
experiment takes place when everything else but the item under investigation
is held constant. This is an essential component of scientific method. However
economists have no such luxury when testing economic laws. Therefore, when
formulating economic principles economists are usually careful to state that
such and such will happen, ceteris paribus which is the Latin expression meaning
all other things remaining constant.
1.8 Methodology of economics
There are two approaches to the study of economics namely positive and
normative analysis.
Positive analysis (deductive): is more central to micro-economics and it is
concerned with what is, what was, and what will be. That is it is more specific
and objective. It employs economic theory in explaining and predicting
circumstances. The economic theories are tested against observations and are
used to construct models from which prediction are made.
A theory therefore is a reasoned assumption intended to explain a phenomenon.
A model on the other hand is a mathematical representation based on the
economic theory. In case of controversies in positive analysis, we refer to
economic theories that have been proven through empirical observations.
Normative analysis (inductive): goes beyond theory to ask questions like “what
is best, what ought to be” etc. it is subjective meaning that it depends on value
judgment on what is desired. In case of controversies, individual policy choices
will rule. It is concerned with alternative policy actions that helps in illuminating
and sharpening debates.
Example to help distinguish between positive and normative.
Government imposes tax on a good; effect of this would be



Increased price of the commodity
Good expensive than competing product
As quantity demanded falls, firms to decrease number of workers employed.
(Positive analysis; what is, what will be)
Normative analysis: For the firm on who’s the product has been imposed
they would ask; what should they do to improve their sales?
How should they improve competitiveness (normative – what ought to be)
1.9 BRANCHES OF ECONOMICS
Economics is divided into two main branches:- microeconomics and
macroeconomics.
1.9.1 Microeconomics


Deals with the behaviors of individual economic units. These units include
consumers, workers, investors, owners of land, business firms, any individual or
entity that plays a role in the function of our economy.
Microeconomics explains how and why these units make economic decisions. For
example, it explains how consumers make purchasing decision and how their choices
are affected by changing prices and income


It also explains how firms decide how many workers to hire and how workers
decide where to work and how much work to do.
Another important concern of microeconomics is how economic units interact to
form large units-markets and industries. By studying the behavior and interaction of
individual firm and consumers, microeconomics reveal how industries and markets
operate and evolve, why they differ from one another, and how they are affected
by government policies and global economic conditions.
1.9.2 Macroeconomics
Macroeconomics deals with aggregate economic quantities, such as the level and
growth rate of national output, interest rates, unemployment and inflation.

However the boundary between macroeconomics has become less and less distinct
in the recent years. The reason is that macroeconomics also involves the analysis of
markets for goods and services and for labour.
To understand how these aggregate markets operate, one must first
understand the behavior of the firms, consumers, workers, and investors who
make up these markets. Thus macroeconomists have become increasingly
concerned with microeconomics foundation of aggregate economic
phenomena and much of macroeconomics is actually an extension of
microeconomic analysis.
1.10 The central economic problem
There are many economic problems which we encounter everyday – poverty,
inflation, unemployment etc. However in this case we use the term The
Economic Problem we are referring to the overall problem of the scarcity of
resources. Each society has to make the best use of scarce resources. The great
American economist Paul A. Samuelson said that every economic society has to
answer three fundamental questions;
What commodities shall be produced, clothes, food, cars, submarines etc. and in what
quantities?
How shall the goods be produced? That is given that we have scarcity of
resources of land, labour etc, how should we combine them to produce goods
and services which we want?
For whom shall goods be produced? Who is to enjoy and get the benefit of the
nation's goods and services?
Economic Systems
There are only a limited number of ways in which societies have set out the answer to
the aforementioned fundamental questions. The methods used are called Economic
systems. These include free enterprise, centrally planned and mixed economies.
1.11 The free enterprise: the price system
The free market system is where the decision about what is produced is the outcome
of millions of separate individual decisions made by consumers, producers and owners
of productive resources. The decisions reflect private preferences and interests.
For the free enterprise to operate there must be a price system/mechanism.
The price system is the state where the vital economic decisions in the economy are
reached through the workings of the market price.
Thus, everything – houses, labour, food, land etc come to have its market price, and it
is through the workings of the market prices that the "What?", "How?", and "For
whom?" decisions are taken. The free market thus gives rise to what is called Consumer
Sovereignty – a situation in which consumers are the ultimate dictators, subject to the
level of technology, of the kind and quantity of commodities to be produced.
Consumers are said to exercise this power by bidding up the prices of the goods they
want most; and suppliers, following the lure of higher prices and profits, produce more
of the goods.
The features of a free market system are:
Ownership of Means of Production
Individuals are free to own the means of production i.e. land, capital and enjoy incomes
from them in the form of rent, interest and profits.
Freedom of Choice and Enterprise
Entrepreneurs are free to invest in businesses of their choice, produce any product of
their choice, workers are free to sell their labour in occupations and industries of their
choice; Consumers are free to consume products of their choice.
Competition: Economic rivalry or competition envisages a situation where, in the
market for each commodity, there are a large number of buyers and sellers. It is the
forces of total demand and total supply which determine the market price.
Self Interest as the Dominating Motive
Firms aim at maximizing their profits, workers aim at maximizing their wages,
landowners aim at maximizing their return from their land, and consumers at
maximizing their satisfaction.
Limited Role of Government
In this system, apart from playing its traditional role of providing defense, police service
and such infrastructural facilities as roads for public transport, the Government plays a
very limited role directly in economic profit making activities.
Reliance on the Price Mechanism
Price mechanism is where the prices are determined on the market by supply and
demand, and consumers base their expenditure plans and producers their production
plans on market prices. Price mechanism rations the scarce goods and services in that,
those who can afford the price will buy and those who cannot afford the price will not
pay.
Advantages of a Free Market System
Incentive: People are encouraged to work hard because opportunities exist for
individuals to accumulate high levels of wealth.
Choice: People can spend their money how they want; they can choose to set up their
own firm or they can choose for whom they want to work.
Competition: Through competition, less efficient producers are priced out of the
market; more efficient producers supply their own products at lower prices to the
consumers and use factors of production more efficiently.
Disadvantages of a Free Economy
Free market gives rise to certain inefficiencies called market failures i.e. where the
market system fails to provide an optimal allocation of resources. These include:
Unequal distribution of wealth: The wealthier members of the society tend to hold
most of the economic and political power, while the poorer members have much less
influence. There is an unequal distribution of resources and sometimes production
concentrates on luxuries i.e. the wants of the rich. This can lead to excessive numbers
of luxury goods being produced in the economy.
Public goods: These are goods which provide benefits which are not confined to one
individual household i.e. possess the characteristic of non -rival consumption and nonexclusion. The price mechanism may therefore not work efficiently to provide these
services e.g. defence, education and health services.
Externalities: Since the profit motive is all important to producers, they may ignore
social costs of production, such as pollution. Alternatively, the market system may not
reward producers whose activities have positive or beneficial effects on society.
Hardship: Although in theory factors of production such as labour are “mobile” and
can be switched from one market to another, in practice this is a major problem and
can lead to hardship through unemployment. It also leads to these scarce factors of
production being wasted by not using them to fullest advantage.
Wasted or reduced competition: some firms may use expensive advertising campaigns
to sell “new” products which are basically the same as many other products currently
on sale. Other firms, who control most of the supply of some goods may choose to
restrict supply and therefore keep prices artificially high; or, with other suppliers, they
may agree on the prices to charge and so price will not be determined by the interaction
of supply and demand.
1.12 planned economic system
This is a system where all major economic decisions are made by a government
department or a planning organization. Here all questions about the allocation of
resources are determined by the government.
Features of this system: The command economies relies exclusively on the state. The
government will decide what is made, how it is made, how much is made and how
distribution takes place
Advantages of Planned System
Uses of resources: Central planning can lead to the full use of all the
factors of production, so reducing or ending unemployment.
Large scale production: Economies of scale become possible due to mass
production taking place.
Public services: “Natural monopolies” such as the supply of domestic power
or defense can be provided efficiently through central planning.
Basic services: There is less concentration on making luxuries for those who can
afford them and greater emphasis on providing a range of goods and services
for all the population.
There are less dramatic differences in wealth and income distribution than in market
economy
Disadvantages of the Planned System
The planned economies suffer from the following limitations:
Centralized control: Because the state makes all the decisions, there must be large
influential government departments. The existence of such a powerful and large
bureaucracy can lead to inefficient planning and hence problems of communication.
Lack of choice: Consumers have little influence over what is produced and people may
have little to say in what they do as a career.
Little incentive: Since competition between different producers is not as important as in
the market economy, there is no great incentive to improve existing systems of
production or work.
The task of assessing the available resources and deciding on what to produce, how
much to produce and how to produce and distribute can be too tedeous
The Mixed Economy
There are no economies in the world which are entirely market or planned, all will
contain elements of both systems. The degree of mix in any one economy is the result
of a complex interaction of cultural, historic and political factors. For example the USA
which is a typical example of a largely work-based society, but the government still
plans certain areas of the economy such as defense and provides very basic care for
those who cannot afford medical insurance.
Advantages of the Mixed Economy
Necessary services are provided in a true market economy, services which were not able
to make profit would not be provided.
Competition: Prices of goods and services in the private sector are kept down through
competition taking place.
Incentive: Since there is a private sector where individuals can make a lot of money,
incentives still exist in the mixed economy.
Disadvantages of Mixed Economy
Large monopolies can still exist in the private sector, and so competition does not
really take place
There is likely to be a lot of bureaucracy and “red tape” due to existence of a public
sector.
1.13 SUMMARY
Overall the study of economics is divided into two halves, microeconomics and macroeconomics.
"Microeconomics is the study of individual economic units or particular parts of the economy e.g. how
does an individual household decide to spend its income? How does an individual firm decide what
volume of output to produce or what products to make? How is price of an individual product
determined? How are wage levels determined in a particular industry? It thus gives a worm’s eye view of
the economy.
Macroeconomics is the study of "global" or collective decisions by individual households or producers. It
looks at a national or international economy as a whole, e.g. Total Output, Income and Expenditure,
Unemployment, Inflation Interest Rates and Balance of International Trade, etc and what economic
policies a government can pursue to influence the conditions of the national economy. It thus gives a bird's
eye-view of the economy.
REFERENCES
1. Ahuja H.L. (2009). Principles of microeconomics. New Delhi S. Chand and Co. Ltd.
2. Gregory M. N. (2014). Principles of Microeconomics. 7th Ed. ISBN-13:978-1285165905. Cengage
learning.
3. Frank, R.H. (2010). Principles of Microeconomics. McGraw-Hill publishers.