Chapter 1: Nature and Scope of Economics

CHAPTER 1

NATURE AND SCOPE OF ECONOMICS

1 st Semester, S.Y 2014 – 2015

Pangasinan State University

Social Science Department – PSU Lingayen

BACHELOR OF ARTS IN ECONOMICS SOC SCI 104 – BASIC ECONOMICS W/ TAR

Chapter Outline

A. Definition of Economics

B. Importance of Economics

C. Microeconomics vs. Macroeconomics

D. Nature of Economic Choice (Scarcity and Opportunity Cost)

E. Economic Activities

F. Economic Resources

G. Economic Goals

H. Fundamental Economic Problems / Questions

I.

Types of Economic System

J. Economic Models

K. Ceteris Paribus

L. Normative and Positive Economics

M. Scientific Method

N. Circular Flow Model

O. The Production Possibility Frontier

P. Graphs

Q. Linear Relationship




What is Economics?

 The study of how individuals and societies choose to allocate and use scarce resources to satisfy unlimited wants.

 Embedded in the definition are four key words:

 Choice

 Resource Allocation

 Scarcity

 Unlimited Wants




What is Economics?

Economics involves

 Examining how individuals, businesses, governments, and societies choose to use scarce resources to satisfy their wants.

 Organizing, analyzing, and interpreting data about those economic behaviors.

 Developing theories and economic laws that explain how the economy works and to predict what might happen in the future.




Why Study Economics?

A good understanding of this subject will not only help us learn economics as an academic discipline but would also help us understand the world and the reality that we are in. Specifically, a study of this course will help us:

1. Appreciate events in economic history and understand how the present-day system of economics came to be.

2. Learn the ways in which economics explain the activities of man through its tools, models, principles and standards.

3. Make use of production and consumption concepts in business endeavors or simply in understanding people’s economic behavior.




Why Study Economics?

4. Manage economic and financial affairs; thereby, achieving a good standard of living for ourselves, our families and our nation.

5. Understand government’s functions in economics and choose leaders who are economically sensible.

6. Understand what is happening in the economy of the

Philippines and the world and know how nationwide and worldwide economic policies and events affect us all.




Two Branches of Economics

Microeconomics

 A branch of economics which is concerned with the behavior of individual entities such as markets, firms, and households.

Macroeconomics

 A branch of economics which is concerned with the overall behavior and performance of the economy as whole.




Scope of Microeconomics

Microeconomics studies

 Buying decisions of the individual

 Consumers ’ satisfaction

 Buying and selling decisions of the firm

 The determination of prices and in markets

 The quantity, quality and variety of products

 Profits




Scope of Microeconomics

Macroeconomics studies



Economic growth



Unemployment and inflation



Aggregate demand and aggregate supply



Economic policies – fiscal and monetary



International trade – exports and imports



Money supply




Let’s Check Your Understanding!

Which of the following questions involve microeconomics, and which involve macroeconomics? In each case, explain your answer.

1. Why did consumers switch to using Smart TVs in 2013?

2. Why did overall consumer spending slow down in 2013?

3. Why did the standard of living rise more rapidly in the current administration compared to previous administration?

4. Why have starting salaries for students with geology degrees risen sharply of late?

5. What determines the choice between rail and road transportation?

6. Why did the computers get cheaper over the past 5 years?




Concept of Scarcity

 Scarcity exists because individuals want more than can be produced. It implies that there are not enough resources to satisfy human wants.

 The condition in which our wants are greater than the resources available to satisfy them.

 Scarcity means making choices.

Wants are unlimited and resources are limited. Therefore, scarcity exists, and people must make choices.




Wants versus Needs

Wants are desires that can be satisfied by consuming a good or service.

Needs are things, such as food, clothing, and shelter, that are necessary for survival.

Necessities are few but our wants are endless.




Let’s Check Your Understanding

Determine whether each of the following is a want or a need.

1. Fruits and Vegetables

2. Education

3. Medicine

4. Luxurious car

5. Jewelry




Goods versus Services

Good is something that is intended to satisfy some wants or needs of a consumer and thus has economic utility.

It is normally used to denote tangible commodities such as products and materials that can be purchased and consumed.

Goods can be categorized as:

 Economic Good and Free Good

 Durable Good and Nondurable Good

 Intermediate Good and Final Good

 Consumer Good and Capital Goods



Goods versus Services

Service is an intangible commodity.

More specifically, services are an intangible equivalent of economic goods. These are tasks that you pay other people to perform for you.

Services are work that one person performs for another for payment. Services include the work of sales clerks, technical support representatives, teachers, nurses, doctors, lawyers, etc.





Determine whether each of the following is a good or a service.

1. Beauty shop or barbershop.

2. Furniture

3. Pineapples

4. Legal counsel

5. Books




Opportunity Cost

 This is a key concept in economics, and has been described as expressing "the basic relationship between scarcity and choice“.

 It is the cost of any activity measured in terms of the value of the best alternative that is not chosen (that is foregone).

 It is the sacrifice related to the second best choice available to someone, or group, who has picked among several mutually exclusive choices.




Opportunity Costs

Opportunity Cost Examples

What to Do

What you have Done

Watch a television Read a book

Going to college

Buy good A

Produce tablet

Spend on infrastructure

Having a job

Buy good B

Produce laptop

Spend on national defense

Opportunity Cost

The opportunity cost of watching television is reading a book.

The opportunity cost of going to college is having a job

The opportunity cost of buying good A is buying good B.

The opportunity cost of producing tablet is producing laptop

The opportunity cost of spending infrastracture is spending on national defense




Cost-Benefit Analysis

Individuals do make their choices randomly. Rather, they carefully looked at the benefits they would gain and the opportunity costs they would incur from their decisions. This practice of examining the costs and the expected benefits of a choice as an aid to decision making is called cost-benefit analysis . It is an approach that weighs the benefits of an action against its costs. Cost-benefit analysis is one of the most useful tools for individuals, businesses, and governments when they need to evaluate the relative worth of economic choices.




Economic Activities

1. Production .

The process of transforming inputs into outputs.

2. Distribution .

The way total output, income, or wealth is distributed among individuals or among the factors of production

3. Exchange .

The process of trading goods between buyers and sellers in a particular market.

4. Consumption.

The process of how goods and services are utilized that give satisfaction to the consumers.




Categories of Economic Resources

Land includes all natural resources, such as minerals, timber, and water, as well as the land itself.

Labor refers to the physical and intellectual services of people and includes the training, education, and abilities of the individuals in a society.

Capital refers to products such as machinery and buildings that are used to produce other goods and services

Entrepreneurship is a human resource that combines these factors of production creatively and efficiently.




Functions of an Entrepreneur

 The entrepreneur takes the initiative in combining the resources of land, labor, and capital to produce a good or a service.

 The entrepreneur makes the strategic business decisions that set the course of an enterprise.

 The entrepreneur is an innovator.

 The entrepreneur is a risk bearer.





Determine what category of economic resources each of these belongs.

1. Factory worker

2.

Company’s CEO

3. Assembly plant

4. Industrial robots

5. Mineral deposits




Economic Resources

Economic Resources (also called factors of production or productive inputs) are what people use to produce goods and services. These are inputs used by the firm to produce a good or service. These inputs include the following:

 Land

 Labor

 Capital

 Entrepreneurship




Economic Goals

1. Economic efficiency

2. Economic growth and economic development

3. Economic freedom

4. Economic security

5. Equitable distribution of income

6. Full employment

7. Price level stability

8. Reasonable balance of trade




Three Economic Questions

Economic System is the way in which a society decides what goods to produce, how to produce them, and for whom goods will be produced. Whether rich or poor, every nation must answer the same three fundamental economic questions:

1. What to produce?

2. How to produce?

3. For whom to produce?




What to Produce?

To answer the first fundamental economic question, a society must decide the mix of goods and services it will produce. Will it produce mainly food, or will it also produce automobiles, televisions, computers, furniture, and shoes? The goods and services a society chooses to produce depend, in part, on the natural resources it possesses.

Because of scarcity, no country can produce every good it wants in the quantity it would like. More of one good (say, television sets) leaves fewer resources to produce other goods (such as cars). No matter what nation we are talking about —the United States, China, Japan, India, Russia, Cuba, or Brazil —each must decide what goods will be produced.




How to Produce?

The next question every society has to answer deals with the ways in which people produce the goods. Will farmers using modern tractors produce food, or will farmers using primitive tools produce it? Will the food be produced on private farms, where production decisions are made by individual farmers, or will it be produced on collective farms, where production decisions are made by people in the government?

Answering this second question involves using scarce resources in the most efficient way to satisfy society’s wants.

Again, decisions on methods of production are influenced, in part, by the natural resources society possesses.




For Whom to Produce?

This answers how goods and services are distributed among people in society. This actually involves two questions.

Exactly how much should people get and how should their share be delivered to them? Should everyone get an equal share of the goods and services? Or should a person’s share be determined by how much he or she is willing to pay? Once the question of how much has been decided, societies must then decide exactly how they are going to get these goods to people. To do this, societies develop distribution systems, which include road and rail systems, seaports, airports, trains, ships, airplanes, computer networks —anything that helps move goods and services from producers to consumers in an efficient manner.




Economic System

 An economic system is a set of economic institutions that dominates a given economy.

 a particular set of institutional arrangements and a coordinating mechanism —to respond to the economizing problem. It is a society decides what goods to produce, how to produce them, and for whom goods will be produced.

 The way a society uses its scarce resources to satisfy its people’s unlimited wants.




Salient Functions of an Economic

System

1. To produce the goods for consumption of the population

2. To utilize the resources in efficient method of production

3. To employ the labor force in occupations where productivity is at optimum

4. To apportion the wealth and income available to everyone in an equitable manner

5. To encourage innovation and technology in order to maximize efficiency, optimize satisfaction and minimize waste




Classification of Economic System

1. Traditional Economy

2. Market Economy

3. Command Economy

4. Mixed Economy




Traditional Economy

 Traditional economy is an economic system in which the society produces what best ensures its survival.

 Resources are allocated according to long-lived practices from the past.

 People make economic decisions based on customs and beliefs that have been handed down from generation to generation.




Market Economy

 Market economy is characterized by the private ownership of resources and the use of a system of markets and prices to coordinate and direct economic activity.

 Private individuals own most, if not all, the resources and control their use.

 The prices of goods and services are determined in a free price system .

 Market economy or capitalism is sometimes called laissez-faire ; translated from the French, this phrase means “to let do,” or to let people do as they choose without government intervention.




Characteristics of a Market Economy

1. Private Property

2. Freedom of Enterprise or Choice

3. Self-interest

4. Competition

5. Markets and Prices

6. Technology and Capital Goods

7. Specialization

8. Use of Money

9. Active, but Limited, Government




Command Economy

 an economy characterized by public ownership of virtually all property resources and the rendering of economic decisions through central economic planning.

 Government owns most of the businesses and makes all economic decisions.

 There is no free competition because the government is the only seller.

 Countries using mainly the command system include

Turkmenistan, Laos, Belarus, Libya, Myanmar, Iran,

North Korea and the former Soviet Union.




Flaws of Command Economy

In practice, the pure command system also has flaws, most notably :

1. Running an economy is so complicated that some resources are used inefficiently.

2. Because nobody in particular owns resources, each person has less incentive to employ them in their highestvalued use, so some resources are wasted.

3. Central plans may reflect more the preferences of central planners than those of society.

4. Because government is responsible for all production, the variety of products tends to be more limited than in a capitalist economy.

5. Each individual has less personal freedom in making economic choices.




Mixed Economy

 Mixed Economy is a blend of market system and some form of government regulation and control.

Private ownership of resources exists side by side with substantial public ownership of resources and government participation in economic activities.

 This involves a degree of private economic freedom mixed with a degree of government regulation of markets.

 The major and strategic industries are owned and managed by the state while the minor industries belong to the private sector.




Categories of Goods and Services

Consumption goods and services

 Goods and services that are bought by individuals and used to provide personal enjoyment and contribute to a person’s quality of life.

Capital goods

 Goods that are bought by businesses to increase their productive resources.

Government goods and services

 Goods and services that are bought by governments.

Export goods and services

 Goods and services that are produced in one country and sold in other countries.




Economic Model

 A simplified representation of economic forces.

It is a simplified representations of complex economic activities, systems, or problems —to clarify trade-offs.

 It is also a simplified description of reality used to understand and predict the relationship between variables.




Forms of Economic Model



Descriptive economic model (words, statements)



Assumption



Mathematical model (Equations and

Functions)



Graphs




Ceteris Paribus Assumption

Ceteris paribus assumption is a Latin phrase that means while certain variables change, “all other things remain unchanged.

”

This assumption allows analysis of the effect of a change in one factor by holding all other relevant factors unchanged.




Positive and Normative Economics

Positive Economics

 It is concerned with “what is”.

 A statement that can be proved or disproved by reference to facts

 A way of describing and explaining economics as it is, not as it should be.

Normative Economics

 It is concerned with what should be.

 A statement that reflects an opinion, which cannot be proved or disproved by reference to the facts.

 a way of describing and explaining what economic behavior ought to be, not what it actually is.

It does involve value judgments because it seeks to make recommendations for actions





Determine whether each of the following statements is normative or positive.

1. The inflation rate in this country is too high.

2. The government should increase the minimum wage in Metro

Manila.

3. Increasing the minimum wage results in more unemployment.

4. What government policies should be adopted to make it easier for low-income students to attend college?

5. How many people are employed in the economy as a whole this year?




Scientific Method

To study economic problems, economists employ a process of theoretical investigation called the scientific method .

Scientific method consists of four steps.

1. Step One: Identify the Question and Define

Relevant Variables

2. Step Two: Specify Assumptions

3. Step Three: Formulate a Hypothesis

4. Step Four: Test the Hypothesis




The Circular-Flow of Income Diagram

Circular-flow diagram is a visual model of the economy that shows how income flows through markets among households and firms.




The Circular-Flow Diagram




Components of the Circular-Flow Model:

Households and Firms

Households are individuals or groups of people living together and considered the consuming-unit of the economy. They sell economic resources and buy goods and services

Firms are the institutions that organize the production of goods and services and are considered the producing-unit of the economy. They buy economic resources and they sell goods and services.





Resource Market and Product Market

Market is a place or any arrangement that brings buyers and sellers together and enables them to get information and do business with each other. The circular flow model has two classifications of market.

Resource Market is a market in which a resource

(land, labor and capital) is bought and sold.

 Land market, capital market, labor market

Product Market is a market in which a good or service is bought and sold.





Resource Market and Product Market

Real Flows (input-output flows) depicts the flows of the economic resources (inputs) that go from households through resource markets to firms and of the goods and services that go from firms through goods markets to households.

Money Flows indicates the flows of payments made in exchange for the services of factors of production and of expenditures on goods and services.




Real Flows and Money Flows

When households choose the quantities of services of land, labor, capital, and entrepreneurship to offer in resource markets, they respond to the incomes they receive — rent for land , wages for labor , interest for capital , and profit for entrepreneurship . When firms choose the quantities of factor services to hire, they respond to the rent, wages, interest, and profits they must pay to households. Similarly, when firms choose the quantities of goods and services to produce and offer for sale in goods markets, they respond to the amounts that they receive from the expenditures that households make. And when households choose the quantities of goods and services to buy, they respond to the amounts they must pay to firms




Production Possibility Frontier

The production-possibility frontier (or PPF ) shows or measures the maximum quantity of goods that can be efficiently produced by an economy, given its technological knowledge and the quantity of available inputs.





Like all other economic models, the PPC is based on assumptions that simplify the economic interactions. For the

PPC these assumptions are:

1. Resources are fixed.

There is no way to increase the availability of land, labor, capital, and entrepreneurship.

2. All resources are fully employed.

There is no waste of any of the factors of production. In other words, the economy.

3. Only two things can be produced.

This assumption simplifies the situation and suits the graphic format, with one variable on each axis.

4. Technology is fixed.

There are no technological breakthroughs to improve methods of production.




PPF: An Analysis

The PPF model demonstrates the following economic principles:

 The economy is said to be operating efficiently if it is operating on the production possibilities frontier (e.g. Point

A or B) because it is producing a mix of output that is the maximum possible from the resources available.

 Points inside the curve (e.g. Point C) are therefore inefficient while points outside the curve (e.g. Point D) are currently unattainable.

 If the economy is operating on the production possibilities frontier, we can see the tradeoffs society faces. To produce more of one good, it must produce less of the other. The amount of one good given up when producing more of another good is the opportunity cost of the additional production.




PPF: An Analysis

 The production possibilities frontier is bowed outward because the opportunity cost of producing more of a good increases as we near maximum production of that good. This is because we use resources better suited toward production of the other good in order to continue to expand production of the first good.

 A technological advance in production shifts the production possibilities frontier outward. This is a demonstration of economic growth.





Combination

Capital

Goods

Consumer

Goods

C

D

A

B

160

140

80

0

0

40

80

100




Graphs in Economic Analysis

One way to express the relationship between variables is with a graph.

Graphs serve two purposes:

1. Graphs offer a way to visually express ideas that might be less clear if described with equations or words.

2. When analyzing economic data, graphs provide a way of finding how variables are related in the world.




Forms of Graphs

Pie graph

 is a circular chart divided into sectors illustrating proportion. It is a convenient way to represent the different parts of something that when added together equal the whole.

Bar graph

 is a chart with rectangular bars with lengths proportional to the values that they represent. The bars can be plotted vertically or horizontally. It is used for marking clear data which has learned value.

Line Graph

 is a type of graph, which displays information as a series of data points connected by straight line segments. It is an extension of a scatter graph, and is created by connecting a series of points that represent individual measurements with line segments.




Pie Graph

Number of Android Tablets Sold in 2013

88; 10%

125; 15%

76; 9%

78; 9%

100; 12%

68; 8%

56; 6%

45; 5%

40; 5%

60; 7%

55; 6%

67; 8%

January

July

February

August

March April

September October

May June

November December



BACHELOR OF ARTS IN ECONOMICS

Month

January

February

March

April

May

June

July

August

September

October

November

December

Number of

Android Tablets

Sold

88

76

100

67

55

60

40

45

56

68

78

125

SOC SCI 104 – BASIC ECONOMICS W/ TAR

Bar Graph

140

120

100

80

60

40

20

0

88

76


100

67

55

60

40

45

56

68

78

125

Month

Month

January

February

March

April

May

June

July

August

September

October

November

December

Number of

Android Tablets

Sold

88

76

100

67

55

60

40

45

56

68

78

125




Line Graph


140

120

100

80

60

40

20

0

88

76

100

67

55

60

40

45

56

68

78

125

Month

January

February

March

April

May

June

July

August

September

October

November

December

Number of

Android Tablets

Sold

88

76

100

67

55

60

40

45

56

68

78

125

Month




Graphs of Two Variables:

The Coordinate System

Economists are often concerned with the relationships between variables.

Thus, they need to display two variables on a single graph.

The coordinate system makes this possible.




Variable and Constant

Variable is q quantity that assumes different values in a particular problem. It is a value that may change within the scope of a given problem or set of operations.

Constant is a quantity whose value remains unchanged throughout a particular problem.

 Numerical Constant – has the same value in all problems

 Parametric Constant (Parameter) – has the same value throughout the problem but may assume different values in different problems

Ex: 𝑅 = 10𝑥 (Revenue ) , 𝑇𝐶 = 𝑎 + 𝑏𝑋 (Cost) , 𝑄𝑑 = 𝑎 – 𝑏𝑌 (Demand)




Dependent and Independent Variables

Function is a relationship between two or more variables such that a unique value of one variable is determined by the values taken by the other variables in the function.

These variables can be:

Independent Variable – the variable representing the value being manipulated or changed.

Dependent Variable – observed result of the independent variable being manipulated

If every value of x is associated with exactly one value of y, then y is said to be a function of x.

In the function, 𝑦 = 𝑓 𝑥 , 𝑦 is the dependent variable and 𝑥 is the independent variable.




Direct vs. Inverse Relationship

Direct Relationship is a positive relationship between two variables in which change in one variable is associated with a change in the other variable in the same direction.

Ex. Price and Quantity Supplied

Inverse Relationship is a negative relationship between two variables in which change in one variable is associated with a change in the other variable in the opposite direction.

Ex. Price and Quantity Demanded




Inverse and Direct Relationship

Inverse Relationship has a downward sloping curve .

Direct relationship has an upward sloping curve .

Inverse Relationship



BACHELOR OF ARTS IN ECONOMICS

Direct Relationship

SOC SCI 104 – BASIC ECONOMICS W/ TAR

Slope

The slope of the line represents the change in one variable that occurs when another variable changes.

It is an exact numerical measure of the relationship between the change in 𝑌 and the change in 𝑋 .

Slope measures the rate of change. It is expressed as :

𝑚 = 𝑟𝑖𝑠𝑒 𝑟𝑢𝑛

∆𝑌

=

∆𝑋

=

𝑌

2

𝑋

2

− 𝑌

1

− 𝑋

1




Slope of a Line

 Slope is negative if the line slopes downward to the right

 Slope is positive if the line slopes upward to the right

 Slope of the x-axis or horizontal line is zero

 The slope of the y-axis or vertical line is undefined .




Let’s Check Your Understanding

Study the four accompanying diagrams. Consider the following statements and indicate which diagram matches each statement. In each of these statements, is the slope positive, negative, zero, or infinity?

1. If the price of movies increases, fewer consumers go to see movies.

2. Whatever the temperature outside, people consume the same number of hotdogs per day.

3. Consumers buy more frozen yogurt when the price of ice cream goes up.

4. Research finds no relationship between the number of diet books purchased and the number of pounds lost by the average dieter.

5. Regardless of its price, consumers in Lingayen buy the same quantity of salt.




Linear Equation to Economic Analysis

Linear Equation is an algebraic equation which expresses a relationship between two or more variables.

 𝑌 = 𝑓 (𝑋) says the value of 𝑌 is determined by the value of 𝑋 ; 𝑌 is a “function of 𝑋 .

”

 𝑌 is the dependent variable

 𝑋 is the independent variable

A linear relationship may be in the common form: 𝑦 = 𝑚𝑥 + 𝑏 where 𝑥 and 𝑦 are variables, 𝑚 is slope, 𝑏 is y-intercept




X and Y – Intercepts

The x-intercept is the point where a line crosses the x -axi s. The general form of the x -intercept is ( x ,

0). The y -coordinate will always be zero.

The y-intercept is the point where a line crosses the y axis. The general form of the y -intercept is (0, y ). The x -coordinate will always be zero.





Given the equation: 𝑦 = −3𝑥 + 9

1. What is the Y intercept? The slope?

2. What is the X intercept? Is this a positive (direct) relationship or negative (inverse)?

Given the equation 𝑦 = 2𝑥 + 10

1. What is the Y intercept? The slope?

2. What is the X intercept? Is this a positive (direct) relationship or negative (inverse)?


