Principles of Economics
Class 1
Introduction to Economics
State and Market
Supply and Demand
Prerequisites 1: Graphs
• A Graph is a picture that shows a relationship
between 2 or more variables.
• 2D graphs – linear or nonlinear.
• The slope of the curve shows by how much y
changes if x changes by 1 small unit. The sign
of the slope tells whether an increase in x
causes an increase in y (+), or a decrease (-).
Linear function(y = ax + b)
y
y
1
a
1
0
0
x
Inverse relation
a
x
Direct relation
Nonlinear functions
-slope changes = slope at point and slope on segment is different
y
α Δy
Δx
β
0
y*
x*
x
Exercise 1a
Draw the following graphs:
y = 2x - 3
y = -0.5x +1
y = -x2 +4
Then find slopes for x = 0, 1 and 2.
Prerequisites 2: Indices and growth
rates
year
2012
2013
2014
2015
production
Base index
(2012 = 100)
2500
2750
2900
3000
Chain index
100,0
110,0
116,0
120,0
Growth rate
(%)
110,0
105,5
103,4
𝑉𝑎𝑙𝑢𝑒
𝐼𝐵=100 = 𝑉𝑎𝑙𝑢𝑒 𝑡 ×100
𝐵
𝑉𝑎𝑙𝑢𝑒𝑡
𝐼𝑉 = 𝑉𝑎𝑙𝑢𝑒
𝑡−1
×100
𝑔𝑉 = 𝐼𝑉 − 100
10,0
5,5
3,4
Exercise 1b: Inflation rate and CPI
Year
Trade
union
basket
cost
2011
4500
2012
4575
2013
4450
2014
4500
CPI (2011 = 100)
Chain index
𝑉𝑎𝑙𝑢𝑒
𝐼𝐵=100 = 𝑉𝑎𝑙𝑢𝑒 𝑡 ×100
𝐵
Inflation rate
𝑉𝑎𝑙𝑢𝑒𝑡
𝐼𝑉 = 𝑉𝑎𝑙𝑢𝑒
𝑡−1
×100
𝑔𝑉 = 𝐼𝑉 − 100
Exercise 1b: Inflation rate and CPI
Year
Trade
union
basket
cost
CPI (2011 = 100)
Chain index
Inflation rate
2011
4500
=4500×100/4500 = 100
-
-
2012
4575
=4575×100/4500 = 101.7
=4575×100/4500=101.7
101.7-100=1.7
2013
4450
=4450×100/4500 = 98.9
=4450×100/4575=97.3
97.3-100=-2.7
2014
4500
=4500×100/4500 = 100
=4500×100/4450=101.1
101.1-100=1.1
PRINCIPLES OF ECONOMICS
• ECONOMICS is a science which investigates how
societies use scarce resources in order to produce
useful goods and how they are distributed among
them.
• ECONOMY is the overall economic activity in a country
(region)
• If resources were not scarce, there would have been no
economics -> scarcity is the main trait of ECONOMIC
GOODS.
• Resources are used efficiently if no additional unit of
any good can be produced without reducing
production of the other good.
MICROECONOMICS AND
MACROECONOMICS
• MICROECONIMICS is a branch of economics
which analyses the behaviour of individual
entities (companies, consumers) and their
interaction on the market.
• Found in 1776 (Adam Smith – Wealth of the
Nations)
• MACROECONOMICS is a branch of economics
which analyses the sum of economic activity.
• Found in 1936 (John Maynard Keynes – General
Theory of Employment, Interest Rate and
Employment).
ECONOMY TYPES
• MARKET ECONOMY is an economy where
consumers and producers freely set prices and
quantities. It boosts efficiency, but fails to solve
situations like monopoly and lacks justice.
• PLANNED ECONOMY is an economy where
consumption and production is commanded by
the state (e.g. communistic economies)
• MIXED ECONOMY is the most common type
where majority of the market is self-regulated,
but state interferes when it is needed to provide
justice.
Positive vs. Normative economy
POSITIVE ECONOMY – description of economic
phenomena – the answer provided by economic
analysis
Example: Why housekeepers earn less than
doctors?
NORMATIVE ECONOMY –value or normative
judgments about economic fairness or what the
outcome of the economy or goals of public policy
ought to be – the answer provided by political
discussion and political decisions.
Example: Should production of some arms and
drugs be made illegal?
INPUTS AND PRODUCTS
INPUTS are the goods used in production of the
other goods and services. Basic inputs are
labour, capital and land.
PRODUCTS are useful goods and services that
are either consumed or used for production
of other goods.
The three basic economic questions
1. What goods and services should be produced?
Those that bring producers the most profit.
2. How should the goods and services be
produced? To stay competitive, one has to
minimize costs and produce efficiently.
3. For whom should the goods and services be
produced? It depends on the input market – the
product of all factors and its prices define the
income of consumers
Production possibility frontier
• PPF shows the maximum amount of
production that a country can produce using a
given technology and avaialble inputs.
q2
q2
Economic Growth
Inefficiency
Efficiency
A
0
B
q1
0
q1
Capital & Consumer goods
Consumer goods
•Economic growth depends on the choice
between consumer goods and capital goods.
PPF2018
A
B
PPF2018
PPF 2013
0
Capital goods
Exercise 2: PPF curve
case
coconut
fish
A
0
8
B
1
6
C
2
4
D
3
2
E
4
0
coco
nut
PPF – production possibility frontier
4
3
2
1
0
2
4
6
8
fish
Exercise 3
• Country can produce the following combination of goods
using all the inputs:
Option
X
Y
A
100
0
B
C
D
80
50
0
100
200
300
– a) Draw PPF.
– b) Is country efficiently using its inputs if it produces X = 70, Y = 90
– c) Due to technological advances a production of X is doubled and the
production of Y increases by 50%. Draw new PPF curve.
Solution
c) New PPF
Option
X
Y
A
100*2=200
0
B
C
D
80*2=160
50*2=100
0
100×1,5=150
200×1,5=300
300×1,5=450
Market and State
• Market is a system in which sellers and buyers
interact in order to determine prices and
quantities of goods and services.
• Price is the value of a good or service in
money.
• Market equilibrium is a situation in which
sellers are willing to sell just as much
consumers are willing to buy at certain price.
Market system
Labour, savings, land
money
Households
Companies
money
Goods and services
Exchange, money and capital
• Exchange of goods is based on the specialisation
and money is the mean for exchange.
• Specialization and division of labour increases
productivity of labour which increases the
amount of goods and thus the welfare of
consumers.
• Capital is an input which is an accumulation of
investments. Capital is made by sacrificing
current consumption.
• Ownership of capital is protected – it is the
foundation of capitalism.
Economic role of the state
• Laissez-faire (Fr.) – “let it be” – classical economics,
today revised.
1. EFFICIENCY – best in perfect competition (invisible
hand) but sometimes regulation of market
competition needed:
• Imperfect competition appear – antitrust laws needed
• Externalities - levying costs or benefits to others.
• Public goods – financed by the state.
• Taxes – price of the public goods.
2. JUSTICE
• Unregulated markets can lead to the unjust
differences between the incomes.
3. MACROECONOMIC GROWTH AND STABILITY
• Fiscal policy (public spending, taxes) and
monetary policy (supply of money) affect the
employment, GDP growth rate, inflation, etc.
4. PROTECTION OF INDIVIDUAL AND PROPERTY
RIGHTS