CHAPTER 1 NATURE AND SCOPE OF ECONOMICS 1st Semester, S.Y 2014 – 2015
Chapter Outline • Definition of Economics • Importance of Economics • Microeconomics vs. Macroeconomics • Nature of Economic Choice (Scarcity and Opportunity Cost) • Economic Activities • Economic Resources • Economic Goals • Fundamental Economic Problems / Questions • Types of Economic System • Economic Models • Ceteris Paribus • Normative and Positive Economics • Scientific Method • Circular Flow Model • The Production Possibility Frontier • Graphs • 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 lawsthat 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: Appreciate events in economic history and understand how the present-day system of economics came to be. Learn the ways in which economics explain the activities of man through its tools, models, principles and standards. Make use of production and consumption concepts in business endeavors or simply in understanding people’s economic behavior.
Why Study Economics? Manage economic and financial affairs; thereby, achieving a good standard of living for ourselves, our families and our nation. Understand government’s functions in economics and choose leaders who are economically sensible. 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
Macroeconomics studies Economic growth Unemployment and inflation Aggregate demand and aggregate supply Economic policies – fiscal and monetary International trade – exports and imports Money supply Scope of Microeconomics
Let’s Check Your Understanding! Which of the following questions involve microeconomics, and which involve macroeconomics? In each case, explain your answer. Why did consumers switch to using Smart TVs in 2013? Why did overall consumer spending slow down in 2013? Why did the standard of living rise more rapidly in the current administration compared to previous administration? Why have starting salaries for students with geology degrees risen sharply of late? What determines the choice between rail and road transportation? Why did thecomputers 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 Wantsare desires that can be satisfied by consuming a good or service. Needsare 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. Fruits and Vegetables Education Medicine Luxurious car Jewelry
Goods versus Services Goodis 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 materialsthat 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 Serviceis an intangible commodity. More specifically, services are an intangible equivalent of economic goods.These are tasks that you pay otherpeople to perform for you. Servicesare work that one person performs for another for payment. Services include the work of sales clerks, technical support representatives, teachers, nurses, doctors, lawyers, etc.
Let’s Check Your Understanding! Determine whether each of the following is a good or a service. Beauty shop or barbershop. Furniture Pineapples Legal counsel 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.
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 Production. The process of transforming inputs into outputs. Distribution. The way total output, income, or wealth is distributed among individuals or among the factors of production Exchange. The process of trading goods between buyers and sellers in a particular market. 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. • Laborrefers 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 • Entrepreneurshipis 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.
Let’s Check Your Understanding! • Determine what category of economic resources each of these belongs. • Factory worker • Company’s CEO • Assembly plant • Industrial robots • 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 Economic efficiency Economic growth and economic development Economic freedom Economic security Equitable distribution of income Full employment Price level stability Reasonable balance of trade
Three Economic Questions • Economic Systemis 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: • What to produce? • How to produce? • 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 To produce the goods for consumption of the population To utilize the resources in efficient method of production To employ the labor force in occupations where productivity is at optimum To apportion the wealth and income available to everyone in an equitable manner To encourage innovation and technology in order to maximize efficiency, optimize satisfaction and minimize waste
Classification of Economic System Traditional Economy Market Economy Command Economy 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 • Private Property • Freedom of Enterprise or Choice • Self-interest • Competition • Markets and Prices • Technology and Capital Goods • Specialization • Use of Money • 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 Koreaand the former Soviet Union.
Flaws of Command Economy In practice, the pure command system also has flaws, most notably: Running an economy is so complicated that some resources are used inefficiently. Because nobody in particular owns resources, each person has less incentive to employ them in their highest-valued use, so some resources are wasted. Central plans may reflect more the preferences of central planners than those of society. Because government is responsible for all production, the variety of products tends to be more limited than in a capitalist economy. 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 • Asimplifiedrepresentation ofeconomic 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 beproved or disproved byreference 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 reflectsan opinion, which cannotbe proved or disproved byreference 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
Let’s Check Your Understanding! Determine whether each of the following statements is normative or positive. The inflation rate in this country is too high. The government should increase the minimum wage in Metro Manila. Increasing the minimum wage results in more unemployment. What government policies should be adopted to make it easier for low-income students to attend college? 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. Step One: Identify the Question and Define Relevant Variables Step Two: Specify Assumptions Step Three: Formulate a Hypothesis 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.
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 Firmsare the institutions that organize the production of goods and servicesand are considered the producing-unit of the economy. They buy economic resources and they sell goods and services.
Components of the Circular-Flow Model: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.
Components of the Circular-Flow Model:Resource Market and Product Market Real Flows (input-output flows)depictsthe 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.