BM1709

PRINCIPLES OF ECONOMICS

The Economic Method

Division of Economics
• Microeconomics – This branch of economics examines the functioning of individual industries
and the behavior of individual decision-making units, such as firms and households. It looks at
the household, the firm, and the industry.
• Macroeconomics – This branch of economics examines the economic behavior of factors such
as income, employment, and output on a national scale. It looks at the whole, the aggregate.

Approaches in Economics
• Positive Economics – This approach attempts to understand the behavior and operation of
economic systems without making judgment about whether the outcomes are good or bad. It
describes what exists and how it works.
• Normative Economics – This approach looks at the outcomes of economic behavior and asks
whether they are good or bad and whether they can be made better. Normative economics is
also known as policy economics.

Factors used in judging economic outcomes

• Efficiency – An efficient economy is an economy that produces what people want at the least
possible cost. It is also known as allocative efficiency.
• Equity – The definition of equity, or fairness, may vary. For some, equity focuses on a more
equal definition of income and wealth. For others, fairness means giving people what they earn.
• Growth – Economic growth is the increase in total output of an economy. If output grows faster
than the population, output per person rises and standards of living increase.
• Stability – This is a condition in which national output is growing steadily, with low inflation and
full employment of resources.

The Economic Problem

Three (3) Basic Economic Questions:

• What gets produced? – This question determines the quantities of goods and the kinds of
services that people produce.
• How is it produced? – This question focuses on the ways goods and services get produced.
Different economies may have different ways of producing the same good or service.
• Who gets what is produced? – The answer to this question depends on the incomes that people
earn and the prices they pay for the goods and services they buy. At given prices, a person who
has a high income is able to buy more goods and services than a person who has low income.

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Production Possibilities Frontier (PPF)

• PPFs show the combinations of products that can be produced using the same resources, given
the technology. The PPF shows the limits to production with the available resources and
technology. If either resources or technology change, the PPF shifts. More resources or better
technology shift it outward and a loss of resources shifts it inward.
• The PPF is a valuable tool for illustrating the effects of scarcity and its consequences. The PPF
shows the following features of production possibilities:
o Opportunity cost – Opportunity cost is opportunity lost. It is what people give up when
they make economic decisions. The PPF is curved because of the law of increasing
opportunity cost. This means that as a seller devotes more of its resources to one (1)
kind of product, it becomes less efficient.
o Economic growth – Economic growth is the sustained expansion of the production
possibilities. The PPF can expand if the firm is willing to make tradeoffs or move along
the curves. However, if the firm wants to grow economically, they must consume fewer
resources and still produce the same or consume fewer resources and produce more
goods. Economic growth shifts the PPF outwards. Economic growth is not a magic
formula for solving scarcity. The new PPF will continue to face opportunity costs. To
keep producing capital, current consumption must be less than its maximum possible
level.
o Efficient production – Efficient production means that you are able to use all resources
to produce goods and services. Conversely, inefficient production means that the
individual or firm is not able to use all of its resources or use up too much of its
resources to produce goods and services.
o Attainable and unattainable combinations – Because the PPF shows the limits to
production, it separates the attainable combinations from unattainable ones. The
economy can produce any of the combinations smaller than those in the PPF or under
the PPF line, and those that are on the PPF, but it is impossible to produce combinations
that are larger than those in the PPF.
o Tradeoffs and free lunches – A tradeoff is an exchange – giving up one thing to
exchange something else. The PPF illustrates the idea of a tradeoff. If the economy
produces at a certain point and wants more of a certain product, they must forego some
other product. In order to move from points in the PPF, people trade off products. A
free lunch, on the other hand, is a gift – getting something without giving up something
else. In the PPF, if the production is taking place inside the PPF, it is possible to move
from that point to a point in the PPF, by using currently unused resources or by using
resources in their most productive way. In this way, nothing is foregone to increase
production, there is a free lunch.

Theory of Comparative Advantage – This theory states that specialization and free trading will benefit
all trading parties.

Specialization and Trade

• Absolute advantage – A producer has an absolute advantage over another in the production of
a good or service if s/he can produce that product using fewer resources. This occurs when one
(1) person is more productive than the other because s/he needs fewer inputs or takes less time
to produce a good or perform a production task.

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• Comparative advantage – A producer has a comparative advantage over another if s/he can
produce a good at a lower opportunity cost. Ricardo, an economist, argued that two (2) parties
can benefit from specialization and trade even if one (1) party has an absolute advantage in the
production of both goods if each party takes advantage of his/her comparative advantage.

References:
Bade, R., & Parkin, M. (2015). Foundations of microeconomics (7th ed.). Upper Saddle River: Pearson
Education Inc.

Case, K. E., Fair, R. C., & Oster , S. E. (2017). Principles of microeconomics (12th ed.). Harlow: Pearson
Education Limited.

Mankiw, N. G. (2015). Principles of microeconomics. Stamford: Cengage Learning.

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