THE FOUNDATION

OF ECONOMICS
To study, or to fail
that is the question!
ECONOMICS AS A SOCIAL SCIENCE
• Economics, the social science, is the study of choices leading to the best
possible use of scarce resources to satisfy unlimited human needs and wants.
• Economics is derived from the Greek word “oikonomia”, meaning
'household management’.
• ​Economics is regarded as a social science because it uses scientific methods
to build theories that can help explain the behavior of individuals, groups,
and organizations. Economics attempts to explain the economic behavior,
which arises when scarce resources are exchanged.
 SCARCITY
• Scarcity: Scarcity is a central concept in economics. Scarcity is the
situation in which available resources, or factors of production, are
finite, whereas wants are infinite. There are not enough resources to
produce everything that we need and want. The basic economic problem
arises because people have unlimited wants but resources are limited.
Because of scarcity, various economic decisions must be made to allocate
resources efficiently.
 FACTORS OF PRODUCTION AND
SCARCITY
• Factors of Production = resources = Inputs used to produce all goods and services. Four
types of services:
• Land (All natural resources, above or under the ground)
• Forests, rivers, agricultural land, fish…
• Oil, natural gas, minerals
• Capital (physical capital)
• Machines, tools, equipment, factories, etc.
• Labor: Human effort in producing goods and/or services
• Entrepreneurship: Human effort in organizing the other three factors, in addition to risk-taking,
innovation, management.
 Three Qs
• What to produce?
• How to produce?
• For whom to produce?
 CHOICE
• Choice: Economics is the study of choice because resources are scarce
and many needs and wants cannot be satisfied. As such, choices must be
made, and whenever a choice is made an opportunity arises. Households,
businesses and governments are always making choices between
alternatives competing with each other. The consequences of such choices,
present and future, is studied in economics.
 EFFICIENCY
• Efficiency refers to making the best possible use of resources, through
minimizing the waste. Allocative efficiency is where scarce resources are
put to their best possible use in producing goods and services in optimal
combinations for society, minimizing the waste of resources.
 EQUITY
• Equity is the idea of being fair and/or just. It differs from equality.
Fairness has a different meaning from one person to another. Inequity
(unfair) is often referred to as inequality, in economics, and may refer to
how income, wealth, or even opportunity is distributed in society.
 ECONOMIC WELL-BEING
• Economic well-being refers to levels of prosperity, economic satisfaction, and
standards of living among the members of a society. Economic well-being includes:
• Security with respect to income and wealth, having a job and housing
• The ability to pursue one’s goals, work productively, and develop one’s potential
• Quality of life: health service, education, social connections, environmental quality, personal
security
• The ability to maintain all the above over time
• Levels of significant well-being vary significantly, both between and within nations.
 SUSTAINABILITY
• Sustainability: Sustainability focuses on meeting the needs of
the present without compromising the ability of future
generations to meet their needs. Sustainability refers to limits
on current economic activities that harm our environment by
depleting and degrading resources, negatively impacting future
generations.
 CHANGE
• Change: Change is an essential concept in economics. As economists, we
need to be aware that the economic world is in a state of constant change
and adjust our thinking accordingly. Change is an important concept in
economic theory and in empirical evidence from the real world. Our
economic world is subject to profound and continuous economic change
that occurs in technologies, institutions, and societies, as well as structural
change.
 INTERDEPENDENCE
• Individuals, communities, and countries are interdependent, not self-
sufficient. Economic groups such as consumers, households, businesses,
and governments all interact together within and across national borders to
achieve their economic goals. The more these groups interact, the more
they are interdependent. The economic world is highly interdependent,
and decisions made by economic actors can cause many unintended
consequences for other economic actors.
 INTERVENTION
• Intervention means governments getting involved to rectify perceived
failure in markets. Markets may be the most efficient at organizing scarce
resources, but they often fail to achieve many of the goals of societies
such as economic well-being, equity, or sustainability. Such failures may
be considered just cause for government intervention, however, there is
considerable disagreement between policy makers and economists as to
the need for intervention, the type of intervention to be used, and the
extent of any such intervention.
 Choice and Opportunity Cost
• Due to the scarcity of resources, choices have to be made. What, for whom, and
how to produce?
• Resource allocation: assigning particular resources to the production of particular good
and services
• Overallocation/Underallocation of resources, results in Overproduction/Underproduction
• Reallocation of resources: changing the allocation of resources, and hence the
combination and quantities of goods and services provided
• Misallocation of resources: assigning wrong amount of resources to the production of a
particular goods and services, resulting in overallocation or underallocation
 Scarcity and Sustainability
• Sustainability depends crucially on sustainable resource use, referring
to the preservation of the environment over time. The problem of
sustainability arises since resources are scarce.
 Opportunity Cost
• The value of the next best alternative that is sacrificed as a result of
making a choice. As scarcity necessitates choice, and choice involves the
opportunity cost.
 FACTORS OF PRODUCTION AND
SCARCITY
• Factors of Production = resources = Inputs used to produce all goods and services. Four
types of services:
• Land (All natural resources, above or under the ground)
• Forests, rivers, agricultural land, fish…
• Oil, natural gas, minerals
• Capital (physical capital)
• Machines, tools, equipment, factories, etc.
• Labor: Human effort in producing goods and/or services
• Entrepreneurship: Human effort in organizing the other three factors, in addition to risk-taking,
innovation, management.
 Capital
• Physical capital
• Human Capital
• Natural/Environmental Capital
 Scarcity, choice and opportunity cost
• The concept of opportunity cost, or the value of the next best alternative
that must be sacrificed, is central to the economic perspective of the
world, and results from the scarcity that forces choices to be made.
 Positive vs Normative
• Positive economic statement - objective statements that can be
tested, amended or rejected by referring to the available evidence.
• Normative economic statement - a subjective statement of
opinion which can neither be proven or dis-proven.
Production Posibilities Curve
 Production Posibilities Curve
• Many of you may have noticed that the PPF curve is not a straight
line but instead a curve. This is because the factors of production
are not perfect substitutes for each other.
 Free Good
• A free good is a good that is not scarce, and therefore is available
without limit. A free good is available in as great a quantity as
desired with zero opportunity cost to society. A good that is
made available at zero price is not necessarily a free good.

Examples of free goods:

• Air.
• Sunlight.
Circular Flow
 Circular Flow - Key terms

Circular flow of income - a diagrammatic illustration of a simple

economy diagram.
Two sector model - a simplified form of the circular flow diagram,
presuming no international trade or government intervention.
Four sector model - a more complex form of the circular flow diagram,
containing leakages and withdrawals in the model.
Leakages from the circular flow - leakages out of the economy from
savings, taxes, and imports.
 Circular Flow - Key terms
Injections into the circular flow - injections into the economy from
investment, government purchases, and exports.
Transfer payments - government redistribution of income and wealth
(payment) made without any transfer of goods or services in
exchange. Examples of transfer payments include welfare benefits
as well as retirement payments. Transfer payments are not counted
as part of injections into the circular flow because transfer they do not
add to the overall output of the economy.
Circular flow of income, with leakages and
injections
 Economic systems
• Economic systems - an economic system, or economic order, is a
system of production, resource allocation and distribution of goods
and services. These are free market economic systems, planned /
command economies and mixed economic systems.
• An important point to note is that there are currently no nations
which can be considered either a pure free market system or
entirely a command economy, but that some nations are closer in
character than others.
 Free market systems
• Market in which resource allocation (or price and/or output) is
determined by demand and supply or a price mechanism or
producers and consumers or where the means of production are
privately held by individuals and firms, or where demand and
supply determine how much to produce, how to produce, and for
whom to produce.
 Centrally planned system
• Centrally planned economic system - an economic system
where resources are allocated by the government or a central
planning authority.
 Mixed economy system
• Mixed economy - a combination of both planned and free market
systems and includes both a private and public sector.
• Public sector - the (government sector) which controls basic
services e.g. schools, hospitals, roads as well as some key
industries.
• Private sector - the sector of the economy providing services, free
from government control although dangerous goods are illegal e.g.
drugs, weapons, etc.
 Advantages of the Free-market
• Free market economies provide individuals with the freedom to
make their own choices about which services or products to
purchase.
• Efficiency is probably also improved because profit acts as a signal
to producers to produce more of the goods or service that are
successful
 Disadvantages of the Free-market
• There are significant external costs associated with production. If the
cheapest and most profitable solution is to pollute the local river then
businesses will do so. Not doing so would mean losing market share to
the company's rivals.
• Income inequality is considerable. A footballer or banker earns
substantially more than a teacher because this reflects their market price.
• A market economy will produce what people want, not necessarily what
they need.
 Advantages of the Mixed system
• Most of the advantages of both planned and free market economic
systems are also present in a mixed economy. This economic system
provides an incentive for profit as well as the provision of basic services.
 Disadvantage of the Mixed system
• Mixed economies also include most of the disadvantages of other
economic systems. For example monopolies are common place and
dangerous demerit goods are produced, though to a more limited extent.
Advantages of the Planned system
• The government controls which products are produced and so
private monopolies cannot develop.
• Income inequality and social inequality are much lower.
Disadvantage of the Planned system
• With no incentives for entrepreneurs and innovators productivity
and economic growth are low. Research and development is not a
priority because of a lack of profit incentive.
• Government bureaucracy leads to a lack of supplies and inefficient
use of resources.
 Market versus government intervention
• One of the main issues in economics is the extent to which the
government should intervene in the economy.
 Arguments for government intervention
• ​Greater equality – redistribute income and wealth to improve equality of
opportunity and equality of outcome.
• Overcome market failure – Markets fail to take into account externalities and are
likely to under-produce public/merit goods. For example, governments can
subsidise or provide goods with positive externalities.
• Macroeconomic intervention – intervention to overcome prolonged recessions and
reduce unemployment.
• Disaster relief – only government can solve major health crisis such as pandemics.
 Arguments against government
intervention
• Governments liable to make the wrong decisions – influenced by
political pressure groups, they spend on inefficient projects which lead to
an inefficient outcome.
• Personal freedom – Government intervention is taking away individuals
decision on how to spend and act. Economic intervention takes some
personal freedom away.
• The market is most efficient at deciding how and when to produce.