INTRODUCTION TO ECONOMICS

Sampath Hewage
BSc Eng (Hons) MBA

AN INTRODUCTION TO ECONOMICS
The study of economics is classified as a social science as it is associated with human problems and deals with human behaviour. Economics is the study of how society manages its scarce resources. Economics is the study of how societies allocate scarce resources between competing users. Economics is about the choices made by people, individually and collectively, in the production, exchange, distribution and consumption of goods and services.

WHY STUDY ECONOMICS

Economics is concerned with how people get goods and services they need and want. Money how it is made, lost, used and misused. All citizens must be informed of the economy.

When our economy does well, we as a nation and as people do well. When our economy is in crisis, nation suffers and we as people dont always get the goods and services we need.

ECONOMIC THEORY

Macroeconomics

Studies entire economic systems

Microeconomics

Observes the workings of the market on an individual or group within an economic system

Adam Smith Father of modern economics and writer of book An Inquiry into the Nature and Causes of the Wealth of Nations Milton Friedman Money supply is the most important influence on the economy Pure Economics furnishes the tools with which applied economics work. Applied Economics Use of tools which are created by pure economics to accomplish tasks.

Positive Economics A body of systematized knowledge concerning what is.

Normative Economics A body of systematized knowledge relating to the criteria of what it ought to be.

INTRODUCTION TO ECONOMIC PROBLEM

A need is something that can be seen as being essential to survival, such as food, water, shelter and warmth. A want is something we would like to have, but which is not essential for survival a car.

The problem is that the world and every individual in it have limited resources in relation to the wants and needs we have.
Tension between scarce resources and unlimited wants and needs. Resources are not distributed between countries and societies.

RESOURCES

Resources are inputs of factors of production used produce goods and services that humans want. Resources are normally classified into 3 categories.

Land Labour Capital

Sometimes classified into 4 categories

Land

All natural resources of the earth. Includes all the minerals, fish in the sea, metal, sand and so on. The reward for the land is rent. All the human mental and physical effort that goes into production. This will include all employed workers such as cleaners, teachers, police, doctors, bricklayers and engineers and so on. The reward for labour is referred to as wages. All the equipment, machinery and building that is not used for its own sake but for the contribution it makes to the production. This includes things like desks, computers, lorries and so on. The price for acquiring capital is referred to as interest. The skills needed to organise other resources into some form of production. The return for enterprise is called profit.

Labour

Capital

Entrepreneurship

FACTOR ENDOWMENT

Country's factor endowment is understood as the amount of land, labour, capital and entrepreneurship that a country possesses and can exploit for manufacturing. Countries with a large endowment of resources tend to be more prosperous than those with a small endowment all other things being equal. The development of sound institutions to access and equitably distribute these resources, however, is necessary in order for a country to obtain the greatest benefit from its factor endowment. Colonisation led to the economic growth with various degrees of inequality in human capital, wealth and political power.

SCARCITY OF RESOURCES

Scarcity

All the economic resources are scarce.

Choice

We all need to make choices as resources are scarce.

Opportunity cost
The cost of something in terms of an opportunity forgone. The benefit that could be received from the missed opportunity. The most valuable alternative or second best option compared with your choice. The cost expressed in terms of the nest best alternative forgone or sacrificed.

PRODUCTION POSSIBILITY BOUNDARY

A simple graphical device that is used to illustrate choice and scarcity, showing all the possible combinations of goods. PPC can reveal economic growth in an economy. This can be shown as an outward expansion of the existing PPC. Assumptions

The factor endowment is considered to be unchanged during the peiod under consideration. Resources are fully utilised. Production is carried out at maximum capacity. The technology used remain unchanged during period of consideration. Only two products are produced using resources available in the economy.

Constant opportunity cost Increasing opportunity cost Decreasing opportunity cost

PPC UNDER CONSTANT OPPORTUNITY COST

Cloth (m Millions)

1.2 1 0.8 0.6

0.4 0.2
0 0 0.5 1 1.5
Paddy (kg Millions)

PPC UNDER CONSTANT OPPORTUNITY COST

Reasons for constant opportunity cost

Homogeneous factors of production Constant factor ratio in each unit of product produced

Reasons for Opportunity Cost not Practical to be Constant

Factors of production are not constant.

Infertile land Unskilled labour

Economic resources are not fully adoptable to alternative uses.

PPC UNDER INCREASING OPPORTUNITY COST

Cloth (m Millions)

1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 0 0.5 1 1.5
Paddy (kg Millions)

PPC UNDER INCREASING OPPORTUNITY COST

Reasons for Increasing Opportunity Cost

Production factors are not homogenous Change in factor ratios Economic resources are not completely adoptable to alternative uses. Change in efficiency

PPC UNDER REDUCING OPPORTUNITY COST

Cloth (m Millions)

1.2

1
0.8 0.6 0.4 0.2 0 0 0.5 1 1.5
Paddy (kg Millions)

PPC UNDER REDUCING OPPORTUNITY COST

Reasons for Reducing Opportunity Cost

Technological economies of scale

Labour intensive Capital Intensive Fixed cost per unit is reduced as number of units produced are increased thus reducing the cost per unit product. Setting up cost per unit is reduced as number of units produced are increased thus reducing the cost per unit product.

Managerial economies of scale

Entities are divided into functional areas and each functional area is handled by expert in that function. This is due to division of labour and specialisation.

Marketing economies of scale

Marketing function is handled by professionals in the marketing function.

Financial economies of scale

Some costs for facilitation of funding remains the same even though amount of funding increased. Average cost of facilitation is reduced as the funded amount is increased.

PRACTICAL USES OF PPC

Scarcity of resources Alternative uses of resources Choice Under utilisation of resources Factor endowment increase Resource migration Technological progress Destruction of resources Opportunity cost Economic growth Change in productivity of resources Change in resource utilisation Change in demand for goods and services

NATURE OF MODERN PRODUCTION

Economies use various inputs to produce outputs, goods and services. Goods differ with services in 3 ways;

Physical presence Durability Production and consumption of services occur at the same time.

Goods

Consumer goods

Goods that cater to individual household needs and wants. For corporate entities to further producer products and services.

Producer goods

BASIC ECONOMIC PROBLEMS

What goods and services will be produced ?

How will these goods and services be produces ?

How much to produce ?

Economic Systems

Traditional system Command economy Market economy Mixed economy Transformation economy

For whom to produce ?

ECONOMIC GOALS

Full employment of factors of production This goal can be described conceptually as a situation where anyone who wishes to work can find a job, anyone that owns a piece of capital can put it to work as fair return and anyone who own land can put it to use and receive a fair return. Economic stability Economic stability or price stability is defined as absence of excessive inflation. Inflation is defined as an increase in average prices in an economy. Inflation rate is the actual measurement of inflation and it is determined by a price index. Eg; CCPI Colombo Consumer Price Index Equity Income refers to the receipt of something of value by an entity for a period of time. There are many possible income distributions, but there are two possible extremes; perfectly equal income distribution and perfectly unequal income distribution . Economic growth and development Economic growth is measured by growth of gross domestic product of a country. Economic growth is defined as positive rate of change of real GDP. That is the economy grows faster than population, increasing standards of living for individuals in an economy. Free trade with other nations Increased trade is desirable because it benefits consumers. With increased trade, more goods are available to consumers or existing goods are available at lower prices or some combination of the two occurs. Efficient allocation of factors of production The efficient allocation of factors of production is also called just economic efficiency. Individual freedoms, privacy and property

ECONOMIC ORGANISATIONS

Market system Central planning system

Disadvantages of economic planning

Inefficient resource distribution surplus and shortage Can not determine and prioritise social goods better than the market can Lack of incentive for innovation Infringement on individual freedoms Corruption

CHOICE OF FORMS OF ENTERPRISE

State

In a state enterprise, steps are taken by the government in the name of common interest of the people of the state. A collective enterprise has the responsibility of every member of a group or society, without regard to an individual members participation in decision making and his or her position or rank.

Collective

Cooperative

Cooperative enterprise is defined as an autonomous association of persons united voluntarily to meet their common economic, social and cultural needs and aspirations through a jointly-owned and democratically owned enterprise.

Private

Private enterprise is a basis of a free market capitalist system, it is a business unit established, owned and operated by private individuals for profit.

A COMPARATIVE STUDY

Capitalist

Individual Profit Factors of production owned privately. Market activities are determined by voluntary private decision. Private rights and property protected by rule of law. Greater equality. Desire to produce rather than desire for profit. Government directs the kind and nature of production.

Socialist

Mixed

Mixture of capitalism and socialism People enjoy the right

to possess means of production To participate in managerial decisions To travel To buy To sell To maintain organizations and create wealth To organize To communicate To protest peacefully

END