Chapter 1

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Ch. 1: 1

Principles of Economics second edition

© Oxford Fajar Sdn. Bhd. (008974-T) 2010

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INTRODUCTION TO MICROECONOMICS

CHAPTER 1

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DEFINITION OF ECONOMICS

Economics is a science which studies human behaviours as a relationship between ends

and scarce which have alternative uses.

OR

Economics is a study of how people use their limited resources to try to fulfil unlimited wants and involves alternatives or choices.

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MICROECONOMICS VS. MACROECONOMICS

MICROECONOMICS

The study of individual parts of the

economy such as public choices,

business choices and personal choices.

MACROECONOMICS

The study of the economic system as a

whole such as national income, trade cycle, unemployment

rate, inflation and general price level.

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POSITIVE VS. NORMATIVE ANALYSIS

A positive analysis is to deal with the question of “what is” and no indication of approval or disapproval. It focuses on facts and cause-and-effect relationships.

A normative analysis is to deal with the question of “what ought to be”. It incorporates value judgements about what the economy should be or what policy should be used to achieve economic goals.

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BASIC ECONOMIC CONCEPTS


SCARCITYSCARCITY

OPPORTUNITY COSTOPPORTUNITY COST

CHOICECHOICE

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1. SCARCITY

One of the important concepts in economics is scarcity.

Scarcity is defined as wants always exceed limited resources to satisfy them.

Scarcity is a universal problem faced by poor as well as rich nations in order to fulfil their needs.

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BASIC ECONOMIC CONCEPTS (cont.)

2. CHOICE When scarcity exists, choices are to be

made.

3. OPPORTUNITY COST Opportunity cost is defined as the second

best alternative that has to be forgone for another choice which gives more satisfaction.

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BASIC ECONOMIC PROBLEMS (cont.)

1. WHAT TO PRODUCE? Refers to the type of goods and services to be produced

2. HOW TO PRODUCE? Refers to the cheapest method of production

3. FOR WHOM TO PRODUCE? Refers to the distribution of income

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PRODUCTION POSSIBILITIES CURVE (PPC)

Used to explain the basic economic concepts: Scarcity, Choices and Opportunity cost.

DEFINITION:

The PPC shows the various possible combinations of goods and services

produced within a specified time periodwith all its resources fully and

efficiently employed.

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PRODUCTION POSSIBILITIES CURVE (PPC) (cont.)

Assumptions:

1. The economy is operating in full employment and full production capacity (full efficiency).

2. The amount of resources available are fixed.

3. The state of technology does not change throughout the production.

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Sewing Machine

Butter

12

4

D

C

6

5

If it allocates all its resources to sewing machine, it will produce at Point A.

If it allocates all its resources to butter, it will produce at Point F.

A

F


2

4

8

10

14

16

0 1 2 3

The country Jaya, produces two products – butter and sewing machine.

If the country Jaya is at Point C on the PPC, it can produce the combination of 2,000 kg butter and 12,000 units of sewing machine.

Point D shows the production of 3,000 kg butter and 9,000 units of sewing machine.

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Sewing Machine

Butter

12

4

D

C

6

5

Any point along the PPC CHOICES

A

F


2

4

8

10

14

16

0 1 2 3

Point outside the PPC (Point Z) SCARCITY

B

E

Z

Y

Point inside the PPC (Point Y) Waste of resources and inefficiency

ATTAINABLE

UNATTAINABLE

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Sewing Machine

Butter

12

4

6

5

When the country enjoys economic growth, the PPC bounds outward.

2

4

8

10

14

16

0 1 2 3

When the country is struck by natural disasters, economic growth will decline and the PPC will shift to the left.

Factors that Influence the Shift of PPC1. Economic Growth

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Factors that Influence the Shift of PPC2. Improvements in Technology

Sewing Machine

Butter

12

4

6

5

Technology increases the production of sewing machine.

2

4

8

10

14

16

0 1 2 3

Technology increases the production of butter.

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Sewing Machine

Butter

12

4

6

5

Increase in population

2

4

8

10

14

16

0 1 2 3

Decrease in population

Factors that Influence the Shift of PPC3. Population

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Sewing Machine

Butter

12

4

6

5

2

4

8

10

14

16

0 1 2 3

Increasing Opportunity Cost

Shape of PPC

PPC IS CONCAVE

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Sewing Machine

Butter

12

4

6

5

2

4

8

10

14

16

0 1 2 3

Shape of PPC (cont.)

PPC IS CONVEX

Decreasing Opportunity Cost

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Sewing Machine

Butter

12

4

6

5

2

4

8

10

14

16

0 1 2 3

Shape of PPC (cont.)

PPC IS LINEAR

Constant Opportunity Cost

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CAPITALISMCAPITALISM SOCIALISMSOCIALISMMIXED

ECONOMYMIXED

ECONOMY

ECONOMIC SYSTEM

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CAPITALISM An economic system where individuals and sellers make

economic decisions using a price system

CHARACTERISTICS

MERITS AND DEMERITS

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CHARACTERISTICS

1. Private ownership of resources

2. Freedom of enterprise and choice

3. Consumers’ sovereignty

4. Competition

5. Government intervention

6. Price system

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MERITS DEMERITS Production according to

consumers’ needs Economic freedom Efficient utilization of

resources Variety of consumer

goods Enhanced trade, business

and R&D Automatic incentives Flexibility

Inequality of distribution of wealth and income

Inflation and high unemployment rate

Lack of social welfare Wasteful competition Misallocation of

resources Social cost

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SOCIALISM An economic system where all the economic decisions are

made by the government or a central authority

CHARACTERISTICS

MERITS AND DEMERITS

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CHARACTERISTICS

1. Public ownership of resources

2. Central planning authority

3. Price mechanism of lesser importance

4. Central control and ownership

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MERITS DEMERITS

Production according to basic need

Equal distribution of income and wealth

Better allocation of resources

No serious unemployment or inflation

Rapid economic development

Social welfare

Lack of incentives and initiative by individuals

Loss of economic freedom and consumer sovereignty

Absence of competition Waste of economic

resources

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MIXED ECONOMY An economic system which combines both capitalism and

socialism

CHARACTERISTICS

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CHARACTERISTICS

1. Public and private ownership of resources

2. Price mechanism and economic plans in making decisions

3. Government helps to control income disparity

4. Government intervention in the economy

5. Co-operation between the government, public and business sectors

6. Government control of monopolies

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