Contents

[Link] of economics

[Link] of economics

1.3. Central goals of Economics

1.4. Basic Economic Problems and Alternative Economic Systems

1.5. Decision Making Units and The Circular flow of Economic Activities

1.6. Scarcity and the Production Possibility Curve

 1. Introduction

1.1. Definition of Economics

• Economics: is the study of efficient allocation of resources in
order to attain the maximum fulfillment of unlimited human
wants or needs.
• Economics: is a branch of social science which deals with
efficient utilization of scarce or limited resources to fulfill
the unlimited human wants .
wants are unlimited-because
• Wants are multiplicative, wants multiply endlessly and wants are
recurrent.
Limited resources: Economic resources like,
• Land, labor, capital, and entrepreneurial skill are limited to
produce all goods & services needed by society.
• The need to balance unlimited wants with limited
resources call for a discipline called economics.

• Or because of scarcity economic resources must be

allocated efficiently.

• To allocate economic resources efficiently the discipline

called economics has emerged

• It is about,

– the efficient use of the scarce resources . How?

– by minimizing loss so as to get the maximum possible

satisfaction.

• If there is no scarcity, no need of economizing

1.2. Branches of Economics
• Economics is categorized into two broad categories as,

– macroeconomics and

– microeconomics

• Macroeconomics: is a branch of economics which studies the

economy as a whole

• It is the study of the behavior of the economy as a whole.

• Microeconomics: It is a branch of economics which deals with

the decision making behavior of individual economic agents
such as households, business firms,
1.3. .Central aim / goal of economics

 Central aim / goal of economics

• Efficiency

• Economic Growth

• Full employment

• Price stability

• Equitable distribution of income

 1.4. Scarcity and the Production Possibility Curve

Scarcity

Limited resource + Unlimited wants = Scarcity

• Scarcity: refers to a physical condition where the quantity desired

of a particular resource exceeds the quantity available.

• Sscarcity leads to the problem of choice.

Production Possibilities Curve

• Assumptions:

– There are only two goods, consumer and capital.

– There are limited inputs and given technology of production.

– Full employment:- refers to using all the available resources.

– full production should also be realized. full production implies two kinds of
efficiency:-Productive efficiency and Allocative efficiency.
• Productive efficiency is a production of any particular mix of goods
and services in the least cost.

• Allocative efficiency:- refers to the production of that particular

mix of goods and services most wanted by the society. This is the
question of priority.

• Definition:

– The PPC shows the maximum amount of consumer and capital

goods you can produce, given the resources and technology.

– Show the different combinations of goods and services that can

be produced with a given amount of resources and technology

• PPF curve is also called transformation curve because in moving

from one point to another on it , one good is transformed in to
another , not physically but by transferring resources from one use
to another
• Table 1- production possibility table for a
hypothetical economy
Types of product Production alternatives
A B C D E
Wheat 0 1 2 3 4
(consumer good
Machinery 10 9 7 4 0
( Capital good)

• In the above table, we broadly classified the goods

produced by the economy as consumer goods and
capital or producer goods
• Fig. PPC

Capital
Goods A U
(Y)
10 B
9
C
7

4
U’

E
1 2 3 4 Consumer
Goods(X)
Production Possibilities Curve

• No ‘ideal’ point on the curve

• Any point inside the curve – suggests resources are not being
utilised efficiently

• Any point outside the curve – not attainable with the current level
of resources

Therefore.

• Points on the curve are both attainable and efficient (A, B,C,D,E)

• Points inside the curve are attainable but inefficient (U’). imply
that the economy could have more of both goods if it achieved
full employment and productive efficiency

• Points out side the curve are (U) unattainable given resources and
technology
 Opportunity Cost
• Definition – the cost expressed in terms of the next best
alternative sacrificed.
• The opportunity cost of producing an extra Xo – X1
consumer goods is Yo – Y1 capital goods in Fig. above

• If we reallocates resources (moving from A to B along

PPF).

• It can produce more consumer goods but only at the

expense of fewer capital goods. The opportunity cost of
producing an extra 0 – 1 consumer goods is 10– 9
capital goods.
• But, the more of a product which is produced, the greater is its
opportunity. This is what we call the law of increasing opportunity
cost
• The law of increasing opportunity cost states that the
opportunity cost of each additional unit of output of a good
over a period increases as more of that good is produced.

• In other words, the law states that in order to get more of

something one must give up ever increasing quantities of
something else

• This law is reflected in the shape of the PPF. The curve is

Concave, or bowed out, from the origin.

• That is, the slope of the curve gets steeper as we move down
from A to E.

• That is, negative slope of the PPF illustrates the existence of

scarcity.
 Shift in PPF
PPF can shift when there is
• Fig in
 Change in technology
Capital  Change in productivity
Goods  Increase in resources
Y1
C i.e. Economic growth

.
Yo

Xo X1 Consumer Goods
Cont.………………………………………….
 Show the shift in PPF, when
there is advancement in
technology in consumer
goods Production.
Machine  The above cases of
ry advancement in technology
(Capital are referred to as biased
Goods) technological changes.

Yo

Xo X1 Wheat(Consumer Go
• To sum up, PPF illustrates four basic concepts:

a) Scarcity of resources: - this is reflected by the negative slope of

the PPF. Moreover, points outside the curve are unattainable because
of the scarcity of resources.

b) Choice: - this is reflected in the need for the society to select

among the various attainable goods on the curve.

c) Downward slope of the PPF: - this indicates the trade-offs that

exist in the real world, i.e. opportunity cost.

d) Law of increasing opportunity cost: - this is reflected by the

concavity of the PPF.
 1.5. Basic Economic Problems and Alternative Economic Systems

Basic Economic problems

Scarcity of resources gives rise to various basic

economic problems.

• There are three basic economic problems

• These economic problems are universal

• These are,

– what,

– how and

– for whom to produce?

What to produce?

• What product in what quantity?,

• It refers to the problem of allocation of scarce resource

between their alternative uses.

• Guns or butter?

How to produce?

• It refers to the methods of production.

• It refers to techniques of production.

• It is about the choice of technology (labor intensive or

Capital intensive )

• It is about combination of factors and the particular

technique to use in producing a good or service.
For whom to produce?

• It is about the distribution of output (income) among

the society.

• Once the product is produced who will get it?

• Shall we have society in which few are rich and

majority are poor?

• It seems sharing of cake to among people constitute

the society.

• These basic Economics problems are solved

differently in different Economic Systems.
• In order to solve the basic economic problems

– economists devise policies based up on

• principles or

• theories .

• This Economic principles or theories are derived from facts.

• Observation→Theory→Data→Testing

• Economic theories/analysis are drawn from facts through

– Induction and

– Deduction

• Induction: is a movement from particular to general

On the basis of facts observed from a specific event we make

generalization for the general case

• Deduction: A movement from general to particular methods

Economic System:
Economic System: The set of Organizations and Institutions that
are established to solve the economic problems (What, How and
for whom?)
• The economic system are different from each other on the basis
of,
• The ownership of means of production
• Who coordinate or lead the economic activities
Historically four forms of economic systems are observed
• Traditional Economy
• Command Economy
• Mixed Economic System
• Free market economy system
1. Traditional Economy:

Production and distribution are coordinated by custom rule

• Technological change and innovation is constrained by tradition

• Economic activities are considered secondary to religion and

cultural values

2. Command Economy system:

 Resources are owned by the state.

 Economic activities are led by the central government.

 Social welfare is a guiding factor for economic activity

• The role of Market and competition are eliminated by law

• Freedom of choice is curbed by what the society afford for all.
• Innovation, Quality of product are problems of this system
3. Mixed Economy System: It is the hybrid of the Free and command economy
system

It supposed to combine the good elements of both economy system

4. Free market economy system

• Resources are privately owned

• The economic activities are led by invisible hand.

• Self interest is the motivating factor / guiding force to carry out

economic activities

• Freedom of choice

• Government plays limited role.

The market economy is beloved to lead to

– innovation and

– quality of products

• Public Goods, Externality, Market power are some of the problem of this
system.
1.6. Decision Making Units and The Circular flow of Economic Activities

Economic agents.
• Major economic agents (decision making units).
1. Households
2. Business Firms
3. Government
1. Households : are consumers of goods and services
• Most of them own labor, capital and some natural resources that
are rented, or sold.
 The objective of the households is to maximize their utility.
 Household play a dual role in economic activity.
o They consume goods and services (demanders)
o They supply economic resources (suppliers).
2. Business Firms
• These are producing unit of the economy

• The common objective of a firm is profit maximization

• Business Firms play a dual role

o They purchase (employ) economic resources (demanders).

o They supply final goods and services (suppliers)

3. Government

 Government assumed to play limited role in market economy

system.

 It only provide legal frame-work for proper functioning of

the market system
 Circular flow economic activities

• It studies the flow of goods and services from producers

to the consumers and how these good and services are

priced in the flow.

• It also studies the flow of economic resources and how

they are priced in the flow

• The flow of goods and services and the flow of resources

are presented by a simple flow diagram.

 Process
Rev. from Sales by Birr
Payment for Fact .Birr

services
Factor
Factor
services
(3) (2)
P P Products
Factors S S
market  Red arrow-money flow
market
PF2  Blue arrow-real flow

PF1 P1
D2 D2
D1 D1
O Q F1 Q F2 Q O Q1 Q
(1)
Factor Consu
services Goods mer
(4) deman
Factor d
supply W,I,R,P BY Birr Con. Exp. Birr