Dilla University

Department of Economics

Introduction to Economics
Tamirat M.
 Chapter One
Introduction

 Have you ever heard anything about Economics? Yes!!! It is

obvious you heard about economics and even you talked a lot
about economics in your day to day activities.

 And you may have questions such as: What are resources?
What does efficient allocation mean? What are human needs?
What does demand mean? What is economics?

 This course will answer those questions and introduce you to

the nature of economics, demand and supply theories, theories
of consumer, production, cost, market structure and
fundamental concepts of macroeconomics at large.
1.1 Definition
 Economics ofexciting
is one of the most economics
disciplines in social
sciences.
 The word economy comes from the Greek phrase ―one
who manages a household.
 There is no universally accepted definition of economics
(its definition is controversial). This is because different
economists defined economics from different
perspectives:
a) Wealth definition,
b) Welfare definition,
c) Scarcity definition, and
d) Growth definition
Cont…..
 Hence, its definition varies as the nature and scope
of the subject grow over time. But, the formal and
commonly accepted definition is as follow.

 Economics is a social science which studies about

efficient allocation of scarce resources so as to attain
the maximum fulfillment of unlimited human needs.

 As economics is a science of choice, it studies how

people choose to use scarce or limited productive
resources (land, labour, equipment, technical
knowledge and the like) to produce various
commodities.
 Cont…..
 The following statements are derived from the
above definition.
 Economics studies about scarce resources;
 It studies about allocation of resources;
 Allocation should be efficient;
 Human needs are unlimited
 The aim (objective) of economics is to study
how to satisfy the unlimited human needs up to
the maximum possible degree by allocating the
resources efficiently.
1.2 The rationales of economics
There are two fundamental facts that provide the
foundation for the field of economics.
1) Human (society‘s) material wants are unlimited.
2) Economic resources are limited (scarce).

 The basic economic problem is about scarcity and

choice since there are only limited amount of
resources available to produce the unlimited amount
of goods and services we desire. Thus, economics is
the study of how human beings make choices to use
scarce resources as they seek to satisfy their
unlimited wants.
 Therefore, choice is at the heart of all decision-
making.
1.3 Scope and method of analysis in
economics
1.3.1 Scope of economics

 The core of modern economics is formed by its two

major branches: microeconomics and
macroeconomics. That means economics can be
analyzed at micro and macro level.
A. Microeconomics is concerned with the economic
behavior of individual decision making units such as
households, firms, markets and industries.

 In other words, it deals with how households and

firms make decisions and how they interact in
specific markets.
Cont…

B. Macroeconomics is a branch of economics that deals

with the effects and consequences of the aggregate
behavior of all decision making units in a certain
economy.

 In other words, it is an aggregative economics that

examines the interrelations among various aggregates,
their determination and the causes of fluctuations in
them.
 It looks at the economy as a whole and discusses about
the economy-wide phenomena.
 Cont…
Microeconomics Macroeconomics
 Studies individual economic units of an  Studies an economy as a whole and its
economy. aggregates.
 Deals with individual income, individual  Deals with national income and output
prices, individual outputs, etc. and general price level

 Its central problem is price determination  Its central problem is determination of

and allocation of resources. level of national income and employment.

 Its main tools are the demand and supply of  Its main tools are aggregate demand and
particular commodities and factors. aggregate supply of an economy as a
whole.

 It helps to solve the central problem of what,  Helps to solve the central problem of
how and for whom to produce‘ in an full employment of resources in the
economy so as to maximize profits economy.‘

Examples: Individual income, individual Examples: national income, national

savings, individual prices, an individual firm‘s savings, general price level, national output,
output, individual consumption, etc. aggregate consumption, etc.
Method of analysis in economics
1.3.2 Positive and normative analysis
Economics can be analyzed from two perspectives:
positive economics and normative economics.

A) Positive economics: it is concerned with analysis of

facts and attempts to describe the world as it is. It tries
to answer the questions what was; what is; or what will
be? It does not judge a system as good or bad, better or
worse.
Example:
 The current inflation rate in Ethiopia is 12 percent.
 Poverty and unemployment are the biggest problems
in Ethiopia.
Cont…
B) Normative economics: It deals with the questions like,
what ought to be? Or what the economy should be?

 Normative analysis is a matter of opinion (subjective

in nature) which cannot be proved or rejected with
reference to facts.
Example:
 There is a need for intervention of government in the
economy.
· Females ought to be given job opportunities.

 Any disagreement on a normative statement can be

solved by voting.
1.3.3 Inductive and deductive reasoning in
economics
 The fundamental objective of economics, like any
science, is the establishment of valid generalizations
about certain aspects of human behaviour.

 Those generalizations are known as theories.

 A theory is a simplified picture of reality. Economic

theory provides the basis for economic analysis which
uses logical reasoning.
 There are two methods of logical reasoning: inductive
and deductive.
 Cont…
 Inductive reasoning is a logical method of reaching at
a correct general statement or theory based on several
independent and specific correct statements.

 In short, it is the process of deriving a principle or

theory by moving from facts to theories and from
particular to general economic analysis.

 Deductive reasoning is a logical way of arriving at a particular

or specific correct statement starting from a correct general
statement.
1.4 Scarcity, choice, opportunity cost and
production possibilities frontier
1. Scarcity
The fundamental economic problem that any human
society faces is the problem of scarcity.
 Scarcity refers to the fact that all economic resources
that a society needs to produce goods and services
are finite or limited in supply

 Thus, the term scarcity reflects the imbalance

between our wants and the means to satisfy those
wants.
Cont…
Free resources: A resource is said to be free if the amount
available to a society is greater than the amount people
desire at zero price. E.g. sunshine
Scarce (economic) resources: A resource is said to be
scarce or economic resource when the amount available to
a society is less than what people want to have at zero
price.
Cont…

Economic resources are usually classified into four categories.

 Labour: refers to the physical as well as mental efforts of human
beings in the production and distribution of goods and services.
The reward for labour is called wage.

 Land: refers to the natural resources or all the free gifts of nature
usable in the production of goods and services. The reward for the
services of land is known as rent.

 Capital: refers to all the manufactured inputs that can be used to

produce other goods and services. Example: equipment,
machinery, transport and communication facilities, etc.
The reward for the services of capital is called interest.
 Cont…
 Entrepreneurship: refers to a special type of human talent that
helps to organize and manage other factors of production to
produce goods and services and takes risk of making loses. The
reward for entrepreneurship is called profit.
Note: Scarcity does not mean shortage.

2. Choice
If resources are scarce, then output will be limited. If
output is limited, then we cannot satisfy all of our wants.
Thus, choice must be made.
 Cont….
 In short, scarcity implies choice. Choice, in turn,
implies cost. That means whenever choice is made, an
alternative opportunity is sacrificed. This cost is known
as opportunity cost.

 Scarcity → limited resource → limited output → we might not

satisfy all our wants →choice involves costs → opportunity cost

3. Opportunity cost
Definition: Opportunity cost is the amount or value of the next best
alternative that must be sacrificed (forgone) in order to obtain one
more unit of a product.
Opportunity = The amount of the good scarified
The amount of the good gained
 4.Production Possibility Frontier(PPF)

PPF is a graph that shows the various combinations of
output that the economy can possibly produce given the
available factors of production and the available production
technology

Assumptions about the PPC/PPF

i. Efficiency
ii. Fixed resource
iii.Two products
iv. Fixed technology
Gizaw G.
08/08/2021 19
 Cont…..
Suppose a hypothetical economy produces Computer and
Car given its limited resources and
available technology (table 1.1).
Type of Product Unit Production possibilities

A B C D E

Qty of computer No. 3000 2200 2000 1000 0

Qty of Car No. 0 300 600 700 1000

Cont……
Cont…
All points on the PPF are attainable and efficient
-
- Point B is attainable but inefficient
- Point D is unattainable

Opportunity = The amount of the good scarified

The amount of the good gained
Example: Referring to table 1.1 above, if the
economy is initially operating at point C, what is
the opportunity cost of producing one more unit
of car?
Solution: Moving from production alternative C
to A we have:
 Cont…
Economic Growth and the PPF 
•Economic growth or an increase in the total
output level occurs when one or both of the
following
•
conditions occur.
 
1.Increase in the quantity or/and quality of
economic resources.
2. Advances in technology.
 Cont…
Figure 2
 Cont…
A change in technology can be symmetrical or
asymmetrical
 If the change is in one sector =>Asymmetrical
 If the change is in both sectors =>symmetrical
The Basic Economic Questions
Economic problems faced by an economic system
due to scarcity of resources are known as basic
economic problems.
1. What to Produce?
This problem is also known as the problem of
allocation of resources (selecting the good) . It implies
that every economy must decide which goods and in
what quantities are to be produced.
2. How to Produce?
This problem is also known as the problem of choice of
technique.
3. For Whom to Produce?
This problem is also known as the problem of
distribution of national product.
1.6 Economic systems
Economic system
 Is a set of organizational and institutional
arrangements
 There are three types of economic systems
a. Pure capitalism
b. Command economy
c. Mixed economy
 A. Pure capitalism
The private ownership of resources and the use of
markets and prices to coordinate and direct
economic activity characterize the market system, or
capitalism.

 In this system each participant acts in his or her

own self-interest; each individual or business seeks
to maximize its satisfaction or profit through its own
decisions regarding consumption or production
 B. Command Economic System
The alternative to the market system is the command system,
also known as socialism or communism.

In this system, the government owns most property resources and
economic decision making occurs through a central economic
plan.

 A central planning board appointed by the government makes

nearly all the major decisions concerning the use of resources,
the composition and distribution of output, and the organization
of production
 C. Mixed Economic Systems
The mixed economic system takes the strong
elements of the two economic systems
1.7 Decision making units and the circular flow model

• There are three decision making units in a closed

economy. These are households, firms and the
government.
i) Household: A household can be one person or
more who live under one roof and make joint
financial decisions.
 Households make two decisions.
a) Selling of their resources, and
b) Buying of goods and services.
 Cont….
ii) Firm: A firm is a production unit that uses
economic resources to produce goods and
services. Firms also make two decisions:
a) Buying of economic resources
b) Selling of their products.
iii) Government: A government is an organization
that has legal and political power to control or
influence households, firms and markets.
Government also provides some types of goods
and services known as public goods and services
for the society.
 Cont…
The three economic agents interact in two markets:
 Product market: it is a market where goods and
services are transacted/ exchanged.
That is, a market where households and governments buy
goods and services from business firms.

 Factor market (input market): it is a market where

economic units transact/exchange factors of
production (inputs).

In this market, owners of resources (households) sell

their resources to business firms and governments.
 CIRCULAR FLOW OF ECONOMIC
ACTIVITY(TWO SECTOR MODEL)

HOUSEHOLDS FIRMS
 CIRCULAR FLOW OF ECONOMIC
ACTIVITY
PAYMENTS FOR GOODS AND SERVICES

HOUSEHOLDS FIRMS
 CIRCULAR FLOW OF ECONOMIC
ACTIVITY
PAYMENTS FOR GOODS AND SERVICES:
FIRMS’ REVENUE

HOUSEHOLDS FIRMS

WAGES, SALARIES,PROFITS,& RENT:

FIRMS’ COSTS OR FACTOR PAYMENTS
CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS AND SERVICES:
FIRMS’ REVENUE

LABOR,CAPITAL,LAND &
ENTREPRENEURSHIP
HOUSEHOLDS FIRMS

WAGES, SALARIES,PROFITS,& RENT:

FIRMS’ COSTS OR FACTOR PAYMENTS
CIRCULAR FLOW OF ECONOMIC ACTIVITY
PAYMENTS FOR GOODS& SERVICES:
FIRMS’ REVENUE
Goods Market

LABOR,CAPITAL,LAND &
ENTREPRENEURIALSHIP
HOUSEHOLDS FIRMS

WAGES , SALARIES,PROFITS,& RENT:

FIRMS’ COSTS
Factor Market

REAL GOODS & SERVICES

 CIRCULAR FLOW OF ECONOMIC
ACTIVITY(THREE SECTOR MODEL)
PAYMENTS FOR GOODS& SERVICES:
FIRMS’ REVENUE

LABOR,CAPITAL,LAND &
ENTREPRENEURIALSHIP
HOUSEHOLDS FIRMS

REAL GOODS & SERVICES

WAGES, SALARIES,PROFITS,& RENT:

FIRMS’ COSTS OR FACTOR PAYMENTS
SUBSIDIES SUBSIDIES

GOV’T TAXES

TAXES Talef S.
End of Chapter one