Introduction to economics

INTRODUCTION TO ECONOMICS
Economics is the science which studies human behavior as a relationship between ends (wants) and
scarce means which have alternative uses”

The study of how human beings strive to satisfy their endless wants with the limited resources
available.

BASIC ECONOMIC CONCEPTS

Resources
These are things which are combined in numerous ways to produce goods and services required for
the satisfaction of human wants. Such things are alternatively referred to as factors of production, and
can be classified as:
(i) Natural resources: all free gifts of nature such as arable land, water, minerals (such as
limestone, good etc), fishing ground, forests, hydroelectricity, solar energy potentials etc.
Natural resources are collectively referred to as land in economics.
(ii) Human resources: human efforts in the production process which consist of various mental
and physical ability and skills. The term labour is used for human resources.
(iii) Capital: man-made resources such as roads, dams, buildings, equipment and machines which
help in the production of other goods that satisfy human wants directly or indirectly.
(iv) Enterprise: the person (in case of one-man business) or the business owners/managers who
co-ordinate the other factors of production to produce and market goods and services and
possibly invent and innovate.

Rational Behaviour
As used in economics, behaviour in which economic agents i.e. individuals, firms and government do
the best they can under given circumstances. For example, the assumption of consumer rationality
implies that the average consumer in his purchasing decision will always prefer more to less, or the
basket of goods that will give him the maximum utility given his money income and the unit prices
of the goods. The assumption of rationality permits us to explain and predict how people will act
under specific conditions.

Wants
Refers to human desires which are naturally too numerous

Characretstics of human wants

 They are unlimited
 They are competitive in nature
 They vary in urgency and intensity
 They are complementary
 They are recurring-are felt again and again
Types of human wants
Basic human wants
Also called primary human wants e.g. food, clothing and shelter.
Secondary human wants
Are human wants we can do without: however they provide comfort,leasure and prestige eg expensive
phones.
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 Introduction to economics

Means
Refers to the resources which enable one to meet his/her wants or needs .The means to satisfy these
wants are called economic resources and they are scarce E.g. money, time etc
Ceteris paribus
Is an italic expression which means all other thing remaining constant In order to examine the effect of
price on demand we hold other factors influencing demand constant e.g. level of income, tastes etc.

MICROECONOMICS AND MACROECONOMICS

Traditionally economics is divided into two main branches: microeconomics and macroeconomics.

Microeconomics
Microeconomics is concerned with specific segments of the economy, particularly the behaviour of
individual consumer and firm and of groups of firms in industries. As a branch of economics, it
examines how resources are organised, controlled and rewarded in various economics activities, as
well as how relative prices of goods and services are determined. The main topics falling within
microeconomics include the theory of price and wage determination, the theory of consumer
bahaviour, the theory of production and welfare economics.

Macroeconomics
Macroeconomic is the study of the economy as a whole. In macroeconomics; emphasis is on
aggregate economic variables such as the economy’s level of employment, total output and income,
total money supply, overall government spending, the levels of taxes, investment and saving, and so
on. It follows that macroeconomics explores the problems of unemployment, inflation, external
disequilibrium, sluggish economic growth, general poverty and inequality in the macro economy.

BASIC ECONOMIC PROBLEMS

The fundamental economic problems facing every society are discussed in this section.
Scarcity

Is the insufficiency of economic resources or goods and services available to fully satisfy
unlimited wantshEconomic scarcity means that people do not have as much as they desire. The
problem of scarcity arises as a result of the fact that, at any point in time, the productive resources
available in any society are limited, whereas human wants are unlimited. It follows that the
amount of goods and services that can be produced are limited and inadequate to meet human
wants. Therefore, every society must resolve four fundamental economic questions.

(i) What is to be produced? Every society must determine in some manner what goods and
services and how much of each to produce during any given period of time.
(ii) How is the output to be produced? Each firm must decide how to combine the inputs to
achieve optimal resources allocation i.e. the manner of combination of factors of
production in order to produce quantum of goods and services.
(iii) For whom to produce? That is, for which category of consumer is the goods being
produced. Is it for the young, the old or for both categories?
Choice
It is the ability and freedom to select from alternatives. Choices become necessary as a result
of scarcity.Making a choice implies giving up something in order to get something else. The
concept of choice relates to all the three main economic agents in the economy.
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 Introduction to economics
 An individual consumer must choose among types of goods and services, between present
and future consumption because of his limited money income.
 The firm must choose what to produce and how to produce within constraint imposed by
its limited resources.
 The government must decide what public goods and services to provide for the people
given its limited revenue as projected in the budget documents.
Opportunity Cost
Economists used the term opportunity cost to mean the value of the next best alternative forgone
in the process of making a choice.
The opportunity cost of an action is the value of the next best foregone alternative action.
To an individual consumer, the opportunity cost of a commodity bought is the next most desirable
commodity he could have bought instead. Opportunity cost is alternatively referred to as real cost
or economics cost.

Production Possibilities Frontier (Curve)

A production possibilities curve (PPC) shows the various combinations of economic goods that
can be produced in a country when all available resources are fully and efficiently utilized.

The PPC in Figure 1.1 is drawn under the assumption that the society is using all its resources to
produce only two goods – Good Y and Good X. Fig 1.1 illustrates points (i

Good Y

G
A
B

C
PPC
F

0 Good X
Figure 1.1 PPC

What it shows:

(i) Scarcity. The boundary formed by the curve joining points A and D indicates that there is
limit to the amount of both rice and beans, the country can produce, at any point in time, with
available resources and technology.
(ii) Full – employment. Any point on the PPC (such as A to D) shows the combinations of the
two goods that the economy can produce given that all available resources are fully and
efficiently utilized.
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 Introduction to economics
(iii) Unemployment or underemployment. Any point inside the PPC, such as F. Shows that
some resources are either left completely idle (unemployed) or are not efficiently utilized
(underemployed).
(iv) Unattainable output level. Any point outside the curve, such as G, shows the output level
that cannot be achieved by the country.
(v) Opportunity cost. The slope of the PPC usually referred to as marginal rate of transformation
(MRT) measures the opportunities cost of a unit more or less of a commodity (Figure 1.2)
(vi) Economic growth. It can be defined as a sustained increase in the production capacity of an
economy which leads to a greater output of goods and services. This is represented by an
outward shift in the production possibilities curve from PPC 1 to PPC2 in Figure 1.3.

WEALTH

 Wealth is the total value of assets, including tangible, intangible, and financial, held and
controlled by an individual, household, business, organization, or nation. It is one of the most
crucial criteria for separating and comparing the rich and poor in society.
 It comprises the possession of limited economic resources, items, money, or anything of value at
any one time but excludes debts or liabilities.
 Net worth indicates that the individual, entity, or country in question is earning or capable of
generating income from many sources.

It considers the net value of personal assets (such as a house), savings, or capital assets (e.g., securities).
The four categories of wealth in economics are financial, social, time, and health

Economic welfare

Definition of economic welfare: The level of prosperity and quality of living standards in an
economy. Economic welfare can be measured through a variety of factors such as GDP and other
indicators which reflect the welfare of the population (such as literacy, number of doctors, levels of
pollution e.t.c)

Factors influencing economic welfare

1. Real income – influencing potential consumption

2. Employment prospects – unemployment significant cost
3. Job satisfaction – satisfaction at work as important as income and wage
4. Housing – High income but unaffordable housing diminishes economic welfare. Good,
cheap housing essential to economic welfare
5. Education – opportunities to study through lifetime, influence welfare
6. Life expectancy and quality of life – access to healthcare, also are lifestyles healthy, e.g.
levels of obesity/smoking rates
7. Happiness levels – normative judgements on whether people are happy.
8. Environment – economic growth can cause increased pollution, which damages health
and living standards.
9. Leisure time – high wages due to working very long hours diminishes economic welfare.
Leisure has economic value.
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 Introduction to economics

Scope of economics
The study of economics is divided into two:

Macroeconomics
This is the study of the behavior of the economy are a whole whereby the relationship is considered
between broad economic aggregates such as national income, employment and prices.
Study of aggregate economic activities in an economy

Macroeconomics deals with:

 Total output of goods and services

 Total employment and unemployment level
 General price level/inflation
 Balance of payment level / external balance
 Exchange rate

Microeconomics
This is the study of the behaviour of individual economic units such as consumers, owners of land,
business forms, workers, investors etc.
The aim of micro economics is to explain the determinant of the prices and quantities of individual goods
and services.
It also considers the impact of government regulation and taxation on individual markets.
It is also called price theory

ECONOMIC SYSTEMS
An economic systems describes the mechanisms by which scarce resources are allocated in society, both
for production and distribution, the nature of the relationship between the individual and society and the
role of government in allocation of resources and the direction of economic activity (Donnelly, 1991).

Types of Economic System

The three main types of economic system – capitalism, socialism and mixed economy are explained in
this section.
Capitalism
This type of economic system, otherwise called free market, free enterprise or laissez – faire economy
is based on private ownership and the freedom of individuals and firms to conduct their economic
activities without interference from the government.

Features
The main features of capitalism are:
 Private property individuals have the right to own or dispose off their property as they may
consider it fit.
 Freedom of choice and enterprise Individuals have the right to buy or hire economic resources,
organize them for production purpose and sell them in the market of their choice.
 Self interest in the pursuant of personal goals. The individuals are free to do as they wish and
have the motive of economic activity in self-interest.
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 Introduction to economics
 Competition There is a large number of buyers and sellers such that each buyer and seller
accounts for but is insignificant to influence the supply and demand and hence prices.
 Reliance on price mechanism. This is an elaborate system of commerce in which numerous
choices of consumers and producers are aggregated and balanced against each other. The
interaction of demand and supply determine prices.
 No government intervention hence no price controls, taxes and subsidies.
 There is excessive advertising.
(a) Advantages
 There is the matching of demand and supply. Production takes place in response to demand hence
a balance between what is produced and consumed. No wastage.
 There is flexibility of the market in responding to changes in demand and supply conditions thus
variety products are offered.
 There are no resources wasted in planning as no planning is required
 Consumer sovereignty and competition gives rise to a wide variety of goods and services giving
consumers a wide range to choice from.
 Higher rates of economic growth due to the incentive available for hard work which is motivated
profits.
 No wastage of resources on unrealistic projects because investment decision are based on profits.
 The costs associated with government bureaucracy are highly reducing encouraging
entrepreneurship in the economy.
 Better quality products are produced due to innovation and inventions
 Intensive innovation and invention is prevalent due to competition.
(c) Disadvantages
 . Income inequality the ability of some people and firms to acquire excessive market power leads
to greater inequality in income and wealth.
 There is likelihood of developing Monopoly powers where one firm controls the production and
distribution of commodities.
 The price mechanism on its own cannot allocate resources to production of public goods e.g.
schools, security etc.
 Instability in economy and unemployment. This is due to trade cycle i.e. recession, depression,
recovery and boom.
 The inability to deal with structural changes caused wars, natural calamities among others.
 Inadequate provision of merit goods. Merit goods are goods of importance to the community
such as health, education, security among others
 Due to excessive advertising consumers are likely to make irrational choices at the expense of
moral life/health
 Over-exploitation of resources
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 Introduction to economics

Socialism /command or centrally planned

It is otherwise referred to as the command or centrally planned economy. The economies of former
Soviet Union, Cuba, a number of Eastern European countries and China are often cited as ready examples.
 Leadership and control of economies. All important means of production (resources) are publicly
owned such as land, power generation, housing among others.
 Rationing of certain commodities if supply of such fall below demand.
 Existence of production targets for different sectors of the economy. The government determines
how resources are allocated through planning.
 Fixing of prices and wages
 Occasional existence of restricted labor market in which workers take up jobs assigned to them.
 Government decides what is to be produced, how it will be produced and for whom to produce.
(a) Advantages
 Avoids economic instability
 Minimize negative externalities
 Makes adequate provision of public and merit goods ie education, health and safety.
 Facilitate the shift of resources in pursuant of grand schemes such rapid industrialization
 Puts checks on monopoly power which are controlled state monopolies (Parastatals).
 Ensures there is full employment.
 Low inflation rate is being experienced.
 Minimum waste of resources.
 Minimum inequalities of wealth and income
 Easier government control.

(b) Disadvantages
 There is wastage of resources in production because consumers demand is judged in advance
without the use of price mechanism.
 The cost of gathering information for planning is expensive to the state.
 There is no individual incentives and initiative for hard work and innovation.
 The power of consumer sovereignty is curtailed.
 There is no incentive for hard work and this discourages the suppliers
 Some resources may end up being underutilized
 Difficulty in estimating demand due to different time frames i.e. Decembers and end month and
sometimes during certain occasions such as valentine demand tends to rise.

Mixed Economy
It is an economic system which combines features of both capitalism and socialism. In a mixed economy
therefore, there exist private and public ownership of productive resources. In those areas where the
private individuals and firms are dominant, allocation and distribution of resources is done by price –
mechanism. But in those activities reserved for the government, central planning and administrative fiat
decisions are used to solve fundamental questions on allocation and distribution of resources, goods and
services. The state intervention, however, is considered necessary to remedy the defects of the market
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 Introduction to economics
economy earlier identified. In the real – world, all economics are mixed, but the extent to which one
mixed economy differs from another depends largely on how the government interprets its role in the
economy.

Advantages

 Optimal utilization of nations resources

 Relatively wider tax base
 Consumers are protected from consumption of harmful products
 A considerable degree of consumer sovereignity.
 High quality products and services due to competition
 More equal distribution /allocation of resources.
 Relatively stable prices

Disadvantages
 Non-cooperation between the private and the public sector. In real – life, public – private
sector partnership to promote economic progress is hardly found.
 Inefficient public sector. The public sector of a mixed economy works inefficiently due to
bureaucratic control, over-staffing of the personnel, corruption and nepotism. As a result,
resources are misutilised and the level of production is low.
 Economic fluctuations. Periods of economic prosperity and hardship alternating which are
characteristic features of a capitalist economy are equally experienced in a mixed economy.
This is a result of the improper mixture of the features of capitalism and socialism.

Functions of an Economic System

All economics perform the following functions
 Allocation of Resources: Every economy has to decide what and how much good and services
to produce at any given time.
 Organisation of Production: Every economic system must decide what alternative techniques
of production are more suitable to its circumstances.
 Distribution of Goods and Services: How the goods are shared among people is determined in
every economic system.
 Economic Growth and Development: The mechanisms to grow the economy and raise average
living standard as determined in each economy.
 Economic Stability: Every economic system had mechanisms designed to control fluctuations
in the level of economic activity e.g. Using fiscal and monetary policies

Role of government.
 Checking quality of products.
 Offering government subsidies
 Offering import and export tariffs
 Ensuring price controls
 Foreign exchange market
 Taxation ensuring there is redistribution of income through a system of taxation.
 Stabilization of the economy.
 The government is able to maintain competition controlling monopoly power.

THE METHODOLOGY OF ECONOMICS

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 Introduction to economics
This section addresses how economists organize their studies to make economic science a worthwhile
field of human endeavour.
The Scientific Method
Economists adopt scientific method in their investigations of economic problems and economic
relationships. In this method, problems are identified and defined, information relevant to the problem are
collected, organized and analyzed leading to the establishment of an economic theory.
An Economic Theory
An economic theory otherwise referred to as economic law, economic principle or economic model helps
to explain human economic behaviors especially production, distribution, exchange and consumption, as
well as to predict the likely course of future events. An economic theory to a particular problem is based
on certain assumptions. The usefulness of any theory to a particular problem situation depends on how
realistic the given assumptions are.
Words, Graphs and Equations
In economic discussions, three types of language are used – verbal, graphic and mathematical.
(a) Verbal Statement: The use of words is often the easiest way to presentation. It has the advantage of
making discussions in economics available to a wide audience.
(b) Graphs: Because of their visual appeal, graphs are used as a further aid to understanding economic
discussions. Moreover, graphs provide a clear picture of the relationship between two economic variables.
(c) Equations: Complex relationships, especially three or more dimensional relations or more are
expressed in mathematical language – algebraic statement or functional relationship. However, for ease
of presentation, variables are often reduced to two so that they can be shown on graphs.

Limitation of Scientific Method in Economics

The nature of the subject matter of economics i.e. human behaviour imposes limitations in the use of
scientific method in economics. Measurements and controlled experiments, which are vital in the
physical sciences, are rarely applicable in economics because people cannot be expected to behave as
predictably as inanimate matter, which can be subject of controlled laboratory experiment.

Positive and Normative Economics

Economics analysis can be divided into two – positive economics and normative economics.

Positive economics is concerned with describing and analyzing the way things are or things will be if
certain conditions exist.
Concerned with the objective statements based on facts, circumstances and relationships in an economy.
In other words, positive economics is an objective science, which provides explanations of the working
of the economic system.

Normative economics, on the other hand, is concerned with what ought to be, particularly how
economic problems should be solved. It is a subjective science dealing with those areas of human
economic behaviour in which personal value judgments are made. Normative economics gives rise to
statements such as ‘money supply should be reduced to lower inflation rate in the economy’.

Scientific method Economics make use of scientific method to develop theories. Inquiry is generally
confined to positive questions. One of the major objectives of sciences is to develop theories. A theory is
a general or unifying principle that describes and explains the relationship between things observed in the
world around us.
The purpose of a theory is to predict and explain. The search for a theory begins whenever a regular
pattern is observed in the relationship between two or more variables and one asks why this should is so.
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 Introduction to economics
A theory refers to a hypothesis that has been successfully tested. It is important to note that economics
hypothesis is not tested realism of its assumptions but its ability to predict accurately and explain. The
following procedures are adopted in the scientific method:

i. The concepts are defined in such a way that they can be measured in order to be able to test the theory
against the facts.
ii. A hypothesis formulated..
iii. The hypothesis is then used to make predictions.
iv. The hypothesis is tested considering whether its predictions are supported facts

Concept of consumer sovereignty

This refers to the freedom of individuals and households to decide for themselves what they want to buy.
Underlying consumer sovereignty is the idea that consumer is the best judge of his or her own welfare.
The preceding idea underlies most of consumer behaviour and through it greater part of economic
analysis including pareto optimum. Consumer sovereignty is limited by the following factors.

 The nature of economic system-in general, the consumer is more sovereign in a free market oriented
system where commodities are produced in line with consumer preferences.
 The size of the consumer’s income-in general, the large the consumer’s income, the greater is the
consumer can afford to choose from a wider range of goods/services he/she can afford to buy.
 The range of goods available- different consumers has very different individual tastes and
preferences and it is difficult for the available range of goods to satisfy all consumers.
 Government intervention in providing merit goods-the fact that the government needs to intervene
to provide essential goods/services demonstrates that the complete reliance on consumer preferences
especially in market-oriented economy would lead to the under provision of certain essential goods
/services.
 The power advertising-advertising entices consumers to use products and also creates new wants.
 The existence of monopolies-monopolies often limits consumer sovereignty by providing relatively
higher priced and lower quality commodities.
 Consumer habits-individual consumers have different habits and are often reluctant to change these
habits. Thus, for example individual consumers often get attached to particular suppliers and
particular products and are reluctant to change.
 Provision of standardized goods-it is often cheaper for manufacturers to produce standardized
commodities, but in doing this consumer freedom is inevitably since there is regard for individual
tastes and preferences
 Fashion and customs-consumer behaviour is inextricably linked to the prevailing or latest trends in
society and the reluctance to contravene established conventions limits consumer freedom.

Why study Economics

1) Economics provides the underlying principles of optimal resource allocation and thus enables
individuals and firms to make economically rational decisions. Thus for example the preparation of
budgets involves knowledge of demand and elasticity analysis. The making of price policy decisions
draws heavily on the concept of elasticity in economics.
2) A study of economics enables individuals and organizations to appreciate the constraints imposed the
economic environment within which any entity operates. Thus an individual or firm is more fully enabled

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 Introduction to economics
to appreciate the implications of the annual budget considering how for example the increased
liberation of the economy will affect a particular business entity and the economy in general.
Additionally, the student of economics is able to appreciate the effects of such economic variables as
inflation, exchange rates, interest rates money supply and so on.
3) The area of development economics is fundamentally concerned with the reasons why societies
develop and means of accelerating development. It is vital for individuals as citizens to appreciate the
parameters that determine the development process so that they contribute more fully to facilitate and
contribute to solving the economic problems that characterize their society.
4) Economics is an analytical subject and its study can help develop logical reasoning which is never
superfluous.
5) It is an examinable and mandatory for students persuing business courses
6) Students appreciate the effect of economic variables e.g. inflation, exchange rate, interest rate etc on
the economy

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