Chapter-ONE

Introduction of Economics
 There are two fundamental facts that
The provide the foundation for the field of
rationales economics.
1) Human (society‘s) material wants are
of unlimited.
economics 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.
 Basic themes
1. Scarcity and Choice
The condition in which wants are forever greater
than the available supply of time, goods, and
resources.

Scarcity exists simply because it is human nature for

people to want more than they can have, which
forces people to make choices.
 Opportunity costs and efficiency

➢ Efficiency denotes the most effective use of a

society’s resources in satisfying people’s wants
and needs.

➢ Economic efficiency requires that an economy

produces the highest combination of quantity
and quality of goods and services given its
technology and scarce resources.
 Opportunity costs
Opportunity costs

➢ In a world of scarcity, choosing one thing means giving up

something else. The opportunity cost of a choice is the value of the
best alternative given up.
▪ Opportunity cost is money or benefits lost by not selecting a
particular option during the decision-making process.
 When economists refer to the “opportunity cost” of a resource,
they mean the value of the next-highest-valued alternative use of
that resource. If, for example, you spend time and money going to
a movie, you cannot spend that time at home reading a book, and
you can't spend the money on something else.
Scarcity, choice, opportunity cost and
production possibilities frontier

1 2 3
1. Scarcity The fundamental 2. Choice If resources are scarce, 3. Opportunity cost: Opportunity
economic problem that any then output will be limited. If output cost is the amount or value of the
human society faces is the is limited, then we cannot satisfy all next best alternative that must
problem of scarcity. Scarcity of our wants. Thus, choice must be be sacrificed (forgone) in order to
refers to the fact that all made. Due to the problem of scarcity, obtain one more unit of a
economic resources that a society individuals, firms and government are product. For example, suppose
needs to produce goods and forced to choose as to what output to the country spends all of its
services are finite or limited in produce, in what quantity, and what limited resources on the
supply. But their being limited output not to produce. In short, production of cloth or computer.
should be expressed in relation to scarcity implies choice. Choice, in If a given amount of resources
human wants. Thus, the term turn, implies cost. That means can produce either one meter of
scarcity reflects the imbalance whenever choice is made, an cloth or 20 units of computer,
between our wants and the means alternative opportunity is sacrificed. then the cost of one meter of
to satisfy those wants. This cost is known as opportunity cloth is the 20 units of computer
cost. that must be sacrificed in order
to produce a meter of cloth.
The Production Possibilities Frontier or Curve (PPF/ PPC)

To draw the PPF we need the following assumptions.

The Production
Possibilities Frontier a. The quantity as well as quality of economic
resource available for use during the year is fixed.
(PPF) is a graph that
shows all the different b. There are two broad classes of output to be
combinations of produced over the year.
output of two goods c. The economy is operating at full employment and
that can be produced is achieving full production (efficiency).
using available d. Technology does not change during the year.
resources and e. Some inputs are better adapted to the production
technology. of one good than to the production of the other
(specialization).
 Definition of Economics
❖ The English term ‘Economics’ is derived from the Greek word ‘Oikonomia’.
Its meaning is ‘household management’. Economics was first read in ancient
Greece.

❖ Aristotle, the Greek Philosopher termed Economics as a science of

‘household management’. But with the change of time and progress of
civilization, the economic condition of man changes.

❖ As a result, an evolutionary change in the definition of Economics is noticed.

Economics is the branch of knowledge concerned with the production,
consumption, and transfer of wealth.

❖ We can also say that the study of how individuals, governments, business,
and other organizations make choices that affect the allocation and
distribution of scarce resources is called economics.
 Definition of Economics
With time the definition changes since the scope of economics increases. For a better idea, from three
different periods of time, we can define economics

 Classical definition:
 Towards the end of the eighteenth century Adam Smith, the celebrated English Economist and the
father of Economics, termed Economics as the ‘Science of Wealth’. According to him, “Economics is a
science that enquires into the nature and causes of the wealth of nations”.

 Neo-Classical definition:
According to Alfred Marshall, ‘‘Economics is a study of mankind in the ordinary business of life”. In
other words, according to Marshall, Economics studies not only the wealth but also the activities centering
the wealth. That is economics in one side a study of wealth and on the other and most important side, a
part of the study of man.
 Definition of Economics
 Modern definition: According to Lionel Robins

In modern times more realistic definitions have been given to

economics. In social life human wants are unlimited, but the
means to satisfy those wants are scarce. Economics studies how
to use limited resources to satisfy the unlimited wants of men. In
the words of Lionel Robbins, the modem economist, ‘Economics
is a science which studies human behavior as the relationship
between ends and scarce means which have alternatives uses.

 Ends means unlimited wants

 Scarce means indicate limited resources to fulfill the wants and
 Alternative uses indicate various types of uses of the same resource.
 Subfields of Economics- Microeconomics and
Macroeconomics

Microeconomics Macroeconomics
1. It is the study of individual economic units of an economy. It is the study of the economy as a whole.

2. It deals with Individual Income, Individual prices, Individual It deals with aggregates like national income, general
output, etc. price level, national output, etc

3. Its main tools are the demand and supply of a particular Its main tools are aggregate demand and aggregate
commodity/factor. supply of the economy as a whole.

5. It helps to solve the central problem of ‘what, how and for It helps to solve the central problem of the full
whom’ to produce. employment of resources in the economy.

6. It discusses how the equilibrium of a consumer, a producer or It is concerned with the determination of the
an Industry is attained. equilibrium level of income and employment of the
economy.

7. Examples are Individual Income, Individual savings, price Examples are National Income, national savings,
determination of a commodity, individual firm’s output, general price level, aggregate demand, aggregate
consumer’s equilibrium, etc. supply, poverty, unemployment, etc.
Positive and normative analysis

Positive economics: it is concerned

with analysis of facts and attempts to
describe the world as it is. It tries to • Example: The current inflation rate in Ethiopia is 12 percent.
answer the questions what was; what • Poverty and unemployment are the biggest problems in Ethiopia.
is; or what will be? It does not judge a • The life expectancy at birth in Ethiopia is rising.
system as good or bad, better or
worse.
Normative economics: It deals with
the questions like, what ought to
be? Or what the economy should be?
It evaluates the desirability of
alternative outcomes based on one‘s
value judgments about what is good • Example:
or what is bad. In this situation • The poor should pay no taxes.
since normative economics is loaded • There is a need for intervention of government in the economy.
with judgments, what is good for • Females ought to be given job opportunities
one may not be the case for the
other. Normative analysis is a matter
of opinion (subjective in nature)
which cannot be proved or rejected
with reference to facts.
Ten Principle of Economics
Three Central Economic Problems

1. What to Produce and in What Quantities?

2. How to Produce these Goods?

3. For whom to Produce?

Problem # 1. What to Produce and in
What Quantities?

 The first central problem of an economy is to decide what goods and

services are to be produced and in what quantities. This involves
allocation of scarce resources in relation to the composition of total
output in the economy. Since resources are scarce, the society has to
decide about the goods to be produced.
 Suppose the economy produces capital goods and consumer goods. In deciding
the total output of the economy, the society has to choose that combination of
capital goods and consumer goods which is in keeping with its resources.
Explanation with the help of production possibility
curve

❑ It cannot choose the combination R which is inside the

production possibility curve PP1 because it reflects
economic inefficiency of the system in the form of
unemployment of resources.
❑ Nor can it choose the combination K which is outside
the current production possibilities of the society. The
society lacks the resources to produce this combination
of capital goods and consumer goods.

❑ It will, therefore, have to choose among the

combinations В or D which give the highest level of
satisfaction. If the society decides to have more capital
goods, it will choose combination B; and if it wants
more consumer goods, it will choose combination D
Problem # 2. How to Produce these
Goods?
 The next basic problem of an economy is to decide about the techniques or methods to be
used in order to produce the required goods. This problem is primarily dependent upon the
availability of resources within the economy.

 For example, precisely how much land, labor, and capital should be used to produce consumer goods
such as computers and motor cars?

 Two techniques of production by using the factors of production are:

1. Labor intensive technique and
2. Capital intensive technique
Problem # 3. For whom to Produce?

 Goods and services produced in the economy are consumed by its citizens. The
individuals may belong to the economically weaker section or rich class of people. This
is the problem of distribution.

 For whom to produce deals with the way that the output is distributed among the
members of society. Those individuals who possess the most valued skills or own a
greater amount of other resources will receive higher incomes and will able to pay and
coax firms to produce more of the commodities they want.

 Their greater monetary ‘Votes’ enables them to satisfy more of their wants. For
example, Society produces more goods and services for the average physician than for
the average clerk because the former has a much greater income than the latter.
  There are three decision making units in a
closed economy. These are households, firms
and the government.
Decision  i) Household: A household can be one person
or more who live under one roof and make
making units joint financial decisions. Households make two
decisions. a) Selling of their resources, and b)
and the Buying of goods and services.

circular flow  ii) Firm: A firm is a production unit that uses

economic resources to produce goods and
model 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.
Two
Sector
Economy
Three
Sector
Economy
The relation between engineering & economics
❖ Economics and Engineering
 From the definition of economics, we know that economics is a social science that studies the
production, distribution and consumption of wealth. It also discusses the effects of scarcity, the science
of choice, human behavior etc. Now, the question is, as a student of engineering field, why you are
studying economics?

 Economics helps us in understanding the economic terms and conditions which is needed in day-to-
day life. In our personal as well as professional life we get helps from economics. Because it is important
to know about the production and development process of an organization, current knowledge of
software market, industrial policy, national budget, etc. All these are discussed in Economics.

 As a student of --------department studying Economics will help us in financial strategic planning and
decision making in organizational planning as well as in day-to-day life.
continued____
 Economics and Engineering with Example:
 Economics is important for everyone in all domains. Taking into consideration engineering as a domain, all of an
engineer’s activities are towards cost and justification of how a project goes about. Engineers with a good sense of
economics can not only plan execution accordingly but execute the project with the least financial effort. This is critical
especially when you have limited financial resources.
 Economics does not always mean dealing with taxes, accounts and lots of numbers. It ultimately means understanding
science behind time and effort calculations, approach towards pricing, understanding terms like man-hours and its
implications etc.

 Software engineer get a lot of requests from the customers to build a system or software for their daily usage.
Software engineers have to build that software for the customers so they have to know the requirements of the system and
how much time will take to complete the project they choose. After taking on a project if they don’t have a basic
knowledge of Economics then the effort, they put in their work may not be fruitful. If they took on a project and the
estimated budget is not enough for the project then it will not be complete and the customer will not get his software. So,
to estimate the budget of their project, Software engineer need to have basic knowledge of economics. That’s why they
have to learn Economics too.

 Note: Just change the underlined yellow section according to your field of interest as well as example of software if
its not related to your field of study.
Beside the above explanation, we can
explain in short way-
 Finally Why do we study economics?

Thereare four main reasons to study

economics:
• to learn a way of thinking,
• to understand society,
• to understand global affairs, and
• to be an informed voter/Citizens