Introduction

to
Economics
Economics: Principles Problems and Policies,
Mcconnell & Brue 17th edition

Introduction to Economics, Case and Fair 12th Edition

&

Introduction to Economics, Gregory Mankiw 5th Edition

Mohsin Mushtaq Chandna

 The Scope and
Method of Economics

Chapter # 1
 Why Study Economics?

• To Learn A Way Of Thinking

• To Understand Society
• To Understand Global Affairs
• To Be An Informed Citizen
 The Scope And Method of Economics

• Economics The study of how individuals and

societies choose to use the scarce resources
that nature and previous generations have
provided.
• The key word in this definition is choose.
Economics is a behavioral, or social, science. In
large measure it is the study of how people
make choices. The choices that people make,
when added up, translate into societal choices.
• Also important is scare resources
 Scarce Resources

• The resources are scarce and therefore the

goods and services produced using these
resources are also scarce. “There is no such
thing as free lunch, some body pays for it”
• Since we use scarce resources therefore they
must be used in most productive manner i:e
Best use. Every single use means it foregoes
another possible use “Opportunity Cost” of
not going for 2nd best option
 Utility
• An economic term referring to the total
satisfaction received from consuming a good or
service in a rational manner
• It is an abstract concept rather than concrete
• Utility is hard to measure but it can be
determined indirectly with consumer behavior
• Utility increases with wealth but at a decreasing
rate.
• Marginal utility is the additional satisfaction
derived from each extra unit of consumption
 Rational Behavior
• It means same person may make different
choices under different circumstances
• Choices will vary greatly among individuals
and also change as costs and benefits
change
• Rational self interest is different from selfish
behavior.
• Choices reflect the pursuit of self interest
and are rational but they are based on
differing preferences and circumstances
 Economic Wants

• Wants are different from Needs which are

necessary for survival like food shelter
• Want is something which a person likes to
have needs have high priority wants have low
• Some foods are needs but some may be wants
as well as needs
• Ice cream is want but milk is need
 Marginal Analysis

• Economics involves lot of marginal analysis like

marginal utility, marginal cost & marginal benefits
• For instance a gain of additional utility (marginal
Utility) by consumption of one more drink is
corresponded with additional cost (Marginal Cost)
• If you consume too much of a good which means
its marginal benefits are outweighed by its
marginal costs so you are sacrificing goods which
are more valuable at the margins-the place where
we consider very last unit of each.
 Economic Methodology
• Observation of raw facts or data collection
• Formulation of a hypothesis
• Testing of Hypothesis
• Acceptance, rejection or modification of it
• Continued testing of hypothesis.
• If favorable hypothesis evolves into theory and it
is well tested and widely accepted then it leads
to law.
• The process of deriving theories and principles is
called theoretical economics
 What is Economics

a. Economics is the study of money and financial

systems.
b.Economics is the study of business.
c. Economics is a behavioral science that studies
how people make choices.
d.Economics is a natural science that studies the
resources that nature and previous generations
have provided.
 Why Study Economics?
• Three fundamental concepts:
• Opportunity cost: The best alternative that we
forgo, or give up, when we make a choice or a
decision.
• Marginalism: The process of analyzing the
additional or incremental costs or benefits arising
from a choice or decision.
• Efficient markets: No Free Lunch, A market in
which profit opportunities are eliminated almost
instantaneously.
 What is opportunity cost?
a. Opportunity cost refers to costs that cannot be avoided,
regardless of what is done in the future, because they have
already been incurred.
b. Opportunity cost is the value of what we give up by not
making the alternative choice.
c. Opportunity cost is a business concept that explains why it is
important to consider the additional cost of production, not
just the initial cost, in making production decisions.
d. Opportunity cost is a cost associated with the allocation of
abundant resources among alternative uses.
e. Opportunity cost is a monetary measure of cost that takes
into account only explicit costs, or costs that can be counted.
 Microeconomics and Macroeconomics

• Microeconomics The branch of economics that

examines the functioning of individual industries
and the behavior of individual decision-making
units—that is, business firms and households. It
looks at the individual unit, the tree.
• Macroeconomics The branch of economics that
examines the functioning of individual industries
and the behavior of individual decision-making
units—that is, business firms and households. It
looks at big picture, the forest
 Microeconomics and Macroeconomics
TABLE 1.1 Examples of Microeconomic and Macroeconomic Concerns

Divisions
Production Prices Income Employment
of Economics
Microeconomics Production/output in Price of individual Distribution of Employment by
individual industries and goods and services income and individual businesses
businesses wealth and industries

How much steel Price of medical care Wages in the auto Jobs in the steel
How much office Price of gasoline industry industry
space Food prices Minimum wage Number of employees
How many cars Apartment rents Executive salaries in a firm
Poverty Number of
accountants

Macroeconomics National Aggregate price level National income Employment and

production/output unemployment in
the economy

Total industrial output Consumer prices Total wages and Total number of jobs
Gross domestic Producer prices salaries Unemployment rate
product Rate of inflation Total corporate
Growth of output profits
 The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics
Comparative economic examines the ways alternative economic systems function. What are the advantages and
systems disadvantages of different systems?

Econometrics applies statistical techniques and data to economic problems in an effort to test
hypotheses and theories. Most schools require economics majors to take at least one
course in statistics or econometrics.

Economic development focuses on the problems of low-income countries. What can be done to promote
development in these nations? Important concerns of development economists include
population growth and control, provision for basic needs, and strategies for international
trade.

Economic history traces the development of the modern economy. What economic and political events and
scientific advances caused the Industrial Revolution? What explains the tremendous
growth and progress of post—World War II Japan? What caused the Great Depression of
the 1930s?

Economics of race and examines the role of race and gender in economic theory, in economic life, and in
gender policymaking. How has discrimination by race or gender affected the well-being of
households and the distribution of income and wealth?

Environmental economics studies the potential failure of the market system to account fully for the impacts of
production and consumption on the environment and on natural resource depletion.
Have alternative public policies and new economic institutions been effective in
correcting these potential failures?
 The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics (continued)

Finance examines the ways in which households and firms actually pay for, or finance, their
purchases. It involves the study of capital markets (including the stock and bond
markets), futures and options, capital budgeting, and asset valuation.

The history of economic which is grounded in philosophy, studies the development of economic ideas and
thought, theories over time, from Adam Smith in the eighteenth century to the works of
economists such as Thomas Malthus, Karl Marx, and John Maynard Keynes. Because
economic theory is constantly developing and changing, studying the history of ideas
helps give meaning to modern theory and puts it in perspective.

Industrial organization looks carefully at the structure and performance of industries and firms within an
economy. How do businesses compete? Who gains and who loses?
International economics studies trade flows among countries and international financial institutions. What are
the advantages and disadvantages for a country that allows its citizens to buy and sell
freely in world markets? Why is the dollar strong or weak?

Labor economics deals with the factors that determine wage rates, employment, and unemployment.
How do people decide whether to work, how much to work, and at what kind of job?
How have the roles of unions and management changed in recent years?

Law and economics analyzes the economic function of legal rules and institutions. How does the law change
the behavior of individuals and businesses? Do different liability rules make accidents
and injuries more or less likely? What are the economic costs of crime?
 Why Study Economics?
The Diverse Fields of Economics
TABLE 1.2 The Fields of Economics (continued)

Public economics examines the role of government in the economy. What are the economic functions of
government, and what should they be? How should the government finance the
services that it provides? What kinds of government programs should confront the
problems of poverty, unemployment, and pollution? What problems does government
involvement create?

Urban and regional studies the spatial arrangement of economic activity. Why do we have cities? Why are
economics manufacturing firms locating farther and farther from the center of urban areas?
 Which statement is correct?
a. The aggregate price level is a subject of concern in
microeconomics.
b. A study of employment in the semiconductor industry
would be categorized as a microeconomic study.
c. The production and growth of output in the domestic
economy is a microeconomic concern.
d. Microeconomics is an in-depth study of aggregate
economic behavior.
e. Microeconomics includes the study of fiscal and
monetary policies, or government policies designed to
steer the economy in the right direction.
 The Method of Economics
• Positive Economics An approach to economics
that seeks to understand behavior and the
operation of systems without making
judgments. It describes what exists and how it
works.

• Normative Economics An approach to

economics that analyzes outcomes of economic
behavior, evaluates them as good or bad, and
may prescribe courses of action. Also called
policy economics.
 The Method of Economics
Descriptive Economics and Economic Theory

• Descriptive Economics The compilation of data

that describe phenomena and facts.

• Economics Theory The compilation of data that

describe phenomena and facts.
 The Method of Economics
Theories and Models

• Model A formal statement of a theory, usually a

mathematical statement of a presumed
relationship between two or more variables.

• Variable A measure that can change from time

to time or from observation to observation.

• Ockham’s Razor The principle that irrelevant

detail should be cut away.
If you apply your own values to judge economic
decisions, which category of economics would
you be applying?
a. Normative economics.
b.Positive economics.
c. Descriptive economics.
d.Economic theory.
e. Empirical economics.
If you apply your own values to judge economic
decisions, which category of economics would
you be applying?
a. Normative economics.
b.Positive economics.
c. Descriptive economics.
d.Economic theory.
e. Empirical economics.
 The Method of Economics
Theories and Models
All Else Equal: Ceteris Paribus
• Ceteris Paribus, or All Else Equal A device used
to analyze the relationship between two
variables while the values of other variables are
held unchanged.
• Using the device of ceteris paribus is one
part of the process of abstraction. In
formulating economic theory, the concept
helps us simplify reality to focus on the
relationships that interest us.
Economic models are:
a. Precise representations of reality that include as many
details as possible in order to accurately predict
behavior.
b. Simplifications of reality that focus only on key
relationships and ignore less relevant details.
c. General interpretations of cause and effect.
d. Analytical interpretations of economic behavior
involving a good deal of the surrounding social and
political structure of society.
e. Devices that usually make it impossible to isolate the
impact of a single factor.
Economic models are:
a. Precise representations of reality that include as many
details as possible in order to accurately predict
behavior.
b. Simplifications of reality that focus only on key
relationships and ignore less relevant details.
c. General interpretations of cause and effect.
d. Analytical interpretations of economic behavior
involving a good deal of the surrounding social and
political structure of society.
e. Devices that usually make it impossible to isolate the
impact of a single factor.
 The Method of Economics
Theories and Models

Expressing Models in Words, Graphs, and

Equations: The most common method of
expressing the quantitative relationship
between two variables is graphing that
relationship on a two-dimensional plane.
 Graphs

• In a graph we have 2 axis, X and Y. Have u ever

thought which variable should be taken on X
and which variable u take on Y?
• Independent variable on X and Dependent on Y
• To draw a line we need two points of X
variable which have their corresponding Y
Values
 Graphs
• Now lets think about the slope of the line
• What is the Slope: Its Rise over Run
• What is the equation of the line:
• As we know the equation of the line: Y=mX+C
 Graphs

Income per week Consumption per week

$0 $ 50
100 100
200 150
300 200
400 250

So Which variable should we take on X-Axis and which

variable should we take on Y. Income is independent
variable so goes on X and Consumption is dependant
variable and hence goes on Y.
 Graphs
• So what is the slope of the line and equation of this
line
• Begin by taking 2 points say 100, 100 and 50, 0
• Rise over Run means distance between 2 vertical
points and 2 horizontal points
So 100-50
= 50/100 or 0.5
100-0
• So the slope of this line is 0.5
• Positive Slope means when X increases Y also
increases
 Graphs
• Now what is the line equation
• As I mentioned it is Y=mX+C where m=slope and
C is a constant. So lets find out the equation for
this line
• To do this we need only one point of X and Y
• So lets take 200, 150 (x, y)
• Now 150 = 0.5 * 200 + C
• Or 150 = 100 + C or
• C = 150 – 100 or C = 50 (See graph even when
X=0 the person still spends 50 and it is constant
 $400 C = 50 + .5Y

300 CONSUMPTION
CONSUMPTION (C)

e
200
d
c
100
b
a
0 100 200 300 400

INCOME (Y)
 Graphs
Relationship between ticket price & attendance

Ticket Price (in $) Attendance (in

thousands)
50 0

40 4

30 8

20 12

10 16

0 20

Now lets take Attendance on X Axis and Ticke

on Y Axis. What is Slope and Equation of the
 a P=50-2.0Q
$50

b
40

c
TICKET PRICE (P)

30

20
d

10
e
f
0 4 8 12 16 20
ATTENDANCE IN THOUSANDS (Q)
 The Economizing Problem

• Two fundamental problems

• Society’s economic wants i:e economic
wants of its citizens and institutions are
unlimited and insatiable
• Economic resources- the means of
producing goods and services- are scarce or
limited
 10 Principles of Economics
• Principle 1: people face tradeoffs. To get one thing
we give up another. There is no such thing as free
lunch. Tradeoff may be between equity and
efficiency.
• Principle 2: cost of something is what u give up to
get it: or Opportunity cost
• Principle 3: Rational people think at the margin,
they compare costs and benefits at the margins.
Marginal means a small incremental change. We will
discuss a lot about marginal costs, marginal revenue
and marginal utility etc in the course
 10 Principles of Economics
• Principle 4: People respond to incentives: they
change their decisions when marginal benefits
exceed marginal costs. When costs go up people
consume less of a good and consume more when
costs go down
• Principle 5: Trade can make every one better off.
Competition results in gains from trade as people
specialize. Trade is not like sports match where one
wins and other loses. Trade allows for specialization
and therefore allows comparative advantage.
 10 Principles of Economics
• Principle 6: Markets are a good way to organize
economic activity. Market economy exists where
resources are allocated through the decentralized
decisions of firms and households as they interact in
markets for goods and services. Also Adam Smith’s
invisible hand
• Principle 7: Governments can, sometimes, improve
market outcomes. When markets fail to allocate
resources efficiently, governments can intervene to
promote efficiency and equity. Please note here
externality and market power
 10 Principles of Economics
• Principle 8: the standard of living depends on a
country’s production. It can be measured in terms of
personal incomes or market value of a nation’s
production
• Principle 9: prices rise when the governments print
too much money. Large quantity of money
decreases value of the currency
• Principle 10: Society faces a short run tradeoff
between inflation and unemployment. When prices
go up unemployment goes down: only in short run
!!!
 Pitfalls to Sound Reasoning

• Biases: some people have biases like most of

us have about foreign debt etc
• Loaded Terminologies: Like high profits are
termed as Obscene, low prices as exploitative,
government is bunch of mindless bureaucrats
and government regulations as socialists.
• Misperception of definitions like investment is
construed as purchase of bonds instead of
purchase of capital assets like plant and
machinery
 Pitfalls to Sound Reasoning
• Fallacy of composition which means what is
correct for an individual is not true for whole.
Example: A bumper crop is good for an individual
farmer but not for all of them as prices will go
down.
• Causation Fallacy: Post hoc and correlation v/s
causation. Post hoc occurs because event A
precedes event B which make people to believe
that B was caused by A. In other words “after
this therefore because of this” fallacy”
 Pitfalls to Sound Reasoning

• Correlation v/s Causation: Correlation between 2

events means that they are associated in some
systematic way. For instance if X and Y also then
it doesn’t necessarily mean that Y has increased
because X increased. It could be coincidental or
dependant on a 3rd factor.
• Economic Example, income and higher education
• Proverbial Example Old Woman’s Cock
• Ceteris Paribus, or All Else Equal To analyze the
relationship between two variables while the
values of other variables are held unchanged.
 The Method of Economics
Economic Policy

Criteria for judging economic outcomes:

1.Efficiency
2.Equity
3.Growth
4.Stability
 The Method of Economics
Economic Policy
Efficiency

• Efficiency In economics, allocative efficiency. An

efficient economy is one that produces what
people want at the least possible cost.

Equity

• Equity Fairness.
 The Method of Economics
Economic Policy
Growth
• Economic Growth An increase in the total
output of an economy.

Stability
• Stability A condition in which national output is
growing steadily, with low inflation and full
employment of resources.
Which of the following criteria for judging
economic outcomes refers to producing what
people want at the least possible cost?

a. Efficiency.
b.Equity.
c. Growth.
d. Stability.
e. All of the above.
Which of the following criteria for judging
economic outcomes refers to producing what
people want at the least possible cost?

a. Efficiency.
b.Equity.
c. Growth.
d. Stability.
e. All of the above.
 APPENDIX
How To Read And Understand Graphs
Time Series Graphs
TABLE 1A.1 Total Disposable Personal
Income in the United States, 1975–2006 (in
billions of dollars)
Total
Disposable Total Disposable
Year Year
Personal Personal Income
Income
1975 1,181.4 1991 4,474.8
1976 1,299.9 1992 4,754.6
1977 1,436.0 1993 4,935.3
1978 1,614.8 1994 5,165.4
1979 1,808.2 1995 5,422.6
1980 2,019.8 1996 5,677.7
1981 2,247.9 1997 5,968.2
1982 2,406.8 1998 6,355.6
1983 2,586.0 1999 6,627.4
1984 2,887.6 2000 7,120.2
1985 3,086.5 2001 7,393.2
1986 3,262.5 2002 7,827.7
1987 3,459.5 2003 8,159.9
1988 3,752.4 2004 8,646.9  FIGURE 1A.1 Total Disposable Personal
1989 4,016.3 2005 8,945.6 Income in the United States: 1975–2006 (in
1990 4,293.6 2006 9,501.5 billions of dollars)
 Appendix APPENDIX
How To Read And Understand Graphs
Graphing Two Variables On A Cartesian Coordinate System

 FIGURE 1A.2 A Cartesian

Coordinate System
A Cartesian coordinate system
is constructed by drawing two
perpendicular lines: a vertical
axis (the Y-axis) and a
horizontal axis (the X-axis).
Each axis is a measuring scale.
 APPENDIX
How To Read And Understand Graphs
Plotting Income And Consumption Data For Households
TABLE 1A.2 Consumption Expenditures
and Income, 2005

Average
Average Income Consumption
Before Taxes Expenditures
Bottom fifth $ 9,676 $ 19,120
2nd fifth 25,546 28,921
3rd fifth 42,622 39,098
4th fifth 67,813 54,354
Top fifth 147,737 90,469

 FIGURE 1A.3 Household Consumption and

Income
A graph is a simple two-dimensional geometric
representation of data. This graph displays the data
from Table 1A.2. Along the horizontal scale (X-axis),
we measure household income. Along the vertical
scale (Y-axis), we measure household consumption.
Note: At point A, consumption equals $19,120 and
income equals $9,676.
At point B, consumption equals $28,921 and income
equals $25,546.
 APPENDIX
How To Read And Understand Graphs
Slope Y Y2  Y1

X X 2  X 1
 FIGURE 1A.4 A Curve with (a) Positive Slope and (b) Negative Slope

A positive slope indicates that increases in X are A negative slope indicates the opposite—
associated with increases in Y and that decreases when X increases, Y decreases and when X
in X are associated with decreases in Y. decreases, Y increases.
Refer to the figure below. The expression of the slope of the line between
points A and B equals:

a. Y2  Y1
X 2  X1
Y2  X 2
b.
Y1  X 1
X 2  X1
c.
Y2  Y1

d.
X 2  Y1
Y2  X 1

e. X 2  X1
Y1  Y2
Refer to the figure below. The expression of the slope of the line between
points A and B equals:

a. Y 2  Y1
X 2  X1
Y2  X 2
b.
Y1  X 1

c.
X 2  X1
Y2  Y1

d.
X 2  Y1
Y2  X 1

e. X 2  X1
Y1  Y2
How To Read And Understand Graphs

 FIGURE 1A.5 Changing Slopes Along Curves

Refer to the figure below. According to this graph, the relationship
between hours of study time and points on the exam is as follows:

a. The relationship is first positive and then it turns negative.

b. Positive but diminishing.
c. Positive and increasing.
d. Negative.
e. Nonexistent.
Refer to the figure below. According to this graph, the relationship
between hours of study time and points on the exam is as follows:

a. The relationship is first positive and then it turns negative.

b. Positive but diminishing.
c. Positive and increasing.
d. Negative.
e. Nonexistent.
 APPENDIX
Some Precautions
TABLE 1A.3 Aggregate National Income and
Consumption for the United
States, 1930–2006 (in billions of
dollars)
Aggregate National Income Aggregate Consumption

1930 $ 75.6 $ 70.2

1940 81.1 71.2
1950 241.0 192.7
1960 427.5 332.3
1970 837.5 648.9
1980 2,243.0 1,762.9
1990 4,642.1 3,831.5
2000 7,984.4 6,683.7
2004 10,306.8 8,195.9
2005 10,887.6 8,707.8
2006 11,655.6 9,224.5

 FIGURE 1A.6 National Income and Consumption

It is important to think carefully about what is represented

by points in the space defined by the axes of a graph. In
this graph, we have graphed income with consumption, as
in Figure 1A.3, but here each observation point is national
income and aggregate consumption in different years,
measured in billions of dollars.