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ECONOMIC
CONCEPTS
Chapter 1

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Lecture Plan
What is Economics?
Scarcity
Basic economic
problems
Production possibility
analysis
The two sector circular
flow model
Comes from
Greek
(house) (custom or law)
ECONOMICS
Nomos
Oikos +
Management of a household

Father of Economics
Inquiry into the Nature and Causes
of the Wealth of Nations
Adam Smiths primitive study of economics
paved the way for all future study. He was the
first to analyze economic theory and its
importance. Adam Smiths ideas still prove to be
very valid today.

Smith's successors - Thomas Robert Malthus
(14 February 1766 29 December 1834),

Jean-Baptiste Say (5 January 1767
15 November 1832)

David Ricardo (19 April 1772 11
September 1823)

John Stuart Mill (20 May 1806 8 May
1873),

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What is Economics
Alfred Marshall's ------- Principles of Economics

a study of wealth; and on the other, and more
important side, a part of the study of man."
Milton Friedman 1912-2006

"Economics is the
science of how a
particular society
solves its economic
problems.

"Economics is a study
of how people use their
limited resources to try
to fulfill unlimited wants
and involves alternatives
or choices
THE BASIC ECONOMIC
PROBLEMS
Economics is the study of how
individuals and groups make
decisions with limited (scarce)
resources as to best satisfy their
unlimited wants and desires.

resources are scarce
human wants are unlimited.
Resources

Resources are inputs that can be used to produce goods
and services of various types to help satisfy peoples
unlimited wants. Goods and services are scarce
because resources are scarce

Often referred to as the factors of production.

Resources include land, capital, labour and
enterpreneurship.








Land

Gifts of nature including
Natural resources
Soil
Trees
Water
Air
Mineral
sunlight
Oil reserves

Capital
Physical capital : produced
goods that can be used as
inputs for further
production.
Examples :
factories,
machinery tools,
Computer
Human capital : consists
of the knowledge and skill
people acquire to enhance
their labor productivity
Labour
Labour is the physical and mental
work of people, whether, skilled or
unskilled
Examples:
mechanics,
doctors,
farmers,
computer programmers,
clerks,
fisherman

Entrepreneurship
Refers to the particular
talent that some people
have for organizing the
resources of land, labor
and capital to produce
goods, seek new business
opportunities and
develop new ways of
doing things.

Private vs Public Goods
Private goods have two important features
First, private goods are rival in consumption
the amount consumed by one person is
unavailable for others to consumer
Second, private goods are exclusive
the supplier of a private good can easily
exclude those who fail to pay

Example : car, computer, private college,
private medical centre
Public Goods
Public Goods are non-rival in consumption
one persons consumption does not
diminish the amount available to others.

Example : public school, public hospital, national
defense.


Public Goods
Furthermore, once produced, public
goods are available to all they are non-
exclusive suppliers cannot easily
prevent consumption by those who fail to
pay

Because public goods are non-rival and
non-exclusive, private sector firms cannot
sell them profitably.
Need Want
Food Toys
Shelter Jewellery
Clothing Entertainment
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Consumer Needs and Wants
Needs Wants
limited Unlimited
those things
necessary for
human
survival
goods/services
desired by the
consumer for a
comfortable life
Similar for all
individuals

Varies from one to
another

Example :
Food, shelter,
clothes
Example : luxury
cars, travel,
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SCARCITY
CHOICES
OPPORTUNITY COST
ECONOMIC PROBLEM




Scarcity. . . means that society has limited
resources and therefore cannot produce all the
goods and services people wish to have.
Because of scarcity, we all have to
make choices. No one, not even you, can have
everything they want. Every time you make a
choice, you have to give up something.

Decisions require comparing costs and benefits
of alternatives.
Example : Whether to go to college or to work?
Whether to go to class or sleep in?

The opportunity cost of an item is what you give up
to obtain that item.
Opportunity cost
Definition : The second best alternative
forgone in choosing one need or want
rather than another.

Note: Situations where there is NO opportunity cost = free
goods

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Example 1 : Household
Jason only has RM 1000 and he wants to go
shopping and go for a holiday. He cannot fulfill all
his desires because his money is insufficient. He
faces scarcity

Jason has to make a choice.
If he chooses to go
shopping, then the
opportunity cost will be
going for holiday.
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Example 2 : Government
Malaysian government has 4 Billion and it wants to build
schools and police stations for the welfare of the citizens.
However, the government also faces scarcity because the
fund is not sufficient to build both schools and police
stations.
Therefore the
government has to
make a choice. If it
chooses to build
schools, then the
opportunity cost
will be police
stations.

Example 3: Firm
Firm A wants to diversify its business. It wants to expand its
production to produce dolls and toaster. But the fund it has is
not sufficient to produce both type of products.

Therefore firm A has to
make a choice, whether
to produce dolls or
toasters.
If it chooses to produce
dolls, then the
opportunity cost will be
toasters
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Basic Economic Problem
How much to produce ?
The amount of production. Example : 10000
cars per month or 1000 cars per month?

What to produce ?
Every society must choose what goods or
services to produce. Example : computer or
radio?

Basic Economic Problem
How to produce ?
Refers to method of production. Example :
should factories use more human power or
robotics?

For Whom to produce ?
Refers to distribution. Example : Who will drive
the latest model of an imported car?


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MICROECONOMICS
MACROECONOMICS
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Microeconomics vs. Macroeconomics
Microeconomics focuses on the individual parts of the
economy.
(Micro = the ancient Greek word for small)
How households and firms make decisions and how
they interact in specific markets

Macroeconomics looks at the economy as a whole.
(Macro is the Greek word for large)
Economy-wide phenomena, including inflation,
unemployment, and economic growth



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The production possibilities curve is used to
explain the basic economic concepts of scarcity,
choices and opportunity cost.

The PPC shows various possible combinations
of goods and services that can be produced with
the given amount of resources in a given period
of time.
Production Possibilities Curve (PPC)
Production Possibility Curve
The following assumptions are made to illustrate
the PPC.

There is a fixed quantity of resources
The economy only produces two products
All resources within the economy are used


Production Possibility Schedule
Combination

Consumer
Goods (Unit)
Capital Goods
(Unit)
A 0 15
B 4 14
C 7 12
D 9 9
E 11 5
F 12 0
Production Possibility Curve
Calculation of opportunity cost
Opportunity to move from B to C :
(12-14)/(7-4) = - 2/3
meaning : to increase 1 unit of consumer goods, capital goods
must be reduced as much as 2/3 units.
Opportunity to move from D to E :
(5-9)/(11-9)= -2,
meaning : to increase 1 unit of consumer goods, 2 units of
capital goods must be reduced
This example explains the concept or law of
increasing opportunity cost.

Points along the PPC
Any point along the
PPC such as A, B, C,
D and E and F are
known as efficient
points because the
resources are used
efficiently.
Points Outside the PPC
Points outside the PPC
(e.g. M) is known as
unattainable point
because it is not
possible to produce this
combination using
existing technology and
resources

Points Inside PPC
Point T is known as
inefficient point
because the resources are
not being fully employed.
This point also shows
unemployment.
Economic Growth
When the country enjoys economic growth, the
PPC bounds outward. With economic growth,
the production capability of a country increases
as there is expansion of resources such as land,
labour, capital and entrepreneurship.
Increase in resources or technology can shift the
PPC to right.
Rightward Shift in PPC - Economic
Growth
Leftward Shift in the Economys PPC
Decrease in the availability
or the quality of resources
shifts the PPF inward
Parallel shift again implies
that the change was equally
applicable to both consumer
and capital goods
Decrease in available
resources
Factors that can Shift the PPF
Changes in Resource Availability
Increase in Quantity of resourses rightward shift
Reductions in Quantity of resources leftward shift

Changes in Quality of Resources
Improvement in Quality of resourses rightward shift
Reductions in Quality of resources leftward shift

Increases in the Capital Stock
Increases rightward shift
Decreases leftward shift

Technological Change
Employs available resources more efficiently rightward shift
Shifts in the Economys PPF
I ncrease in resources
or technological
change that benefits
consumer goods
Shifts in the Economys PPF
I ncrease in resources
or technological
advance that benefits
capital goods
Model:
The Circular-Flow Diagram
The Circular-Flow Diagram: A visual model of the
economy, shows how dollars flow through markets
among households and firms.

Includes two types of actors:
households
firms

Includes two markets:
the market for goods and services
the market for factors of production
FIGURE 1: The roles of firm and household
Households:
own the factors of production,
sell/rent them to firms for income
buy and consume goods & services
Households
Firms
Households
Firms:
buy/hire factors of production,
use them to produce goods
and services
sell goods & services
The Circular-Flow Diagram
Markets for
Factors of
Production
Households Firms
Income Wages, rent,
profit
Factors of
production
Labor, land,
capital
Spending
G & S
bought
G & S
sold
Revenue
Markets for
Goods &
Services
Markets
Product markets
Markets in which goods and services are
bought and sold.
Example : supermarket, shoe shop,
restaurant
Resource Markets
Markets in which the resources are
exchanged
Example : Job market is the most important
of the resource markets
Households supply resources in the
resource market and demand goods and
services in the product market.

Firms supply goods and services in
product market and demand resources in
the resource market


Money flows in resource market determine
wages, interest, rents, and profits which flow
as income to households


Product markets determine the prices for
goods and services which flow as revenue to
firms