Economics is a social science.
Why?
It studies the behaviour of human beings just as sociology and other social sciences do. (For instance it examines how and why do consumers allocate their resources among competing ends?)
Definition of Economics
There are numerous definitions of the subject of economics. The following definitions in a nutshell sufficiently captures the job of an economist.
Economics is defined as a social science which seeks to explain the economic basis of human societies (Hardwick et al, 1994).
Economics is the study of how human beings coordinate their wants and desires, given the decision making mechanisms, social customs, and political realities of the society (Colander, 2006).
Branches of Economics
1. Microeconomics – a study of economic decisions of economic agents (consumer/household, firms and government) each of which with different objectives. E.g. Consumer – utility maximization, firm – profit maximization and government – social welfare maximization.
2. Macroeconomics – an analysis of the entire economy (how the collective decisions of each individual economic agent affects the economy?) E.g. decisions by firms to produce more or less gives rise to more employment or more unemployment.
The study of economics and scarcity
Many writings on this study highlight that the economic basis of human society is that of scarcity.
In fact, many of the world’s pressing problems (such as poverty and unemployment) are economic in nature (Baumol and Blinder, 1999).
Scarcity is seen as the excess of human wants over what can actually be produced to fulfill these wants (Sloman, 2003).
It is a case where the Supply of available resources are not equal to the Demands on those resources.
Understanding Scarcity:
Microeconomic Face of Scarcity
1. Individual – need to budget limited income to meet the household’s or individuals needs and wants.
2. Firm – deciding on the employment of factor inputs (FOP) due to limited financial capital.
3. Government – deciding and choosing among public expenditure options (Should government construct a piece of public road or use such resources to construct a school building instead?).
Understanding Scarcity(Cont.): Macroeconomic Face of Scarcity
1. Poverty
2. Unemployment
3. Inflation
4. Debt/GDP Ratio
5. Balance of Payment Problems
6. Government Budget Deficits
7. Crime
Summary of the Economic Problem
Opportunity Cost
Choices
Scarcity
Summary (Cont.)
Opportunity Cost –
is the value of the next best alternative that the decision forces the decision maker to forgo (Baumol and Blinder, 1999).
of any activity is the sacrifice made to do it (Sloman, 2003).
Is the value of the next best alternative forgone (Hardwick et al, 1994).
N.B. a good whose opportunity cost is zero is called a free good. A good with an opportunity cost is called an economic good.
Illustrating the Summary Concepts
The study of economics uses models in an effort to explain concepts (this is what makes it similar to the natural sciences).
N.B. An Economic Model is a representation of a theory or a part of a theory, often used to gain insight into cause and effect (Baumol and Blinder, 1999).
How the Economist study their subject?
While we are looking at models in economics, we must keep in mind that the Economist uses two approaches in studying how humans allocate scarce resources.
1. Positive Economics (focuses on what is and factual/can be tested such as the real inflation rate is 10%).
2. Normative Economics (focuses on what should be and is based on value judgments/cannot be tested such as government should increase its expenditure on health care to improve on the competitiveness of the economy).
Production Possibility Curve (PPC)
In Economics, the PPC (or PPF or PPB) could also be called transformation curve/frontier/boundary, provides a tool for illustrating the concepts of scarcity, choice, opportunity cost and economic efficiency.
Defined:
it joins together the different combinations of goods and services which a country can produce using all available resources and the most efficient techniques of production (technology).
N.B. Can also be called Transformation Curve/Boundary/Frontier
PPC (cont.)
There are three shapes of the PPC. These indicate the slope of the PPC and the level of suitability of resources.
Marginal Rate of Transformation (MRT)
Defined: is the rate at which one product can be transformed or converted into another product by reallocating resources (Hardwick et al, 1994).
The MRT measures the slope of the PPC. In the above example 1.33 represents the amount of good y that are being forgone in order to increase the amount of good X by a small amount (1 unit change). (∆ in the forgone Good y / ∆ in units of the good being increased x).
PPC (Shifts)
The PPC can shift inwards, outwards or pivot at a point.
1. An inward shift will represent negative economic growth (occurs when an economy is LESS able to produce more goods and services for each consumer- Baumol and Blinder, 1999)
2. This could be the result of; lost or depletion of resources, retardation of technology, brain drain etc.
PPC (Shifts)
3. In the case of outward shifts this will represent positive economic growth.
4. Positive economic growth may occur for the opposite reasons which explains why negative economic growth takes place.
5. The PPC can pivot at a point to show the increase or decrease in the potential of the economy to produce more or less of a good, while keeping the potential of the economy to produce the other good unchanged.
PPC (Inward & Outward Shifts)
Allocative Mechanisms (the economy – a mechanism which facilitates the allocation of resources so that the production, exchange and distribution of commodities can take place).
In the previous PPC, the owners and managers of the resources in the economy will decide what combination point, A, B and C the economy will produce at. Essentially, the allocative mechanisms answer the questions of:
1. What to produce?
2. How to produce?
3. And for whom to produce?
These questions addressed the issue of resource allocation.
Allocative Mechanism (Cont.)
N.B. The traditional system was a subsistence system which eventually evolved into a trading system which centered upon the use of Barter.
(Failure of the barter system is a result of the problem of double coincidence of wants)
Modern economic system/allocative mechanism exist along a continuum
Market Economy Mixed Economy Command Economy
Types of Economic Systems
Economic
System
How to Produce?
What to Produce?
For Whom to Produce?
Free Market Individuals who are
Owners of the resources (Land, Labour, Capital (money) and Enterprise). This decision will depend on relative prices of inputs and the need to meet the profit maximizing objective
Individual owners of resources who will seek to allocate resources towards the production of a good which is highly demanded on the market and thus, will better able a firm to meet its profit maximizing level.
As with the two functions, this will be based on the price mechanism.
Those who can afford the equilibrium price will consume the commodity
Mixed Owners of resources
(individual and government will make this decision)
1.Price Mechanism
2. Based on government objective and in response to market failure (externality and public good).
1. Price mechanism
2. Based on government objective.
Command Government ownership
(decisions to be taken by some central authority)
Central Authority (often informed by little market data)
Central Authority (often through some form of rationing)
Appendix: Money
Thus, in a market economic system, the monetary system plays a key role in determining the allocation of resources.
Money can be seen in terms of narrow or broad money (Hardwick et al, 1994), however the most simplistic definition is a commodity which is generally accepted both as a measure of value and a medium of exchange.
Money (Continue)
(A) Functions
1. Medium of Exchange
2. Store of value
3. Unit of Account
4. Standard of Deferred Payment
(Hardwick et al, 1994)
Money (Continued)
(B) Characteristics
1. Durable
2. Portable
3. Divisible
4. Scarce
5. Homogenous
6. Generally acceptable
References
1. Baumol, William J, and alan S. Blinder. Economics: Principles and Policy. 8th Edition. USA: Dryden Press, 1999.
2. Colander, David C. Economics. 6th Edition. New York: McGraw – Hill/Irwin, 2006.
3. Hardwick, Philip, Bahadur Khan and John langmead. An Introduction to Modern Economics. Essex: Addison Wesley Longman Ltd, 1994.
4. Sloman, John. Economics. 5th Edition. Essex: Pearson Education Ltd, 2003.
Alex Infohub 