Basic Concepts of Economics

Literature: Samuelson &

Nordhaus
Why Study Economics?
May be...
To get a good job?
Understand more deeply what lies behind report
on inflation and unemployment?
What kinds of policies might slow global
warming
etc....
“All these reasons, and many more, make good
sense...”
“Studying Economics will not make you a genius,
but without Economics the dice of life are loaded
againts you....”

“Without studying Economics, you can not be

fully informed about international trade, tax
policy, or cause of recession and high
employment...”
What are the major subjects in
Economics ?
Economics explores the behavior of the financial
markets
The subjects examine the reason why some
people or countries have high income while other
are poor
It studies business cycle
Economics studies international trade and
finance and the impacts of globalization
It asks how government policy can be used to
persue important goals, such as economic
growth, etc.
Definition and Themes

Definition :
Economics is the study of how societies use scarce resources
to produce valuable commodities and distribute
them among different people

The Twin Themes

of
Economics

SCARCITY EFFICIENCY
Two key ideas behind the
definition
1. That goods are scarce
2. That society must use its resources efficiently

A situation of scarcity is one in which goods are

limited relative to desires
Efficiency denotes the most effective use of a
society’s resources in satisfying people wants
and needs
 Goods or Wants and
resources needs

limited limitless
efficiency

Economic Efficiency requres that economy produce the

highest combination of quantity and quality goods and
services given its technology and scarce resource
An economy is producing efficiency when no individual’s
economic welfare can be improved unless someone else
is made worse off
Principle #1:
People Face Tradeoffs.

“There is no such thing as a free lunch!”

 People Face Tradeoffs.

To get one thing, we usually have to give up

another thing.
Guns v. butter
Food v. clothing
Leisure time v. work
Efficiency v. equity

Making
Making decisions
decisions requires
requires trading
trading
off
off one
one goal
goal against
against another.
another.
 People Face Tradeoffs
Efficiency v. Equity
Efficiency means society gets the most that it
can from its scarce resources.
Equity means the benefits of those resources are
distributed fairly among the members of society.
The Cost of Something Is What You Give Up to
Get It.

Decisions require comparing costs and benefits

of alternatives.
Whether to go to college or to work?
Whether to study or go out on a date?
Whether to go to class or sleep in?

The opportunity cost of an item is what you

give up to obtain that item.
Microeconomics - Macroeconomics
 Microeconomics
concerned with the behavior of individual entities
such as markets, firms, and households
“The Wealth of Nations”  Adam Smith (The Founder of
Microeconomics) consider
 How individual prices are set
 Studied the determination of prices of land, labor, and
capital, and inquired into the strengths and weaknesses
of the market mechanism
“Today, Microeconomics have move beyond the early
concerned to include the study of monopoly, international
trade, finance, etc.”
 Macroeconomics :
concerned with the overall performance of the
economy  GDP, Growth, employments, inflation
and the balance of payments.
“ General Theory of Employment, Interest and
Money” John Maynard Keynes (1936):
 Written when England and US were still stuck in the
Great depression of the 1930s, and over one-quarter of
the American labor force was unemployed
 Keynes developed an analysis of what causes
unemployment and economic downturns, how investment
and consumption are determined, how central banks
manage money and interest
 Adam Smith – John Maynard Keynes

1776
 An inquiry into the nature and causes
of the wealth of nations
 Classical economic 1936
 Laissez-faire  The General Theory of Employment,
 Market mechanism interest and Money
 Keynesian economic
or
 Competitive Capitalism  Economic Role of Government
 Welfare State

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Thinking Like an Economist
Economics trains you to. . . .
Think in terms of alternatives.
Evaluate the cost of individual and social
choices.
Examine and understand how certain events
and issues are related.
 THE ECONOMIST AS A SCIENTIST
The economic way of thinking . . .
Involves thinking analytically and objectively.
Makes use of the scientific method.
 The Scientific Method:
Observation, Theory, and More
Observation
The Scientific Method
Uses abstract models to help explain how a
complex, real world operates.
Develops theories, collects, and analyzes data to
evaluate the theories.
THE ECONOMIST AS POLICY ADVISOR
When economists are trying to explain the
world, they are scientists.
When economists are trying to change the
world, they are policy advisor.
Logic of Economics
The Logic of Economics

Scientific Approach
(to understand economic life)

Economics Economics
Theory Descriptive

Causality
Assumptions
Ceteris Paribus
Positive Economics and
Normative Economics
1. Positive Economics
Describes the facts of economy:
What is? :
definition,
explanation,
description,
prediction
They can all be resolved by reference to
analysis and empirical evidence
2. Normative Economics
Involves ethical precepts, norms of fairness, and value
judgments
There are no right or wrong answers to these questions,
because they involve ethics and values rather than facts
They can be resolve only by political debate and
decisions, not by economic analysis alone  there is a
solution
What ought to be?
Prescription
Recommendation
Policies
The Three Problems of Economic
Organizations (Problems of
Choice)

WHAT

scarcity of
resources
vs
unlimited human
wants

HOW FOR WHOM

edited by lilik
Solution of the three problem of
economic in different economy system
A Market economy (a laissez-faire
economy)
Firms produce the commodities that yield the
highest profits (the what)
By the techniques of production that are least
costly (the how)
Consumption is determined by individual’s
decision (the for whom)
 How Market Solve the Three Economic Problem
(What – How – For Whom)
 What goods and services will be produced is determined by the
rupiahs votes of consumers – and firm’s motivated to maximize
profits.
 How things are produced is determined by the competition
among different producers. The best way for producers to meet
price competition and maximize profits is to keep costs at
minimum by adopting the most efficient methods of production.
 For Whom things are produced – who is consumers and how
much – depends, in large part, on the supply and demand in the
markets for factors of production.
 The end of the major force affecting the shape of the economy
are the dual monarchs of taste and technology
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Market Failure
The Visible Hand of Government
 In reality, no economy actually conforms totally to
idealized world of smoothly functioning invisible
hand.
 Based on Keynesian Economic  The government
anywhere in the world take on many tasks in
response to the flaws in the market mechanism.
 How do the governments perform their functions?
 The governments increase efficiency by promoting
competition, curbing externalities, and providing
public goods,
 The governments promote equity by using
(progressive) tax, and expenditure programs to
redistribute income toward particular groups,
 The governments foster macroeconomic stability and
growth, reducing unemployment and inflation,
encourage economic growth through fiscal and
monetary regulation.
Efficiency
 The invisible-hand doctrine applies to
economies in which all markets are
perfectly competitive (a market in which
no firm or consumers is large enough to
affect the market price)
 Perfect competitive market will produce an
efficient allocation of resource, so the
economy is on it production possibility
frontier
 The are many ways that markets can fall
short of efficient perfect competition 
market failure
 Imperfect competition, such as monopoly
 Externalities (spillover effect), such as pollution
Equity
 The market mechanism works as follows to
determine the “what” and “how”; but can
not solve problem the “for whom”.
 The distribution of income is determined
by the ownership of factor of production
(land, labor, and the capital) and by factor
prices.
A Command economy
Government makes all important decisions about
production and distribution
The government answers the major economic
questions through its ownership of resources and its
power to enforce decisions
A mixed economy
With elements of market and command economy
Most societies today operate mixed economies
So the government plays an important role in:
Overseeing the functioning of the market
Governments pass laws that regulate economic life
Produce educational and police services, and control
pollution
Economic Models
 Economists use models to simplify reality
in order to improve our understanding of
the world
Economists make assumptions in order to
make the world easier to understand.
The art in scientific thinking is deciding
which assumptions to make.
Economists use different assumptions to
answer different questions.
Two of the most basic economic models
include:
The Circular Flow Diagram

Society’s Technological
Possibilities
Inputs
Inputs are commodities or services that are used to
produce goods and services.
An economy uses its existing technology to combine
inputs to produce output,
Factor of productions  Land, Labor, Capital,
Output
Output are the various useful goods or services that
result from the production process and are either
consumed or employed in further production.
The production Possibility Frontier
 Shows the maximum amounts of production that can be
obtained by an economy, given its technological knowledge
and quantity of inputs available,

 Represents the menu of goods and services available to

society.
Opportunity Cost is the value of the next best goods or services
forgone if choosing to produce something else

Example: the opportunity cost of increasing gun purchased from

900 (D) t0 12,000 (C) is 1 million pounds of butter forgone
 Productive efficiency occurs when an economy cannot
produce more of one good without producing less of
another good; this implies that the economy is on ts PPF

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35 edited by lilik