INTRODUCTION TO ECONOMICS

INTRODUCTION TO ECONOMICS NOTES

Economics essentially studies the way in which mankind provides for the
material well being. It’s thus concerned with the way people apply their
knowledge, skills and effort to the gift of nature in order to satisfy
human their material wants. Economics
is a social science which studies the allocation of scarce resources
which have alternative uses among competing and usually limitless wants
of the consumers in the society.

Basic Economic Concepts

Human wants This refers to people desires for goods and services and
circumstances that enhance their material well being.
Economic Resources These are ingredients that are available for
providing goods and services in order to certify the human wants. A
resource must be scarce and have money value. Resources can be
categorized as natural, or man made.
Natural Resources refer to anything given
by God or nature such as fertile soil, rivers, lakes, mountains etc.
Man Made Resources refers to anything created by man to assist in
further production such as tools, equipments, roads and buildings etc.
N/B Economics resources also refer to as factors of production which
includes land, labour, capital and entrepreneurship.
Scarce and Choice if the resources available are not enough to
produce goods and services to satisfy all the wants then they are
said to be scarce. As a result, individuals and society cannot have
all the things that they want. Since resources are limited, choices
have to be made. The choice to satisfy one want implies others are
forgone. Individuals have to make choices e.g. consumers
with their limited income
and unlimited wants have to choose how they spent their income.
Opportunity Cost refers to the value of benefit expected from the
best second alternative forgone. It is based on the fact that
resources being scarce have competing alternative uses. The choice
to satisfy one alternative means that another is forgone. The value
of the second best forgone alternative is the opportunity cost.

Production Possibility Frontier/Capacity (PPF/PPC)

It provides a graphical illustration of the problem of scarcity and
choice which is the basic economic problem. The curve shows what a
country produces with existing supply of land, capital and
entrepreneurship ability. With limited supply of economics resources
a country has a wide variety of options and variety of goods and
services it can produce. Assume a simple hypothetical economy where a
country produces two types of goods i.e. agriculture and manufactured
goods. The two extreme possibilities are:

The country commits all its resources to the production of
agriculture and non to manufacturing.
All the resources are put to manufactureand non to agriculture.

These two extreme cases are unlikely and the country will most likely
choose to produce goods of both commodities. The opportunity cost of
producing either of them is increasing which the law of diminishing return.

The PPF is a locus of all combination point which represents goods and
services that a country can produce if all resources are utilized fully
and efficiently. Points on the curve such as A, B and C show maximum
possible combined output of the two commodities.
The economy can produce any combination inside the curve such as point Q
where it means some resources are unemployed. The resources in such a
case will produce more commodities by moving either to point B or point
A. The points outside the curve are not attainable with the country’s
present productive capacity. The country can only achieve this if its
productive capacity has been increased and this will cause the curve to
shift to the right as shown by the dotted curve. A country’s productive
capacity can increase if there is advancement in technology or if there
is a discovery of new resources. The PPF/C is concave to the original
indicating the concept of increasing opportunity costs.

1.2 Scope of Economics

The main branches of economics are:
Microeconomics which is the study of the smallest economic decisions
making units of the society. Microeconomics theory is a branch of
economics that studies the behavior of individual decision making units
such as consumers, resource owners and business firm as well as
individual markets in a free market economy. The aim of microeconomics
is to explain the determination of prices and quantities of individual
goods and services. Microeconomics also considers the impact of
government regulation and taxation of individual markets. For example,
microeconomics analyses the forces that determine the prices and
quantities of television sets sold. Microeconomics can be considered as
the ultimate cellular structure of economics.

It is the study of individuals, households and firms. The major areas are

demand and supply analysis
market equilibrium
consumer theory
theory of the firm
market structure
distribution theory

Macroeconomics is the study of bigger and complex systems. Macroeconomic
theory is the study of the behaviour of the economy as a whole whereby
the relationship is considered between broad economic aggregates such as
national income, employment and prices. The economy is disaggregated
into broadly homogenous categories and determinants of the behavior of
these aggregates are integrated to provide a model to the entire economy.

Macroeconomics focuses on the economic stabilization whereby government
policy is used to moderate business cycles and encourages real economic
growth. Macroeconomics became a separate topic of discussion in the
aftermath of John Maynard Keynes and the great depression. The line
between microeconomics and macroeconomics is, however, blurred and there
are many areas of overlap between the two. Key areas of macroeconomics are:

national income
economic growth and development
money and banking
public finance
unemployment
inflation
international trade

1.3 Why Study Economics?

It is useful to study economics for the following reasons\

Economics provides the underlying principles of optimal resource
allocation and thus enables individuals and firms to make
economically rational decisions. Thus for example the preparation of
budgets involves knowledge of demand and elasticity analysis. The
making of price policy decisions draws heavily on the concept of
elasticity in economics. Additionally, the theory of
production in economics is concerned with the principles that
facilitate the optical combination factors of production.
A study of economics enables individuals and organizations to
appreciate the constraints imposed by the economic environment
within which any entity operates. Thus an individual or firm is more
fully enabled to appreciate the implications of the annual budget
considering how for example the increased liberation of the economy
will affect a particular business entity and the
economy in general. Additionally, the student of economics is able
to appreciate the effects of such economic variables as inflation,
exchange rates, interest rates money supply and so on.
The area of development economics is fundamentally concerned with
the reasons why societies develop and means of accelerating
development. It is vital for individuals as citizens to appreciate
the parameters that determine the development process so that they
contribute more fully to facilitate and contribute to solving the
economic problems that characterize their society.
Economics is an analytical subject and its study can help develop
logical reasoning which is never superfluous.

1.4 The Methodology of Economics

A useful insight into the methodology applied in economics can be gained
by distinguishing between positive and normative economics. This enables
one to appreciate the limitations and scope of economics. Positive
economics is concerned with what is, or how the economic problem facing
societies are actually solved. Positive statements therefore, only deal
with facts for example; “Kenya is a member of the East African
community” and “Uganda is currently Kenya’s major trading partner” are
positive statements. For example a dispute over whether Uganda is
currently Kenya’s major trading partner can be settled by looking at the
statistics of Kenya’s trade with its partners. Normative economics
refers to the part of economics that deals with the value of judgments.
This implies that normative deals with what ought to be, or how the
economic problems facing the society should be solved. Normative
statements usually reflect people’s moral attitudes and are expressions
of what particular individuals group thinks ought to be done. A
statement such as “Uganda to should join the Southern Africa
Development Community” or “upper income classes ought to be taxed
heavily”, are normative statements.

Economics makes use of the scientific methods to develop theories.
Scientific inquiry is generally confined to positive questions. One of
the major objectives of sciences is to develop theories. A theory is a
general or unifying principle that describes and explains the
relationship between things observed in the world around us. The purpose
of a theory is to predict and explain. The search for a theory begins
whenever a regular pattern is observed in the relationship between two
or more variables and one asks why this should is so. A theory refers to
a hypothesis that has been successfully tested. It is important to note
that economics hypothesis is not tested by realism of its assumptions
but its ability to predict accurately and explain.

The following procedures are adopted in the scientific method:

The concepts are defined in such a way that they can be measured in
order to be able to test the theory against the facts.
Whereas these facts may seem superfluous, in practice it is quite
difficult to define many concepts in economics in a way that is
agreeable to all schools of thought. It is often correctly
postulated that when you want to argue, first define your terms.
A hypothesis formulated A hypothesis refers to tentative untested
statement, which attempts to explain how one thing is related to
another. Hypotheses are based on observation and upon certain
assumptions about how the real world works. The assumptions may
themselves be based upon prevailing theories that have proved to
have a high degree of reliability. In a social science, the basic
assumptions or paradigms about reality are vital. A discipline’s
basic assumptions about reality determine what it focuses on. In
economics for example, many theories are based on the rationality
assumption. The formulation hypothesis is thus arrived at through a
process of logical reasoning using observed facts and certain
assumptions. As mentioned earlier, a hypothesis is not tested by the
realism of its assumptions but its ability to predict accurately.
Economic hypothesis must be framed in a manner that enables
scientists to test their validity.
The hypothesis is then used to make predictions.
If the hypothesis is correct, then if certain things are done,
certain others will happen. For example hypothesis may predict the
rise in the price of a given commodity may lead in the fall of the
quantity demanded of that commodity.
The hypothesis is tested by considering whether its predictions are
supported by facts.
In order to test a hypothesis and arrive at a theory, one must go to
the real world and see whether the hypothesis is indeed true for
various situations. The social scientists however cannot carry out
controlled experiments in the laboratory. The laboratory of the
social scientist in the human society and human beings cannot be put
into a controlled situation to see what happens. Observed economic
data is subjected to statistical analyses whose techniques help the
economist to determine the probability that particular events have
certain causes. If a hypothesis is supported by factual evidence we
have a successful theory, note that a theory can never be true in
all circumstances and new theories are developed as old ones are
discarded because their predictions have become unreliable.

1.5 Economic Systems

These refer to the way in which different societies solve the three
different basic economic problems which are:

Which goods should be produced and in what quantities?
How should various goods and services be produced?
How should various goods and services be distributed?

These in turn determine various political and economic structures in the
society. The economic systems are as follows:

Free market economy Also referred to as capital system or laiser
faire economy. It refers to a system where decisions about allocation of
resources are made by individuals on the basis of prices generated by
forces of market prices of demand
and supply. A free market economy has the following features

Private property individuals have the right to own or dispose off
their property as they may consider it fit.
Freedom of choice and enterprise Individuals have the right to buy
or hire economic resources, organize them for production purpose and
sell them in the market of their choice. Such persons are referred
to as entrepreneurs.
Self interest the pursuant of personal goals. The individuals are
free to do as they wish and have the motive of economic activity in
self interest.
Competition There is a large number of buyers and sellers such that
each buyer and seller accounts for but is insignificant to influence
the supply and demand and hence prices.
Reliance on price mechanism This is an elaborate system of commerce
in which numerous choices of consumers and producers are aggregated
and balanced against each other. The interaction of demand and
supply determine prices.
No government intervention Hence no price controls, taxes and subsidies.
There are property rights provided and enhanced by the government
through copy rights patents, trademarks etc.

Advantages of Free Market Economy

There is the matching of demand and supply. Production takes place
in response to demand hence a balance between what is produced and
consumed. No wastage.
There is flexibility of the market in responding to changes in
demand and supply conditions.
There are no resources wasted in planning as no planning is required
Consumer sovereignty and competition gives rise to a wide variety of
goods and services giving consumers a wide range to choice from.
Higher rates of economic growth due to the incentive available for
hard work which is motivated by profits.
No wastage of resources on unrealistic projects because investment
decision are based on profits.

Disadvantages

Income inequality the ability of some people and firms to acquire
excessive market power leads to greater inequality in income and wealth.
Monopoly power refers to the ability of a firm to control its prices
Externalities spill over refers to social costs and benefits not
taken into consideration when determining price levels.
Public goods. The price mechanism on its own cannot allocate
resources to the production of public goods such as roads, schools,
security etc., which have no rivals and no excludability.
Instability and unemployment due to the trade cycles of recession,
depression, recovery and boom.
The inability to deal with structural changes caused by wars,
natural calamities among others.
Inadequate provision of merit goods. Merit goods are goods of
importance to the community such as health, education, security
among others
Planned economy Also referred to as command economy or government
controlled economy, socialism or communism. It refers to an economic
system where the crucial decisions are determined a body appointed by
the state. The body takes up the role of mechanism which prevails in a
free market economy

Features of a Command Economy

Leadership and control of economies. All important means of
production (resources) are publicly owned such as land, power
generation, housing among others.
Rationing of certain commodities if supply of such fall bellow demand.
Existence of production targets for different sectors of the
economy. The government determines how resources are allocated
through planning.
Fixing of prices and wages
Occasional existence of restricted labour market in which workers
take up jobs assigned to them.
Government decides what is to be produced

Advantage of planned economy

Avoids economic instability
Minimize negative externalities
Makes adequate provision of public and merit goods
Facilitate the shift of resources in pursuant of grand schemes such
rapid industrialization
Puts checks on monopoly power which are controlled by state
monopolies (Parastatals).

Disadvantages of Planned economy

There is wastage of resources in production because consumers demand
is judged in advance without the use of price mechanism.
The cost of gathering information for planning is expensive to the
state.
In absence of profit motive in production there is no incentives for
hard work and innovation.
The power of consumer sovereignty is curtailed
Mixed economy refers to an economic system where resource allocation
is determined by the state and price mechanism. This form of economic
system can exist in two ways:

Where the means of production are privately owned but the government
through fiscal and monetary policies regulate the working of price
mechanism towards desired levels.
The government does not only regulate the working of the price
mechanism but also strategic resource thus taking part in production.

Fiscal policy refers to the policies which the government uses to
stabilize the economy through government revenue and expenditure.
Monetary policy refers to the policies implemented by the central bank
to stabilize the economy by use of money supply and interest rates. Both
policies make up the budgetary policy of the government.

1.6 Why Intervene in the Economy

To create a framework of regulations and rules to ensure fair
competition thus promote competition between firms both small and big.
Redistribute income through a system of taxation
Prevent market failure of price mechanism
Stabilize the economy
Maintain competition by controlling monopoly

Partial Equilibrium refers to the study of the behaviour of individual
decisions making units and the functioning of individual markets in
isolation. General Equilibrium is the analysis of the behaviour of all
individuals‟ decision making units on all individual markets simultaneously.

1.7 Specialization
This refers to the process where people concentrate on those activities
where they are best at. It takes a form of division of labour which is
dividing up of economic tasks of production into tasks which people
specialize into. Division of labour therefore leads to
specialization which leads to increase in output.

Advantages of specialization

It help individual development by exploring their talent
It is possible to use machines to do specific/ particular task
Increase in skills result in increased expertise and performance
Time saving as a worker will accomplish more by doing a particular task.

Disadvantages

Leads to loss of craftsmanship. Extensive specialization leads to
increased use of machines which are more automated leading to loss
of basic skills
Production of standardized goods limiting the range of goods
consumers can choice from. It does not cater for different tastes
and preferences.
Monotony and boredom due to repetitions of the same work. This leads
increased accidents, absenteeism which are associated with lack of
motivation.
Increased inter-dependence as a specialized system of production
increases the extent to which different sectors of the economy rely
on each other. If mistakes are made in one production unit it may
cause the fall of all or other organization which depend on items
from that production unit.
Increase in risk of unemployment if one’s skills are no longer
required in the market they may get an alternative employment.