Chapter 1: Introduction to the Study of Economics

Objectives:

At the end of the chapter, the student is expected to:

1. Identify basic economic terms;

2. Identify the elements involved in the objective of satisfying wants;

3. Differentiate economic analysis from economic policy;

4. Itemize characteristics of microeconomics;

5. Identify examples of factors of production

6. Differentiate the two division of economics.

7. Identify the different economic system

8. Identify examples of normative and positive economics

Engage: In the table below, list down the breakdown on how you spend your daily school
allowance last semester.
Particulars Amount

Explore:

1. What are the problems you encounter in budgeting your allowance?

2. How did you solve the problems in your budgeting?

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Explain:

Introduction:

We hear stories of poverty in the country through the radio and television. We read
stories of another increase in the prices of petroleum products. We observed the alarming
social unrest in both rural and urban areas. We see how our fellow Filipinos lived in
squatters and shanties. We notice the effect of continuous increase in the prices of basic
commodities.

In a world of complex issues and realities, and as the society we lived today
become more and more complex more than ever. How are we now to understand these
numerous issues and relate them to our everyday living?

The study of economics is indeed important, as it will help us understand the

society in which we live in. Economics is defined as “the study of the proper allocation and
efficient use of scarce resources to produce commodities for the satisfaction of unlimited
needs and wants of man”. The scarcity of resources alongside with man’s unlimited wants
are the two facts of our existence that brought economics as a discipline. Economics came
from the two Greek roots of the word economics are oikos- meaning household and nomus
meaning system or management. Oikonomia or oikonomus therefore means the
“management of household”.

Economic Activity

Man’s Basic Economic Activity

Man’s basic economic activity consist of efforts to satisfy human wants with the
use of goods and services. Three elements are involved in this objective of satisfaction as
discussed in this section.

The first is human wants. The best description that can be made of human wants is that
they are unlimited and vary from the needs, otherwise known as basic needs. The second
element is the use of resources. These resources are also called as factors of production
which consist of:

1. Land – this broadly refers to all natural resources, which are given by, and found in
nature, and are, therefore not man- made.
Compensation for the use of land is called rent.
2. Labor- it is any form of human effort exerted in the production of goods and
services. The reward for labor rendered is salary or wage

3. Capital- these are man made goods used in the production of other goods and
services. The reward for the use of capital is called interest.

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 4. Entrepreneurship- entrepreneur is a person who organizes, manages and assumes
the risks of a firm, taking a new idea or a new product and turning it into a
successful business. Entrepreneurship is an economic good that commands a price
referred to as profit or loss.

The last element is the technique of production which shows how resources are
used and combined in production. Thus, production is described as capital intensive or
labor intensive depending on what factor is predominantly used.

Some Economic Problems

Most societies aim to use economic activity as a channel to improve the people’s
standards of living within the limits of available resources. Hence, a government can
restructure the economic system in order to solve its shortcomings or problems like:

1. Unemployment
2. Economic instability that causes highs and lows in production and investment
levels;
3. Low level of growth and development, which make them more difficult for
underdeveloped and developing nations to rise from their low levels of income
and development;
4. Inequality in income distribution resulting in the concentration of the wealth in
the hands of few; and
5. Determination of the type of economic system to be adopted to meet the
country’s peculiar conditions and needs.

Economic Analysis

Economic analysis is the process of directing economic relationships by examining

economic behavior and events and determining the causal relationships among the data and
activities observed.

A student of Economics who attempts to analyze relationships among economic

variables must learn to draw conclusions from the particular to the general (inductive
reasoning) or from the general to the particular (deductive reasoning). This necessitates the
use to the first tool of economics which is logic.

On the other hand, an economic analyst uses statistics to quantitatively describe

economic behavior and therefore serves as a basis in hypothesis testing. A hypothesis
becomes a principle or theory when empirically validated.

The third tool of economics is mathematics which enables an analyst to foresee and
assess a hypothesis for empirical validation.

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 Purposes of Economic Analysis

1. Economic analysis is an aid in understanding how economy operates because it

explains how economic variables are related to one another.
2. It permits prediction of the results of changes in the economic variables.
3. It serves as a basis for just policy formulation.

Economic Policy

Economic policy consists of intervention or courses of action taken by the

government or other private institutions to manipulate the results of economic activity. The
economic policy adopted by the government may be monetary, fiscal or trade for the
purposes of achieving economic welfare.

Methodology

To make a useful, systematic study of the economic activity, one must use
economic theory. Economic theory, like the theory of any other sciences, consists of sets of
principles or causal relationships among the important facts or variables that surround and
permeate economic activity. We look first at the constructions and functions of sets of
economic principles; then, we turn to the overall framework of the economic discipline.

The Functions of Economic Theory

The principal functions of economic theory fall into two categories: (1) to explain the
nature of economic activity; and (2) to predict what will happen to the economy as facts
change. The explanation of the nature of the economic activity enables us to understand the
economic environment in which we live in- how one part relates to others and what causes
what.

Economist differentiate positive economics and normative economics on the basis of

whether the users of theory are concerned with causal relationship only, or they in tend
some kind of intervention in economic activity to the course of that activity. Positive
Economics is an analysis that considers economic conditions “as they are”, or considers
economics “as it is”. It is completely objective, limited to the cause-and-effect relationship
of economic activity; it is concerned with the way of economic relationships are. By the
contrast, Normative Economics is an economic analysis which judges economic conditions
“as it should be”. It is concerned with what ought to be. Value judgments must necessarily
be made, that is, possible objectives to be achieved must be ranked, and choices must be
made among those objectives. Economic policy-making conscious intervention in
economic activity with the intent of altering the course that it will take.

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 Price Theory and Economic Theory

Price Theory (microeconomic Theory) and the theory of the economy as a whole
(macroeconomic theory) constitute the basic analytical tool kit of the disciplines of
economics. Microeconomics is a branch of economics which deals with the individual
decisions of units of the economy. It is concerned primarily with the market activities on
individual economic units such as consumers, resource owners, and business firms.
Macroeconomics treats the economic system as a whole rather than individual economic
units of which it is composed. It is a branch of economics that studies the relationship
among broad economic aggregates like national income, national output, money supply,
bank deposits, total volumes of savings etc.

Characteristics of Microeconomics

As mentioned earlier, the microeconomics is concerned with the process of resource

allocation by individual decision units or markets. From this definition, some
characteristics can be deduced, among them are:

1. Microeconomics looks at the decision of the individuals units. It focuses on the

choices made by individual’s decision units. Resource allocation decisions are
made by these individual entities in a market economy.
2. Microeconomics, often called price theory looks at how process are determined in
various types of market structures.
3. Microeconomics is concerned with social welfare. It examines efficiency, relative
desirability, and choice of alternative methods by which resources are utilized to
alleviate scarcity.

4. Microeconomics has a limited focus. Microeconomics is just a part of the

economics discipline.
5. Microeconomics develop skills such as logical reasoning, skill in the construction
and use of models, skills in optimizing techniques that are useful in making
decision and skills in personal resource allocation decisions.

AN OVERVIEW OF THE ECONOMY

The Circular Flow of Economy

Within the economy, the basic activities of production, consumption, employment, and
income generation take place through the interrelationship existing between the basic
consuming unit (household) and the basic producing unit (firm).

A simplified model of the circular flow of economic activity is shown in Figure 1.

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 Factors of Productions

Payment for factors of production

Household Firm

Payment for goods and services

Goods and Services

Figure 1: The Circular Flow of Economic Activity Model

Basic Economic Questions

Every economy is confronted with the basic economic problems, which arose as
consequences of our scarce resources and unlimited needs and wants.

1. What to produce? - This question refers to the type of goods to be produced.

2. How much to produce? - This question answers the manner of production to be
used while producing the goods.

3. How to produce? – This pertains to the quantities of goods to be produced.

4. For whom to produce? – This is a question concerning the allocation of outputs
produce by the economy.

Types of Economic System

Economic system is a system of addressing economic problems. It may be classified as

traditional, command or market system.

1. Traditional Economy- it is basically a subsistence economy. A family produces

goods only for its own consumption. The decision on what, how, how much and for
whom to produce are made by the family head, in accordance with the traditional
means of production.
2. Command Economy- it is a type of economy, wherein the manner of production is
dictated by the government. This system id socialistic as the government owns and
control the factors of production.
3. Market Economy- also known as capitalism. This deals with the economic
problems by considering consumers’ choices.

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PRODUCTION POSSIBILITIES FRONTIER (PPF)

Since society is faced by limitations due to scarcity of resources, decisions have to be

made on combinations of goods that are to be produced using a given amount of input.
Production Possibilities Frontier or Production Possibilities Curve is a curve depicting all
maximum output possibilities for two or more goods given a set of inputs (resources, labor,
etc.). The PPF assumes that all inputs are used efficiently.

Let us use the following example to illustrate this:

Goods x Goods Y

0 15

1 14

2 12

3 9

4 5

5 0

Plotting this combination in a graph, we get the production possibilities curve, a

downward sloping line to indicate that increase in the production of Good X will lead to a
decrease in the production of Product Y.
16
A
14 B

12 C

10
Y
D
8

6
X
E
4

0 F
0 1 2 3 4 5 6

Figure 2: Production Possibilities Curve

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As indicated on the chart, points A, B, C, D, E, and F represent the points at which
production of Good X and Good Y is most efficient. Point X demonstrates the point at
which resources are not being used efficiently in the production of both goods; point Y
demonstrates an output that is not attainable with the given inputs.

Three Concepts Illustrated in PPF

1. Scarcity- it pertains to the limited availability of economic resources

relative to society’s unlimited demand for goods and services. It is indicated by the
attainable and unattainable combination above the boundary.
2. Choice- can be seen by the need to choose among the alternative attainable
points along the boundary.
3. Opportunity Cost – value of the foregone alternative. Due to opportunity
cost, trade-off arises.

Trade-off- is a situation in which more of one good thing can be obtained only by giving of
another thing.