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Types of Economics
• Microeconomics focuses on how individual consumers and firm make decisions; these
Introduction to Economics individuals can be a single person, a household, a business/organization or a government
agency. Analyzing certain aspects of human behavior, microeconomics tries to explain they
respond to changes in price and why they demand, what they do at particular price levels.
Microeconomics tries to explain how and why different goods are valued differently, how
individuals make financial decisions, and how individuals best trade, coordinate and cooperate
with one another. Microeconomics' topics range from the dynamics of supply and demand to the
efficiency and costs associated with producing goods and services; they also include how labor is
divided and allocated, uncertainty, risk, and strategic game theory.
Dr. Muhammad Shahadat Hossain Siddiquee • Macroeconomics studies an overall economy on both a national and international level. Its
focus can include a distinct geographical region, a country, a continent, or even the whole world.
Professor, Department of Economics Topics studied include foreign trade, government fiscal and monetary policy, unemployment
University of Dhaka rates, the level of inflation and interest rates, the growth of total production output as reflected
by changes in the Gross Domestic Product (GDP), and business cycles that result in expansions,
E-mail: shahadat_eco@yahoo.com booms, recessions, and depressions.
Contact: +8801719397749 • Micro- and macroeconomics are intertwined; as economists gain an understanding of certain
phenomena, they can help us make more informed decisions when allocating resources. Many
believe that microeconomics’ foundations of individuals and firms acting in aggregate constitute
macroeconomic phenomena.

Schools of Economic Theory

What is Economics? • Two most common school of thoughts: monetarist and Keynesian. Monetarists generally
favors the views on free markets as the best way to allocate resources and argue that stable
• Economics is a social science concerned with the production, monetary policy is the best course for managing the economy. In contrast, the Keynesian
distribution, and consumption of goods and services. approach believes that markets often don’t work well at allocating resources on their own and
favors fiscal policy by an activist government in order to manage irrational market
• It studies how individuals, businesses, governments, and nations make swings and recessions.
choices on allocating resources to satisfy their wants and needs.
• Economic analysis often progresses through deductive processes, including mathematical
• It determine how these groups should organize and coordinate efforts to logic, where the implications of specific human activities are considered in a ‘means-ends’
achieve maximum output. framework. Some branches of economic thought emphasize empiricism, rather than formal
logic—specifically, macroeconomics or Marshallian microeconomics, which attempt to
• Economics generally divides into macroeconomics, which concentrates use the procedural observations and falsifiable tests associated with the natural sciences.
on the behavior of the aggregate economy and microeconomics, which
• Since true experiments cannot be created in economics, empirical economists rely on
focuses on individual consumers and businesses/firms. simplifying assumptions and retroactive data analysis. However, some economists argue
economics is not well suited to empirical testing, and that such methods often generate
incorrect or inconsistent answers (i.e., dismal science).

Types of Economic Systems

Understanding Economics
• Economic systems are defined either by the way that stuff is produced or by how that
• In the 8th-century BC, Hesiod (Greek farmer/poet) argued that labor, stuff is allocated to people. For example, in primitive agrarian societies, people tend to
materials, and time need to be allocated efficiently to overcome scarcity. But self-produce all of their needs and wants at the level of the household or tribe. Family
modern Western economics emerged much later, generally credited to the members would build their own dwellings, grow their own crops, hunt their own
publication of Scottish philosopher Adam Smith's 1776 book, An Inquiry Into game, fashion their own clothes, bake their own bread, etc. This self-sufficient
the Nature and Causes of the Wealth of Nations. economic system is defined by very little division of labor and is also based
• The principle (and problem) of economics is that human beings have on reciprocal exchange with other family or tribe members. In such a primitive society,
unlimited wants and occupy a world of limited means. For this reason, the the concept of private property didn’t typically exist as the needs of the community
concepts of efficiency and productivity are held paramount by economists, were produced by all for the sake of all.
who argue that increased productivity and a more efficient use of resources could • Later, as civilizations developed, economies based on production by social class
able to lead a higher standard of living. emerged, such as feudalism and slavery. Slavery involved production by enslaved
• However, economics has been pejoratively known as the “dismal science”, a individuals who lacked personal freedom or rights and existed as the property of their
term coined by Scottish historian Thomas Carlyle in 1849. Carlyle was actually owner. Feudalism was a system where a class of nobility, known as lords, owned all of
describing the gloomy predictions by Thomas Robert Malthus that population the lands and leased out small parcels to peasants to farm, with peasants handing over
growth would always outstrip the food supply. much of their production to the lord. In return, the lord offered the peasants relative
safety and security, including a place to live and food to eat.

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Types of Economic Systems: Capitalism PPF: A Graphical Representation

• Capitalism emerged with the advent of industrialization. It is defined as a
system of production whereby business owners (capitalists) produce goods for
sale in order to make a profit and not for personal consumption. In capitalism,
capitalists own the business including the tools used for production as well as
the finished product. Workers are hired in return for wages, and the worker
owns neither the tools he uses in the production process nor the finished
product when it’s complete. If you work at a shoe factory and you take home a
pair of shoes at the end of the day, that’s stealing even though you made them
with your own hands. This is because capitalist economies rely on the concept
of private property to distinguish who legally owns what.
• Capitalist production relies on the market for the allocation and distribution
of the goods that are produced for sale. A market is a venue that brings
together buyers and sellers, and where prices are established that determine
who gets what and how much of it. The United States and much of the
developed world today can be described as capitalist market economies.

Types of Economic Systems: Capitalism Alternatives PPF (Contd.)

• Alternatives to capitalist production exist. Two of the most significant ones developed • This tradeoff is usually considered for an economy, but also applies to each
in the 19th century as a response to what was seen as capitalism’s abuses. individual, household, and economic organization. One good can only be
• Socialism is a system of production whereby workers collectively own the produced by diverting resources from other goods, and so by producing less of
business, the tools of production, the finished product, and share the profits – them.
instead of having business owners who retain private ownership of all of the business • Graphically bounding the production set for fixed input quantities, the PPF
and simply hire workers in return for wages. Socialist production often does shows the maximum possible production level of one commodity for any given
produce for profits and utilizes the market to distribute goods and services. In production level of the other, given the existing state of technology. By doing so, it
the U.S., worker co-ops are an example of socialist production organized under a defines productive efficiency in the context of that production set: a point on the
broader capitalist system. frontier indicates efficient use of the available inputs (such as points B, D and C in
• Communism is a system of production where private property ceases to exist and the the graph), a point beneath the curve (such as A) indicates inefficiency, and a point
people of a society collectively own the tools of production. Communism does beyond the curve (such as X) indicates impossibility.
not use a market system, but instead relies on a central planner who organizes • PPFs are normally drawn as bulging upwards or outwards from the origin
production (tells people who will work in what job) and distributes goods and services ("concave" when viewed from the origin).
to consumers based on need. Sometimes this is called a command economy.

Production Possibility Frontier/Curve(PPF/PPC) PPF (Contd.)

• An outward shift of the PPC results from growth of the availability of inputs, such as physical capital or
• A PPF or PPC is a curve which shows various combinations of the amounts labor, or from technological progress in knowledge of how to transform inputs into outputs. Such a shift
of two goods which can be produced within the given resources and means that more of both outputs can now be produced during the specified period of time without
sacrificing the output of either good. Conversely, the PPF will shift inward if the labor force shrinks, the
technology. supply of raw materials is depleted, or a natural disaster decreases the stock of physical capital.
• A graphical representation shows all the possible options of output for two • An inward shift of the PPC reflects that both labor and physical capital are underemployed (i.e., idle).
products that can be produced using all factors of production, where the • In microeconomics, the PPF shows the options open to an individual, household, or firm in a too good
given resources are fully and efficiently utilized per unit time. world. By definition, each point on the curve is productively efficient, but, given the nature of market
demand, some points will be more profitable than others. Equilibrium for a firm will be the
• A PPF illustrates several economic concepts, such as allocative combination of outputs on the PPF that is most profitable.
efficiency, economies of scale, opportunity cost (or marginal rate of • From a macroeconomic perspective, the PPF illustrates the production possibilities available to a nation
or economy during a given period of time for broad categories of output. It is traditionally used to show
transformation), productive efficiency, and scarcity of resources the movement between committing all funds to consumption on the y-axis versus investment on the x-axis.
(the fundamental economic problem that all societies face). However, an economy may achieve productive efficiency without necessarily being allocatively
efficient. Market failure (such as imperfect competition or externalities) and some institutions of social
decision-making (such as government and tradition) may lead to the wrong combination of goods being
produced (hence the wrong mix of resources being allocated between producing the two goods) compared
to what consumers would prefer, given what is feasible on the PPF

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PPF (Contd.) PPF: Slope

Position of PPF PPF: Marginal Rate of Transformation

• The two main determinants of the position of the PPF at any given time are the state
of technology and management expertise (which are reflected in the • The slope of the PPF at any given point is called the marginal rate of
available production functions) and the available quantities of factors of transformation (MRT). It defines the rate at which production of one good can be
production (materials, direct labor, and factory overhead). redirected (by reallocation of productive resources) into production of the other. It
• Only points on or within a PPF are actually possible to achieve in the short run. In the is also called the (marginal) ‘opportunity cost’ of a commodity, that is, it is the
long run, if technology improves or if the supply of factors of production increases, opportunity cost of X in terms of Y at the margin. It measures how much of good
the economy's capacity to produce both goods increases; if this potential is Y is given up for one more unit of good X or vice versa. The shape of a PPF is
realized, economic growth occurs. That increase is shown by a shift of the production- commonly drawn as concave to the origin to represent increasing opportunity cost
possibility frontier to the right. with increased output of a good. Thus, MRT increases in absolute size as one
• Conversely, a natural ecological disaster might move the PPF to the left in response to a moves from the top left of the PPF to the bottom right of the PPF.
reduction in an economy's productive capability. Thus all points on or within the curve • The marginal rate of transformation can be expressed in terms of either
are part of the production set: combinations of goods that the economy could potentially commodity. The marginal opportunity costs of guns in terms of butter is simply
produce.
the reciprocal of the marginal opportunity cost of butter in terms of guns. If, for
• If the two production goods depicted are capital investment (to increase future example, the (absolute) slope at point BB in the diagram is equal to 2, to produce
production possibilities) and current consumption goods, the higher the investment this one more packet of butter, the production of 2 guns must be sacrificed. If at AA,
year, the more the PPF would shift out in following years. Shifts of the curve can the marginal opportunity cost of butter in terms of guns is equal to 0.25, the
represent how technological progress that favors production possibilities of one good, say sacrifice of one gun could produce four packets of butter, and the opportunity cost
guns, more than the other shifts the PPF outwards more along the favored good's axis, of guns in terms of butter is 4.
‘biasing’ production possibilities in that direction. Similarly, if one good makes more use
of say capital and if capital grows faster than other factors, growth possibilities might be
biased in favor of the capital-intensive good

Properties of PPF: Efficiency PPF: Opportunity Cost

• Efficiency: Specifically, at all points on the frontier, the economy achieves productive
efficiency: no more output of any good can be achieved from the given inputs without
sacrificing output of some good. Some productive efficient points are Pareto efficient:
impossible to find any trade that will make no consumer worse off. Similarly, not all
Pareto efficient points on the frontier are Allocative efficient. Allocative efficient is only
achieved when the economy produces at quantities that match societal preference.
• A PPF typically takes the form of the curve illustrated above. An economy that is
operating on the PPF is said to be efficient, meaning that it would be impossible to
produce more of one good without decreasing production of the other good. In contrast,
if the economy is operating below the curve, it is said to be operating inefficiently because
it could reallocate resources in order to produce more of both goods or some resources
such as labor or capital are sitting idle and could be fully employed to produce more of
both goods.
• Any point that lies either on the production possibilities curve or to the left of it is said to
be an attainable point: it can be produced with currently available resources. Points that
lie to the right of the production possibilities curve are said to be unattainable because
they cannot be produced using currently available resources. Points that lie strictly to the
left of the curve are said to be inefficient, because existing resources would allow for
production of more of at least one good without sacrificing the production of any other
good. An efficient point is one that lies on the production possibilities curve. At any
such point, more of one good can be produced only by producing less of the other

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PPF: Opportunity Cost (contd.)

• From a starting point on the frontier, if there is no increase in productive
resources, increasing production of a first good entails decreasing production of a
second, because resources must be transferred to the first and away from the
second. Points along the curve describe the tradeoff between the goods. The
sacrifice in the production of the second good is called the opportunity cost (because
increasing production of the first good entails losing the opportunity to produce
some amount of the second). Opportunity cost is measured in the number of
units of the second good forgone for one or more units of the first good.
• In the context of a PPF, opportunity cost is directly related to the shape of the
curve (see above). If the shape of the PPF curve is a straight-line, the opportunity
cost is constant as production of different goods is changing. But, opportunity cost
usually will vary depending on the start and end points. In the diagram above,
producing 10 more packets of butter, at a low level of butter production, costs the
loss of 5 guns (shown as a movement from A to B). At point C, the economy is
already close to its maximum potential butter output. To produce 10 more packets
of butter, 50 guns must be sacrificed (as with a movement from C to D). The ratio
of gains to losses is determined by the marginal rate of transformation.