An Introduction to Economics

The Nature of Economics

Economics is the social science that studies the production, distribution and consumption
of goods and services.

Economics is also defined as the study of scarcity and choice.

The central economic problem is that of scarcity. Scarcity refers to the excess of human
wants over what can actually be produced. All individuals and societies face the problem of
scarcity.

Economics is divided into two parts microeconomics and macroeconomics.

Microeconomics is the branch of economics that studies individual units: e.g. households,
firms and industries.

Macroeconomics is the branch of economics that studies economic aggregates (grand

totals): e.g. the overall level of prices, output and employment in the economy.

An economy consists of the economic systems of a country or other area; the labour,
capital and land resources; and the manufacturing, production, trade, distribution and
consumption of goods and services of that area.

The Main Sectors of an Economy

There are three main sectors of an economy namely primary, secondary and tertiary.

Primary Sector – the primary sector of the economy extracts or harvests products from
the earth. It includes the production of raw materials and basic foods. Activities
associated with the primary sector include agriculture, mining, forestry, fishing and
quarrying.

Secondary Sector – the secondary sector of the economy manufactures finished goods.
All of manufacturing, processing and construction lie within the secondary sector.
Activities associated with the secondary sector include the building of roads, automobile
production and the canning of food items.

Tertiary Sector – the tertiary sector of the economy is the service industry. This sector
provides services to the general population and to businesses. Activities associated with
the tertiary sector include transportation and distribution, entertainment, insurance,
banking and healthcare.
Scarcity and Choice

Scarcity requires choice. People must decide which of their desires they will satisfy and
which they will leave unsatisfied. ‘Rational consumer choice theory’ is an economic principle
that assumes that individuals always make prudent and logical decisions that provide them
with the greatest benefit or satisfaction and that are in their highest self interest.

When we choose more of something, scarcity forces us to take less of something else. In
other words we have to make sacrifices. This sacrifice is called the opportunity cost of
the choice made.

Opportunity Cost

Opportunity Cost – is cost measured in terms of the next best alternative forgone.
Example 1: Choosing to buy a piece of land instead of a car. The opportunity cost is the
car that was not purchased which was the next best alternative.
Example 2: Choosing to buy a patty instead of a cooked lunch. The
opportunity cost is the cooked lunch that was given up.

The Production Possibility Frontier/Curve

Production possibility frontier (PPF) – is a curve showing all the possible combinations of
two goods that a country can produce within a specific time period with all its resources
fully and efficiently employed.

A production possibility frontier is shown in Figure 1.1 it is based on the data shown in
Table 1.1.

Table 1.1 Maximum possible combinations of food and clothing.

Units of food Units of Clothing
(millions) (millions)
700 0
660 100
600 200
500 300
300 400
0 500
 Production Possibilities Frontier for Country X
Fig 1.1

700
660

600

500
Units
of 400
Food
300

200

100

0
100 200 300 400 500
Units of Clothing

Country X can produce any combination of food and clothing as depicted on the graph if it
uses all its capital, land and labour resources. If it chooses to use all its resources to
produce food, then zero (0) units of clothing would be produced and a maximum of 700
units of food. If however, it produces 660 units of food it could also produce 100 units of
clothing. The country could choose any combination shown by the PPF.

 Can you identify two other possible combinations that Country X can produce with
its given resources.

Points on the Production Possibilities Frontier

Fig 1.2
The points labeled on the above diagram are very important.

Point A - all points inside the frontier are feasible but productively inefficient (such as A).
This simply means that while production is attainable or possible within the curve, these
combinations do not make full use of all the resources; therefore there are unused or idle
resources.

Points B, C and D - If production is efficient, the economy can choose between

combinations (i.e. points) on the PPF: B if guns are to be prioritized, C if more butter is
needed, D if a mix is required, and so forth. All points on the PPF are attainable and
efficient, i.e. all the resources are fully utilized and there is no wastage or idle resources.
Hence, all points on the curve are points of maximum productive efficiency (no more output
can be achieved from the given inputs).

Point X - all points outside the curve are not feasible for the given resources and thus
unattainable in the short run, such as X. In other words, the resources which are available
are insufficient to produce the quantities illustrated by point X.

The PPF and Opportunity Cost

In order for an economy to increase the quantity of one good produced, production of the
other good must be sacrificed; assuming that the economy's factors of production do not
increase.

In figure 1.1 above, initially Country X was producing 700 units of food and 0 units of
clothing. In order to increase its production of clothing from 0, Country X had to make a
sacrifice, it gave up 40 units of food (i.e. 700 – 660) and was able to produce 100 units of
clothing. Therefore the opportunity cost of the 100 units of clothing is that which was
given up, the 40 units of food.

The opportunity cost of an additional 100 units of clothing is 60 units of food, therefore
to reallocate resources and change production from the combination 660 units of food and
100 units of clothing to 600 units of food and 200 units of clothing, a sacrifice of 60 units
of food had to be made. The outward bowed PPF indicates increasing opportunity cost.
Therefore to produce more units of clothing, additional units of food has to be sacrificed
and in order to produce more units of food more and more clothing must be given up.
Other Shapes of the PPF

The Linear PPF

If opportunity costs are constant, a linear PPF is produced. In the above diagram, for
every additional 10 units of butter produced, 25 guns must be sacrificed. This however, is
more applicable to products requiring similar resources. Bread and pastry, for instance will
have an almost straight PPF, and hence almost constant opportunity costs (when increasing
production rates).

The Inverted PPF

PPF would appear inverted with opportunity costs falling as more units of a particular
product are produced.

Shifting of the PPF

The PPF can shift outwards for any of the following reasons:

 Increase/improvement in technology
 Capital accumulation (human and man-made)
 Increase/improvement in resources

A decrease in resources would, on the other hand cause the PPF to shift inwards.

Pivoting of the PPF

An increase or improvement in the resources used in the production of only ONE of the
goods being produced will cause the PPF to pivot outwards on that good’s axis only.

700
Units
of
Food

500 600
Units of Clothing

As illustrated in the diagram above, if there is an improvement in the resources for the
production of clothing more units of clothing could be produced. Therefore, instead of
producing a maximum of 500 units of clothing, Country X can now produce a maximum of
600 units of clothing. Food production remains at a maximum of 700 units. A decrease in
the resources or technology for that particular good, on the other hand, would cause the
PPF to pivot inwards/leftwards.

Production Possibility Schedule for Country Z

Food Capital Goods

0 30

1 28

2 24

3 18

4 10

5 0

Yam Pumpkin

0 500

300 400

400 280

500 130

600 0
Identify the influences on consumers and producers in making economic decisions