Lesson 1

Economics and its Nature

Economics
 is a social science concerned with the production, distribution, and
consumption of goods and services.
 It studies how individuals, businesses, governments, and nations make
choices about how to allocate resources.
 It focuses on the actions of human beings, based on assumptions that
humans act with rational behavior, seeking the most optimal level of
benefit or utility.
 is the proper allocation and efficient use if available resources for
maximum satisfaction of human wants. It is the study of how we manage
our scarce resources.
 It is concerned with production, distribution and use of material
goods and services, and the study of human efforts to satisfy
unlimited wants with limited resources.

Adam Smith
 was an 18th-century Scottish economist, philosopher, and author, and
is considered the father of modern economics.
 Smith is most famous for his 1776 book, "The Wealth of Nations."
 Smith's ideas–the importance of free markets, assembly-line production
methods, and gross domestic product (GDP)–formed the basis for
theories of classical economics.

Nature of Economics
1. Economics - is classified as a social science because it deals with
the study of man/s life and how he lives with other men. It is
interdependent with other sciences like sociology, geography, history,
physics, and political science.
2. Scarcity - arises from the assumption of unlimited wants and desires
and the fact that resources to obtain goods and services are limited.
It implies that we cannot have all want we want. Hence, we need to
make the best use of scarce resources to satisfy our wants as much as
possible. Scarcity limits our options and forces us to make hard
choices which means that in order to get something we have to give up
of something else.

Fundamental Economic Activities

1. Production - simply means the process of transforming raw materials
(inputs) to a finished product (output). It brings about the creation
or addition of utility by getting things that give them pleasure and
avoiding the things that give them pain.
2. Distribution - refers to the physical apportion of goods and services
from the producers to the consumers or it is imply called as marketing
distribution of trade (barter).
3. Consumption – is the process of using goods and services in the direct
satisfaction of human wants. It is regarded as the most important
function in economics because it is the ultimate end of economic
activity. Without consumption there would be no need for production
and distribution.
4. Exchange - is the transfer of ownership over goods and services from
one person to another. This is anchored on the use of money or credit.
Activities of buying and selling are involved.

Basic terms in Economics

 Positive economics - deals with what is or the scientific analysis of
economic behavior
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 Normative economics - deals with what should be or suggests what ought
to be.
 Goods - refer to things that are produced, traded, sold, bought, and
utilized which satisfy a person’s wants and desires.
 Tangible goods - they are in the form of material goods or commodities
like shoes, books, umbrellas, etc.
 Intangible goods - they are in the form of services, rendered by
doctors, teachers, and others, which also satisfy human needs and
wants. Aside from services, copyrights, franchises, or patents are
also intangible goods.
 Consumer goods - are goods that are intended for final use by the
consumer, like milk, soft drinks, and food.
 Capital goods - are goods that bare used in the creation or production
of other goods and services like building, machinery, and equipment.
 Essential or necessity goods - are goods that are used to satisfy the
basic needs of man such as food, clothing, shelter, and medicine.
 Luxury goods - are goods that man may do without, but are used to
contribute to his comfort and well-being, such as chocolates,
perfumes, expensive cars and houses.
 Durable goods - are goods that last more than three (3) three years
when used on a regular basis. Examples of durable goods are
appliances, vehicles and machineries.
 Non-durable goods - are goods that last less than three (3) years when
used on a regular basis. Non-durable goods include food, medicine and
clothing, among others.
 Consumers - are people who use goods and service.
 Services - are the efforts rendered by someone for a price such as
haircuts, doctor’s visits, or economic consulting.
 Value - is an assignment of worth basically expressed in terms of
price. The assignment is usually based on the usefulness or scarcity
of the item.
 Wants - are means of expressing a perceived need or desire for goods
and services. Such wants are unlimited and numerous. It does not mean
that we have the ability to pay for the goods and services desired.
 Needs - are basic requirements for survival like food, water, and
shelter. In recent tears we have seen a perceived shift of certain
items from wants to needs. Telephone service, motor vehicles and
education are needs.

Microeconomics
 it is the study of what is likely to happen (tendencies) when
individuals make choices in response to changes in incentives, prices,
resources, and/or methods of production. Individual actors are often
grouped into microeconomic subgroups, such as buyers, sellers, and
business owners. These groups create the supply and demand for
resources, using money and interest rates as a pricing mechanism for
coordination.
 Microeconomics studies the decisions of individuals and firms to
allocate resources of production, exchange, and consumption.
 Microeconomics deals with prices and production in single markets and
the interaction between different markets but leaves the study of
economy-wide aggregates to macroeconomics.

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Theories of Microeconomics
1. Consumer demand theory - relates preferences for the consumption of
both goods and services to the consumption expenditures; ultimately,
this relationship between preferences and consumption expenditures is
used to relate preferences to consumer demand curve. The link between
personal preferences, consumption and the demand are one of the most
closely studied relations in economics. It is a way of analyzing how
consumers may achieve equilibrium between preferences and expenditures
by maximizing utility subject to consumer budget constraints.
2. Production theory - is the study of production, or the economic
process of converting inputs into outputs. Production uses resources
to create a good or service that is suitable for use, gift-giving in a
gift economy, or exchange in a market economy. This can include
manufacturing, storing, shipping, and packaging. Some economists
define production broadly as all economic activity other than
consumption. They see every commercial activity other than the final
purchase as some form of production.
3. Cost-of-production theory of value - states that the price of an
object or condition is determined by the sum of the cost of the
resources that went into making it. The cost can comprise any of the
factors of production (including land, labor and capital) and
taxation. Technology can be viewed either as a form of fixed (e.g.an
industrial plant) or circulating capital (e.g. intermediate goods). In
the mathematical model for the cost of production, the short-run total
cost is equal to fixed cost plus total variable cost. The fixed cost
refers to the cost that is incurred regardless of how much the firm
produces. The variable cost is a function of the quantity of an object
being produced.
4. Price theory - is a field of economics that uses the supply and demand
framework to explain and predict human behavior. Price theory focuses
on how agents respond to prices, but its framework can be applied to a
wide variety of socioeconomic issues that might not seem to involve
prices at first glance. Price theorists have influenced several other
fields including developing public choice theory and law and
economics. Price theory has been applied to issues previously thought
of as outside the purview of economics such as criminal justice,
marriage, and addiction.

Factors of Production
1. Land - includes all natural resources, including mineral deposits,
water, air, trees, poultry, livestock, and all other forms of these
raw materials used in production. Natural resources inputs have to
be paid for by firms upon using them in their production processes.
2. Labor - is any form of human effort like physical or mental, which
is exerted in the production of goods. The physical labor includes
those that extract raw materials and process these into finished
goods or capital goods, transport and sell finished products. The
mental labor includes the teachers, lawyers, doctors, nurses,
scientists and others who provide services.
3. Capital - refers to the machinery, tools, equipment, and structures
used in the production of goods into finished goods or products.
Capital has to be produced and is valuable to firms because it
contributes to the generation of revenue. Financial capital
represents all the money received from or retained for use in
business.
4. Entrepreneurship - is the ability of an individual to provide the
right kind of good or service at the right place and time, to the
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right people at the right price. A person who puts together or
organizes the other factors or production to generate goods and
services which can satisfy the needs of man is an entrepreneur.
Innovative and risk taker.

Opportunity Cost
 is closely related to the idea of time constraints. One can do only
one thing at a time, which means that, inevitably, one is always
giving up other things. The opportunity cost of any activity is the
value of the next-best alternative thing one may have done instead.
Opportunity cost depends only on the value of the next-best
alternative. It doesn't matter whether one has five alternatives or
5,000.
 is the value of benefits foregone from alternative uses if resources.

Macroeconomics
 is a branch of economics that studies how an overall economy—the
market or other systems that operate on a large scale—behaves.
 Macroeconomics studies economy-wide phenomena such as inflation, price
levels, rate of economic growth, national income, growth domestic
product (GDP) and changes in unemployment.
 is the branch of economics that deals with the structure, performance,
behavior, and decision-making of the whole, or aggregate, economy
 Unlike microeconomics—which studies how individual economic actors,
such as consumers and firms, make decisions—macroeconomics concerns
itself with the aggregate outcomes of those decisions. For that
reason, in addition to using the tools of microeconomics, such as
supply and demand analysis, macroeconomists also utilize aggregate
measures such as gross domestic product (GDP), unemployment rates, and
the consumer price index (CPI) to study the large-scale repercussion
of micro-level decisions.

Basic Macroeconomic Concepts

1. Output and income - national output is the total amount of everything
a country produces in a given period of time. Everything that is
produced and sold generates an equal amount of income. The total
output of the economy is measured GDP per person. The output and
income are usually considered equivalent and the two terms are often
used interchangeably, output changes into income. Output can be
measured or it can be viewed from the production side and measured as
the total value of final goods and services or the sum of all value
added in the economy.
2. Unemployment - the amount of unemployment in an economy is measured by
the unemployment rate, i.e. the percentage of workers without jobs in
the labor force. The unemployment rate in the labor force only
includes workers actively looking for jobs. People who are retired,
pursuing education, or discouraged from seeking work by a lack of job
prospects are excluded.

Circular Flow Diagram

The interrelationship Between the Household Sector and Business Sector
 Economic activities take place within economy. These include
production, consumption, employment, and income generation. They take
place through the interrelationship that exists between two economic
units. The household unit which is the basic consuming unit, and the
firm, which is the basic producing unit.
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 Economic activities refer primarily to production that employs
resources such as land, labor, and capital, and entrepreneurship. The
basic processes therefore, can be described as a process of change and
transformation of economic resources into actual goods and services
 Production is the use of economic resources in the creation of goods
and services for the satisfaction of human wants. The use of these
economic resources in production is employment. Whenever resources are
used in production, a price is paid to the resource owners.

The Circular Flow Model

 Circular flow of an economy is only a model, a simplification of a
complex reality. However, it is necessary for it to be understood in
order to have a clear understanding of the complexities that are
encountered in the economic activities of a nation.
 The circular-flow diagram (or circular-flow model) is a graphical
representation of the flows of goods and money between two distinct
parts of the economy:
o market for goods and services, where households purchase goods
and services from firms in exchange for money;
o market for factors of production (such as labor or capital),
where firms purchase factors of production from households in
exchange for money.
 The market for goods and services is the place where households spend
their money buying goods and services produced by firms. In other
words, is the place where firms sell the goods and services they have
produced, receiving a revenue paid by households.
 This market represents the place where money and goods are exchanged.
In this case, the flow of money (green arrow in the diagram below)
goes from households to firms, in exchange for finished products,
which flow from firms to households (red arrow).

 The market for factors of production is the place where households

offer their labor, capital and other factors such as land, receiving
an income for their use. Firms use these factors in their production.
 In this case, money flows from firms to households (green arrow in the
diagram below) in the form of wages in exchange for labor, interests
for capital and rent for the use of land. Factors of production flow
form households (red arrow) to firms, so they can produce more goods
and services.

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 When we combine both diagrams, we get the circular-flow diagram, as

shown below. The exchanges made in the economy imply a redistribution
of rent according to the diagram, and the creation of value makes the
economy grow.

END OF LESSON