Elements of Economics

DR. Grace Ofori-Abebrese

 Course outline
1. Introduction to Economics
• Definition
• Nature and scope
2. Basic microeconomic issues
• Demand and supply
• Market equilibrium conditions
3. Demand and supply elasticities,
• measurement and
• interpretations
4. The consumer demand theory
• Marginal utility
• Budget line and equilibrium of the consumer
 Course outline
5. The theory of production
6. The theory of cost
7. The theory of the firm
• The equilibrium of the firm
• Basic analysis of market structures
8. The theory of resource adistribution
 Introduction to Economics
• Why do we study economics
1. To be informed about international trade, inflation, unemployment and
other economic issues
2. Choosing your profession- it is important to know that your future depends
not only on your abilities but also on economic forces beyond your control
that affect your wage.
3. Knowledge in economics may help you to invest your earnings
4. It helps you to have a better understanding of how the economy works
5. It helps you to appreciate the management of pollution and environmental
degradation
6. It helps you to understand how taxes affect people’s ability to work and save
among others.
 Introduction to Economics
• The nature and scope of economics
• Economics refers to the study of human efforts to satisfy what appears to be
unlimited and competing wants through a careful use of relatively scarce
resources.
• In economics;
• Analyse how society, institutions and technology affect prices and the
allocation of resources among different uses.
• Explore the behaviour of financial markets, interest rates and stock prices
• Examines the distribution of incomes and suggest ways that the poor can be
helped without distorting the performance of the economy.
• Studies the business cycle and examines how economic policy is used to
manage the economy.
 Introduction to Economics
• Studies the pattern of trade among nations and analyse the impact of barriers
• Looks at growth of nations and proposes ways of efficient use of resources
• Looks at government policies that can be used to attain rapid economic
growth, efficient use of resources, full-employment, price stability and fair
distribution of income
 Introduction to Economics

• Definition
• Economics can be defined as the study of how society use scarce
resources to produce and distribute income to different people
 Introduction to Economics
• The fundamental economic problem
• The fundamental economic problem is scarcity

Seemingly s limited
unlimited resources
wants

scarcity

choices

What to produce How to produce For whom to produce

 Introduction to Economics
• Factors of production
1. Land
2. Labour
3. Capital
4. entrepreneurship
 Production possibility curve
• All points that lie on or
8
inside the line would be
7 attainable combinations.
• The negatively sloped line
provides a boundary
Private

6
goods

5
Private goods public goods between attainable and
unattainable combinations.
4 8 0.0
7 2.2
• The PPC illustrates: scarcity
3 6 4.0 choice and opportunity cost
5 5.0 • All unattainable combinations
2 4 5.6
3 6.0 illustrate scarcity
1 2 6.4 • All attainable options illustrate
1 6.7 choices, and
0 7.0
0 • The negative slope of the curve
0 1 2 3 4 5 6 7 8
illustrates opportunity cost
Public goods
• The PPF has a negative slope due to trade off

• Thus producing more of one good implies less of the other good.

• It shows the maximum amounts of production that can be obtained by an

economy given its technological knowledge and quantity of inputs

• Opportunity cost is a concept of the need to choose by measuring the cost of

anything that is chosen in terms of the next best alternative that could have
been chosen instead.
• Constant Costs:
• The marginal rate of transformation (MKT) is the amount of one good G which
must be given up in order to release resources necessary to produce an
additional unit of second good D.

• The constant opportunity cost between good G and good D is illustrated in a

PPC model as a straight line production possibilities curve.

• . When choosing between the production of two goods, the more similar the
resources needed to produce each good, the straighter the PPC will be.

• If all resources were identical in their productive abilities, the opportunity cost
of reallocation would be constant, and the production possibility curve would
be a straight line (a constant slope).
• Each additional unit of D
has the same cost in terms
of G,
• Resources capable of
producing 8 units of G must
be diverted to increase
output of D by one unit,
regardless of the level of
production of G and D.
• Constant cost means that
the MRT is constant.
• It is the result of each factor
of production being equally
effective in producing both
goods,
• The full employment output must be on the production possibilities
curve.
• The slope of the production possibilities curve is the marginal rate of
transformation.
• The slope shows the reduction required in one commodity in order to
increase the output of the second commodity.
• Since the MRT is constant, the slope must be constant and thus the
production possibilities curve must be straight line.
• It can be seen that the MRT of G for D is 8 to 1; reducing the output of D
by one unit will provide resources sufficient to expand output of G by 8
units.
• Shifts in the PPF Growth in potential output

An increase in inputs and technology enable a country to produce more of all

goods and services shifting out the PPF.
• The principle of increasing cost
• The principle of increasing cost states that as the production of one good expands, the
opportunity cost of producing another unit of this good generally increases.
• Public goods and private goods require very different resources to produce, and therefore,
as the production of one good increases, the opportunity cost of its production in terms of
the other good increases.
• Increasing opportunity costs are present when the production possibility frontier bulges
outwards from the origin.
• A bowed-out production possibility frontier indicates that the opportunity cost (marginal
rate of transformation) is increasing as resources become more heavily allocated to the
production of one good.
• That bowed-out shape occurs because of the imperfect adaptability of resources to
different uses.
• it may be assumed that the opportunity cost is one of increasing cost; this means that every
time an additional unit of public goods are produced, ever increasing amount of private
goods must be given up in order to provide the resources for expanding public goods.
• Fundamental economic questions
Every society must have a way of determining what commodities are produced,
how these are produced and for whom they are produced.
1. What commodities are produced –resources are scarce so the allocation of
resources among alternative uses-
2. How to produce considers who will take care of production, with what
resources and what production technique would be used.
3. For whom to produce: distribution of income and wealth. Thus how the
national income is divided among different people.
• Economic systems
• The development of every society depends on the ability to produce goods
and services.
• Societies face scarcity and decisions concerning the basic economic questions
that must be made.
• All societies have economic systems and the organised way in which
provisions for goods and services are made determines the type of economic
system.
1. Market economy
• Market economy is the one in which individuals and private firms make major
decisions about production and consumption.

• Decisions are made in markets-here individuals or firms agree to exchange

goods and services through payments with money.

• Thus in this system prices, markets, profits and losses, incentives and rewards
determine what to produce, how to produce and for whom to produce or the
laissez-faire economy
2. Command economy
• Government makes all important decisions about production and distribution.

• The government owns most of the means of production.

• It also owns and directs the operation of firms in most industries. It is the
employer of most workers and instruct how work should be done.

• It decides how the output of the society should be distributed.

• Major economic questions are answered by the government through

ownership of resources and its power to enforce decision.
• Mixed economy
• It is an economy in which some decisions about the allocation of resources
are made by the government, firms and households

• Private sector owns resources

• The price mechanism allocates resources subject to government regulation

• Government controls some output through taxation, transfer payments and

the provision of public goods.
• Forms of Economics
• Microeconomics:
• Microeconomics refers to the study of economics which concerns with the
behaviour of individual entities such as individuals, households, firms and
markets.
• It is concerned with how prices are determined, the market mechanism,
efficiency of markets and how prices for inputs are determined among
others.
• It analyses reactions of individuals consumers and firms to economic
situations and how these reactions determine resource allocation, output,
distribution of income and the prices to be charged for goods and services.
• Microeconomics is said to be the study of the detailed workings of the
individual markets and interrelations between markes.
• Macroeconomics
• Macroeconomics refers to the branch of economics that studies the overall
performance of economies.

• It studies what causes business cycles, unemployment, inflation inter alia.

• It explains how investment and consumption are determined, how central

banks manage money, interest rate among others.

• What causes international financial crisis and how some nations grow faster
than others.
• The Logic of Economics
• Normative – value judgement
• Normative economics is an approach to economics that analyses outcome of
economic behaviour.
• It involves percepts and norms of fairness. There is no right or wrong answer
• It incorporates value judgement about what the economy should be like.
• Normative economics looks at the desirability of certain aspects of the
economy.
• It underlies expressions of support for particular economic policies.
• They involve ethics or value rather than facts
• It embodies subjective feelings about what ought to be.
• Eg. Ghana ought to undertake measure to reduce unemployment, people
should save etc
• Positive Economics
• Positive economics is an approach to economics that seeks to understand the
behaviour and operation of systems without making judgement
• It describes what exists and how it works
• It refers to statements that explain the causes and results
• It looks at the economy and forecast the impact of changes in economic
policies or conditions on observables variables such as production, sales,
prices and personal incomes, then tries to determine who gains or loses as a
results of changes.
• It deals with scientific or objective explanations of the workings of the
economy.
• Eg. The unemployment rate in Ghana is higher that in the UK.
• Is Economics a Science;
• Though economics is a science, it is not a natural science. It is a social science.
• Economics uses the scientific approach to understand economic life.
Economics relies on analyses and theories to resolve complex phenomena like
budget deficits, causes of inflation and fluctuations in the business cycles.
• Econometrics, which is another branch of economics, applies statistical tools
to analyze mountains of data to hammer home simple relationships to resolve
economic problems
• Economics makes use of mathematical models, arithmetic and algebra to
measure economic variables of interest, while political science, sociology, and
most courses in the social sciences do not.
• The Tools of Economic Analysis
1. An economic theory
• It is a deliberate simplification of factual relationships that are designed to
aid the understanding of the successes or the failure of free market
economies.
• It is an explanation of the mechanism behind observed phenomena.
Economists have data suggesting that government policies can affect the
degree of a country’s development.
• Economic theory is therefore a necessity that provides a logical structure
for organizing and analyzing economic data.
• It proceeds deductively from assumptions to conclusions, which can later
be tested against data
2. Economic models
• A model is a formal or informal framework of analysis which seeks to abstract
from the complexities of the real world those characteristics of an economic
system which are crucial for an understanding of the behavioural, institutional,
and technical relationships which underlie that system.
• A model makes a series of simplified assumptions from which conclusions or
predictions are deduced.
• Models are frameworks for organizing the way we think about a problem. They
simplify by omitting some details of the real world to concentrate on the
essentials.
• An economic model is thus a simplified small-scale version of some aspects of
the economy. Economic models are often expressed in equations, graphs or in
words.
• Economists use models because the real world is so complex that it is necessary
to simplify and abstract to obtain needed information with ease.
3. Data Resources
• In detailed research projects, economists may collect new data by talking
directly to firms or households. However, most economic analysis uses
numbers routinely collected by private bodies, national governments, and
international agencies.
• The data help quantify the relationships to which theoretical models draw
attention.
• The data help us to test our models. Like all careful scientist, economists must
check that their theories square with the relevant facts.
• The data may alert us to logical relationships we had previously overlooked.
And whatever theory we wish to maintain should certainly be checked against
the facts.
a) Time Series Data
• A time series is a sequence of measurement of a variable at different points in
time.
• It shows how a variable changes over time.
• For instance, an annual time series on national income would involve
observation on the value of the variable in successive years.
• The most common time series consist of annual, quarterly or monthly
observation.
• The information may be presented in tables or charts.
b. Cross Section Data
• Cross-section data record at a point in time the way an economic variable
differs across different individuals or groups of individuals.
• Such data might be used to examine whether young workers, who have not yet
had time to receive a full industrial training, are more vulnerable to
unemployment than older workers, who on average have more skills.
• Because cross-section data disaggregate national data by some characteristic
like age, region, or industry, they tend to be used to investigate detailed
questions in microeconomics.
• For example, cross section data on income would involve observation on
incomes of different households in a country or the national incomes of a set
of countries in a given year.
price Graphs for Economic Analysis

price
Two variable graph

quantity quantity

Infinite slope
Negative slope positive slope zero slope

slopes
• The Price Mechanism and its Functioning
• In a free enterprise economy, the equilibrium price and quantity of a commodity are
determined at the intersection of the market demand and supply curves of the
commodity.
• This helps to determine “what” commodities and how much of each are produced.
• Similarly, the equilibrium price and quantity of each factor of production are
determined at the intersection of the market demand and supply curves of the factor.
• That is the wage of each particular type of labour, the interest on each type of capital
and the rent on each type of land is determined at the intersection of the market
demand and supply for that particular factor.
• These factor prices help determine “how” businessmen should combine factors of
production to minimise production costs.
• In addition, factor prices, together with wealth determine the distribution of income
in society, which in turn determines “for whom” goods and services are produced.
• Government in the modern economy
• In a perfect market economy, goods and services are exchanged for money at
the existing market prices.
• In reality, the market economy usually faces some imperfections which result
in excessive pollution, income disparities and unemployment.
• In the name of fairness and equity, the government redistributes income from
the rich to the poor in order to reduce the income inequality that results from
the operation of the market mechanism.
• It does this through progressive taxation (the rate of taxation is greater on
higher incomes than lower incomes), inheritance taxes and welfare
programmes for the poor.
• The government is also responsible for devising general policies to eliminate or
reduce unemployment and or inflation.
• The government also tries to reduce the discrepancies between private cost
and benefits on the one hand, and social costs and benefits on the other
through taxes and subsidies.
• Thus the government often taxes polluters and subsidizes education. It also
provides such public services like defense, roads etc.
• the question is no longer big or small government but enough and efficient
government to accomplish maximum welfare of society.
• Only government can create rules of law, security, setting policies, enforcement
of contracts, wider participation of civil society, reducing discrimination, a
provider of education and health to prevent anarchy and social upheaval.
• Despite the free market and knowledge-based economy, the need for
government has still not been diminished.
• Combing ideas from private and public sectors will strengthen both sectors and
enhance the changes of society’s success.