Economics concepts

Definitions of economics
A. Wealth definition (classical view)

Prior to this economics had been fairly simple, agricultural systems with
most people involved in producing basics products such as food and
cloth, farming equipment and leather goods. The coming of the steam
engine, increased use of machinery, the emergence of banks for
investment and the birth of the stock exchange, made everything much
more complex and in need of explanation

Adam smith (1723-1790), known as the ‘father of modern economics’

wrote a books during the beginning of the industrial revolution in great
Britain on subject of economics, an inquiry into nature and causes of
the wealth of nations.
Smith believed in the ‘’free market’’ that is consumers may buy what
they like and producers may produce what they like, with no government
interference (laissez-faire). He believed that the “invisible hand” of
competition would result in the most efficient outcome.

Economics as “the study of the laws which govern wealth”- J.B, Say
Economics “ the subject treated by political economists…is not
happiness, but wealth”-Nassau Senior at Oxford
 Economics is “the body of knowledge which relates to wealth”-F.A
walker
Economics teach “the nature of wealth and the laws which govern its
production, distribution and exchange”-J.S, Mill.
 Economics it “deals with phenomena of wealth”- J.E Cairnes.
 Economics that “all are agreed that it is concerned with wealth
B. Welfare definition (Neo- classical definition)

Alfred Marshall (1922) “Economics” is the study of mankind or human kind

in the ordinary business of life.

It examines that part of individual and social action which is mostly closely
connected with the attainment or earn and with the use of the material
requisites for well being and enjoy a living.
C. Scarcity definition of economics- modern view.

Lord Lionel Robbins (1934); ‘Economics’ is the science which studied human behavior as
relationship between ends and scarce means which have alternative uses”
Needs are things that we must have to survive, such as food, shelter, and clothing. Wants
are things that we would like to have but which are not necessary for our immediate
physical survival such as televisions and mobile phones
Economics is the study of rationing systems. It the study of how scarce resources are
allocated to fulfill the infinite wants of consumers.

This definition is based on the following related postulates or assumptions:-

(i) Economics is related to one aspect of human behavior, of maximizing satisfaction of

wants from scarce resources.
(ii) Ends or unlimited wants and need implies that when a particular want is
satisfied by people in real life another want come up or crop up to take it
place through use of scarce resources. Multiplicity of wants creates
impossibility to satisfy all wants. The endlessness of human wants can be
attributed by-
(a) Expansion in knowledge about inventions and innovation of new goods
and services with greater convenience, efficiency and serviceability.

(b) Human tendency to accumulate thing beyond the present need.

(c) People’s insatiable desire to raise standard of living, comfort and

efficiency.

(d) Multiplicative nature of some wants (e.g. buying a car creates wants for
many other things- petrol, driver, cleaning, parking place, safety locks, spare
parts, insurance etc.)
(e) Biological needs (food, water) are repetitive

(f) Imitative and competitive nature of human beings creating needs due
to demonstration and bandwagon effects

(g) Influence of advertisement in modern times creating new kind of wants

(h) Expansion of education, scientific advancement, economic growth.

Hence, the satisfaction of all these wants is not possible and human wants
continue to increase endlessly.

(iii) People ends are of different or varying importance or intensity which

necessarily leads to problem of choice (economic problem) of selecting
the uses to which scarce resources can be put.
(iv) The reason for the non- satisfaction of unlimited wants is the scarcity of means
at disposal of mankind.

(v) Scarce means implies that resources are limited in supply i.e. all resource
command market price and relatively scarce to people’s demand for them or
wants.

Means or resources is any thing that available to individuals, households, firms and
societies and can be used to satisfy human wants and desire.

(a) Natural productive resources (include cultivatable land surface, space, lakes,
rivers, coastal range, minerals, wildlife, forest, climate, rainfall etc)
(b) Man made resources or capital goods (including machinery, equipment, tools,
and technology and building- capital.)
(c) Human resources (including manpower, human energy, talent, professional skill,
innovative ability and organizational skill- labor)
(d) Consumer goods, money, technology, information and time available
with men.
(e) Entrepreneurship i.e. the ability, knowledge and talent to put land,
labor and capital in the process of production, and ability and
willingness to assume risk in business.

(vi) The scarce means are capable to put into alternative or various
uses. Land is capable of being used for growing rice, sugarcane, wheat,
maize etc. Likewise coal can be made use of in factories as fuel for the
production; coal can be used for running trains; coal can be used for
domestic cooking purpose; coal can be used for generation of
electricity etc. Monetary resources can be utilized for the production of
essential consumer goods, for the production of capital goods. At a
time, the use of scarce resource for one end prevents its use for any
other purpose.
(vii) Economics is related to all kinds of behavior that involve the problem
of choice. But the problem of choosing the best combination of resources
or the problem of allocating given building resources between an
auditorium, library, laboratory, lecture room, cycle shed and canteen is
economic.

Economics terms
Goods
material and non- material goods
Material goods
economic and non economic goods
Economic goods
consumer’s goods and producer’s goods.
Consumer’s goods
Durable- use consumers’ goods
single- use producers’ and durable- use producers’ goods.

Non- material goods

(C) Intermediate and final goods
(D) Utility
Meaning of utility
Types of utility such as Form utility, Place utility, Time utility, Service
utility, Possession utility, Knowledge utility and Natural utility
Characteristics of utility
(E) Wealth- characteristics, forms of wealth
Meaning of wealth
Characteristics of wealth
forms of wealth such as individual wealth, social wealth, national or real
wealth and financial wealth
(F) production, consumption, exchange and distribution

Question
Distinguish between economic goods and free goods
Micro economics is the branch of economics which study of economic
behavior or actions of individuals and small groups of individuals or
individual markets.

For instance, an economist may study the market for compact discs. This
will involve looking decision and behavior of people who buy compact
discs, the firms that sell the compact discs and other groups which
influence the price and availability of compact discs such as government.

Other examples are such as the determination of equilibrium or fixation

output or production and employment of the firm or industry, the wage
of a particular type of labor, the price of particular commodity like rice,
tea or car, personal income, individual industries demand of an
individual consumer for good, individual supply, individual taxes and
specific public spending programme.
Macro economics is the branch of economics, which studies large
aggregates or averages economic variables covering the entire economy.
For example, the study of the nature, causes, consequences of
unemployment, inflation, economic growth and international trade and
government policy.

A positive statement or positive economics is deals with area of the

subject that are capable of being proven to be right (correct) or wrong
(not) by looking at the facts. For example, unemployment rate for china
for 2004 was 9.8%.

A normative statement or normative economics deals with areas of the

subject that are open to person opinion and belief and cannot be
conclusively proven to be right or wrong i.e. it uses value judgment words
such as ‘ought’, ‘should’, ‘too much’, ‘too little’. For example, ‘the Chinese
government put to little emphasis on curing unemployment in 2004.
Examples of normative statements
Desirability or undesirability of economic happening is determined
based on socially determined values.

production and sale of harmful goods like alcohol, drugs, cigarettes

may be very profitable business; but in production and sale of these
goods desirable for society is normative question- public interest-
social costs and benefits of various economics activities and events
and prescribes control and regulatory measures.
high level of unemployment and inflation in Britain out to be reduced
and the distribution of income in Britain should be made equal
Is economics a positive or normative statement? Which of the following
statement is associated with positive or normative economics or both? Explain
your view, where in doubt

(a) If cigarette production is not banned, the number of death caused by cancer
will increase.
(b) High tax rate lead to tax evasion
(c) The government of Tanzania has withdrawn food subsidies to reduce fiscal
deficits
(d) The withdrawal of mid-day meal scheme will reduce the growth of literacy in
the country.
(e) Tanzania universities must increase tuition fee to be able to sustain higher
education.
(f) Corruption in Politics and bureaucracy has helped economic growth in
Tanzania.
(g) Rise in onion price lead to the fall of BJP Government in Delhi in 1998
Production possibility frontiers (PPF) or transformation curves or
opportunity curve

PPF is the curve shows alternative maximum combination of goods and

services that can be produced by an economy in a given time period, if
given resources in the economy are being used fully and efficiently and the
state of technology is fixed.

PPFs are used by economists to show the concepts of scarcity, choice and
opportunity cost
Assumptions under production possibility frontier curve

(i) Only two goods X and Y are produced in different proportions in the
economy by using fixed resources.
(ii) The same and given amount of productive resources can be used to
produce either or both of the two goods and can be shifted freely
between production of one good to another
(iii) Given economy resources are being efficiently used or full
employment of resources i.e. assume that the resources are neither
unemployed nor underemployed or economy is working at the level of
full employment and using its productive resources capacity full.
(v) The level of technology or production technique is given and
constant.
(vi) The time period is short.
Consider the following table showing alternative production
possibilities
Agricultural Manufactured ΔA ΔM
Products Products (millions A2- A1= +ve M2- M1 = -ve
(millions of of units) (trade off) (trade off Opportunity cost of
Opportunity cost
tonnes) 1 million units of
of 1 million tonne
manufactured
of agricultural
products expressed
products
in million of tonnes
expressed in
of agricultural
million of units of
products.
manufactured
products.

0 60 - -
1 58 1 -2 2 1/2
2 55 1 -3 3 1/3
3 50 1 -5 5 1/5
4 42 1 -8 8 1/8
5 30 1 -12 12 1/12
6 0 1 -30 30 1/30
Production possibility curve from production possibility schedule
From figure above, if all production is devoted to agricultural products, then
quantity of agricultural products is 60 million tons (all resources or factors of
production of economy will used to produce agricultural products) and no
manufactured product and if all production is devoted to manufactured
products, then quantity of manufactured products is 60 million tons (all
resources or factors of production of economy will used to produce
manufactured products) with no agricultural products. At any point between
corner points on PPF, resources are being shared between productions of
agricultural and manufactured products i.e. points shows the possible
combination of agricultural and manufactured products

Consider the following PPF curve again

From figure above, it is possible to produce any point inside the PPF
such as point D that not all of the factors of production or resources are
being used or utilized or are being used inefficiently. In real life in
country there are always some of unemployment of factor of
production, point D.

From figure above, the point E is unattainable for an economy as it is

outside the PPF .

From the figure above, any point on PPF curve such as (A, B, C) show
potential output (produced output when resource fully utilized)
The implications of production possibility frontier curve include the
following
1. Scarcity and choice- the country cannot produce beyond its PPF
because of scarcity of resources (fixed resources), there is a need to
make choice in what to produce and how much of each of the product
should be produced with the scarce resources, thus E is unattainable
for lack of resources i.e. scarcity of resources does not permit
production of any combination of food and clothing indicated by a
point outside the PPF.

2.Efficiency in production- the PPF shows that points on the curve

(frontier) such as A, B, C shows the efficient utilization of available
resources such that available resources are fully utilized (there is no
wastage); point inside the PPF curve such as D implies under utilization
of resources or unemployment of resources or inefficiency in
production.
3. Opportunity cost- that is illustrated by movement along the PPF
curve, point A to C shows decrease in the output of one commodity
lead an increase in the output of the other.
4. Economic growth is an increase in the country’s productive capacity
or persistent quantitative increase in volume of goods and service
produced in the economy in the given period. This illustrated by shift of
the PPF outward (to the right). However, a fall in quality and quantity of
factor of production due to wars or natural disaster cause the PPF to
shift inward.

Consider the figure below which shows the outward shift of PPF curve
from PPF1 to PPF2
The shift of PPF outward is due to the following reasons
The PPF shift outwards from PPF1 to PPF2
(i) Due to discovery of new natural resources i.e. expansion of
resources or increase in the supply of productive resources labor and
capital.
(ii) Due to improvement in technology that leads to production of more
commodities.
Technology improvement refer to change in production technique so
that more of goods can be produced per unit of time by using a given
quantity resources i.e. technological improvement increases the
productivity of resources, both labor and capital.
(iii) Discovery of new market that encourage further production.
(vii) Improvement in the quantity and quality of factor of production
would increase in potential output not actual output.
READ
Types of PPF
Uses of PPF
Scarcity, choice and opportunity cost
Scarcity- resources are scarce when they are insufficient to satisfy
people’s wants

Choice- the resources available to satisfy people’s wants are at any

time, limited in supply. As most people cannot have all the goods and
services they want have to make choice. If some one wants to buy, for
instance, a new coat they may have to spend less on eating for the
while. Similarly with limited resources, if country wishes to devote
more resources to health care it will have to reduce the resources it
devotes to, for example education
Opportunity cost
In considering scarcity and choice economist make use of opportunity
cost. It make clear the true resource cost of any economic decision. For
instance, building a new hospital may mean that the construction of a
stretch of motorway has to be postponed.

Economic systems
There are a variety of economic systems operating in the world such as
planned economies, market economies and mixed economies.

Economic system refers to ownership, organization, allocation and

distribution of resources in an economy. It shows the nature of
ownership and use of resources and the extent of government
intervention
Economy is a social organism in which people act, interact, cooperate
and compete in the process of production and consumption to make
their living.
Types of economic system

(A) Capitalist economic system or free private enterprise economic

system or unplanned economy or competitive economy or market
economy or laissez-faire.
It is a system of economic organization in which all means of
production (farms, factories, mines, transport, raw material) or
productive resources or factors of production are owned and managed
(controlled) privately by private individuals and firms with little
government interference, the motive of production being to maximize
profits. Examples of capitalist countries include Western Europe, USA,
Canada etc.
Capitalist economic system refer to an economic system in which all resources are
privately owned and resources owner are free to make any economic decisions as
how, when, what, where and for whom to produce without any government
intervention.

The essential features of capitalist economic system

(i) Private property- individual have the legal right to acquire, own or posses, use
or control, dispose of land, buildings, machinery and other natural and man made
resources. (Private property induces its owner to work hard, to organize his
business efficiently and to produce more.

(ii) Freedom of enterprise and choice- individuals or entrepreneurs are free to buy
and hire economic resources to organize these resources for production and to
sell their product in the markets for their own choice. Entreprenuer are risk takers
Freedom of choice mean that the owners of land and capital may use these
resources as they see fit.
 workers are free to enter and leave any occupations for which they qualified-
what about during period of high unemployment??-freedom?
Consumers are free to spend their income in any way they wish. therefore
consumers are free to buy varieties goods and service which suits their tastes and
preferences.
Consumer sovereignty implies consumer is the king in which s/he chooses to spend
his income according to wishes and preference then producers respond to
consumers preference they produce what consumer demand.
(iii) motive of economic activity is self interest - each units individual should be free
to do as they wish (best for itself).
 Decision of (firms-entrepreneurs, businessmen, farmers, producers) in their
productive activity are guided by the private profit or profit motive that induces
firms to put their factor of production into the most productive uses to produce
goods and service, which ensure greater or maximum profit(or minimum losses).
 Owners of land and capital will employ these assets so as to obtain
the highest possible reward
workers will tend to move to those occupation and location which
offer the highest wages
Consumers will spend their income on those things which yield the
maximum satisfaction
(iv) Competition- price competition
There are large numbers of buyers and sellers. Each buyer and seller
account for an insignificant share of business transacted and hence
has no influence on the market demand or market supply. It is the
forces of total demand and total supply which determine the market
price- each buyer and seller are price takers (beyond their influence
and control)
(v) Markets and prices- market economy use of the price mechanism
for allocating resources to various uses. The decisions of producers determine
the supply of a product, the decisions of buyers determine the demand of a
product. The interactions of demand and supply causes change in market prices
in which bring about the changes in ways in which society resources uses its
resources
 in market economy, price acts as a rationing device. Price serves to rations
scarce goods and service among the people who are demanding them.

(B) Socialist economic system or planned or command or centrally planned or

government controlled or collective economies.
the system that material means of production are owned, controlled, regulated
and managed by state or government agencies like central planning authorities
and government ministries on behalf of citizen and all decision about what,
how, for whom to produce are made by centrally planned authority. Such
economies are China, Cuba, Vietnam and North Korea, UK become planned
economy during the WW II
Features or characteristics of pure socialist economic system
(i) Ownership and control of resources- in full planned economy, means
of production such as land, housing, factories, offices, power stations,
transport systems etc are usually owned by state.
Public ownership in these societies because of desire for fair
distribution of income wealth.
Private ownership of property leads to great inequalities of wealth, in
turn wealthier groups are able to exercise greater economic power
such as
 inequalities of opportunity such business opportunity
Better off members of society are able to use their greater wealth to
obtain superior education, better health services, more effective
training.
(ii) Forms of collective control- the ultimate ownership of resources may be in
the hand of the state the control and day-to day running of the farms,
factories, offices and shops may be handed over to operating groups of
collective workers and consumers, that no form of personal income (interest,
rent and profit)which is derived from ownership of property.
(iii) Production decisions- decision on the quantities and varieties of goods and
services to be produced must then be made and each unit of production (e.g.
each farm or factory or mine) will be given target output for the period of the
plan and allocation of the necessary supplies of materials equipments, labor
to the various units of production.
(iv) Distribution decisions- complete distribution of what is produced can then
be allocated to consumers by some kind of physical rationing scheme, workers
could be paid in kind, receiving vouchers. Pattern and volume of consumption
could matched exactly to the planned output.
(v) Assessing consumer demand- planners can test consumer demand by
Continuous poll or carry out survey of public attitudes and preference.
State fix prices and where shortages arise the good or service may be
physically rationed. Movements in retail stocks (shortages and the
surpluses) which act as indicators to the planners.
(vi) Labor market decisions- getting the right amounts of labor in the
right places to meet the production targets cannot achieved by the
direction but is inducement.
Firms which are short of labor will have to be given permission to
offer higher wages in order attract labor from other sources.
In the long run the state can influence the supplies of the different
types of labor by providing more and better training facilities for
those skills which are short supply and reducing the intake of trainee
for occupation where demand is declining.
(C) Mixed economies- the economies with some measure of state control in
market economies. Indeed, there are no pure planned or pure market
economies in the world. Where there is both a public (i.e. a state) sector and a
private sector (where non-government firms and individuals decides what is
produced).
Examples of Mixed Economies, share of Government Spending as a % of GDP
are Iceland (57%) , Sweden (52%) , France (52.8%) , United Kingdom 47.3% ,
United States 38.9, Russia 34.1, China - 20% of GDP, Hong Kong 18.6%
Features or characteristics of mixed economic system or mixed economy
(i) There is public sector which is controlled and directed by the state. The
economic decisions regarding what, how and for whom to produce are taken
by state. Public utilities, such as rail construction, road building, canals, power
supply, means of communication etc are included in the public sector. They
are operated for public welfare and not for profit motive. The public sector
operates basic, heavy, strategic and defence production industries which
require large investment
(ii) There is private sector which produces and distributes goods and service.
Private sector operates in farming, plantations, mines, internal and external
trade, and in the manufacture of consumer’s goods and some capital
goods. This sector operates under state regulations in the interest of public
welfare.

(iii) There is joint sector which is run jointly by the state and private
enterprises. It is organized on the basis of a joint stock company where the
majority shares are held by state.

(iv) There is a cooperative sector formed on cooperative principles. The state

provides financial assistance to the people for organizing cooperative
societies, usually in dairying, storage, processing, farming, and purchase of
consumer goods.
(v) The system maximize social welfare by removing inequalities of
income and wealth, class minimization, unemployment and poverty
through using measures such as social security, public works fiscal
(use of progressive tax) and monetary policies, welfare legislation to
help poor. Further more, concentration and economic power of
monopoly is restricted through fiscal and direct control measures.
The role of government
Creating legal framework- rules and regulations are designed to see
that there is fair play in the competition between producers and in
relations between producers and consumers. For example, Laws
which protect property right and which enforce contractual obligation
(people are legally obligated to pay their debt), prevent dishonest
labeling of product. Example for regulation which insist on adequate
standards of hygiene and on minimum safety standards in
manufacture protect the public from unnecessary dangers and health
hazard
Workers are protected by regulations which govern the condition of work in
factories, offices and shops.
 Supplementing and modifying the price system-certain goods and services
such as defense, internal law and order, education roads and health services
regarded as essential will not provided by market (private enterprise) will be
financed by state.
The government may influence the pattern of production such as the output
of goods and service subject to taxation is likely to fall while subsidies lead
to increase in output.
 Redistributing income and promoting economic welfare- more heavily
taxation on the richer members of society, combined with provision of
benefits for needier group such as child benefit etc
Stabilizing the economy- use level of spending, the amount of investment,
level of employment, rate of inflation and international trade position. The
aim is to ensure a steady rise in output and improvements in living
standards.
Central problems of the economy
Every economic system whether capitalist, socialist or mixed has to
contend with problem of allocating scarce resources or selecting
alternative uses to which scarce resource can put relative to unlimited
wants lies in the pricing system. The problem of choice is often
expressed in term of central problems of economy or questions that
the every economic system must solve.

(i) Which goods and services shall be produced and in what

quantities?
this implies that society has to decide what and range or varieties of
goods should be produced and in what quantities (how many or how
much) are to be produced.
In free enterprise economy or capitalist system the “the what to
produce” is solved by the price mechanism such that goods and
services that are produced by firms in a market economy are
determined by consumers demand i.e. consumer are willing to pay
price per unit sufficiently to cover at least full costs of producing
them, increasing demand for a good cause consumer to pay higher
price make the profit of the producer and increase supply and vice
versa.

In socialist economic system or economy the “what to produce” is

solved by centrally planning authority what commodities and what
quantities should be produced and allocate resources accordingly
depend upon the priorities of the economy.
(ii) How should the various goods and services be produced?-refers to
decision of the choice of combination of factors of production or resources
(land, labor, capital and entrepreneur etc) or choice of different technique of
production such as labor intensive technique or capital intensive technique
to be used in production of goods and service would depend on the
available supplies of different factors of production and relative price, this
problem arises mainly because of scarcity of resources.
Should sports shoes be produced by an automated production line or by
manual workers? Should crops be grown with usage of fertilizers or
organically?
In free enterprises economy or capitalist economy the “how to produce” is
solved by the price mechanism; because the price of a factor normally
represent its relative scarcity, firm produce for profit maximization by
minimizing cost of production or least costs where firm choose or use best
technique of production.
In socialist economic system or economy the “how to produce” is solved by
centrally planning authority that technique of production is chosen by
centrally planning authority keeping in view the plan priorities, availability
and efficient utilization of resources and net social benefit.

(iii) How should the goods and services be distributed-refer to how the total
output (consumer goods or necessities and luxuries) is to be divided or
shared or allocated among different consumers or member of society since
goods and service are scarce in every economy in relation to wants.
 should everyone be given equal share?
Should the division depend upon the individual contribution to production?
Should the output be shared out in accordance with ability to pay for the
price?
 should the shares be decided according to tradition and custom?
In free enterprises economy or capitalist system the problem of “for whom to
produce” is solved by the market mechanism or price mechanism that good
produced for those who have ability and willingness to pay the price of
goods and service. Ability to pay depends on income (determined by
employment pattern of factors). A rich persons may have larger share of
luxuries good because they possesses the means to buy and poor persons
may have more quantities of basic consumers good.

In socialist economic system or economy- the problem “for whom to produce”

is solved through centrally planning authority such that distribution of
national product is based not on purchasing power but on the need of the
people. Goods are normally distributed at fixed prices on ration cards
through government stores.
The objectives of studying economics

(i) Develop an understanding of microeconomic and macroeconomic

theories and concepts and their real-world application.

(ii) Develop an appreciation of the impact on individuals and societies

of economic interactions between nations.

(iii) Develop an awareness of development issues facing nations as they

undergo the process of change.
Reasons For Studying Economics:

It is a study of society and as such is extremely important.

It trains the mind and enables one to think systematically about the
problems of business and wealth.
From a study of the subject it is possible to predict economic trends
with some precision.
It helps one to choose from various economic alternatives.

END