MODULE 2

BASIC CONCEPTS IN ECONOMICS

INTRODUCTION
While having a basic understanding of economic theory isn't perceived as being
as important as balancing a household budget or learning how to drive a car,
the forces that underpin the study of economics impact every moment of our
lives. At the most basic level, economics attempts to explain how and why we
make the purchasing choices we do.

Four key economic concepts—scarcity, supply and demand, costs and benefits,
and incentives—can help explain many decisions that humans make.

Economic concepts refer to the collection of basic ideas that explain various
occurrences in the economy, like the actions and choices of economic agents.
Therefore, a basic understanding of the concepts is important in studying and
analyzing the decisions and behavior of economic agents. For example, it includes
the producers’ and consumers’ decisions on producing and buying.

1. Wants/Ends/Needs:

Want may be defined as an insatiable desire or need by human beings to own

goods or services that give satisfaction. In economics, wants are unlimited while
the means of acquiring them (resources) are limited.

2. Scarcity:

Scarcity is defined as a limited supply of resources which are used for the
satisfaction of unlimited wants. This means that people do not have as much as
they desire. The problem of scarcity arises as a result of the fact that, at any
point in time, the productive resources available in any society are limited,
whereas human wants are unlimited. Scarcity is the central problem of every
society.

3. Choice:

This is defined as a system of selecting one out of a number of alternatives.

Choices become necessary as a result of scarcity. Making a choice implies giving
up something in order to get something else. The concept of choice relates to all
the three main economic agents.

 An individual consumer must choose among types of goods and services

because of his limited income.
 The firm must choose what to produce and how to produce within the
constraint imposed by its limited resources.
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  The government must decide what public goods and services to provide
for the people given its limited revenue as projected in the budget
documents.

4. Scale of Preference:

It is described as a list of all wants to be satisfied in order of priority or

importance. The concept of ‘Scale of Preference’ underscores the basic
assumption in economics that every economic agent exhibits rational behaviour in
the process of making a choice.

5. Opportunity Cost:

Economists use the term ‘opportunity cost’ to mean the next best alternative
forgone in the process of making a choice. To an individual consumer, the
opportunity cost of a commodity bought is the next most desirable commodity he
could have bought instead. For example, Alex has ₦50 and wants to buy Gala
and Cake but discovers that he cannot get both with the amount has because
each item costs ₦50. If he chooses to buy the cake, the gala he sacrifices,
because of limited resources, is the forgone alternative and this is what is
referred to as opportunity cost. Opportunity cost is alternatively referred to as
alternative forgone, real cost, true cost, or economic cost.

ALLOCATION OF RESOURCES
Allocation of resources refers to apportionment of productive assets among
different uses. Resource allocation arises as an issue because the resources of a
society are in limited supply, whereas human wants are usually unlimited, and
because any given resource can have many alternative uses.

How does one choose which commodities and services should be created? Well,
it depends on the type of system that society has. The economic system used by
society, like a market, command, or mixed economy, has a substantial impact
on resource allocation. Each system has its own set of legal frameworks for
allocating limited resources and output.

Market economy is a type of economic structure in which two forces, supply and
demand, govern the creation of products and services. In a market economy, the
government has quite a limited role to play.

Command economy is an economic structure in which a central governing body

determines the permissible levels of output.

Mixed economy is an economic structure that consists of elements of a market

economy and those of a command economy.

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Islamic Economics is an economic system guided by the teaching of Quran and
Hadith and the Jurisprudence of Ulma.

TYPES OF ECONOMIC RESOURCES

The three types of economic resources are commonly known as human resources,
mineral resources and capital resources. Economists often refer to these three
resources as the factors of production.
1. Human resources refer to the output of labor applied to natural
resources for conversion into a tangible good. A tangible good that
began as a natural resource and had conversion by labor into an item
with exchange value is known as wealth. Service is when labor results in
material goods.
2. Mineral resource refers to anything that is found in nature. This includes
sun, air, water and oil. Anything not created by a human being is a
natural resource. All tangible goods known as wealth began as natural
resources. For example, a can of chicken soup once began as vegetable
and animal, and with labor, became a tangible good.
3. Material resource is the conversion of wealth into more wealth, such as the
can of chicken soup that needs more than labor and nature for creation. It
needed machinery and equipment. Also, truck drivers carried the finished
product from one place to another.

FUNDAMENTAL PROBLEMS IN ECONOMICS

The main problem of an economy is of economizing resources: in this sense
economics is the study of the allocation of scarce resources alternative ends. In
other words the fundamental problem of economics is scarcity. Human wants are
unlimited and the means to satisfy them are scarce and limited. Thus, economics is
concerned with problem of using resources to meet the unlimited wants of human
beings. The solution to these problems of allocation scarce resources lies in the
price system, which exists in every economic system whether it is capitalism,
sociology or mixed economy. In an endeavour to solve these problems, the
economist is pre-occupied with the following different questions: -
1. What to Produce and in What Quantities?
The first central problem of an economy is to decide what goods and
services are to be produced and in what quantities. This involves allocation
of scarce resources in relation to the composition of total output in the
economy. Since resources are scarce, the society has to decide about the
goods to be produced: wheat, cloth, roads, television, power, buildings,
and so on.

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 Figure 1

Once the nature of goods to be produced is decided, then their quantities

are to be decided. How many tonnes of wheat, how many televisions, how
many million kws of power, how many buildings, etc. Since the resources of
the economy are scarce, the problem of the nature of goods and their
quantities has to be decided on the basis of priorities or preferences of
the society.

If the society gives priority to the production of more consumer goods now,
it will have less in the future. A higher priority on capital goods implies less
consumer goods now and more in the future. But since resources are
scarce, if some goods are produced in larger quantities, some other goods
will have to be produced in smaller quantities. This problem can also be
explained with the help of the production possibility curve as shown in
Figure 1.

Suppose the economy produces capital goods and consumer goods. In

deciding the total output of the economy, the society has to choose that
combination of capital goods and consumer goods which is in keeping with
its resources.

It cannot choose the combination R which is inside the production possibility

curve PP1 because it reflects economic inefficiency of the system in the
form of unemployment of resources. Nor can it choose the combination R
which is outside the current production possibilities of the society. The
society lacks the resources to produce this combination of capital goods
and consumer goods.

It will, therefore, have to choose among the combinations В, E, or D which

give the highest level of satisfaction. If the society decides to have more
capital goods, it will choose combination B; and if it wants more consumer
goods, it will choose combination D.

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2. How to Produce these Goods?
The next basic problem of an economy is to decide about the techniques
or methods to be used in order to produce the required goods. This
problem is primarily dependent upon the availability of resources within
the economy.

If land is available in abundance, it may have extensive cultivation. If land

is scarce, intensive methods of cultivation may be used. If labour is in
abundance, it may use labour-intensive techniques; while in the case of
labour shortage, capital-intensive techniques may be used.

The technique to be used also depends upon the type and quantity of
goods to be produced. For producing capital goods and large outputs,
complicated and expensive machines and techniques are required. On the
other hand, simple consumer goods and small outputs require small and
less expensive machines and comparatively simple techniques.

Further, it has to be decided what goods and services are to be produced

in the public sector and what goods and services in the private sector. But
in choosing between different methods of production, those methods
should be adopted which bring about an efficient allocation of resources
and increase the overall productivity in the economy.

Suppose the economy is producing certain quantities of consumer and

capital goods at point A on PP curve in Figure 2. у adopting new
techniques of production, given the supplies of factors, the productive
efficiency of the economy increases. As a result, the PP 0 curve shifts
outwards to P1P1. It leads to the production of more quantities of consumer
and capital gods from point A on PP0 curve to point С of PP with be the
new production possibility curve and the economy will move from point A
to В where more of both the goods are produced.

Figure 2

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3. For whom is the Goods Produced?
The third basic problem to be decided is the allocation of goods among
the members of the society. The allocation of basic consumer goods or
necessities and luxuries comforts and among the household takes place on
the basis of among the distribution of national income.

Whosoever possesses the means to buy the goods may have then. A rich
person may have a large share of the luxuries goods, and a poor person
may have more quantities of the basic consumer goods he needs. This
problem is illustrated in Figure 3 where the production possibility curve PP
shows the combinations of luxuries and necessaries.

At point В on the PP curve, the economy is producing more of luxuries ОС

for the rich and less of necessaries ОС for the at whereas at point D more
of necessaries OH are being produced for the poor and less of luxuries
OF for the rich.

Figure 3

4. How efficiently are the Resources being utilised?

This is one of the important basic problems of an economy because having
made the three earlier decisions, the society has to see whether the
resources it owns are being utilised fully or not. In case the resources of the
economy are lying idle, it has to find out ways and means to utilise them
fully.

If the idleness of resources, say manpower, land or capital, is due to their

misallocation, the society will have to adopt such monetary, fiscal, or
physical measures whereby this is corrected. This is illustrated in Figure 4
where the production possibility curve PP reflects idle resources within the
economy at point A, while the production possibility curve P 1P1 reflects the
full utilisation of the resources at point В or C.

It is for the society to decide whether to produce more capital goods at

point В or more consumer goods at point C, or both at point D at the level
of full employment represented by the In an economy where the available

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 resources are being fully utilised, it is characterised by technical efficiency
or full employment.

To maintain it at this level, the economy must always be increasing the

output of some goods and services by giving up something of others.

Figure 4

5. Is the Economy Growing?

The last and the most important problem is to find out whether the
economy is growing through time or is it stagnant. If the economy is
stagnant at any point inside the production possibility curve, says in Figure
5, it has to be moved on to the production possibility curve PP whereby
the economy now produces larger quantities of consumer goods and
capital goods. Economic growth takes place through a higher rate of
capital formation which consists of replacing existing capital goods with
new and more productive ones by adopting more efficient production
techniques or through innovations. This leads to the outward shifting of the
production possibility curve from PP to P1P1; (in Figure 5). The economy
moves, say after 5 years, from point A to В or С or D on the P1P1 curve.
Point С represents the situation where larger quantities of both consumer
and capital goods are produced in the economy. Economic growth enables
the economy to have more of both the goods.

Figure 5
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6. Is the economy's capacity to produce goods and services growing from
year to year or at least remaining static? Here, if the economic capacity
to produce goods and services is growing time to time as a result of
technological advancement as well as advertisement of that society then
there will be an increase in the level of output being produced by that
society. In other word, there is economic growth in the society. Economic
growth is defined as the total increase in the level of output being
produced by a society, which is the same thing as an outward shift of
production possibility curve (PPC).

All these central problems of an economy are interrelated and interdependent.

They arise from the fundamental economic problems of scarcity of means and
multiplicity of ends, which lead to the problem of choice or economizing of
resources.

THE METHODOLOGY OF ECONOMICS

The methodology of economics helps economists understand economic
phenomena, predict future trends, and inform policy decisions.

The methodology of economics involves the systematic study of economic

phenomena using various approaches and techniques. Key aspects include:
1. Observation and Data Collection: Gathering data on economic variables
and phenomena.
2. Theory Development: Formulating hypotheses and theories to explain
economic relationships.
3. Model Building: Creating mathematical or statistical models to analyse
economic systems.
4. Empirical Testing: Evaluating hypotheses and models through data and
statistical techniques.
5. Analysis and Interpretation: Interpreting results, drawing conclusions, and
making policy recommendations.

In economics, inductive and deductive methods are used to develop and test
theories.

INDUCTIVE METHOD
Inductive methods are us in economics to test theories from particular to general.
It has possess the following features:
1. Observation: Collecting data and observing economic phenomena.
2. Pattern Identification: Identifying patterns and relationships in the data.
3. Generalization: Drawing general conclusions or theories based on specific
observations.
Example: Analysing historical data on economic growth and inflation to identify
trends.

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DEDUCTIVE METHOD
Inductive methods are us in economics to test theories from general to particular.
It possesses the following features:
1. Theory Development: Formulating a theory or hypothesis based on
assumptions.
2. Logical Reasoning: Using logical reasoning to derive conclusions from the
theory.
3. Testing: Testing the theory against empirical evidence.

Example: Developing a theory of consumer behaviour based on assumptions

about rational choice, and then testing it using survey data.

Both methods are essential in economics, and researchers often combine them to
develop and test theories.

STUDY QUESTIONS
1. Distinguish between inductive and deductive methods of testing theories
2. What is Economics
3. Why do we study Economics
4. Outline and explain the basic concepts in Economics
5. Discuss the subject matter of Economics and five (5) different questions
economists seek to answer.
6. Explain how the resources are allocated in various economic system.