INTRODUCTION

PART 1

CHAPTER

Getting Started

1.1 DEFINITION AND QUESTIONS

All economic questions and problems arise

because human wants exceed the resources
available to satisfy them.

Scarcity
The condition that arises because the available
resources are insufficient to satisfy wants.
Unlimited wants a new handphone, a high end
lap top, a brand new car, more free time
Limited resources time, income

Scarcity is not the same as Poverty

Poverty lack of money
Scarcity inability to satisfy all wants and
needs
Rich and poor alike, face scarcity
Very rich people too face the problem of scarcity,

e.g. a desire to go for a holiday, but no free time.

Making Choices

Faced with scarcity, we must make choiceswe

must choose among the available alternatives.
Buy an economic textbook vs monthly
handphone top up
Study for an economic test or Watch a movie
Work or study
The choices we make depend on the incentives
we face.

EXAMPLES
Here are some examples of scarcity and the trade-offs
associated with making choices:
You have a limited amount of time. If you take a part-time job,
each hour on the job means one less hour for study or play.

A city has a limited amount of land. If the city uses an acre of

land for a park, it has one less acre for housing, retailers, or
industry.
You have limited income this year. If you spend $17 on a music
CD, thats $17 less you have to spend on other products or to save.

1.1 DEFINITION AND QUESTIONS

Economics
The social science that studies the choices that we make
as we cope with scarcity and the incentives that
influence and reconcile our choices.

The big economic questions:

How choices determine what, how, and for whom
goods and services get produced?

1.1 DEFINITION AND QUESTIONS

What, How, and For Whom?

Goods and services
The objects (goods) and actions (services) that people
value and produce to satisfy human wants.
What goods and services get produced and in what
quantities?
How are goods and services produced?
For Whom are the various goods and services
produced?

2.1 WHAT, HOW, AND FOR WHOM?

What Do We Produce?
We divide the vast array of goods and services
produced into:

Consumption goods and services

Capital goods
Government goods and services
Export goods and services

2.1 WHAT, HOW, AND FOR WHOM?

Consumption goods and services

Goods and services that are bought by individuals and
used to provide personal enjoyment and contribute to a
persons standard of living. For example, movies and
Laundromat services.

Capital goods
Goods that are bought by businesses to increase their
productive resources. For example, cranes and trucks.

2.1 WHAT, HOW, AND FOR WHOM?

Government goods and services

Goods and services that are bought by governments.
For example, missiles, bridges and police protection.

Export goods and services

Goods and services produced in one country and sold
in other countries. For example, airplanes produced by
Boeing and Citicorp banking services sold to China.

2.1 WHAT, HOW, AND FOR WHOM?

How Do We Produce?
Factors of production
The productive resources used to produce goods and
services.
Factors of production are grouped into four categories:

Land
Labor
Capital
Entrepreneurship

2.1 WHAT, HOW, AND FOR WHOM?

Land
All the gifts of nature that we use to produce goods
and services. All the things we call natural resources.

Land includes minerals, water, air, wild plants,

animals,birds, and fish as well as farmland and forests.

2.1 WHAT, HOW, AND FOR WHOM?

Labor
The work time and work effort that people devote to
producing goods and services.

The quality of labor depends on how skilled people

arewhat economists call human capital.

Human capital
The knowledge and skill that people obtain from
education, on-the-job training, and work experience.

2.1 WHAT, HOW, AND FOR WHOM?

Capital
Tools, instruments, machines, buildings, and other
items that have been produced in the past and that
businesses now use to produce goods and services.
Capital includes semifinished goods, office buildings,
and computers. Capital does not include money,
stocks, and bonds. They are financial resources.

2.1 WHAT, HOW, AND FOR WHOM?

Entrepreneurship
The human resource that organizes labor, land, and
capital.

Entrepreneurs come up with new ideas about what and

how to produce, make business decisions, and bear the
risks that arise from these decisions.

2.1 WHAT, HOW, AND FOR WHOM?

For Whom Do We Produce?

Answer depends on incomes that people earn and the prices
they pay for the goods and services they buy

Factors of production are paid incomes:

Rent Income paid for the use of land.
Wages Income paid for the services of labor.
Interest Income paid for the use of capital.
Profit (or loss) Income earned by an entrepreneur for
running a business.

Examples

With more research, we could cure cancer

More research How; cure cancer What

A good education is the right of every child

good education What; every child Who

1.2 THE ECONOMIC WAY OF THINKING

Micro and Macro Views of the World

Microeconomics: The study of the choices that
individuals and businesses make and the way these
choices interact and are influenced by governments.

Macroeconomics: The study of the aggregate (or

total) effects on the national economy and the global
economy of the choices that individuals, businesses,
and governments make.

MICRO vs MACRO ISSUES

People must install catalytic converters in

their car.
A microeconomic issue because it deals with what
individuals must do.

US unemployment should be much lower

A macroeconomic issue because total employment is
considered from the vantage of the nation as a whole

MICRO vs MACRO ISSUES

All issues have a micro and macro

dimensions:
Effects of globalization on the textile industry is a micro
topic but its effect on average incomes in Malaysia is a
macro topic.
The influence of the Internet and online commerce is a
micro topic, its influence on economy wide production is
a macro topic.
Unemployment in a particular industry is a micro topic
but national unemployment is a macro topic.

1.2 THE ECONOMIC WAY OF THINKING

Economists distinguish between positive and

normative statements.
Positive statements: What is
What is currently understood about how the world
operates
Might be right or wrong
Can be tested by checking it against the data

Normative statements: What ought to be

- Depends on values and cannot be tested

EXAMPLES

EXAMPLE 1
Global Warming
Our planet is warming because of an increased carbon
dioxide buildup in the atmosphere.
-A positive statement because it can be tested.
We should cut back on our use of carbon-based fuels
such as coal and oil.
-A normative statement. You may agree or disagree
but you cannot test it. It is based on values.

EXAMPLE 2
Table 1.1 COMPARING POSITIVE AND NORMATIVE QUESTIONS
Positive Questions

Normative Questions

If the government increases the

Should the government increase the
minimum wage, how many workers will
minimum wage?
lose their jobs?
If two office-supply firms merge, will the Should the government block the
price of office supplies increase?
merger of two office-supply firms?
How does a college education affect a
persons productivity and earnings?

Should the government subsidize a

college education?

How do consumers respond to a cut in

income taxes?

Should the government cut taxes to

stimulate the economy?

If a nation restricts shoe imports, who

benefits and who bears the cost?

Should the government restrict

imports?

1.2 THE ECONOMIC WAY OF THINKING

Core Economic Ideas:

Rational choice
Cost
Benefit
Margin

1.2 THE ECONOMIC WAY OF THINKING

Rational Choice
Rational choice
A choice that uses the available resources to best
achieve the objective of the person making the choice.
We make rational choices by comparing costs and
benefits.

1.2 THE ECONOMIC WAY OF THINKING

Cost: What You Must Give Up

Opportunity cost
The best thing that you must give up to get
somethingthe highest-valued alternative forgone.
-e.g. 2 hours on a weekend night
-Choices: study for economic test, surf the net,
watch movie, leisure reading.
Only the alternative forgone, not every expenditure
that is made.
-e.g. tuition fee is part of the opportunity cost. But
your meal is not.

ECONOMIC WAY OF THINKING

Sunk Cost
A previously incurred and irreversible cost.

Sunk costs are costs that cannot be avoided,

regardless of what is done in the future,
because they have already been incurred and
cannot be refunded.
Example:
Suppose you have paid your tuition fees and it is non
refundable. If you are contemplating to quit now, the
paid tuition is irrelevant. Whether you remain in school
or quit, the tuition that you have paid is not part of the
opportunity cost of remaining in school.

EXAMPLE
Suppose that you have purchased a round-trip ticket to
the Bahamas for spring break. The ticket is nonrefundable and cannot be changed. Your best friend
tells you that she is getting married during the same
week in Chicago (where you live) and has asked you to
be in the wedding party. Does the price you paid for
your Bahamas trip matter in your decision of whether to
go to the Bahamas or Chicago? Why or why not?
It should not matter because the plane fare is a
sunk cost. No matter what decision you make, you
will have to pay for the ticket to the Bahamas.

1.2 THE ECONOMIC WAY OF THINKING

Benefit:
The gain or pleasure that something brings.
Measured by what you are willing to give up

e.g. choices: hand phone or economic textbook

The hand phone that you are willing to give up to get
the economic textbook measure the benefit that you
get from the textbook.

1.2 THE ECONOMIC WAY OF THINKING

On the Margin
Margin
A choice that is made by comparing all the relevant
alternatives systematically and incrementally.

1.2 THE ECONOMIC WAY OF THINKING

Marginal Cost

The cost of a one-unit increase in an activity

- What you must give up to get one more unit of something
- Marginal cost of any activity increases as you do more of it.
e.g. going to movies decreases study time, hence your grade.
Seeing second movie lowers your grade by 5%. Seeing the third
movie could reduce your grade by more than that, lets say 7%.

 Marginal Benefit
- What you gain when you get one more unit of something.
-Measured by what you are willing to give up to get that one
additional unit.
-Fundamental feature of marginal benefit: it diminishes.
- Seeing movies in a week. The more movies you see, the
marginal benefit of each subsequent movies decreases. So,
you are willing to give up less to see another additional
movie for the week.

Making a Rational Choice

When we take those actions for which marginal
benefit exceeds or equals marginal cost.

What you gain when you get one more unit of

something
must exceeds or at least equals to

What you must give up to get one more unit of

something

EXAMPLE
Kate tennis (2 hours), Math grade 70%
Kate considered playing for another hour, cut her Math
study time by one hour.
Her Math grade fell to 60%

What is her opportunity cost of the third hour of tennis?

Given that Kate played the third hour, what can you conclude
about her MB and MC of the second hour of tennis?
Was Kates decision to play the third hour of tennis rational?
Did Kate make her decision on the margin?

Solutions to Example 1

10 percentage point drop in her grade.

MB (from the second hour) must have exceeded
the MC because Kate chose to play the third
hour.
If MB exceeds MC, then Kates decision was
rationale.
Kate made her decision on the margin because
she considered the benefit and cost of one
additional hour.

EXAMPLE 2

If a bus company adds a 3rd daily bus trip

between 2 cities, the companys total cost will
increase from RM500 to RM600. Its total
revenue will increase by RM150 a day. Should
the company add the third bus?
MC of increasing daily trip = RM100
MB of increasing daily trip = RM150.
So, MB > MC. The company should add the
daily trip.

2.2
THE MARGINAL PRINCIPLE

How Many Movie

Sequels?
MB decreases because
revenue falls off with
each additional movies
MC increases because
actors demand higher
salaries