ECON107Principles of

MicroeconomicsWeek 2

FEB 2014

1

Chapter-1

Lesson Objectives Define economics and distinguish between

microeconomics and macroeconomics.

Explain the two big questions of economics.

Explain the key ideas that define the economic way of thinking.

Explain how economists go about their work as social scientists and policy advisers

2

3

Definition of EconomicsEconomics is the social science concern that studies of how individuals, businesses, governments, and entire societies use their scarce resources to satisfy their unlimited wants. Economics divides in two main parts: Microeconomics Macroeconomics

4

Definition of Economics

Microeconomics is the study that deals with an individual industry, firm or household. It means it talk about individual decision maker.

An example of a microeconomic question is: Why is Dr.Islam buying more e-books and fewer hard copy books?

5

Definition of Economics

Macroeconomics is a study that examine the economy as a whole. It means that it is concerned with the overall performance of the economy.

An example of a macroeconomic question is: Why is the women unemployment rate in the Kingdom of Saudi Arabia so high?

6

Key Tools and Terms of Economics

ECONOMIC PROBLEM

Basic economic problem is wants are virtually unlimited while the resources available to satisfy these wants are scarce.

7

Key Tools and Terms of EconomicsSCARCITYLack of enough resources to satisfy our all desired uses of those resources. Resource are scarce when they are not freely available alternatively we can say when its price exceeds zero. Since human and property resources are scarce, it follows that the goods and services we produce must also be limited.

8

Key Tools and Terms of EconomicsCHOICEDue to scarcity, we can’t have all that we want. We must decide what we will have, and what we must forgo. That is why we make choices.Goods

Tangible items Require scarce resources Satisfy human wants

Services Intangible items Require scarce resources Satisfy human wants

9

Two Big Economic Questions Two big questions summarize the

scope of economics:How do choices end up determining

what, how, and for whom goods and services get produced?

When do choices made in the pursuit of self-interest also promote the social interest?

10

What, How, and For Whom?

Goods and services are the things that people value and produce to satisfy human wants.

What?In 2011, Agriculture accounts for 2% of total Saudi Arabian production, Industry goods for 69.1%, and Services for 28.9% (Source:  Central Intelligence Agency (CIA) World Factbook 2012).

11

Two Big Economic Questions

How?

Goods and services are produced by using productive resources that economists call factors of production.Factors of production are grouped into four categories: Land Labor Capital Entrepreneurial Ability

12

Two Big Economic Questions

LANDIt does not refer only a plots of ground but also includes all other natural resources such as crude oil, water, air, and minerals etc. that we use to produce goods and services LABOR

It is not simply the number of human bodies but it refers to the work time and work effort that people devote to producing goods and services. It categorized into two parts– physical and mental (9.56 millions out of 26.53 millions in 2010 where about 80% of the

labor force is non-national - Source: CIA World Factbook 2012).

13

Two Big Economic Questions

CAPITALIn economics the term capital refers to final goods produced for use in further production. It also categorized into two parts. These are:

Physical capital: factories, machines, tools, buildings, airports, highways and other manufactured items employed to produce goods and services.

Human capital: consists of the knowledge and skill people acquire to enhance their labor productivity.

14

Two Big Economic Questions

ENTREPRENEURIAL ABILITY Special kind of human skill Talent required to dream up a new product or

find a better way to produce an existing one.

15

Two Big Economic Questions

For Whom?

Who gets the goods and services depends on the incomes that people earn. Land earns rent.

Labor earns wages.

Capital earns interest.

Entrepreneurial ability earns profit.

16

Two Big Economic Questions

Self-Interest

People always try to make the best choices they can, given the available information. Moreover, Individuals try to maximize the expected benefit achieved with a given cost or minimize the expected cost of achieving a given benefit. Peoples allocate their time, energy, and money to maximize it.

17

Two Big Economic Questions

Social InterestChoices that are best for society as a whole are said to be in the social interest. Social interest has two dimensions: Efficiency Equity

18

Two Big Economic Questions

Efficiency and Social InterestResource use is efficient if it is not possible to make someone better off without making someone else worse off.

Equity and Social InterestEquity is fairness. The idea that the social interest requires “fair shares” is a deeply held one.

19

Two Big Economic Questions

The Economic Way of ThinkingSix key ideas define the economic way of thinking: A choice is a tradeoff. People make rational choices by comparing benefits and costs. Benefit is what you gain from something. Cost is what you must give up to get something. Most choices are made based on “how-much” at the margin. Choices respond to incentives.

20

Economics: A Social Science and Policy Tool

Economics as Social ScienceEconomists distinguish between two types

of statement: What is —positive statements What is —normative statements

Positive economic statementAbsolute Facts. A statement about

economic reality that can be supported or rejected by test.

21

Economics: A Social Science and Policy Tool

Normative economic statementWhat Ought to beReflects an opinion.Cannot be shown to be true or false by

reference to the facts.Most of the disagreements in economics

involve normative debates.A normative statement can not be tested.

22

Economics: A Social Science and Policy Tool

Scientific MethodTo study economic problem, economists

employ a process of theoretical investigation that is called the scientific method. It consists four steps:

A.Identify the question and define relevant variables

B.Specify assumptionsC.Formulate a hypothesisD.Test the hypothesis

23

Economics: A Social Science and Policy Tool

Identify the Question and Define Relevant Variable.

Example: The question might be “ What is the relationship between the price of Al-Baik and the quantity of Al-Baik purchased?

Relevant variables of this question are ‘Price and Quantity’.

24

Economics: A Social Science and Policy Tool

Specify AssumptionsOne major category of assumptions is the ‘other things constant assumption’. It is called ‘ceteris paribus’ assumption. To isolate the relation between ‘price and quantity’, we assume that there are no changes in other relevant variables such as income, the price of McDonald, the price of KFC, the price of chicken etc.

25

Economics: A Social Science and Policy Tool

Formulate a hypothesisHypothesis refers a theory about relationships among key variables. It means a theory about how key variables relate to each other. From our example, what will happen to the quantity purchased of Al-Baik if the price of Al-Baik goes up.

26

Economics: A Social Science and Policy Tool

Test the hypothesisBy comparing its predictions with evidence, we test the validity of a hypothesis. The test lead us either to (1) Reject the hypothesis or (2) except the hypothesis.

27

Economics: A Social Science and Policy Tool

Economics as Policy ToolEconomics is a way of approaching problems in all aspects of our lives. Three broad areas are Personal economic policy Business economic policy Government economic policy

28

After studying this appendix, you will be able to:

Make and interpret a scatter diagram.

Identify linear and nonlinear relationships and relationships that have a maximum and a minimum.

Define and calculate the slope of a line.

29

After studying this appendix, you will be able to:

Scatter DiagramsA scatter diagram plots the value of one variable against the value of another variable for a number of different values of each variable.

A scatter diagram reveals whether a relationship exists between the two variables.

30

After studying this appendix, you will be able to:

31

Figure A1.4(a) is a scatter diagram of income and expenditure, on average, during a ten-year period.

Point A shows that in 2006, income was $33,000 and expenditure was $31,000.

The graph shows that as income increases, so does expenditure, and the relationship is a close one.

After studying this appendix, you will be able to:

32

A relationship between two variables that move in same directions is called a positive relationship.

After studying this appendix, you will be able to:

33

A relationship between two variables that move in opposite directions is called a negative relationship or an inverse relationship

After studying this appendix, you will be able to:

34

The relationship that have a Maximum or a Minimum

After studying this appendix, you will be able to:

35

The slope of a relationship is the change in the value of the variable measured on the y-axis divided by the change in the value of the variable measured on the x-axis.We use the Greek letter (capital delta) to represent “change in.”So y means the change in the value of the variable measured on the y-axis and x means the change in the value of the variable measured on the x-axis.Slope equals y/x.

After studying this appendix, you will be able to:

36

After studying this appendix, you will be able to:

37

The Slope of a Curved Line:

Now it’s over for today. Do Now it’s over for today. Do you have any question?you have any question?

38