Preliminaries Basic Concepts of Economics

Preliminaries and Basic Concepts

BUS 509: Introduction to Economics

DR. FAYQ AL AKAYLEH PAGE 1 OF 5

PRELIMINARIES AND BASIC CONCEPTS

WHAT IS ECONOMICS?

Economics is a branch of social sciences, which deals with the study of choice

under conditions of scarcity. In other words, Economics is the study of allocation

of the scarce (limited) resources to satisfy the unlimited human needs (wants).

Scarcity: - is the case in which the availability of anything is insufficient to satisfy

the need (want) for it.

From the above mentioned definitions, the problem that economics introduced into

literature to solve can be presented in three main questions:

1- What to produce?

2- How to produce?

3- For whom to produce?

Resources: Those resources that we use to produced goods and services. The key

resources are represented in Factors of Production, which can be categorized into

Land, Labor, Capital and Entrepreneurship.

1- Land:- Land is that physical space on which production processes take place,

which also includes natural resources such as crude oil, raw phosphate, potash

and water.

2- Labor: Labor is the volume of human being or the time human being spend to

produce goods and services a nation needs.

3- Capital: Capital is a tool which is produced and then used to produce other

goods or services, and last for at least one year. There are two types of capital,

namely Physical Capital and Human Capital.

- Physical Capital: is that portion of capital stock such as machineries,

equipments, etc.




- Human Capital: is the accumulation of knowledge, skills, training

and experience of the labor force.

4- Entrepreneurship: is the management of the use of the other resources

(labor, land and capital) in order to obtain an effective production process.

It is very important to distinguish between factors of production and inputs.

An input: is any object used to produce good or service, such as wires, cement

electricity, labor, capital, all raw materials, intermediate goods or services, and all

factors of production. Every factor of production is an input but not every input is a

factor of production.

Inputs include:

Factors of Production.

Raw Materials.

Social Choice: in the case of society, the problem is then a scarcity of resources. In

the light of this scarcity, the society choice is to achieve high standard of living for

individuals, clean environment, safe streets, food security and more.

In order to solve the above mentioned problem, two types of economics are used to

solve this problem, namely Microeconomics and Macroeconomics.

- Microeconomics is the study of the behavior of individual households, firms and

governments, including the choices they make and their interaction in particular

markets.

- Macroeconomics is the study of the behavior of the overall economy. For

instance, aggregate demand and aggregate supply of a nation (or a country).

POSITIVE AND NORMATIVE ECONOMICS:

Positive Economics is the study, analysis and description of the world as it is, and is called as

Descriptive Economics.




Normative Economics, on the other hand, is the study of how to theoretically understand

economics. In other words, Normative Economics is the study of "How the world should be

(ought to be). Normative Economics is called Prescriptive Economics.

For example: When the money supply in Saudi Arabia increased from SR 789755 million in

2007 to SR 929125 million in 2008. This statement describes the Saudi money market as it is

in 2007 and 2008. But if a statement is that: in macroeconomics, there is a positive

relationship between money supply and inflation, then such a statement lies under Normative

Economics (or Prescriptive Economics).

IMPORTANCE OF ECONOMICS (WHY STUDY ECONOMICS?)

We study economics for various purposes amongst which are the following:

1- To understand the world better:

- Relationship between economics and environment.

- Relationship between economics and politics and wars.

- Relationship between economics and medicine, and so on.

2- To achieve social change.

In our world there are a large number of serious social problems such as poverty,

malnutrition, unemployment, hunger, diseases, child abuse, drug addiction, etc.

Economics can help us to understand the causes and effects of these problems and

to introduce new and more effective solutions.

3- As a prerequisite for other careers.

Almost all life practical fields need knowledge of economic theory. Lawyers,

doctors, psychologists, businessmen, planners, government employees etc, all

need a sufficient knowledge in economic theory and analysis.

4- To become an economist.

That is, to become a scientist, a businessman, or an academician.




HOW TO UNDERSTAND ECONOMIC THEORY?

To understand anything in real life, one may need different models. Children dolls are

representative for real world, which is child uses and plays with model cars, model

tanks, etc.

To study the geography and demography, geographists represent the whole world on a

map. This map is a model.

Similarly, to understand economics, one should explain the economic phenomena

using various models. In general, a model is an abstract representation of reality.

We proceed explaining how to understand economic theory using models with the

help of the following example:

The economic theory (Economic Phenomena) states that "there is a positive

relationship between income and consumption".

To understand the above economic phenomenon, we explain it in a model.

Each economic model includes the followings:

i. The original economic statement: There is a direct and positive relationship

between income and consumption.

ii. Logic: Why should this relationship be? Logically, consumers always seek to

maximize their social and economic welfare (utility maximization), to

maximize their welfare they need to consume more goods and services in

terms of quality and quantity. To consume more, people need to spend on this

consumption and, therefore, they need more money incomes. Thus, as income

increases consumption increases and vice-versa.

iii. Assumptions: Simplifying assumptions and critical assumptions.

Simplifying assumptions are used to better understanding the theory, and can

be relaxed once the basic theory is understood. Like the assumption of

"Ceteris Paribus"-Everything else is kept constant when a study of particular

variables is performed.




Critical assumptions are those assumptions without which the theory in

question cannot work. If these critical assumptions are realistic then the theory

would be true, otherwise it is invalid.

iv. Tables, Graphs and symbols.

v. Mathematics: (C= a+bY).

vi. Conclusions.

Preliminaries Basic Concepts of Economics

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