1. Introduction to Economics How Economics Originated? Economics and Government How do we define it? What are its branches? What is Opportunity cost? What is GDP? The three basic questions for any economy Welfare Economics Market Structures

2. The Theory of Social Contract Thomas Hobbes Nature is always in a state of conflict John Locke Nature is in a state of harmony

3. Thomas Hobbes (1651)

4. Hobbes was the supporter of absolutism. In the opinion of Hobbes, “law is dependent upon the sanction of the sovereign. Government without sword are but words and of no strength to secure a man at all ”.

5. According to Locke, The purpose of Government and law is to uphold and protect the natural rights of men. When it ceases to fulfilil this purpose, the Government can be thrown out of power. In Locke’s view, unlimited sovereignty is contrary to natural law

6. Adam Smith 18 th century Scottish economist Published “The Wealth of Nations” in 1776 Explained the workings of the free market within capitalist economies Invisible hand of the market

7. Adam Smith Laissez-faire - Government stays out of business practices “hands off” to let the market determine production, consumption and distribution. Individual freedom and choice emphasized.

8. 8 The Foundation of Economics Economics is the study of what constitutes rational human behavior in the endeavor to coordinate between limited resources (that have alternative uses) and unlimited wants. Economics is the study of what constitutes rational human behavior in the endeavor to coordinate between limited resources (that have alternative uses) and unlimited wants. -Lionel Robbins -What is Economics?

9. William Baumol says, let the subject matter speak for itself. The Basic Function: To observe, explain and predict how people (individuals, households, firms and the Government) make choice about resources (land, labour, capital, etc.)

10. 10 ECONOMICS MICROMACRO

11. The Study of Economics Macroeconomics – The big picture: growth, employment, etc. – Choices made by large groups (like countries) Microeconomics – How do individuals make economic decisions

12. 12 Micro Economics Micro Economics studies how the individual parts of the economy make decisions to allocate limited resources Micro Economics studies how the individual parts of the economy make decisions to allocate limited resources Microeconomics studies: Microeconomics studies: – how individuals use limited resources to meet unlimited needs – the consequences of their decisions – the behaviour of individual components like industries, firms and households. – how individual prices are set – what determines the price of land, labour and capital – inquire into the strengths and weaknesses of the market mechanism.

13. 13 Macro Economics Macroeconomics studies about the functioning of the economy as a whole Macroeconomics studies about the functioning of the economy as a whole It examines the economy through wide-lens. It examines the economy through wide-lens. Macroeconomics studies about Macroeconomics studies about the total output of a nation the total output of a nation the way the nation allocates its limited resources of land, labor and capital the way the nation allocates its limited resources of land, labor and capital the ways to maximize production levels the ways to maximize production levels the techniques to promote trade the techniques to promote trade After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning. After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning.

14. PRODUCTION A measure of the production of an entire country in one year is GDP The total money value of ALL final Goods and Services produced in a country in a year. (GROSS DOMESTIC PRODUCT)

15. The three basic questions What to produce? (what not to produce) How to produce? (refers to choice of technique) How much to produce? (determination of quantity)

16. There is a fourth question: For whom to produce?

17. 17 In a pure market economy there is no government intervention in economic decisions. Market Economies Contd….

18. 18 The Government lets the market answer the following three basic economic questions: 1. What ? Consumers decide what should be produced in a market economy through the purchases they make. Consumers decide what should be produced in a market economy through the purchases they make. 2.How ? Production is left entirely up to businesses. Businesses must be competitive in such an economy and produce quality products at lower prices than their competitors. 3.For whom ? In a market economy, the people who have more money are able to buy more goods and services. In a market economy, the people who have more money are able to buy more goods and services.

19. Karl Marx 19 th century German economist Author of “Communist Manifesto” and “ Das Kapital” – Government should control economy and distribute goods and services to the people

20. 20 In a command economy the Government takes economic decisions. Command Economies

21. 21 In a command economy the Government answers the three basic economic questions. In a command economy the Government answers the three basic economic questions. 1. What? A central planning committee decides what products are needed. 2. How? Since the Government owns all means of production in a command economy, it decides how goods and services will be produced. Since the Government owns all means of production in a command economy, it decides how goods and services will be produced. 3. For Whom ? The Government decides who will get what is produced in a command economy. The Government decides who will get what is produced in a command economy. Command Economies

22. 22 In the Mixed economies the Government and the Market work together in decision making Mixed Economies

23. John Maynard Keynes The Invisible Hand doesn’t always work. “The long run is a misleading guide to current affairs. In the long run we are all dead.” or... the trouble is people eat in the short run.

24. Keynesian Economics Government should intervene in economic emergencies through tax and spending (Fiscal Policy) and changing the money supply (Monetary Policy). This is done to smooth out the business cycle (expansion and recession) and keep inflation low.

25. 25 Opportunity Cost  Definition – the cost expressed in terms of the next best alternative sacrificed  The cost of anything in terms of other things given up or sacrificed.

26. 26 Production Possibility Frontiers PPF Shows the different combinations of goods and services that can be produced with a given amount of resources PPF Shows the different combinations of goods and services that can be produced with a given amount of resources No ‘ideal’ point on the curve No ‘ideal’ point on the curve Any point inside the curve – suggests resources are not being utilised efficiently Any point inside the curve – suggests resources are not being utilised efficiently Any point outside the curve – not attainable with the current level of resources Any point outside the curve – not attainable with the current level of resources Useful to demonstrate economic growth and opportunity cost Useful to demonstrate economic growth and opportunity cost

27. Production Possibility Frontiers Capital Goods Consumer Goods Yo Xo A B Y1 X1 Assume a country can produce two types of goods with its resources – capital goods and consumer goods If it devotes all resources to capital goods it could produce a maximum of Ym. If it devotes all its resources to consumer goods it could produce a maximum of Xm Ym Xm If it reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of pro If the country is at point A on the PPF It can produce the combination of Yo capital goods and Xo consumer goods ducing an extra Xo – X1 consumer goods is Yo – Y1 capital goods.

28. Production Possibility Frontiers Capital Goods Consumer Goods Yo Xo A.B.B C Y1 X1 Production inside the PPF – e.g. point B means the country is not using all its resources It can only produce at points outside the PPF if it finds a way of expanding its resources or improves the productivity of those resources it already has. This will push the PPF further outwards.

29. 29 Vilfredo Pareto (1848-1923) Founder of modern welfare economics Most famous contribution: “Pareto Optimality” – Maximum welfare = no change could make anyone better off without making someone worse off.

30. Allocative Efficiency or Pareto optimality. Pareto improvement Given a set of alternative allocations and a set of individuals, a movement from one allocation to another that can make at least one individual better off without making any other individual worse off is called a Pareto improvement. Pareto efficient or Pareto optimal An allocation of resources is Pareto efficient or Pareto optimal when no further Pareto improvements can be made. If an economic system is not Pareto efficient, then it is the case that some individual can be made better off without anyone being made worse off.

31. Equity and efficiency Horizontal equity – the identical treatment of identical people Vertical equity – the different treatment of different people in order to reduce the consequences of their innate differences

32. 32