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Nanyang Junior College (2024/25 H2 Economics Lecture Notes) © Chapter 1: Nature and Scope Page 1-1 CONTENT OUTLINE 1. INTRODUCTION 1.1. The Nature of Economics 1.2. The Scope of Economics 2. THE CENTRAL PROBLEM OF ECONOMICS 2.1. Scarcity, Choice and Opportunity Cost 2.2. Basic Economic Decisions 2.3. Summarising the Central Problem of Economics 3. THE PRODUCTION POSSIBILITY CURVE 3.1. Introduction to the Production Possibility Curve (PPC) 3.2. Characteristics of the PPC 3.3. Summary : Illustration of Scarcity, Choice & Opportunity Cost on the PPC REFERENCES 1. Beardshaw, J. Economics: A Student's Guide, Pitman Publishing (330 BEA) 2. Lipsey and Chrystal, Positive Economics, Oxford University Press (330 LIP) 3. Maley S and Welker J., Economics, Pearson 4. Miller, R. Economics Today, Harper Collins (330MIL) 5. N. G. Mankiw, E. Quah, P Wilson, Principles of Economics, Asian Edition, Cengage Learning 6. Sloman, J. Economics, Prentice Hall (330 SLO) Theme 1: Central Problem of Economics Nature and Scope Chapter 1
Nanyang Junior College (2024/25 H2 Economics Lecture Notes) © Chapter 1: Nature and Scope Page 1-2 1. INTRODUCTION 1.1 The Nature of Economics a) What is Economics? Alfred Marshall who authored one of the first and most influential textbooks in economics, Principles of Economics, defines it as: “... a study of mankind in the ordinary business of life ...” However, most contemporary definitions of economics involve the two important notions of scarcity and choice: “A study of human behaviour as a relationship between ends and scarce means which have alternative uses.” – Lionell Robbins, 1935 “It is the study of how society allocates and distributes limited resources to satisfy wants (i.e. how society answers the 4 basic economic questions of what, how, how much and for whom to produce).” Summing up, economics is a branch of social science that uses scientific methods to build theories that can help to explain the behaviour of households, firms, and the government and how they make decisions relating to the allocation of limited resources to productive uses, to derive maximum satisfaction. b) Ceteris Paribus Ceteris paribus is a Latin phrase meaning all other things being unchanged or constant. The assumption of ceteris paribus is used throughout all economic analysis to make analysis easier. Although it is unrealistic that only one variable change at any one time, the assumption is used to explain possible relationship between 2 variables. For example, “If you spend more time studying, ceteris paribus, you will get better grades”. There is a strong relationship between grades and the number of hours one studies. This idea is based on the assumption of ceteris paribus. If we relax the assumption, one may not get better grades even when they spend longer hours studying as they could have been ill during the exam! (i.e other factors may influence the outcome) Using an example related to economics, “If the price of facemask rise, ceteris paribus, less people will use them. Ceteris paribus does not consider the fact that there is currently a pandemic and legislation on the use of mask. It simply considers the decision of consumers to lower the consumption of a good when there is a rise in price. If the assumption of ceteris paribus is relaxed, even with a rise in the price of facemask, other factors like the fear of catching Covid19 and requirements of the use of facemask may not lower the consumption of facemask. c) Positive and Normative Economics Economists often distinguish between 2 approaches to economic reasoning – positive and normative economics. This distinction allows us to discern between objective and subjective statements when presented with information and/or perspectives of different economic agents regarding an economic issue. • Positive economics can be defined as the branch of economics that describes and explains economic phenomena, focusing on facts and cause-and-effect behavioural relationships. This includes the development and testing of
Nanyang Junior College (2024/25 H2 Economics Lecture Notes) © Chapter 1: Nature and Scope Page 1-3 economic theories. Therefore, a positive statement is a statement of fact. It may be right or wrong, but its accuracy can be tested by appealing to the facts. Example of positive statement: ‘A fall in household income will lead to a fall in demand for luxury goods.’ The above is a positive statement as it can be tested by collecting data. It however need not hold true to make it a positive statement! • Normative economics refers to the branch of economics that expresses value judgments about economic issues. They usually contain the verb "should", "would", "could" , “ought” or "must". They also include statements that are subjective and hence impossible to verify or test. Unlike positive statements, normative statement are non-testable. Examples of normative statements: • “The government ought to implement policies to reduce the unemployment rate.” (The term ought expresses an opinion) • “Smoking is bad for you”. The term ‘bad’ is not clearly defined (ambigious) and hence impossible to test. Had the statement been modified to “Smoking is bad for the teeth”, it can be verified and hence will be classified as a positive statement. 1.2 The Scope of Economics The study of economics covers both microeconomics and macroeconomics. a) Microeconomics Microeconomics is that branch of economics that is concerned with the individual parts of the economy. It involves the study of economic behaviour of individuals (households) and firms with regard to the choices they make over scarce resources, and how this affects individual markets (e.g. market for goods and services such as petrol or market for resources such as labour) in terms of price and output. Some examples of microeconomic issues are • Impact of immigration policy on housing prices. • Should a firm lower the price of its good. • What is the impact of Covid19 on the price of face mask. b) Macroeconomics Macroeconomics can be defined as the study of the economy as a whole. It focuses on aggregate changes in the overall economy measured by indicators such as general price levels and real gross domestic product. Some examples of macroeconomic issues are • Impact of Covid on Economic growth. • Should the government raise its expenditure to raise employment level. • What are the impact of Covid19 on the Singapore economy.
Nanyang Junior College (2024/25 H2 Economics Lecture Notes) © Chapter 1: Nature and Scope Page 1-4 2. THE CENTRAL PROBLEM OF ECONOMICS 2.1 Scarcity, Choice and Opportunity Cost Scarcity occurs when there is an excess of human wants (unlimited wants) over what can actually be produced (limited resources) to fulfil these wants. Since resources to produce goods and services are limited, it is impossible to satisfy all wants. Scarcity is a situation where available resources are unable to produce enough goods and services that people desire to satisfy all their wants. Consumers, producers and the government face the problem of scarcity. Due to scarcity, people are compelled to make choices (or decisions). There is a need to choose among the alternative uses of limited resources to satisfy unlimited wants. To make rational choices, the costs and benefits of each option must be weighed. But whenever a choice is made, it involves a trade-off known as opportunity cost. Opportunity cost refers to the value of the next-best alternative forgone as a result of a decision made. It is usually measured in terms of goods and services or monetary value of what is given up. It is also known as implicit cost In other words, the opportunity cost of a decision is the value of what you will need to give up or forgo when choosing one possibility over another. OTHER KEY ECONOMIC TERMS (a) ECONOMIC RESOURCES There are 4 broad types of economic resources (also known as factor inputs or factors of production). (i) Land • Land refers to all natural resources available for production (to satisfy human wants). • Land as a renewable natural resource (e.g. wind and water) renews themselves at a fast enough rate for sustainable economic extraction. • Land as a non-renewable natural resource (e.g. fossil fuels and mineral ores) do not renew themselves at a fast enough rate for sustainable economic extraction. • The reward for land is “rent”. (ii) Capital • Capital refers to all man-made materials, physical resources used or are available for use in production such as production factories, machinery, and tools. • The reward for capital is “interest”. (iii) Labour • Labour refers to work (manual or mental) undertaken by people in the production of goods and services. • The reward for labour is “wages”. (iv) Entrepreneurship • Entrepreneurship refers to the factor of production that takes overall responsibility for the decision-making process in the firm so that other factors of production can be combined to provide the good or service. • The reward for entrepreneurship is “profits”. (b) ECONOMIC GOODS & SERVICES Economic goods are those that are produced using scarce resources. They are limited in quantity relative to demand (i.e. scarce). Hence consumption of such goods involves a sacrifice or an opportunity cost. [Side note: “Free goods”, on the other hand, are not produced using scarce resources. They are available in large amounts relative to demand (i.e. not scarce). Hence, consumption of such goods does not involve any opportunity costs. E.g. free gifts of nature such as rain and air] Economics is fundamentally about decisions regarding the use of scarce resources to fulfil human wants through the consumption of such economic goods and services. Economic goods (or merchandise) are tangible output that can be categorized into producer and consumer goods. • Producer goods (also known as intermediate or capital goods) are used to assist in the production of other goods (E.g. machines and raw materials). • Consumer goods are goods that are directly consumed by people. Firms also provide services which refer to the intangible output of individuals or firms. Services rendered to households (e.g. haircut, medical services etc.) are final services while services rendered to firms (e.g. accounting services provided by an accounting firm to a particular company) are known as intermediate services.