BFT101 BUSINESS ECONOMICS LESSON 1 - INTRODUCTION TO ECONOMIC CONCEPTS

Why Study Economics To understand the world better You’ll begin to understand the cause of many of the things that affect your life To gain self-confidence You’ll lose that feeling that mysterious, inexplicable forces are shaping your life for you

Why Study Economics To achieve social change You’ll gain tools to understand origins of social problems and design more effective solutions To help prepare for other careers You’ll discover that a wide range of careers deal with economic issues on many levels To become an economist You’ll begin to develop a body of knowledge that could lead you to become an economist in the future

How to Study Economics Following alone in class and learning are two different things Economics must be studied actively, not passively What does active studying mean? Closing the book periodically and reproducing what you have learned Reading with a pencil in your hand and a blank sheet of paper in front of you Listing the steps in each logical argument Retracing the cause-and-effect steps in each model Drawing the graphs that represent the model Thinking about the basic principles of economics and how they relate to what you are learning

Economics, Scarcity, and Choice A good definition of economics Study of choice under conditions of scarcity Study of how society manages its scarce resources Scarcity Situation in which the amount of something available is insufficient to satisfy the desire for it

Scarcity and Individual Choice There are an unlimited variety of scarcities, however they are all based on two basic limitations Scarce time Scarce spending power Limitations force each of us to make choices Economists study choices we make as individuals, and consequences of those choices Economists also study more subtle and indirect effects of individual choice on our society

Scarcity and Social Choice The problem for society is a scarcity of resources Scarcity of Labor Time human beings spend producing goods and services Scarcity of Capital Something produced that is long-lasting, and used to make other things that we value Human capital Capital stock Scarcity of land Physical space on which production occurs, and the natural resources that come with it Scarcity of entrepreneurship Ability and willingness to combine the other resources into a productive enterprise As a society our resources—land, labor, and capital—are insufficient to produce all the goods and services we might desire In other words, society faces a scarcity of resources

Scarcity and Economics The scarcity of resources—and the choices it forces us to make—is the source of all of the problems studied in economics Households allocate limited income among goods and services Business firms choices of what to produce and how much are limited by costs of production Government agencies work with limited budgets and must carefully choose which goals to pursue Economists study these decisions to Explain how our economic system works Forecast the future of our economy Suggest ways to make that future even better

Microeconomics Micro Microeconomics Micro comes from Greek word mikros, meaning “small” Microeconomics Study of behavior of individual households, firms, and governments Choices they make Interaction in specific markets Focuses on individual parts of an economy, rather than the whole

Macroeconomics Macro Macroeconomics Macro comes from Greek word, makros, meaning “large” Macroeconomics Study of the economy as a whole Focuses on big picture and ignores fine details

Positive Economics Study of how economy works A positive statement is one that is objective or specific and can be backed up by evidence. Statements about how the economy works are positive statements, whether they are true or not Accuracy of positive statements can be tested by looking at the facts—and just the facts

Normative Economics Study of what should be Used to make value judgments, identify problems, and prescribe solutions A normative statement is a value judgement and states what someone thinks ‘ought to be’. Normative statements are subjective and influenced by personal biases, background, personal politics Normative statements suggest what we should do about economic facts and they are based on values, cannot be proved or disproved by the facts alone

Examples of positive and normative statements An example of a positive statement: If carbon emissions were cut by 25%, air quality would improve and the number of people diagnosed with asthma would decrease significantly. An example of a normative statement: To clean up air quality and cut down carbon emissions by 25%, 4 x 4 vehicles should only be sold to farmers and those living in rough terrain areas. 13

Positive Statements Positive statements are objective statements that can be tested, amended or rejected by referring to the available evidence. Positive economics deals with objective explanation and the testing and rejection of theories. For example: A fall in incomes will lead to a rise in demand for own-label supermarket foods The rising price of crude oil on world markets will lead to an increase in cycling to work A reduction in income tax will improve the incentives of the unemployed to find work. A rise in average temperatures will increase the demand for sun screen products. Higher interest rates will reduce house prices

Pollution is the most serious economic problem Normative Statements Normative statements are subjective statements rather than objective statements – i.e. they carry value judgments. For example: Pollution is the most serious economic problem Unemployment is more harmful than inflation The congestion charge for drivers of petrol-guzzling cars should increase to £25 The government should increase the minimum wage to £6 per hour to reduce poverty. The government is right to introduce a ban on smoking in public places. The retirement age should be raised to 70 to combat the effects of our ageing population. Resources are best allocated by allowing the market mechanism to work freely The government should enforce minimum prices for beers and lagers sold in supermarkets and off-licences in a bid to control alcohol consumption Normative Statements Normative statements are subjective statements rather than objective statements – i.e. they carry value judgments. For example: Pollution is the most serious economic problem Unemployment is more harmful than inflation The government is right to introduce a ban on smoking in public places. The retirement age should be raised to 70 to combat the effects of our ageing population. Resources are best allocated by allowing the market mechanism to work freely

The Methods of Economics Economics relies heavily on modeling Economic theories must have a well-constructed model While most models are physical constructs Economists use words, diagrams, and mathematical statements What is a model? Abstract representation of reality

The Art of Building Economic Models Guiding principle of economic model building Should be as simple as possible to accomplish its purpose Level of detail that would be just right for one purpose will usually be too much or too little for another Even complex models are built around a simple framework

How Does An Economy Work?. Economic Systems Economic Systems How Does An Economy Work?.

Quick Review: Take out a sheet of paper and answer the following questions: What are Goods? What are Services? What are Resources? What is Scarcity? Nations must answer 3 basic Economic question: What goods and services should be produced? How should the goods and services be produced? For who should the goods and services be produced? The way a nation answers these questions defines their economy.

Economic Systems Definition: The method used by a society to produce and distribute goods and services. Or, How the government tells us what we can get and how to get it! All economic systems fall into one of two broad categories: Market (or Capitalist) System Command (or Planned) System No economy can be purely market or purely command Elements of both economies are found in all systems this makes all economies mixed

All Economic Systems Must Consider the Following Questions: What goods and services to produce? How will they produce them? Who will get them? How much will they produce now, and how much later? Each economic system answers these questions in a DIFFERENT WAY.

Types of Economic Systems There are 4 basic types of economic systems: 1. Traditional Economy Command (Planned/Socialist) Economy Free Market (Capitalist) Economy Mixed Economy

1. Traditional Economy Economic questions are answered by habits and customs (the way it has always been done) Children work the same jobs parents worked, often farming or hunter/gatherer Fear Change! Ex. Eskimos, the Amish, Pigmies, Bush People

2. Command Economy The government answers the basic economic questions Advantages: able to act quickly in emergencies, provide for all people equally Disadvantages: Inefficient, no incentive to work hard or be creative Ex. Communist Countries (China, Vietnam, North Korea, former Soviet Union, Cuba)

3. Free Market Economy Economic questions are answered by individual buyers and sellers. Supply and demand influence economy People act out of self interest; motive for profit (money) drives the economy Also known as FREE ENTERPRISE or CAPITALISM Ex. The United States, Western Europe, Japan

4. Mixed Economy Mixed Economy: No economy is pure market, pure command or pure traditional, elements of each appear in all economies, some have more elements of one economy than another.

Features of Free Market Economy Economic Freedom: individuals have the right to choose Competition: more than one producer of good/services insures choice Private Property: individuals have the right to own their own property, including business

Features of Free Market Economy (cont) Self-Interest: individuals make decisions based on what is best for them Voluntary Exchange: individuals may freely buy and sell goods Profit Motive: individuals are driven by a desire to profit (make money)

Features of Command Economy Government regulation of some business practices Ex. Monopoly of electricity services (TNB) Government limits certain choices Ex. Cannot buy or produce certain goods/services Government provides aid to the needy Ex. Medicare, Medicaid, welfare

“Business School Pizza” in Malaysia How would “Business School Pizza” function under different economic systems?

Business School Pizza in a Free Market The owner answers the basic economic questions! The owner determines how much cheese and pepperoni goes on the pizza The owner determines the quality of the cheese and pepperoni The owner sets his/her employees wages The owner sets his/her business hours

“Business School Pizza” in a Command Economy The government answers the basic economic questions The government sets the amount of cheese and pepperoni on each pizza The government determines quality of cheese and pepperoni The government sets employees wages The government sets business hours Problem: What does the government know about pizza?

“Business School Pizza” in a Mixed Economy The Government and the owner both answer the basic economic questions The owner determines the amount of cheese and pepperoni on the pizzas; government determines the quality of cheese and pizza The owner sets employee wages; government sets minimum wage for employees The owner determine business hours; government determines whether the business is safe to be open or not

To be continued….