PRINCIPLE OF ECONOMICS CHAPTER 1: PRINCIPLE OF ECONOMICS 1.1 Introduction: Why study economics? 1.2 Economics Defined 1.3 The Scope of Economics 1.4 Economic Method 1.5 Economic System 1.6 Production Possibility Frontier (PPF)

To learn a way of thinking 1.1 Introduction: Why study economics? To learn a way of thinking To understand the society To understand global affairs To be an informed voter

1.2 Economics Defined Economics: a) Is the study of how to allocate limited resource to satisfy unlimited wants. b) Is a social science concerned chiefly with the way a society choose to employ its limited (scarce) resources, which have alternative uses, to produce goods and services for present and future consumption. c) Deal with human behavior and characteristic as an individual, family, group, state or as decision maker units in a firm.

Three basic economic problems: Scarcity: The core problem Three basic economic problems: What products to produce (Price theory), How to produce and how much to produce (Output theory), For whom to produce (Distribution theory). Choice Opportunity cost

PPF Analyze thru: Economic method View from: Economic philosophy Scarcity: The core problem Choice Opportunity cost Economic System Economic Thought PPF Analyze thru: Economic method View from: Economic philosophy

1.3 The Scope of Economics Categorization: Economic philosophy: positive, normative and applied economics Major Fields: microeconomics and macroeconomics industrial organization, econometric, finance, development economics, etc Specific Fields:

Economic philosophy: positive, normative and applied economics Positive economics attempts to understand behavior and the operation of economics system without making judgments about whether the outcomes are good or bad. Normative economics looks at the outcomes of economic behavior and asks whether they are good or bad and whether they can be made better. Thus, normative economics involves judgments and prescriptions. Applied economics is about the application of economics theory and statistic, combined with knowledge of institutions to explain the behavior of real-world phenomena. It is known as the art of economics that accepts some set of goals determined in normative economics and discusses how to achieve those goals in reality, given insights of positive economics.

Major Fields: microeconomics & macroeconomics Microeconomics studies the economics activities of economic decision-making units that included individuals, households and firms. It concerned about the behavior and interaction of those units in the market. Macroeconomics studies the behavior of economics aggregates or the economy as a whole. Thus, macroeconomics focuses on the behavior of the overall economy, including growth, unemployment and inflation. Microeconomics looks at the individual unit – the household, the firm, the industry. It sees and examines the “tree”. Macroeconomics looks at the whole, the aggregate. It sees and analyzes the “forest” (Case & Fair 2004: 6).

Macroeconomics Specific field Economic Method Economic philosophy PPF Economic System Economic Thought

1.4 Economic Method Theoretical economics: Empirical economics Consists (1) observing the real facts; (2) formulating possible explanation (hypothesis); (3) testing the hypothesis; (4) formulation of theory; (5) the evolvement of hypothesis into principle or law; and (6) incorporating principle or law into model. Empirical economics Use data to test economic theory Economic policy Applying theory in policy Explain & predict theory effectiveness

1.5 Economics System i. Capitalist system Known as laissez-faire, market economy, free enterprise and free market economy. No government intervention in the economic activities and the present of free competition. Price, demand and supply are said play the role of invisible hand that governs the economy in achieving maximum efficiency. The pure capitalist system or laissez-faire market is the highest degree of economic globalization.

ii. Socialist system Also called centrally planned economy or command economy. Seen as an opposite to the capitalist system, anti-globalization and being linked with communist or Marxist ideology. Main characteristics are the presence of total or heavy control of the economy by the government and thus, the absence of competition. Consumers theoretically have no power to determine which product to be produced but to accept the government or central planning authority’s decision.

iii. Mixed economy The most widely practice in reality. There is several of selective government interventions in the economy to “fix” the weaknesses of the laissez-faire system but free competition still exist. both public and private sector exist and both play important role to ensure the growth of the economy and the welfare of the society. The Keynesian economic schools of thought that questioned the efficiency of invisible hand and emphasize the need of active role of the government in the economy fall into this mixed economy system.

1.6 Production Possibility Frontier (PPF) The curve that shows all of the possible combinations of goods (products) and services that can be produced. C: Maximum possible production H: Under production F: Not possible production

Movement along the PPF represent the opportunity cost That mean increase in producing a particular product can only possible with reduce production of another product.

Table 1.2: Opportunity Cost (per bushels of extra wheat per year) Point on PPF Opportunity cost (bushels of corn) A to B (700 – 650) / (200 – 100) = 0.50 B to C (650 – 510) / (380 – 200) = 0.78 C to D (510 – 400) / (500 – 380) = 0.92 D to E (400 – 300) / (550 – 500) = 2.00 The opportunity cost from point A to B, B to C, C to D and D to E are increasing, implying the law of increasing opportunity cost. It also represented in the increasing steepness of the slope and the concave shape of PPF. End

Figure 1.4 (c): PPF Pivot Outward from “Industrial Product”-axis Figure 1.4 (b): PPF Shift Outward Figure 1.4 (a): PPF Shift Inward Figure 1.4 (c): PPF Pivot Outward from “Industrial Product”-axis Figure 1.4 (c): PPF Pivot Outward from “Agriculture Product”-axis

Example of PPF analysis Figure 1 illustrated the Production Possibility Frontier (PPF) for the allocation of resources in Malaysian banking sector. Assumed that the Malaysian banking sector only consist of two types of banking product/services that are the conventional banking and Islamic banking.

Example of PPF analysis Point on PPF Opportunity cost (Ringgit of conventional outputs per one Ringgit of Islamic banking output) (i) A to B (800 – 600) / (400 – 0) = 0.50 (ii) B to C (600 – 400) / (500 – 400) = 2.00 (iii) C to D (400 – 200) / (550 – 500) = 4.00 End

Scenario A: Malaysian is currently producing at Point B. The government is encouraging the development of Islamic banking, thus, advising all the banks in Malaysia to divert more resources to Islamic banking from conventional banking. If all the banks follow the government’s advice, sketch a PPF diagram to illustrate this scenario. Mark a possible new production combination (point) as “E”. Give your explanation.

Scenario B: The government successfully invites foreign Islamic banks to invest in Malaysia by opening branches here. What happen to the PPF? Illustrate this scenario in the same PPF diagram as in question (c). Mark a new possible production point as “F”. Give your explanation.

Scenario C: If scenario A & B happen that is both the local banks and the foreign Islamic bank follow the Malaysian government’s advice, mark a possible production combination as “G” in the same PPF diagram you have sketched. Give your explanation.