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MICROECONOMICS (ECO 162) INTRODUCTION TO MICROECONOMICS
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1. ECO 162-Introduction to Micro Economic

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Page 1: 1. ECO 162-Introduction to Micro Economic

MICROECONOMICS(ECO 162)

INTRODUCTION TO MICROECONOMICS

Page 2: 1. ECO 162-Introduction to Micro Economic

LEARNING OUTCOMES• At the end of this lesson, the students should be

able to: i. Define economics and distinguish between

microeconomics and macroeconomics.ii. Describe basic economic concepts: Scarcity, choices

and opportunity cost.iii. Explain the basic economic problems.iv. Explain graphically basic economics concept using

PPC.v. Distinguish the three types of economic systems.

Page 3: 1. ECO 162-Introduction to Micro Economic

HISTORY ON DEFINITION OF ECONOMICS

i. ‘Economics is a science that studies human behavior as a relationship between ends and scarce means which have alternative uses’ – L.Robbins (1894-1984) .

ii. ‘Economics is a study of how people use their limited resources to try to fulfill their unlimited wants and involves alternative or choices’ – K.E. Case and R.C. Fair.

iii. ‘Economics is the science of how a particular society solves its economic problems’ – Milton Friedman (1912)

iv. ‘ Economics is the study of man’s actions in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well-being. Thus it is on one side a study of wealth and on the other and more important side, a part of the study of man’ - Alfred Marshall (1824-1924)

Page 4: 1. ECO 162-Introduction to Micro Economic

DEFINITION OF ECONOMICS• Economics is a social science study which concern on how

human being allocates the limited resources in order to fulfill the unlimited needs and demands.

• Economic can be subdivided into two branch; macroeconomic and microeconomic.

• Microeconomic analyzes the specific economic units in details such as households, firms and government.

• Macroeconomics, on the other hand, analyzes the aggregate behavior of the entire economy.

Page 5: 1. ECO 162-Introduction to Micro Economic

MICROECONOMICS VS MACROECONOMICS

HOUSEHOLDS FIRMS

GOVERNMENT OPEN ECONOMICS

Should we produce

rice or car?

What is the unemployment rate in Malaysia?

What should I buy for lunch?

Build more hospitals or schools?

Price of sugar increase!

How does inflation occurs?

Impact of doing

international trade.

What influenced the

interest rate to

decrease?

Price of shirts

decrease, should I

buy more or less?

Page 6: 1. ECO 162-Introduction to Micro Economic

ECONOMIC CONCEPTS• Three main economic concepts involves;

i. Scarcity (land, labour, capital and enterprise) Occurs as human wants are always greater than the

available resources. The most important concept in economics. If there is no

scarcity, then there will be no economics study.

ii. Choice When scarcity exists, choices are to be made out of the

available alternatives.

iii. Opportunity cost (Second Best-Forgone alternative) The second-best alternative that has to be forgone for

another choice which gives more satisfaction.

Page 7: 1. ECO 162-Introduction to Micro Economic

ECONOMIC CONCEPTS• This economics concept is simple : Because the resources are scarce, therefore choices

have to be made. Once choices are made, there will be an opportunity cost as the value of the next-best choice (alternative) available.

• What is the opportunity cost by choosing to study at university???

Page 8: 1. ECO 162-Introduction to Micro Economic

THREE BASIC ECONOMIC PROBLEMS

• What to produce? What kind of product/services are going to be produces. Depends on the type and quantity of goods and services needed

by the countries• How to produce? What resources are going to be used, what techniques are going

to be used to produce. Depends on the cheapest method of production (Labor VS

Machine).• For whom to produce? How will nation distribute income to reduce the gap between rich

and poor. Depends on the distribution of income in the society.

Page 9: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE (PPC)

• Since with scarcity problem, no country in this world can produce unlimited numbers of goods.

• Therefore, an economy will produce goods depending on various combinations of factors of production.

• PPC shows the various possible combination of goods and services produced within a specified time period with given technology and resources.

• Assumptions to illustrate PPC includes;i. Full-employment The economy is operating in full employment and full efficiency

ii. Fixed resources The amount of available economic resources or factor of production are fixed

iii. Technology constant State of technology and method of production does not changeiv. Production of two goods Assuming that the country is producing only two type of goods

Page 10: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

Foods (Million units)

Clothes (Million units)

150

120

90

60

30

10 20 30 40 50

X

Y

A

B

C

D

Figure 1.1 : Production Possibilities Curve

(Unattainable due to scarcity)

ABCD: Attainable and Efficient points (Choices)

(Attainable but inefficient: Lead to wastage/unemployment)

Page 11: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

i. Point inside the PPC (Point X) These combinations of foods and clothes are attainable and can be

produced. However, it shows the resources are not fully utilized and the production

has not reached its maximum level.

ii. Points Outside the PPC (Point Y) This point which lies outside the PPC is unattainable due to limited

resources Shows the concept of scarcity.

iii. Points along the PPC (Point A, B, C and D) Combination are attainable and efficient. Shows the second basic economic concept of choices.

Page 12: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

iv. Movement from one point to another point Illustrate the third basic economic concept of opportunity cost. E.g. movement from point A to B Point A (100 X, 50 Y) to Point B (50 X, 75 Y) : In order for this

country to produce an additional of 25 millions units of good Y, it has to forgone 50 millions units of good X.

B

A

Good Y

Good X

75

50

50 100

Page 13: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

v. Shifts of the PPCa) Outward shift (Increase in output): Due to improvement in the new

technology, increase in resources and technology, economy growth and increase in population.

b) Inward Shift (Decrease in output) : Due to natural disaster, reduction in factors of production and

Corn Corn Corn

Page 14: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

vi. Shape of the PPC The shape of PPC depends on the types of opportunity cost. Opportunity cost is calculated based on how much one

good is forgone to obtain other good. Basically, there are three types of opportunity cost;i. Increasing opportunity costii. Constant opportunity costiii. Decreasing opportunity cost.

Page 15: 1. ECO 162-Introduction to Micro Economic

Production Possibilities Curve: Increasing Opportunity Cost

• Increasing opportunity cost means that when a country produces more of one good, it has to forgone more amounts of another goods.

• Figure 1.2 shows that 1 unit increase in Good X from 1 to 2 units had to forgone 1 unit of Good Y.

• Additional unit of Good X from 2 to 3 units involves 2 units of Good Y.

• This is called increasing opportunity cost as more units of Good Y are forgone for additional unit of Good X.

• PPC is concave due to increasing opportunity cost.

Good Y

Good X

Figure 1.2 : Increasing Opportunity Cost

1 2 3 4

2

4

5

6

Page 16: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE: Constant Opportunity Cost

• Constant opportunity cost means that when a country produces more of one good, it has to forgone the same amounts of another goods.

• Figure 1.3 shows that same amount of Good Y is forgone for each additional unit of Good X.

• PPC is linear as the opportunity cost is constant.

6

2

4

2 6 4

Good Y

Good X

A

B

C

D

Figure 1.3 : Constant Opportunity Cost

Page 17: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE: Decreasing Opportunity Cost

• Decreasing opportunity cost occurs when a country produces more of one good, it has to forgone lesser amounts of another goods.

• Figure 1.4 shows that 1 unit increase in Good X from point A to B involves two units of Good Y forgone.

• An additional increase of Good X from point B to C forgone 1 units of Good Y and number of Good Y forgone continues to decrease.

• This is called decreasing opportunity cost as lesser units of Goods Y are forgone for additional unit of Good X.

• PPC is convex due to decreasing opportunity cost

Good Y

Good X2 31

1

2

4

Figure 1.4 : Decreasing Opportunity Cost

A

B

C

D

Page 18: 1. ECO 162-Introduction to Micro Economic

PRODUCTION POSSIBILITIES CURVE

i. Apr 2010 (Part B, Q 2)ii. Apr 2006 (Part B, Q2)

Page 19: 1. ECO 162-Introduction to Micro Economic

ECONOMIC SYSTEMS• Economic system is a way of organizing the relationship

among individuals, firms and government to make choices on the basic economic questions.

• The three basic economic problems (what to produce, how to produce and for whom to produce) are solved depending on the economic system chosen by the society.

• Basically, there are four types of economic system which have been practiced, namely;

i. Capitalist economy systemii. Socialist economy systemiii. Mixed economy systemiv. Islamic economy system

Page 20: 1. ECO 162-Introduction to Micro Economic

i. CAPITALIST MARKET SYSTEM

• A capitalism is an economic system where individuals without government intervention take all the main economic decision.

• Also known as market economy, free enterprise system and laissez-faire.

• This economy is characterized as economic freedom, where an individual can act at their own wishes without any control from the government.

• The example of countries practicing the capitalist economic system are the United States of America (USA), France, Canada, Japan, and Britain.

Page 21: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: CHARACTERISTICS

i. Government intervention There is no intervention by the government in the making of

economic decisions. Government only exist as the law enforcer and set the rules and

regulation to ensure the stability of economic condition of the country.

ii. Private ownership of resources Every individual in the country has a right to acquire resources. This enable individual to own resources as well as to establish any

enterprise at their choices. They are free to trade, invest and organize to produce within the

country’s legal framework.

Page 22: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: CHARACTERISTICS

iii. Consumers’ sovereignty ‘Consumer is the king’ concept is practiced in this system. Consumers’ taste and preference will affect the production of

goods and services.iv. Competition Market economy also characterized as highly competitive

among the producers to obtain the highest profit. In order to attract more customers, producers will use

various marketing strategies to sell their products better.

Page 23: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: CHARACTERISTICS

v. Price System Price system is a system used to make economic decisions. In this system, price mechanism is practiced. It means that

the price is determine according to the force of demand and supply and without any intervention.

All economic processes of consumption, production, exchange, savings, investment and distribution will work according to this price mechanism and is labeled as ‘invisible hand’ by Adam Smith.

Page 24: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: ADVANTAGES

i. Production according to the needs of consumers Producers are producing goods and services according to the

tastes of consumers, which maximize the consumers’ needs and satisfaction.

ii. Economic freedom It means the right to earn and retain property as well as

freedom of enterprises and choices of occupation. Thus, it will lead to the sourcing of the country’s manpower in

different units of production.iii. Resources are efficiently utilized Competition creates efficiency in producing quality goods at

lower cost since techniques are more efficient.

Page 25: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: ADVANTAGES

iv. Varieties of consumer goods Competition takes place in various aspects such as shape,

colour, design and packaging of the products. Thus, consumer will enjoy a wide variety of the same

product.v. Enhance trade, business and R&D Entrepreneurs or producers will always look out for new

innovations to compete with other producers to provide high quality goods.

Page 26: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: DISADVANTAGES

i. Inequality of distribution of wealth and income Since with no government intervention, the system of

private property widens the gap between the rich and the poor.

Thus, this will lead to unequal distribution of income among the societies.

ii. Inflation and high unemployment rate Disparity of demand and supply of labour occurs as it is

governed by the ‘invisible hand’ Unstable business fluctuation will cause high

unemployment rate during the depression.

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CAPITALIST MARKET SYSTEM: DISADVANTAGES

iii. Lack of social welfare In market economy, social welfare is ignored as the

business entrepreneurs do not provide any pension, social security or accident benefits to their employees.

iv. Unnecessary variety and wasteful competition Too much of competition will lead to unnecessary high cost

of production. This happen as some producers will highly advertised their

products in order to attract consumer due to stiff competition in this market system.

Page 28: 1. ECO 162-Introduction to Micro Economic

CAPITALIST MARKET SYSTEM: DISADVANTAGES

v. Misallocation of resources In this system, producer’s objective is to maximize profit and

therefore only produce outputs which give higher profits. This will lead to production of luxury goods (for rich people)

and resulting surplus as well as lack of production for the poor people.

vi. Social cost Workers may face social cost (health problem) arising from

the polluted environment caused by improper disposal of factory wastes since producers' intention is to increase the private profit and welfare of the workers is often neglected.

Page 29: 1. ECO 162-Introduction to Micro Economic

HOW CAPITALIST MARKET SYSTEM SOLVE BASIC ECONOMIC PROBLEM

i. What to produce? In this economic system, production depends on the goods

demanded by the consumer. An entrepreneur will only produce goods and services where there is

demand from consumer in order to gain higher profit.ii. How to produce? Depends on the techniques of production whether to use labor

intensive, capital intensive or combination of both techniques. Cheapest method of production will be adapted not only to

maximize profit but also to achieve efficiency. iii. For whom to produce? This problem will be solve through price system. Goods and services are obtained by anyone who can afford.

Page 30: 1. ECO 162-Introduction to Micro Economic

ii. SOCIALIST MARKET SYSTEM

• Socialist market system is a centrally planned economy where government or central authority makes all economic decision.

• Any private individual has no right to make their own economic decisions.

• There will be no private property rights since all resources are owned by government.

• Also known as command economy and planned economy.• There are only few countries which practice this economic

system such as Russia, Cuba, Laos, Vietnam and North Korea.

Page 31: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: CHARACTERISTICS

i. Public ownership of resources All resources are owned and operated by the state or the

government in the interest of society as a whole. This is to ensure equal opportunity for all citizens regardless

of their income.ii. Central planning authority Central Planning Authority acts as government and

responsible for making economic decision for the society. Government will plan and allocate the resources between

current consumption and investment for the future.

Page 32: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: CHARACTERISTICS

iii. Less importance of price mechanism Market forces are less important in this economic system. Prices are fixed by the government and not determined by

the forces of demand and supply. Private profits are not allowed and public interest is

emphasized.iv. Central control and ownership Government intervenes in all aspect of economic activities

including production, consumption and distribution of goods and services.

Page 33: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: ADVANTAGES

i. Production according to the basic of society Government produced goods and services according to the

societies’ basic needs such as foods, clothes and building material.

Production is not by the purchasing power of rich society but more concern on the society as a whole.

ii. Equal distribution of income There will be no difference between rich and poor as this

system provides equal opportunity for all citizens in earning income.

Wealth is also equally distributed since private enterprise are limited.

Page 34: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: ADVANTAGES

iv. No serious unemployment/recession or inflation Since the economy is taken fully care by the government,

there will be no serious economic problems as the government’s main objectives is to maintain the stability of economic.

v. Social welfare Government will provide all citizens of the country full

social security such as pensions, accident benefits and others.

With all concerns from government, labor dispute and wastage of resources do not exist in socialist system.

Page 35: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: DISADVANTAGES

i. Lack of incentives and initiatives by individuals There is absence of profit motive in individuals. Thus, this will lead to economic inefficiency since jobs are

provided by the government and individuals are not motivated to work harder.

ii. Loss of economic freedom of consumers There is no choice given to consumer and they accept

whatever the public enterprise produce. Since with the limited number of private enterprises, there

are limited variety of goods and services as well as restricted available choices.

Page 36: 1. ECO 162-Introduction to Micro Economic

SOCIALIST MARKET SYSTEM: DISADVANTAGES

iii. Absence of competition Since there are limited private enterprise exist in this

market system, there will be less R&D activities occurs. Thus, quality of products will be low since there is no

competition. iv. Waste of economic resources Government might produce goods and services that are not

required by the people such as military equipments. This will lead to overproduction of certain goods and

underproduction of certain other goods.

Page 37: 1. ECO 162-Introduction to Micro Economic

HOW SOCIALIST MARKET SYSTEM SOLVE BASIC ECONOMIC PROBLEM

i. What to produce? In this economic system, planning authorities decides what to produce. The Central Planning Authority will collect detailed statistics on the resources

availability and fix up with national priorities.ii. How to produce? The Central Planning Authority will also decides on what techniques to be

used in the production of goods and services. The choice is between traditional or modern techniques.iii. For whom to produce? The distribution of national product is decided by Central Planning Authority. The distribution of various commodities is done through a set of administered

fixed prices. (Necessities good are fixed at lower price while luxurious good are fixed at higher price)

This is to ensure low inequalities in the distribution of income among societies.

Page 38: 1. ECO 162-Introduction to Micro Economic

iii. MIXED MARKET SYSTEM

• Mixed market system is an economic system which has a mix of capitalist and socialist systems to solve basic economic problems.

• A mixed economy is where both public and private sectors play their roles in the economy.

• Most of the countries in the world practiced this type of economic systems. This includes Malaysia, Singapore, Thailand, Germany, South Africa and many others.

Page 39: 1. ECO 162-Introduction to Micro Economic

MIXED MARKET SYSTEM: CHARACTERISTICS

i. Public and private ownership of resources Private enterprise conduct business freely. The government encourages private sectors by providing

infrastructure and facilities.ii. Price mechanism and economic plan used to make

economic decisions. Price mechanism is used on pricing of goods and services. However, government will intervene in setting up prices on

certain commodities. This includes sugar, oil, rice where government declared as

‘controlled items’ .

Page 40: 1. ECO 162-Introduction to Micro Economic

MIXED MARKET SYSTEM: CHARACTERISTICS

iii. Government intervention Government will not intervene in the economy except for

particular industries. Government uses the legislation for unsafe goods,

categorized as illegal products such as military items, drugs, etc.

Government also uses direct provision such as education, defense and health to increase standard of living.

Besides, government also control the income disparity through income taxes and welfare payment.

Government will also control the existence of monopolies in order to avoid customers being exploited by monopolist.

Page 41: 1. ECO 162-Introduction to Micro Economic

MIXED MARKET SYSTEM: ADVANTAGES

i. More stable economics Since there is a lot of government intervention, the economic will

be more organized. Thus, economic condition will be more stable.

ii. Lower social cost Externalities such air, noise and water pollution will be lower due to

government intervention. Thus, social cost will be lower as government enact laws to ensure

production methods used caused least harm to the environment.

iii. Narrow gap between rich and poor Government intervention through imposing progressive tax will

help to narrow down the gap between the rich and the poor. Higher income earners are taxed more than lower income earners.

Page 42: 1. ECO 162-Introduction to Micro Economic

MIXED MARKET SYSTEM: ADVANTAGES

iv. Social welfare The government will provides public goods at an affordable

price in order to enable lower income earners to benefit the public goods as well.

Government will ensure that public and private enterprise provide all citizens of the country full social security such as pensions, accident benefits and others.

Page 43: 1. ECO 162-Introduction to Micro Economic

HOW MIXED MARKET SYSTEM SOLVE BASIC ECONOMIC PROBLEM

i. What to produce? In this economic system, what to produce decided by the public and private

sectors. The goods and services produced depends on the consideration of social welfare

as well as economic growth. ii. How to produce? The private sector will choose the most efficient and cost-effective techniques of

production (labor intensive vs. capital intensive) while government will enact laws to combat inefficiencies arising from externalities.

iii. For whom to produce? The distribution of goods and services is also decided by the public and private

sectors. Price mechanism is not fully functional in mixed economies. Government intervene directly through price control and indirectly imposing

indirect taxes and subsidies.

Page 44: 1. ECO 162-Introduction to Micro Economic

iv. ISLAMIC MARKET SYSTEM

• Economic activities in Islam are not seen from the materialistic aspect only but also the spiritual aspect in this world and the life hereafter.

• The only objective of the Islamic Economic System is to achieve Al-Falah, which means success in one’s life in the world and also the life hereafter.

• The basic philosophical foundation in the Islamic Economic System includes;

a) Tauhidb) Rububiyyahc) Tazkiyyahd) Khalifahe) ukhuwwah

Page 45: 1. ECO 162-Introduction to Micro Economic

ISLAMIC MARKET SYSTEM: PHILOSOPHICAL

a) The concept of Tauhid The concept of believing that in Islam there is only one God to

be worshipped which is Allah SWT. The belief of Tauhid is divided into two, namely;i. The relationship between man and Allah SWT (Habluminallah)ii. The relationship among mankind (Habluminannas) b) The concept of Rububiyyah The concept of believing that Allah SWT alone is the creator

and the most powerful. He also gives bounties and organizes man’s economies

activities for genuine interest to achieve Al-Falah in this world and the life hereafter.

Page 46: 1. ECO 162-Introduction to Micro Economic

ISLAMIC MARKET SYSTEM: PHILOSOPHICAL

c) The concept of Tazkiyyah The concept of purification of man. Islam believes that before one indulges in any economic activities,

he must mould pure and good soul. For example, one can purify his wealth by giving out tithe (Zakat)

and donating (Sedekah) to the poor. When the wealth of the rich reaches a certain stated amount, it

must be levied with zakat, which aims to help the poor.d. The concept of khalifah The concept of vicegerent that man is the servant of Allah SWT. In Islam, men are created as trustees and they are responsible to

prosper the land and always to be in servitude to Allah SWT set by the Islamic Law (syariah)

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ISLAMIC MARKET SYSTEM: PHILOSOPHICAL

e) The concept of Ukhuwwah The concept of brotherhood in Islam. Islam believes that all men are brothers and they must love

and respect each other and be responsible. Those who are willing to sacrifice for their brothers show the

sign of faith. Oppression, extortion and miserliness do not exist in the

Islamic Economic System.

Page 48: 1. ECO 162-Introduction to Micro Economic

HOW ISLAMIC MARKET SYSTEM SOLVE BASIC ECONOMIC PROBLEM

i. What to produce? In this economic system, what to produce are decided through the

principles of Syariah as been stated in Al-Quran and As- sunnah. The goods and services produced must be permissible (halal) and in

accordance with the classification of goods in Islam. ii. How to produce? The producer will choose the most efficient and cost effective methods of

production. (labor vs. capital intensive)iii. For whom to produce? In distributing the goods and services, the need of the poor should come

first instead of the rich. This, however, does not mean that the needs of rich are being ignored. It

just that the production of luxury goods for the rich should come later than the need of the poor.

Page 49: 1. ECO 162-Introduction to Micro Economic

END OF CHAPTER 1

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