CHAPTER 1: INTRODUCTION TO

ECONOMICS

1.1 WHAT IS ECONOMICS?

Meaning and scope of economics
Economics studies the optimal utilization of scarce resources
Economics is essentially concerned with the choices people have to make because their wants
are unlimited while the means available to satisfy those wants are scarce.
Economics also studies the decisions of businesses, governments and other decision makers in
society. The central elements of economics are therefore scarcity, choice and opportunity cost.
Economics also seeks to describe, explain, analyse and predict phenomena such as economic
growth, unemployment, inflation, prices, poverty, wealth, money, interest rates.

Definitions of economics
Economics is the study of how society manages its scarce resources.
— N Gregory Mankiw
Economics is the study of how societies use scarce resources to produce
valuable commodities and distribute them among different people.
— Paul Samuelson
Economics is the study of how individuals, firms, governments and other
organizations within our society make choices and how those choices determine
how the resources of society are used.
— Joseph Stiglitz

1.2 SCARCITY, CHOICE AND OPPORTUNITY COST

Scarcity
Scarcity exists because there are not enough goods and services to satisfy everyone's wants.
Wants are unlimited, but the means of satisfying them are limited.

Scarcity affects everyone. The rich are also subject to scarcity. Even the richest person on
earth will have unsatisfied wants and will have to make economic decisions.

Wants, needs and demand

 Demand refers to the quantities of a good or service that prospective buyers are willing and
able to purchase during a certain period e.g. a consumer buying 1 liter of milk at R20
 Wants are human desires for goods and services. Our wants are unlimited- we all want
everything e.g. a new TV or phone.
 Needs are necessities, the things that are essential for survival, such as food, water,
shelter, clothing. Needs unlike wants are not unlimited e.g. clean drinking water.
 Thus demands differs from wants, desires or needs. There is a demand for a good/service
only if those want to buy have the means to do so.
Resources and factors of production
 Natural resources include agricultural land, minerals and fishing resources.
 Human resources include labour.
 Man-made resources include machines.
These resources are used to produce goods and services and are called factors of production.
Because resources are limited, the goods and services that can be produced are also limited.

Choice
Because resources are scarce, individuals, businesses and governments must choose between
alternative uses of their limited resources.
When resources are used to produce certain goods, they not available to produce other goods.
A decision to produce more of on good therefore also means that less of another good can be
produced. Therefore, choosing one alternative requires another alternative to be sacrificed.
Eg: Hendrik Mathibela goes to the shop with R15 in his pocket. He wants an ice cream, a cool
drink, a chocolate and a packet of chips. But his resources are limited. He cannot buy all the
things he wants with the R15. He therefore has to choose what to buy and what to sacrifice.
When we are faced with such a choice we can measure the cost of the alternative we have
chosen in terms of the alternatives that we have to sacrifice. This is called opportunity cost

TANSTAAFL principle
“There ain't no such thing as a free lunch”.
The principle means that there are always costs involved in using scarce resources because
other opportunities have to be sacrificed.

Opportunity cost
The opportunity cost of a choice is the value to the decision maker of the best
alternative that could have been chosen but was not chosen. In other words,
the opportunity cost of a choice is the value of the best forgone opportunity
Opportunity cost is the best alternative sacrificed when a choice is made.
Every time a choice is made, opportunity costs are incurred and economists always measure
costs in terms of opportunity costs

1.3 PRODUCTION POSSIBILITIES CURVE

The production possibilities curve (PPC), also called the production possibilities frontier,
illustrates scarcity, choice and opportunity cost.
The production possibilities curve indicates the combinations of any two goods
or services that are attainable when the community's resources are fully and
efficiently employed.

What the PPC shows

 Scarcity is shown by points beyond the curve, which are unattainable with the available
resources and technology.
 Choice is shown by the need to choose between attainable combinations.
 Opportunity cost is shown because producing more of one good requires sacrificing some of
the other good.
 The negative slope represents a trade-off between the two goods.
 Points on the curve represent full and efficient use of resources.
 A point inside the curve is attainable but inefficient.
 A point outside the curve is unattainable.

1.4 FURTHER APPLICATIONS OF THE PRODUCTION POSSIBILITIES CURVE

Increasing opportunity cost
As production moves along the PPC, the amount of one good that must be sacrificed to
produce an additional unit of another good increases. This causes the PPC to bulge outwards
from the origin.

Production possibilities and potential output

 The production possibilities curve (PPC) shows attainable and efficient combinations of
goods, while points beyond the curve are unattainable and points inside the curve are
attainable but inefficient.
 The PPC is also called the production possibility boundary or frontier.
 It indicates the maximum attainable combinations of two goods and services, also called
potential output.
IMPORTANT
When resources are fully and efficiently used: Actual output = Potential output.
When an economy operates inside the PPC, actual output is below potential output because
some resources are unemployed or used inefficiently.

Economic growth and the PPC

An outward shift of the PPC represents economic growth.
Economic growth can result from:
 An increase in the quantity of available resources.
 An improvement in production techniques or technology.
 An increase in the productivity or efficiency of resources.
If the quantity or productivity of resources decreases, the PPC shifts inward and potential
output decreases.

CLASSIFICATION OF GOODS

Goods and services

 Goods are tangible objects such as food, clothing, houses, books and motorcars.
 Services are intangible things such as medical, legal and financial services.
 Economics often refers to “goods and services”, but the term “goods” may be used to
refer to both goods and services.
Consumer goods
Consumer goods are goods that are used or consumed by individuals or households
(ie consumers) to satisfy wants.

Capital goods
Capital goods are goods that are not consumed in this way but are used in the
production of other goods.

 Capital goods are an important factor of production.

 Capital goods do not provide direct consumer satisfaction but allow for greater
production and satisfaction in the future.
 Choosing between consumer goods and capital goods involves a choice between present
and future consumption.
 Capital goods have a limited lifetime and are subject to wear and tear and
obsolescence, causing their value to depreciate over time.

Non-durable, semi-durable and durable goods

Type Definition
Non-durable goods Non-durable goods are goods that are used once only.
Semi-durable goods Semi-durable goods can be used more than once and usually last
for a limited period.
Durable goods Durable goods normally last for a number of years.

Final goods and intermediate goods

Final goods are the goods that are used or consumed by individuals, households and firms.

Intermediate goods, on the other hand, are goods that are purchased to be used as inputs in
producing other goods.

 Intermediate goods are processed further before being sold to end users.

Private goods and public goods

Private goods Public goods
A private good is a good that is consumed by A public good is a good that is used by the
individuals or households. community or society at large.
Individuals cannot be excluded from
Consumption by others can be excluded.
consumption.

Economic goods and free goods

An economic good is a good that is produced at a cost from scarce resources.

 Economic goods are therefore also called scarce goods.

A free good is a good that is not scarce and therefore has no price.

 Goods from nature are not necessarily free in the economic sense, because resources,
effort and costs may be required to make them useful.
 A good or service labelled “free” is not necessarily economically free because someone
else may bear the cost.
 This relates to the TANSTAAFL principle: “there ain't no such thing as a free
lunch”.

Homogeneous and heterogeneous goods

Homogeneous goods Heterogeneous or differentiated goods
Goods available in different varieties,
Goods that are exactly alike.
qualities or brands.

Changes in production techniques

 If the technique for producing capital goods improves while resources and the technique for
producing consumer goods remain unchanged, the maximum potential output of capital
goods increases.
 If the technique for producing consumer goods improves while resources and the technique
for producing capital goods remain unchanged, the maximum potential output of consumer
goods increases.
 If the quantity or productivity of available resources increases, both consumer goods and
capital goods can be produced in greater quantities.
 Basically swipe the axis for the main point  improved technique for producing capital good
(main point on the consumer goods axis)  improved technique for producing
consumer goods (main point on capital goods axis)

Actual output and efficiency

 If the economy operates inside the PPC, actual output is less than potential output because
some resources are unemployed or not used efficiently.
 Production can increase by using existing resources more fully and efficiently, without
necessarily increasing the available resources or changing technology.

Choice and resource allocation

 The PPC illustrates potential output, but it does not determine which combination of goods
should be produced.
 The final choice depends on the preferences of society.
 Producing more capital goods means fewer resources are available for current consumer
goods.
 However, greater current production of capital goods increases the economy's potential
output and future production of consumer goods.
 Producing mainly consumer goods means the capital stock will not expand as rapidly,
which can reduce future potential output.
Problem of resource allocation
The decision about what to produce is therefore really a decision about how to allocate the
scarce resources among different possible uses. That is why the decision about what to
produce is called the problem of resource allocation.

1.5 ECONOMICS IS A SOCIAL SCIENCE

Economics is a science because it systematically attempts to discover regular patterns of
behaviour. These patterns are used to explain what is happening, predict what might happen
and assist policymakers to choose appropriate economic policies.
Economics is a social science because it studies the behaviour of human beings individually
and in groups.

Laws in economics are not exact as the laws of natural sciences.

Ceteris paribus
Ceteris paribus (which is the Latin term for "all things being equal") is the
economist's substitute for the natural scientist's controlled laboratory.
experiments.
The ceteris paribus assumption means that all other relevant factors remain constant or
unchanged while the effect of one change is examined. It is essential to economic reasoning
because it allows economists to isolate the effect of one variable at a time.

1.6 MICROECONOMICS AND MACROECONOMICS

Microeconomics
Microeconomics focuses on the individual parts of the economy. It examines the decisions and
behaviour of individual consumers, households, firms and organisations. It also studies
individual goods and services, including their demand, supply and prices.
MEMORY TIP
MICRO = individual parts / small units.

Macroeconomics
Macroeconomics is concerned with the economy as a whole and focuses on aggregate
economic behaviour.
MEMORY TIP
MACRO = whole economy / totals.
Microeconomics Macroeconomics
Studies individual parts of the economy. Studies the economy as a whole.
Focuses on individual consumers, households
Focuses on aggregate economic behaviour.
and firms.
Studies totals such as production, income
Studies individual goods, markets and prices.
and unemployment.
1.7 POSITIVE AND NORMATIVE ECONOMICS
Positive economics
A positive statement is an objective statement of fact.
Positive statements can be proved or disproved by comparing them with facts.

Normative economics
A normative statement involves an opinion or value judgement.
Normative statements cannot be settled objectively by facts alone because they involve value
judgements.
Words such as “should”, “ought”, “desirable” and “must” usually indicate normative
statements, but a statement does not have to contain these words to be normative.
Positive Normative
Objective statement of fact. Opinion or value judgement.
Can be tested against facts. Cannot be settled by facts alone.
Describes what is. Concerns what ought to be.

Why economists disagree

1. They make different value judgements.
2. They may be biased by their interests or employers.
3. They may have different views about how the economy operates.

1.8 THE ECONOMIC WAY OF THINKING

1. Blinkered approach / biased thinking
The blinkered approach occurs when people analyse an economic problem from their own
limited perspective and therefore produce an oversimplified explanation or solution.

2. Fallacy of composition
This is called the fallacy of composition. Something that is true for the single
case (or a part of the object being studied) is not necessarily true for the whole.
The fallacy of composition occurs when something that is true for an individual or part is not
always true for the whole economy.

3. Post hoc ergo propter hoc

Post hoc ergo propter hoc is a Latin phrase meaning "after this, therefore
because of this".
The post hoc fallacy occurs when people assume that because one event occurs before
another, the first event must have caused the second.
 MEMORY TIP
Sequence does not prove causation.

4. Correlation and causation

Correlation does not imply causation.
Two variables may occur together or change together without one causing the other.
A statistical correlation does not prove that one variable caused another. To establish
causation, there must be a logical theory explaining how one variable affects the other.
Correlation Causation
A change in one variable produces a change
Two variables are related or move together.
in another.

Correlation refers to a relationship between two variables where they change or move
together, but it does not mean that one variable causes the other to change. Causation
occurs when a change in one variable directly causes a change in another variable. Therefore,
correlation shows that variables are related, while causation shows a cause-and-effect
relationship.

5. Levels and rates of change

A level refers to the amount or position of a variable at a particular point.
A rate of change refers to how quickly the level of a variable is changing.
 Do not confuse a high level with a high rate of increase.
 Do not confuse a falling rate of increase with a fall in the level itself.
If the inflation rate decreases, prices may still be increasing, but at a slower rate.
IMPORTANT
A variable can have a low level but a high growth rate if it started from a low base.

APPENDIX: THEORY AND ECONOMIC ANALYSIS

A.1 THEORY AND REALITY

Three purposes of economic theory

1. To explain how different things are related in the real economic world.
2. To predict what will happen if something changes.
3. To provide a basis for formulating and analysing economic policy.

A.2 DIFFERENT WAYS OF EXPRESSING A THEORY

Economic theory is an attempt to explain and analyse economic behaviour by
isolating certain important relationships, patterns or regularities.
Equations
Equations provide a shorthand way of expressing relationships and allow relationships
between several variables to be analysed using algebra.
EXAMPLE
C = f(Y) means household spending C depends on household income Y.

Graphs
Graphs provide a visual representation of economic theories and relationships. Students must
be able to interpret and draw economic graphs.

A.3 VARIABLES AND FUNCTIONAL RELATIONSHIPS

A variable is anything that can be measured and that can change.
A function is a statement of how one variable depends on one or more other
variables.

Exogenous and endogenous variables

An exogenous or autonomous variable is used to explain other variables but is not self
explained by the theory.
An endogenous variable is a variable that is explained by the theory.

Types of functional relationships

Relationship Meaning
The dependent and independent variables
Direct / positive
change in the same direction.
The dependent and independent variables
Inverse / negative
change in opposite directions.

Types of equations in economics

A behavioural equation represents a functional relationship or theory about the behaviour of
individuals, groups or institutions.
An equilibrium equation or equilibrium condition indicates the equilibrium state of the variables
and identifies the equilibrium position.

A.4 EQUILIBRIUM, COMPARATIVE STATICS AND CETERIS PARIBUS

Equilibrium refers to a situation in which none of the participants has any
incentive to change his or her behaviour - everyone is content to continue with
things as they are.
Equilibrium is a state of balance in which opposing forces offset each other and there is no net
tendency for the system to change.
Static analysis / statics
Static analysis is the description of an equilibrium state. It is called static because it does not
involve time or motion.

Comparative statics
Comparative statics compares an original equilibrium with a new equilibrium after one
underlying force has changed. It determines the effect of the change by comparing the two
equilibrium positions. Comparative statics does not involve time.
MEMORY TIP
Statics = one equilibrium. Comparative statics = compare two equilibria.

Ceteris paribus
Ceteris paribus is a Latin term that means "other things being equal".
The ceteris paribus assumption means that all other factors remain constant or unchanged
while the effect of one change is examined.
It is essential because economists need to isolate the effect of one variable at a time when
analysing cause-and-effect relationships.

A.5 READING AND WORKING WITH GRAPHS

Graphs are used to illustrate economic facts and figures and to present an economic theory or
model visually.

Axes
 The horizontal axis is the x-axis.
 The vertical axis is the y-axis.
 The origin is where the two axes intersect.
 The first quadrant contains positive values for both x and y and is commonly used for
economic graphs.

Graph scale
Once a scale is chosen for an axis, it must be applied consistently throughout that axis. Equal
distances on an axis must represent equal quantities.

Linear and non-linear relationships

A straight line represents a linear relationship. A curved line represents a non-linear
relationship.
Graphs must have clearly labelled axes, origin, lines and curves so that the relationship can be
interpreted correctly.

Equation of a straight line

GENERAL EQUATION
y = a + bx

y = dependent variable
 x = independent variable
a = y-intercept
b = slope

Intercept
The intercept of a graph or curve is the point at which it crosses (or intersects)
one of the axes.
 The y-intercept is found by setting x = 0.
 The x-intercept is found by setting y = 0.

Slope
The slope of a function, curve or graph indicates the response of one variable to
changes in the other variable.
FORMULA
Slope = Δy / Δx = change in y values / change in x values
Slope = difference in values on vertical axis / difference in values on horizontal axis
= 7-5 / 300-200
= 2 / 100
= 0.02
Slope = m / r
Where: m = annual maize production (in millions of tons)
r = annual rainfall (in millimetres)