INTRODUCTION TO ECONOMICS AND MICROECONOMIC

CONCEPTS
Learning objectives
By the end of this chapter you should be able to;
(i) Describe the meaning of economics.
(ii) Distinguish between microeconomics and macroeconomics.
(iii) Understand the economic concepts of scarcity, scale of preference, choice and opportunity cost.
(iv) Distinguish between positive and normative economics.
(v) Explain the basic economic problems.
(vi) Describe different types of economic systems.
(vii) Explain the concept of production possibility frontier.

1.1. Introduction

The word “economics” originated from the Greek language “oikonomos”. This word oikonomos is a combination
of two words which are “oikos” meaning “house” and “nomos” meaning “managing”. Accordingly, economics
portrays the meaning of “household management". As time elapses, economics has been defined by different
scholars basing on different perspectives. These scholars defined economics and delimited its scope and subject
matter differently at different stages of its growth as a social science. A brief review of some popular definitions of
economics will show the evolution of the definition of economics. It will also help in understanding the nature and
scope of economics. The various definitions and views on the nature and scope of economics may be
chronologically grouped under four categories; these are Early definitions, Classical views, Neo-classical definition
and Scarcity or Modern definitions.

1.1.1. Early definitions

In this stage, economics is being regarded as it was in its embryonic stage till the middle of 18 th century. During
this period, Greek Philosophers like Aristotle and Xenophon viewed economics as an art of household management.
In later years, wealth gained an important place and role in the life of nations. In the period of merchants’ economics
rose to the status of political economy, and the scope of economics was widened to include the management of
national wealth. Economics remained a part of social studies.
1.1.2. Classical views

These views attempt to distinguish economics as a separate branch of social studies. Adam Smith (1723 – 1790)
“Father of Economics” defined economics as a subject concerned with an enquiry in to the nature and causes of
wealth of nations. He also called it a “science of wealth.” Most classical economists supported Smith’s idea.
Therefore, classical economists limited the scope of economics to the enquiry of material wealth and prosperity of
the nations. It may also be argued that Smithian views were very narrowed compared to its modern connotation. It
delimited the scope of economics only to the enquiry of “wealth of nations.” As a result, human economic behavior;
the main subject matter of modern economics; relegated economic studies to a position secondary to the acquisition
of material wealth and prosperity. Smithian idea however, remained in vogue till the end of the 19 th century when
Alfred Marshall attempted to redefine economics and widened its scope.

1.1.3. Neo-classical definition

Alfred Marshall (1842 – 1924) re-oriented economics towards the “study of mankind” and provided economic
science with more comprehensive definition. According to Marshall, economics is a study of mankind 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 material requisites of well-being. While Adam Smith emphasized wealth,
Marshall emphasized both wealth and mankind. Marshall added that economics “is one side of a study, and on the
other and more important side, a part of study of man.” Marshall widened the scope of economics to include the
study of mankind and their activities undertaken to promote their material welfare.

1.1.4. Scarcity or Modern definitions

It is more important to have a clear sense of what economics is about, via examples. Many non-economists think
that economics is all about how to make or manage money. This is not true; economics is much broader in scope.
It is about making choices in the face of scarcity. If things were not scarce, there would not be a subject matter like
economics, because then an individual or a nation could have anything that it wanted. Unfortunately, that is not the
case. If nothing else, time is scarce. Given the problem of scarcity, choice is inevitable in our daily lives. Even the
richest person in the world today, Bill Gates, has to make a choice on a particular morning whether to go for gym
for one hour or to have a video conference with a Microsoft top executive officers. Because things are scarce, one
has to make a choice; thus, the problem of choice arises due to scarcity. The study of such problems of choice at
the individual, social, regional, national and international level is what economics is all about.
Lionel Robbins (1898 – 1984) stressed the notion of scarcity in all economic behavior. He defined economics as a
science which studies human behavior as a relationship between ends and scarce means which have alternative
uses. Robbins argued that the dominant characteristic of human behavior which is relevant to the economist is that
of decision-making subject to constraints. Therefore, Robbins’ definition implies that economics essentially deals
with human behavior which is related to the allocation of scarce resources between their alternative uses. The main
characteristics of Robbins’ definition are the following;
(i) Unlimited wants of human beings
(ii) Limited or scarce resources
(iii)Alternative uses of resources
(iv)Different importance of wants
The main objective of economic activity is to allocate the scarce resources in such a way that maximum satisfaction
may be achieved. The scarcity is the subject matter of economics. Therefore, economics is a field of study which
deals with human behavior in the process of allocating scarce resources so as to produce goods and services in
order to satisfy human wants.

Many modern economists have defined economics in Robbinsonian fashion with of course some modifications
without altering the spirit of his definition. For example, Samuelson (2003) defines economics as the study of how
people and society end up choosing with or without the use of money, to employ scarce productive resources that
could have alternative uses to produce various commodities and distributing them for consumption, now or in the
future, among various persons and groups in the society. Economics is the study of how society solve basic
economic questions of what to produce, how to produce and for whom to distribute the produced goods and service,
using the scare resources. Other economists like Cairn Cross, Alfred Stonier, Douglas Hague, Tibour Scitovsky, C.
E. Furgon also have defined economics in terms of scarcity of resources and problem of resource allocation or
resource management.

1.2. The distinction between microeconomics and macroeconomics

Every science has its own terminology, a system of words and phrases with specific connotations. Likewise,
economic science has its own terminologies, concepts and approaches. Some economic terms have been coined by
the economists and some concepts and terms have been borrowed from other sciences to express certain economic
phenomena. Here we shall discuss the distinction between microeconomics and macroeconomics. The two terms
microeconomics and macroeconomics were first coined by Ragnar Fisch, a German Economist in
1933. The prefixes micro and macro have been derived from Greek words mikros meaning “small” and makros
meaning “large.” Thus, microeconomics and macroeconomics refers to the two branches of economics.

1.2.1. What is microeconomics?

Microeconomics is the study of scarcity and choice. It focuses on the behavior of individual and group decision-
making in parts or sectors of the economy which are most conveniently described as markets. Microeconomics is
the branch of economics which deals with the choice and decision-making behavior of the individual consumers or
households, workers, investors, owners of land, business firms or industries. Microeconomics explains why and
how these economic units make economic decisions.

For example, it explains how consumers make purchasing decisions and how their choices are affected by changing
prices and incomes. Microeconomics helps us to understand for example why Coca Cola Company grows the way
it is and how the producers and consumers of Coca Cola interact in the market. It further explains how Coca Cola
prices are determined, how much Coca Cola company invests in new factories and how many Coca Cola crates are
produced each year.
Microeconomics is concerned with how individual firms decide how to allocate scarce resources (how they answer
three basic economic problems/questions) to minimize costs of production. By studying the behavior and
interaction of individual firms and consumers, microeconomics reveals how industries and markets operate and
evolve, why they differ from one another and how they are affected by government policies and global economic
conditions.

1.2.2. What is macroeconomics?

Macro means “too large.” Macroeconomics is the branch of economics which is chiefly concerned with the behavior
of and relationship between aggregate variables which affect the economy as whole, e.g., national income, total
output, total consumption, total savings, investment, total money supply, total employment, general price level etc.
In contrast to microeconomics, macroeconomics is concerned with the nature, relationships and behavior of such
aggregate quantities and averages such as national income, total consumption, savings and investments, total
employment, general price level, aggregate expenditure and aggregate supply of goods and services.
Infact, macroeconomic theories seek to answer such questions as; How is the level of national income of country
determined? What determines the level of total employment? How is the general level of price determined? What
causes the fluctuations of national output, employment and general price level? What determines the level of foreign
trade and what factors contribute to the growth of surplus and deficits in the balance of payment position of a
country? What determines the real GDP or inflation rate in an economy? What policies can reduce the rate of
unemployment in a developing country like Tanzania?
Briefly speaking, theories of national income, consumption, savings and investment, theories of employment,
economic growth, business cycles and stabilization policies, theories of money supply and money demand and
theory of foreign trade broadly constitute the subject of macroeconomics.

1.3. The nature of economic science

Apart from the three broad questions, what kinds of more specific questions/issues are addressed in economics?
There are several. For instance, what are the various factors that determine the demand for a particular product in
the market? What are the various factors that determine the supply of a particular product in market? How would
an increase in the price of Coca Cola affect the demand for Pepsi? What should be the government’s policy in order
to increase employment in the economy? Why does the announcement of a new government budget every year
have some sort of an impact on the prices of goods and services? What should be Tanzania’s best policy with
respect to exportation of Gold, Diamond and Tanzanite?

There are of course many more questions of potential interest and relevance. However, if you look at the sample of
questions outlined above, you will see that all the questions can be categorized into two types. One type is concerned
with the effect of something or some policy change on some variables. The other type is concerned with how a
particular policy should be shaped in the best interests of the economy in a given context. The former is called
positive economics, whereas the latter is called normative economics.

1.3.1. What is positive and normative science?

A positive science may be defined as a body of systematized knowledge concerning what is, was or will be and
hence depends on facts. Positive science describes how the circumstances occur. A normative science or regulatory
science is a body of systematized knowledge relating to criteria of what ought to be and hence depend on value
judgment as to what is good or bad. It concerned therefore with ideal as distinguished from actual. It states how the
circumstances should occur. Economics as a body of systematized knowledge is concerned with both the questions;
what is and what ought to be. Therefore, economic science is concerned with both what is and what ought to be.
Economic science is thus both a positive and a normative science.
 1.3.2. Economics as a positive science

The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful.
If one examines economics in the light of this statement, one finds that a part of economic science studies the
economic phenomena as they exist, finds out the common characteristics of economic events, specify “cause and
effect” relationship between them and generalizes their relationship in the form of theoretical propositions which
can be used to make predictions. Thus, one of the tasks of economic science is “to provide a system of
generalizations” or economic theories capable of being used to make predict ions about both past and future course
of economic phenomena. For instance, the relationship between price and quantity demanded in micro context, and
the relationship between money supply and inflation in macro context. Samuelson (2003) defines economics as a
positive science is a body of tentative accepted generalizations about economic phenomena that can be used to
predict the consequences of changes in circumstances.

1.3.3. Economics as a normative science

This is concerned with the ideal economic world, not with what actually happens. Its objective is to examine real
economic events from moral and ethical angles and to judge whether certain economic events are desirable or
undesirable. It states how the circumstances should occur. Thus, normative economics involves value judgments.
It deals primarily with economic goals of a society and the policies to achieve these goals. It also prescribes the
methods to correct undesirable economic happenings. It is therefore called “prescriptive” aspect of economic
science.
Clarification
To clarify the positive and normative character of economics, consider the following two examples:
Example 1
Economics studies the pattern of resource allocation in the economy i.e., how much resources (men and material)
go to essential goods sector and how much it goes to luxury goods sector. This kind of economic study is related
to what is. It is the task of economists to find out whether the existing pattern of resource allocation is optimum,
and not how can it be optimized, i.e., what should be the pattern of resource allocation to fulfill the social maximum
needs. The whole price theory is concerned with what is, whereas the price controls and regulations, subsidies and
public distribution of scarce and essential commodities are the economic events concerned with what ought to be.
Thus, economics is both positive and normative science.
Example 2
Economics studies what is the pattern of national income distribution between different sections of the society. It
also studies whether the existing pattern of national income distribution is justifiable from social equity point of
view. If not, what should be the desirable pattern of national income distribution and how can national income be
equitably distributed among the people. Therefore, economics is both positive and normative science.

1.4. Definitions of some economic terms

1.4.1. Scarcity

Scarcity means limited in supply, or less than requirement. This is the main economic problem in any economy
(developed and underdeveloped). It is the main problem in the sense that resources to satisfy human wants are
scarce or limited compared to human wants which are unlimited. Anything is considered to be scarce when it is
limited in supply.

1.4.2. Wants and their characteristics

These are human desires. They are also called ends. All human beings have desires to get better quality of food,
more clothes, modern houses, new model cars, T.V. set etc. All wants of human beings cannot be satisfied at a time
because resources required to produce these wants are limited.

Characteristics of human wants:

Human wants differ in different places at different times. Human wants vary according to physical, social,
economic and political conditions. However, human wants as a whole do show certain general characteristics.
(i) Wants are unlimited in number.
In primitive societies, wants were very few and simple, mostly food, clothing and shelter. With the technical
and economic progress new wants have cropped up. It is the tendency of human being that when he/she has
got one thing, he/she desires to possess something else, and then another and so on. It is for this reason
economists conclude that wants are unlimited.
(ii) Wants are complementary
Wants are said to be complement when for satisfying one want, one has to satisfy two more. Example; a car
requires petrol or diesel and a fountain pen requires ink, a mobile phone requires air time etc.
(iii) Wants are alternative (or competitive)
 To some extent, wants are alternative. It is possible to satisfy a given want through the use of substitute goods.
For example, a person may take tea instead of coffee, drink Coca-Cola instead of Pepsi, study at IFM instead
of CBE, drive a Vanguard instead of Harrier, spend a holiday at Mikumi instead of Ngorongoro, use Vodacom
network instead of Airtel etc. The choices among these alternatives may depend on taste and of course the
money at someone’s disposal.

(iv) Wants vary in urgency and intensity

Though wants may be competitive, they are not generally equally urgent. The intensity of a particular want may
differ from person to person, time to time etc.
Example 1
The urgency of a sick person is to acquire a service of medical doctor; however, the intensity of this demand
depends on the illness of that individual. Some sick persons require an intensive care unit (ICU) service while
others may just make a call to doctor, receive medical instructions and proceed with their daily activities.
Example 2
The urgency of a driver whose car has experienced a mechanical failure is to get a service of mechanics. However,
the intensity of this demand depends on some factors. A car that experience a problem at the mid of a river bridge
and the one which breaks at the nearby home upon returning after working hours will differ in terms of their
intensity of demand for mechanical services.

1.4.3. Choice

Choice means selecting from a list of preferences. It is the action of choosing some wants from the list of alternative
human wants. Since all wants cannot be satisfied at a time due to scarcity nature of resources, then choice has to be
made. If there are several wants and resources to satisfy these wants are not sufficient (are scarce), then only a few
wants will be satisfied and, in this case, choice will be made. The wants which have greater importance will be
satisfied first, and therefore this selection is known as choice.

1.4.4. Utility

Different commodities can satisfy different human wants. Any commodity which can satisfy any human want has
utility. The quality of that commodity which satisfies any human want is called its utility. In other words, utility is
the level of satisfaction that a person derives from consuming goods and/ services.
1.4.5. Goods

Is anything which satisfies human wants and that has exchange value. It may be commodity like soda, bread and
milk or service like lawyer service, doctor service etc. Characteristics of goods are; goods are scarce, goods must
have utility, goods must have exchange value (though not all goods possess exchange value, e.g., sun shine) etc.
Types of Goods
(i) Free goods vs. economic goods

Free goods are free in nature e.g., air and sun shine. These goods have utility but no exchange value.
Economic goods are those goods which are scarce when compared to human wants. They have both utility
and money value.

(ii) Consumer goods vs. producer goods

Consumer goods are directly capable of satisfying economic wants. They are meant for immediate
consumption. Producer goods or Capital goods are goods which are not used for immediate consumption,
but are used to produce consumer goods. They are desired not for their own sake, but because they assist
production of other goods.

1.4.6. Opportunity cost

This is the next best alternative sacrifice made in order to obtain something. Due to scarcity problem, order of
preferences has to be made starting with the most important at the top and least important preferences at the bottom.
This is called scale of preference. From this scale of preference, choice has to be made hence selecting from these
preferences. The next best alternative of this choice is called opportunity cost of that choice.

1.4.7. Scale of preference

When making choice, the alternative wants are arranged in the order of priority or preference, starting with the
most important at the top and the least important at the bottom. This arrangement is usually referred to as scale of
preference. One has to rank the alternatives in order to make choice because resources are scarce.

1.5. Economic problems

There are many specific economic problems; poverty, inflation, unemployment etc. However, if we use the term
economic problem, we are referring to the overall problem of scarcity of resources.
1.5.1. Problem of scarcity

Most definitions of economics focus on scarcity and choice. To economists virtually everything is scarce, not just
diamonds or oil but also bread and water. How can we say this? The answer is that one only has to look around the
world to see that there are not enough resources to give people all they want. When economists use the word
scarcity, they mean that; all resources are limited in supply in the sense that there are not enough resources to satisfy
fully everyone’s wants. It is in this sense that resources are limited both in reach countries and poor countries. The
focus for much of economics is to evaluate the choices that exist for the use of these resources. We make such
choices every day because we cannot buy everything we want. What we do is to choose between the things/wants.
Thus, we have another characteristic of economics; it is concerned with choice. Scarcity means that available
resources are insufficient to satisfy all wants and needs. If there is no scarcity and alternative uses of available
resources, then there is no economic problem and it would have been meaningless to study Economics. Thus, the
subject matter of economics as defined above involves the study of choices and sacrifice (technically called
opportunity cost).
SCARCITY = Unlimited wants – Limited resources

1.5.2. The basic economic problems

Remember that economics deals with choice problems arising out of scarcity. There are indeed many choice
problems that any particular economy solves within a given time period. For example, the output of rice in Mbeya
is not entirely driven by external factors like rainfall. It is partly influenced by how much of land is used to raise
that particular crop and partly by the applications of fertilisers, human efforts (labour) and so on. All these are
consequences of individual choice as well as government policies. Hence, external factors held constant, production
of rice in Mbeya at a particular time (year) is an outcome of choice. Tanzania, like many other countries, does not
produce jet planes. But it produces minerals, tourism services, soft drinks, textiles and other products. This is also
a choice problem, given the constraints1, and that is scarcity.
We have seen in the earlier discussion that scarcity is the main economic problem in any economy which results
into choice. Due to this problem, economics centered on how to allocate scarce resources among unlimited and

1
It may be argued that Tanzania does not produce jet planes because it does not have the necessary technology. However, if a technology
is not available domestically, it can certainly be acquired by paying for it. So, acquiring a particular technology is also a choice problem.
Many technologies can be purchased if we decide to pay for it. But we should not buy any available technology even if we can afford it.
The benefits from having a technology must be weighed against the cost of acquiring it.
alternative human wants. It is also from scarcity problem where economists derive other three basic economic
problems, these are:
(i) What to produce?
(ii) How to produce?
(iii) For whom to produce?

(i) What to produce

This is the problem of choice between commodities. It answers the question “what goods are to be produced with
the scarce resources?” The problem arises mainly for two reasons which are; first, scarcity of resources does not
permit the production of all the goods and services that people would like to consume, and second, all the goods
and services are not equally valued in terms of their utility by the consumers, and also in terms of production costs.
Since all the goods cannot be produced at a time due to scarcity of resources, then choice between goods have to
be made. That is, what commodities should be given preference in production so that consumers are able to satisfy
their needs in the order of preference?

(ii) How to produce

By which methods would the goods and services be produced? Which technology is to be used in a new cement
plant to be established let say Tanga region? Thus, how to produce is the problem of choice of technology. Here,
the problem is to determine the input combination of labor and capital to be used in the production of goods and
services. This problem also arises due to scarcity nature of resources, i.e., if capital and labor were unlimited, then
any amount would be combined to produce goods and services.
(iii) For whom to produce
From the various goods and services that are available to an economy, who gets how much to consume? It depends
on who earns how much or who has how much assets. For example, how much does an economics bachelor degree
earn per annum as compared to a political science or a chemical engineer bachelor degree candidate? The ‘for
whom’ question refers essentially to the issue of income and wealth distribution in an economy. The question is
how the national output is shared among the households, or what determines the share of each household?
Note that, all these three problems are answered regarding the nature of the prevailing economic system; i.e.
Command economy, Market economy and Mixed economy.

1.6. Economic system (different answers to the same questions)

We stated earlier that each society has to answer the three fundamental economic questions: What, how and for
whom to produce. While there are a million variations on answers to these questions, when we look around the
world, we find that there are only a limited number of ways in which society have set about answering them. Briefly
we will examine them. What is economic system? Economic system is that institutional arrangement whereby
human and natural resources of an economy co-operate with each other to produce goods and services. The main
objective of economic system is to allocate and utilize the scarce resources available in such a way that production
of goods and services may be maximized. Economic systems are of three types;
(i) Free enterprise/capitalist/market economy
(ii) Command/socialist/centrally planned economy
(iii) Mixed economy

1.6.1. Free enterprise/capitalist/market economy

In a market-oriented or capitalist economy, the three fundamental problems are solved by the ‘market.’ Itself.
Indeed, there is a price of any good or service, which is influenced by the forces of demand and supply. These
forces guide which goods are to be produced and consumed and in what quantity. Decisions regarding what, how
and for whom to produce are made through these market forces of demand and supply also known as price
mechanism. Here, price mechanism means a system where the economic decisions are reached through the
workings of the market forces of demand and supply. Changes in the relative scarcity of goods and services are
reflected in changes in prices and these price changes produce incentives for producers to reallocate available
resources towards reducing market shortages and surpluses. In free enterprise economy, there is economic
competition; economic freedom and individuals can form their property. The main defects are unfair distribution
of wealth, unemployment, over utilization of resources etc.

1.6.2. Command/socialist/centrally planned economy

Besides, there is a central planning authority that decides which goods and how much should be consumed and
produced in the economy within a given span of time, say a year or five years. These are like targets. They are set
according to the overall growth and development strategy for the economy that is considered ‘desirable’ by the
members of the planning authority. Factories are government-owned and the production methods are chosen by the
planning authority. Salaries are also decided by the government. In brief, all three central problems (what, how and
for whom) are essentially solved by direct command from the government. That is why a centrally planned economy
is also called a command economy. The merits of this system are that there is fair distribution
of wealth and employment is relatively higher. On the other hand, there is neither economic freedom nor
competition, so there is a possibility of producing low quality commodities. Which system is better in solving the
fundamental problems of an economy?

1.6.3. Mixed economy

Under the mixed economy, some resources are owned by the government and some are owned by the private
individuals, the same applies for the decision making about what, how and for whom to produce. It is therefore that
under mixed economy, features of both free enterprise and centrally controlled economies are found. The decisions
about resources allocation are done partly by the government and partly by the private individuals.

1.7. Production possibility frontier/curve

Production possibility frontier/curve (PPF) represents the point at which an economy is most efficiently producing
its goods and services and, therefore, allocating its resources in the best way possible. If the economy is not
producing the quantities indicated by the PPF, resources are being managed inefficiently and the production of
society will dwindle. The production possibility frontier shows there are limits to production, so an economy, to
achieve efficiency, must decide what combination of goods and services can be produced. The slope of the PPF is
called marginal rate of transformation (MRT) and it defines the opportunity cost of one product in terms of the
other. This is the rate at which one product can be transformed or converted into another product by reallocating
resources. The shape of the PPF also defines the opportunity cost of one product in terms of the other. If the PPF is
the straight line, then there is constant slope and hence constant opportunity cost but if the PPF is bowed upward,
the there is increasing opportunity cost.

Assumptions
(i) Simple economy which produces two products
(ii) Scarcity of resources
(iii)Constant technology
(iv)Full employment/utilization of resources
Let's turn to the chart below. Imagine an economy that can produce only wine and cotton. According to the PPF,
points A, B and C (all appearing on the curve) represent attainable combination and the most efficient use of
resources by the economy. Point X represents an attainable combination but inefficient use of resources, while
point Y represents the goals that the economy cannot attain with its present levels of resources.
 Product A: Wine

Product B: Cotton
Figure 1.1 Efficiency, inefficiency, attainable and unattainable combinations
As we can see, in order for this economy to produce more wine, it must give up some of the resources it uses to
produce cotton (point A). If the economy starts producing more cotton (represented by points B and C), it would
have to divert resources from making wine and, consequently, it will produce less wine than it is producing at point
A. As the graph shows, by moving production from point A to B, the economy must decrease wine production by
a small amount in comparison to the increase in cotton output. However, if the economy moves from point B to C,
wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B,
and C all represents the most efficient allocation of resources for the economy; the nation must decide how to
achieve the PPF and which combination to use.

Point X means that the country's resources are not being used efficiently or, more specifically, that the country is
not producing enough cotton or wine given the potential of its resources. Point Y, as we mentioned above,
represents an output level that is currently unreachable by this economy. However, if there was a discovery of new
resources or a change in technology while the level of land, labor and capital remained the same, the time required
to pick cotton and grapes would be reduced. Output would increase, and the PPF would be pushed outwards i.e.,
the PPF would shift outward. A new curve, on which Y would appear, would represent the new efficient allocation
of resources.
 Product A: Wine

Product B: Cotton

Figure 1.2 Shifting of the production possibility curve (Technology and resources)

When the PPF shifts outwards, we know there is growth in an economy. Alternatively, when the PPF shifts inwards
it indicates that the economy is shrinking as a result of a decline in its most efficient allocation of resources and
optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in
technology. An economy can be producing on the PPF curve only in theory. In reality, economies constantly
struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo one choice for
another, the slope of the PPF will always be negative; if production of product A increases then production
of product B will have to decrease accordingly.

The relationship between the shape of the production possibility frontier and its slope
Normally production possibility frontier is bowed outward. This shape indicates that the opportunity cost is not
constant; accordingly, slope is not constant because the opportunity cost defines the slope of the production
possibility frontier. It must be noted that the opportunity cost or slope measures the quantity of one product which
must be sacrificed for an additional unit of another product when resources are used efficiently. Therefore, when
the production possibility frontier is bowed outward it indicates that there is an increasing opportunity cost or there
is an increasing slope. Conversely, when production possibility frontier is a straight line it indicates that there is
constant opportunity cost or constant slope.
 Product A: Wine Product A: Wine

Product B: Cotton Product B: Cotton

Figure 1.3A PPF with increasing opportunity cost Figure 1.3B PPF with constant opportunity cost

1.8. Equilibrium and disequilibrium

The term “equilibrium” has been derived from the Latin words, “acqui” meaning “equal” and “libra” meaning
“balance.” Thus, “equilibrium” means “equal balance.” The concept of equilibrium has been used in economics
to serve variety of purposes. The most liberal use of equilibrium has been made in the sense of equal weights on
the two arms of the scale “without any analytical, explicatory, predictive or evaluative connotation” in the context
of practically measurable quantities, such as income and expenditure in budget, export and import in trade balance
etc.
Another and probably the most prevalent use of equilibrium concept in economic theory is in the form of
“methodological device in abstract theory” or in abstract models, to establish the cause-and-effect relationship
between the interrelated variables which may be real or imaginary. Disequilibrium is therefore the opposite of
equilibrium. If the two arms of scale have unequal weights, then there is unequal balance, hence disequilibrium is
said to exist.

Types of equilibria
Types of equilibria can be classified based on different classifications such as coverage, time of adjustment, status
etc.
(i) Partial equilibrium v/s general equilibrium
Partial equilibrium is the technique of analyzing the behavior of an individual economic unit, example analyzing
the production behavior of an individual firm, analyzing the consumption behavior of an individual household etc,
while general equilibrium is the technique of analyzing the economic system as a whole. It deals with
relationships and interdependence between the various sectors of the economy and between variables which play a
key role in the economy, example relationship between industrial sector and agricultural sector.
(ii) Short term equilibrium v/s long term equilibrium.
Short term equilibrium refers to equilibrium position of consumer, producer or economy as a whole under the
conditions prevailing in the short term, while long term equilibrium refers to the equilibrium position of a consumer,
firm or the economy as a whole under the long-term conditions.
(iii) Stable, unstable and neutral equilibria
When displaced due to some small disturbances brings forces in operation which restore the initial equilibrium,
then that kind of equilibrium is called stable equilibrium. When displaced has tendency to move further and further
away from its original position, then that kind of equilibrium is called unstable equilibrium. When displaced, it
moves to another position of rest and establish a new equilibrium, then that kind of equilibrium is called neutral
equilibrium. Other types of equilibria are such as static v/s dynamic equilibria, unique v/s multiple equilibria etc.

1.9. Efficiency vs. equity trade-off

The issues between efficiency and equity have always been a contentious political debate. Efficiency means that
society is getting the most it can from its scarce resources. A more efficient society can produce more with the same
amount of resources. Equity means that the resources are distributed fairly among the individuals. We can view
efficiency as the size of a pie, and equity being how evenly the pie is being divided. When government policies are
being made, there is always a conflict between the two goals because we have to sacrifice one in order to gain the
other. Now we introduce the idea of tradeoffs. In order to get one thing that we like, we usually have to give up
something else. For example, if we spend more time on the job, we will have less time to spend on leisure. If we
sleep more, we will have less time to study. Efficiency and equity are in fact one of the biggest tradeoffs that a
society will face. When government designs its policies, it has to make sure that the society is making the maximum
use of its scarce resources while also making sure that the distribution of the benefits received by using the resources
is divided somewhat evenly among the citizens.

Example;
Suppose that in a certain society, there are two groups of individuals, namely group one and group two. Suppose
also that there are two projects which require two different costs (and which yield different benefits), namely project
A and project B which are highly demanded by group one and group two respectively; i.e., group one prefers project
A while group two prefers project B. Given that resources are scarce, the government is not able to
finance project A and project B at once hence only one project either project A or project B will be financed and
sacrifice the other. If efficiency is to be promoted, then the project with relatively low cost will be financed and the
other one will be sacrificed. In this case one group will be satisfied while the other will be forced to sacrifice their
preference and consume the project out of their preferences. Here, there is no equity because some individuals’
preference has been ignored, but there is efficiency because resources will be optimized. If equity is to be promoted,
then the available resources will be distributed equally (regardless their costs and benefits) among the two projects
so that every individuals’ preference in that society will be considered.
For a society to achieve full economic efficiency, three conditions must be met:
(i) Efficiency in production (productive efficiency)
This is a situation where firms are producing the maximum output for a given amount of inputs, or producing a
given output at the least/minimum cost. This means producing any other way would cost more.
(ii) Efficiency in consumption
This is a situation where consumers allocate their expenditures so as to get maximum satisfaction from their
income. It means that any other pattern of consumption would make people feel worse off.
(iii) Efficiency in specialisation and exchange
This is a situation where firms specialize in producing goods for sale to consumers, and where individuals specialize
in doing jobs in order to buy goods, so that everyone maximizes the benefits they achieve relative to the costs of
achieving them.

1.10. Economic methodology

It may be recalled that economics is the study of human behavior. Human behavior can be studied empirically as
well as analytically. In this subsection, we shall discuss the methods of economic generalization or what may be
expressed as methods of formulating economic theory.

What is economic theory?

Economic theory like theories of other sciences, present the complex realities of economic life in the form of
statements. It brings out the causal-relationship between the observed economic facts; it helps in predicting the
future course of economic events. The two kinds of methods which have been adopted at different stages of growth
of economic science by different schools of thought are deductive method and inductive method.
(i) Deductive method
In this method, reasoning proceeds from general to particular or from universal to individual. In this method,
inferences are drawn from general cases to establish the particular case.
 (ii) Inductive method
In this method, reasoning proceeds from particular to the general or from individual to the universal, and a general
case is made from the individual case.
What is an economic model?
An economic model is simplification of reality and is used as a systematic description of theories or representation
about certain problems or phenomena. The simplification involves making assumptions from which conclusion or
predictions are deduced. Economic models can be described in many ways depending on users and what problems
are being analysed. All sciences use models and the objective is the same for all, that is to simplify complicated
situation so that it is possible to handle the problem they are facing. When economic model relates two quantities
one is treated as Independent Variable while the other is treated as dependent variable. Independent variable is the
variable in an equation whose value is used to determine the value of another variable in the same equation.
Dependent variable is the variable in the equation whose value is determined by the value taken by another variable
in the equation.

1.11. Review questions

1. Write short notes on the following concepts

(i) Economics
(ii) Scarcity
(iii) Utility
(iv) Opportunity cost
(v) Choice
(vi) Equilibrium
(vii) Economic model
(viii) Economic system
(ix) Economic resources
2. Distinguish between positive economics and normative economics.
3. ‘Should Tanzania try to negotiate a free trade agreement with Canada?’ Is this a positive or a normative
question? Justify.
4. Give brief explanation on the basic economic problems.
5. Explain the relationship between scarcity, scale of preference, choice and opportunity cost.
6. Distinguish between microeconomics and macroeconomics.
7. Give two examples of economic questions through which one can
distinguish between micro and macroeconomics.
8. What is production possibility frontier/boundary/curve?
9. Draw a figure to illustrate production possibility frontier and identify
attainable, unattainable, efficient and inefficient points.
10. An economy always produces on, but not inside, a PPF. Defend or refute this
argument.
11. Explain why production possibility frontier for an economy is normally bowed
outward.
12. Under what circumstances would the production possibility frontier be a straight
line?
13. Discuss the factors that can shift the economy’s production possibility frontier.
14. Is there any relationship between scarcity of resources and the three basic economic
problems? Explain.
15. How can economists say that cars are scarce while millions are produced each year?
16. Tanzania is a developing country. Explain how scarcity affect its economic
performance.
17. Mention various economic problems (both micro and macro) which are found in
Tanzania.
18. Explain how choice can be applied to solve the above-mentioned economic
problems.
19. Why do you study economics?
20. The government should provide jobs to every adult capable of working.
This is a noble economic objective for any government. But are there any
constraints in meeting this objective? Discuss