ENGINEERING, MANAGEMENT AND SOCIETY I

CIE 421
Economic Concept

Lecture 1
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Definition
Economics is the study of the allocation of scarce resources
to meet unlimited human wants.

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Microeconomics
 Microeconomics is concerned with decision-making by individual
economic agents such as firms and consumers.
 Microeconomics is the study of;
 how households and firms make choices,
 how they interact in markets, and
 how the government attempts to influence their choices

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Macroeconomics

 Macroeconomics is concerned with the aggregate performance of the

entire economic system.

 Macroeconomics is the study of the economy as a whole, including

topics such as inflation, unemployment, and economic growth.

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How an Economy can be studied

 Empirical economics - relies upon facts to present a description of

economic activity.
 Economic theory - relies upon principles to analyze behavior of
economic agents.
 Inductive logic - creates principles from observation.
 Deductive logic - hypothesis is formulated and tested.

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Usefulness of economics and analysis
of an economy
Economics provides an objective mode of analysis, with rigorous
models that are predictive of human behavior.
 Two approaches can be used;
 Scientific approach
 Rational choice

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Rational choice
 Rational choice is defined to mean the process of determining
what options are available and then choosing the most
preferred one according to some consistent criterion.

Rational choice theory starts with the idea that individuals

have preferences and choose according to those

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Rational choice
Three Key Ideas
Idea 1: People Are Rational
 Rational consumers and firms weigh the benefits and costs
of each action and try to make the best decision possible.
 Example: Microsoft doesn’t randomly choose the price of its
Windows software; it chooses the price(s) that it thinks will
be most profitable.
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Rational choice

 Idea 2: People Respond to Economic Incentives

 Example: Changes in several factors have resulted in increased
obesity in Americans over the last couple of decades, including:
 Decreases in the price of fast food relative to healthful food
 Increased availability of health care and insurance, protecting
people against the consequences of their actions

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Rational choice
 Idea 3: Optimal Decisions Are Made at the Margin
 Marginal cost and benefit (MC and MB): the additional cost or benefit
associated with a small amount extra of some action.
Example:
 Should you watch an extra hour of TV, or study instead?
 What are the benefits of an extra hour of TV?
 What are the costs (i.e. the benefits of studying instead)?
(Comparing MC and MB is known as marginal analysis.)

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The Scientific Nature of Economics

When analysing human behaviour, we can perform:

Positive analysis: the study of “what is?”; and/or
Normative analysis: the study of “what ought to be?”
Economists generally perform positive analysis.

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Economic Models
Economists develop economic models to analyze real-world issues.
Building an economic model often follows these steps:
1.Decide on the assumptions to use in developing the model.
2.Formulate a testable hypothesis.
3.Use economic data to test the hypothesis.
4.Revise the model if it fails to explain the economic data well.

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Important Features of Economic Models

Assumptions and simplifications

Testability
Economic variables

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Modern Economic Systems

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Interdependence and the Global Economy
 The modern economic system is no longer the closed system upon
which the debates surrounding isolationalism occurred prior to
World War II.
I. Imports and Exports are increasingly important
II.Foreign investment versus Country investment abroad
Outsourcing
Technological transfers

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Interdependence and the Global Economy

III.Balance of trade issues.

 Current accounts (import v. exports)
 Capital accounts (foreign investment)

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Capitalist Ideology
 The characteristics of a capitalist economy and the ideology that has developed concerning
this paradigm are not necessarily the same thing.
 The elements of a capitalist ideology are:
a) freedom of enterprise
b) self-interest
c) competition
d) markets and prices
e) a very limited role for government
f) different countries with different views of these matters i.e., equity v. efficiency again.

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Market System Characteristics
The following characteristics are typical of a system that relies substantially on markets for
allocation of resources.
These characteristics are:
 division of labor & specialization
 capital goods
 comparative advantage - is concerned with cost advantages.
1. Comparative advantage is the motivation for trade among nations and persons.
2. Terms of trade are those upon which the parties may agree and depends on the respective
cost advantages and bargaining power.

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Comparative Advantage: The Basis of Exchange
Why do people exchange goods and services in the first place?
Why not just produce our own food, cars, clothing, shelter, and
the like?
 The answer is that we can all have more of every good and
service if we specialize in the activities at which we are we are
relatively most efficient.

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Comparative Advantage
Example 1: Consider Ted, a house painter whose roof needs fixing and Tom, a roofer whose
house needs painting. Although Ted is a painter, he also knows how to repair roofs. Tom, for
his part, knows how to paint houses. The time each requires to perform these tasks is given in
the table. How should the roofing and painting jobs be allocated among them?

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Comparative Advantage
Note in the table that Tom has an absolute advantage over Ted at both
painting and roofing, which means
that Tom takes fewer hours to perform each task than Ted does.
At first glance, this might seem to suggest that Tom do the roofing and
painting jobs for both houses.
 Tom would probably object to this proposal as being unfair.
But an even more telling objection is that it is inefficient.

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Comparative Advantage

The reason is that Ted has a comparative advantage over Tom at

painting,
This means that he is relatively more efficient at painting than Tom is.
The word "relatively" is the key word here.
For Ted to be relatively more efficient at a task is for him to have a
lower opportunity cost of performing that task than Tom has.

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Comparative Advantage

For Ted, the opportunity cost of painting one house = 0.75 roofing jobs

For Tom, the opportunity cost of painting one house = 2 roofing jobs.

 Ted thus has a comparative advantage at painting, and it makes sense for him
to do both painting jobs, leaving both roofing jobs for Tom.

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Comparative Advantage
 Note that if each person performed both tasks for himself, the total time spent
would be 700 hours for Ted and 300 hours for Tom.
 When each specializes in his comparative advantage, these totals fall to 600
for Ted and 200 for Tom, a savings of 100 hours each.
 The Principle of Comparative Advantage:
 Everyone does best when each person (or country) concentrates on the
activities in which he or she is relatively most efficient.

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Market system
 Money market facilitates activities are necessary in complex market systems
 Barter economy - is where commodities are directly traded without the use of money.
The challenge of barter is that;
1. Direct trade requires a coincidence of wants.
2. Prices become complicated by not having a method to easily measure worth.
 Functions of money:
1. medium of exchange
2. store of value
3. measure of worth

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Foreign exchange of one currency vs another
Exchange rates affect both imports and exports; and foreign
investment
Kwacha gains strength, Imports becomes very less expensive,
exports less expensive abroad

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 The Circular Flow Diagram
The Circular Flow Diagram is used to show the interdependence that exists among sectors
of the economy:

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The Circular Flow Diagram
Product markets are where the domestic parties obtain and sell commodities [inside the
pyramid],
The factor markets [shown with the dotted lines] are where the domestic parties obtain and
supply productive resources.
The base reads as foreign sector , which indicates that the same buying and selling of
commodities and resources is not limited to just domestic parties, but can include foreign
businesses and resources as well.
The circular flow diagram shows that each of the sectors relies on the others for resources
and supplies the others commodities and resources.

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