THE

FUNDAMENTAL
OF ECONOMICS
By GulRukh Zahid
What is economics

Economics is the science that deals with the production and

consumption of goods and services and the distribution and
rendering of these for human welfare.
The following are the economic goals.
A high level of employment
Price stability
Efficiency
Equitable distribution of income
Growth
What is economics

■ Economics is the social science that studies the

choices that individuals, businesses, governments, and
entire societies make as they cope with scarcity and the
incentives that influence and reconcile those choices.
What is Scarcity

■ A fundamental fact dominates our lives: We want

more than we can get. Our inability to get everything
we want is called scarcity. Scarcity is universal. It
confronts all living things.
Two big questions

■ Two big questions summarize the scope of economics:

■ How do choices end up determining what, how,
and for whom goods and services are produced?
■ Can the choices that people make in the pursuit of
their own self-interest also promotes the broader
social interest?
What, How and For Whom?

Goods and services are the objects that people value and
produce to satisfy human wants. Goods are physical objects such
as cell phones and automobiles. Services are tasks performed for
people such as cellphone service and auto repair service.
What?

■ What we produce varies across countries and changes over

time. In the United States today, agriculture accounts for 1% of
total production, manufactured goods for 22%, and services
(retail and wholesale trade, health care, and education
are the biggest ones) for 77%. In contrast, in China today,
agriculture accounts for 11% of total production,
manufactured goods for 49%, and services for 40%
How

■ Goods and services are produced by using pro-

ductive resources that economists call factors of pro-
duction. Factors of production are grouped into four
categories:
■ Land
■ Labor
■ Capital
■ Entrepreneurship
For Whom?

■ Who consumes the goods and services that are produced

depends on the incomes that people earn. People with large
incomes can buy a wide range of goods and services. People
with small incomes have fewer options and can afford a
smallerrange of goods and services
Micro economics

■ Microeconomics is the study of the choices that

individuals and businesses make, the way these
choices interact in markets, and the influence of
governments. An example of micro economics is why
people are buying more smart phones.
Macro economics

■ Macroeconomics is the study of the performance of

the national economy and the global economy. Some
examples of macroeconomic questions are: Why is
the unemployment rate so high? Can the
Federal Reserve make our economy expand by cutting
interest rates?
Law of Supply and Demand
■ An interesting aspect of the economy is that the
demand and supply of a product are interdependent
and they are sensitive with respect to the price of that
product. The interrelationships between them are
shown in Fig. 1.2.
Factors influencing demand
■ The shape of the demand curve is influenced by the
following factors: Income of the people Prices of
related goods Tastes of consumers If the income level
of the people increases significantly, then their
purchasing power will naturally improve.
What happens when the income increase

■ If the income level of the people increases significantly, then their

purchasing power will naturally improve. This would definitely
shift the demand curve to the upward direction of Fig. 1.2. A
converse situation will shift the demand curve in the downward
direction. If, for instance, the price of television sets is lowered
drastically their demand would naturally go up. As a result, the
demand for its associated product, namely VCDs would also
increase. Hence, the prices of related goods influences the
demand of a product.
Factors influencing supply

The shape of the supply curve is affected by the

following factors:
■ Cost of the inputs
■ Technology
■ Weather
■ Prices of related goods
If the cost of inputs increases, then naturally, the cost of the
product will go up. In such a situation, at the prevailing price of
the product, the profit margin per unit will be less. The producers
will then reduce the production quantity, which in turn will affect
the supply of the product. For instance, if the prices of fertilizers
and cost of labour are increased significantly, in agriculture, the
profit margin per bag of grain will be reduced. So, the farmers
will reduce the area of cultivation, and hence the quantity of
supply of grain will be reduced at the prevailing prices of the
grain.
Significance of price in making decisions

■ From the discussions in the previous section, it is clear

that price has a major role in deciding the demand and
supply of a product. Hence, from the organization’s
point of view, efficient and effective functioning of the
organization would certainly help it to provide
goods/services at a lower cost which in turn will
enable it to fix a lower price for its goods or services.
A Choice Is a Tradeoff

■ Because we face scarcity, we must make choices. And when we make a

choice, we select from the available alternatives.
■ You can think about your choices as tradeoffs. A tradeoff is an exchange
—giving up one thing to get something else. When you choose how to
spend your Saturday night, you face a tradeoff between studying and
hanging out with your friends.
Making a Rational Choice

■ Economists view the choices that people make as rational. A

rational choice is one that compares costs and benefits and
achieves the greatest benefit over cost for the person making
the choice.
Benefit: What You Gain

■ The benefit of something is the gain or pleasure that it brings

and is determined by preferences—by what a person likes and
dislikes and the intensity of those feelings. Economists
measure benefit as the most that a person is willing to give up
to get something. You are willing to give up a lot to be in
school.
Cost: What You Must Give Up

■ The opportunity cost of something is the highest valued

alternative that must be given up to get it. To make the idea of
opportunity cost concrete, think about your opportunity cost of
being in school. It has two components: the things you can’t
afford to buy and the things you can’t do with your time.
How Much? Choosing at the Margin

■ The benefit that arises from an increase in an activity is called

marginal benefit. For example, your marginal benefit from
one more night of study before a test is the boost it gives to
your grade. Your marginal benefit doesn’t include the grade
you’re already achieving without that extra night of work.
Choices Respond to Incentives
■ Economists take human nature as given and view people as
acting in their self-interest. All people— you, other consumers,
producers, politicians, and public servants—pursue their self-
interest. Self-interested actions are not necessarily selfish
actions. You might decide to use your resources in ways that
bring pleasure to others as well as to yourself. But a self-
interested act gets the most benefit for you based on your view
about benefit. The central idea of economics is that we can
predict the self-interested choices that people make by looking
at the incentives they face.
Six key ideas that define the economic way of thinking.

■ A choice is a tradeoff.
■ People make rational choices by comparing benefits and costs.
■ Benefit is what you gain from something.
■ Cost is what you must give up to get something.
■ Most choices are “how-much” choices made at the margin.
■ Choices respond to incentives.
The Economic Way of Thinking

■ Every choice is a tradeoff—exchanging more of something for

less of something else.
■ People make rational choices by comparing benefit and cost.
■ Cost—opportunity cost—is what you must give up to get
something.
■ Most choices are “how much” choices made at the margin by
comparing marginal benefit and marginal cost.
■ Choices respond to incentives.
Economics as Social Science and Policy Tool

■ Economists distinguish between positive statements—what is

—and normative statements— what ought to be.
■ To explain the economic world, economists create and test
economic models.
■ Economics is a toolkit used to provide advice on government,
business, and personal economic
decisions.
What is Engineering economy

■ Definition: Engineering economics deals with the

methods that enable one to take economic decisions
towards minimizing costs and/or maximizing benefits
to business organizations.
Scope
■ The issues that are covered in this book are elementary
economic analysis, interest formulae, bases for
comparing alternatives, present worth method, future
worth method, annual equivalent method, rate of return
method, replacement analysis, depreciation, evaluation
of public alternatives, inflation-adjusted investment
decisions, make or buy decisions, inventory control,
project management, value engineering, and linear
programming
What is Engineering economy

■ Engineering economy involves the systematic evaluation of the

economic merits of proposed solutions to engineering in
problems. To be economically acceptable (i.e., affordable),
solutions to engineering problems must demonstrate a positive
balance of long-term benefits over long-term costs, and they
must also
• promote the well-being and survival of an organization,
• embody creative and innovative technology and ideas,
• permit identification and scrutiny of their estimated outcomes,
• translate profitability to the “bottom line” through a valid and
acceptable measure of merit.
Examples of Engineering economics
■ A few more of the myriad situations in which engineering
economy plays a crucial role in the analysis of project
alternatives come to mind:
1. Choosing the best design for a high-efficiency gas furnace
2. Selecting the most suitable robot for a welding operation on
an automotive assembly line
3. Making a recommendation about whether jet airplanes for
an overnight delivery service should be purchased or leased
4. Determining the optimal staffing plan for a computer help
desk
■ Engineering economy is the dollars-and-cents side of the decisions that
engineers make or recommend as they work to position a firm to be
profitable in a highly competitive marketplace. Inherent to these
decisions are trade-offs among different types of costs and the
performance (response time, safety, weight, reliability, etc.) provided by
the proposed design or problem solution. The mission of the engineering
economy is to balance these trade-offs in the most economical manner.
For instance, if an engineer at Ford Motor Company invents a new
transmission lubricant that increases fuel mileage by 10% and extends the
life of the transmission by 30,000 miles, how much can the company
afford to spend to implement this invention? Engineering economy can
provide an answer.
The Principles of Engineering Economy

■ The development, study, and application of any discipline must

begin with a basic foundation. We define the foundation for
engineering economy to be a set of principles that provide a
comprehensive doctrine for developing the methodology. Once
a problem or need has been clearly defined, the foundation of
the discipline can be discussed in terms of seven principles.
Financial effectiveness
■ Studying engineering economy can have significant financial benefits for
individuals, businesses, and society as a whole. Here are some ways in
which studying engineering economy can improve financial
effectiveness:
■ Cost analysis and optimization: Engineering economy provides tools and
techniques to analyze and optimize the costs of projects, processes, and
products. By applying these methods, businesses can identify cost-saving
opportunities and make more informed decisions about investments and
operations.
■ Investment analysis: Engineering economy helps businesses evaluate the
financial viability of investments and projects by analyzing their costs,
benefits, and risks. This analysis can help businesses make more
informed decisions about which projects to pursue and how to allocate
resources.
■ Financial management: Engineering economy provides a
foundation for financial management by teaching key concepts
such as time value of money, cash flow analysis, and risk
assessment. These concepts are critical for managing finances
effectively and making informed financial decisions.
■ Competitive advantage: Studying engineering economy can
provide individuals and businesses with a competitive
advantage by improving their ability to analyze costs, evaluate
investments, and make informed decisions. This can lead to
increased profitability and growth.
■ Innovation: Engineering economy encourages innovation by
promoting the development of new products, processes, and
technologies that can improve efficiency, reduce costs, and
create value. By applying engineering economy principles,
businesses can develop innovative solutions that can improve
their competitiveness and financial effectiveness.
■ Studying engineering economy can have significant financial
benefits for individuals and businesses by providing tools and
techniques for cost analysis, investment analysis, financial
management, competitive advantage, and innovation.
Non-monetary factors
■ Engineering economy is the application of economic principles
to engineering decision-making. While monetary factors such
as costs, revenues, and profits are critical considerations in
engineering economy, non-monetary factors can also play a
significant role in decision-making. Here are some non-
monetary factors that can affect engineering economy:
■ Safety: Engineering projects need to be designed and
constructed in a way that ensures safety. The cost of ensuring
safety measures such as safety equipment, training, and testing
may not necessarily result in direct financial gains, but they
can prevent costly accidents and loss of life.
■ Environmental impact: Environmental concerns are an
increasingly important consideration in engineering projects.
Projects that have a negative impact on the environment may
face regulatory challenges or public backlash that can affect
their economic viability.
■ Quality: The quality of engineering products and services is
crucial to their success. Factors such as reliability, durability,
and customer satisfaction can affect a product's marketability
and long-term profitability.
■ Social impact: Engineering projects can have significant social
impacts on the communities in which they are located. The
effects on local culture, health, and quality of life can be
positive or negative and can affect the project's acceptance and
economic viability.
■ Technological innovation: Engineering projects often involve
the development of new technologies that can have long-term
economic benefits. Investing in research and development can
help companies stay ahead of their competitors and create new
opportunities for growth.
■ Political factors: Political stability, government regulations,
and policies can affect engineering projects. Political
instability or changing regulations can create uncertainty and
impact investment decisions.
Ceteris Paribus
■ "Ceteris paribus" is a Latin phrase that means "all other things
being equal." It is commonly used in economics and other
fields to describe a situation where a particular variable is
changed while all other relevant factors are held constant. By
assuming that all other factors remain the same, researchers
can isolate the effect of the variable they are interested in
studying. This allows them to better understand the
relationship between that variable and the outcome they are
trying to measure. Ceteris paribus is an important concept in
scientific research, as it helps to control for extraneous
variables and improve the validity of experimental results.