MAE 405

Introduction to Economics

Ms. W.P.W Anjalika

Faculty of Engineering and Management
Ocean University of Sri Lanka
Aim of the Cause Unit:

This course unit aims to equip students with basic principles,

concepts and theories of microeconomics and develop them to
apply knowledge in the decision making process studying various
economic issues in social and business environment.

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1. Scope
Basic economic issues
Economic problems
Types of economic systems
Economics as social science
2 Elementary theory of demand and supply
Nature and determinant of quantity of demand
Demand and price
Nature and determinant of quantity of supply
Supply and price
Concept of market
Law of demand and supply
Prices in inflation
Theory of market price and market behavior
Price fluctuation and dynamic theory of price
Elasticity of demand and supply

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3. Issues of economic growth in developing countries
Restraints on economic development (inadequate or inefficient use of natural resources, inefficient
agriculture, rapid population growth, cultural barriers, inadequate financial institutions, inadequate
infrastructure)
Strategies for industrial development; import substitution and export promotion; industrial planning;
execution of development plans Balance of payment

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 Intended Learning Outcomes (ILOs)
On completion of this course unit, students will be able to:

1. Introduce microeconomics and its importance

2. Explain the core concepts of microeconomics
3. Explain the theory of demand, supply and price
determination
4. Explain different market structures
5. Understand the applicability of microeconomic theories in
the socio-economic environment

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 Evaluation
Your performance will be assessed using;
• Continuous Assessments (CAs) - 40 marks out of 100
• End Semester Examination - 60 marks out of 100
• Continuous Assessments (CAs):
• 40 marks out of 100 have been allocated for CAs. Students require to face
quizzes which will be given without prior notice during the lecture time. In
addition, assignments are given to test the students’ ability of the applicability
of microeconomic theories in the socio-economic environment.
• End Semester Examination:
• 60 marks out of 100 have been allocated for the end semester examination.

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 What is economics?
• Economics as a social science
It study the behaviour of the individuals and different units of the
society living in the world.
• Economics as a science
• Economics is a science of scarcity. Scarcity means that we have limited
resources to satisfy unlimited wants. Since we are unable to have
everything we desire, we must make choices on how we will use our
resources.
• Hence economics is study of choices

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 What is economics?
• The word ‘Economics’ was derived from two Greek words,

• Oikos (a house) and

• Nemein (to manage)

• This mean ‘managing an household’ using the limited funds available,

in the most satisfactory manner.
• Thus, Economics shows,
‘’ how scarce resources can be used to increase human wants.’’

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Two major factors are responsible for the emergence of economics
problem.
1. The existence of unlimited human wants.
2. The scarcity of available resources.

 The numerous human wants are to be satisfied through the scarce

resources available in nature.
Economics deals with how the numerous human wants are to be
satisfied with limited resources.

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What is Industrial Economics?
Industrial Economics is the study of firms, industries markets and
their relationship with society

When analyzing decision making at the levels of the individual firm

and industry, Industrial Economics helps us understand such issues as:

a. the levels at which capacity, output and prices are set;

b. the extent that products are differentiated from each other;
c. how much firms invest in research and development (R&D)
d. how and why firms advertise

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 Economics is a Social Science
• Science can be grouped into two broad categories:

1. Pure Science and

2. Social Science.

• Pure Science is the study of the behaviour of naturally occurring objects

or phenomena such as light, objects, matter, earth, the human body.
(exploratory and explanatory)

• Social Science is the study of the behaviour of people such as individuals,

group of people, firms, societies, or economies, and their individual or
collective behaviours. 11
 Why we study economics?
Individuals face numerous problems in day to day life such as;
• How individuals/business firms behave to maximize their wants by
minimizing costs.
• How can we spend money to achieve the greatest satisfaction or happiness?
• How can a business firm decide maximum output at the lowest costs?
• How does a firm determine what quantity to produce and what price to
charge for its product to maximize its profit?
• The government face many challenges
• how to increase income of the nations,
• how to minimize poverty,
• how to reduce inflation,
• how to increase investment,
• how to spend money on welfare etc.
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Micro and Macroeconomics
• Two main branches are identified in economics; microeconomics and
macroeconomics.
• Microeconomics relates to the study of behaviour of individual economic
units such as individual consumer, business firm, commodity etc.
• Macroeconomics is dealing with aggregates. Aggregates represent the
society as whole.
• For instance, per capita income, employment, unemployment, general
price level, balance of payment, literacy rate, HDI, Poverty etc. are
considered as the macroeconomic variables.
• Thus, microeconomics gives us a microscope view of the economy while
macroeconomics gives us a bird’s eye view of the economy .
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Fundamental economics concepts
Needs Wants
Needs: The necessities of life Wants : Those things that make
Or minimum things you need to live as life enjoyable and pleasurable
an individual in the society Ex: Designer cloths /
Two types of needs we want as, Cars/coca cola / sarees
1.Physical needs
2. Mental needs
Main characteristics of needs is limited
Ex: Food / Clothing / Shelter /
Warmth / Medical Care

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Characteristics of wants
1. Unlimited
2.Grow frequently
3.Complex
4.Different

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Basic human needs

A need is something necessary for a person in order to survive and

grow. Physical needs include:
• Food and water Protection
• Shelter Activity
• Sleep and rest
• Safety Comfort,
• especially freedom from pain Success
• self-esteem Psychological needs include: Love and affection

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 Achieving the human needs
• Human needs can be achieved only by the consumption of the goods and
services. This goods are,
• Free goods
• Economics goods
• Free goods / Products:
Free Products are so plentiful no price can be attached
sunshine or air.

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Economic goods/ Products

• Economic Products are goods and services that are useful, relatively
scarce, and transferable to others.
• Basic characteristics of this type of good is scarcity

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 Goods / Commodity
Good or service that can be satisfied human wants.
• Consumer Goods – to be used by
individuals.
• Capital Goods – a good used to
produce another good.
OR
• Durable Goods - last three years or
more.
• Nondurable Goods – last less than
three years.
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Services

work performed for someone.

This includes work that doctors, lawyers, and teachers
perform.
The difference between a good and service is that a service
cannot be touched or felt.

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Choice
Decision made among alternatives or possibilities. We make choice every
day.

Why do we have to make choices about which goods or services

we can buy?

The resources used to make goods and services are scare and scare resources
have alternative uses.

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Why do we have to make choice? - Scarcity
The fact that there is a limited amount of resources to satisfy unlimited
wants.
This situation requires people to make decisions about how to allocate
resources efficiently, in order to satisfy basic needs and as many
additional wants as possible.
 Any resource that has a non-zero cost to consume is scarce to some
degree, but what matters in practice is relative scarcity.

Even free natural resources can become scarce if costs arise in

obtaining or consuming them, or if consumer demand for previously
unwanted resources increases due to changing preferences or newly
discovered uses. 22
There might be a scarcity of,
• Time
• Money
• Space
• Goods and service

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Opportunity cost
• NEXT BEST choice given up when a decision is made
• EX;

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 • If I choose the main highways -my
opportunity cost is missing the beautiful
scenery of big surrounding.

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Example 2:
1. If Abby can spend her time either watching videos or studying, the
opportunity cost of an hour watching videos is the hour of studying
she gives up to do that.
2. Sleeping is the opportunity cost of studying for
test

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What are resources/ Factors of Production?
• Definition: The things used to make other goods

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1. Land • Natural resources that are used in the production of goods and services.
Some examples of land are lumber, raw materials, fish, soil, minerals, and
energy resources.
2. Labor
• Work effort used in the production of goods and services. Some examples
are the number of workers and number of hours worked.
3. Capital
• Physical goods that are produced and used to produce other goods.
Examples of capital would be machinery, technology, and tools such as
computers; hammers; factories; robots; trucks, and trains used to transport
goods; and other equipment employed in the production of a good or
service.

4. Entrepreneurship
• Organize factor of production and take a risk.
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Economic Actors
1. House hold/consumers:
Organize to consume
Maximize the economic welfare of satisfaction is main objective.
2. Firms /Producers:
Organize to production
Maximize the profit is main intention.
3. Workers /Labours
4. Market:
Through which buyers and sellers carry out exchange (Product market/factor
market)
5. Government
Maximize the welfare of the citizen
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Basic Economic Problems

(I) What and how (ii) How to

much to produce produce

(iii) For whom to

produce

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(i) What to Produce:
Let us consider the first question: ‘which commodities are to be
produced and in what quantities?

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(ii) How to Produce:
In context of this it is:
‘which techniques are to be adopted’?
 Technology means the correct proportion in which the different
factors of production are to be employed.
There are two types of techniques.
A labour-intensive technique would employ relatively more labour
and less capital.
On the other hand, capital- intensive technique means more capital
and less labour.

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(iii) For Whom to Produce:

This question relates to the final market of the goods and services we
are going to produce.
 Whom are we going to sell these goods and services? Should we
produce for rich people or the middle class? Should we produce for
youth or the elderly?

The solution of this problem is very simple commodity can be

consumed only by people who have more purchasing power.

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Production Possibility
Curve (PPC)
What is PPC/PPF?
 The production possibility curve represents, maximum possible output
combinations of two goods using all the available resources.
Since we are using all available resources, increasing the production of one of
the goods means decreasing the production of other goods
PPC curve designed to describe ‘’Choice and effect of choice of the
economy’’
Assumptions in PPC

PPC can draw based on following Assumptions,

1. Only two products can be produced in the economy
2. The resources available are fixed
Quantity and qualities of all resource inputs remain unchanged
during period of time.
2. All resources are fully employed
Economy operates with all its factors of production fully
employed and producing the greatest output possible without waste or
mismanagement.
3. 4. The technology remains unchanged
How derive Production Possibility Curve? (PPC)
Assume that the economy produces only two goods (say Paddy and Garment) using its
resources fully and production possibilities are given below.

If the economy uses all the resources to produce garment production, it cannot produce
paddy.
If we assume that the economy uses all the resources to produce paddy, no garment
production can be made.
The economy decides to produce both, it can have different combinations.
Draw the curve
Reasons of having different shapes of PPC
The shape of the production possibility curve (PPC) differ when
change the opportunity cost. When,
Opportunity Cost is constant PPC shapes linear
Opportunity Cost is increasing PPC shapes Concave to the origin
Opportunity Cost is decreasing PPC shapes Convex to the origin

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Constant Opportunity Cost
increase production of one good, the opportunity cost to produce an additional
good will remain constant., or,
when the opportunity cost of a good remains constant as output of the good
increases
Constant Opportunity Cost shows Linear PPC

Δ 𝐺𝑎𝑟𝑚𝑒𝑛𝑡
 Δ 𝑃𝑎𝑑𝑑𝑦= Opportunity Cost of Paddy

 Draw the curve

When increasing the paddy production, sacrificing value of garment is constant.
Increasing Opportunity Cost
• The increasing opportunity costs states that as you increase production of
one good, the opportunity cost to produce an additional good will increase.
• The shape of Increasing Opportunity Cost curve is Concave to origin.

Draw curve
Δ 𝐺𝑎𝑟𝑚𝑒𝑛𝑡
= Opportunity Cost of Paddy
Δ 𝑃𝑎𝑑𝑑𝑦
When increasing the paddy production, sacrificing value of
garment decreases at increasing rate showing Increasing
Opportunity Cost.
Decreasing Opportunity Cost
The decreasing opportunity costs states that as you increase production
of one good, the opportunity cost to produce an additional good will
decrease.
Shape of Decreasing Opportunity Cost is Convex to origin

Draw curve
When increasing the paddy production, sacrificing value of garment decreases at
decreasing rate showing Decreasing Opportunity Cost.
Summery
Increasing Opportunity costs
when the opportunity cost of a good increases as output of the good
increases.

constant opportunity costs

when the opportunity cost of a good remains constant as output of the good
increases.

Decreasing Opportunity costs

when the opportunity cost of a good decreases as output of the good
increases.

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Practical usage of PPC
1. Shift PPC totally into the right side
2. Shift PPC totally into the left side
3. Shift PPC right side only one axis

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 Factors cause to shift in PPC
1. Change in quantity or quality of factors of production (Resources)
2. Change in technology

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PPC shift outward when (shift right side),
Increasing the Economic Growth
Increasing productivity of labour
New labours coming in to the labour market
Increasing the international trade
Finding new technology
Use new land for cultivation
Construct new rail ways, road ways high ways, Building

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Shift PPC totally into the left side

1. destruction
of resources in an earthquake
2. Black death pandemic spread in the Europe between 1347 and 1351
3. Yugoslavia war destroyed all roads, water supply, bridges etc.
4. Economic recession

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 Shift PPC only one axis

Reason to having a point on the PPC curve

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Points left side in the PPC and right side in the PPC

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Can you answer the following questions?
1. What do you mean by Economics?
(5 marks)
2. ‘Economics is considered as a Science’ Do you agree? Explain.
(5 marks)

3. Briefly discuss why do you study economics?

(6 marks)
4. Distinguish between micro and macroeconomics.
(6 marks)
5.What do you mean by Opportunity cost? Explain this using examples.
(5 marks)
6.Explain following as factors of production.
Labour
Capital
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( 8 marks)
7. What is Production Possibility Curve? Explain it using real world
example.
(5 marks)

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