Introduction to Economics (PDF)

Introduction to Economics, By: Mohammed Ibrahim (MSc.)
E-mail:- [e-mail]
(Introduction to Economics Lecturer Note), for Natural students
Chapter One
Basics of Economics
1.1 Definition of economics
Economics is one of the most exciting disciplines in social sciences. The word economy comes
from the Greek phrase ―one who manages a household‖. The science of economics in its current
form is about two hundred years old. Adam Smith – generally known as the father of economics
– brought out his famous book, ―An Inquiry into the Nature and Causes of Wealth of Nations‖,
in the year 1776. Though many other writers expressed important economic ideas before Adam
Smith, economics as a distinct subject started with his book. There is no universally accepted
definition of economics (its definition is controversial). This is because different economists
defined economics from different perspectives:
a. Wealth definition,
b. Welfare definition,
c. Scarcity definition, and
d. Growth definition
Hence, its definition varies as the nature and scope of the subject grow over time. But, the formal
and commonly accepted definition is as follow.
Economics is a social science which studies about efficient allocation of scarce resources so as
to attain the maximum fulfillment of unlimited human needs. As economics is a science of
choice, it studies how people choose to use scarce or limited productive resources (land, labour,
equipment, technical knowledge and the like) to produce various commodities.
1.2 The rationales of economics
There are two fundamental facts that provide the foundation for the field of economics.
1) Human (society‘s) material wants are unlimited.
2) Economic resources are limited (scarce).
The basic economic problem is about scarcity and choice since there are only limited amount
of resources available to produce the unlimited amount of goods and services we desire. Thus,
economics is the study of how human beings make choices to use scarce resources as they seek
to satisfy their unlimited wants. Therefore, choice is at the heart of all decision-making. As an
individual, family, and nation, we confront difficult choices about how to use limited resources
to meet our needs and wants. Economists study how these choices are made in various settings;
evaluate the outcomes in terms of criteria such as efficiency, equity, and stability; and search for
alternative forms of economic organization that might produce higher living standards or a more
desirable distribution of material well-being.
Scope and method of analysis in economics
1.3.1 Scope of economics
The field and scope of economics is expanding rapidly and has come to include a vast range of
topics and issues. In the recent past, many new branches of the subject have developed, including
development economics, industrial economics, transport economics, welfare economics,
environmental economics, and so on. However, the core of modern economics is
Assosa University, college of Business and Economics, Department of Economics

Introduction to Economics, By: Mohammed Ibrahim (MSc.)
E-mail:- [e-mail]
(Introduction to Economics Lecturer Note), for Natural students
1.3.2 Positive and normative analysis
Economics can be analyzed from two perspectives: positive economics and normative
economics.
Positive economics: it is concerned with analysis of facts and attempts to describe the world as it
is. It tries to answer the questions what was; what is; or what will be? It does not judge a system
as good or bad, better or worse.
Example:
 The current inflation rate in Ethiopia is 12 percent.
 Poverty and unemployment are the biggest problems in Ethiopia.
 The life expectancy at birth in Ethiopia is rising.
All the above statements are known as positive statements. These statements are all concerned
with real facts and information. Any disagreement on positive statements can be checked by
looking in to facts.
Normative economics: It deals with the questions like, what ought to be? Or what the economy
should be? It evaluates the desirability of alternative outcomes based on one‘s value judgments
about what is good or what is bad. In this situation since normative economics is loaded with
judgments, what is good for one may not be the case for the other. Normative analysis is a matter
of opinion (subjective in nature) which cannot be proved or rejected with reference to facts.
1.3.3 Inductive and deductive reasoning in economics
The fundamental objective of economics, like any science, is the establishment of valid
generalizations about certain aspects of human behaviour. Those generalizations are known as
theories. A theory is a simplified picture of reality. Economic theory provides the basis for
Assosa University, college of Business and Economics, Department of Economics

Introduction to Economics, By: Mohammed Ibrahim (MSc.)
E-mail:- [e-mail]
(Introduction to Economics Lecturer Note), for Natural students
economic analysis which uses logical reasoning. There are two methods of logical reasoning:
inductive and deductive.
a) Inductive reasoning is a logical method of reaching at a correct general statement or theory
based on several independent and specific correct statements. In short, it is the process of
deriving a principle or theory by moving from facts to theories and from particular to general
economic analysis.
Inductive method involves the following steps.
1. Selecting problem for analysis
2. Collection, classification, and analysis of data
3. Establishing cause and effect relationship between economic phenomena.
b) Deductive reasoning is a logical way of arriving at a particular or specific correct statement
starting from a correct general statement. In short, it deals with conclusions about economic
phenomenon from certain fundamental assumptions or truths or axioms through a process of
logical arguments. The theory may agree or disagree with the real world and we should check the
validity of the theory to facts by moving from general to particular. Major steps in the deductive
approach include:
1. Problem identification
2. Specification of the assumptions
3. Formulating hypotheses
4. Testing the validity of the hypotheses
1.4 Scarcity, choice, opportunity cost and production possibilities frontier
It is often said that the central purpose of economic activity is the production of goods and
services to satisfy consumer‘s needs and wants i.e. to meet people‘s need for consumption both
as a means of survival and also to meet their ever-growing demand for an improved lifestyle or
standard of living.
1. Scarcity
The fundamental economic problem that any human society faces is the problem of scarcity.
Scarcity refers to the fact that all economic resources that a society needs to produce goods and
services are finite or limited in supply. But their being limited should be expressed in relation to
human wants. Thus, the term scarcity reflects the imbalance between our wants and the means to
satisfy those wants.
Economic resources are usually classified into four categories.
 Labour: refers to the physical as well as mental efforts of human beings in the production
and distribution of goods and services. The reward for labour is called wage.
Assosa University, college of Business and Economics, Department of Economics

Introduction to Economics, By: Mohammed Ibrahim (MSc.)
E-mail:- [e-mail]
(Introduction to Economics Lecturer Note), for Natural students
 Land: refers to the natural resources or all the free gifts of nature usable in the production of
goods and services. The reward for the services of land is known as rent.
 Capital: refers to all the manufactured inputs that can be used to produce other goods and
services. Example: equipment, machinery, transport and communication facilities, etc. The
reward for the services of capital is called interest.
 Entrepreneurship: refers to a special type of human talent that helps to organize and
manage other factors of production to produce goods and services and takes risk of making loses.
The reward for entrepreneurship is called profit.
Note: Scarcity does not mean shortage. We have already said that a good is said to be scarce if
the amount available is less than the amount people wish to have at zero price. But we say that
there is shortage of goods and services when people are unable to get the amount they want at the
prevailing or on going price. Shortage is a specific and short term problem but scarcity is a
universal and everlasting problem.
2. Choice
If resources are scarce, then output will be limited. If output is limited, then we cannot satisfy all
of our wants. Thus, choice must be made. Due to the problem of scarcity, individuals, firms and
government are forced to choose as to what output to produce, in what quantity, and what output
not to produce. In short, scarcity implies choice. Choice, in turn, implies cost. That means
whenever choice is made, an alternative opportunity is sacrificed. This cost is known as
opportunity cost.
3. Opportunity cost
In a world of scarcity, a decision to have more of one thing, at the same time, means a decision
to have less of another thing. The value of the next best alternative that must be sacrificed is,
therefore, the opportunity cost of the decision.
Definition: Opportunity cost is the amount or value of the next best alternative that must be
sacrificed (forgone) in order to obtain one more unit of a product. For example, suppose the
country spends all of its limited resources on the production of cloth or computer. If a given
amount of resources can produce either one meter of cloth or 20 units of computer, then the cost
of one meter of cloth is the 20 units of computer that must be sacrificed in order to produce a
meter of cloth.
When we say opportunity cost, we mean that: It is measured in goods & services but not in money costs It should be in line with the principle of substitution.
In conclusion, when opportunity cost of an activity increases people substitute other activities in
its place.
4. The Production Possibilities Frontier or Curve (PPF/ PPC)
The production possibilities frontier (PPF) is a curve that shows the various possible
combinations of goods and services that the society can produce given its resources and
technology. To draw the PPF we need the following assumptions. a. The quantity as well as
quality of economic resource available for use during the year is fixed.
b. There are two broad classes of output to be produced over the year.
c. The economy is operating at full employment and is achieving full production (efficiency).
d. Technology does not change during the year.
e. Some inputs are better adapted to the production of one good than to the production of the
other (specialization).
Assosa University, college of Business and Economics, Department of Economics