INTRODUCTION

Mr. Erick Mchuma

Institute of Accountancy
Arusha
What is Economics?
 Introduction
• The science of economics was born with the
publication of Adam Smith’s An Inquiry into the
Nature and Causes of Wealth of Nations in the year
1776. Adam Smith is known as the father of
Economics. At its birth, the name of economics was
‘Political Economy’. Towards the end of the 19th
century there was a definite change from use of word
‘Political Economy’ to ‘Economics’.
• The word ‘Economics’ was derived from two Greek
words oikou (a house) and nomos (to manage). Thus,
the word economics was used to mean home
management with limited funds available in the most
economical manner possible.
 Definition of economics
a) Wealth Definition
• Adam smith (1776) defined economics as the science of
wealth. He explained how a nation’s wealth is created. He
considered that the individual in the society wants to promote
only his own gain and in this, he is led by an “invisible hand”
to promote the interests of the society though he has no real
intention to promote the society’s interests.
• Criticism:
• Smith defined economics only in terms of wealth and not in
terms of human welfare. Ruskin and Carlyle condemned
economics as a ‘dismal science’, as it taught selfishness which
was against ethics. However, now, wealth is considered only
to be a mean to end, the end being the human welfare.
Hence, wealth definition was rejected and the emphasis was
shifted from ‘wealth’ to welfare’.
 Definition of economics
(Cont.)
b) Welfare Definition
• Alfred Marshall (1842-1924) wrote a book Principles of
Economics in 1890. In it, he defined economics as “a study
of mankind in the ordinary business of life”. An altered form
of this definition is: “Economics is a study of man’s actions
in the ordinary business of life”. Marshall agrees that
economics studies about wealth. But he does not accept
the view that economics studies about wealth alone. In the
words of Marshall, “Economics is on the one side a study of
wealth, and on the other and more important side, a part of
the study of man. In economics, we do not study about all
aspects of humankind. As Cairn Cross puts it, Economics
studies about man as “buyer and seller, producer and
consumer, saver and investor, employer and worker”.
Marshall’s definition is known as material welfare definition
of Economics because of its emphasis on welfare.
• Criticism:
 Definition of economics
(Cont.)
c) Robbins’s Definition
• According to Lionel Robbins’s famous definition,
“Economics is the science which studies human behaviour
as a relationship between ends and scarce means which
have alternative uses”. By “ends” Robbins means human
objectives, possible states of affairs that can be ranked in
terms of their importance or desirability. By “means” he
has in mind the available time and other resources that
could be deployed to achieve those ends. Economic
problems, as he conceives them, arise in situations where
there are competing ends of different levels of importance,
and where the available means could be put to more than
one use and are scarce relative to those ends. In situations
of this kind economic choices have to be made:
 Definition of economics
(Cont.)
• Criticism:
• a) Robbins does not make any distinction between goods
conducive to human welfare and goods that are not
conducive to human welfare. In the production of rice and
alcoholic drink, scarce resources are used. But the production
of rice promotes human welfare while production of alcoholic
drinks is not conducive to human welfare. However, Robbins
concludes that economics is neutral between ends.
• b) In Economics, it does not only study the micro economic
aspects like how resources are allocated and how price is
determined, but it also study the macroeconomic aspect like
how national income is generated.
• c) Robbins definition does not cover the theory of economic
growth and development.
 Definition of economics
(Cont.)
d.Growth Definition
• According to Prof. Paul Samuelson defined
economics as “the study of how men and society
choose, with or without the use of money, to
employ scarce productive resources which could
have alternative uses, to produce various
commodities over time, and distribute them for
consumption, now and in the future among
various people and groups of society”.
• Of all the definitions discussed above, the
‘growth’ definition stated by Samuelson appears
to be the most satisfactory. However, in modern
Economics, the subject matter of Economics is
divided into main parts, viz., i) Micro Economics
and ii) Macro Economics. Economics is, therefore,
 Definition of economics
(cont..)
• There are three economic concepts
derived from the meaning of
economics
a) Scarce resources
b) Unlimited wants
c) Choices
 Difference between want and
needs
• NEEDS:
are the basic necessities that a person
must have in order to survive
e.g. food, water, warmth, shelter and
clothing

• WANTS:
are the desire that people have
e.g. things that people would like to have,
such as bigger homes,cars, iphones, etc.
 Scope of Economics
• Scope means province or field of study. In discussing the
scope of economics, we have to indicate whether it is a
science or an art and a positive science or a normative
science. It also covers the subject matter of economics.
a) Economics as a Science
• Science is a systematized body of knowledge that traces
the relationship between cause and effect. Another
attribute of science is that its phenomena should be
amenable to measurement. Applying these
characteristics, we find that economics is a branch of
knowledge where the various facts relevant to it have
been systematically collected, classified and analyzed.
Economics investigates the possibility of deducing
generalizations as regards the economic motives of
human beings. The motives of individuals and business
firms can be very easily measured in terms of money.
Thus, economics is a science.
 Scope of Economics (Cont.)
• Economics as a Social Science: In order to
understand the social aspect of Economics, we
should bear in mind that labourers are working on
materials drawn from all over the world and
producing commodities to be sold all over the world
in order to exchange goods from all parts of the
world to satisfy their wants. There is, thus, a close
inter-dependence of millions of people living in
distant lands unknown to one another. In this way,
the process of satisfying wants is not only an
individual process, but also a social process. In
Economics, one has, thus, to study social behaviour
i.e., behaviour of men in-groups.
Scope of Economics (Cont.)
b) Economics as an Art.
• An art is a system of rules for the
attainment of a given end. A science
teaches us to know; an art teaches us to
do. Applying this definition, we find that
economics offers us practical guidance in
the solution of economic problems.
Science and art are complementary to
each other and economics is both a
science and an art.
 Scope of Economics (Cont.)
a. Economics as Positive science
• Positive economics deals with what is or how
an economics problem facing a society is
actually solved. Robbins held that economics
was purely a positive science. According to
him, economics should be neutral or silent
between ends, i.e., there should be no desire
to learn about ethics of economic decisions.
• In other words, in positive economics we study
human decisions as facts which can be
verified with actual data.
 Scope of Economics (Cont.)
• Examples of positive economics are:
a) Tanzania is an overpopulated country.
b) A fall in the price of a good leads to a rise in its
quantity demanded.
c) Prices have been rising in Tanzania.
d) Minimum Wage Law increases unemployment.
e) A profit maximizing firm will set its price where
marginal revenue is equal to marginal cost.
f) Air is a mixture of gases.
g) Increase in real per capita income increases the
standard of living of people.
 Scope of Economics
(Cont.)
• Positive economics is the part of economics
that concerns with the description and
explanation of economic phenomena. It
focuses on facts and cause effect behavioural
relationships includes the development and
testing of economic theories.
• Positive economic statements are capable of
being verified or refuted via data or further
investigation
• Statements in positive economics are
statements that start with assumptions and
derive some conclusions which can be
checked with data
Scope of Economics (Cont.)
b) Economics as a Normative science
• Normative economics deals with what
ought to be or how an economic
problem should be solved. Alfred
Marshall and Pigou have considered the
normative aspect of economics.
• They maintain that economics is a
normative science as it prescribes that
course of action which is desirable and
necessary to achieve social goals.
• In other words, in normative economics
 Scope of Economics (Cont.)
• Examples of normative economics are:
a) Government should guarantee a minimum
wage for every worker.
b) Government should stop Minimum Support
Price to the farmers.
c) Tanzania should not take loans from foreign
countries.
d) Tanzania should spend more money on
defence.
e) Rich people should be taxed more.
f) Free education should be given to the poor.
Difference between Positive and
Normative Economics
 Types of economics
There are two types of economics
i. Microeconomics
ii. Macroeconomics

Qn. How does Micro economics differs

from Macro economics?
 Microeconomics
• The word ‘Micro’ is derived from the Greek
word mikros meaning small.
Microeconomics deals with small segments
of the society.
• Microeconomics is the part of economics
concerned with the behavior of individuals,
household, and firm in making decisions
regarding the allocation of scarce
resources and interactions among these
individuals, households and firms.
• Microeconomics studies the behavior of
individual unit of the economy.
 Microeconomics (cont)
• Microeconomics is the study of how
individuals and firms make themselves as
well off as possible in a world of scarcity,
and the consequences of those individual
decisions for markets and the entire
economy.
• In studying microeconomics, we examine
how individual consumers and firms make
decisions and how the interaction of many
individual decisions affects markets.
22
 Microeconomics(cont.)
• Micro economics is often called price theory
to emphasise the important role that prices
play in determining market outcomes.
• This is due to fact that the major subject-
matter of microeconomics deals with the
determination of price of commodities and
factors.
• Microeconomics explains how the actions of
all buyers and sellers determine prices and
how prices influence the decisions and
actions of individual buyers and sellers.
23
 Microeconomics(cont.)

• In allocation of resources
• Consumers pick the mix of goods and
services that makes them as happy as
possible given their limited wealth.
• Firms decide which goods to produce, where
to produce them, how much to produce to
maximise their profits, and how to produce
those levels of output at the lowest cost by
using more or less of various inputs such as
land, labour, capital, materials, and energy.

24
 Importance of
Microeconomics
• Microeconomics has both theoretical and practical
importance. It is clear from the following points:
1)Microeconomics helps in formulating economic
policies which enhance productive efficiency and
results in greater social welfare.
2)Microeconomics explains the working of a
capitalist economy where individual units (i.e.,
producers and consumers) are free to take their
own decision.
3)Microeconomics describes how, in a free
enterprise economy, individual units attain
equilibrium position.
 Importance of
Microeconomics (cont..)
4) It helps the government in formulating
correct price policies.
5) It helps in efficient employment of
resources by the entrepreneurs.
6) It helps business economist to make
conditional predictions and business
forecasts.
Limitations of Microeconomics

• Microeconomics fails to explain the

functioning of an economy as a whole. It
cannot explain unemployment, poverty,
illiteracy and other problems prevailing in
the country.
 Macroeconomics
• The word ‘Macro’ is derived from the Greek word
makros meaning large. Macroeconomics deals
with aggregative economics. Macroeconomics
is defined as the study of overall economic
phenomena, such as problem of full
employment, GNP, savings, investment,
aggregate consumption, aggregate
investment, economic growth, etc.
• It is also known as Theory of Income and
Employment since its major subject-matter
deals with the determination of income and
employment.
• The study of macroeconomics is used to
solve many problems of an economy like,
monetary problems, economic fluctuations,
 Macroeconomics (cont..)
• Macroeconomics is an analysis of aggregates
and averages of the entire economy, such as
national income, gross domestic product,
inflation, total employment, total output,
total consumption, aggregate demand,
aggregate supply, etc.
• Macroeconomics is the part of economic
which looks to the statistics of a nation's
total economic activity and holds that policy
change designed to alter these total
statistical aggregates is the way to
determine economic policy and promote
economic progress.
 Importance of
Macroeconomics
The importance of macroeconomics on theoretical and
practical reasons is clear from the following points:
1) It gives an overall view of the growing complexities of
an economic system. It provides powerful tools to
explain the working of the complex economic systems.
2) It provides the basic and logical framework for
formulating appropriate macroeconomic policies (e.g.,
for inflation, poverty, unemployment, etc.) to direct and
regulate economy towards desirable goals.
3) It helps in analyzing the reasons for economic
fluctuations and provide remedies.
4) It is used to explain gains from trade, disequilibrium in
the balance of payment position and determination of
international exchange rate.
Limitations of Macroeconomics
Some of the major limitations of
macroeconomics are:
1) Macroeconomics ignores structural
changes in an individual unit of the
aggregate. The conclusions drawn on the
basis of aggregate variables may be
misleading.
2) Most of macro magnitudes which figure
so largely in economic discussions are
subject to errors and ambiguities.
 Economic agents
• Households
• Firms
• Government
 Circular Flow Model/Two Sector
Model
• A model showing how households and firms interact in
the markets for goods and services as well as in the
markets for the factors of production.

• Assumption:
1. Two economic agents Firms and Households
• Households
Are the owners of the factors of production and they sell
the FOP to firms, so as to obtain income though the
Markets for FOP (wages, rent, profit, interest).

The obtained income is used to purchase/buy the goods

and services that are produced by firms
 Circular flow model (cont)
• Firms
Hire and use the FOP services as provided by HH. They use
the hired FOP to produce goods and services that they later
sell in the market for Goods and services so as to obtain
revenues.

2. All income obtained is spent on consumption i.e. no savings

3. Firms produce the exact quantity of goods and services that

HH demands.

4. No Government intervention

5. No foreign Trade/sector.
 Spending/Expenditure
Revenue

MARKETS FOR GOODS AND

SERVICES
Goods and
Services sold
Goods and
Services Bought

FIRMS HOUSEHOLDS

Labor, Land and

Inputs for
Capital
Production

MARKETS FOR FACTORS OF

PRODUCTION
Wages, Rent and Profit Income
Economic agents (cont)
 Economic Theory

A statement or set of related statements

about cause and effect, action and reaction,
for instance the law of demand as put
forward by Alfred Marshall “When the price
of product rises, people tend to buy less of
it; when the price of product falls, they tend
to buy more.
Theories do not always arise from out of
formal numerical data, at times they can
arise from observation of peoples behavior.
 Models

A formal statement of a theory, it is

usually a mathematical statement of a
presumed relationship between two or
more variables. Models are usually a
simplification of reality.
Economist also use model to predict
how a change in one variable will
affect another variable.
Central Problems of the Economy
• Economic problems are reflected in the form of Central or
Basic Problems of an economy.
• Economics is mainly concerned with the achievements and
uses of material requirements to satisfy human wants.
However, human wants are unlimited and productive
resources are limited. Therefore, goods and services which
satisfy human wants are scare. Because of the scarcity and
limited resources and limited availability of goods and
services we have basic economic problems.
• The basic economic problems of an economy can be given
as follows:
1. What to produce?
2. How to produce?
3. For whom to produce?
 What to Produce?
• As the resources are limited and wants are unlimited
the problem of what to produce implies that a society
has to decide which goods and in what quantities are
to be produced.
• If the means were unlimited, then it would lead to a
stage of salvation.
• But the means are limited and the economy must
decide the efficient allocation of scarce resources so
that both output and output-mix are optimum.
• An economy has to make a choice of the wants
which are important for the economy as a
whole.
• For example, if the economy decides to produce
more cloth, it is bound to reduce the production of
food.
• The reason is that resources used to produce food and
 How to Produce?
• This is the problem of choice of technique. There
are mainly two types of technology available for
the production of a good.
• First is the labour intensive technology, which
uses more labour than machines and second is
the capital intensive technology, in which there is
more use of capital or machines as compared to
the labour.
• Further it means with what combination of
resources a society decides to produce goods.
Usually, there are various alternatives; there are
various techniques of production of a commodity.
• In order to explain these problems we take into
account two factors of production which are
labour and capital.
How to Produce? (cont..)
• It is always technically possible to produce a given
amount of wheat or rice with more of labour and less
of capital (i.e. with labour intensive technology) or
with more of capital and less of labour (i.e. with capital
intensive technology).
• The same is true for most commodities. In the case of
some commodities however, choices are limited. For
example, production of woollen carpets and other
items of handicrafts is by nature labour intensive,
while production of cars, TV sets, computers, aircrafts,
etc., is capital intensive.
• Thus, every economy has to choose the most efficient
technique of producing a commodity.
 For whom to produce?
• This is the problem of distribution of goods
between different income groups of the society.
How many resources are used for the rich and the
middle class and what is left for the poor?
• This tells us about the relative importance the
economy gives to the needs of the rich and poor.
• It also means the choice between present and the
future needs.
• It implies how the national product is distributed
among the various sections of societies, there are
limited resources an economist has to decide who
should get what and how much.
• This is to say how the national income is
distributed among various segments of the
society.
 SCARCITY
• Scarce means limited in supply/ shortage in
what is actually needed or required/ not in
abundance/ insufficient.
• All economics goods and services are scarce,
it of importance to understand that the goods
and services are considered to be scarce
relative to people’s desire for them.
• They therefore have to ultimately make a
decision over what can be satisfied and what
cannot, they have to make a choice. In order
to enjoy some things it is necessary to do
without others.
 OPPORTUNITY COST
• Opportunity cost is the value of alternative forgone in
order to have something else. This value is unique for
each individual.
• Opportunity cost is the cost expressed in terms of the
next best alternative sacrificed.
• The opportunity cost of an item is what you give up
to get that item.
– Eg. An opportunity cost of you choosing to come to
TMA for 3 years, it could be the amount of money
you could be earning working somewhere .
• It helps us view the true cost of our decision making
• Implies valuing different choices
 CHOICE
• Since people do not have infinite
income, they need to make choices
whenever they purchase goods and
services.
• They have to decide how to allocate
their limited financial resources and
so always need to choose between
alternatives.
• People wants are infinite; resources
are finite, therefore, choices must be
 PRODUCTION POSIBILITY
CURVE
• Production possibility set refers to different
possible combinations of two goods that can be
produced from a given amount of resources and a
given level of technology.
• Production possibility curve or frontier
(PPF) shows the various alternative
combinations of goods and services that an
economy can produce when the resources
are all fully and efficiently employed. PPC
shows the obtainable options.
• There is a maximum limit to the amount of goods
and services which an economy can produce with
the given resources and the state of technology.
The resources can be used to produce various
 Production Possibility Curve
(cont.)
• Assumptions underlying production possibility curve are:
a) Economy produces only two goods, X and Y. (Examples
of goods X and Y can be gun and butter, wheat and
sugar cane, cricket bats and tennis rackets or anything
else.)
b) Amount of resources available in an economy are given
and fixed.
c) Resources are not specific, i.e., they can be shifted from
the production of one good to the other good.
d) Resources are fully employed, i.e., there is no wastage of
resources. Resources are not lying idle.
e) State of technology in an economy is given and remains
unchanged.
f) Resources are efficiently employed (efficiency in
production means output per unit of an input).
Production Possibility Curve
(cont.)
• PPC refers to graphical presentation of
different possible combinations of two goods
that an economy can produce with given
resources and available technology.
• Panel (A) gives a production possibility
schedule. It shows that, with given resources,
an economy can produce either zero unit of X
and 21 units of Y or 1 of X and 20 of Y or 2
units of X and 18 units of Y or 3 units of X and
15 units of Y or 4 of X and 11 of Y or 5 of X
and 6 of Y or 6 units of X and zero units of Y.
Production Possibility Curve
(cont.)
Production Possibility Curve
(cont.)
Production Possibility Curve
(cont.)
• From Panel (B) the economy can either
produce OP of good Y or OP' of good X or
any other combination shown by points A,
B, C, D or E.
• All points on the curve are attainable. The
problem is that of choice, i.e., to choose
among the attainable points on the curve.
• It depends upon tastes and preferences of
an individual. This is the basic problem of
an economy.
• Any point inside the curve, such as point F,
indicates unemployment of resources or
 Shifts in Production Possibility
Curve
• With discovery of new stock of resources
or an advancement in technology, the
productive capacity of an economy
increases (economic growth)
• The economy can produce more good X or
more good Y or more of both goods.
• The effect of economic growth on the
production possibility curve to a country is
illustrated in the following curves
Shifts in Production Possibility
Curve (cont.)
Shifts in Production Possibility
Curve (cont.)
 ECONOMIC SYSTEMS
• A country’s economy or economic system
is that society’s way of coordinating the
production and consumption of goods and
services.
• The three basic questions of any economic
system is trying to answer usually are
1.What will be produced?
2.How will it be produced? and
3.For whom will it be produced?.
• Moreover, there are different goals of an
economic system which depend on
 Economic Systems (cont.)
• For instance some of the values which are considered in
choosing an economic system are;
– Economic Efficiencies
• Making the most of resources
– Economic Freedom
• Freedom from government in production and distribution
– Economic Security and Predictability
• Assurance that good and services will be available,
payments will be made, a safety net will assist in case of
disaster
– Economic Equity
• Fair distribution of wealth
– Economic Growth and Innovation
• Innovation leads to growth, growth leads to higher standard
of living
 Economic Systems (cont.)
• There are four basic types of economic
system
1.A traditional economy
2.A market economy
3.A command (or planned) economy
4.A mixed (or hybrid) economy
 Economic Systems (cont.)
1.A Traditional Economy
• Custom and tradition dictate what to produce,
how to produce it, and for whom.
• Hunting, fishing and farming are the main
economic activities in such an economy.
• Although traditional economies are rare in the
21st century, some still exist (e.g., Remote tribal
areas in South America, Africa and Asia).
• Also, some peoples like the Amish or the Inuit
organize their economic lives that way.
 Economic Systems (cont.)
• Advantages of Traditional Economy
– Every member of the society knows
exactly what they are to do.
– There is a strong social network.
– Positions within society are already
established.
– Basic Economic questions are already
answered by traditions and customs.
– Life is generally stable, predictable and
continuous.
 Economic Systems (cont.)
• Disadvantages of Traditional Economy
– This type of society is often very slow to change.
– It does not take advantage of technological
change.
– There is relatively little promotion of intellectual
and scientific development.
– There is inefficient provision of goods and
services.
– There is inadequate use of skill in relation to the
factors of production.
– No upward movement of labor takes place.
 Economic Systems (cont.)
2.Command Economy
• In this type of economic systems the
government controls all economic activity
- government decides what goods are
produced, how much of each good to
produce and how much the people should
get.
• Examples of this economic systems
includes the former Soviet Union (now 15
countries including Russia and Ukraine)
dismantled their planned economies from
 Economic Systems (cont.)
• Advantages of Command Economy
– The welfare of all citizens is the primary
goal
– Full employment of all available
resources
– Government possesses the information
to be able to direct resources where
they are most needed.
– Wasteful competition is avoided
– There is no industrial unrest such as
striking, as the government controls
 Economic Systems (cont.)
• Disadvantages of Command Economy
– No freedom of choice for consumers or
producers
– System is too rigid to adjust when changes
occur, can result in shortages
– Lack of incentive for workers results in low
morale and efficiency. Managers also are not
motivated.
– There are too many officials, and too much
unnecessary procedure and paperwork (red-
tape or bureaucracy)
– Conflicts of interests can arise because what
the country needs may not be what the people
want.
 Economic Systems (cont.)
3.Free Market Economy
• The government plays little role in economic
activity. Emphasis is on freedom of the individuals
(consumers and producers).
• The private sector (private firms and individuals)
answer the basic economic questions. There is
consumer sovereignty. Profit maximization is the
main goal in this economy.
• Price drives the economy Example of Free Market:
There is no real life example of a purely free
market economy, this only exists in theory.
 Economic Systems (cont.)
• Advantages of free market economy
– Manufacturers are free to produce what the consumers
demand and the consumers in turn are free to spend
their money as they see it fit.
– The decision of what to produce is not controlled by
government or any single individual/firm. Hence, there is
greater participation in the decision-making process.
– A large variety of goods and services are produced to
satisfy the needs of consumers.
– Prices are determined by the forces of demand and
supply (the price mechanism).
– There is freedom from government interference.
– Efficient production is promoted since resources are
allocated to their most profitable use.
– Competition among firms improves quality, keeps prices
low and spurs new technology and innovation.
 Economic Systems (cont.)
• Disadvantages free market economy
– Since the making of profits is the dominant
motive of the private sector, only goods and
services that yield the highest profit will be
produced.
– Since there is no government intervention in
this type of system, consumer could be
exploited through the charging of high prices
for essential goods and services.
– This system leads to great inequalities as the
few rich get richer and the many poor get
poorer.
– There is much pollution associated with this
system especially when industrialization begins
 Economic Systems (cont.)
4.A mixed (or hybrid) economy
• Both the government and individuals play
important roles in deciding how much to produce
and what to buy.
• The government’s role in a mixed economy could
vary considerably from country to country. In
some its function could be limited to enforcing
the laws and regulating the currency whereas in
others it could involve many of the trappings of
the welfare state, such as universal health care,
free day care, and so on.
• In general, the aim of the private sector is to
maximize profits while the aim of the public
 Economic Systems (cont.)
• Advantages of mixed economy
– The state can intervene in areas of the
economy through the passing of laws to
protect citizens from unfair trading
practices.
– Both the government and the private
sector can cooperate in offering certain
services; e.g. transportation, health
care.
 Economic Systems (cont.)
• Disadvantages of mixed economy
– Too much government regulation may dampen
the free enterprise spirit.
– Some state-owned industries are allowed to
operate inefficiently, thus wasting resources.
– Where government intervenes in the market by
setting maximum and minimum prices, this
may cause excess demand or supply, which
may be difficult to regulate in the long-run.
– Since the private sector helps to answer the
economic questions, there can be the creation
of monopolies.
– Inequitable distribution of wealth can also