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CHAPTER 1:
INTRODUCTION TO ECONOMICS
DEFINITION OF ECONOMICS
BASIC ECONOMICS CONCEPTS
PRODUCTION POSSIBILITIES CURVE
BASIC ECONOMIC PROBLEMS

The word ‘economy’ comes from a Greek word which means ‘one
who manages a household’

Resources used by firms to
produce goods and
services during the
production process

Economics or political economy is an
enquiry into the nature and cause of
the wealth of nations

Adam Smith (1776)

Economics is the science of how a
particular society solves its economic
problems

Milton Friedman (1962)

Economics is the study of scarce
resources to satisfy unlimited human
wants

Richard Lipsey (1990)

Definition
Social science that studies how society allocates scarce resources to
fulfil their unlimited wants
Society is divided into four main groups:
1
...
Firms
3
...
Foreign sectors

Factors of
production

1
...
Labour
•

•
•

Natural resources
E
...
Capital
• Wealth used for
production
• E
...
Entrepreneur
• A person who
organizes the
other factors of
production
• Has the ability to
plan, organize,
direct & control
• Able to take risks

*these four factors of production
are scarce and society should try to
use them efficiently in the process
of fulfilling their unlimited wants

Branches of Economics
Microeconomics
•

Deal with individual and specific units of economics

•

A branch of economics which studies the behaviour and decisions of individual entities, such as
households, firms and markets

•

Studies the way in which individual markets work, the detailed way in which regulations and
taxes affect the allocation of labour, and goods and services

Macroeconomics
•

Deal with economics as a whole

•

Examines the determination of the overall levels of economic activity, such as unemployment,
aggregate income, average prices, inflation and international trade

MICROECONOMICS

MACROECONOMICS

Studies individual and specific economic units

Studies economics as a whole

Analyzes the economic entity in detail

Analyzes the economic unit in general

Looks at the individual unit

Looks at the entire or aggregate aspects

Example:

Examples:

•
•
•

•

Production

•

Production

Individual, firm and industry

Gross Domestic Product (GDP), Gross

Prices

National Product (GNP), aggregate

Individual goods and services

demand & aggregate supply

Income

•

Prices

Distribution among factors of

Average price, Consumer Price Index

production

(CPI), inflation

Employment

•

Household supply of labour

Income
Total wages & salaries, total profit

•

Employment
Total employment & unemployment

CONVENTIONAL PERSPECTIVES

ISLAMIC PERSPECTIVES

A study of how societies organize scarce

Studies the economic problems faced by

resources to fulfill their unlimited wants

people imbued with Islamic values

Scarcity
•

Arises due to limited resources and unlimited human wants

Choice
•

Make best choice possible due to scarcity

•

Individuals – maximize their satisfaction

•

Firms – maximize their profits

•

Government – maximize social welfare

•

Must choose what to produce and who gets the final product

Opportunity Cost
•

The forgone cost of not choosing other alternative uses

•

The second best alternative and its benefits that is given up

•

Can be exemplified as the quantity of good A given up for a unit of Good B that is consumed
or produced

Sample Question

Explain briefly the three basic economic concepts
...
Therefore, society must make the best choices possible to maximize their
satisfaction
...
For example, if the government has to decide between building a
school and a hospital in a certain area, and the government cannot build both simultaneously
due to scarcity, then a choice has to be made, if society prefers a school to a hospital in
that area, then the government will build a school and maximize social welfare
...


or

Definition
A

production

Assumptions:
possibilities

curve

shows

the

1
...
Fixed resources

be produced with the existing resources and the

3
...
Economy is operating full employment

PRODUCTION ALTERNATIVE

TELEVISION (UNIT)

RADIO (UNIT)

A

20

0

B

18

1

C

15

2

D

11

3

E

6

4

F

0

5

Points inside the PPC – attainable but inefficient production due to
waste of resources
Points outside the PPC – unattainable production due to lack of resources
(scarcity)
Points along the PPC – the most efficient and attainable production
(choice)
Movement from one point to another point – opportunity cost

PRODUCTION

TELEVISION

RADIO

MOVEMENT

OPPORTUITY OPPORTUNITY

ALTERNATIVE

(UNIT)

(UNIT)

FROM ONE

COST

COST

POINT

(TOTAL)

(PER UNIT)

A

20

0

-/-

-/-

-/-

B

18

1

A to B/A to B

2 TV/2 TV

2/1=2 TV
/ 2/1=2 TV

C

15

2

B to C/A to C

3 TV/5 TV

3/1=3 TV
/ 5/2=2
...
5 TV

F

0

5

E to F/A to F

6 TV/20 TV

6/1=6 TV
/ 20/5=4 TV

The (total) opportunity cost
Can be determined by calculating the number of goods sacrificed
The opportunity cost (per unit)
Can be measured by dividing the number of goods forgone by the number of goods increased

Shapes of Production Possibilities Curve
Concave – increasing opportunity cost
•

In order to get one more unit of a good,

Linear/straight line – constant opportunity

more units of another good would have

cost

to be sacrificed
•

To increase the units of good X, more

•

As more units of a good is produced,
the

units of good Y should be sacrificed

same

number

of

units

(or

constant amount) of another good
would have to be sacrificed
•

To increase the units of good X, the
amount good Y that is forgone are
the same

Convex – decreasing opportunity cost
•

To obtain one more unit of a good,
less units of another good would have
to be sacrificed

•

To increase the units of good X, less
units of good Y should be sacrificed

Factors that Influence the Shift of the PPC
Right/outwards
1
...


Improved level of technology
•

3
...


Due to successful R&D enhances efficiency
Able to produce more goods and services

Increased population
•

the number of people who are willing to
work increase

•

The bigger the population, the higher the
demand of goods & services

Left/inwards
1
...
Inferior technology
3
...
Decrease in population

PPC will also shift outwards/inwards towards
only one good & the production of the other
good remains unchanged – based on technology

1
...
How to produce?
•

Refers to the methods or techniques of production

•

Labour intensive

•

Capital intensive

•

Choose the best method of production that minimizes the cost

3
...

The efficient use of scarce resources is crucial in order to produce goods & services in demand by
society
...
The producer should be able to utilize the resources efficiently and use available
technology to produce the goods and services
...
The rich will
get more goods & services while the poor will get less
...
g Tenaga Nasional Berhad (TNB)

•

Government – reduces/controls monopoly power

Advantages
•

Variety of goods & services at affordable prices

•

Economic activities are more stable & organized – negative externalities curbed when the
government control the existence of monopolies

•

Income gap between the rich & the poor is narrowed down – because of tax

•

Social cost is minimized – government regulate laws

Disadvantages
•

Mixed economy is run by a social democratic government – gain too much power in finding a
balance between wealth equality, market freedom & individual freedom → discourage investment

•

Allows excessive intervention of the government

•

More government intervention requires a greater investment which comes from tax revenues →
reduce investment & decrease motivation

•

Government may limit company sizes to reduce monopoly power – entrepreneurial spirit destroyed

Islamic Economic System
•

Based on the principles of Islamic Shariah

•

Classifications of goods in Islam

done out of compassion, love

-

Dharuriyyah (necessity goods)

etc

-

Hajiyyah (comfort goods)

-

Kamaliyyah/Tahsiniyyah (luxury goods)

•

Concept of Khalifah
•

•

Social interest should be fulfilled first

•

Objective – achieve al-Falah (success in

•

Sadaqah – voluntary charity

Refers to

the

‘steward’/leader

of

a

caliphate
•

Means men are the servants of Allah who

one’s life and the life hereafter)

are created as trustees & are responsible

Basic philosophical foundations:

to prosper the land set by Islamic Law

Concept of Tauhid
•

Refers

to

the

concept

of

Concept of Ukhuwah

believing that in Islam there is

•

Means brotherhood

only one God, Allah SWT to be

•

Willing to help, reconcile & sacrifice for

worshipped
•
-

their brothers show the sign of faith

Belief of Tauhid:

•

The relationship between man and
Allah (Habluminallah)

-

The

relationship

among

mankind

(Habluminannas)

Concept of Rububiyyah
•

Believing that Allah SWT alone
is the most powerful creator,
who

organizes

and

rewards

man’s economic activities for
genuine interest to achieve alFalah

Concept of Tazkiyyah
•

Purification as Islam believes
that man must have a pure &
good soul before he indulges in
any economic activities

•

Purify wealth – tithe (zakat),
donating (sadaqah)

•

Zakat

–

mandatory

for

Muslims, considered as a tax

all

Oppression & extortion do not exist in
Islamic economic system

Economic Decisions in the Economic System
SOCIALIST

CAPITALIST

MIXED

ISLAMIC

WHAT & HOW

Government/Central

Consumer

Determined by

Determined by

MUCH

Planning Authority

sovereignty

market’s demand

principles of

*goods & services

& supply

Shariah

that society needs

mechanism

Production of

Both private &

permissible goods

public goods are

Based on the

provided

classifications of
goods in Islam

HOW

Government/Central

Lowest cost of

The most

Least costly

Planning Authority

production

efficient & cost-

method

*might use a

Relies on the

effective

Philosophy of the

modern/traditional

efficacy of

Producer – choose

Islamic economic

method which will

resources

method that

system should be

minimize cost

utilization &

minimizes cost,

applied in

objective of

maximizes profit

economic decision-

maximizing profit

& achieve

making

efficiency

FOR WHOM

Social welfare

Only those who

Depends on

Poor – served

*cheaper – essential

are able to pay

market’s demand

first

goods

the market price

& society’s need

Rich – zakat,

*expensive – luxury

will be allocated

Based on society’s

sadaqah, waqf

goods

the goods and

income

services

distribution
Public – basic
goods
Private – based
on market’s
demand

Summary of the Four Basic Economic System
ITEM
CHARACTERISTIC

SOCIALIST
1
...


Production

MIXED
1
...
No private

2
...


Production
based on
Shariah
principles

2
...
Price

sector are

sector/Central

m

mechanism is

Planning

government

vital, at the

Authority

intervention

same time,

economic

3
...
Price

certain goods

gain profit,

involvement
3
...
No competition

is

the

5
...
Competition

6
...
Production of

is highly

both private

practiced

& public

6
...
Production

4
...
Production

of
permissible

private

of various

sectors work

goods &

together to

services

maximize

goods &
services,
but no
production

profit &

of non-

social welfare

permissible
goods &
services
4
...


Social welfare is
served first

2
...


Society has

Society has

economic

economic

freedom

freedom &

2
...
Equitable

1
...
Production

social welfare
is fulfilled
2
...


Production
of goods &
services
depends on
the
classification
s of goods
in Islam

distribution of

of quality

allocation

wealth & income

products

since public &

interests

due to

private goods

are served

competition

are produced

first

4
...
The poor’s

on the society’s

4
...
Less monopoly

at the same

place

time

5
...
There is

power

foreign

competition,

direct

leading to the

investment

production of
quality
products &
the
production of
basic goods by
the
government
4
...


No/less economic

1
...


The

freedom &

goods are

government

consumer

produced

may have

sovereignty
2
...
There is a

excessive

price to be

control over

competition,

paid for all

business

leading to the

goods &

activities,

production of low

services

may

quality products
3
...
Inequality in
distribution

technology since

of wealth &

no initiatives for

income

R&D
4
...
Allocation

discourage
investment
2
...
Existence of
monopoly
power
6
...
The
government

discriminate

may limit

d

company sizes

7
...
Social

to reduce
monopoly
power, hence

welfare is

affecting the

disrupted

entrepreneuri
al spirit

3

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