The Price System

1. Price System

Using the tools of demand and supply model we can know look at the question on how goods are allocated in an economic system. The price system is the idea that prices serve as a way to allocate goods to households whenever quantity demanded exceeded quantity supplied. This is also referred to as price rationing. Let us take a closer look at how it works.

A.  Price Rationing

Here’s an intuitive example on how prices can be used to ration demand. Suppose that a newly discovered Vincent Van Gogh painting is being brought before an auction market. (See Figure 1) If the opening bid was at $100, there would be 1,000,000 people who would demand this one of a kind painting at that price.  Clearly, there is excess demand.  How does the market system determine which of these 1,000,000 bidders will end up with the painting? Well, bidders will start pushing the prices higher. As prices increase, the number of bidders will drop until there is only one bidder left.  At $200,000,000 there will be only 1 buyer and that is the person who will get the Picasso painting. Continue reading

An introduction to economics terms and concepts



A simple and most widely quoted definition of economics is that given by the British Economists, Lionel Charles Robbin (1898 – 1984):

Economics is the science which studies human behaviour as a relationship between ends and scare means which have alternative uses.

In the above definition, the word ‘ENDS’ refers to human wants usually classified as goods and services.  The word ‘MEANS’ refers to productive resources otherwise called factors of production.  In every society, the productive resources are combined in different ways to produce different types of goods and services.

Economics is described as a science subject based on the way economists study and explain human behaviour concerning how best to allocate scarce resources among competing uses.  The economists adopt scientific method in which theories of human behaviour and developed and tested against the facts in a way similar to the practice in the pure sciences like Chemistry and physics.  However, economics is more appropriately placed within the social sciences because its subject matter, human behaviour in the production, distribution and consumption of goods and services can neither be controlled in the laboratory nor be predicted with absolute accuracy.


A number of basic concepts or terms lie at the heart of economic science.  The most important ones are explain in this section. Continue reading

Introduction to Economics


Foundation of Economics

  • Social Science concerned with how resources are used to satisfy wants—the economizing problem.
  • Study of how people and countries use their resources to produce, distribute and consume goods and services.
  • An examination of behaviour related to how goods and services are acquired
  • A study of how people decide who will get the goods and services.


Introduction to Economics – Meaning and Definition

Like any other discipline the definition of Economics has evolved over time.

Adams Smith defined Economics as an inquiry into the native and causes of the wealth of actions this is popular known as the wealth definition.

Other Economists who adopted his view call Economics a science wealth, however this definition was criticized as teaching selfishness and economic was referred to as dismal science.

Alfred marshal the study of man’s everyday business of life that is how man obtain his income how he uses it. This definition was criticized to be too vague in this that man’s activity were not defined and didn’t scarcity was referred to as the material definition of economic

Lord Robbin (1933) discussed Economics as the study of human behaviour as a relationship between ends (wants) and the scarce means (resource) which have alternative uses from this definition there are three implications:

  1. a) Human beings have unlimited wants that can’t be completely satisfied at any one time
  2. b) The means to meet this wants resources must be available to fulfil these
  3. c) Those resources have various alternative and competing

The first two implications resource are said to be that is limited in supply. Scarcity of resources passes a problem of choice that is how to make the best use of the scarce resource.

Economics is defined as the study of how individuals and society choose to use scarce resources. In essence, economics is a study on how individuals make choices.

Economic Perspective

Society’s material wants are unlimited and insatiable; economic resources are limited or scarce.

  • Demand for goods and services exceeds the supply
  • Material wants means that consumers want to obtain products that provide utility.
  • Necessity vs. wants
  • Wants multiply over time with new products and incomes
  • Human wants tend to be unlimited, but human, natural, and capital resources are limited

Resources are materials from which goods and services are produced.

Four types of resources are:

Land —All Natural Resources

  • Gifts of nature – Fields, Forests, Sea, Mineral deposits

Labour— Human Resources

Capital—Means of production

  • Machinery, Tools and equipment, Factories

Entrepreneurship­- a particular type of human resource

  • Business innovator

Opportunity Cost:  All decisions involve trade-offs. Opportunity cost measures the cost of the next best alternative that we give up when making a choice.

For example, when calculating the cost of college, economists think not only about the direct costs such as tuition, textbooks, living expenses, etc, but also the opportunity cost. What is the opportunity cost for going to college? This varies from individual to individual as people have different alternatives to going to college. For many individuals, they could have worked instead of going to college. The wages one could have earned is the opportunity cost of going to college.

Branches of Economics

  • Microeconomics looks at the decision making behaviour of individual decision making units:
  • Macroeconomics looks at the entire (aggregate) economy (Big Picture)

Micro vs Macro

  Production Prices Income Employment
Micro How many Pizza

does Eat More produce ?


What is the price of an

Eat More Pizza?


What are the wages of

the workers at Eat More?


How many workers are

employed at Eat More?


Macro How much goods and

services does the Country Honky Tonky produce

each year?


What is the price of all

consumer goods in the economy?


What are the total

wages and salaries of workers in the economy?


What are the total

number of workers in

an economy?



Method of Study

  1. Positive vs Normative
  • Positive approach: concerned with the investigation of this ways in which different economic agents in the society seek to achieve their goods it relates to statements such as –what is?
  • What was?
  • What will be?

It employs economic theory in explaining circumstances.

The theories are tested against observations and other information and used to construct models from which predictions are made. A theory is a reasoned assumption intended to explain an occurrence or a phenomenon a model on the other hand is a mathematical representation based on economic theory  any disagreement are appropriately settled.

  • Normative approach: It is very subjective and depends on value judgment on what is desirable its concerned with making suggestions about the ways in which society goals might be more efficiently realized it relates to statement such as:
  • What should be?
  • What ought to be?

It’s concerned with alternative policy action that helps to illuminate and sharpen debates.


  1. Descriptive vs Economic Theory

Descriptive Economics complies data that describe economic phenomena and facts. For example the Bureau of Statistics collects unemployment data for the country every month. Economists use that data to analyse the job picture in the economy.

Economic Theory attempts to interpret the data gathered. It is a statement about cause and effect. For example, data has shown that petrol prices often rise during the winter months. Economists have developed theories explaining what causes this rise in petrol prices during the winter.

  1. Economic Theory and Models

Economic models are a formal representation of economic theory.  Economic models follow the principle of Ockham’s Razor which state that irrelevant detail should be cut away.   Like a road map, economic models are simplified generalization of reality that helps explain economic behaviour. Models can be expressed in words, graphs or mathematical equations. Economist use mathematical equations to illustrate relationships between two or more variables. A variable is a measure that can change over time or across observations.


Economists will look at only one variable at a time and try to isolate its effect. This idea is called ceteris paribus (all else equal).  In the economic model, we will assume that only 1 variable is changing at a time and hold all other variables as fixed. By doing this we can clearly analyse the relationship between two variables, by holding all other variables unchanged.