1. What is Economics?
• Economics is the study of the choices made by people who are faced with
scarcity.
• Scarcity is a situation in which resources are limited and can be used in
different ways.
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2. • Due to limited amount of resources, we must sacrifice one thing in order to
obtain another thing.
• Economics is the study of how society manages its scarce resources.
• Three fundamental questions to answer
 What goods and services should be produced?
 If we devote more resources to the production of one good, we have
fewer resources for the production of another.
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3.  How should these goods and services be produced?
 How do we organize the factors of production and what methods or
techniques should we use?
 Factors of production
• Natural resources (land, water, oil,…)
• Labor (human effort)
• Physical capital (all the machines, buildings, equipments…)
• Human capital
• The knowledge and skills acquired by a worker through
education and experience
 For whom should the output be produced?
 How should we distribute the output produced among members of
society?
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4. MEDIEVAL ECONOMY
• Consider a simple medieval economy.
• Landlord owns all land.
• Peasants work on land allocated them by landlords.
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5. • For example, a landlord may require a peasant family to cultivate 2 acres
of land for him, for every 3 acre of land he allocates to the family.
• If a peasant family cultivates 5 acres of land, the production of only 2 acres is
going to the landlord.
• Assume that the only production is wheat.
 For wheat production , the factors of production are
Labor
 Land
Wheat (as seeds)
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6. So, the production process can be shown as
Labor (work) + Land + Wheat = Wheat
In economic terminology,
• Inputs are combined by the production process in a specific way
to produce output.
• This specific way is called the technique of production.
The difference of
• Wheat output – Wheat Input = Economic Surplus (or simply “surplus”
or net output)
• It is also referred as Income.
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7. Three basic questions we have to address:
1. What determines the size of the surplus?
2. What determines the distribution of the surplus?
3. How is the composition of surplus determined?
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8. 1) What determines the size of the surplus?
Surplus= f(Landcultivable) and
Landcultivable=g(Landavailable , Number of Peasant Families, Stock of Wheat
Input)
Or combining,
Surplus=h(Landavailable , Number of Peasant Families, Stock of Wheat Input)
• Any of these factors can be a constraint on the amount of surplus that can
be produced.
 If population has been reduced, fewer land can be cultivated. Thus, the
size of surplus will be reduced in this case, etc..
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9. • Production technique is another determinant of the surplus, given the total
amount of cultivable land.
 A better use of land, for example by increasing irrigation techniques, may
rise surplus (for a given amount of cultivable land)
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10. 2) What determines the distribution of the surplus?
• This is the question of income distribution.
• In our economy,
 Peasants, and
 Landlords
have claims over the income.
• These claims are competing
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11. • Suppose an acre of land gives 500 kg of wheat:
• Our family has 5 acres, hence total production is 2500 kg.
• Produce of 2 acres goes to landlord (1000 kg). This is what landlord dictates.
• Then, family retains 1500 kg.
• Here the distribution of surplus is determined by the ratio given by the landlord.
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12. 3) How is the composition of surplus determined?
• Suppose now that, there are two products: Wheat and Banana
• What will be the strategy of landlords?
• What will they produce? Wheat or Banana?
• When the resources have alternative uses, a choice has to be made.
 In this case a resource allocation problem arises
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13. • If the demand for banana is higher, then banana is more valuable relative
to wheat
 In this case, landlords would decide cultivate more banana in the next
period.
• Hence, the composition of the surplus (what is produced) has to match the
composition of demand (what is demanded).
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14. (2) CAPITALIST ECONOMY
• In this case, means of production (such as land and capital) are owned by
individuals or groups of individuals.
• We call them as capitalists.
• There are also workers.
• Capital consists of machines, buildings and also funds to be used in
financing production.
• There are also intermediate inputs, which are produced by other firms and used
up in the production process.
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15. • Firms produce output combining capital, labor and intermediate inputs.
• Hence, the production process of a firm can be seen as follows:
Labor + intermediate inputs.....[P]....Output
• Labors receive wages (or more specifically, nominal wages; wages in
monetary units).
• Capitalist sells the output at a certain price.
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16. • Now, consider a simple bread production.
 Bakery (firm) has capital goods (Owens, other machines) which are
operated by labors.
 Bakery pays wages for labor (TL 200).
 Suppose wheat is the only intermediate input for simplicity (TL 500)
 100 units of bread (Q) is produced and its price (p) is TL 10.
• Hence,
(TL 200, wages)+(TL 500, intermediate input)...[P]...TL 1000
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17. • Surplus (S), created by the firm, is the excess of the value of output over the value
of intermediate inputs used:
S=p.Q-value of intermediate inputs
• Note that only the value of intermediate inputs is deducted to obtain surplus.
• Surplus is also called the value added created by the firm.
• This surplus is to distributed between workers and capitalists.
 Hence, if it is zero, there is nothing left to be distributed to them.
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18. Now we came to the distribution problem .
1) What determines the distribution of the surplus?
• The question is not simple as in the case of medieval economy.
• Workers’ claim over surplus is wages,
• Capitalists’ claim over surplus is called profit, and given by:
Profits= value of surplus (S) – wage bill
where wage bill refers to total payment to workers.
• Hence, the shares of workers and capitalists depend on
 the wage bill, and
 the price of output, which is used to compute the surplus.
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19. • In our example,
S=p.Q-value of intermediate inputs
S=10.100-500=500
Profits= value of surplus (S) – wage bill=500-200=300
 Share of the workers in surplus is TL 200 (40 % of the surplus)
 Share of the capitalist in surplus is TL 300 (60 % of the surplus)
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20. • Now, suppose that the price of the output changed to TL 13 from TL 10.
S=p.Q-value of intermediate inputs
S=13.100-500=800
Profits= value of surplus (S) – wage bill
Profits=800 –200=600
 Now, share of the workers in surplus is 25 % of the surplus
 Share of the capitalist is 75 % of the surplus
• To sum up, a specific price corresponds to a given pattern of income distribution.
• The income distribution changes by the price of the output.
• Hence, in a capitalist economy; the price at which the output is sold determines a
specific income distribution.
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21. 2) What determines the size of the surplus?
• Suppose that only one good, X, is produced.
• Labor is the only factor of production
• 2 Labor produces 1 unit of X
• No intermediate input is used
• Wage is 0.25 units of X per year.
• Hence
0.5 units of X as wages...[P]...1 unit of X
• Since there is no intermediate inputs by assumption, the surplus is equal to
1 unit of X.
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22. • Labor takes 0.5 unit and capitalist take 0.5 units. (50-50 distribution)
• Now suppose, there are 1000 workers in the economy
 In this case, 500 units of X will be produced
 With no inputs assumption, it is also Surplus (500)
 Workers get 250 units of X
 Capitalists get 250 units of X
• Workers use their entire shares of the surplus to survive.
• If capitalists use also their entire shares of the surplus, then;
Total employment= 1000 workers
Corresponding size of the surplus=500 units of X =wages+profits
(1) Workers’ consumption=250 units of X=wages
(2) Capitalists’ consumption= 250 units of X=profits
Total use=(1)+(2)=500 units of X 22

23. • Now suppose that, capitalists are only willing to consume 200 units of X
 Now total use will 450
 In this case, capitalists would NOT employ 1000 workers since all resulting
output can not be sold.
 What would be the size of surplus in this case?
Total employment= 800 workers
Corresponding size of the surplus=400 units of X=wages+profits
(1) Workers’ consumption=200 units of X=wages
(2) Capitalists’ consumption= 200 units of X=profits
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24. • Hence, the size of the surplus may be quite different depending on the level of
demand
• In our example, a change in demand by capitalists leads to a different level of
employment and hence a different size of the surplus.
To sum up,
The distribution of the surplus
 The wage
 The price of the output
The size of the surplus
 Demand for the output
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25. THE PRODUCTION POSSIBILITIES FRONTIER (PPF)
• The PPF is a graphical illustration of fundamental economic problems related with
production.
• Shows all possible combinations of goods and services available to an economy,
when all resources are fully and efficiently employed.
• Capital goods and consumer goods.
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26. • A, maximum production of capital goods
• B, maximum production of consumer goods
• All possible combinations on the concave curve, production possibilities frontier (PPF)
• Points D and G ?
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27. • All the points on the PPF curve indicates efficient production.
• All the points inside the PPF curve indicates that resources are not used efficiently.
• All the points outside the PPF curve are unattainable points.
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28. •Negative slope,
 More x can be produced only at a cost of smaller amount of y
 The value of the slope is called as Marginal Rate of Transformation.
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29. Point on Total Corn Total Wheat
PPF Production Production
A 700 100
B 650 200
C 510 380
D 400 500
E 300 550
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30. • Some resources (such as land) is poorly suitable for wheat production but very
suitable for corn production.
• At the point C, much of the resources are used for wheat production.
•Going from point C to D requires the use of resources that are suitable for corn for
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wheat production.

31. • Since resources are not perfectly adaptable, the PPF curve will not be a straight line
but a concave curve.
Increasing slope
 Increasing MRS
 Increasing opportunity cost
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32. • Economic growth
 Society observes new resources or learns to produce more with existing
resources. 32