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    Unit 1 Introduction To Economics What Is An Economy?

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    This document provides an introduction to economics, including definitions of key economic concepts. It discusses that an economy provides livelihood and that economic problems arise due to scarcity of resources and unlimited wants. There are three central problems of an economy: what to produce, how to produce, and for whom to produce. These problems can be solved through market mechanisms in a market economy or through central planning in a planned economy. Most modern societies use a mixed approach. The document also distinguishes between microeconomics, which studies individual units, and macroeconomics, which studies the overall economy. It provides overviews of concepts related to consumer behavior, the theory of demand, and the law of demand.

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    Unit 1 Introduction To Economics What Is An Economy?

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    khushnuma20
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    This document provides an introduction to economics, including definitions of key economic concepts. It discusses that an economy provides livelihood and that economic problems arise due to scarcity of resources and unlimited wants. There are three central problems of an economy: what to produce, how to produce, and for whom to produce. These problems can be solved through market mechanisms in a market economy or through central planning in a planned economy. Most modern societies use a mixed approach. The document also distinguishes between microeconomics, which studies individual units, and macroeconomics, which studies the overall economy. It provides overviews of concepts related to consumer behavior, the theory of demand, and the law of demand.

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    This document provides an introduction to economics, including definitions of key economic concepts. It discusses that an economy provides livelihood and that economic problems arise due to scarcity of resources and unlimited wants. There are three central problems of an economy: what to produce, how to produce, and for whom to produce. These problems can be solved through market mechanisms in a market economy or through central planning in a planned economy. Most modern societies use a mixed approach. The document also distinguishes between microeconomics, which studies individual units, and macroeconomics, which studies the overall economy. It provides overviews of concepts related to consumer behavior, the theory of demand, and the law of demand.

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    © All Rights Reserved
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    Download as docx, pdf, or txt
    39 views8 pages

    Unit 1 Introduction To Economics What Is An Economy?

    Uploaded by

    khushnuma20
    This document provides an introduction to economics, including definitions of key economic concepts. It discusses that an economy provides livelihood and that economic problems arise due to scarcity of resources and unlimited wants. There are three central problems of an economy: what to produce, how to produce, and for whom to produce. These problems can be solved through market mechanisms in a market economy or through central planning in a planned economy. Most modern societies use a mixed approach. The document also distinguishes between microeconomics, which studies individual units, and macroeconomics, which studies the overall economy. It provides overviews of concepts related to consumer behavior, the theory of demand, and the law of demand.

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    of 8

    UNIT 1

    Introduction to Economics
    What is an Economy?
    It is an organization that provides livelihood to the people of the nation.

    The problem of choice arises because of scarcity. And this is the main focal point of study
    in economics.
    Economic Problem refers to the problem of choice arising from the use of limited means to
    the satisfaction of various ends.
    Why does an economic problem arise?
    An economic problem arises primarily due to scarcity of resources.
    The main causes of economic problems are as follows :1.

    Human wants are unlimited.

    2.

    Limited means.

    3.

    Alternative uses

    Whereas means are limited they have alternative uses as well


    Central or Basic Problems of An Economy Which Arise Due to Scarcity
    1.

    What to produce

    If refers to which goods and services will be produced and in what quantities with the limited
    resources i.e. consumption goods or capital goods.
    2.

    How to produce

    It refers to the choice of methods of production of goods & services i.e. whether labour intensive
    or capital intensive technique is to be adopted taking into consideration the proportion of capital
    and labour in an economy.
    3.

    For whom to produce.

    It concerns with the distribution of income & wealth which refers to who earns how much or
    who has more assets than others.

    Production Possibility Curve And Opportunity Cost


    It refers to a curve which shows the various production possibilities that can be produced with
    given resources and technology.
    Planned Economy:
    A Planned economy is an economy in which the central problems of What, how and for whom to
    produce are solved by government through planning. Economic planning replaces price
    mechanism. It is regulated or controlled market.
    Need for a planned economy:
    1. The projects in which private sector do not show interest e.g. water supply, education,
    health, etc. the production of these services requires huge investment and may earn less
    profit.
    2. The projects involving long gestation period e.g. electric Hydel projects.
    Market Economy:
    A market Economy is an economy in which the central problems of What, how and for whom to
    produce are solved by the freely operating market forces of demand and supply.
    Distinction between Planned Economy and Market Economy:
    Planned Economy
    Market Economy
    1. All the economic decisions are
    1. All the economic decisions are
    taken by the state.
    taken by the market mechanism
    with the help of the forces of
    demand and supply.
    2. Consumer is sovereign.
    2. The decisions
    produced are
    government

    what
    taken

    will be
    by the
    3. Profit motive is the main force
    behind all economic decisions.

    3. Social welfare is the main motive


    behind all economic decisions.
    4. Prices are fixed by the government.

    4. Prices are fixed in the market by


    price mechanism.

    Mixed Economy
    Today most societies are mixed economies. Most decisions are taken in the market but
    government plays an important role in overseeing the functioning, passes laws, that regulates the
    economies life, produce educational and police services and control pollution, etc. so most
    societies today operate as mixed economy.

    How are fundamental problems solved in the capitalistic economy.


    In a market-oriented or capitalist economy, these fundamental problems are solved by the
    market. There is a price, which is influenced by the market forces of demand and supply. These
    forces guide which goods and how much is to be produced and consumed.
    How are fundamental problems solved in the planned economy.
    In a planned economy all the economic decisions regarding what, how and for whom to produce
    are solved by the state through planning. Economic planning replaces the price mechanism. The
    market is regulated and regulated by the state. The prices of the various products are fixed by the
    state called administered prices.
    Positive Economics:
    Analysing economic behavior without making any value judgement whether the outcome is good
    or bad is positive economics. It concerns what is or what will be. Eg. People normally, do buy
    less when price rises.
    Positive economics analyses what is without any value judgement.
    Normative Economics:
    Normative Economics deals with what ought to be and based on value judgement. Eg. Senior
    citizens should be given free medical facilities.
    Positive Economics
    Normative Economics
    1. Deals with what is
    1. Deals with what ought to be
    2. No value judgement made on the
    2. Value judgement made on the
    outcome.
    outcome.
    3. Verifiable from the facts.
    3. Not verifiable from the facts.
    4. E.g. demand falls when price rises,
    4. E.g. Govt should generate more and
    Prices of food grains are rising in
    more employment opportunities,
    India, etc.
    etc.
    Micro Economics and Macro Economics:
    Micro Economics is the branch of economics that studies the behavior of the individual units e.g.
    behavior of an individual consumer, behavior of an individual firm, etc.
    Macro Economics is the branch of economics that studies the economy as a whole e.g. the level
    of output, income, employment, general price level, etc.
    Consumer Behavior

    Basic concepts: 1. Utility: The want satisfy quality of a commodity is called utility.
    2. Total Utility: -It signifies the total satisfaction which a consumer gets by consuming all
    the units of a commodity.
    3. Marginal Utility: - It is the addition in the total utility by consuming an additional unit of
    commodity.
    The relationship between total utility and marginal utility is summed up as:
    1. Initially total utility increases and reaches to point M at its maximum, marginal utility
    diminishes and reaches to 0
    2. After point M, total utility diminishes and marginal utility becomes negative.
    3. At point M, TU is maximum and MU is 0.
    4. Law of Diminishing marginal utility: As a consumer goes on consuming more and more
    units of a commodity the additional benefit that he derives from the additional unit of
    commodity goes on falling.
    Assumptions of the Law:
    1. Consumer is Rational
    2. Utility can be measured in Cardinal numbers
    3. Marginal Utility of money remains constant
    4. No change in Income, price and prices of related goods
    5. Continuous consumption of commodity in appropriate units.
    Consumers Equilibrium:
    Meaning: A consumer is in equilibrium when the difference between total utility in terms of
    money and the total expenditure on it is maximum.
    Condition of consumers Equilibrium.
    = MU of Product = Price
    MU of Rupee
    Indifference Curve Analysis:
    Meaning: An indifference curve is a locus of all such points which shows different combinations
    of two commodities which yield equal satisfaction to the consumer. In other words, consumer
    gives equal importance to all the combinations on a given indifference curve.
    Indifference Curve Schedule:

    An IC schedule refers a schedule that indicates different combinations of two commodities which
    yield equal satisfaction.
    Law of diminishing marginal rate of substitution:
    The concept of IC analysis is based on the law of diminishing marginal rate of substitution. To
    understand the law we must know the marginal rate of substitution.
    Marginal rate of substitution: The marginal rate of substitute of X for Y (MRSxy) is defined s
    the amount of Y, the consumer is willing to give up to get one more unit of X and maintain the
    same level of satisfaction.
    MRSxy = Y / X
    Explanation of the Law of diminishing marginal rate of substitution:
    According to this Law, as a consumer gets more and more units of X, he will be willing to give
    up less and less units of Y. In other words, the MRSxy will go on diminishing while the level of
    satisfaction of the consumer remain the same.

    Theory of demand
    Basic concepts: 1. Demand:- It is defined as the quantity of a good a person is willing to buy at a given
    price and at a given point of time
    2. Law of demand:- Other things remains constant, demand of a quantity falls with rise in
    price, and vice versa.
    3. Normal goods :- Normal goods are those goods which are positively related with the
    change in income. It means their demand increases with increase in income.
    4. Inferior goods :- Are those goods which are negatively related with change in income
    i.e. their demand falls with rise in income and vice versa.
    5. Substitute goods :- Substitute goods are those goods which are substituted for each
    other ex. Tea and coffee.
    6. Complementary goods :- Are those goods which are used together eg. Car & petrol.
    7. Demand function :- It explains relationship between demand of a commodity and its
    determinants.
    Dx = f(Px,Pa,Pb .Pn,income, taste, fashion etc.)
    8. Demand Schedule :- It is a tabular presentation which shows the different quantities of a
    commodity bought at various price levels.

    9. Changes in quality demanded:- It is a movement along the same demand curve.


    10. Change in demand:- It shows the shift of the demand curve.
    11. Elasticity of demand :- It is the responsiveness of quantity demanded of a good to the
    change in its price.
    12. Increase in demand :- The demand increases due to the change in other factors like
    increases in the income of the consumer. In this case the demand curve shifts to the right.
    13. Decrease in demand :-At same price-less is demanded. In this case the demand curve
    shifts to the right.
    Demand -It refers to the quantity of a commodity that consumers wish to purchase in the market
    in a given period of time and at a given price.
    Law of Demand -It states that other things remaining the same, the demand for a commodity
    increases with fall in its price and decreases with a rise in its price. It shows inverse relationship
    between price of a commodity and its demand.
    Demand Schedule and Demand Curve
    The law of demand in tabular form showing different quantities of good that a consumer is
    prepared to buy at different level of price is called Demand Schedule.
    Demand Curve is the geometrical representation of the demand schedule showing the
    relationship between price of the commodity and its demand.
    If we go on consuming more and more of a good, the additional benefit goes on falling.
    Therefore, a consumer buys more of a good at lower price
    Determinants of Demand:
    1) Px As the Price of the commodity increases its demand falls and vice-versa.
    2) Prices of related goods Related goods are of two types:
    a. Complementary Goods : If the price of complimentary good increases the
    demand for the commodity(x) falls and vice versa.
    b. Substitute Goods:If the price of substitute good increases the demand for the
    commodity(x) increases and v/s.
    3) Income of the consumer - Income of the consumer has direct relationship with the
    demand for the good. If the income of the consumer increases the demand for NORMAL

    good increases and v/s. In the case of INFERIOR good the demand of inferior good falls
    if the income of the consumer increases and v/s.
    4) Tastes If the consumer develops favorable taste for the good its demand increases.
    5) Fashion It the commodity comes in fashion its demand increases.
    Market Demand: Market demand is the horizontal submission of the demand of all the
    consumers in the market at a given price and at a given point of time.
    Why is the demand Curve Downward Sloping ?
    (i)

    Law of diminishing marginal utility : If we go on consuming more and more units of a


    good , the additional benefit that a person derives from the additional benefits that the
    additional unit goes on falling. Therefore the consumer buys more of a good at lower
    price.

    ii)

    Income effect :- If the price of the product falls the real income of the consumer
    increases, so consumer will buy more.

    iii)

    Substitution effect : If the price of the product falls it becomes cheaper in comparison to
    its substitutes so the consumer will buy more.

    iv)

    Uses of commodity : If a commodity has diverse uses, with the fall in the price of
    product consumer will buy more.

    Changes in Quantity Demand V/S Change in Demand


    Change in Quantity Demanded
    Change in Demand
    i) Other things being equal if the quantity i) If more or less quantity of commodity is
    demanded increases with the fall in the price demanded at the same
    of a product and decrease with the rise in the price due to charge in factors other than the
    price of commodity, it is known as movement price of the commodity is called shift in the
    along a demand curve or change in quantity demand curve. Or change in demand.
    demanded.
    ii) The movement is either upward or

    ii) There is either rightward shift or

    downward along the same demand curve.


    leftward shift of the demand curve itself.
    iii) Downward movement along the demand iii) Rightward shift indicates increase in
    curve is called extension in demand.

    demand and leftward shift shows

    the decrease in demand


    Importance of Elasticity of Demand
    1) To a producer: -Every producer, especially a monopolist has to decide its output and price at
    which he has to sell his output. If demand for his product is elastic, he will keep the price
    low to earn maximum profit.
    2) To a finance minister -Before charging taxes, finance minister takes into consideration,
    elasticity of those commodities, which are to be taxed. He often charges high taxes on
    those commodities which have inelastic demand.
    3) Useful in factor pricing -The factor having inelastic demand can obtain a higher price than
    those with elastic demand.
    4)

    Useful in international trade -If a country knows that the commodity produced in a country
    has inelastic demand in international market, then high prices can be charged for exporting
    goods.

    Factors Affecting Elasticity of Demand


    1)

    Availability of substitute goods -Demand of a commodity will be highly elastic if it has


    many substitutes.

    2)

    Nature of commodity -Demand of necessary and essential goods are always inelastic
    because consumers are restricted to buy those goods.

    3)

    Different uses of the commodity: If the commodity has different uses, its demand will be
    elastic.

    4)

    Taste & preferences -If the consumer is bound to use particular brand of a commodity then
    its demand will be inelastic because consumer will buy that particular commodity only even
    at higher price.

    5)

    Level of Income -If consumer belongs to richer section then his demand will not be affected
    by change in price, hence demand will be inelastic.

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