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“The
Foundation of
Economics”
Economics
1.1 Scarcity
What is Economics ?
Economics is one of the Social Sciences. It studies the human behaviour as a relationship
between ends and scarce means which have alternative uses.
Why scarcity arises?
Unlimited Wants Limited Economic Resources:-
Things that are inputs to production of
goods and services. There are 4 factors of
production-
Land Labour Technology Capital
Fig 1.1
Scarcity means insufficient resources to satisfy everyone’s needs and wants.
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Fig 1.2
1.2 Why scarcity forces choice to be made?
As we do not have enough resources to produce all the goods/ services in the amounts
that are desired, so people must choose what goods and services are valued more.
Choices - The decisions, individuals and society make, about the use of scarce resources.
3 central problems of an economy due to scarcity and choice
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Fig 1.3
1.3 The Economic Perspective ( Scarcity, Choice and Opportunity Cost)
“How Economists view things”
Resources can only be used for one purpose at a time.
Scarcity requires that choices be made.
The cost of any good, service or activity is the value of what must be given up to
obtain it (opportunity cost).
Opportunity Cost
Fig 1.4
1.4 Opportunity Cost and the Production Possibility Curve :-
The PPC is also called production possibility frontier, production possibility boundary and
production transformation curve. The PPC curve shows the various combinations of two
commodities that can be produced by an economy with the given resources and given
technology.
Qu
anti
+10 A B
ty
of
gu
ns
C
pro
du 50
ce D
d
+10 +10
Quantity of butter produced
Production Possibility Curve
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Main Points:-
The PPC curve always slopes downwards form left to right. Because when the production of
one commodity is increased the production of another commodity will be foregone.
It is concave to the origin because MRT goes on increasing.
The slope of the PPC at any given point is called Marginal rate of transformation (MRT). The
slope defines the rate at which production of one good can be redirected into production of
other. It is also called opportunity cost.
Suppose, we are on the point D of the left hand diagram of fig.1.2. If we now try to move to the right,
we are in fact throwing away guns and taking butter instead. There are some specialised input which
are meant for gun factory will be useless in the butter factory. So, gradually more and more inputs
will become unemployed. Hence, the sacrifice of the same number of guns will yield less and less
amount of butter as we move to the right and this will result in a concave curve. In other words, the
Marginal Rate of Transformation will be falling.
Note:
• If the PPC curve is straight line, the opportunity cost is constant.
• All the combinations which lie on the PPC curve are possible combinations.
• The points beyond the PPC curve are impossible combinations.
• Shift of the PPC curve is nothing but economic growth.
• Any point which lies below the PPC curve is possible combination. But if the economy is working
below the PPC curve that indicates the unused resources ‘or’ unemployment.
PPC curve solves the economic problems:-
If we can choose a point a point on the PPC curve, then we will be able to solve the first of the
economic problems ie., what to produce. Since the chosen point is on the PPC curve, we are utilising
all the resources fully and efficiently. Now the question is how to land up on a point on the PPC
curve. Adam Smith identified an “invisible” hand which will guide the economy to reach that coveted
point. The “invisible” hand is nothing but the “price system”. If too little has been produced, demand
for that good would exceed supply. This would push up the price of that good. This will induce
producer to produce more of that good than others. Once we have solved the first question what to
produce, next question comes up: how to produce. A labour intensive technique would employ
relatively more labour and little capital. A capital intensive technique would do the opposite. Which
technique is to be chosen depends on the prices of the factors of production. If labour is cheap and
capital is expensive, a labour intensive technique would be chosen. Third question is : for whom to
produce. A commodity is consumed only by people who have the purchasing power. When the price
system decides the price of labour ie., the wage rate and the amount of labour to be employed, it
also determines the income of the workers ie., their purchasing power. Thus, when the prices of
every commodity and every factor of production are determined, we know which commodity will go
to which consumer and in what quantity.
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1.5 ECONOMICS AS A SOCIAL SCIENCE
Nature:-
Economics is considered a social science because it seeks to explain how society deals with
the scarcity problem. Economics is one of the several disciplines that apply the scientific
method to the study of human behaviour, a social science.
The Scientific Method:-
It is a method of investigation used in all the social and natural sciences.
It consists of the following steps:-
Fig 1.5
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1.6 Economics as a Model Builder:-
In this method, a model is a theoretical construct representing economic processes
by a set of variables and a set of logical and quantitative relationships between
them.
Fig 1.6
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2nd Assumptions:-
a) Ceteris Paribus Assumption-
Fig 1.7
b) Self Interest – A fundamental assumption that the economic man is a rational decision
maker who acts in his self interest.
1.7 Positive and Normative Concept:-
Fig 1.8
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1.8 Micro and Macro Economics:-
Fig 1.9
1.9 Central themes of an Economy:-
In this topic the economics will focus on 4 main themes which include-
a) The Distinction between Economic Growth and Economic Development.
Economic Growth Economic Development
Narrower Concept Wider Concept, includes Economic
Growth and standard of living.
Short term process Long term process
Related to only developed countries Related to both under developed and
developed countries
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Where do Economists disagree?
They agree on the point that there should be policies to encourage growth
and development in developing countries. But “HOW” it is to be done is
where they disagree.
Which should be given more importance, Growth or Development is where
they contradict.
b) Current patterns of resource allocation, a threat to sustainability.
Economic Growth and Development occurs at the cost of depletion of
natural environment and resources. Eg- Fossil fuels, wild life, air pollution.
Sustainable Development occurs when society grows without leaving behind
fewer or lesser quality resources for future generations.
Problem of sustainability arises due to:-
What to produce How to produce
In high income society, the The issue involves method of
consumption relies strongly on production used,leading to
fossil fuels that leads to air deforestation, soil erosion, etc
pollution
Where do Economists disagree?
a) A large number of scientific, environmental, economic and social variables are inter-related
in complex ways which are not understood by many social scientists.
b) Another issue arises on ethical and philosophical front.
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C) The extent to which the government should intervene in the allocation of
resources.
There are 2 methods to make the choice of How, what and where to produce.
Market Method Command Method
Owned by only individuals and firms and Resources are ownd by government and
they make all the decisions. they make decisions.
In mixed Economies, it is a combination of both the methods.
Where do economists disagree?
Government should not interfere at all, Government should interfere.
Firms should take all the decisions.
c) The extent to which the goals of economic efficiency and equity might conflict:-
Economic efficiency :- Making best use of resources and avoiding waste.
Equity:- It means fair or just equitable distribution of income.
Where do economists disagree?
Which should be given more importance, equity or efficiency
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