Introductory Economics Lecture1 : - Ten Principles

INTRODUCTION TO ECONOMICS
BADRI NARAYAN RATH, IIT HYDERABAD
1
WHAT IS ECONOMICS?
 Economics is about making choices and you make
economics choices everyday.
✓ Whether to get a part-time job or focus on your

studies
✓ Joining at IITs vs joining at NITs
✓ Live in hostel or rent a room outside campus
✓ Entering job markets vs going for higher study
✓ Taking a course on Economics or Psychology or
English or Sociology within the LA basket.
2
FORMAL DEFINITION
 Economics is the social science that analyzes the
production, distribution, and consumption of goods
and services.
 Economics is the study of how people use their

scarce resources to satisfy their unlimited wants.
▪ Resources (Inputs of factors of production used to

produce goods and services that people want).
❑ Labour, Capital, Natural resources (both
renewable & exhaustible), Entrepreneurial ability 3
THE ART AND SCIENCE OF ECONOMIC
ANALYSIS
 You have been hearing about economics issues for
years:
▪ Unemployment, Inflation, poverty, fiscal deficits,
stock prices, computer prices, etc.
▪ When explanations of these issues go into any
depth, you may feel confused.
4
 Why Study Economics?
 The economics profession thrives because its

models usually do a better job for understanding
the complex world.
 Economics ideas help economists to influence
policy (ministerial cabinet posts, Central
Bank/World Bank/IMF, NITI Aayog, Indian
Economics service, etc.)
 Better job perspective
 But not all economists are wealthy, nor is personal

wealth the goal of the discipline (like not all
doctors are healthy or not all child psychologists
have well adjusted children). 5
THE ECONOMIC PROBLEM
Unlimited Needs Limited
& Wants Resources
Scarcity
Choices
WHAT HOW FOR

to to WHOM to 6
produce produce produce

TEN PRINCIPLES OF ECONOMICS
Society and Scarce Resources:
 The management of society’s resources is important because
resources are scarce.
 Scarcity. . . means that society has limited resources and
therefore cannot produce all the goods and services people
wish to have.
7
 How people make decisions.
 People face tradeoffs.
 The cost of something is what you give up to get it.
 Rational people think at the margin.
 People respond to incentives.
8
 How people interact with each other.
 Trade can make everyone better off.
 Markets are usually a good way to organize economic
activity.
 Governments can sometimes improve economic
outcomes.
9
 The forces and trends that affect how the
economy as a whole works.
 The standard of living depends on a country’s
production.
 Prices rise when the government prints too much
money.
 Society faces a short-run tradeoff between inflation
and unemployment.
10
PRINCIPLE #1: PEOPLE FACE
TRADEOFFS.
“There is no such thing as a free lunch!” There is no free

lunch because all goods and services involve a cost to
someone.
11
PRINCIPLE #1: PEOPLE FACE
TRADEOFFS.
To get one thing, we usually have to give up
another thing.
 Guns v. butter
 Food v. clothing
 Leisure time v. work
 Efficiency v. equity
Making decisions requires trading

off one goal against another. 12
#1: PEOPLE FACE TRADEOFFS
 Efficiency v. Equity
 Efficiency means society gets the most that it can from
its scarce resources.
 Equity means the benefits of those resources are
distributed fairly among the members of society.
➢ Policies: Unemployment insurance, Redistribution of

income from rich to poor
➢ Although above policies aimed at achieving greater
equity, but they have a cost in terms of reduced
efficiency.
➢ It reduces the reward of working hard.
➢ People work less and produce fewer goods and services
➢ In this process, when govt. tries to cut the economic
13
pie into more equal slices, the pie get smaller.
PRINCIPLE #2: THE COST OF SOMETHING IS
WHAT YOU GIVE UP TO GET IT.
 Because people face trade-offs, making decisions require

comparing costs and benefits of alternatives.
 Decision to join the B.Tech. program at IIT Hyderabad/IIIT

Raichur (Benefit???, Costs???)
▪ The cost at studying does not truly represent what you give
up to spend 4 years in IITs/IIITs.
 The opportunity cost of an item is what you give up to

obtain that item. (e.g. College athletes, Entrepreneur).
➢ Opportunity cost = Explicit costs + Implicit costs 14
PRINCIPLE #3: RATIONAL PEOPLE THINK AT
THE MARGIN
 Economists normally assume that people are rational.
Rational people systematically and purposefully do the
best they can to achieve their objectives.
 A rational people know that decisions in life are rarely
black and white.
✓ At dinner time, the decision we face is not between fasting or
eating like a pig, rather whether to take extra spoon of rice/curry.
✓ When exams roll around, your decision is not between blowing
them off or studying 24 hrs. a day, rather whether to spend an
extra hour reviewing your notes instead of watching T20 world
cup match/TV.
 Economists use the term marginal changes to describe
small incremental adjustment to an existing plan of
action.
 Comparing Marginal benefits and Marginal costs 15
PRINCIPLE #4: PEOPLE RESPOND TO
INCENTIVES.
 An incentive (reward or punishment) that
induces a person to act.
 Because rational people make a decisions by
comparing costs and benefits, thus, they respond
to incentives.
 Incentives are crucial to analyzing how markets
work.
 (Market for petroleum)
❖ Excise duty on petrol and diesel by the govt. of
India
❖ Benefits & Perks to employee
❖ Research incentives to faculties in IITs/IIMs. 16
PRINCIPLE #5: TRADE CAN MAKE
EVERYONE BETTER OFF.
 People gain from their ability to trade with one
another.
 Competition results in gains from trading.
 Trade allows people to specialize in what they do

best.
 Ford and Toyota
 Dell and Lenovo
 Increasing trading partners around the world

 Global Value Chains (GVCs)
17
PRINCIPLE #6: MARKETS ARE USUALLY A
GOOD WAY TO ORGANIZE ECONOMIC
ACTIVITY.
 The collapse of Communism in the Soviet Union and
Eastern Europe in the 1980s may be the most important
change in the world during the past half century.
 Communism: The government officials decides the
allocation of resources in the economy (what goods and
services are to produce, how much, and who
produces/consumes?)
 Central Planning: The govt. could organize economic
activity in a way to promote economic wellbeing for the
country as a whole.
 Market Economy: the decisions of a central planners are
replaced by the decisions of the millions of firms and
households. 18
 Father of Economics (Adam Smith): His book, 1776: “An
Inquiry into the Nature and Causes of the Wealth of
Nations”
 Adam Smith made the observation that households and
firms interacting in markets act as if guided by an
“invisible hand.”
 Because households and firms look at prices when deciding
what to buy and sell, they unknowingly take into account the
social costs of their actions.
 As a result, prices guide decision makers to reach outcomes
that tend to maximize the welfare of society as a whole.
❑ In Communist countries, prices were not determined
in the marketplace but were dictated by central
planners.
❑ Mixed economy: Capitalism & Communism 19
PRINCIPLE #7: GOVERNMENTS CAN
SOMETIMES IMPROVE MARKET OUTCOMES.
 If Invisible hand of the market is so great then why do
we need government?
 Answer: Invisible hand can work its magic only if the government
enforces the rules and maintains the institutions that are key to a
market economy.
 The government also intervenes when market failure
occurs (Market failure refers to a situation in which
market on its own to fail to produce an efficient
allocation of resources ).
 To promote efficiency
 To promote equity
 Either to enlarge the economic pie or to change how the

20
pie is divided.
❑Possible cause of market failure:
 Externality, which is the impact of one person or firm’s
actions on the well-being of a bystander.
 Market power, which is the ability of a single person or firm

to unduly influence market prices.
21
PRINCIPLE #8: THE STANDARD OF LIVING
DEPENDS ON A COUNTRY’S PRODUCTION.
 Standard of living may be measured in different
ways:
 By comparing personal incomes.
 By comparing the total market value of a nation’s
production.
 Almost all variations in living standards are
explained by differences in countries’
productivities.
 Productivity is the amount of goods and services
produced from each hour of a worker’s time.
22
PRINCIPLE #9: PRICES RISE WHEN THE
GOVERNMENT PRINTS TOO MUCH MONEY.
 Inflation is an increase in the overall level of
prices in the economy.
 One cause of inflation is the growth in the
quantity of money.
 When the government creates large quantities of
money, the value of the money falls.
23
PRINCIPLE #10: SOCIETY FACES A SHORT-RUN
TRADEOFF BETWEEN INFLATION AND
UNEMPLOYMENT.
 Short-run effect of monetary injections:
 Increase in money supply leads to stimulate overall
spending.
 Which leads to demand for more goods and services
 Higher demand leads firms to raise their prices

(inflation) but high demand also requires more
production of output which is possible through
hiring more workers (less unemployment)
 Phillips Curve
24
FAMOUS ECONOMISTS
▪ Four of the last eight U.S. presidents including

John F. Kennedy, Donald Trump.
▪ CEO of Berkshire Hathaway – Warren E Buffett;
Former eBay president Meg Whitman, Former
Microsoft Chief Executive Officer: Steve
Ballmer, CNN founder Ted Turner, Intel
president Paul Otellini, high-tech guru Esther
Dyson, etc.
25

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INTRODUCTION TO ECONOMICS

BADRI NARAYAN RATH, IIT HYDERABAD

✓ Whether to get a part-time job or focus on your

 Economics is the study of how people use their

▪ Resources (Inputs of factors of production used to

 The economics profession thrives because its

 But not all economists are wealthy, nor is personal

WHAT HOW FOR

produce produce produce

“There is no such thing as a free lunch!” There is no free

Making decisions requires trading

➢ Policies: Unemployment insurance, Redistribution of

 Because people face trade-offs, making decisions require

 Decision to join the B.Tech. program at IIT Hyderabad/IIIT

 The opportunity cost of an item is what you give up to

 Trade allows people to specialize in what they do

 Dell and Lenovo

 Increasing trading partners around the world

 Either to enlarge the economic pie or to change how the

 Market power, which is the ability of a single person or firm

 Higher demand leads firms to raise their prices

▪ Four of the last eight U.S. presidents including

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