Economics and Financial Management

Unit-I
Introduction to Economics
Syllabus of Unit-I
Fundamentals of Economics, Definition and scope of economics,
the nature of the economic problem, finite resources and unlimited wants,
definitions of the factors of production and their rewards,
definition of opportunity cost, the influence of opportunity cost on decision making.
Microeconomics and Macroeconomics
The role of markets in allocating resources,
the market system, introduction to the price mechanism, Demand, Supply and Price
determination, Price elasticity of demand and supply (PED),
Definitions of Economics
Adam Smith: "Economics is the study of wealth." Focuses on the production,
accumulation, and distribution of wealth.
Alfred Marshall: "Economics is a study of mankind in the ordinary business of life." It
examines how individuals and societies use scarce resources to satisfy unlimited wants.
Lionel Robbins: "Economics is the science which studies human behavior as a relationship
between ends and scarce means which have alternative uses." This definition highlights the
centrality of scarcity and choice in economic analysis.
John Maynard Keynes: Emphasizes the role of aggregate demand in the economy and the
importance of government intervention to stabilize economic cycles.
The fundamentals of economics 1. Scarcity and Choice
•Scarcity: Resources (time, money, labor, etc.) are limited, but human wants are unlimited. This
creates the need to make choices about how to allocate these limited resources effectively.
•Choice: Decision-making is essential in economics. Individuals and organizations must choose
between different alternatives due to scarcity.
2. Supply and Demand
•Demand: The quantity of a good or service that consumers are willing and able to purchase at
various prices. The law of demand states that, ceteris paribus (all other factors being equal), as the
price of a good decreases, the quantity demanded increases, and vice versa.
•Supply: The quantity of a good or service that producers are willing and able to sell at various
prices. The law of supply states that, ceteris paribus, as the price of a good increases, the quantity
supplied increases, and vice versa.
•Market Equilibrium: The point where the quantity demanded equals the quantity supplied. At this
price, the market is in balance, and there is no surplus or shortage.
3. Opportunity Cost
•Opportunity Cost: The value of the next best alternative that is foregone when a decision is made.
It represents the benefits an individual, investor, or business misses out on when choosing one
alternative over another.
4. Economic Systems
•Market Economy: Economic decisions are made by individuals or the open market. Prices are
determined by supply and demand.
•Command Economy: The government makes all economic decisions, controlling factors of
production and distribution.
•Mixed Economy: A combination of market and command economies. Both the private sector and
government influence economic decisions.
5. Production Possibilities Frontier (PPF)
•PPF: A curve depicting the maximum feasible amount of two goods that a society can produce with
its limited resources. It illustrates concepts of opportunity cost, trade-offs, and efficiency.
6. Marginal Analysis
•Marginal Cost: The additional cost of producing one more unit of a good or service.
•Marginal Benefit: The additional benefit received from consuming one more unit of a good or
service.
•Decision-Making: Rational decisions are made where the marginal benefit equals the marginal
cost.
7. Elasticity
•Price Elasticity of Demand: Measures how much the quantity demanded of a good responds to a
change in the price of that good.
•Price Elasticity of Supply: Measures how much the quantity supplied of a good responds to a
change in the price of that good.
•Income Elasticity of Demand: Measures how much the quantity demanded of a good responds to a
change in consumers' income.
8. Market Structures
•Perfect Competition: Many small firms, identical products, and free entry and exit from the
market. Firms are price takers.
•Monopolistic Competition: Many firms, differentiated products, and some barriers to entry.
•Oligopoly: A few large firms dominate the market. They may collude or compete.
•Monopoly: A single firm controls the entire market, with significant barriers to entry.
9. Gross Domestic Product (GDP)
•GDP: The total market value of all final goods and services produced within a country in a given
period.
•Nominal GDP: Measured at current market prices.
•Real GDP: Adjusted for inflation, reflecting the true value of goods and services.
10. Inflation and Unemployment
•Inflation: The rate at which the general level of prices for goods and services rises, eroding
purchasing power.
•Unemployment: The situation where individuals who are able and willing to work cannot find a
job. It is a key indicator of economic health.
11. Fiscal and Monetary Policy
•Fiscal Policy: Government adjustments to spending and taxation to influence the economy.
•Monetary Policy: Central bank actions involving the management of interest rates and money
supply to control inflation and stabilize the currency.
12. International Trade and Finance
•Comparative Advantage: The ability of a country to produce a good at a lower opportunity cost
than another country.
•Exchange Rates: The value of one currency in terms of another currency.
•Balance of Trade: The difference between the value of a country's exports and imports.
Nature of Economic Problem
Key Elements:
1. Scarcity: Resources like time, money, labor, and raw materials are finite. Because of this,
we can't have everything we want, and choices must be made.
2. Choice: Due to scarcity, people must make decisions on how to use their limited resources.
This could involve deciding how to allocate time and effort.
3. Opportunity Cost: Every choice has an opportunity cost, which is the value of the next
best alternative that is given up when a decision is made. This concept is crucial because it
helps to understand the trade-offs involved in every decision.
4. Efficiency: Since resources are scarce, it is essential to use them as efficiently as possible.
Economic efficiency occurs when resources are used in a way that maximizes the production
of goods and services.
5. Equity: Beyond efficiency, there's also the question of fairness in how resources and
wealth are distributed in society. Equity deals with the just distribution of resources, which
can be in conflict with efficiency.
The Three Central Economic Questions:
1. What to produce?
Given limited resources, societies must decide which goods and services to produce.
2. How to produce?
This involves determining the methods and processes used to produce goods and services,
including the technology and labor required.
3. For whom to produce?
This question deals with the distribution of the output among members of society. It
considers who gets what, based on income, wealth, and needs.
Finite Resources and Unlimited want:

Finite resources refer to the limited availability of resources that are used to produce goods
and services.
Examples:
Natural resources: Oil reserves, freshwater supplies, forests, and arable land are all finite and
can be depleted.
Human resources: The number of workers, their skills, and the time they have to offer is
limited.
Capital: Factories, machinery, and technology have a limited lifespan and production capacity.
Time: Both individuals and societies have a finite amount of time to allocate between different
activities and needs.
Because these resources are finite, there is a limit to how much can be produced at any given
time.
Finite Resources and Unlimited want:

Unlimited wants refer to the concept that human desires and needs are endless.
People always want more goods and services, better living standards, more leisure time, and so
on. Even as people's basic needs (food, shelter, clothing) are met, they continue to desire new
and better things.
Examples:
• Individuals might want a new car, a bigger house, more vacation time, better healthcare,
or more entertainment options.
• Society as a whole may desire improved infrastructure, more advanced technology,
better education, and greater security.
Definitions of the factors of production and their rewards

1. Land:
Definition: Land refers to all natural resources used in the production process. This includes
not only physical land but also resources like minerals, forests, water, and fossil fuels.
Reward: Rent. The income earned by the owner of the land or natural resources is called rent.
This is the payment made for the use of land or other natural resources.
2. Labor:
Definition: Labor refers to the human effort used in the production of goods and services. This
includes physical and mental work done by people to produce goods and services.
Reward: Wages. Wages or salaries are the payments made to labor for their work. This
includes all forms of compensation, such as hourly wages, salaries, and benefits.
Definitions of the factors of production and their rewards

3. Capital:
Definition: Capital refers to the man-made resources used in the production process, such as
machinery, tools, equipment, and buildings. It also includes money used to purchase these
physical assets.
Reward: Interest. The return on capital is interest, which is the payment made to those who
lend their capital for production purposes, typically in the form of money.
4. Entrepreneurship:
Definition: Entrepreneurship is the factor that brings together the other three factors of
production (land, labor, and capital) to produce goods and services. Entrepreneurs take risks to
create and manage businesses.
Definitions of the factors of production and their rewards

Reward: Profit. Profit is the reward for entrepreneurship. It is the residual income left after all
costs (including rent, wages, and interest) have been paid. Entrepreneurs earn profit by
successfully managing their business, taking on risks, and innovating.
Definitions of the opportunity cost
Opportunity cost is an economic concept. It is the cost of what you have to give up in order
to pursue a certain action or decision. Opportunity cost is a fundamental principle in
economics because it highlights the trade-offs involved in every decision.
Key Aspects of Opportunity Cost:
Scarcity and Choice , Alternative Use of Resources, Decision-Making
Examples
Personal Finance
Time Management
Business Decisions
Influence of the opportunity cost
1. Resource Allocation:
• Scarcity of Resources: Since resources like time, money, and labor are limited,
understanding opportunity cost helps individuals and organizations allocate these resources
more efficiently.
• Prioritization: By considering the opportunity cost, decision-makers can prioritize options
that offer the highest returns or benefits relative to what is sacrificed. This ensures that
resources are used in the most effective way.
Influence of the opportunity cost
2. Personal Decision-Making:
• Daily Choices: When making everyday decisions—like how to spend time or money—
individuals often weigh the opportunity cost. For example, choosing to work overtime instead
of spending time with family involves an opportunity cost of reduced leisure or family time.
• Long-Term Planning: For major life decisions, such as pursuing further education or
buying a home, understanding opportunity cost helps in evaluating whether the potential
benefits outweigh what is given up, such as current income or alternative investments.
Influence of the opportunity cost
3. Business Decision-Making:
• Investment Choices: Businesses use opportunity cost to compare potential investments. If a
company decides to invest in new equipment, the opportunity cost might be the profit they
could have earned from investing in research and development instead.
• Production Decisions: Opportunity cost helps businesses decide on the best use of their
resources, such as whether to allocate labor and capital to produce one product over another.
It influences decisions on pricing, product development, and resource utilization.
Influence of the opportunity cost
4. Government Policy:
• Budgeting: Governments use opportunity cost when deciding how to allocate public funds.
For example, if money is spent on military defense, the opportunity cost might be the social
programs or infrastructure projects that could have been funded instead.
• Policy Trade-Offs: In policy-making, opportunity cost is considered when evaluating trade-
offs between different initiatives.
For example, a government may need to decide between funding healthcare improvements or
educational reforms, and the opportunity cost of choosing one is the benefits of the other.
Influence of the opportunity cost
5. Risk Management:
•Weighing Options: Opportunity cost helps in assessing risks by comparing the potential
gains of different actions. It encourages a more comprehensive evaluation of options,
considering not just the immediate outcomes but also the long-term effects.
•Avoiding Regret: Understanding opportunity cost can help in minimizing regret by ensuring
that the chosen option provides greater value than what is sacrificed, leading to more
confident decision-making.
Influence of the opportunity cost
6. Optimal Decision-Making:
•Informed Choices: By explicitly considering opportunity costs, decision-makers are more
likely to make informed choices that maximize utility, profit, or other desired outcomes.
•Trade-Off Analysis: Opportunity cost forces a comparison between alternatives, leading to
more thoughtful and deliberate decision-making. This analysis often reveals hidden costs or
benefits that might not be immediately apparent.
Microeconomics
Definition: Microeconomics is the branch of economics that studies the behavior and
decision-making processes of individual economic agents, such as consumers, firms, and
households. It examines how these entities interact within markets to allocate scarce
resources.
Focus:
• Individual Markets: Microeconomics looks at specific markets for goods and
services, analyzing supply and demand, price formation, and consumer behavior
within those markets.
• Decision-Making: It explores how individuals and businesses make choices based on
limited resources, and how these choices affect the allocation of resources.
• Market Structures: Microeconomics also studies different market structures, such as
perfect competition, monopoly, oligopoly, and monopolistic competition, to
understand how they influence pricing and output.
Microeconomics
Key Concepts:
Supply and Demand: The relationship between the quantity of a good or service that
producers are willing to sell and the quantity consumers are willing to buy at various prices.
Elasticity: The responsiveness of demand or supply to changes in price or other factors.
Consumer Choice: How consumers make decisions to maximize their utility (satisfaction)
given their budget constraints.
Production and Costs: How firms decide on the quantity of output to produce and the
inputs to use, considering the costs of production.
Market Equilibrium: The point where supply equals demand, determining the market price
and quantity of goods traded.
Macroeconomics
Definition: It is the branch of economics that studies the economy as a whole. It focuses on
aggregate measures and large-scale economic phenomena to understand broad trends and
policies that affect the overall economy.
Focus:
National and Global Economy: Macroeconomics looks at the entire economy of a country,
analyzing total output, income, and the level of employment.
Economic Growth: It studies the factors that contribute to economic growth and long-term
increases in a country's output and standard of living.
Inflation and Unemployment: Macroeconomics examines the causes and consequences of
inflation (general price level increase) and unemployment (joblessness).
Monetary and Fiscal Policy: It evaluates government policies aimed at stabilizing the
economy, such as controlling the money supply, adjusting tax rates, and public spending.
Macroeconomics
Key Concepts
• Gross Domestic Product (GDP): The total value of all goods and services produced
within a country over a specific period, used as a measure of economic performance.
• Inflation: The rate at which the general level of prices for goods and services is rising,
eroding purchasing power.
• Unemployment: The percentage of the labor force that is jobless and actively seeking
employment.
• Monetary Policy: The actions taken by a central bank to control the money supply
and interest rates to influence economic activity.
• Fiscal Policy: Government spending and taxation policies used to influence economic
conditions.
1. The Role of Markets in Allocating Resources
Microeconomics:
• Markets allocate resources at the level of individual goods and services.
• Prices and consumer preferences drive the allocation of resources. For example, if there's
high demand for electric cars, resources will be directed towards producing more electric
cars.
Macroeconomics:
• Markets influence the allocation of resources across the entire economy, impacting sectors
like agriculture, industry, and services.
• Resource allocation decisions are influenced by broader economic factors like economic
growth, unemployment rates, and inflation, rather than just individual market transactions.
2. The Market System
Microeconomics:
• Focuses on individual markets and how they function within a specific sector. It examines
how competitive and non-competitive markets operate and the outcomes of different market
structures (e.g., perfect competition, monopoly).
Macroeconomics:
• Looks at the market system from a holistic perspective, examining how various markets
interact to shape the overall economy.
• Includes the study of the aggregate market outcomes and the effectiveness of policy
interventions on a larger scale.
3. Introduction to the Price Mechanism
Microeconomics:
• The price mechanism is central, as it dictates how prices are set in individual markets based
on supply and demand.
• It helps in understanding how prices signal producers and consumers, leading to
adjustments in production and consumption.
Macroeconomics:
• The price mechanism is considered in the context of its impact on the overall economy,
such as its role in inflation or deflation.
• It also includes how changes in aggregate prices affect the general economic conditions,
such as purchasing power and cost of living.
4. Demand
Microeconomics:
• Focuses on the demand for individual goods and services.
• Analyzes factors affecting demand such as consumer preferences, income levels, and the
prices of related goods.
Macroeconomics:
• Examines aggregate demand, which includes the total demand for all goods and services in
an economy.
• Considers how changes in aggregate demand affect overall economic indicators like GDP,
employment, and inflation.
5. Supply and Price Determination
Microeconomics:
• Analyzes how supply and demand determine prices in specific markets.
• Studies how individual firms decide on the quantity to produce and the prices to charge
based on market conditions.
Macroeconomics:
• Looks at aggregate supply and how it interacts with aggregate demand to determine overall
price levels in the economy.
• Includes the analysis of supply-side factors, such as productivity and technology, that
impact the economy's total output and price level.
6. Price Elasticity of Demand and Supply (PED)
Microeconomics:
• Focuses on the price elasticity of demand (PED) and supply in individual markets.
• Analyzes how sensitive consumers and producers are to price changes for specific goods
and services.
Macroeconomics:
• Considers price elasticity in the context of overall economic policies and their effects on
aggregate demand and supply.
• Studies how changes in price elasticity can impact macroeconomic variables like inflation
and economic growth.