Unit-I

Introduction to Economics
 Definition
Economics is the study of how societies use
scarce resources to produce valuable
commodities and distribute them among
different people
Defined as a body of Knowledge or study that
discuss how a society tries to solve the human
problems of unlimited needs and wants with
limited resources
Evolution of Economics
 History of Economics

Economics as a science of wealth.

Economics as a science of material welfare.
Economics as a science of scarcity and choice.
Economics as a science of growth and
efficiency
 Adam Smith
Adam Smith (1723 -1790)

Economics is the subject that tells us how to make a nation

wealthy

Body of knowledge which relates to wealth.

The study of nature and causes of generating of wealth of a

nation.

Adam Smith in his famous book, An Enquiry into the Nature and
Causes of the Wealth of Nations emphasized the production and
expansion of wealth as the subject matter of economics
 Alfred Marshall

Role of the individual in the creation and the

use of wealth
It enquires how he gets his income and how
he uses it.
 Lionel Robbins
Economics is a science which studies human
behavior as a relationship between ends and
scarce means which have alternative uses.
Human wants are unlimited
Limited means to satisfy human wants
Alternative uses of scarce resources
Efficient use of scarce resources
Need for choice and optimization
 Prof. Paul Samuelson

It analyses costs and benefits of improving

patterns of resource allocation.
Modern Growth-Oriented -Samuelson
Economics is the study of how people and
society end up choosing, with or without the
use of money, to employ scarce productive
resources that could have alternative uses to
produce various commodities over time and
distributing them for consumption, now or in
the future, among various persons or groups
in society.
 Nature of Economics
Micro & Macro Economics
Emphasizes on Quantitative analysis
Inter Disciplinary
Normative in Nature
Positive Economics
Pragmatic in Nature
Prescriptive in nature rather than Descriptive
Choice and Allocation
Economic as Arts or Science
 Scope of Economics
a) Subject matter of economics.
How a man utilizes his limited resources for the satisfaction of
his unlimited wants
Economic Activity = wants -> Efforts -> Satisfaction
b) Economics is a social science
Consumption- the satisfaction of wants.
Production- i.e. producing things, making an effort to satisfy our wants
Exchange- its mechanism, money, credit, banking etc.
Distribution sharing of all that is produced in the country. In
addition, Economics also studies Public Finance
c) Whether Economics is a science or an art?
d) If Economics is science, whether it is positive science or a normative
science?
Demand
Cost of the Product
Profit Analysis
Capital Budgeting
Sales Analysis
 Factors of Production
Land refers to all natural resources
Labor refers to the human effort to produce
goods and services
Capital is anything that is produced in order to
increase productivity in the future.
Entrepreneurship refers to the management
skills
 TWIN THEMES OF ECONOMICS

Scarcity occurs where it's impossible to meet

all unlimited the desires and needs of the
peoples with limited resources .
Efficiency denotes the most effective use of a
society's resources in satisfying peoples wants
and needs
 Fundamental Economic Problems
How to make the best use of limited, or
scarce, resources.

The problem of choice making arising out of

limited means and unlimited wants is called
economic problem.
 Why do Economic Problems Arise?

Unlimited wants.
Different priorities.
Limited means.
Means having alternative uses.
BASIC OR CENTRAL OR FUNDAMENTAL PROBLEMS OF
ECONOMY
 FUNDAMENTAL PROBLEMS OF ECONOMY

WHAT TO PRODUCE?
(Types and amount of commodities to be
produced)

HOW TO PRODUCE?
(Problem of the selection of the technique of
production )

FOR WHOM TO PRODUCE ?

(Problem of distribution of income)
What to produce? (Types and amount
of commodities to be produced)
 Factors which determine what to
produce?
Consumers needs
Market demand
Consumer income
Cost of production
Availability of resources
Type of economy
 Factors which determines how to
produce?
Technique of production
-labour intensive
-capital intensive
Technological advancement
Production function
cost of factors of production
 Factors which determines whom to
produce for?
Satisfaction of wants or needs of the
consumers.
Level of income the higher the level of
income of the consumer, the more they are
able to buy goods and services produced.
Type of economic system practiced in the
society.
 Fuller Utilization/Employment of Resources
(Efficient use)

Out means and resources are limited and

scarce, so they should be properly used
 Growth of Resources
(Economic development)

It becomes necessary that the rate of

economic development must be faster than
the rate of increase in the population,
the reasonable standard of living of the
citizens can be maintained
 Societys capability
Takes the initiative in combining the
resources of land, labour, and capital
Makes strategic business decisions
Is an innovator
Commercializes new products, new
production techniques, and even new forms
of business organization
Takes risk to get profits
 Production possibility frontiers
Production Possibility Frontier represents the
point at which an economy is most efficiently
producing its goods and services and,
therefore, allocating its resources in the best
way possible.
 Assumptions of PPF
Human wants are unlimited.
The resources are limited with alternative uses.
Production of Two Goods only.
Economy has utilized scarce resources efficiently
and fully.
State of technology is Constant.
Resources are Fixed and Constant.
Quality of Resources are also Fixed and Constant.
Production only related to short-period rather than
long period
Efficiency, Inefficiency & Unemployment
 Opportunity Cost
Opportunity cost is defined as the value of
something that is lost because you choose
an alternative course of action.

Every resource (land, money, time, etc.) can be

put to alternative uses, every action, choice,
or decision has an associated opportunity cost.
Opportunity Cost
Shifts in PPF
 Trade, Comparative Advantage and
Absolute Advantage

An economy can focus on producing all of the

goods and services it needs to function
Lead to an inefficient allocation of resources
and hinder future growth
 Specialization and Comparative
Advantage

A country can concentrate on the production

of one thing that it can do best, rather than
dividing up its resources
 Absolute Advantage
If a country can produce more than another
country, even though countries both have the
same amount of inputs.
For example, Country A may have a
technological advantage that, with the same
amount of inputs enables the country to
manufacture more of both cars and cotton
than Country B.
A country that can produce more of both
goods is said to have an absolute advantage
 Importance and Application of the
Concept
1. Since PPC shows the productive capacity of the economy, it gives reliable answers
for the fundamental economic problems of what to produce?, How to produce?, and
To whom to produce?.
2. Secondly, it illustrates the concept of opportunity cost. Here the country is trying to
produce any two goods. So the production of the one commodity can be increased by
reducing the production of other good. This is due to the fact that economic resources
are scarce. Also opportunity cost ratios can be calculated.
3. Thirdly, it leads to the efficient allocation of scarce economic resources. More
resources should be diverted to the commodity that economy demands more than
another commodity.
4. It illustrates the productive potential of the economy. The growth of the economy
can be judged from the shifts in the PPC. Economics growth in both quantitative and
qualitative terms can be known from PPC.
5. It is very useful in order to achieve the social welfare of the community.
6. Last but not least, PPC can be used by the producers to make their decisions
regarding the use of factors of production and it assist in the determination of the
costs of the production.
PPC, therefore, shows unemployment of resources, Technological Progress, economic
growth and economic efficiency.
 Economic Efficiency

It is defined as an economic state in which

every resource is optimally allocated to serve
each person in the best way while minimizing
waste and inefficiency.
 Technical Efficiency

A firm is said to be technically efficient if a

firm is producing the maximum output from
the minimum quantity of inputs such as
labour, capital and technology.
 Pareto efficiency
It is defined as a situation where it is not
possible to make one party better off without
making another party worse off.
 Static Efficiency
Static efficiency has two aspects.
The first is that there is maximum output of
goods given the volume of resources in the
economy.
Second, the goods produced must be a
preferred combination
 Dynamic efficiency
Dynamic efficiency involves the introduction
of new technology and working practices to
reduce costs over time.
 Distributive Efficiency
It is concerned with allocating goods and
services according to who needs them most.
Therefore, requires an equitable distribution.
 Social efficiency
It is the optimal distribution of resources in
society, taking into account all external costs
and benefits as well as internal costs and
benefits. Social Efficiency occurs at an output
where Marginal Social Benefit (MSB) =
Marginal Social Cost (MSC).
Economic Growth & Stability
 Economic Growth
Economic growth is the sustained increase in the
production of goods and services.
It is measured by Gross Domestic Product (the
total value of all final goods and services
produced in a nation in a year).
A nation's standard of living can only improve if
GDP increases.
To achieve economic growth a country must
invest in education, technology and capital goods.
This goal is closely related to a country's long
term ability to use resources to achieve the other
goals.
 Policies for Economic Growth

Government policies to increase economic

growth are focused on trying
to increase aggregate demand
(demand side policies)
or
increase aggregate supply/productivity
(supply side policies)
 Demand side policies

Demand side policies include:

Demand Side Policies are attempts to
increase or decrease aggregate demand in order
to affect output, employment and inflation.
Fiscal policy (cutting taxes/increasing government
spending)
Monetary policy (cutting interest rates)
 Supply side policies include
Supply side policies include:
Supply side policies are government attempts to
increase productivity and shift aggregate supply
(AS) to the right.
Privatization, deregulation, tax cuts, free trade
agreements (free market supply side policies)

Improved education and training, improved

infrastructure.
 What Policy Should be used?

Demand side policies are important during a

recession or period of economic stagnation.

Supply side policies are relevant for improving

the long run growth in productivity.
 Policies for Economic Growth
Monetary Policy
Fiscal Policy
Human Capital Development.
Improving the Quality & Quantity of Investment
Tax reform
Encouraging research and development
Providing incentives
Infrastructure Investment
 Economic Stability
Economic stability refers to an economy that
experiences constant growth and low inflation.
Advantages of stable economy include increased
productivity, improved efficiencies, and low
unemployment.
Common signs of an instability are extended time
in a recession or crisis, rising inflation, and
volatility in currency exchange rates.
An unstable economy causes a decline in
consumer confidence, small economic growth,
and reduced international investments.
 Policies for Economic Stability
Fiscal stabilizers
Technology policy
Reducing red-tape and de-regulation
Providing incentives
Tax reform
Increasing competitiveness and contestability
New markets
Infrastructure
Micro economies and Macro economies
Microeconomics is that branch of economics
which is concerned with the decision-making
of a single unit of an economic system.
Macroeconomics is the branch of economics
that studies the behavior and performance of
an economy as a whole.
focuses on the aggregate changes in the
economy such as unemployment, growth
rate, gross domestic product and inflation.
 Importance of Micro Economics

Determination of demand pattern

Determination of the pattern of supply
Pricing
Policies for improvement of resource
allocation
Solution to the problems of micro-units
 Importance of Macroeconomics
Income and employment determination
Price level
Business cycles
Balance of payments: The difference between
the total inflow and the total outflow of
foreign exchange is known as the balance of
payments of a country.
Government policies
Interrelations between markets
 Microeconomics Macroeconomics
It is that branch of economics which deals with It is that branch of economics which deals with aggregates
the economic decision-making of individual and averages of the entire economy, e.g., aggregate output,
economic agents such as the producer, the national income, aggregate savings and investment, etc.
consumer, etc.

It takes into account small components of the whole It takes into consideration the economy of any
economy. country as a whole

It deals with the process of price determination It deals with general price-level in any
in case of individual products and factors of production economy

It is concerned with the optimization goals of It is concerned with the optimization of the growth process of
individual consumers and producers (e.g., individual the entire economy.
consumers are utility-maximisers, while individual producers
are profitmaximisers.)

Microeconomic theories help us in formulating appropriate Macroeconomic theories help us in formulating appropriate
policies for resource allocation at the firm level. policies for controlling inflation (i.e., rising price-level),
unemployment, etc.

It takes into account the aggregates over It takes into account the aggregates over
homogeneous or similar products (e.g., the heterogeneous or dissimilar products (say, the Gross
supply of steel in an economy.) Domestic Product of any country during any year
 Role of Governments in managing the growth
in Emerging/Developing Economies
I. Role of Government as a Regulatory and
Growth promoting body
Monetary and Fiscal Policies
Bank Rate
Repo Rate
Reverse Repo Rate
Cash Reserve Ratio
Statutory Liquidity Ratio
Production in Core Sectors
Regulatory Responsibilities
Providing the economy with a legal structure
Maintaining competition
Redistribution of income
 Role of Governments in managing the growth
in Emerging/Developing Economies
Provision of public goods
Promoting growth and stability
Promoting Positive Externality
Providing the Legislative Framework
Providing a Stable Environment for Businesses
Investing in Infrastructure and Manpower.
Facilitating Businesses.
Promoting growth and stability
Providing Public Goods and Ensuring Positive
Externalities
 Role of Market in economy

Price Discovery
Foreign Investment Opportunities
Growth in GDP
Rise of the Consumer
 Externality
Externalities are third party effects arising
from production and consumption of goods
and services for which no appropriate
compensation is paid.
Types of Externality
Positive Externality
Positive Externality in Production
Positive Externality in Consumption
Negative Externality
Negative Externality in Production
Negative Externality in Consumption
 Types of externality
Positive Externality in Consumption
Negative Externality in Consumption
Positive Externality in Production
Negative Externality in Production
 PRIVATE AND SOCIAL COSTS
Externalities create a divergence between the
private and social costs of production.
Social cost includes all the costs of production
of the output of a particular good or service.
We include the third party (external) costs
arising, for example, from pollution of the
atmosphere.
SOCIAL COST = PRIVATE COST + EXTERNALITY
 Policies to reduce Externality
Forcing polluters to pay compensation to
those who suffer
Providing more information to consumers and
producers regarding Pollutions.
Imposing fines for over-consumption
Controlling supply through a licensing system
Imposing indirect taxes
Command-and-control policies
Pigovian tax (Corrective Tax)