CHAPTER 1

INTRODUCTION

 Economics is the study of mechanism that an economy or a society uses to make

choices and to allocate the scarce resources to the areas with maximum possible and
optimum returns. Economics is about how an individual or a particular society makes
these decisions regarding their choices.
 The need for economics stems from the basic problem of scarcity and choice. The basic
concern of economics is to allocate the scarce resources to the best possible use in the
face of unlimited wants.
 Positive statements
These are factual and objective statements, and describe what was, what is and what
would be. These statements can be tested, proven or disproven and does not include
personal value judgments.
 Normative Statements
These describe what should be or what ought to be. These statements cannot be tested.
These involve personnel value judgments and are usually debatable in nature. These
statements are subjective in nature.
 Examples of positive and normative statements

‘Indian stock market has boomed in recent years’ is an example of positive statements.

‘Indian government should make legal formalities for foreign investors less-stringent’ is an
example of normative statements.
 Microeconomics and Macroeconomics

Points of Difference Microeconomics Macroeconomics

1. Study matters It studies about individual It studies about an economy
economic units like households, as a whole.
firms, consumers, etc.
 2. Deals with It deals with how consumers or It deals with how different
producers make their decisions economic sectors such as
depending on their given budget households, industries,
and other variables. government and foreign
sector make their decisions.
3. Method It uses the method of partial It uses the method of general
equilibrium, i.e. equilibrium in equilibrium, i.e. equilibrium
one market. in all markets of an economy
as a whole.
4. Variables The major microeconomic The major macroeconomic
variables are price, individual variables are aggregate price,
consumer’s demand, wages, aggregate demand, aggregate
rent, profit, revenues, etc. supply, inflation,
unemployment, etc.
5. Theories Various theories studied are: Various theories studied are:
1) Theory of Consumer’s 1) Theory of National Income
Behaviour and Demand 2) Theory of Money
2) Theory of Producer’s 3) Theory of General Price
Behaviour and Supply Level
3) Theory of Price 4) Theory of Employment
Determination under Different 5) Theory of International
Market Conditions Trade
6. Popularised by Alfred Marshall Keynes

 Scarcity of Resources & Problem of Choice

The resources available to any economy are always limited and are never sufficient to
meet the unlimited demands of everyone. Further, these scarce resources have
alternative uses, and can be allocated in the production of different goods and services.
 The economy need to analyse the opportunity cost of the resources and choose as to
which use of resources will benefit the economy the most.
Thus, due to the scarce availability of resources with alternative uses and
simultaneously unlimited wants, we confront the problem of choice. We can say that
the choice is the consequence of the problem of scarcity of resources. For example,
one cannot buy both TV and refrigerator with Rs 10000.
 Central Problems of an Economy
Due to problem of allocating the scarce resources to their alternative uses and the
problem of choice, every economy faces mainly three central problems. These are:
1) What to produce?
2) How to produce?
3) For whom to produce?

 Labour Intensive Technique

The production process in which labour is used comparatively more than capital or
machine is called labour intensive technique of production. Example for the same can
be activities related to agriculture.
 Capital Intensive Technique
The production process in which capital is used comparatively more than labour is
called capital intensive technique of production. For instance, production of durables
goods like T.V, refrigerator, vehicles, etc employs capital intensive production
technique.
 Production Possibility Curve (PPC)
 It is a curve which shows combinations of two goods and services, that can be produced
with full utilisation of a given amount of resources in their most efficient way and with
the given production technology. It is also called production possibility frontier (or
PPF).

 Opportunity Cost (Economic Cost)

If the economy decides to use resources in the production of one good (say consumer
goods) then it needs to forego or sacrifice some amount of other goods (say capital
goods) as the resources will be withdrawn from the production of capital goods and will
be employed in the production of consumer goods. The cost of enjoying more of one
good in terms of sacrificing the benefit of other goods is called opportunity cost of the
additional unit of the first good. It is also known as economic cost.
 Production Possibility Schedule
The schedule which depicts the various possibilities of production of consumer and
capital goods is known as production possibility schedule.
 Shifting and Rotation of PPC
PPC of any economy depends on two factors:
1) Quantity and quality of productive resource endowment
2) Level of technology
1) Change in Endowment of Resources
If resource availability in the economy increases (decreases) then the PPC will shift
outwards (inwards) to the right (left).

2) Change in Technology
a) Change in technology in production of capital goods:-
If the technology employed in the production of capital goods appreciates
(depreciates), then the production of capital goods will be more (less) with the
same level of resources or inputs and PPC pivots outwards (inwards) with the
same vertical intercept.

b) Change in technology in production of consumer goods

If the technology employed in the production of consumers good appreciates
(depreciates), the PPC pivots outwards (inwards) along the same horizontal
 intercept. The economy has more (less) amount of consumer goods if the
technology appreciates (depreciates) with the same level of productive
resources.

c) Change in technology in production of both the goods

If the technology employed in the production of both the goods appreciates
(depreciates) then the economy has more (less) of both the goods – consumer
and capital goods. The PPC curve shifts outwards (inwards) to the right (left).

 Economic Activity
An activity which involves the use of scarce resources for the production of goods and
services for the fulfillment of the satisfaction of human wants is called an economic
activity. For example, consumption, investment, etc.
 Classification of Economic Activity
Based on the nature of economic activities economies can be classified as:
1) Market Economy
 2) Centrally Planned Economy
3) Mixed Economy

 Market Economy/Capitalist Economy

1) The capitalists or the private entrepreneurs, who own capital, organise and
undertake production with the sole motive of profit making.
2) They are guided by profit motive.
3) The role of government is required only for defence and to maintain law and order.
Besides this, the government does not interfere in the economic activities.
4) This system is known as free market economy or laissez-faire system.
5) Price mechanism plays an important role in determining what to produce, how to
produce and for whom to produce. Price reflects the valuation and need of the
society for a particular good or service.
6) Price acts as a signal for the capitalists.
7) For example, the economy of Britain during the industrial revolution period is
classified as a market economy.
 Centrally Planned Economy
1) Central authority or state plans and organises all important economic activities.
2) The state controls, owns and manages the production units. It also decides and
controls the distribution of goods and services among the population in the pattern
that the state feels desirable.
3) Central planning plays an important determining role.
4) The private entrepreneur has no role to play and everything is determined by the
state.
5) The main focus is to enhance social welfare and service.
6) For example, Soviet Union had centrally planned economy for a major part of the
twentieth century.
 Mixed Economy
1) Both private and public sectors works side by side.
2) The private sector is free to choose its production line but is simultaneously
governed by the public sector.
3) State (government) interferes in the private sector activities in order to safeguard
the interests of workers and consumers and. It also ensures social justice along with
accomplishing higher growth rate.
4) While the state owns the core and base industries, the less important industries are
owned by the private sector.
5) The state also keeps a keen watch and tries to curtail the formation of monopolies
and price rigging, manipulation and unfair trade practices. India is a mixed
economy.