BASICS OF ECONOMICS

UNIT 1
 INTRODUCTION
 A good definition of economics
 Study of choice under conditions of scarcity
 Scarcity
 Situation in which the amount of something available is insufficient to satisfy the
desire for it
 There are an unlimited variety of scarcities, however they are all based on two basic
limitations
 Scarce time
 Scarce spending power
 Limitations force each of us to make choices
 Economists study choices we make as individuals, and consequences of those choices
 Economists also study more subtle and indirect effects of individual choice on our
 INTRODUCTION
 The problem for society is a scarcity of resources
 Scarcity of Labor
Time human beings spend producing goods and services
 Scarcity of Capital
Something produced that is long-lasting, and used to make other things that
we value
Human capital
Capital stock
 Scarcity of land
Physical space on which production occurs, and the natural resources that
come with it
 Scarcity of entrepreneurship
Ability and willingness to combine the other resources into a productive
enterprise
 INTRODUCTION
 As a society our resources—land, labor, and capital—are insufficient to produce
all the goods and services we might desire
 In other words, society faces a scarcity of resources
 The scarcity of resources—and the choices it forces us to make—is
the source of all of the problems studied in economics
 Households allocate limited income among goods and services
 Business firms choices of what to produce and how much are limited by costs
of production
 Government agencies work with limited budgets and must carefully choose
which goals to pursue
 Economists study these decisions to
 Explain how our economic system works
 Forecast the future of our economy
 Suggest ways to make that future even better
 INTRODUCTION
 The
word Economics is derived from the Greek words “OKIOS
NEMEIN” meaning household management .
 Man is bundle of desires. Goods and services satisfy these wants. But
almost all the goods are scarce. To produce goods land, labour, capital
and organization are needed. Economic problem arises because of
scarcity.
 Economics is a study of economic problems. Wants are motive force
for economic activity. Wants leads to efforts. Efforts secures
satisfaction.
 Definitions of Economics
1. Wealth Definition. Adam Smith
2. Welfare Definition. Alfred Marshall
3. Scarcity Definition. Lionel Robbins
4. Growth Definition. Paul Samuelson
1.Wealth Definition
 Father of Economics Adam Smith in his book “ Wealth of Nations
1776” defined economics as the study of wealth.
 J.B Say, J.S Mill, Walker, B.Price all agreed that Economics is concerned
with wealth.
 In this definition wealth is given first place, man has given second
place
 Definitions of Economics
2. Welfare definition
 Alfred Marshall in his book “Principles of Economic Science-1890” defined Economics is the study of
man kind in the ordinary business of life.
 “Economics is one side a study of wealth; and on the other side more important side a part of study of
man
 He said economics is a science of human welfare.
 Important Points
1. Mainly concerned with the study of man in relation to wealth.
2. First place to man, second place to wealth.
3. It studies man not in isolation but a member of a social group.
4. Definition considered only material welfare, ignored immaterial welfare.
3. Scarcity Definition
 Lionel Robbins in his book ‘Nature and Significance of Economic Science-1932 given scarcity definition.
 “Economic is the science which studies human behavior as a relationship between ends and scarce means
which have alternative uses.”
 Definitions of Economics
 Scarcity Definition-main Points
 Unlimited wants.
 Scarce means.
 Means have alternative uses.
4. Growth definition
 Economics Noble prize winner (1970) Paul Samuelson proposes a
dynamic definition in his book Economics(1948)
 Economics is the study of how people and society end up choosing
with or without money to employ scarce productive resources that
could have alternative uses to produce various commodities and
distribute them for consumption, now or in the future among various
persons and groups in society. Economic analysis the cost and benefits
of improving patterns of resources use.
 Definitions of Economics
 Important Points
1. Scarcity : Unlimited wants, scarcity of resources and alternative uses.
2. Dynamism: The importance of time is brought in the definition.
3. Economic growth: His definition gave importance to economic growth
4. Wide scope: Economic choice exist not only in a monetary economy but also
in a barter economy.
5. Problem of choice: Definition explains problem of choice in present and
future in dynamic conditions.
 POSITIVE & NORMATIVE ECONOMICS
 Positive economics studies economic behavior without making
judgements. It describes what exists and how it works.
 Statements about how the economy works are positive statements, whether
they are true or not
 Accuracy of positive statements can be tested by looking at the facts—and
just the facts
 Positive economic statements do not have to be correct, but they must be
able to be tested and proved or disproved.
 Many data sets are available to facilitate economic research. They are
collected by both government agencies and private companies,
 The statement, "government-provided healthcare increases public
expenditures" is a positive economic statement,
POSITIVE & NORMATIVE ECONOMICS
 Normative economics, also called policy economics, analyzes
outcomes of economic behavior, evaluates them as good or bad,
and may prescribe courses of action.
 Study of what should be
 Used to make value judgments, identify problems, and prescribe
solutions
 Statements that suggest what we should do about economic facts, are
normative statements
 Based on values
 Normative statements cannot be proved or disproved by the facts alone
 For example, the statement, "government should provide basic
healthcare to all citizens" is a normative economic statement.
MICRO & MACRO ECONOMIC THEORIES
◼ Economics noble prize winner (1969), Ragner Frisch was the first to
use the terms micro and macro in economics in 1933.
◼ The terms micro and macro derived from Greek. Mikros (small) and
makros (large).
◼ Micro means individualistic and macro aggregative.
 The study of Economics is divided into two parts on the basis of
looking the system as whole or in terms of its innumerable decision-
making units
 Micro Economics
 It is also called Price Theory
 Macro Economics
 It is also called Income Theory
 MICRO ECONOMICS
 Micro
 Micro comes from Greek word mikros, meaning “small”
 Microeconomics
 Study of behavior of individual households, firms, and governments
 Choices they make
 Interaction in specific markets
 Focuses on individual parts of an economy, rather than the whole
 Micro economics is based on the assumption of full employment and
other things remain constant.
 Micro economics was popularized by David Ricardo, Marshall, J.B
Say and J.S Mill.
 Micro economics called as ‘ Price Theory.’
 IMPORTANCE OF MICRO ECONOMICS
 It tells us how millions of consumers and producers take decisions about
the allocation of productive resources among millions of goods and
services
 It explains how through market mechanism goods and services produced
in the community are distributed
 It also explains the determination of the relative prices of the various
products and productive services
 It explains the conditions of efficiency both in consumption and
production and departure from the optimum
 Micro-economics helps in the formulation of economic policies
calculated to promote efficiency in production and the welfare of the
masses
 MACROECONOMICS
 Macro comes from Greek word, makros, meaning “large”
 Macroeconomics
 Study of the economy as a whole
 Focuses on big picture and ignores fine details
 Macro economics is concerned with aggregates and averages of the entire
economy
 E.g national income, aggregate output, total employment, total consumption, savings and
investment, aggregate demand, aggregate supply, general level of prices etc.
 Macro-economics also analyses the chief determinants of economic development
and the various stages and processes of economic growth
 Macro economics is called ‘ Income and Employment theory.’
 J.M Keynes popularized macro Economics
 Where micro economics explain a tree in the forest, macro economics explains all
the trees in the forest.
IMPORTANCE OF MACRO ECONOMICS
 It is helpful in understanding and functioning of a complicated economic
system
 It gives bird’s eye view of the economic world
 It is useful in framing economic policies for the nation
 Macro-analysis also occupy an important place in economic theory in its
pursuit of the solution of urgent economic problems
 These problem relate to aggregate output, employment and national income
RELATIONSHIP BETWEEN MICRO &
MACRO ECONOMICS
 Neither the two approaches (micro and macro) can alone adequately help us in
analysing the working of the economic system

 It is, therefore, essential to integrate two approaches

 Ignoring one and exclusively concentrating attention on the other may often lead not
only inadequate or wrong explanation but also to inappropriate or even disastrous
remedial measures
Kinds of Economic Decision/EVOLUTION
 AGRARIAN ECONOMIC SYSTEM
 Also known as traditional or subsistence economy, favours equitable
distribution of land.

 Allocate a larger distribution of goods and services to those with a defined

social status within the society.

 Rely on historical, social, political, or religious arrangements or tradition for

decision making.

 Fairly small, close, and rural, and they often work to support all members.
 MARKET ECONOMIC SYSTEM
 The economic system where the people extensively engaged in
free enterprise, in which is why market economies are often
associated with capitalism.
 Rooted in the belief that decisions are best made by individuals,
thus private property rights are essential to this system (Adam
Smith, The Wealth of Nations).
 Also known as the price system as it utilized the pricing system for
economic decision making.

 Independent buyers & sellers (households & business) in the

marketplace determine what to produce.
 Businesses decide on the least-cost method of production.
 Distribution (access to goods and services) is based on the
ability to pay, which is determined by the resources that the
people offer to businesses.
MARKET ECONOMIC SYSTEM
 PLANNED ECONOMIC SYSTEM
 Also known as socialism, communism, or command system
 Rely on planning authority (central policy planner or a
government) for all major economic decisions
 Planning authority decides on what goods and services to be
produced by the nation
 Planning authority will instruct enterprises on how to produce
various items.
 Planning authority also decide who to get the goods and
services
 In a planned economy, most enterprise/business firms are owned
by the central planning authority
PLANNED ECONOMIC SYSTEM
 Mixed Economic system
Refers to the economic system in which economic decisions
are addressed by some combination of market and centralized
decision making.
Pure market and pure planned economies are only used as the
basis, but neither have real-world counterparts, and neither are
perfect in their design.
As market economies experience problems, they tend to move
away from pure market to mixed economies, and as planned
economies experience failures, they move away from pure
planned to mixed economies.
 Significance
 Economics applies economic theory and methods to
business and administrative decision making.
 Economics prescribes rules for improving managerial
decisions.
 Economics also helps managers recognize how economic
forces affect organizations and describes the economic
consequences of managerial behavior
 ResourceAllocation: Scare resources have to be used with
utmost efficiency to get optimal results. These include
production programming and problem of transportation
etc.
 Significance
 Inventory and queuing problem: Inventory problems involve decisions about
holding of optimal levels of stocks of raw materials and finished goods over a
period. These decisions are taken by considering demand and supply conditions.
Queuing problems involve decisions about installation of additional machines or
hiring of extra labor in order to balance the business lost by not undertaking
these activities.
 Pricing Problem: Fixing prices for the products of the firm is an important
decision-making process. Pricing problems involve decisions regarding various
methods of prices to be adopted.
 Investment Problem: Forward planning involves investment problems. These are
problems of allocating scarce resources over time. For example, investing in new
plants, how much to invest, sources of funds, etc.
 Key Economic Concepts
 Three fundamental concepts:
 Opportunity cost
 Marginalism, and
 Efficient markets
• the best alternative that we forgo, or give up, when
Opportunity we make a choice or a decision
Cost
• arises because time and resources are scarce.
• In weighing the costs and benefits of a decision, it
Marginalism is important to weigh only the costs and benefits
that arise from the decision
• is one in which profit opportunities are eliminated
almost instantaneously
Efficient Market
• Profit opportunities are rare because, at any one
time, there are many people searching for them
Economics Principles relevant to managerial
decisions
 The Incremental Concept
 The Concept of Time Perspective
 The Opportunity Cost Concept
 The Discounting Concept
 The Equi-marginal Concept
 The Incremental Concept
 Incremental concept is closely related to the marginal cost and marginal
revenues of economic theory.
 The two major concepts in this analysis are incremental cost and incremental
revenue. Incremental cost denotes change in total cost, whereas incremental
revenue means change in total revenue resulting from a decision of the firm.
 The incremental principle may be stated as follows:
 A decision is clearly a profitable one if
(i) It increases revenue more than costs.
(ii) It decreases some cost to a greater extent than it increases others.
(iii) It increases some revenues more than it decreases others.
(iv) It reduces costs more than revenues.
 Concept of Time Perspective:
 The time perspective concept states that the decision maker must give due
consideration both to the short run and long run effects of his decisions.
 Managerial economists are also concerned with the short run and long run
effects of decisions on revenues as well as costs.
 In the short period, the firm can change its output without changing its size.
In the long period, the firm can change its output by changing its size.
 In the short period, the output of the industry is fixed because the firms
cannot change their size of operation and they can vary only variable factors.
In the long period, the output of the industry is likely to be more because the
firms have enough time to increase their sizes and also use both variable and
fixed factors.
 In the short period, the average cost of a firm may be either more or less
than its average revenue. In the long period, the average cost of the firm will
be equal to its average revenue.
 The Opportunity Cost Concept:
 In Managerial Economics, the opportunity cost concept is useful in decision
involving a choice between different alternative courses of action.
 Resources are scarce, we cannot produce all the commodities. For the
production of one commodity, we have to forego the production of another
commodity. We cannot have everything we want. We are, therefore, forced to
make a choice.
 Sacrifice of alternatives is involved when carrying out a decision requires using a
resource that is limited in supply with the firm. Opportunity cost, therefore,
represents the benefits or revenue forgone by pursuing one course of action
rather than another.
 The concept of opportunity cost implies three things:
 1. The calculation of opportunity cost involves the measurement of sacrifices.
 2. Sacrifices may be monetary or real.
 3. The opportunity cost is termed as the cost of sacrificed alternatives.
 Equi-Marginal Concept
 The principle states that an input should be allocated so that value added by the
last unit is the same in all cases. This generalisation is popularly called the equi-
marginal.
 It is behind any rational budgetary procedure. The principle is also applied in
investment decisions and allocation of research expenditures.
 For a consumer, this concept implies that money may be allocated over various
commodities such that marginal utility derived from the use of each commodity
is the same.
 Similarly, for a producer this concept implies that resources be allocated in such a
manner that the marginal product of the inputs is the same in all uses.
 Scope of Managerial Economics
1. Demand Analysis and Forecasting

2. Cost and Production Analysis

3. Pricing Decisions, Policies and Practices

4. Profit Management

5. Capital Management