INTRODUCTION TO ECONOMICS

What is Economics?

What is Economics?
A social science that studies and influences human behavior Economics is the study of what constitutes rational human behavior in the endeavor to fulfill needs and wants.
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The Father of Modern Economics

Adam Smith (1723 - 1790)

Author of the famous book "An Inquiry into the Nature and Causes of the Wealth of Nations"
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The Foundation of Economics

Scarcity

- Robbins

Scarcity refers to our limited resources and our unlimited wants and needs. For an individual, resources include time, money and skill. For a country, limited resources include natural resources, capital, labour force and technology.

Needs v. Wants.
Human wants are unlimited. We live in a world of limited resources. The above leads to scarcity. People try to balance needs and wants.
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ECONOMICS

MICRO

MACRO
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Micro Economics
Micro Economics studies how the individual parts of the
economy make decisions to allocate limited resources

Microeconomics studies: how individuals use limited resources to meet

unlimited needs the consequences of their decisions the behaviour of individual components like industries, firms and households. how individual prices are set what determines the price of land, labour and capital inquire into the strengths and weaknesses of the market mechanism.
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Macro Economics

Macroeconomics studies about the functioning of the economy as a whole It examines the economy through wide-lens. Macroeconomics studies about the total output of a nation the way the nation allocates its limited resources of land, labor and capital the ways to maximize production levels the techniques to promote trade After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning.
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The Factors of Production

Land

Labour

Capital

Organization

Product

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Figure 1.2

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ECONOMY

MARKET

COMMAND

MIXED

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Market Economies
In a pure market economy there is no government involvement in economic decisions.
Contd.
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The Government lets the market answer the following three basic economic questions: 1. What ?
Consumers decide what should be produced in a market economy through the purchases they make.

2. How ?
Production is left entirely up to businesses. Businesses must be competitive in such an economy and produce quality products at lower prices than their competitors.

3. For whom ?
In a market economy, the people who have more money are able to buy more goods and services.
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Command Economies
In a command economy the Government answers the three basic economic questions.
1. What?
A central planning committee decides what products are needed.

2. How?
Since the Government owns all means of production in a command economy, it decides how goods and services will be produced.

3. For Whom ?
The Government decides who will get what is 15 produced in a command economy.

Mixed Economies
In the Mixed economies the Government and the Market work together in decision making

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The Economic Problem

Unlimited Wants Scarce Resources Land, Labour, Capital Many Uses of Resources Choices

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The Economic Problem

What goods and services should an economy produce? should the emphasis be on agriculture, manufacturing or services, should it be on sport and leisure or housing? How should goods and services be produced? labour intensive, capital intensive? Who should get the goods and services produced? Even distribution? More for the rich? For those who work hard?

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What is Utility?
Satisfaction Can not be measured
Marshall Utility can be measured in Utils

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What are kinds of Utility?

Form Utility Place Utility Time Utility

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Form Utility
In what form is a product available Whole chicken Chicken parts Cooked chicken Each step adds value

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Place Utility
The place where is a product available Convenience

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Time Utility
When is a product available

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Rational Behavior
People know what they want Their behaviors are consistent with what they want Assume that the market information is given.

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Opportunity Cost
Definition the cost expressed in terms of the next best alternative sacrificed The cost of anything in terms of other things given up or sacrificed.

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Production Possibility Frontiers

PPF Shows the different combinations of goods and services that can be produced with a given amount of resources No ideal point on the curve Any point inside the curve suggests resources are not being utilised efficiently Any point outside the curve not attainable with the current level of resources Useful to demonstrate economic growth and opportunity cost
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Production Possibility Frontiers

Capital Goods Ym

Yo

If reallocates Assume a its If it the country is resources to resources (moving at point A on country can itthe capital goods round the PPF from A PPF It can produce two a could produce to B) it can produce produce thegoods types of goods maximum of more consumer Ym. but only at the expense combination of Yo with its If it devotes goods. its of fewer capitalall and capital goods resources resources to The opportunity cost of Xo consumer capital angoods it consumer extra producing goods Xo goods and consumer X1 consumer goods is could produce a Yo Y1 capital goods. goods maximum of Xm

If it devotes all

Y1

Xo

X1 Xm Consumer Goods
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Production Possibility Frontiers

Capital Goods
It can only produce Production at points outside the PPF if it finds a way inside the of expanding its PPF e.g. resources or point the improvesB means the productivity of those resources it is not country already has. This will push using all its the PPF further resources outwards.

Y1 Yo

A
B

Xo X1

Consumer Goods
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Principles of Economics

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HOW DO PEOPLE MAKE DECISIONS?

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1. People face trade-off

Every decision involves choices, and more of one
good means less of another good. Trade-off applies to individuals, families, corporations and societies.

Trade off between Efficiency and Equity Efficiency means the society is getting maximum
benefits from its scarce resources(Size of the economic pie)

Equity means the distribution of the benefits

among the members of the society equally (How the pie is divided)
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2. Cost of something is what you give up to get it

When we make a decision we compare the
costs and benefits of our choices.

Opportunity cost is whatever must be given up

to obtain something.

People compare costs and benefits

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3. Rational people think at the margin

Basic economics assumes that people act
rationally

They try to act so as to gain the most benefit

compared to the costs

Microeconomics focuses on small or marginal

changes

Economists use the term marginal changes to

describe small incremental adjustments to an existing plan of action

Rational people often make decisions by

comparing marginal benefits and marginal costs
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4. People respond to incentives

If rational people compare costs and benefits,
then changes in either one may change decisions.

An incentive is something that induces a person

to act .

An example of an incentive is that, people

respond to changes in prices. In general, people are more likely to buy something if it is cheaper. If an action becomes more costly, then there is an incentive to switch to other choices. Note that all actions have substitutes.
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HOW PEOPLE INTERACT?

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Trade makes everyone better off

Trade between two countries can make each country
better off

Trade allows each person to specialize in the

activities he or she does best, whether it is farming or home building

Trade with others enables people to buy a variety of

goods at lower cost

Countries as well as families benefit with the ability to

trade with one another

Trade allows countries to specialize in what they do

best and to enjoy greater variety of goods
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Markets are usually a good way to organize economic activity

Firms decide whom to hire and what to make Households decides which firms to work for
and what to buy with their incomes

These firms and households interact in the

market place, where prices and self interest guide their decisions

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Government can sometimes improve market outcomes

The invisible hand can work only if the
Government enforces the rules and maintains the institutions that are key to a market economy

Markets work only if the individual

interests are protected by Government policy
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HOW THE ECONOMY AS A WHOLE WORKS?

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A countrys standard of living depends on its ability to produce goods and services
The living standards of various countries over
time differ . This is due to the differences in productivity

The quantity of goods and services produced

from each hour of a workers time is known as productivity

There is relationship between the productivity

and the living standards

A rise in productivity helps to boost living

standards
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Prices rise when the Government prints too much money

Inflation is a situation where there is an
increase in the overall level of prices in the economy

Issuing of more currency leads to a fall

in the value of money

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Society faces a short run trade-off between inflation and unemployment

Business cycle Large fluctuations in

Economic activity

Policy instruments can be used to

influence the combination of Inflation and Unemployment

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