Key terms

Economic resources are scarce. Economics is primarily concerned with the scarcity
of resources. Faced with this scarcity, we must choose how to allocate our resources.
Economics is the study of how societies choose to do that. Microeconomics focuses on how
individuals, households, and firms make those decisions.

Ceteris paribus- A Latin phrase essentially meaning "other things being equal". This
assumption is used in modelling to indicate that the value of other independent variables
are held constant.

Q. Ceteris paribus is used in economics when

a. two variables are positively related

b. two variables are negatively related

c. the value of an independent variable affecting the dependent variable is held constant

d. the value of an dependent variable affecting the independent variable is held constant

Scarcity- The fact that there is a limited amount of resources to satisfy unlimited wants.

Economic resources- Things that are inputs to production of goods and services. There
are four economic resources: land, labor, capital, and technology. Technology is
sometimes referred to as entrepreneurship.

Q. Which of the following is NOT an economic resource?

 Money (Money is not an economic resource because it is not directly used to produce)
 Land
 Water
 Capital
 Labor

Q. What does it mean to say that a resource is scarce?

1. There is an unlimited amount of the resource available.

2. A society does not have enough money to purchase this resource.

3. Nobody wants to buy this resource.

4. There is not enough of this resource to satisfy all the wants and needs of a society.

Scarcity refers to the conflict that arises from competition over a society's limited
resources.

5. The resource is no longer available

Land- Natural resources that are used in the production of goods and services. Some
examples of land are lumber, raw materials, fish, soil, minerals, and energy resources.

Labor- Work effort used in the production of goods and services. Some examples are the
number of workers and number of hours worked.

Capital- Physical goods that are produced and used to produce other goods. Examples
of capital would be machinery, technology, and tools such as computers; hammers; factories;
robots; trucks, and trains used to transport goods; and other equipment employed in the
production of a good or service.

Technology- (sometimes called entrepreneurship) The ability to combine the other

productive resources into goods and services.

UNIT 1- INTRODUCTION TO ECONOMICS

 Definition, scope, and nature of economics
 Difference between Micro and Macro Economics
 Difference between Positive and Normative Economics
 Concept of Production Possibility Frontier
 Concept of Opportunity Cost

Microeconomics- The study of economic behaviour of individual decision-making units,

such as consumers, resources owners, and business firms in a free enterprise economy.

Macroeconomics- The study of aggregate economic activity, such as the economy’s level of
output, level of national income, level of employment and general price level.

Difference between Micro and Macro Economics

The major difference between micro and macroeconomics are mentioned below:

1. The word ‘micro’ means small. It is a study of individuals or groups.

According to Shapiro ‘Microeconomics deals with a small part of the

economy’. It is a piece meal study. On the other hand, ‘Macro’ means large. It
is a study of economy as a whole.
2. Microeconomics is a study of particular households, particular firms,
particular industries, particular commodities, particular prices etc.

On the other hand, macroeconomics deals with aggregate of these quantities,

not with individual income but with national income, not with individual
prices but with price level, not with individual output but with national output.

3. The objective of microeconomics is to maximise utility or maximization of

profit or minimization of cost. But the objective of macroeconomics are full
employment, price stability, economic growth, favourable balance of payment
etc.

4. The basis of microeconomics is the price mechanism which operates with the
help of demand and supply forces. These forces help to determine the
equilibrium price in the market.

On the other hand, the bases of macroeconomics are the national income,
output, employment and the general price level which are determined by
aggregate demand and aggregate supply.

5. Microeconomics is based on the assumption of ‘ceteris paribus’ (It means

other things remaining constant) to explain the various laws. It means
microeconomics uses the technique of partial equilibrium analysis which
explains the equilibrium conditions of an individual, a firm or an industry.

But macroeconomics uses the technique of general equilibrium analysis that

studies aggregate economic variables and their interrelations.

6. Microeconomics is a static analysis while macroeconomics is a dynamic

analysis.
Microeconomics does not take into account the time element while
macroeconomics based on time lags, the rates of change and the past and
expected value of the variables.
 7. The variables of microeconomics are taken as given (or constant) in
macroeconomics and the variables of macroeconomics are taken as given in
microeconomics.

Microeconomics assumes full employment, optimum allocation of total

resources and general price level as given. But macroeconomics assumes the
situation of less than full employment. It studied under employment. It takes
general price level as variable and assumes price of a particular product or
factor has given.

8. Microeconomics problems are many. It possesses maximum generality and

applicability to a wide range of situations. But macroeconomics seeks
particular understanding of an economy. So macroeconomic problems are
relatively few and so are their specific solutions.

9. Under micro study the main problem is of price determination. But under
macro study the main problem is income determination.

10. Micro studies based on the objective of optimum allocation of resources while
macro study is based on the objective of full employment of total resources.

Questions-

Which of the following is NOT a microeconomic question?

1. How should a firm respond if it knows a competing firm will advertise?

2. How do labor unions influence wages in the trucking industry?
3. How is the unemployment rate related to GDP?

The relationship between the unemployment rate and the business cycle is a
macroeconomic question because macroeconomic questions deal with problems facing
the entire economy. Microeconomic questions deal with decision-making by individuals,
households, and firms.

4. What happens to a firm’s revenue if they increase a good’s price?

5. How does a mother’s education influence a child’s health?
Which of the following is an example of a macroeconomic question?

1. How many smartphones should Samsung produce this quarter?

2. What is the optimal number of workers for an ice cream shop to employ during the
summer months?
3. What would be the likely impact of an increase in business taxes on the overall level
of inflation in the country?
4. Who are the winners and losers from the imposition of a tax on cigarettes?
5. How will a consumer react if their income decreases?

Which of the following is not a macroeconomic issue?

1. Unemployment
2. Inflation
3. The wages paid to footballers
4. Economic growth

Positive vs. normative analysis

Positive Statements:

 Statements of fact or description of how something actually is.

 Positive statements are objective statements that can be tested and validated through
observation or empirical evidence.
 Descriptive and factual.
 Example: "The inflation rate in India is 5%." This statement can be verified with
data.

Normative Statements:

 Statements that describe opinions or how things ought to be.

 Normative statements are subjective statements that express opinions, beliefs, or
judgments about what ought to be. They reflect values and preferences.
 Prescriptive and opinion-based.
 Example: "The government should reduce the inflation rate to 3%." This statement
expresses a judgment about what should be done and cannot be tested for truth.
Questions-

Which of the following is a normative statement?

A) Taxes should be higher.

B) Lower taxes would result in lower revenues.
C) A 2% increase in foreign investment is associated with a 0.5% rise in economic
growth.
D) Lower taxes would result in a 12% increase in spending.

Which of the following is an example of a positive statement?

A) The government should increase the minimum wage.

B) Inflation in the country is currently at 3%.

C) Everyone should have access to healthcare.

D) The unemployment rate is too high.

What type of statement expresses a value judgment?

A) Positive Statement

B) Normative Statement

C) Both A and B

D) Neither A nor B

Which of the following is a normative statement?

A) The GDP of Country X has grown by 2% this year.

B) Education should be free for all citizens.

C) The average income in City Y is $50,000.

D) The cost of living has increased.

Which of the following statements could be classified as both normative and positive?

A) The crime rate has increased in urban areas.

B) The government should allocate more funds to education.

C) Higher taxes can lead to reduced disposable income.

D) All citizens should have the right to vote.

True/False Questions/ fill in the blanks

Normative statements can be tested and verified through empirical evidence.

A statement that expresses an opinion about how things should be is a normative statement.

Positive statements are often used to make policy recommendations.

Positive statements are focused on ___________, while normative statements focus on

___________.

An example of a normative statement is: "__________ should be reduced to improve social

welfare."

The Production Possibilities Frontier

 The Production Possibilities Frontier (PPF) is a graph

that shows all the different combinations of output of
two goods that can be produced using available
resources and technology. The PPF captures the
concepts of scarcity, choice, and tradeoffs.
 The shape of the PPF depends on whether there are
increasing, decreasing, or constant costs.
 Points that lie on the PPF illustrate combinations of
output that are productively efficient. We cannot
determine which points are allocatively
efficient without knowing preferences.
 The slope of the PPF indicates the opportunity cost of
producing one good versus the other good, and the
opportunity cost can be compared to the opportunity
costs of another producer to determine comparative
advantage.
 The economist uses the term opportunity cost to
indicate the benefits forgone when a specific
decision is made. When there are two options and
 one is chosen, the OC of the option chosen is the
opportunity forgone. For example, the OC of
studying economics is the time one could have
spent on alternative activities. In taking this
approach, the economist makes no judgement
about the decision made since it is assumed
that the options selected provide the greatest
anticipated benefits.

PRODUCTION POSSIBILITY FRONTIER

The production possibility frontier shows the maximum amount of alternative

combinations of goods and services that a society can produce at a given time
when there is full utilization of economic resources and technology.

Table presents alternative combinations of guns and butter output for

hypothetical economy (guns represent the output of military good while butter
represents the production of non-military goods and services ).
In choosing what to produce decision makers have a choice of producing, for
example alternative C- 5000 guns and 14 million units of butter - or any of the
other alternatives. This production possibility schedule is plotted in figure.

The curve, labelled PP, is called the production possibility frontier. Point C
on the production possibility curve represents a position of full employment
of the economy’s resources and full use of its technology.

At point C, 5000 guns and 14 million units of butter are produced. Point D is
another possible alternative, one in which more guns and fewer units of butter
are produced.

The production possibility frontier depicts not only limited productive

capability and therefore the problem of scarcity but also the concept of
opportunity cost.

When an economy is on the production possibility curve such as at Point C, gun

production can be increased only by decreasing butter output.

Thus, to move from alternative C to alternative D, 8 million fewer units of

butter are produced in order to increase gun production 4000 units. The
opportunity cost of the additional 4000 units of gun production is 8 million
units of butter.
The production possibility frontier shifts outward overtime as more resources
become available and/or technology is improved.
Growth in the economy’s productive capability is depicted in figure by the
outward shift of the production possibility frontier from PP to P’P’.

Suppose the economy is at Point C producing 5000 guns and 14 million unit of
butter. When the production possibility frontier shifts upward from PP to P’P’,
4000 additional guns can be produced without sacrificing any butter production.

This example of growth in productive capacity should not be constructed as

a refutation of the law of opportunity cost. Fewer sacrifices may be made
when growth occurs. However, when there is an efficient utilization of
resources and an absence of growth, additional gun production is possible
only when the output of butter is decreased.

Points on a production possibility frontier are efficient, Points within the

frontier are inefficient and point outside the frontier are not unattainable.

Points C and D on production possibility frontier PP are efficient because all

available resources are utilised and there is full use of existing technology.
Positions outside the production possibility frontier PP are unattainable
since the production possibility frontier defines the maximum amount that
can be produced at a given time. Positions within a production possibility
frontier are inefficient because some resources are either unemployed or
underemployed that is either not employed at all or employed at tasks that
do not fully utilise the production capability of the resources.

Q. True or False Questions

1. A production-possibility frontier depicts the unlimited
wants of a society.
2. When there is full employment, the decision to produce
more of one good necessitates decreased production of
another good.
Q. Figure presents a production-possibility frontier for
food and clothing.
a. What is the opportunity cost of increasing food production
from 0 to 2 million units, from 2 million to 4 million units, and
from 4 million to 6 million units?
b. What is happening to the opportunity cost of increasing food
production from 0 to 6 million units?
c. Explain how the shape of the production-possibility frontier
implies increasing costs for the production of clothing.
Solution:
a. In increasing food production from 0 to 2 million units,
production of clothing decreases from 16,000 to 15,000 units.
Thus, the opportunity cost of producing the first 2 million units
of food is 1 thousand units of clothing. The opportunity cost of a
second and third additional 2 million units is 2,000 and 3,000
units of clothing, respectively.
b. The opportunity cost of increasing food production is
increasing from 1,000 units of clothing to 2,000 to 3,000 units
of clothing.
c. Increasing clothing and food costs are reflected in a concave
(outward-sloping) production-possibility frontier. Moving down
the frontier from point A to points B, C, D, E, and F shows that
to produce 2 million incremental units of food (the 2-million-
unit-length horizontal dashed lines in Figure), we must give up
more and more units of clothing (the vertical dashed lines of
increasing length).
Q. Table presents the production possibility schedule for
a hypothetical economy which produces only food and
clothing.
a. What does this production possibility schedule show?
b. Suppose production is currently set at 3 million unit of food
and 5000 units of clothing. How can this economy increase food
production by 1 million units when there is no change in
technology or the quantity of economic resources?
c. What is the opportunity cost of increasing food production 1
million unit?
d. Use the data from table to establish the opportunity cost of
producing additional units of food in 1 million increments when
food production is initially zero.

Alternative or Units of Food Units of Clothing

Points (Millions) (Thousands)
A 0 8.0
B 1 7.5
C 2 6.5
D 3 5.0
E 4 3.0
F 5 0.0

Answer-
1. The production possibility schedule represents the
alternative combination of 2 goods that society can produce
assuming that all its resources and the best technology
available used. Table shows that this economy can produce
either no food and 8000 units of clothing, 1 million unit of food
and 7.5 thousand units of clothing, 2 million units of food and
6.5 thousand units of clothing, 4 million unit of food and 3000
units of clothing or 5 million units of food and no clothing. Since
we assume that society is utilising all its resources and the best
technology, this society can produce more units of food only by
releasing economic resources from clothing production and
thereby producing less clothing.
2. This economy can increase food production only by
decreasing clothing production. Increasing food production 1
million unit necessitates moving from alternative D to
alternative E. Societies production changes from 3 million units
of food and 5000 units of clothing to 4 million units of food and
3000 unit of clothing. Thus 2000 unit of clothing must be given
up to increase food production 1 million units.
3. The opportunity cost of producing the additional 1 million
unit of food is the 2000 unit of clothing that society no longer
produces.
4.
Alternative Units of Units of Cost of
or Points Food Clothing additional
(Millions) (Thousands unit of food
)
A 0 8.0
0.5
B 1 7.5
1
C 2 6.5 1.5
D 3 5.0 2
E 4 3.0 3
F 5 0.0