BASICS OF
ECONOMICS
UNIT 1
A
INTRODUCTION
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
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
Thescarcity 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
Explainhow 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
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
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
Economics noble prize winner (1969), Ragner Frisch
THEORIES
was the first to use the terms micro and macro in
economics in 1933.
Theterms 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
MICRO ECONOMICS
Micro
Micro comes from Greek word mikros, meaning “small”
Microeconomics
Studyof 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
Microeconomics 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.
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
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 we make a choice or a
Opportunity decision
Cost • arises because time and resources are
• scarce.
In weighing the costs and benefits of a
decision, it is important to weigh only
Marginalism
the costs and benefits that arise from
the decision
• is one in which profit opportunities are
eliminated almost instantaneously
Efficient • Profit opportunities are rare because,
Market
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.
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
