ECONOMICS NOTES

MODULE 1
Scarcity – The limited nature of society’s resources.
Economics – The study of how society manages its scarce resources.
 Economics is about choices and decisions.
 Making a decision is a complex process as people are using
scarce resources
 In econ, resources = Factors of production – Land, labor,
capital, organization. They are the inputs that go into the
production process.
 Resources ten to gravitate towards their most valuable uses if
voluntary exchange is permitted, and voluntary exchange is
possible only when market:
 Ensures property rights
 Enforce contracts
 Ensure a general rule of law

 When resources are used where their value is highest or

when no reallocation would increase their value, we say that
they are being employed efficiently.

 Opportunity Costs; cost of the next best alternative

 Human behavior/action; Richard Thaler – nudge theory

 Purposeful human behavior – when you are cautious of what

you are sacrificing, specific purpose, conscious of costs.

PRINCIPLES OF ECONOMICS;
PRINCIPLE 1 – PEOPLE FACE TRADE OFFS
 To get one thing that we like, we usually have to give up
another thing that we like.
Making decisions requires trading off one goal against
another.
Efficiency – the property of society getting the most it can
from the scarce resources.
Equity – the property of distributing economic prosperity

PRINCIPLE 2 – WHAT U GIVE UP TO GET IT

Making decisions requires comparing the costs and benefits
of alternatives course of action
Opportunity costs – whatever must be given up to obtain
some item.

Principle 3 – RATIONAL PEOPLE THINK AT MARGIN

Marginal changes – small incremental adjustments to a plan
of action
A rational decision maker takes an action if and only if the
marginal benefit of the action exceeds the marginal cost
RATIONL CHOICE / RATIONALITY + INCENTIVES + UTITLITY MAX

Express your views on Economics as a study of ‘rational choice’

and its relationship with law.

ANSWER: Economics as a study is all about choices and decisions

that we make in our day-to-day life and thus making such decisions
is a complex process because we have very scarce resources in
the economy, hence it’s very important for individuals to form a
rational choice when we decide something. Individuals and
businesses can make their best decisions or achieve their highest
level of satisfaction only when they think outside the box and
rationally.

As studied in the lectures, we have come to know what kind of

paradigm does rationality come into and what economics would
have to assume for it to work. To define this, we can say that a
rational consumer is one who focuses on maximizing his
satisfaction and a rational producer is the one who maximizes his
profits. Economics as a subject tends to assume that all human
beings are perfectly rational or make rational choices, but that is a
false statement and economists have recently done a study and
found that humans are only 20-30% rational. They have stated that
rationality cannot be precisely defined and that it is easier to define
what irrational or abnormal behaviour is.

Making rational choices is one of the principles of economics given

by Gregory Mankiw. He has stated that rational people think at the
margin. Margin refers to ‘edge’. Thus, according to him, a rational
decision maker will take action if the action's marginal gain is more
than the marginal cost.

Rationality or rational choice is the cornerstone of economics. As

law students, we may have had the thought that Economics is the
study of money or economy but we learned that the scope of
economics is actually much broader because it is the study of
rational choice or rationality. Economics, at the most fundamental or
basic level is not money or economy, it studies the implications of
rational choices.

The fundamental assumption of the economic approach to law is

that people are rational all the time. They think that whatever action
we take, we are being rational. But as stated above, our ability to
understand and assimilate information is severely restricted. So,
even if economics says that all human beings are rational, that
cannot be the case as there are many fallacies to that statement.

Economists have come to understand that we are only limitedly

rational. We always tend to maximize our utility. To explain it in
detail, as a consumer, we always try to maximize our satisfaction or
utility and as a producer, we always try to maximize our profit or
returns. Thus, that is how a rational person is expected to behave.
Thus, we can come to a conclusion that man is a rational utility
maximiser, not just when he is engaging in selling and buying in the
market place but in pretty much everything that he does in life and
all aspects of it.
For example, whether we want to pollute our surroundings or not
pollute it is much of an economic question as much as it is a legal
question. Another example we can think of is whether we want to
commit a crime or not. This also involves rational decision making.
Thus, every person in this world will try to maximize their utility in
every point of life.
Thus, we now know that rationality means we as humans always
tend to make rational choices in life but by contrast, the concept of
bounded rationality actually stands true which states that we are not
as rational as we are limited by three component factors which
include cognitive limitations, imperfect information and time
constraints.

If we try to maximize our utility then we also try to respond to

incentives, this implies that if my surroundings change in such a
way that I can increase my satisfaction if I alter my behaviour, then I
will definitely do so as it will help me reach my ultimate utility or
goal.

We have the concept of the law of demand where when the price of
a commodity goes up, the quantity of the demand for that
commodity goes down and when the price of the commodity goes
down, the quantity demanded for that commodity goes up. This can
also be said for incentives. One suitable example is that crime and
sanction are inversely related. The same analytical apparatus can
be used to study a whole other list of laws.

Rational-choice theory related to law is further shown by their

discussion of criminals' discounting of future punishments. Such
discounting is hyperbolic and this refutes the rational-choice
approach to crime and punishment. Similarly, if stricter sanctions to
break the laws are created, people will be rational and be more
aware of following the law and not breaking the rules.

For instance, if a person commits a certain kind of crime, such as

accidentally injuring another person or interfering with another’s
property, the person is subject to a monetary sanction. Rational
decision makers will pay higher prices for the same legal services
and will follow the law’s duties if they do so.
Thus, to conclude, we can say that in economics and law, rational
choice theory has been acknowledged as an appropriate model for
most legal decisions. This theory states that decisions have a
market-like quality and are therefore not made for profit. So, we use
this theory in both the fields of study.

NUDGE THEORY
He says that you can in fact nudge people to behave in a certain way
rather than bringing about strict laws because nobody wants to be
governed by strict laws. Ex How kids in America are nudged to
choose those food items which are beneficial for their health. The
government is not banning unhealthy food, instead they are nudging
them to behave in a way that is acceptable to govt.

PRINCIPLE 4 - PEOPLE RESPOND TO INCENTIVES

Should choose the right incentive to solve problems
Incentives can be counterproductive if not implemented properly.
Example; the cobra effect
There was a British overlord in north area with excess cobras, he
called on all villages and told them from tomorrow whoever gets him
cobra skin, will be paid a handsome amount as reward. The villages
started to breed cobras and the British lord realized after couple of
months that he has been taken as a royal raid by the villagers, thus
that vicinity had more snakes than before.
SCARCITY
Resources are scarce. When something gets scarcer and scarcer,
economic analysis can apply how to handle that particular resource.
Scarcity of air, water, depletion of ozone layer created a new field
called environmental economics. We have a whole set of distinct
disciplines in economics.
PRINCIPELE 5 - TRADE OFF
Countries as well as families benefit from the ability to trade with
one another.
Trade allows countries to speacilize in what they do best and enjoy a
greater variety of goods and services.
Giving up something to gain something. If we want to get something,
we have to give up something. There is not anything as free lunch in
this world. How as a society we can face trade off. A classic example
is the guns and butter theory. e.g. Guns and Butter- the more we spend on national
defense to protect our shores (guns) , the less we can spend on consumer goods(butter)
Countries as well as families benefit from the ability to trade with one another.
Trade allows countries to specialize in what they do best and enjoy a greater variety of goods and
services.

E.g. India trading spices with America for weapons, both get advantage

If you want to produce more guns(capital goods), then

you will have to reduce production of butter(consumer
goods).
 Clean env vs high level of income

Principle 6: Markets are usually a good way to organize economic activity

Market Economy: an economy that allocates resources through the decentralized decisions of
many firms and households as they interact in markets for goods and services .
E.g.

Principle 7: Government can improve market outcomes

Market Failure- a situation in which a market left on its own fails to allocate resources efficiently.
Externality- the impact of one person's action on the well-being of bystanders.
Market Power- the ability of a single economic actor to have a substantial influence on market
prices.

E.g. basically the govt creates law, so that we are benefitted

MARGINALITY AS MARGINAL PRINCIPLES

Margin – edge, decisions are taken at the margin. Rational people
usually don’t take extreme decisions.
Ex – when hungry you make the decision of eating an additional unit
and hagging like a pig.
Marginal benefit – marginal cost

Economics – efficiency + productivity = diff perspectives

What Is Marginal Analysis? Marginal analysis is an examination of the additional

benefits of an activity compared to the additional costs incurred by that same
activity. Companies use marginal analysis as a decision-making tool to help them
maximize their potential profits.

EFFICIENCY
We achieve economic efficiency when all your resources are being allocated to the
best possible uses.
Productive efficiency is making the maximum output with the minimum amount of
resources.
What is productivity?
Ans – productivity refers to output produced per unit of production.

RICARDO LABOR THEORY

Wages paid should be equal to marginal productivity
Types of efficiency – technical eff, dynamic eff, static eff.

In law, we use efficiency as a measure. There are diff criterion of efficiency

 Pareto Efficiency
 Hicks – Kaldor efficiency
 Scitovsky criterion
Pareto efficiency. Pareto is named after Swedish
economist Wilfred pareto. Pareto efficiency or pareto
optimality is a state of allocation of resources in which
it is impossible to make any one individual better off
without making atleast one individual worse off.
No regulation can bring you to a pareto situation. It is
simply not possible to make someone better off without
adversely affecting one person.

Hicks – Kaldor efficiency is more possible in law. One is

named after an American economist john hicks and the
other after a Swedish economist Kaldor. A policy is
hicks Kaldor efficient if those that can gain in principle
can compensate those that have been harmed and still
be better off.
Ex. Village of mandoor cuz of garbage problem,
relocation somewhere else for the people. A village
called madur in Karnataka was being dumped
with garbage from Bangalore that caused a lot of
problems. Villages took up action and stopped
the trucks from reaching the village. Bangalore
had to compensate for the problem
We can apply this same logic to a lot of related
problems. This is what law should try and achieve, that
is when the loss becomes efficient and is the best
measure for a good law. Hicks-Kaldor is something that
law can be achieved whereas pareto can not.

Means refers to inputs, resources, and factors of

production.
Law gives resources more capacity to generate wealth.

 Economics is about making people happy.

Happiness is one proper measure for social
conduct.
 There is a census now that a country could have a
high GDP, but people of the country might still be
sad.
  If a country has the best tech in the world but it is
not available to common people in cheap prices,
then no use. Similarly even if gdp is high and
common people are sad then no use.
 GNH – GROSS NATIONAL HAPPINESS
 Some factors/parameters – good governance,
sustainable socio-economic development,
preservation and promotion of culture,
environmental conservation
 GDP cant really measure happiness

What is good to me might not be good to you

Ex – a diabetic medicine might not be good to a non
sugar patient.

INTERNATIONAL TRADE THEORY

ABSOLUTE THEORY [ EXPL IN NOTEBOOK]
Comparative adv Is when one country has comparatively better
position in producing one good compared to the other country. This
better position is measured with the help of opportunity cost. In
other words, a country which can produce one good at a lower
opportunity cost compared to the other country is having
comparative advantage in the production of that particular good.
Example; let’s say country A can produce 1 block with the amount
of resources produce 2 coins. In that case, in order to produce 2
blocks, this country will have to give up 2 coins. This is the
opportunity cost of country A in producing 1 block.
Country B can produce 1 block by giving up 3 coins, in this case, the
opportunity cost in country B of producing 1 block is 3 coins.
To see that country A can, produce 1 block with lower opportunity
cost which is 2 compared to country B which can produce 1 block
with the opportunity cost of giving up 3coins. In this case, country A
has comparative advantage in production of blocks compared to
country B. How when one country has comparative adv in one good
compared to the other country and specialized in the production of
that particular good may generate surplus and this surplus can be
exchanged between the countries so that both the countries will be
on higher level of consumption
Car food grains
India 100 100
Japan 200 150

C = loss/gain
200/150 = 1.33
Car food grains
India 0 100
Japan 160 30
160 130
+10 +5
Economics is about good/s(economic good) –
Micro and Macro
Microeconomics – study of economics within a particular unit of a
industry/ that branch of economics which deals with the firm and
the household. It goes on to examine how these entities go on to
act in the marketplace (market is also a microeconomic entity)
Macroeconomics – deals with the aggregate/ largescale market as a
whole ex- unemployment for the country as a whole, govt policies,
fiscal and monetary policies.
Macroeconomics became a topic of a study by an economist called
John Maynard Keynes. [after great depression of 1929]
Markets – market is a place where people include in voluntary
exchange of good and services
Types – labor market, market for services, capital markets, goods
market.
HISTORY OF ECONOMIC THOUGHT
1. Classical school [1750-1850]
Adam smith
David Ricardo – theories on rent, trade, labour
Robert Thomas Malthus
John Stuart mill – theory of utility, theory of dd
2. Neo- classical school
3. Keynesian school [john Keynes]
Labor theory value – David Ricardo
Value of a good is proportional to how much labor was required to
produce it (including labor to produce raw material and machinery
used) hence labor should get the reward.
This idea was taken by Marx and put into a socio-economic sense
but it was put forward by Ricardo
Marxist view – value of product is due to labor put into it and
hence the profits should go to them, instead of it being
appropriated by capitalists [labor theory]

THEORY ON POPULATION – Robert Thomas Malthus

Food supply increases in arithmetic progression, whereas a
population increase is a geometric proportion
[food supply population exponentially]

ADAM SMITH
 Founding father of economics
 Foundation of classical economics based on his idea
 He lived in diff parts of Europe where there was diff economic
systems.
MERCANTILISM
The main goal was to increase nation’s wealth by imposing
government regulations. The fundamental phenomenon of a
mercantilist strategy is to engage in trade. The fundamental belief
was that strength of a nation can be maximized if u engage in more
trade. Mercantilism was all about one sided trade that was export
and not import. There was zero import.
Mercantilism as an economic philosophy had a great influence in
the mind of adam smith. That was one econ system he
experienced.
PHYSIOCRACY – ANTI THESIS OF MERCENTALISM [FRANCE – ECON
IDEOLOGY]
Persons associated with this were AHJ Turgot, Condorcet, Francois
Quesnay – tableau economique
They[physiocrats] believed that wealth of nations is not derived
from wealth of its rulers. It is derived from value of land agriculture
and land development. They emphasized on productive work as the
main source of nations wealth. The more productive work the
population engages in the more wealth that nation generates.

CONTRIBUTIONS OF ADAM SMITH [IDEALS OF SMITH]

 PRINCIPLE OF SELF INTEREST / SELF INTEREST BEHAVIOUR-
the best economic benefit for all can usually be accomplished when individuals act in
Give people all freedom to do what they want,
their own self-interest.
and in the course of doing that he is not only going to make his
state of affairs better, unknowingly he is also promoting general
good. Hence, allow individuals to pursue their self-interested
goals. This is the cornerstone of classical economics. All other
ideas are taken from this principle. Do not mistake this for
selfish behaviour
 Invisible hand – When you allow ppl to pursue their self-
interest goals, there is an invisible hand that it at play. An
invisible hand is always behind all human motives. He suggests
that it is a market system of demand and supply. An invisible
hand according to Adam smith is nothing but the
invisible/intangible/unobservable forces of demand and supply
 that keeps continuously acting and interacting in the market
place, thereby bringing about equilibrium.
 DIVISION OF LABOR- Adam smith regarded the entire world as
a big factory created by division of labor. He spent some time in
Germany and observes a pin factory closely and says that to
produce a product as silly as pin, you have eighteen specific
tasks to produce that pin. He tells us if one person were to do
all this process by himself, in any single day he will able to
produce 20 pins. Smith observes that when you apply division
of labor in that factory where one group of people specialize in
a specific task, they can produce 20 to 48,000 pins. That is the
power of division of labor.