ECONOMICS: AN INTRODUCTION

Every Activity done by human being is called as Human Activities.

ECONOMIC ACTIVITIES
Activities that are done to satisfy our wants/needs, maximize our
profits or even earn income are called Economic Activities like
Chef Cooking in a Restaurant

NON-ECONOMIC ACTIVITIES
Activities that are done primarily out of love and affection,
sympathy for others, friendship etc. are called as Non-Economic
Activities like Mother cooking for Family Members.

Adam Smith is known as father of microeconomics

MEANING OF ECONOMY
An economy is a system which provides people, the means to work and earn a living.

VITAL PROCESSES OF AN ECONOMY

Economy is a system which provide living to the people. For this objective to be
fulfilled, it is necessary that every economy should undertake three economic activities:
1. Production
2. Consumption
3. Investment or Capital Formation

SCARACITY AND CHOICE

A situation where demand for a resource is much more than its availability, it is called
as Scarcity of Resources. Also, the same resources can be put to multiple or alternate
uses.

Human wants Resources

Unlimited in nature Limited/Scarce in nature Limited
Differ in priorities Have alternate uses Resources

Unlimited
Scarcity refers to the limitation of Supply in Wants
relation to demand for a commodity.
ECONOMIC PROBLEM
Economic Problem is a problem of choice involving satisfaction of unlimited wants out
of limited resources having alternative uses.

Reasons for Economic Problem

Unlimited Human
Scarcity of Resources Alternate Uses
Wants

(i)Scarcity of Resources: Resources (i.e. land, labour, capital etc.) are limited in
relation to their demand and economy cannot produce all what people want. It is the
basic reason for existence of economic problems in all economies.

(ii)Unlimited Human Wants: Human wants are never ending, i.e. they can never by
fully satisfied. As soon as one want is satisfied, another new want emerges. Wants of
the people are unlimited and keep on multiplying and cannot be satisfied due to
limited resources. Human wants also differ in priorities.

(iii)Alternate Uses: Resources are not only scarce, but they can also be put to various
uses. It makes choice among resources more important. As a result, economy has to
make choice between the alternative uses of the given resources.

MEANING OF ECONOMICS
Economics is a social science which studies the way a society
chooses to use its limited resources, which have alternate
uses, to produce goods and services and to distribute them
among different groups of people. In other words,
Economics is all about making choice in the presence of
scarcity.

POSITIVE ECONOMICS AND NORMATIVE ECONOMICS

What is?

ECONOMICS AS A SCIENCE Positive Economics What was?

What will be?

 What ought to be?

ECONOMICS AS A Normative Economics What should happen?

SCIENCE

What should have happened?

POSITIVE ECONOMICS AND NORMATIVE ECONOMICS

Positive Economics
o It deals with economic issues which are based on past, present and future.
o These are statements which deal with What was, What is and What will actually
happen in the economy.
o These are the issues which are based on some facts or data. Therefore, they can be
verified and do not involve any judgements or opinion.
o The statements made under Positive Economics consist of data which may not be
true always. However, one can always verify the correctness of the statement.
o Example: India's population is 121 crores. (What is?) India's literacy rate was as low
as 15% on the eve of independence. (What was?) By the year 2022, with the given
population growth rate, India's population is expected to increase by 22% (What
will?)

Normative Economics
o It deals with economic issues which are based on opinions and suggestions.
o These are statements which deal with "What ought to be” or "What should happen?"
These are the issues which are not based on some facts or data. Therefore, they
cannot be verified and involve judgements or opinion.
o The statements made under Normative Economics consist of opinions which may not
be true always. However, one cannot verify the correctness of the statement.
o Example: MNREGA will one day bring an end to the problem of unemployment in
India. Indian government should take steps to enhance the productivity in
Agriculture Sector. MNREGA scheme is expected to generate employment
opportunities for 100 lakh people by year 2022.

Positive Economics Normative Economics

It deals with What is, What was and It deals with What should be and What
What will happen in the economy ought to happen in the economy
It deals with facts, actual data and It deals with ideal situations
figures
It involves time dimensions It does not involve time dimensions
It is not based on judgements It is based on judgements
For Example: There is poverty in our For Example: Government should take
country, population is increasing, GDP is steps to reduce population growth rate,
growing etc. steps should be taken to reduce poverty
etc.
MICROECONOMICS AND MACROECONOMICS
Microeconomics
 The word Micro has been derived from a greek work "Mikros" which means "small".
 Microeconomics involves the study of economic activities done at an individual level
 The variables studied under Microeconomics do not affect economy.
 It is assumed that all macroeconomics variables are constant.
 It is called as Price Theory.

Macroeconomics
 The word Macro has been derived from a greek word "Makros" which means "large".
 Macroeconomics involves the study of economic activities done at an aggregate level
 The variables studied under Macroeconomics analyze the impact on the
society/Economy.
 It is assumed that all microeconomics variables are constant.
 It is called as Income and Employment Theory.

Basis Microeconomics Macroeconomics

Definition Studies the behaviour of Studies the behaviour of
individual units of an economy aggregates of the economy as a
whole
Tools Demand and Supply Aggregate Demand and
Aggregate supply
Basic To determine the price of the To determine the income and
Objective commodity employment of the economy
Basic It assumes that all the macro It assumes that all the micro
Assumptions variables are constant variables are constant
Other name Price theory Income and employment theory
Examples Individual income and National income and national
individual output output

CENTRAL PROBLEMS OF AN ECONOMY

Central Problems of an economy

What to How to For whom to

produce produce produce
These problems are called central problems because these are the most basic problems of
an economy and all other problems revolve around them
 WHAT TO PRODUCE
This problem involves selection of goods and services to be produced and quantity to
be produced of each selected commodity. Every economy has limited resources and
thus, cannot produce all the goods. More of one good or service usually means less of
others.

The problem of “What to produce” has two aspects:

(i)What possible commodities to produce: An economy has to decide, which
consumer goods (rice, wheat, clothes etc.) and which of the capital goods (machinery,
equipment etc.) are to be produced. In the same way, economy has to make a choice
between civil goods (bread, butter etc,) and war goods (guns, tanks etc.).

(ii)How much to produce: After deciding the goods to be produced, economy has to
decide the quantity of each commodity, that is selected. It means, it involves a decision
regarding the quantity to be produced, of consumer and capital goods, civil and war
goods and so on.
Guiding Principle of “What to produce”. Allocate the resources in a manner
which gives maximum aggregate satisfaction.

2.HOW TO PRODUCE
This problem refers to selection of technique to be used for production of goods and
services. A good can be produced using different techniques of production By
'technique', we mean which particular combination of inputs to be used. Generally,
techniques are classified as: Labour intensive techniques (LIT) and Capital Intensive
techniques (CIT).

 In Labour intensive technique, more labour and less capital (in the form of
machines, etc.) is used.
 In Capital intensive technique, there is more capital and less labour utilization.

The selection of technique is made with a view to achieve the objective of raising the
standard of living of people and to provide employment to everyone. For example, in
India, LIT is preferred due to abundance of labour, whereas, countries like U.S.A.,
England, etc. prefer CIT due to shortage of labour and abundance of capital.

Guiding Principle of 'How to Produce': Combine factors of production in such a

manner so that maximum output is produced at minimum cost, using least
possible scarce resources
3. FOR WHOM TO PRODUCE
This problem relates to the distribution of produced goods and services among the
individuals within the economy, i.e. selection of the category of people who will
ultimately consume the goods, i.e. whether to produce goods for more poor and less
rich or more rich and less poor.

The capacity of people to pay for goods depends upon their level of income. It means,
this problem is concerned with distribution of income among the factors of production
(land, labour, capital and enterprise), who contribute in the production process.

The problem can be categorised under two main heads:

(i) Personal Distribution: It means how national income of an economy is distributed
among different groups of people.
(ii) Functional Distribution: It involves deciding the share of different factors of
production in the total national product of the country.

Guiding Principle of 'For whom to Produce': Ensure that urgent wants of each
productive factor are fulfilled to the maximum possible extent

Central Problems of an economy

(Problem under allocation of resources)

What to How to For Whom to

Produce Produce Produce
Involves selection of Involve distribution of
Involve selection of
goods and services and produced goods and
technique, i.e. whether to
quantity to be produced services among the
use Labour Intensive or
of each selected individuals within the
Capital Intensive Technique
commodity economy

OPPORTUNITY COST

Opportunity Cost means cost of next best alternative foregone.

For example, Aman is working as a sales manager at a salary of

₹1,00,000 per month. He received two more job offers. He got an
offer of ₹70,000 from ABC ltd. and offer of ₹85,000 from PQR ltd.
What is his opportunity cost for working as a sales manager? His
opportunity cost of working as a sales manager is ₹85,000 which
he would have earned if there was no option of Sales Manager
profile available.
PRODUCTION POSSIBILITY FRONTIER
PPF (Production possibility curve/frontier) is a graphical representation of all possible
combinations of two goods that can produced with given resources and technology.
Assumptions of PPF
 Amount of resources in the economy is fixed
 Economy produces two goods X and Y
 Resources are fully and efficiently utilized
 Resources are not equally efficient in production of all products
 Level of technology is assumed to be constant

PRODUCTION POSSIBILITY SCHEDULE

Possibilities Guns Butter MOC MRT =
𝜟 𝑮𝒖𝒏𝒔
𝜟 𝑩𝒖𝒕𝒕𝒆𝒓
(in units) (in units)
A 21 0 - -
B 20 1 1 1G : 1B
C 18 2 2 2G : 1B
D 15 3 3 3G : 1B
E 11 4 4 4G : 1B
F 6 5 5 5G : 1B
G 0 6 6 6G : 1B

 If the economy uses all its resources to produce

only guns, then maximum of 21 Units of guns
and no butter can be produced (point A)
 On the other hand, if all resources are used for
butter, then maximum 6 units of butter and no
guns can be produced (point G)
 In between, there are various possibilities with
different combinations of guns and butter
 When points A, B, C, D, E, F and G are joined, we
get a curve AG, known as “Production
Possibility Frontier” AG Curve shows the
maximum limit of production of guns and butter.

MARGINAL RATE OF TRANSFORMATION

The term "marginal" means "additional” and “Rate of transformation” means ratio in
which resources are transferred from production of one good to production of another
good.
No.of units of a good sacrificed
 MRT =
No.of units of a good gained

 It is called as Slope of PPC

 Often, the term marginal opportunity cost and marginal rate of transformation are
used interchangeably.
 Change in units of Good Y (ΔY) = Final Value of Y – Initial Value of Y = 90 - 100 = 10
 Change in units of Good X (ΔX) = Final value of X – Initial value of X = 20 – 10 = 10
CHARACTERISTICS OR PROPERTIES OF PPF
The two basic characteristics or features or properties of PPF are:
1. PPF slopes Downwards:
 PPF shows all the maximum possible combination of two goods, which can
be produced with the available resources and technology.
 In such a case, more of one good can be produced only by taking resources
away from the production of another good.
 As there exists an inverse relationship between change in quantity of one
commodity and change in quantity of the other commodity, PPF slopes
downwards from left to right.

2. PPF is Concave Shaped:

 PPF is concave shaped because of increasing marginal rate of
transformation (MRT), i.e. more and more units of one commodity are
sacrificed to gain an additional unit of another commodity.
 MRT increases because it is assumed that no resource is equally efficient in
production of all goods.
 As resources are transferred from one good to another, less and less
efficient resources have to be employed. This raises cost and raises MRT.

WHETHER ECONOMY WILL ALWAYS OPERATE ON PPF?

The exact point of operation depends on how well the resources of the economy are
used.
1. Economy will operate on PPF only when resources are fully and efficiently utilised.
2. Economy will operate at any point inside PPF if resources are not fully and
efficiently utilised.
3. Economy cannot operate at any point outside PPF as it is unattainable with the
available productive capacity.
It means:
• Economy can either operate on PPF or inside PPF, known as ‘Attainable
Combinations'.
• But, economy cannot operate outside PPF, known as 'Unattainable Combinations'.

ATTAINABLE AND UNATTAINABLE COMBINATIONS

ATTAINABLE COMBINATIONS: It refers to those combinations at which economy can
operate. There can be two attainable options:

1. Optimum utilisation of resources: If the resources are

used in the best possible manner, then economy will
operate at any point.

2. Inefficient utilisation of resources: However, the actual

production can fall short of its capabilities. If there is
wastage or inefficient utilisation of resources, then
economy will operate at any point inside the PPF.
UNATTAINABLE COMBINATIONS: With the given amount of
available resources, it is impossible for the economy to
produce any combination more than the given possible
combinations i.e. an economy can never operate at any point
outside the PPF.
Attainable Combinations : Point A, B, C, D, E, F
Unattainable Combinations : Point G

PPF AND MRT

When resources are transformed from one use to another, their efficiency decreases,
this play an important role in determining the curvature or shape of PPF

MRT IS INCREASING PPF is concaved shaped due to Increasing MRT

Combination Units of Units of 𝚫𝐘
MRT =
Good X Good Y 𝚫𝐗
A 0 100 -
B 1 90 10Y : 1X
C 2 70 20Y : 1X
D 3 40 30Y : 1X
E 4 0 40Y : 1X

MRT IS DIMINISHING PPF is convex shaped due to diminishing MRT

Combination Units of Units of 𝚫𝐘
MRT =
Good X Good Y 𝚫𝐗
A 0 100 -
B 1 60 40Y : 1X
C 2 30 30Y : 1X
D 3 10 20Y : 1X
E 4 0 10Y : 1X

MRT IS CONSTANT PPF is straight line curve due to diminishing MRT

Combination Units of Units of 𝚫𝐘
MRT =
Good X Good Y 𝚫𝐗
A 0 100 -
B 1 90 10Y : 1X
C 2 80 10Y : 1X
D 3 70 10Y : 1X
E 4 60 10Y : 1X
PPF AND OPPORTUNITY COST
The opportunity cost of a product is the alternative that
must be given up to produce that product. PPF
illustrates the concept of opportunity cost. The
opportunity cost of producing more butter is fewer
guns.
If all the resources of the economy are fully and
efficiently utilised, then more of one good can be
produced only by taking resources away from the
production of another good. The lost production of
such other good is the opportunity cost of the first.

PPF AS TRANSFORMATION CURVE

Slope of PPF indicates the ease or difficulty in transforming one good into another.
when we move down the curve, we transform guns into butter, and when we move up,
we transform butter into guns. Because of this reason, PPF is known as
"Transformation Curve".

CHANGE IN PPF
PPF is based on the assumption, that resources of an economy are fixed. However, in
this changing world, the productive capacity of an economy is constantly changing due
to increase or decrease in resources. Such changes in resource lead to change in PPF.

The change in PPF indicates either an increase or a decrease in the productive capacity of
the economy. The change in PPF can be of two types:

1. Shift in PPF: PPF will shift when there is change in productive capacity (resources or
technology) with respect to both the goods.
2. Rotation of PPF: PPF will rotate when there is change in productive capacity
(resources or technology) good.) with respect to only

SHIFT IN PPF
PPF can shift either towards right or towards left, when there is change in resources or
technology with respect to both the goods.

(i)Rightward Shift in PPF: When there is “Advancement

or Upgradation of Technology" or/and "Growth of
Resources" in respect to both the goods, then PPF will
shift to the right.
For example, if there is increase in resources for
production of butter and guns, we can produce more of
both the goods.
(ii) Leftward Shift in PPF: PPF will shift towards
left, when there is a techno- logical degradation
and/or decrease in resources with respect to
both the goods. For example, destruction of
resources in an earthquake will reduce the
productive capacity and as a result, PPF will shift
to the left.

ROTATION OF PPF
It happens when there is change in productive capacity (resources or technology) with
respect to only one good. The rotation can be either for the commodity on the X-axis or
for commodity on the Y-axis.

(i) Rotation for commodity on the X-axis: When there is a technological

improvement or an increase in resources for production of the commodity on the X-
axis (say, butter), then PPF will rotate to the right.
However, in case of technological degradation or decrease in resources for
production of butter, PPF will rotate to the left.

(ii) Rotation for commodity on the Y-axis: A technological improvement or an

increase in resources for production of commodity on Y-axis , will rotate the PPF from
AB to AB’. However, in case of degradation in technology or a decrease in resources for
production of guns, PPF will rotate to the left.