What is

ECONOMICS about?
T.J. Joseph
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Why Study Economics?
Understanding the behavior of economic agents
in a better way
To understand how business work and how business
can be made more efficient and profitable
Illustration take any business concern
(Example: Tata Motors)
Adam Smith Father of Economics
(Wealth of Nations)
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Why Study Economics?
Economics helps to solve complex problems that are
great importance to society
Economists are concerned with why the world is
what it is
Examine how individuals and firms make decisions
about consumption, investment, pricing, etc.
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The Economic Problem
Two general observation:
(1) Resources are limited.
What are resources?
(2) Human wants are abound/unlimited
Scarcity We cannot have everything we want all
the time
Scarce Resources - not enough to satisfy all wants
So choices have to be made
Any choice involves an opportunity cost - the value of
the best alternative foregone
Unlimited Wants (Scarce goods)
Food (bread, milk, meat, eggs,
vegetables, coffee, etc.)
Clothing (shirts, pants, sarees, shoes,
socks, coats, sweaters, etc.)
Household (tables, chairs, sofas, beds,
goods dressers, television sets, etc.)
Space exploration
Education
National defense
Recreation
Leisure time
Entertainment
Clean air
Pleasant (trees, lakes, rivers,
environment open spaces, etc.)
Pleasant working conditions
Limited Resources
Land (various degrees of fertility)
Natural (rivers, trees, minerals,
Resources oceans, etc.)
Machines and other
human-made physical resources
Non-human animal resources
Technology
Human (the knowledge, skill,
resources and talent of individuals)
Scarcity and Choice
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Fundamental Economic Questions
Scarcity and choice raises several unavoidable
questions to the society
What to produce?
More guns or more breads? More books or more
movies?
How to produce? (optimization)
Use more labour and less machines?
For whom to produce (distribution)
Distribute equally? Then on what basis?
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Economics Defined
Economics is the study of how people cope with
scarcity
Economics deals with the problem of how to allocate
the limited resources among competing wants in order
to satisfy as many of those wants as possible
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Every society must have a means to ration scarce
resources among competing uses.
Scarcity Necessitates Rationing
In a market setting, price is used to ration goods
and resources.
When price is used, the good or resource is
allocated to those willing to give up other things
in order to obtain ownership rights.
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Emergence of Markets
Markets (and its components) emerge in direct
response to scarcity.
In a market, people exchange things that they like less
or have more, for things they like more or have less
Reallocation of their resources and enhance their
individual welfare
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Fundamental Economic Questions
How shall we answer the three basic economic
questions?
Shall we allow for individual freedom of choice? Or
shall we make all these decisions collectively?
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Economic Systems
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Alternative Economic Systems
The nature of economic system depends on
how the fundamental economic questions are resolved and
who coordinates the decisions
Two extremes are Market and Command Economies
In between lies the widely prevalent Mixed Economy
a mix of command and market economies
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Market Economy
Market mechanism or Price mechanism
coordinates the decision making of various economic
agents
Also known as Free-enterprise economy one in
which government does not control economic activity
The three fundamental economic questions are solved
by the price mechanism (through demand and supply)
Adam Smith and Invisible Hand
Perfectly competitive market
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Command Economy
Also known as Centralized economy
The determination of What, How, For Whom goods &
services are produced is done by
a dictator or
a planning committee appointed by the dictator or
using a hierarchical organizational structure
State owns all the productive resources like land,
factories, financial institutions, etc
Authoritarian methods are used to determine resource
use and prices
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Mixed Economy
Most of the world economies use a mix of both
market and command systems
The government modifies (through taxes, subsidies,
etc.) and in some cases replaces (through direct control
of resources) the operation of price mechanism
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Economics A Social
Science
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Economics as a Social Science
What differentiate economists from other social
scientists?
Economic analysis is based on certain presupposition
about human behavior
Tries to understand why the world is what it is
Example (propositions enabling Law of Demand):
People prefer more to fewer;
people seek to maximize welfare by making reasonable and
consistent choices
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Developing Economic Theories
The real world of economic is very complex, therefore,
economists turn to theory
A theory is a set of abstractions about the real world
Economic theories are simplified models abstracted
from the complexity of the real world
Tries to explain observed behavior and make
predictions about the future
Assumption of Ceteris paribus (other things remain the
same)
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Positive and
Normative Economics
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Positive Economics
The scientific study of what is, what was and what
will be the economic relationships
Explanation and prediction (deals with actual
observed phenomena); can be proven right or wrong.

Example:
The inflation rate rises when the money supply is increased
What will be the impact of an import quota on foreign cars?
What will be the impact of an increase in the gasoline excise
tax?
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Normative Economics
What ought to be (deals with opinions and
recommendations); reflects value judgments.
Normative statements reflect subjective values. They
cannot be proved true or false.
Example:
The inflation rate should be lower.
The two can be hard to disentangle.
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Common Mistakes
Pitfalls to Avoid
in Economic Thinking
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Violation of the ceteris paribus condition.
Ceteris paribus is a Latin term meaning other things
constant.
When describing the effect of a change, the outcome
may be influenced by changes in other things.
Three Pitfalls
Association is not causation.
Statistical association alone cannot establish
causation.
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The fallacy of composition is the erroneous view
that what is true for the individual (or the part) is
also be true for the group (or the whole).
Microeconomics focuses on narrowly defined units,
while macroeconomics is focused on highly
aggregated units.
One must beware of the fallacy of composition when
shifting from micro-to macro-units.
Fallacy of composition
Three Pitfalls
Microeconomics
and
Macroeconomics
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Microeconomics and Macroeconomics
Microeconomics is the study of economics at the level
of the individual economic entity
Examples: the behavior of individual consumer,
individual firm, etc.
Macroeconomics deals with the sum of the behaviour
of all economic entities together (the economy as a
whole or about economic aggregates)
Examples: Study of national income (GDP),
employment, Inflation (price level), etc.
T.J. Joseph 26
Micro Vs. Macro
Microeconomics
Studies the economy at the level of individual
consumers, workers, firms, goods, and markets
Macroeconomics
Studies the economy at the aggregate level, at the
level of the economy as a whole.
Examines total consumer behavior, total
employment, total production, total sales, etc.
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Basic Concepts
Opportunity cost: the value of the highest-valued
alternative that must be forgone when a choice is
made. It is the evaluation of a trade-off.
Marginal benefits and costs: the benefits and
(opportunity) costs associated with one additional
unit of the good.
Decision Making
Decision-making is the main job of management
It involves evaluating various alternatives and
choosing the best among them
Decision making is done at the margin
Decision makers evaluate a fixed array of
alternatives.
Decision makers compare the marginal costs to
marginal benefits to determine the best alternative
This is economic decision making.
Questions for Thought
1. Which of the following are positive economic
statements and which are normative?
(a) The speed limit should be lowered to 55 miles per
hour on interstate highways to reduce the number
of deaths and accidents
(b) Higher gasoline prices cause the quantity of
gasoline that consumers buy to increase.
(c) A comparison of costs and benefits should not be
used to assess environmental regulations.
(d) Taxes on alcohol result in less drinking and driving.

Questions for Thought
1. Suppose Amy is a doctor who has records that need to
be entered. Doing this work herself would take 10
hours per week. She is contemplating hiring an
assistant could do the same work in 40 hours. If Amy
can make $80 per hour seeing patients, should she
hire the assistant at $10 an hour?
2. Do you make the food that you consume and the
clothing you wear for your self? Would modern living
standards be possible without trade?

References
1. Dominick Salvatore (DS): Principles of
Microeconomics, 5th edn., Oxford Higher Education.
2. Chapters 1 and 2 in William Boyes and Michael Melvin
(2009), Textbook of Economics, 6
th
edition, Biztantra
publications.