INTRODUCTION TO

ECONOMICS

BINDIYA NAIK
WHAT IS ECONOMICS? RELATED TO
MONEY

RELATED TO
POLICIES

RELATED TO
STOCKS

RELATED TO
TAXES
 SCOPE
(i) What is the subject matter of economics?

Adam smith : defined economics as a subject, which is mainly concerned with the study of nature and causes of
generation of wealth of nation.

Alfred Marshall : . According to Marshall; economics is a study of mankind in the ordinary business of life. It
examines that part of individual and social actions which is closely connected with the material requisites of well being.

Lionel Robins: “economics is a science which studies human behaviour as a relationship between ends and scarce
means which have alternative uses”.
DEFINITION

 Paul Samuelson : “Economics is the study of how men and society choose, with or

without the use of money, to employ scarce productive resources which could have

alternative uses, to produce various commodities over time and distribute them for

consumption now and in the future amongst various people and groups of society”.
 NATURE OF ECONOMICS
ART OR SCIENCE
It is based on
systematic study
of knowledge or
facts;

It has a scale of It develops

measurement. correlation-ship
between cause
and effect;

It can make All the laws are

future universally
predictions; accepted

All the laws are

tested and based
on experiments;
POSITIVE OR NORMATIVE
• The rising price of crude oil on world markets will lead to an increase in cycling to work

• A rise in average temperatures will increase the demand for sun screen products.

• The government should increase the minimum wage to £7 per hour to reduce poverty.

• The government is right to introduce a ban on smoking in public places.

• The U.S should enact price regulations to control the cost of prescription drugs.

• Enacting price controls on prescription drugs will result in fewer new drugs being developed.

• The U.S should allow the re-importation of prescription drugs from Canada.
MICROECONOMICS
The word ‘Micro’ means small.
Microeconomics is a study of particular households,
particular firms, particular industries, particular
commodities, particular prices etc
The objective of microeconomics is to maximize
utility or maximization of profit or minimization of
cost.
The basis of microeconomics is the price mechanism
which operates with the help of demand and supply
forces.
Microeconomics is based on the assumption of
‘ceteris paribus’
MACROECONOMICS
‘Macro’ means large.
Macroeconomics deals with aggregate of these
quantities, not with individual incomes but with the
national income, not with individual prices but with
the price level, not with individual output but with
the national output.
objectives of macroeconomics are full employment,
price stability, economic growth, favorable balance
of payments etc.
the bases of macroeconomics are the national
income, output, employment and the general price
level which are determined by aggregate demand and
aggregate supply.
But macroeconomics uses the technique of general
equilibrium analysis
Microeconomics vs. Macroeconomics
 METHODOLOGY OF ECONOMICS

DEDUCTIVE INDUCTIVE
 Deductive Method
Steps of deductive methods

 Selecting the problem

 Formulating Assumptions

 Formulating hypothesis

 Testing of hypothesis

 Merits

 (i) This method is near to reality. It is less time consuming and less expensive.

 (ii) The use of mathematical techniques brings exactness and clarity in economic analysis.

 (iii) There being limited scope of experimentation, the method helps in deriving economic theories.

 (iv) The method is simple because it is analytical.
 DEMERITS OF DEDUCTIVE METHOD

 Based on wrong assumptions

 Universal applicability – a myth

 Inadequate data

 Difficulty in testing the conclusions

INDUCTIVE METHOD
Steps

 Observation.

 Data

 Formation of hypothesis.

 Generalization.

 Verification.
 Merits
 It is based on facts as such the method is realistic.
 In order to test the economic principles, method makes use of statistical techniques. The inductive method
is, therefore, more reliable.
 Inductive method is dynamic. The changing economic phenomenon are analyzed and on the basis of
collected data, conclusions and solutions are drawn from them.
 Induction method also helps in future investigations.
 Valuable to Government

Demerits
 If conclusions drawn from insufficient data, the generalizations obtained may be faulty.
 The collection of data itself is not an easy task.
 The inductive method is time-consuming and expensive.
 Limited applicability
Economic concepts

 Scarcity

 Choices

 Trade -offs

 Opportunity cost

 Utility

 Externalities
Choices- a consequence of scarcity

TRADE-OFFS

LIMITED
RESOURCES, OPPORTUNITY
CHOICES
GOODS/SERVI COST
CES

UNLIMITED
WANTS

https://www.youtube.com/watch?v=w_PSNoUWibg
TRADE-OFFS

 DEFINITION:A trade-off involves a sacrifice that must be made to get a certain product or
experience. A person gives up the opportunity to buy 'good B,' because they want to buy
'good A' instead.
OPPORTUNITY COST

 Definition: An opportunity cost is the economic concept of potential benefits that a company
gives up by taking an alternative action.

 Opportunity costs are fundamental costs in economics, and are used in computing cost benefit
analysis of a project

 Such costs, however, are not recorded in the account books but are recognized in decision
making .
UTILITY

 DEFINITION: Utility is a term used by economists to describe the

measurement of "useful-ness" that a consumer obtains from any good. Utility
is the want satisfying power of any commodity or capacity of a commodity to
give satisfaction

 utility is measured in terms of money and it is relative.

 There is difference between utility and usefulness.

 Utility depends upon the intensity of want.

EXTERNALITIES

 Definition: Externalities are the positive or negative economic impact of

consuming or producing a good on a third party who isn’t connected to the
good, service, or transaction. In other words, they are unforeseen
consequences to economic activities.

 When the production or the consumption of a good or a service proves

beneficial to a third party, then it is a positive externality.

 when the production or the consumption of a good or a service is

detrimental to a third party, then it is a negative externality.
CONCEPTS

 OPTIMIZATION - Finding an alternative with the most cost effective or highest achievable
performance under the given constraints, by maximizing desired factors and minimizing
undesired ones. In comparison, maximization means trying to attain the highest or maximum
result or outcome without regard to cost or expense.

 MARGANALISM - generally includes the study of marginal theories and relationships within
economics. The key focus of marginalism is how much extra use is gained from incremental
increases in the quantity of goods created, sold, etc. and how these measures relate to
consumer choice and demand.
CONCEPTS

 SHORT RUN - [in economics] is a period of time in which the quantity of at least one

input is fixed and the quantities of the other inputs can be varied.

 LONG RUN - is a period of time in which all factors of production and costs are variable.

In the long run, firms are able to adjust all costs, whereas, in the short run, firms are

only able to influence prices through adjustments made to production levels.

APPLICATIONS OF MICROECONOMICS

 FACILITATES UNDERSTANDING OF THE WORKING OF AN ECONOMIC SYSTEM

 PROVIDES BASIS FOR PREDICTING FUTURE ECONOMIC EVENTS

 PROVIDES GUIDELINES FOR POLICY FORMATION

 HELPS IN BUSINESS DECISION MAKING

 PROVIDES GUIDANCE FOR WELFARE MAXIMIZATION

FACTORS OF PRODUCTION
 Land:

 Land includes all natural physical resources – e.g. fertile farm land, the benefits from a temperate climate
or the harnessing of wind power and solar power and other forms of renewable energy.

 Some nations are richly endowed with natural resources and then specialize in the their extraction and
production

Labor:

 Labor is the human input into production e.g. the supply of workers available and their productivity

 An increase in the size and the quality of the labor force is vital if a country wants to achieve growth. In
recent years the issue of the migration of labor has become important. Can migrant workers help to solve
labor shortages? What are the long-term effects on the countries who suffer a drain or loss of workers
through migration?
Capital:
Capital goods are used to produce other consumer goods and services in the future
Fixed capital includes machinery, equipment, new technology, factories and other buildings
Infrastructure – a crucial type of capital

Entrepreneurship

Regarded by some as a specialized form of labor input

An entrepreneur is an individual who supplies products to a market to make a profit
Entrepreneurs will usually invest their own financial capital in a business and take on the risks. Their main
reward is the profit made from running the business
THE ECONOMIC PROBLEM

 WHAT TO PRODUCE

 HOW TO PRODUCE

 FOR WHOM TO PRODUCE

 PRODUCTION POSSIBILITY FRONTIER

 A production possibility frontier (PPF) is a curve depicting all maximum output possibilities for two
goods, given a set of inputs consisting of resources and other factors. The PPF assumes that all inputs
are used efficiently.
GOODS/ GUNS SUGAR
A 100 0
X-AXIS

PRODUCTION OF B 0 200
E
GUNS C C 80 40
A D 40 80
F
D
G
Y-AXIS
0 B
PRODUCTION OF SUGAR
What could increase the PPF?

-  natural resources found

-  population (labour)

-  technology

-  infrastructure for production

CIRCULAR FLOW OF INCOME

A Simplified Version
RESOURCES

WAGES AND SALARIES

Households Businesses

EXPENDITURES

FINISHED GOODS
CIRCULAR FLOW OF INCOME – 2 SECTOR MODEL

Households
are where you find
regular people who
work and consume in
our economy
Households Firms
are the businesses that
produce, employ us,
and purchase in our
economy
 Factor
Market

The factor market

is where the four
factors of
production are
bought and sold.

Households Firms
The Factor Market
Four Factors Factor
Market

Households
contribute their
land, labor, skills,
and capital to the
factor marker.

Households Firms
 Four Factors Factor Four Factors

Market

Those things are

put to use in firms.

Households Firms
The Product Market
Four Factors Factor Four Factors

Market

The product
market is where
firms sell their
goods and
services and
people buy them.
Households Firms

Product
Market
 Four Factors Factor Four Factors

Market

Firms send those

goods and
services into the
Households market.
Firms

Product
Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Market

The goods and

services go back
into households.
Households Firms

Product
Purchased Goods and Services Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Market Wages and Salaries

Meanwhile, firms
put money back
into the factor
market in the form
Households of wages and Firms
salaries.

Product
Purchased Goods and Services Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Income
Market Wages and Salaries

This money is the

income
households earn.

Households Firms

Product
Purchased Goods and Services Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Income
Market Wages and Salaries

Households spend
this money on
goods and
services

Households Firms

Expenditures
Product
Purchased Goods and Services Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Income
Market Wages and Salaries

And businesses
earn revenue.

Households Firms

Expenditures Revenue
Product
Purchased Goods and Services Market Goods and Services To Be Sold
 Four Factors Factor Four Factors

Income
Market Wages and Salaries

Households Firms

Expenditures Revenue
Product
Purchased Goods and Services Market Goods and Services To Be Sold
THREE SECTOR MODEL
THE MARKET FORCES:DEMAND AND SUPPLY

 MARKET DEFINITION:

“ A market is a mechanism by which buyers and sellers interact to determine the price and exchange

of a good or service. The buyers and sellers may be individuals, firms, factories, dealers and agents. The

buyers constitute the demand side and the sellers constitute the supply side of the market.”

Samuelson and Nordhaus (1995)

FEATURES

 A market need not be situated in a particular place or a locality.

 Buyers and need not come in personal contact with each other .

 The word “market” may refer to a good or a service or to a geographical area.

 Nature of goods and services- commodity market and factor market

 Number of firms and degree of competition- competitive, monopolistic, oligopoly or monopoly

market
THE DEMAND SIDE OF THE MARKET

MEANING:
DEMAND= DESIRE+ABILITY+WILLINGNESS

DEMAND

Individual demand Market demand

LAW OF DEMAND

 “ All other things remaining constant, the quantity demanded

of a commodity increases when its price decreases and the

demand decreases when its price increases.”

There is an inverse relationship between price and quantity
demanded, other things remaining the same.

Law of demand expresses the functional relationship

D = f(P)
where,
P is price and
D is quantity demanded of a commodity
 ASSUMPTIOMS

This law will be applicable only if the below mentioned points are fulfilled.

 No change in price of related commodities.

 No change in income of the consumer.

 No change in taste and preferences, customs, habit and fashion of the consumer.

 No change in size of population

 No expectation regarding future change in price.

THE DEMAND SCHEDULE
 Tabular representation of quantity demanded at various prices per unit of time.

PRICE (IN RS) QUANTITY DEMANDED

800 8
600 15
400 30
300 40
200 55
100 80
DEMAND CURVE

 Graphical presentation of the demand schedule

 Negative slope

 Slopes to the right

 Inverse relationship
FACTORS AFFECTING LAW OF DEMAND

 INCOME EFFECT
- Purchasing power/real income

 SUBSTITUTION EFFECT
- Price of substitutes
- Normal goods

 DIMINISHING MARGINAL UTILITY

- Maximizing satisfaction
- Utility of money
EXCEPTIONS TO THE LAW OF DEMAND

 Expectations regarding future prices

 Prestigious goods/Veblen goods

 Giffen goods

 necessities
MOVEMENT OF THE DEMAND CURVE

 Movement along the demand curve depicts the change in both the factors i.e. the

price and quantity demanded, from one point to another, Other things remain

 Contraction of demand: in essence, a fall in demand is observed due to price rise.

 Extension of demand: It shows expansion in demand, i.e. demand for the product or

service goes up because of the fall in prices.

SHIFTS IN THE DEMAND CURVE

 The position of the demand curve will shift to the left or right

following a change in an underlying determinant of demand.

 Increase in demand

 Decrease in demand
MARKET DEMAND

 Definition: The total quantity that all the individuals are willing to and are
able to buy at a given price, other things remaining the same is called as
Market Demand. In other words, Market Demand refers to the sum of
individual demands for a product at a given price per unit of time.
 MARKET DEMAND SCHEDULE

Individual Demand for good X

Price per unit
Market Demand
A B C
of X

15 2 3 1

10 4 5 4

8 6 8 6

4 7 9 9
DETERMINANTS

 Price of substitutes and complementary goods

 Consumers income and Engel curves

- Essential goods

- Normal hoods

- Inferior goods

- Prestige and luxury goods

 Consumers tastes and preferences

 Utility maximizing behaviour

 Consumers expectations

 Demonstration effect

 Consumer-credit facility

 Population of the country

 Distribution of N.I
TYPES OF DEMAND FUNCTION

 Linear demand function: ∆d/∆p remains constant

 Curvilinear demand function : ∆d/∆p changes

 Dynamic demand function: Other independent variables are included

Dx=f(Px, Y, W, Py, Pc, T, A, FP)

 SUPPLY SIDE OF THE MARKET
 Supply:

The quantity of a commodity which its producers or sellers offer for sale at a given price per unit

of time. Other things remaining constant

 Market Supply:

The sum of supply of a commodity made by all individual firms or suppliers

 Law of Supply:

The supply of a product increases with the increase in its price and decreases with decrease in its

price, other things remaining constant

THE SUPPLY SCHEDULE

PRICE IN ₹ SUPPLY
100 10
200 35
300 50
400 60
600 75
800 80
THE SUPPLY CURVE

 Direct/positive relationship with price

 Has a positive slope

 Upward sloping
SHIFT IN THE SUPPLY CURVE

 Change in input prices

 Technological progress

 Product diversification and cost reduction

 Nature and size of the industry

 Government policy

 Non-economic factors
SUPPLY FUNCTION

 Q𝜘=dp𝜘

 Q= quantity supplied

 𝜘 = Commodity

 P𝜘= Price of commodity 𝜘

 d = Measure of relationship between Q𝜘 and P𝜘

MARKET EQUILIBRIUM: EQUILIBRIUM OF
DEMAND AND SUPPLY

 Refers to a state of market in which demand for a commodity equals the supply of the

commodity.

 Equilibrium price: in a free market is the price at which quantity demanded is equal to

quantity supplied

 Market- clearing price

 DETERMINATION OF EQUILIBRIUM PRICE

 Free market
 Disequilibrium itself creates a condition for equilibrium
 Demand and supply schedule

Price per shirt ₹ Demand supply Market position Effect on price

100 80 10 Demand exceeds supply Rise

200 55 28 Demand exceeds supply Rise
300 40 40 Equilibrium Stable
400 28 50 Supply exceeds demand Fall
500 20 55 Supply exceeds demand Fall
600 15 60 Supply exceeds demand Fall
Market mechanism and Market
equilibrium
Shift in demand and supply curve and market equilibrium

 Shift in demand curve

 Shift in supply curve

 Parallel shift in demand and supply curves

 Stability of market equilibrium:

- Static and Dynamic economy

- Market equilibrium under dynamic conditions : the cobweb theorem

1. Cobweb theorem I: stable equilibrium under dynamic conditions (convergent)

2. Cobweb theorem II: Unstable equilibrium under dynamic conditions (divergent)

3. Cobweb theorem III: Undamped oscillating equilibrium (continuos)

 ELASTICITY OF DEMAND AND SUPPLY

Elasticity of demand refers to the degree of responsiveness of demand and supply of a product
to the change in its price

Applications:

 Price determination of public utilities e.g: transport and medical services

 Fixing prices of essential goods, food grains and medicines

 Determination of rates of commodity taxes

 Determination of import and export duty

DEGREES OF ELASTICITY OF DEMAND

 Infinite or Perfect Elasticity of Demand: Elasticity of demand is infinity when even a

negligible fall in the price of the commodity leads to an infinite extension in the demand
for it.
 Perfectly Inelastic Demand: howsoever great the rise or fall in the price of the commodity in question, its
demand remains absolutely unchanged.

 Relatively Elastic Demand: Demand is said to be very elastic when even a small change in the price of a
commodity leads to a considerable extension/contraction of the amount demanded of it.

 Relatively inelastic demand: When even a substantial change in price brings only a small
extension/contraction in demand, it is said to be relatively inelastic or less elastic.
 Unitary elastic demand: The demand for a good is unitary elastic if a change
in the price of that good causes an equal change in quantity demanded. In
other words, the elasticity is equal to 1.
TYPES OF ELASTICITY

 Price elasticity of demand

 Income elasticity of demand

 Cross- elasticity of demand

 PRICE ELASTICITY OF DEMAND
 Defined as degree of responsiveness of demand for a commodity to the
change in its price.

 Ep= percentage change in the quantity demanded

percentage change in the price

The Arc and point elasticity

Elasticity varies along the demand curve

Ep= Q2-Q1 *100
Q1
P2-P1 *100
P1

Ep= ∆Q
Q1
∆P
P1

Ep = ∆Q * P1
∆P Q1
EXAMPLES

 When the price of CD increased from $20 to $22, the quantity of

CDs demanded decreased from 100 to 87.

What is the price elasticity of demand for CDs?

 Price rises from $15 to $30 (100% rise in price)

 Quantity falls from 100 to 80 (20% fall)

Example of Difference between Point and Arc Elasticity A
to B
ARC ELASTICITY

Ep= ∆Q
Mid point

∆P

Mid point
INCOME ELASTICITY
 Responsiveness of demand to change in consumers income is known as income
elasticity of demand
 ED= Percentage change in quantity demanded
Percentage change in income

 Ep = ∆Qx* Yx
∆Yx Qx
Nature of commodity and income elasticity
Necessities e<1
Comforts e=1
Luxuries e>1
CROSS ELASTICITY

 Measure of responsiveness of demand for a commodity to the changes in price

of its substitutes and complementary goods.
 ED= Percentage change in demand for Q1
Percentage change in Price of substitute
e.g. cross elasticity of demand for tea= percentage change in demand for tea
percentage change in price of coffee
 Ep = ∆Qt* Pc
 ∆Pc Qt
PRICE ELASTICITY OF SUPPLY

 Measure of responsiveness of quantity supplied of a product to a change in its

market price
 ES= Percentage change in Quantity supplied
Percentage change in Price
 Es = ∆Q * P1
 ∆P Q1
DETERMINANTS OF PRICE ELASTICITY OF SUPPLY

 TIME PERIOD
Very short period- supply is inelastic and fixed
Long run period- supply is elastic

 LAW OF DIMINISHING RETURNS

 Stages of production