INTRODUCTION

Economics
It is a subject matter, which deals with alteration of scarce resources in such a
way so that consumer can get maximum satisfaction, producer can get maximum
profit and society can get maximum welfare.
OR
It 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.

Economy
A system which provides people the means to work and earn living is called
economy.

Process of an Economy
a. Production
b. Consumption
c. Investment or Capital Formation

Scarcity
It refers to the limitation of supply in relation to its demand (DD>SS)
Economic Problem
It is a problem of choice involving satisfaction of unlimited wants out of limited
resources having alternative uses.

LIMITED
RESOURCES

UNLIMITED
WANTS

ALTERNATIVE
USES
Reasons for Economic Problem
a. Scarcity of Resources
Resources like land, labour, capital are limited in relation to its demand and
economy does not produce all what people wants. There would be no problem
if resources were not scarce.
b. Unlimited Human Wants
Human wants are never ending. As soon as one want is satisfied another want
emerges. Every human want are different in priorities. Some are more
important than other. Due to this reason people allocate their resources in
order to preference to satisfy their wants.
c. Alternate uses
Resources are not only scarce but also put to many uses. It means choice
among the resources is very important. For e.g. Milk.
Economizing of resources
It refers to making optimum use of the available resources

POSITIVE

Studies the facts what was, what not give

of life is, what will value

NORMATIVE
Studies what
are desirable what ought to gives value
and undesirable
 MICRO ECONOMICS MACRO ECONOMICS

Studies economy as a
Studies individual unit whole

determines income
determines price of a
and employment level
commodity
of the economy

assumes all macro assumes all micro

variables are constant variables are constant

eg. individual demand, eg. aggregate demand,

individual supply aggregate supply

Central Problems of an Economy

1. What to Produce
The problem involves selection of goods and services to be produced and the
quantity of each selected good to be produced. There is problem of allocation
of resources among different good.
The problem of what to produce has two different aspects:
a. What possible commodities to be produced
An economy has to decide whether to produce war time good like gun, gun
powder or civil goods like bread, butter.
 b. How much to be produced
After deciding the goods to be produced economy has to decide the
quantity of each commodity.
Guiding principle
Allocate the resources in a manner which gives maximum aggregate
satisfaction.
2. How to Produce
This problem refers to selection of technique of production of goods and
services. Techniques are classified as:
a. Labour intensive technique
In which more of labour and less of capital is used. E.g. India.
b. Capital intensive technique
In which more of capital and less of labour is used. E.g. U.S.A.
Guiding Principle
Combine factors of production in such a manner so that maximum output is
produced at minimum cost using least possible scare resources.
3. For Whom to Produce
This problem relates to the distribution of 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. Thus a problem of choice arises.
The problem can be catergorised under two main heads:
Guiding Principle
Ensure that urgent wants of each productive factors are fulfilled to the
maximum possible extend.
 Opportunity Cost
The value of next best alternate use of a commodity
OR
The value of the benefit is sacrificed by choosing an alternative.
For example, suppose you have Rs. 50,000 and you want to purchase LED T.V. and
laptop with only Rs. 50,000 in hand. You cannot purchase both. If you desire to
purchase laptop the opportunity cost of choosing the laptop is the cost of the
forgone satisfaction from LED T.V.

Marginal Opportunity Cost

It is the loss of one commodity when shifting resources from one good to another
produces one more unit of another commodity.
MOC= Unit of one good sacrificed/Unit of other good gained

Production Possibility Curve (PPC)

Graphical presentation of various combinations of two goods that can be produced
with available technology and resources assuming effective and efficient utilization
of resources is called PPC.

Assumptions
1. No change in technology.
2. No change in resources.
3. Resources are fully and efficiently utilized.
Characteristics of PPC
The two basic characteristics or features of PPC 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 changes 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
opportunity costs, i.e. more and more units of one
commodity are sacrificed to gain an additional unit of
another commodity.
 In the given example, units of guns sacrificed keep on
increasing each time to increase production of one unit
of butter. Due to increasing marginal opportunity cost,
PPF becomes more and more steep as we move from
points A to G. Technically, a curve with an outward
bend is described as ‘Concave to the Origin’.

Reasons for Rightward Shift in PPC

1. More training of employees, enabling them to be more productive
2. Greater investment in in capital goods such as machines and equipment
3. An increase in the population size, for example, through immigration
4. Improvements in technology, providing better ways of doing things
5. Discovery of new resources.
Overview of ppf:

 PPF slopes downwards as increase in production of one good requires decrease

in production of the other.
 PPF is concave due to increasing Marginal rate of transformation.
 PPF shows transformation of one good into another not physically but by
diverting resources from one use to another use.
 PPF shows maximum available possibility.
 If an economy operates on PPF (Point A, B, C) it means resources are fully
and efficiently utilized.
 Economy cannot operate at any point outside the PPF (Point E) as it is
unattainable with the available productive capacity.
 An outward shift in PPF from PP to P1P1 means the economy can produce
more of both the commodities which was not possible earlier.
 An inward shift in PPF from PP to P2P2 means that the economy’s capacity to
produce both the commodities has reduced.
Concepts of Demand and Supply
Demand
Quantity of the good that buyers are willing and able to purchase at different
prices is called Demand.
Factors Affecting Demand
 Price of the Own Commodity
Price and quantity demanded of a commodity are inversely related. If price of a
commodity rises, its quantity demanded falls and vice versa. The logic behind this
inverse relation is that rise in the price of the commodity lowers the purchasing
power of the consumer and this therefore discourages him to increase his
consumption.
Price of Related Goods
Goods can be related to each other as substitutes or complementaries.
Substitute goods: These are the goods that can be used alternatively. For example:
tea and coffee, pepsi and coke, etc.
Imagine a rise in the price of tea. What will be its impact on the quantity demanded
for coffee? A rise in the price of tea means consuming tea becomes expensive to the
consumer and thus he may want to shift to some other cheaper alternative, that is,
tea. Therefore higher price for tea lowers its quantity demanded but increases the
quantity demanded for coffee.
Hence, we observe a direct relation between price and quantity demanded for
substitute goods.
Complementary goods: These are the goods that are used simultaneously to satisfy
a common purpose. For example: car and petrol.
Imagine a rise in the price of petrol. What will be its impact on the quantity
demanded of car? A rise in the price of petrol means driving cars now become
costlier to the consumer. The consumer might prefer travelling by public means of
transport or any other means. This therefore lowers the quantity demanded for cars.
Hence, we observe an inverse relation between price and quantity demanded for
complementary goods.
Income of the Consumer
The relation between income and quantity demanded of a good depends upon the
nature of the good.
There is a direct relation between income and quantity demanded for normal goods,
but an inverse relation exists between the two in case of inferior goods.
The logic behind this relation is that with rise in income the consumer is able to
save some money and consume more of a better quality good (normal good) than
inferior good.
Tastes and Preferences
Developing favourable tastes and preferences towards a commodity increases its
quantity demanded. For example: people have developed favourable tastes and
preferences towards colour television relative to black and white televisions. So the
quantity demanded for colour television rises relative to black and white televisions.
Role of Expectations
Expecting a rise in the prices in future motivates the consumer to increase his
consumption in present and vice versa.
Law of Demand
It is a statement which says that quantity demanded of any good is inversely
proportional to the prices, keeping all other things/factors constant.
Properties of Law of Demand
• One sided
Law of demand explains the effect of change in quantity demanded due to
change in price but it does not tell us the change in price caused due to
change in quantity demanded. Hence it operates one sidedly only.
• Qualitative but not quantitative
Law of demand is a qualitative statement. It tells us only the direction of
change in quantity demanded due to change in price but not the magnitude of
change in demand due to change in price.
Exceptions to Law of Demand
 Necessary goods: These are the goods essential for survival to a person. These
can be medicines or drugs. Even when prices of such commodities rise, the
consumer still buys it rather than reducing his demand. Law of demand does
not operate in this case.
 Highly luxurious goods: These are some goods demanded by the super wealthy
people. It could be a private chopper or any other luxurious good. If they
experience a price rise, the consumer would still want it. Hence, law of
demand does not operate in this case.
 Giffen goods: (As explained earlier)

 Fashion-related goods
Goods related to fashion do not follow law of demand and their demand
increases even with a rise in their prices. For example: If any particular type
of dress is in fashion, then demand for such dress will increase even if its
price is rising.
Supply
Quantity of a good that the seller/producer is willing to sell at different prices in
the market is called Supply.
Factors affecting supply
 Price of the Commodity
The price and quantity supplied for a commodity are directly related. It
means, as price rises, the quantity supplied of the given commodity also rises
and vice versa. It happens because at higher prices, there are greater chances
of making profit. This induces the firm to offer more for sale in the market.
 Prices of other goods
Increase in the prices of other goods, makes them more profitable in
comparison to the given commodity. As a result, firm shifts its limited
resources from production of given commodity to production of other goods.
For example: increase in the price of other good (say, wheat) will induce the
farmer to use land for cultivation of wheat in place of the given commodity
(say, rice).
 Prices of factors of production (inputs)
When amount payable to factors of production and cost of inputs increases,
the cost of production also increases. This decreases the profitability. As a
result, seller reduces the supply of the commodity. On the other hand,
decrease in prices of factors of production, increases the supply due to fall in
the cost of production and subsequent rise in profit margin.
 State of Technology
Technological changes influence the supply of a commodity. Advanced and
improved technology reduces the cost of production, which raises the profit
margin. It induces the seller to increase the supply.
 Government Policy (Taxes and subsidy)

Increase in taxes raises the cost of production and thus reduces the supply,
due to lower profit margin. On the other hand, subsidies increase the supply
as they make it more profitable for the firms to supply goods.
 Law of Supply
It is a statement which says that quantity supplied of any good is directly related
to the price of the own good, keeping other factors constant.

Changes in Demand and Supply

When changes in demand and supply occur due to price alone, it is called
expansion and contraction of demand and supply.
When changes in demand and supply happen due to factors other than price, it is
called increase and decrease in demand and supply.
Expansion of demand: When quantity demanded of a commodity rises due to fall
in the price of the commodity alone, it is called expansion of demand. It is shown
by a downward movement along the demand curve.
Contraction of demand: When quantity demanded of a commodity falls due to rise
in the price of the commodity alone, it is called contraction of demand.
Increase in demand: When demand for a commodity rises due to factors other
than price, it is called increase in demand.

Decrease in demand: When demand for a commodity falls due to factors other
than price, it is called decrease in demand.
Expansion of supply: When quantity supplied of a commodity rises due to rise in
the price of the commodity alone, it is called expansion of supply.
Contraction of supply: When quantity supplied of a commodity falls due to fall in
the price of the commodity alone, it is called contraction of supply.

Increase in supply: When supply for a commodity rises due to factors other than
price, it is called increase in supply.
Decrease in supply: When supply for a commodity falls due to factors other than
price, it is called decrease in supply.
Market Equilibrium
Equilibrium means a state of balance or a state of rest. A market is said to be in
equilibrium when demand of a good equals its supply, that is, there should be
neither excess demand nor excess supply of any good in the market.