Basic Concepts of Economics –Notes- By SRB

Definition:

Economics is the study of the production, distribution, and consumption of goods and services.

Factors of Production in the economy:

Resources are the inputs used to produce outputs. Resources may include any or all of the
following:

 Land and other natural resources

 Labor (physical and mental)

 Capital, including buildings and equipment

 Entrepreneurship

Resources are combined to produce goods and services. Land and natural resources provide the
needed raw materials. Labor transforms raw materials into goods and services. Capital
(equipment, buildings, vehicles, cash, and so forth) are needed for the production process.
Entrepreneurship provides the skill and creativity needed to bring the other resources together to
produce a good or service to be sold to the marketplace.

Because a business uses resources to produce things, we also call these resources factors of
production. The factors of production used to produce a shirt would include the following:

 The land that the shirt factory sits on, the electricity used to run the plant, and the raw
cotton from which the shirts are made

 The laborers who make the shirts

 The factory and equipment used in the manufacturing process, as well as the money
needed to operate the factory

 The entrepreneurship skill used to coordinate the other resources to initiate the production
process and the distribution of the goods or services to the marketplace

The Questions Economists Ask

Economists study the interactions between households and businesses and look at the ways in
which the factors of production are combined to produce the goods and services that people
need. Basically, economists try to answer three sets of questions:

1. What goods and services should be produced to meet consumers’ needs? In what
quantity? When should they be produced?
 2. How should goods and services be produced? Who should produce them, and what
resources, including technology, should be combined to produce them?

3. Who should receive the goods and services produced? How should they be allocated
among consumers?

Common types of goods

Normal goods-

Law of demand states that if price of product increases demand for this kind of goods decreases,
other things remaining unchanged.

Law of supply states that if price of product increases supply for this kind of goods increases,
other things remaining unchanged.

Substitute goods-

The goods which can be consumed alternatively having similar utility are called substitute goods.
In this case, If price of a product increases, demand for its substitute increases. For example- Tea
and Coffee are considered to be substitute goods of each other in Economics.

Complementary goods-

The goods which are usually consumed together are called complementary goods. For example,
Tea and coffee; Bread and Butter etc.

Economic Systems

The answers to these questions depend on a country’s economic system—the means by

which a society (households, businesses, and government) makes decisions about allocating
resources to produce products and about distributing those products. The degree to which
individuals and business owners, as opposed to the government, enjoy freedom in making
these decisions varies according to the type of economic system. Generally speaking,
economic systems can be divided into two systems: planned systems and free market systems.

 Planned Systems

In a planned system, the government exerts control over the allocation and distribution of all
or some goods and services. The system with the highest level of government control
is communism. In theory, a communist economy is one in which the government owns all or
most enterprises. Central planning by the government dictates which goods or services are
produced, how they are produced, and who will receive them. In practice, pure communism
is practically nonexistent today, and only a few countries (notably North Korea and Cuba)
operate under rigid, centrally planned economic systems.
 Under socialism, industries that provide essential services, such as utilities, banking, and
health care, may be government owned. Other businesses are owned privately. Central
planning allocates the goods and services produced by government-run industries and try to
ensure that the resulting wealth is distributed equally. In contrast, privately owned companies
are operated for the purpose of making a profit for their owners. In general, workers in
socialist economies work fewer hours, have longer vacations, and receive more health care,
education, and child-care benefits than do workers in capitalist economies. To offset the high
cost of public services, taxes are generally steep. Examples of socialist countries include
Sweden and France.

 Free Market System

The economic system in which most businesses are owned and operated by individuals is
the free market system, also known as capitalism. As we will see next, in a free
market, competition dictates how goods and services will be allocated. Business is conducted
with only limited government involvement. The economies of the United States and other
countries, such as Japan, are based on capitalism.

Mixed Economy

Though it’s possible to have a pure communist system, or a pure capitalist (free market)
system, in reality many economic systems are mixed. A mixed market economy relies on
both markets and the government to allocate resources. We’ve already seen that this is what
happens in socialist economies in which the government controls selected major industries,
such as transportation and health care, while allowing individual ownership of other
industries. Even previously communist economies, such as those of Eastern Europe and
China, are becoming more mixed as they adopt capitalistic characteristics and convert
businesses previously owned by the government to private ownership through a process
called privatization.

Sectors of Indian Economy

Primary Sector

The primary sector in India is the sector which is largely dependant on the availability of natural
resources in order to manufacture the goods and also to execute various processes. The services
in this sector are entirely dependant on the availability of the natural resources in order to keep
the day-to-day operations running.

As we have the clear idea of this sector is, the best example to discuss in this sector is the
agriculture sector. The other examples in this sector include fishing and forestry, but agriculture
accounts for the largest in this sector.
One of the major problem that this sector faces is the underemployment and the disguised
employment. Underemployment accounts for the workers not working to the best of their
capabilities while the latter accounts for the workers not working to their true potential.

As a solution to the problems, the state, as well as the national government, can increase the
funds for the irrigation facilities and provide loans for buying high-quality seeds and fertilizers.

Secondary Sector

The economy in the sector is dependent on the natural ingredients which are used to create the
services and products offered and which at the end are used for consumption. In terms of value
added to the products and services, this sector is the best sector. The major examples that fall
under this category are transportation and manufacturing.

Both these sectors end product is the consumption by the people. This sector is responsible for
the employment of almost 14 percent of the entire workforce currently working in India. The
secondary sector also contributes to almost 28 percent of the share of GDP. This sector is the
backbone of Indian economy and there are more development and growth in the near future.

Tertiary Sector

This sector contributes the largest in terms of share in GDP in India. The sector is also the
service sector and is important when you consider the development of the other two sectors. Like
the previous sector, this sector also adds the value to the products. This sector is responsible for
employing 23 percentage of the workforce out of the total workforce currently working in India.

The example of this sector is all service sectors which IT services, consulting, etc. This sector
contributes to almost 59 percent of the total share of GDP. The main problems that this sector
consists, is that the jobs here involve lower salaries thereby do not attract much employment.
And this remains the future dilemma as India is looking for double-digit growth in the near
future.

Common Types of Market Structures

Perfect Competition

Perfect competition occurs when there are a large number of small companies competing against
each other. They sell similar products (homogeneous), lack price influence over the
commodities, and are free to enter or exit the market.

Consumers in this type of market have full knowledge of the goods being sold. In the real world,
the pure form of this type of market structure rarely exists. However, it is useful when comparing
companies with similar features. This market is unrealistic as it faces some significant criticisms
described below.
  No incentive for innovation: In the real world, if competition exists and a company
holds a dominant market share, there is a tendency to increase innovation to beat the
competitors and maintain the status quo. However, in a perfectly competitive market, the
profit margin is fixed, and sellers cannot increase prices, or they will lose their customers.

 There are very few barriers to entry: Any company can enter the market and start
selling the product. Therefore, incumbents must stay proactive to maintain market share.

Monopoly

 In a monopoly market, a single company represents the whole industry. It has no

competitor, and it is the sole seller of products in the entire market. This type of market is
characterized by factors such as the sole claim to ownership of resources, patent and
copyright, licenses issued by the government, or high initial setup costs.
 All the above characteristics associated with monopoly restrict other companies from
entering the market. The company, therefore, remains a single seller because it has the
power to control the market and set prices for its goods.

Monopolistic Competition

Monopolistic competition refers to an imperfectly competitive market with the traits of both the
monopoly and competitive market. Sellers compete among themselves and can differentiate their
goods in terms of quality and branding to look different. In this type of competition, sellers
consider the price charged by their competitors and ignore the impact of their own prices on their
competition.

When comparing monopolistic competition in the short term and long term, there are two distinct
aspects that are observed. In the short term, the monopolistic company maximizes its profits and
enjoys all the benefits as a monopoly.

Oligopoly

An oligopoly market consists of a small number of large companies that sell differentiated or
identical products. Since there are few players in the market, their competitive strategies are
dependent on each other.

For example, if one of the actors decides to reduce the price of its products, the action will
trigger other actors to lower their prices, too. On the other hand, a price increase may influence
others not to take any action in the anticipation consumers will opt for their products. Therefore,
strategic planning by these types of players is a must.

In a situation where companies mutually compete, they may create agreements to share the
market by restricting production, leading to supernormal profits. This holds if either party honors
the Nash equilibrium state or neither is tempted to engage in the prisoner’s dilemma. In such an
agreement, they work like monopolies. The collusion is referred to as cartels.