Introduction to Economics

1.1
MNIT
 Why study Economics?
• What kinds of questions does economics
address?
• What are the principles of how people make
decisions?
• What are the principles of how people
interact?
• What are the principles of how the economy
as a whole works?
 What Economics Is All About
▪ Scarcity refers to the limited nature of society’s
resources.
▪ Economics is the study of how society manages
its scarce resources, including
• how people decide how much to work, save, and
spend, and what to buy
• how firms decide how much to produce, how many
workers to hire
• how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
Ten Principles of Economics
 HOW PEOPLE MAKE DECISIONS
• Decision making is at the heart of economics.
• The first four principles deal with how people
make decisions.
 How People Make Decisions
PRINCIPLE #1: People face trade-offs

“To get one thing that we like, we usually have to give up another thing that
we like. Making decisions requires trading off one goal against another.”

• Example:
• Going to a party the night before your midterm leaves less time for
studying.
• Protecting the environment requires resources that might otherwise be
used to produce consumer goods.
 How People Make Decisions
PRINCIPLE #1: People face trade-offs
• Society faces an important tradeoff:
efficiency vs. equity
• efficiency: getting the most out of scarce resources
• equity: distributing prosperity fairly among society’s
members
• Tradeoff: To increase equity, can redistribute income
from the well-off to the poor.
• But this reduces the incentive to work and produce,
and shrinks the size of the economic “pie.”
 How People Make Decisions
PRINCIPLE #2: The cost of something is what you give up to get it

• Making decisions requires comparing the costs and benefits of

alternative choices.
• The opportunity cost of any item is whatever must be given
up to obtain it.
• It is the relevant cost for decision making.
Example:
The opportunity cost of…
• …going to college for a year is not just the tuition, books, and
fees, but also the foregone wages.
• …seeing a movie is not just the price of the ticket, but the
value of the time you spend in the theater.
 How People Make Decisions
PRINCIPLE #3: Rational people think at the margin.

• Many decisions are not “all or nothing,” but involve marginal changes –
incremental adjustments to an existing plan
• Evaluating the costs and benefits of marginal changes is an important part
of decision making
• As you study economics, you will encounter firms that decide how many
workers to hire and how much of their product to manufacture and sell to
maximize profits.
• You will also encounter individuals who decide how much time to spend
working. So people analyse incremental (marginal) change to take
decisions.
 How People Make Decisions
PRINCIPLE #4: People respond to incentives

• incentive: something that induces a person to

act, i.e. the prospect of a reward or punishment.
• Rational people respond to incentives because
they make decisions by comparing costs and
benefits. Examples:
• In response to higher gas prices-sales of “hybrid”
cars rise.
• In response to higher cigarette taxes, teen
smoking falls.
 HOW PEOPLE INTERACT

An “economy” is just a group of people

interacting with each other.
The next three principles deal with how people
interact.
 HOW PEOPLE INTERACT
PRINCIPLE #5: Trade can make everyone better off

• Rather than being self-sufficient, people can

specialize in producing one good or service and
exchange it for other goods
• Countries also benefit from trade &
specialization:
– get a better price abroad for goods they produce
– buy other goods more cheaply from abroad than could be
produced at home
 HOW PEOPLE INTERACT
PRINCIPLE #6: Markets are usually a good way to
organize economic activity
• A market is a group of buyers and sellers.
• “Organize economic activity” means determining
– what goods to produce
– how to produce them
– how much of each to produce
– who gets them
• In a market economy, these decisions result from the interactions of many
households and firms.

• In a market economy, the decisions of a central planner are replaced by the

decisions of millions of firms and households. Firms decide whom to hire and
what to make. Households decide which firms to work for and what to buy with
their incomes. These firms and households interact in the marketplace, where
prices and self-interest guide their decisions.
 HOW PEOPLE INTERACT
PRINCIPLE #7: Governments Can Sometimes Improve Market
Outcomes
• Govt may alter market outcome to promote efficiency
• market failure, when the market fails to allocate
society’s resources efficiently. Causes:
– externalities, when the production or consumption of a
good affects bystanders (e.g. pollution)
– market power, a single buyer or seller has substantial
influence on market price (e.g. monopoly)
• In such cases, public policy may increase efficiency.
• Govt may alter market outcome to promote equity
• If the market’s distribution of economic well-being is
not desirable, tax or welfare policies can change how
the economic “pie” is divided
 HOW THE ECONOMY AS A WHOLE WORKS

The last three principles deal with the economy

as a whole.
 HOW THE ECONOMY AS A WHOLE WORKS
PRINCIPLE #8: A Country’s Standard of Living Depends on Its
Ability to Produce Goods and Services
• Huge variation in living standards across countries and
over time:
– Average income in rich countries is more than ten times
average income in poor countries.

To boost living standards, policymakers need to raise productivity.

▪ Productivity depends on the equipment, skills, and
technology available to workers.
 HOW THE ECONOMY AS A WHOLE WORKS
PRINCIPLE #9: Prices Rise When the Government Prints Too
Much Money

• Inflation: increases in the general level of prices.

• In the long run, inflation is almost always caused by excessive
growth in the quantity of money, which causes the value of
money to fall.

More Money -> More Demand-> Shortage of Supply -> Price Rise.
 How The Economy as a whole works?
PRINCIPLE #10: Society Faces a Short-Run Trade-off between
Inflation and Unemployment.

• In the short-run, many economic policies push inflation and unemployment in

opposite directions.

➢ fluctuations in economic activity i.e production and Employment -> Fluctuations

in Prices
➢ High Employment( Less Unemployment) -> More Demanders-> Shortage of
Supply-> Price Rise (Inflation)
➢ High Inflation -> Less Demand -> Less number of workers in factories -> High
Unemployment
 Addressing the Central Problems
Basic Economic Theories Basic Economic Decision Making
• Theory of demand • Production decision
• Theory of Consumer What to produce and in what
Behaviour quantity to produce
• Theory of Production Scale of production
• Theory of Cost

• Theory of Market Structure • Exchange Decision

• Theory of Pricing Where to sell and at what
price to sell
• Cost-benefit analysis • Efficient Investment
Decision
 Micro and Macro Economics

• Micro Economics refers about the actions of

an individual unit, i.e. an individual, firm,
household, market, industry, etc.
• Macro Economics studies the economy as a
whole, i.e. it assesses not a single unit but the
combination of all i.e. firms, households,
nation, industries, market, etc.
 Differences between Micro and Macro Economics
• Microeconomics studies the particular segment of the economy, i.e.
an individual, household, firm, or industry. It studies the issues of
the economy at an individual level.
– Macroeconomics studies the whole economy, that does not talk about
a single unit rather it studies aggregate units, such as national income,
general price level, total consumption, etc. It deals with broad
economic issues.

• Microeconomics stresses on individual economic units.

– The focus of macroeconomics is on aggregate economic variables.

• Microeconomics is applied to operational or internal issues,

– whereas environmental and external issues are the concern of
macroeconomics.

• The basic tools of microeconomics are demand and supply.

– Conversely, aggregate demand and aggregate supply are the primary
tools of macroeconomics.
• Microeconomics deals with an individual product, firm, household,
industry, wages, prices, etc.
– Conversely, Macroeconomics deals with aggregates like national
income, national output, price level, total consumption, total savings,
total investment, etc.
• Microeconomics covers issues like how the price of a particular
commodity will affect its quantity demanded and quantity supplied
and vice versa.
– In contrast, Macroeconomics covers major issues of an economy like
unemployment, monetary/ fiscal policies, poverty, international trade,
inflationary increase in prices, deficit, etc.
• Microeconomics determine the price of a particular commodity
along with the prices of complementary and the substitute goods,
– whereas the Macroeconomics helps maintain the general price level,
as well as it helps in resolving major economic issues like inflation,
deflation, disinflation, poverty, unemployment, etc.
• While analysing any economy, microeconomics takes a bottom-up
approach,
– whereas the macroeconomics considers a top-down approach.
 Conclusion

Micro and Macro Economics are neither different subjects, nor

they are contradictory, rather, they are complementary.

The only important point which makes them different is the area
of application.
Positive and Normative Economics
Economics is a science as well as art.
But which type of science is a big question here, i.e.
positive or normative?
• Positive economics is related to the analysis
which is limited to cause and effect relationship.
• Normative economics aims at examining real
economic events from the moral and ethical
point of view. It is used to judge whether the
economic events are desirable or not.
• While Positive economics is based on facts about the
economy.

• Normative economics is value judgment based.

By, understanding the difference between positive and

normative economics, one will learn about how the
economy operates and to which extent the policy
makers are taking correct decisions.
 Key Differences Between Positive and Normative
Economics
• Positive Economics refers to a science which is
based on data and facts. Normative
economics is described as a science based on
opinions, values, and judgment.
• Positive economics is descriptive, but
normative economics is prescriptive.
• Positive economics explains cause and effect
relationship between variables. On the other
hand, normative economics pass value
judgments.
 Key Differences Between Positive and Normative
Economics
• The perspective of positive economics is objective while
normative economics have a subjective perspective.
• Positive economics explains ‘what is’ whereas normative
economics explains ‘what should be’.
• The statements of positive economics can be
scientifically tested, proved or disproved, which cannot
be done with statements of normative economics.
• Positive economics clearly define economic issues. Unlike
normative economics, in which the remedies are
provided for the economic issues, on the basis of value
judgment.
 Conclusion

• These two branches are not contradictory but

complementary to each other, and they
should go hand in hand.
• While laying down laws and theories,
economics should be treated as a positive
science, but at the time of practical
application, economics should be treated as a
normative science.
Thank You