7/16/2019

Chapter 1

Why study economics?

Economics is essential to understanding the world in which you live and work.
• What determines the prices of the goods and services on which you spend your
income, and the prices of the stocks and bonds in which you invest your savings?
• How does education affect the lifetime earnings of people?
• Why do some people earn so much and others so little?
• Why do some jobs pay high wages while other jobs pay low wages?

It can equip you to participate more successfully in the increasingly knowledge-based

and interdependent global economy of the twenty-first century. Economics is
fundamentally about choice behaviour -- about how individuals, families, firms and
governments deploy their scarce resources so as to maximize the economic well-being
of their stakeholders.

It can give you a better understanding of the objectives, methods and limitations of
government economic policy.

• How can government policy help reduce environmental pollution? How does the tax
system affect the incentives for people to work, for families to spend and save, and
for firms to invest?
• How do government budget deficits and debt affect the economy?

1
 7/16/2019

What then is economics?

•Exploring behavior of financial markets, impact of interest rates etc.

•Study of business cycles – credit, unemployment and inflation.
•Exploring how government policies can be tightened to foster quicker growth
•International trade & finance. Impacts of globalization and that of free trade across
borders.

Good list to start with but many more things can be added here

What is scarcity? Do we live in a scarce world?

What would happen if we had abundant resources?

What is efficiency? Why do we need efficiency?

Efficiency from an economics point of view, denotes the most efficient use of resources
so as to meet the needs and demands of society.

Economics is the study of how societies use scare resources to produce valuable
commodities & distribute them amongst different people.

In economics, we say that an economy is producing efficiently when it cannot make

anyone economically better off without making someone else worse off.

Microeconomics + Macroeconomics = Modern economics

•Microeconomics looks at the behavior of individual people and companies within the
economy.
•Consumer demand is the driving force behind the prices and production levels of
goods and services.
•How specific parties choose to use the limited resources that are available to them.
These choices influence the price levels of various commodities.
•Microeconomics also examines how the decisions of individuals impact specific
industries.

Another basic principle of microeconomics is the "theory of the firm." This studies the
actions of businesses as they strive to increase their profits. It looks at which
resources they choose to utilize as inputs, how much they produce, and what they
charge for their goods or services.

Microeconomics concerns itself with the human beings whose purchasing and
production-related decisions come together to form the backbone of a given economy.
Even when it involves companies, the focus of microeconomics is always at the
personal level.

2
 7/16/2019

Macroeconomics is that it is a study of "the big picture" in the economy.

Instead of focusing on individual households and firms, it examines conditions within

the economy as a whole. This is the most vital difference of micro and
macroeconomics.

In more technical terms, macroeconomics looks at the factors that influence aggregate
supply and demand. Since it is associated with the conditions of national economies, it
deals with such statistics as unemployment rates, gross domestic product (GDP),
overall price levels, and inflation.

Can looking at a macroeconomic factor be useful in making predictions at a

microeconomic level?

What is the impact of the Rupee depreciation? What industries does this impact?

Three problems of economic organization

Has always applied to every human society (pre historic days to modern times )

What is being produced? In what quantities? Should I plan for now (consumption good)
or for later (investment good)

How are the goods produced? What resources am I using? Least cost is primary.

For whom are we producing? Who gets to enjoy this economic activity?

Positive economics relies on factual data, using a lot of analysis & empirical evidence
Did the North American Free Trade Agreement (NAFTA) raise or lower the incomes of
most Americans? Do higher interest rates slow the economy and lower inflation?

Normative economics involves ethical precepts & norms of fairness. Lot of political
debate is needed to make decisions related to normative economics. There is no right
or wrong answer to such questions.

Types of economy
• Laissez-Faire
• Command
• Market
• Mixed (govt oversees functioning of markets, rules & regulations, welfare etc)

3
 7/16/2019

Restating the three economic problems in these terms, society must decide (1) what
outputs to produce, and in what quantity; (2) how, or with what inputs and techniques,
to produce the desired outputs; and (3) for whom the outputs should be produced and
distributed.

Land —or, more generally, natural resources— represents the gift of nature to our
societies. It consists of the land used for farming or for underpinning houses, factories,
and roads; the energy resources that fuel our cars and heat our homes; and the non
energy resources like copper and iron ore and sand. In today’s congested world, we
must broaden the scope of natural resources to include our environmental resources,
such as clean air and drinkable water.

Labor consists of the human time spent in production—working in automobile factories,

writing software, teaching school, or baking pizzas. Thousands of occupations and
tasks, at all skill levels, are performed by labor. It is at once the most familiar and the
most crucial input for an advanced industrial economy.

Capital resources form the durable goods of an economy, produced in order to produce
yet other goods. Capital goods include machines, roads, computers,
software, trucks, steel mills, automobiles, washing machines, and buildings. As we will
see later, the accumulation of specialized capital goods is essential to the task of
economic development.

4
 7/16/2019

Points outside the frontier (such as point I ) are infeasible or unattainable. Any point
inside the curve, such as U, indicates that the economy has not attained productive
efficiency, as is the case, for instance, when unemployment is high during severe
business cycles.

Production-possibility frontier (PPF), shows the maximum quantity of goods that can
be efficiently produced by an economy, given its technological knowledge and the
quantity of available inputs

5
 7/16/2019

Before development, the nation is poor. It must devote almost all its resources to food
and enjoys few comforts. (b) Growth of inputs and technological change shift out the
PPF. With economic growth, a nation moves from A to B, expanding its food
consumption little compared with its increased consumption of luxuries. It can increase
its consumption of both goods if it desires.

(a) A poor frontier society lives from hand to mouth, with little left over for public
goods like clean air or public health. (b) A modern urbanized economy is more
prosperous and chooses to spend more of its higher income on public goods and
government services (roads, environmental protection, and education).

6
 7/16/2019

A nation can produce either current-consumption goods (pizzas and concerts) or

investment goods (pizza ovens and concert halls). (a) Three countries start out even.
They have the same PPF, shown in the panel on the left, but they have different
investment rates.
Country 1 does not invest for the future and remains at A1 (merely replacing
machines). Country 2 abstains modestly from consumption and invests at A2. Country
3 sacrifices a great deal of current consumption and invests heavily. (b) In the following
years, countries that invest more heavily forge ahead. Thus thrifty Country 3 has
shifted its PPF far out, while Country 1’s PPF has not moved at all. Countries that
invest heavily can have both higher investment and consumption in the future.

7
7/16/2019

8
7/16/2019

9
7/16/2019

10
 7/16/2019

Interpret this diagram for me 

11