Introduction to ECONOMICS

A class note on Introduction to Economics, complied by

Bindu Raj Khanal
The basic purpose of studying economics is to understand how various economies and their
components work, how an economy is organized, and how successfully it achieves its basic
objectives. The term economics is derived from two Greek words ‘oikou’ and ‘nomos’;
meaning the rule or law of the households. Economics seeks to answer question relating to
the economic behavior of the people, the society and the economy. To be brief, economics
studies the economic behavior of the people. In the early days, economics was not studied as
a different subject. But in the modern days it has expanded to include a vast range of topics.
Now, the economics
i) studies how prices and quantities of goods and services that are produced and sold
in the market are determined by the demand and supply forces,
ii) studies how the prices of labor, capital and land are set in the economy, and how
these prices are used to allocate resources,
iii) explores the behavior of the financial markets and analyze how they allocate
capital to the rest of the economy,
iv) examines the distribution of income and suggests that the poor can be helped
without harming the performance of the economy,
v) looks at the impact of the government spending, taxes and budget deficits on
growth,
vi) studies the swings in unemployment and production that make up the business
cycle, and develops government policies for improving economic growth,
vii) examines the patterns of trade among nations, and analyzes the impact of trade
barriers,
viii) looks at growth in developing countries, and proposes ways to encourage the
efficient use of resources, etc.

Economics is the study of how society utilizes its limited resources to produce most valuable
commodities and distribute them among different people. The key points are: resources are
limited and human wants are unlimited. If the resources are available in plenty then there
would be no problem. Thus economics is choice making and decision making behavior of
people. Therefore, the essence of economics is to acknowledge the reality of scarcity and
then figure out how to organize society in a way, which produces the most efficient use of
resources.
Basic Economic Issues; Scarcity and Choice
Most of the problems of economics emanates from the undeniable truth that human wants are
unlimited and means to fulfill those wants are limited and they have alternative uses. So, at
the heart of economics is the law of scarcity. If infinite quantities of every good could be
produced or if human desires were fully satisfied, what would be the consequences? People
would not worry about stretching out their limited incomes because they could have
everything they wanted; businesses would not need to fret over the cost of labor; government
would not need to struggle over taxes or spending, because nobody would care. In such a
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case of affluence, there would be no economic goods, that is goods that are scarce or limited
in supply. All goods would be free, like sand in the desert or seawater at the beach. But no
society has reached a utopia of limitless possibilities. Goods are limited while wants seem
limitless. Even in developed countries, production is not high enough to meet everyone’s
desires. And in developing countries, there are millions of people suffering from hunger.
Given the unlimited wants and limited resources everyone is forced to choose only some of
the options. In other words, due to the scarcity of resources and unlimited wants, the problem
of choice arises. Therefore, the central economic problem for a society is how to reconcile
the conflict between people’s virtually limitless desires for goods and services, and the
scarcity of resources (labor, machinery, and raw materials) with which these goods and
services can be produced.
In economics, the decision-taker is assumed to be rational. Economic rationality of a decision
taker implies the following:
a) The decision-taker sets out all possible alternatives, which are available to him.
b) He evaluates the costs and benefits associated with each of the possible alternatives.
c) He ranks the alternatives in order of preference.
d) He chooses the alternatives highest in the ordering.

Central Economic Problem

What to produce: There are many goods and services that can be produced with the
resources we have. This problem particularly relates with the decision that an individual or a
society must make in choosing some of the goods and services that should be produced with
the limited resources.
How to produce: The same good or service can be produced by different ways. This
problem is concerned with choosing the particular technique of production. Generally two
production techniques; labor intensive where labor is the main factor for production and
capital intensive, where capital is the main factor for production.
For whom to produce: This problem explains how a society distributes the total output
produced among the different members of the society.

Market and Command Economy

Generally, there are two fundamentally different ways of organizing an economy. Market and
Command Economy
A market economy is one in which individuals and private firms make the major decisions
about production and consumption. In a market economy, decisions are made in markets,
where individuals and enterprises voluntarily agree to exchange goods and services, usually
through payments of money. A system of prices, of markets, of profits and losses, of
incentives and rewards determines the what (profits), the how (costs) and the form whom
(reward for inputs). [Laissez-faire economy]
A command economy is one in which the government makes all important decisions about
production and distribution. In a command economy, the government owns most of the
means of production; it also owns and directs the operations of enterprises in most industries;
it is the employer of most workers and tells them how to do their jobs; and it decides how the

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output of the society is to be divided among different goods and services. In short, in a
command economy, the government answers the major economic questions through its
ownership of resources and its power to enforce decisions.
No contemporary society falls completely into either of these extremes. Rather, all societies
are mixed economies, with elements of market and command

Allocation of Resources; Solution of Economic Problems

Every human society – whether it is an advanced industrial nation or a poor developing
country – must confront and resolve three fundamental economic problems. Every society
must have a way of determining ‘what’ commodities are produced, ‘how’ these goods are
made, and ‘for whom’ they are produced.
Each economy has a stock of limited resources – labor, technical knowledge, land, capital
equipment, etc. In deciding what and how things should be produced, the economy is in
reality deciding how to allocate its resources among the thousands of different possible
commodities and services.
Faced with the undeniable fact that goods are scarce relative to wants, an economy must
decide how to cope with limited resources. It must choose different potential bundles of
goods (the what), select from different techniques of production (the how), and decide in the
end who will consume the goods (the for whom).

The What
A society must decide how much of each of the many possible goods and services it will
produce. Will we use the available resources to produce many consumption goods or will we
produce fewer consumption goods and more investment goods (capital goods)? Due to the
scarcity of resources, only those goods should be produced that are most essential. This will
be determined by the demand and supply of the commodity at the different price level.

The How
A society must determine who will do the production, with what resources and what
production techniques they will use. Will we use labor-intensive techniques or capital-
intensive techniques? Will electricity be generated from oil, water, coal or sun? There may be
various techniques to produce a particular product. Only that technology should be adopted
which ensures efficiency and optimum use of resources. Choice between different techniques
of production depends on the availability of factors of production and their prices.

The For Whom

A society must determine how national product is divided among different households. It is
related with the distribution aspect of the economy.
To answer these three questions, every society must make choices about the economy’s input
and outputs. Inputs are commodities or services that are used to produce goods and services.
An economy uses its existing technology to combine inputs to produce outputs. Outputs are
various useful goods or services that result from the production process and are either
consumed or employed in further production.

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Efficiency
A given economic arrangement is efficient if there can be no rearrangement which will leave
someone better off without worsening the position of others. One important aspect of overall
economic efficiency is productive efficiency. Productive efficiency occurs when an economy
cannot produce more on one good without producing less of another good.

Concepts of Micro and Macro Economics

Economics is divided into two main branches because economic problems can be analyzed in
two ways individually and collectively. The method of analyzing these problems at
individual level is known as microeconomics and that of analyzing at collective level is
known as macroeconomics. Thus, Microeconomics may be defined as that branch of
economic analysis which studies the economic behavior of the individual units, may be a
person, a household, a firm or an industry and Macroeconomics is that branch of economic
analysis which studies the behavior of all the units combined together that is study of
economic system as a whole.

Microeconomics
The word micro has been taken from a Greek word ‘mikos’ which means small. In micro
economic theory, the problems relating to individual production units (firm and industries),
markets, consumers etc are studied. In other word microeconomics deals with the economic
behavior of individual unit (consumers or producers) such as equilibrium of a firm, an
industry, equilibrium of a consumer, price fixation of a commodity etc.
The main objective of microeconomic theory is to explain and predict how production,
exchange and distribution of goods and services respond to the incentive structure operating
in a given society.
In this way, microeconomics is the microscopic study of the economics which picks up a
small unit and observe the details of its operation. Microeconomics is also concerned with
how individual firm decide what to produce, how to produce, and at what cost to produce to
minimize the cost of production. In other word, it seeks to analyze the mechanism by which
various economic units attain the position of equilibrium, the position from which they would
not like to deviate, the conditions remaining the same. The centre problem of
microeconomics is the problem of allocation of resources or the problem of price
determination. It studies relative price of particular goods and services how the various
economic units act and react to change in technology, the output and allocation of resources.
Since prices of products and factor units occupy the central place, microeconomics is also
called price theory. Here, demand and supply are the main tool of analysis.

Purpose and Importance/Uses of Microeconomics

Microeconomics has both theoretical and practical importance. It is highly helpful in the
formulation of economic policies.
1. It is microeconomics that tells us how a free-market economy with its millions of
consumers and producers work to decide about the allocation of productive resources
among the thousands of goods and services.

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2. In explains the determination of the relative prices and quantities of the various
products and productive services.
3. It explains how through market mechanism goods and services produced in the
community are distributed.
Microeconomic analysis is also usefully applied to the various applied branches of
economics such as Public Finance, International Economics, etc. Microeconomics is equally
important for public policy design and business decisions. The importance of
microeconomics can be discussed on the basis of heading explained below.
1. To study human behavior:
Microeconomics studies the human behavior in both subjective as objective manner.
It studies the human behavior with the help of different laws and theories like; law of
demand, theory of consumer behavior in both cardinal and ordinal approach, law of
diminishing marginal utility, law of equi-marginal utility etc.
2. To understand the working of the economy:
The working of free enterprises economy is complex because of the no agency to plan
and control the economic system. Microeconomics helps to understand working of
the market economy. In such, microeconomic analysis is important tool to understand
what to produce, how to produce, what quantities are taken by producers and
consumers etc without any forces because of the absence of the command of the
government.
3. To provide economic tool for policy design:
Microeconomics provides the analytical tools to evaluate the economic policies of the
nation. In dual(mixed) economy, state runs priority sector enterprises such as
educational institutions, hydropower projects, postal services, health services,
drinking water services etc with neither profit nor loss basis so as to serve the
common people. Similarly run certain public enterprises with price-profit policy. To
take the strategic policy for the price determination of such institutions it is necessary
to take help from the private competitive organizations with is microeconomic unit.
4. To allocation of the resources:
The principal problem faced by the modern government is how to allocate resources.
Microeconomic policy provides the basis for efficient employment of resources
among competitive ends to achieve desired growth and development hence
microeconomics deals with the efficient allocation of resources.
5. To business executives:
Microeconomic analysis is basic tool for the business executive to meet objective of
their business with various business decisions. It is helpful for producers’ to decide
what good to produce at what price, which technique to produce, what quantity of
goods to produce, how to manage inventory, advertisement decision, marketing
strategies, sale forecasting, how to face competition to the rival firms etc. For all such
business decision manager has to know the consumer behavior, elasticity of demand
etc to guide them on their businesses which are microeconomic variables.
6. To formulate public policies:

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Microeconomics is useful to formulate various economic policies like, taxation,

subsidies, credit system, interest rate decision etc. Microeconomic analysis can help
to understand impact of such policies to the individuals and instruct government to
take decisions regarding improvement of such policies as well as formulation of
further policies.
7. To the international trade:
Microeconomic studies the demand and supply situation of the goods and services.
Demand and supply analysis help to understand market equilibrium and
disequilibrium. This study of market equilibrium helps to decide foreign trade i.e.
export and import so as to solve unfavorable balance of payment.
8. To examine economic welfare:
Economic welfare is the subjective satisfaction that individual derived from the
consumption of a commodity. Therefore welfare economics is related to
maximization of social benefit. Microeconomics helps to eliminate the wastage and
mis-allocation of resources so as to get maximum output in order to maximize social
benefit (welfare).

Limitations of Microeconomics
No subject is free from limitations. Microeconomics also have limitations as explained
below;
1. Unrealistic assumptions
Microeconomic analysis is based on the unrealistic assumptions of full employment,
laissez-faire, ceteris paribus etc. At present, there is no practice of laissez-faire
economy in the real world, it was ended with the great depression of 1930’s and the
full employment is accidental situation rarely found in an economy. Moreover, the
assumption of ceteris paribus is hypothetical because the factors affecting the
economy are not constant.
2. Inadequate Analysis
The study of microeconomics is not only inadequate but also misleading in analysis
of several economic problems. It is not essential that the principal which are true in
the case of individual household, firm, person may also be applicable to the economy
as a whole. It doesn’t analyze the aggregate manner. The knowledge of economy as a
whole is also equally important which is ignored.
3. Fail to take account of Aggregate
Microeconomics is concerned with the study of part and neglects the whole. The
description of a large and complex fact – economic system is impossible in term of
individual items. Thus, the microeconomic analysis can’t represent the whole picture
of the economy.

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Differences between Microeconomics and Macroeconomics
Distinction between Micro and Macro-economics
Basis Micro-economics
1.Origin The term ‘Micro’ was derived
from Greek word “Mikros”. Its
meaning is small therefore
microeconomics deals with
individual units of the
economy (individual economic
activities).
Microeconomics is defined as
2.Definition that branch of economics
which deals with the study of
individual economic activities.
3.Study Microeconomics studies
microeconomic variables such
as consumer and producer’s
behaviour, pricing of
goods/services, demand for
and supply of commodity etc.
The main objective
4.Objectives microeconomics is
maximize utility (satisfaction)
from consumer’s side and
Profit from producer’s side.
5.Scope Microeconomics covers the
area such as the pricing of
products, pricing of factor of
productions, theory
economic welfare and so on.
Microeconomics studies the
6.Analysis equilibrium at a particular
point of time. It does not
explain the time factor. Hence,
microeconomics is regarded as
the static analysis.
Micro economics was mainly
7.Development developed by classical and
neoclassical economists.
Microeconomic analysis is
8.Equilibrium often called ‘partial
Introduction to ECONOMICS
Macro-economics
The term ‘Macro’ was derived
from Greek word macros means
‘Large’ or ‘Big’. Therefore
macroeconomics deals with
aggregate economic activities.
Macroeconomics is defined as
that branch of economics which
deals with the aggregate study of
economic activities i.e. study as
a whole.
Macroeconomics studies
economics as a whole. In other
words, it studies macroeconomic
variables such as national
income, aggregate demand and
supply, national employment,
poverty level etc.
of Macroeconomics has objectives
to of full employment, price
stability, economic growth,
favourable balance of payment
and so on.
Macroeconomics covers the area
such as theories of income and
employment, macro theory of
of distribution, theory of economic
growth and so on.
Macroeconomics studies the
equilibrium during a period of
time. Hence, macroeconomics is
regarded as the dynamic
analysis.
Macroeconomics was mainly
developed by J. M. Keynes after
the great depression of 1930’s.
Macroeconomic analysis is often
called “general equilibrium
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equilibrium analysis’ because analysis” because

it deals with the determination macroeconomics deals with the
of the equilibrium price and determination of equilibrium
quantity in each market by price and quantity in all markets
forces of demand and supply simultaneously. Here, the market
(demand and supply curves). of all commodities and all
Hence each market is regarded productive factors are
independent of the other. It interrelated. It shows and
means the interrelationship analyzes the relationship
between the various markets is between micro variables without
ignored in microeconomic the assumption of ‘ceteris
analysis and it shows and paribus’.
analyzes the relationship
between micro variables under
the assumption of “ceteris
Paribus” i.e. other things
remaining the same.
9.Theory Microeconomics mainly Macroeconomics mainly
concerns with how equilibrium concerns with the determination
price is determined in different of national income and
types of market. Therefore employment level. Therefore, it
microeconomics is also called is also called Income Theory or
price theory. Policy Science.
Microeconomics assumes full Macroeconomics worries how
10.Employment employment and concerns how full employment can be attained.
Level a consumer and a producer (Consider underemployment i.e.
attain equilibrium and how the below full employment.)
resources of the economy are
allocated.
11.Uses Microeconomics is useful inMacroeconomics is useful in
making production decision for
formulating appropriate
business executives.
economic policies for the
Microeconomics gives a better
government such as monetary
tool in understanding the policy, trade policy, population
economy as a whole. It can’t
policy etc. It can solve present
solve the present day’s days complex economic
complex problems. problems such as hyper inflation,
unemployment, poverty etc.
Microeconomics fails to Macroeconomics fails to explain
12.Limitations explain the working of the the working of individual units
entire economy. of the economy.

Interdependence of Microeconomics and Macroeconomics

Since microeconomics and macroeconomics are the two approaches to the study of the same
economy, their study is not conducted separately in two watertight compartments. The
distribution between microeconomics and macroeconomics is made to help us understand

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behavior of economic units both from micro-perspective and macro-perspective. Moreover,

the distinction drawn between microeconomics and macroeconomics is just to emphasize that
the knowledge of both microeconomics and macroeconomics is essential through
understanding of economics activities in an economy. In fact, the basic goal is the same for
both branches of economics; the social welfare maximization. Thus, the microeconomics and
macroeconomics are interdependent.
The existence of the differences between microeconomics and macroeconomics does not
imply that they are independent. In fact, macroeconomic theory has a foundation in
microeconomic theory and microeconomic theory has a foundation in macroeconomic
theory, i.e., the changes in the variables of microeconomics affect the macroeconomic
variables and vice versa.

Micro-economics foundation of Macro-economic analysis:

Macroeconomic theory examines the determination of general price level and inflation
considering the relative price of commodities and factor of production. But the theory of
production and factor pricing is the subject matter of microeconomics.
Similarly, macroeconomic theory is concerned with analyzing aggregate variables such as
output and National Income, level of national employment, consumption, investment etc.
These variables are also affected by the behavior of individual consumers, firms etc. But the
theory of consumers’ and producers’ behavior is studied in microeconomics. Hence,
Microeconomics is foundation of Macroeconomics.

Macro-economics foundation of Micro-economic analysis:

In microeconomic theory, we examine the consumption and saving behavior of a household
in relation to the rate of the interest which is extremely given to the household. At the macro
level, we look at how households saving plans and their demands for financial assets interact
with the investment and financial plans of firm to determine the level of interest rate in the
economy.
Similarly, the behavior of individual consumers and firms which are the part and parcel of
microeconomics are also affected by the overall macroeconomic condition. Hence,
Macroeconomics is foundation of Microeconomics.

Conclusion:
Thus, in gist, relationship between microeconomics and macroeconomics does exist. They
are interdependent can be summarized cases as follows;
 It may be emphasized that neither of micro or macro approaches can alone
adequately help us in analyzing the working of economic system.
 It is very essential therefore to integrate the two approaches, if we wish to get
correct solutions of our main economic problems.
 If we take a period of unprecedented prosperity in the economy. Even in such
boom conditions, it is not uncommon to come across examples of individual
industries, which may be more dead than alive.
 Like wise, in the period of deep depression, there may yet be some individual
industries, which may be enjoying great prosperity.