Indian Institute of Space Science and Technology

Department of Humanities

HS 211 Introduction to Economics

Class Room Lecture Points

(For 2019 admissions)

Dr. Shaijumon C S
Associate Professor in Economics,
Dept. of Humanities

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Lecture 1

What is Economics? Definitions – Importance of Economics – Schools of thought

The Economic Problem – Scarcity and Choice – Resource allocation – the question of
What to produce, How to Produce and How to Distribute Output

Many of the world’s most pressing problems are economic. For example – slow down of
economic growth, rise in oil prices, international trade and its issues, unemployment, inflation –
etc. are zero unemployment and zero inflation reasonable long – term goals? What is an
acceptable level of unemployment? Why do price in some countries rise more and others less?
Can a country control unemployment and inflation?

‘Problems change over decades, yet there are always problems’. Of course, not all the world’s
problems are primarily economic. But no matter how ‘non economic’ a particular problem may
seem, it will almost always have a significant economic dimension.

One way of define the scope of economics is to say that it is the social science that deals with
such economic problems. Another perhaps, the better known, is Alfred Marshall’s ‘Economics is
a study of mankind in the ordinary business of life’

Wealth definition – Adam smith : more emphasis on wealth – his book titled ‘an enquiry into
the nature and causes of the wealth of nations’ popularly known as ‘wealth of nations’ published
in the year 1776. Adam smith is known as the father of economics -

Welfare definition – Alfred Marshall: here emphasis shifts from wealth to man. Man occupies
a primary place and wealth only a secondary one. Economics is a science of material welfare –
his book titled ‘principles of economics’ published in 1890.

Scarcity definition – Lionel Robbins

Modern definition – J M Keynes

Most accepted definition is Scarcity definition - Economics is the science which studies human
behavior as a relationship between ends and scarce means which have alternative uses – The
study of the way in which mankind organizes itself to tackle the basic problems of scarcity – all
societies have more wants than resources. Therefore a system must be devised to allocate these
resources between competing ends – ends refers to wants – human beings have wants which are
unlimited in number – if one want is satisfied another crops up. Multiplicity of wants calls forth
ceaseless effort for their satisfaction – if wants had been limited, they would have been
adequately satisfied and there would have been no economic problem – all incentive to economic
effort would have ceased – also, since human wants are unlimited, one is compelled to choose
between the more urgent and the less urgent wants. That is why economics is also called a
‘science of choice’.
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What is Economics?

Economics is the study of how societies use scarce resources to produce valuable goods and
services and distribute them among different individuals.
Because resources are scarce, all societies face the problem of deciding what to produce, how to
produce and for whom to produce? Societies differ in who makes the choices and how they are
made, but the need to choose is common to all. Just as scarcity implies the need for choice, so
choice implies the existence of cost (opportunity cost)
Most problems studied by economists can be grouped under four main headings
1. What is produced and How?
The allocation of scarce resources among alternative uses, called resource allocation,
determines the quantities of various goods that are produced. Choosing to produce a
particular combination of goods means choosing a particular allocation of resources
among the industries or regions producing the goods. Further, because resources are
scarce, it is desirable that they be used efficiently. Hence it matters which of the available
methods of production is used to produce each of the goods that is to be produced.
2. What is consumed and by whom?
3. How much unemployment and inflation exist?
4. Is productive capacity growing?
We can derive the following fundamental problems
1. What to produce?
2. How to produce?
3. For whom to produce?
4. Are the resources economically used?
5. Problems of Full employment.
6. Problems of Growth
Importance of Economics
1. How to manage macro economy?
2. Overcoming market failures
3. Efficiency - Optimum utilization of resources
4. Individual economics
A society’s resources consist of natural gifts such as land, forests, minerals, human resources,
machinery, buildings etc. Economists call such resources ‘factors of production’, because they
are used to produce those things that people desire. The things produced are called
‘commodities’. Commodities may be divided into goods and services. Goods are tangible and
services are intangible. The act of making goods and services is called production, and the act of
using them to satisfy wants is called consumption. Goods are valued for the services they
provide.
A decision to have more of one thing requires a decision to have less of something else.
All economies face scarcity, all must decide how to allocate scarce resources and distribute
goods and services; all may face problems of inflation, unemployment, and unsatisfactory rates
of growth.
If all goods would be free, like sand in the desert or seawater at the beach. All prices would
be zero, and markets would be unnecessary. Indeed, economics would no longer be a useful
subject. But no society has reached a utopia of limitless possibilities. Ours is a world of scarcity,
full of economic goods.
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 Economic efficiency requires that an economy produce the highest combination of quantity
and quality of goods and services given its technology and scarce resources. An economy is
producing efficiently when no individual’s economic welfare can be improved unless someone
else is made worse off. (Samuelson, p. 5)
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.
Economic System
An Economic system is the system of production, distribution and consumption of goods
and services of an economy. It is the set of principles and techniques by which problems of
economics are addressed, such as the economic problem of scarcity through allocation of
finite productive resources. The economic system is composed of people and institutions,
including their relationships to productive resources.
There are three basic economic systems
1. Capitalism
2. Socialism
3. Mixed Economy
Capitalism refers to an economic and social system in which the means of production (capital)
are privately controlled; labor and goods are traded in free market and profits are regularly
reinvested in new ventures. Pure capitalism has always only existed in theories. Capitalism has
been dominant in western world since the end of feudalism. The desire for profit is the sole
consideration. The major features are
• Right of Private property
• Freedom of enterprise
• Freedom of choice by the consumers (consumer sovereignty)
• Profit motive
• Class conflict (Haves and have nots) – economic inequalities
• Un- coordinated nature
• Vital role for entrepreneur
• Control with risks – he who risks his money must also control the business
• Perfect competition
• Importance of price system

The demerits of capitalism are

• Wasteful competition
• Human welfare ignored
• Economic instability and unemployment
• Property rights take precedence over human rights
• Class conflict
• Social injustice and economic inequality
• Misallocation of resources
• Emergence of monopolies and concentration of economic power
• Malpractices

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Socialism is an economic organization of society in which the material means of production are
owned by the whole community and operated by the organs representative of, and responsible to,
the community according to general plan, all members of the community being entitled to
benefits from the results of such socialized planned production on the basis of equal rights. The
major features are
• Social ownership of means of production
• No private enterprise
• Economic equality
• Equality of opportunity
• Economic planning
• Social welfare and social security
• Classless society

Merits of socialism
 Social justice
 Better allocation of resources
 Improving productive efficiency
 Social security and welfare
 Economic stability
Demerits
• Bureaucracy and redtapism
• Not successful in business
• Insufficient resources
• Misallocation of resources
• Loss of consumer sovereignty
• Lack of incentives
• Loss of economic freedom
• Concentration of power in the state
• Loss of personal liberty
Mixed Economy
Mixed economy is an economic system which is neither pure capitalism nor pure socialism but a
mixture of the two. In the system we find the characteristics of both capitalism and socialism.
Main features
• Co-existence of the public and private sectors
• Role of price system and government directives
• Govt. regulation and control and private sector
• Consumers sovereignty protected
• Govt. protection of labor
• Reduction of economic inequalities
• Control of monopoly.

Market economy is an economy based on the division of labor in which the prices of goods and
services are determined in a free price system set by supply and demand. This is often contrasted
with a planned economy, in which a central government determines the price of goods and
services using a fixed price system. Market economies are contrasted with mixed economy

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where the price system is not entirely free but under some government control that is not
extensive enough to constitute a planned economy.

Third World Economies

The economically underdeveloped countries of Asia, Africa, Oceania, and Latin America,
considered as an entity with common characteristics, such as poverty, high birthrates, and
economic dependence on the advanced countries. The French demographer Alfred Sauvy
coined the expression ("tiers monde" in French) in 1952 by analogy with the "third
estate," the commoners of France before and during the French Revolution-as opposed to
priests and nobles, comprising the first and second estates respectively.
Is Economics a Science?
A statement is scientific only if it is open to the logical possibility of being found false. This
definition means that we evaluate scientific statements by testing them, by comparing them to
the world about us. (Karl Popper)
Most economists see their discipline as scientific in Popper's sense of the word. Economic theory
makes statements about how facts fit together, and there are constantly new sets of facts arising
that allow one to test the theory to see whether the facts are as theory predicts. However, this
process is more difficult for economists than it is for most physical scientists.
Most economists see their discipline as scientific in Popper's sense of the word. Economic theory
makes statements about how facts fit together, and there are constantly new sets of facts arising
that allow one to test the theory to see whether the facts are as theory predicts. However, this
process is more difficult for economists than it is for most physical scientists.
• Unlike physical scientists, economists can almost never use controlled experiments to
gather facts with which to test theories. Rather they must use whatever facts the world
gives them and rely on statistical procedures to draw conclusions
• There is a minority of economists, however, who do not see economics as scientific in
Popper's sense. A group of economists called the Austrian school, for example, has
argued that economics starts with assumptions and that economic theory is the logically
deduced results of those assumptions. If the theory does not fit the facts, one cannot
conclude that the theory is wrong, but only that it is inappropriate to apply the theory in
that particular situation because the initial conditions do not agree with the assumptions
of the theory.
Economists use the scientific approach to understand economic life. This involves observing
economic affairs and drawing upon statistics and the historical record. Often, economics relies
upon analyses and theories. Theoretical approaches allow economists to make broad
generalizations. In addition, economists have developed a specialized technique known as
econometrics, which applies the tools of statistics to economic problems.
The following are some of the common fallacies encountered in economic reasoning:
1. The post hoc fallacy: it involves the inference of causality. The post hoc fallacy occurs
when we assume that, because one event occurred before another event, the first event
caused the second event. Example: Great Depression of 1930s.
2. Failure to hold other things constant: a second pitfall is failure to hold other things
constant when thinking about an issue.
3. The fallacy of composition: when you assume that what is true for the part is also true for
the whole, you are committing the fallacy of composition.

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 Positive and Normative Economics
Positive economics describes the facts of an economy, while normative
economics involves value judgments. Normative economics involves ethical precepts and
norms of fairness. A positive statement is a statement about what is and that contains no
indication of approval or disapproval. Notice that a positive statement can be wrong.
"The moon is made of green cheese" is incorrect, but it is a positive statement because it
is a statement about what exists. A normative statement expresses a judgment about
whether a situation is desirable or undesirable. "The world would be a better place if the
moon were made of green cheese" is a normative statement because it expresses a
judgment about what ought to be. Economists have found the positive-normative
distinction useful because it helps people with very different views about what is
desirable to communicate with each other
Economists can confine themselves to positive statements, but few are willing to
do so because such confinement limits what they can say about issues of government
policy. Both positive and normative statements must be combined to make a policy
statement. One must make a judgment about what goals are desirable (the normative
part), and decide on a way of attaining those goals (the positive part).

Micro and Macro Economics

Economics is divided into two major subfields – micro economics and macro economics. Adam
Smith is considered as the founder of Micro economics. This branch of economics concerned the
behaviour of individual entities such as markets, firms, and households. Macro economics
studies the overall performance of the economy. John Maynard Keynes is considered as the
founder of Macro Economics. His book named ‘General Theory of Employment, Interest and
Money’ published in 1936 has revolutionised the world of macro economics. Through his new
theory Keynes developed an analysis of what causes business cycles, with alternating spells of
high employment and high inflation.
Demand and Supply
How do we explain the changes in prices or changes in supply or demand etc. of a commodity?
What makes the demand/supply of a commodity? What determines the prices in the market?
Have you ever thought about those things?
I economics we have a very powerful tool for explaining such changes in economic environment.
It is called the theory of supply and demand.
Demand:
Demand is a ‘desire’ backed by ‘ability’ and ‘willingness’ to pay for a commodity. The
demand for anything at a given price is the amount of it which will be bought per unit of
time at that price. The quantity of a good or service which an individual or group desires
at the ruling price.
Demand schedule
There exists a definite relationship between the market price of a good and the quantity
demanded of that good, other things held constant. The relationship between the quantity
and price bought is called the demand schedule, or the demand curve. The demand for
individual consumer is called individual demand. The total amount of a commodity that
all households with to purchase is called the quantity demanded of that commodity.
(add table)

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Demand curve
The graphical representation of the demand schedule is called the demand curve.

P1

q q1 D

Generally the demand curve slopes downward from left to right. It represents the relation
between quantity demanded and price, other things being equal. (explanation with example)
The law of demand states that demand varies inversely with price, not necessarily
proportionately. When the price of a commodity is raised (and other things are held
constant), buyers tend to buy less of the commodity. Similarly, when the price is lowered,
other things being constant, quantity demanded increases.
Why does the demand curve slopes downward?
There are two reasons for this. The substitution effect and income effect.
Substitution effect – which occurs because a good becomes relatively more expensive when
its price rises. When the price of good A rises, we will generally substitute goods B, C or D
for it (provided if they are close substitutes). example of Tea and coffee.
Income effect – a higher price generally also reduces quantity demanded through the income
effect. When price goes up, we find ourselves somewhat poorer than we were before. If
gasoline prices increases, we have in effect less real income. So we will naturally reduce our
consumption.
Cconsumers’ buy more of a commodity when its price is lower is because you can increase
your total utility or the amount of ''satisfaction'' you can gain from your income. If you have
a fixed income and you like tomatoes, if the price of tomatoes falls, then you can buy more of
them.
The market demand curve is found by adding together the quantities demanded by all
individuals at each price.
Factors behind demand curve:
1. The average income of consumers
2. The size of market
3. The prices and availability of related goods
4. Tastes and preferences
5. Special influences

Types of goods
1. Normal goods
2. Substitute goods – A good or service which can be used instead of another. If the price
of substitute goods of X increases, the demand curve of X will shift upward and vice
versa.

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 3. Complementary goods – a relation between two goods or services in which a rise in the
price of one decreases demand for the other. A fall in price of a complementary good of
X will ie. Y, shifts the demand curve of X to the right. More X will be purchased because
of the cheap price of Y.
4. Giffen goods – A good whose demand tends to fall as its price falls, thus apparently
contradicting the law of demand. So named after Sir Robert Giffen (1837 -1910) who
observed the poor buying more loafs of bread as its price rose.
5. Inferior goods – as other things remains the same (ceteris paribus), when income
increases, the quantity demanded for the goods will fall. Those goods are known as
Inferior goods.

Shifts in demand or increase/decrease in demand.

A demand curve is drawn on the assumption that everything except the commodity’s own
price is held constant. A change in any of the variables previously held constant will shift the
demand curve to a new position. (Factors like change in preferences, income, expectation
about future rise in price etc)

Explanation with example

One of the most important points that we must understand in economics is the difference
between shifts in demand (change in demand) curve and movements along a curve. Shifts
in demand occurs because factors other than price. A movement along the demand curve is
because of the changes in price only. Please don’t confuse between change in demand and
change in quantity demanded. Change in demand is shifts in demand and the change in
quantity demanded is the movement along the demand curve.

Supply
The amount of a commodity that firms wish to sell is called the quantity supplied of that
commodity.
Supply schedule
The supply schedule for a commodity shows the relationship between its market price
and the amount of that commodity that producers are willing to produce and sell, other

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 things held constant. (Add table). Supply schedule shows the quantities that producers
would wish to sell at alternative prices of the commodity.

Supply curve
Supply curve is the graphical representation of the supply schedule. It represents the
relation between quantity supplied and price, other things being equal.

Explanation with example

Law of supply
The law of supply states that when price increase the quantity supplied also will increase.
There is a direct relationship between the price and quantity supplied (other things remains
the same). The relationship is not between the quantity supplied and the price.
Factors affecting supply
1. State of technology
2. Prices of inputs (cost of production)
3. Prices of related goods
4. Government policy
5. Special influences

Shifts in supply
A shift in supply curve means that at each price a different quantity will be supplied than
previously.
S s1

S s1

O Q q1

Explanation with example

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 Same as in demand analysis here also we should not confuse between, shifts in supply and
movement along the supply curve. Also change in supply and the change in quantity
supplied.

Equilibrium
Equilibrium occurs where the quantity demanded equals quantity supplied – where there
is neither excess demand nor excess supply. The price at which the quantity demanded equals the
quantity supplied is called the equilibrium price.
We know that the amounts that are willingly bought and sold at each price. Consumers
may demand different amounts of commodities as a function of these goods’ prices. Similarly
producers willingly supply different amounts of goods depending on their prices. But how can
we put both sides of the market together?
The answer is that supply and demand interact to produce an equilibrium price and
quantity, or a market equilibrium. The market equilibrium comes at that price and quantity
where the forces of supply and demand are in balance. At the equilibrium rice, the amount that
buyers want to buy is just equal to the amount that sellers want to sell. The reason we call this an
equilibrium is that, when the forces of supply and demand are in balance, there is no reason for
price to rise or fall, as long as other things remain unchanged.

Explanation with example.

Production
The act of making goods and services is called production. It is a creation of value -
Value addition – changing inputs into outputs etc.
Inputs are commodities or services that are used to produce goods and services. Outputs are
the various useful goods or services that result from the production process and are either
consumed or employed in further production. Another term of inputs is factors of
production.

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 Factors of production can be grouped into four -namely land, labour, capital and
organization. They will get rent, wage, interest and profit respectively as rewards from the
economic activities.

Production function – Production function may be defined as the functional relationship

between physical inputs (i.e. factors of production) and physical outputs (i.e. the quantity of
goods produced).
In a general mathematical form, a production function can be expressed as:
Q = f(X1,X2,X3,...,Xn) where: Q = quantity of outputX1,X2,X3,...,Xn = factor inputs

Production possibility Curve

We learn early in life that we can’t have everything. The consumption opportunities of
countries are limited by the resources and the technologies available to them. Example of
Gun and Butter. Let us dramatize the choice by considering an economy which produces
only two economic goods, guns and butter. The guns represent military spending, and the
butter stands for civilian spending. Extreme possibilities – the following diagram shows
butter (product B) along the horizontal axis and Guns (product A) along the vertical axis. The
curve assumes that the state of technology and the availability of resources are constant. The
point X represents the under utilization of resources and the point Y is the unattainable
combination.

The production possibility frontier shows the maximum quantity of goods that can be
efficiently produced by an economy, given its technological knowledge and the quantity of
available inputs.
• MRT or MRPT (Marginal rate of product transformation) is the rate at which one
product is transformed into another. For example MRPT between good A and good B is
the amount of B which has to be sacrificed for the production of A.

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 • The MRPT at any point on the production possibility curve is given by the slope of the
curve at that point.
• Productive efficiency occurs when an economy produce more of one good without
producing less of other good; this implies the economy is on its production – possibility
frontier.
The production possibility curve will shift upward when the state of technology changes.
When the economy grows the curve will shift upward. All economies are striving for to shift
their respective PPF to the rightward direction.

product A

b q product B

The American Poet Carl Sandburg wrote “Time is the coin of your life. It is the only coin you
have and only you can determine how it will be spent. Be careful lest you let other people spend
it for you”
By sacrificing current consumption and producing more capital goods, a nation’s economy can
grow more rapidly, making possible more both goods (consumption and investment) in the
future.

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