Economics and Management Decision

Unit-2
Ten Principles of Economics
Objectives

After completing this unit, students will be able to:

• Explain the principles of economics

• Outline the works of eminent economists

 Principles of Economics Following are the eight essential principles of economics:

Principle 1: People Face Trade-Offs

1 People face
In everything a person chooses to do, they must perform
trade-offs.
2 What you give up some trade-off either in terms of time or money. For example,
for something, is
3 Rational if one goes to the market to buy something, they have to give
its cost.
people think up the comforts of the home and spend on the commute
at the margin. while taking risks during the said commute. In a broader
4 Trade can make
everyone better off. context, sometimes, to remove disparity and promote equity,
5 Markets are usually a the government chooses to sacrifice efficiency.
good way to organize 6 Market outcomes can
economic activity. For example, the government often redistributes income
occasionally be improved
by governments. taxes to finance unemployment.

7 A country’s living
standard is dependent on 8 If the government
its capability to produce prints excess currency,
goods and services. prices will rise.
Principle 2: What you Give up for Something is its Cost
As per the economic theory, when presented with a choice to select
one from among numerous alternatives, we probably always try
to choose the best option. Opportunity cost is defined as the next
possible best alternative that has to be given up during the selection
process in order to choose the best one. For example, if we are
unwell and have to choose among medicines, clothes and a movie,
we are most likely to choose medicines over the other two options.
The opportunity cost of medicines will be the next best alternative.
Principle 3: Rational People Think at the Margin
Economists hold the view that in order to make rational decisions,
people consider their opportunities and objectives. Sometimes,
rational people make a marginal change to the existing plan of
action. Managers compare the marginal cost and marginal benefit
to arrive at a decision.
For example, an airline has 500
passenger seats available for a flight.
Cost of 500 tickets: Rs. 2,00,000
Average cost per ticket: Rs. 400
Should the airline sell a ticket at a price
less than Rs. 400 if 12 seats are empty?
Yes. If the plane has 12 empty seats just before flying, the airline
can decide the fare at Rs. 300 to attract the last-minute passengers.
It makes sense for the airline to sell those 12 tickets at a cost less
than Rs. 400 as the additional cost of flying these passengers is
small. It is the marginal cost of the ticket, i.e., a bag of peanuts and a
little extra fuel that may be needed to fly those last few passengers.
Principle 4: Trade can Make Everyone Better Off
The result of trading carried out between countries, households
and people is called Specialization and Competition. Japanese and
Americans produce the same type of goods, such as cars. They
have healthy competition between them to produce better cars
to attract people and establish themselves as trustworthy and
consumer-oriented companies.
Principle 5: Markets are Usually a Good way to Organize
Economic Activity
People carry out buying and selling of goods and services in markets.
Markets decide the demand and supply of goods and hence, their
prices. In a market economy, the decision-making is in the hand
of millions of buyers and sellers. It is a fact that the government
is the central planning authority in a communist economy, and as
such, it may not be able to take the best decisions for every buyer
and seller. In a market economy, individuals decide regarding which
jobs they would take up and what they will buy with their income.
Principle 6: Market Outcomes can Occasionally be
Improved by Governments
According to this principle, if the invisible hand of market forces
had been perfect, there would have been no need for a government.
The government is required in order to form and enforce rules. The
working of market forces is based on the imposition of rules by
the government. It is also based on how the government maintains
the related organizations and institutions that are essential for the
functioning of a market economy.
Principle 7: A Country’s Living Standard is Dependent on
its Capability to Produce Goods and Services
High productivity in an economy is depicted by a high standard of
living. Higher productivity ensures higher living standards. Laws
for minimum wages and labour unions do not provide for a higher
standard of living. Policymakers can ensure a better living standard
by raising productivity, which is dependent on skill development and
thus, the efficiency of the workers. Policymakers can also provide
access to the best technology to their workers.
Principle 8: If the Government Prints Excess Currency,
Prices will Rise
Inflation is a phenomenon characterized by an incessant and
persistent increase in prices in the whole economy. The purchasing
power falls whenever inflation rises, thereby affecting the demand.
Inflation can be caused due to the excess supply of currency by the
government.
High inflation means everything costs more, putting pressure on
the market forces and the economy. Hence, economists generally
want to keep the inflation low.
Three Economists and Their Theories
The most influential economic theories were developed by three of
the most important economists and highly original thinkers - Adam
Smith, John Maynard Keynes and Karl Marx. These theories have
affected the world’s economies for generations.
Adam Smith: Theory of the Invisible Hand of Capitalism
Adam Smith (1723–1790) is also referred to as the Father of
Economics. His book “The Wealth of Nations” was published
in 1776. He founded modern economics and classical
economics.
He argued that every person in a society is as an economic
man, who acts rationally in his own interest to maximize his
personal utility.
He explored the concept of wealth accumulation, labour
market and growth productivity.
Karl Marx: Exploitation of Labour
Karl Marx (1818 to 1883) was a German
economist. He was of the view that when all the
resources of production have been set up by
the capitalist, all the value created by labour is
involved in the production of commodities for
capital accumulation of the capitalists.
In his book, Das Kapital (Capital) published in 1867,
Marx presented his views that the capitalists earn
profits when labour is exploited. The exploitation
of labour by the management underlies the class
struggle, which, according to Marx, will ultimately
destroy capitalism.
Keynes: Government as a Helping Hand
John Maynard Keynes (1883 to 1946) was a British economist. He
examined capitalism closely.
His argument was that the overall level of economic activity is
determined by aggregate demand and if the aggregate demand is
inadequate, it could result in higher unemployment for extended
periods.
To alleviate the hostile effects of economic downturns and depressions,
Keynes had advocated the use of fiscal and monetary policies.
The most significant aspect of Keynes' work during the great depression
was that he put forth his views regarding the government’s role in a
capitalist economy. The approach of Keynesian economics refers to
the economic policy that keeps the economy stable and growing.
Summary

The chapter discusses the significance of eight principles of Economics

that help in decision-making. When a decision needs to be taken by
individuals, they face trade-offs between their alternate goals. The chapter
discusses how rational people act to make decisions.

This chapter acquaints us with economists such as Adam Smith, Karl Marx and Lord Keynes
who are widely recognized for their work.

Assessment Questions 4. How has Keynes contributed to the stable

1. Explain the concept of a trade-off.
2. What is deficit financing?
economists want to keep inflation low?
3. Give an example of how managers
compare marginal cost and marginal
benefit to come to a decision?
growth of an economy?
5. Give an example of a situation that
Why do
validates Karl Marx’s views on capitalism.
6. Explain as to how the growth of economies
is assisted by Principle 4 – ‘Trade can
make everyone better off’. How can it
adversely affect markets?