Chapter 1: Preliminaries

Macroeconomics- It is the branch that deals with aggregate economic variables

Microeconomics- It is the branch that deals with the behaviour of individual economic
units

Themes

Trade Offs

1. Consumers- limited income

a. Purchase of more of some goods for the purchase of less of others

b. spent on variety of goods or save money - hence choosing one involves a trade
off

2. Workers

a. Decision to enter whether and when to enter the workforce (current income vs
increasing skills for future income) Eg: Working now or continued education for
future income

b. Choice of employment

c. Typically a trade off between increased income vs leisure

3. Firms

a. What to produce - Trade off between difference goods to produce - Price acts
as the determinant

b. How to produce - capital vs labour intensive - maximum production wrt given

resources

c. How much to produce- Total production that is optimum in generating maximum

resources in terms of sales vs prices (if we produce too much prices will fall, if
we produce too less sales will fall, as revenue is sales * price)

Price and Markets

Chapter 1: Preliminaries 1
 1. Centrally Planned Economy- Prices are set by the govt - eg USSR, Cuba and
North Korea

2. Market Economy- Prices are determined by demand and supply (interaction

between consumers, workers and firms)

Theories and Models

1. Theories: Explanation and prediction based on these. These are developed to

explain observed phenomena in terms of a set of basic rules and assumptions

2. Model - Used for mathematical prediction based on theories Eg : Q demanded of X

= Function of variables like ( price, income etc)

Economics of Crime

Jumping traffic lights cause the time saved may outweigh the cost ( based on the
probability of getting caught being factored into the cost)

Expected Net Benefit = Expected Benefit + Expected Cost

If this (Expected Net Benefit) is greater than 0, its beneficial to do so

Eg: if the fine is 100, and the chances of getting caught is 1/100 then the effective
cost comes down to 1 and expected benefit from saving the time is 100

So Expected Net Benefit = Expected Benefit ( 100*0.99 ) + Expected Cost ( -

100 * 0.01 ) = 98

In this case, the the time saved might outweigh the cost which is why people may
jump

So, it can be resolved in two ways:

a. Increase fine - no additional costs but may alter social perception

b. Increase probability of getting caught ( better regulation, camera, chalans ) - but

have additional costs

So, if we increase the fine and increase the probability of costs, the Expected Cost will
increase a-lot which may push the Net Expected Benefits to negative and discourage
the act.

Chapter 1: Preliminaries 2
 Positive Vs Normative Analysis

1. Positive: Deals with explanation and Prediction (statements that clearly describe
relationships of cause and effect) - check the degree to which the explanatory
variable/independent variable causes changes in the dependent variable

2. Normative: What ought to be

a. Deciding Alternative options

b. balancing cost and benefits and asking the optimal size of that decision

c. Supplemented by a value judgement (choosing between which a pro and con

and if it were to be still be taken in the face of the cons)

d. It need not be empirical but could be based on the empirical evidence

(subjective analysis)

e. Standards for choosing in the Subjective Analysis: Maximum social welfare (

utililitarianism ), Equity

Market

Market: Collection of buyers and sellers that, through their actual or potential
interactions, determine the price of a product or set of products. Includes -

Arbitrage: Practice of buying at a low price at one location and selling at a

higher price in another - helps keep prices uniform across the locations

Competitive Vs Non Competitive Markets

1. Perfectly Competitive Market- Market with many buyers and sellers, so that
no single buyer or seller has a significant impact on price

However they need not have a lot of players, if the competition is severe
enough it can still be competitive Eg : Civil Aviation market

However a Noncompetitive Market can also have a large numbers of

players, who if act cooperatively can be noncompetitive Eg : Oil market in
OPEC

Chapter 1: Preliminaries 3
 Hence the classification depends more on the nature of relationship than
the number of sellers/buyers per se

2. Market Price: Price prevailing in a competitive market. Differentiated because:

Product differentiation

Brand loyalty

Non price incentives like vouchers etc

3. Extent of a market: Boundaries of a market, both geographical and in terms of

range of products and sold within it (Cigarette and Beedis ex- Govt has to
understand what the market is in order to try and make changes)

a. Product Market Extent- Must have similar uses, similar prices and of a similar
nature

b. Geographic Market Extent - when the transaction/transportation costs are a

low percentage of the actual cost of a good, its market extends to larger areas
Eg : The transportation costs of gold are a low percentage of its value, which is
why it tends to have a global geographic value

1. Example 1.1- Corn Syrup being a part of the sugar market rather it being a
distinct market in itself- Archer Daniels Midland Company and Clinton Corn
Processing Company

2. The above example basically explains why delineating Boundaries of a

market is important

3. Mass Market Bicycles and Dealer Bicycles- constitute separate markets- if

there is a dispute, then empirical evidence is to be considered

Arbitrage: Practice of buying at a low price at one location and selling at a higher
price in another.

Price
Real Vs Nominal Prices

1. Product Price Index: Measure of the aggregate price level for intermediate
products and wholesale goods

a. Percentage changes in this measure cost inflation and predict future changes in
CPI

Chapter 1: Preliminaries 4
 b. For products normally purchased by businesses

So which price index should you use to convert nominal prices to real prices?

It depends on the type of product you are examining. If it is a product or service

normally purchased by consumers, use the CPI. If instead it is a product normally
purchased by businesses, use the PPI.

Chapter 1: Preliminaries 5