Economics-1

BALLB-207

Basic Concepts and

Precepts
Economic Problems
• Economic problem is basically a problem of choice.
• A resource may be scarce in relation to its demand,
which depends upon the demand for those goods and
services that it produces. There is nothing like absolute
scarcity.

• The problem of using resource optimally arises because:

 The human wants to be satisfied are unlimited.
 The resources are available to produce goods and
services to satisfy human wants are limited or scarce.
 The resources have alternative uses. The same resource
can be used for the production of various goods
&services.
Central/Basic problems of economy

What to How to For Whom

Produce Produce to Produce
? ? ?

Problem of Problem of Problem

allocation choice of of
of techniques distributio
resources n
What to produce?

• The decision to produce one good will reduce the production of the
other good, as the resources used to produce these goods are
limited.
• For example: a decision to produce armaments is going to affect the
production of clothes. We cannot have more of both cloth and
ammunition.
• Thus, an economy has to decide what good should be produced and
in what quantity on the basis of the importance of various goods to
the economy as a whole. This is a problem of allocation of
resources among different code.
How to produce?
• After determination of goods to be produced and their respective quantities, the
problem comes as to how goods should be produced.
• This is a problem of selection of factor combinations to be used for the production of
a particular good, since a good can be produced with different factor combinations
and with different techniques of production. Here, in general two types of
techniques of production are discussed. These are labour intensive and capital
intensive techniques.
• The producer while deciding about the technique considers the price and
productivity of alternative factors. It should produce the product at the minimum
possible cost.
• For example:
 USA –Capital Intensive
 INDIA—Labour Intensive
For Whom to produce?
• This is the problem of distribution of national products. It relates to the share of various sections of the
economy or factors in national product. Income derived by factors can be classified into two categories :

 First is the income obtained through work. This represents the reward for services rendered by labour
called wages and salaries. Wages earned by various people are different due to many factors: Skill, technical
education, expertise in doing a particular job, bargaining power etc.

Second is the income obtained from property like land, building factories etc. in the form of rent, interest
and profits. There are differences in the ownership of property which results in the difference in the income
obtained from the property.

In capitalist society, rich people share a major part of the national product.
In socialist society, the national product is distributed by the state on an equitable basis.
Economic agents &organizations
•Firms as economics agents or economic organizations face the
problem of the organization of the resources to meet the possible
production goals. The inputs may be regarded as being used up in order
to gain the output.
•The product of one industry may be used in another industry for
example wheat is used in making bread.
•Each distinct input into the production process can be regarded as
factor of production. The 4 primary inputs in the sense that participate
in the production activity are:
•For example for production of garments, a piece of land is required. To
build a factory, where production takes place.
•This also requires the services of labour
•Capital is required to meet capital expenditure on the purchase of
machines, tools and raw material etc
•Finally the services of entrepreneurs are required to organize,
supervise and co-ordinate the whole process of production including the
services of land labour and capital.
Marginalism
• As resources are scarce, each and every additional unit of resources is to be
utilized by the managers with utmost care.

• A decision about additional investment is taken on the basis of additional return

from that investment. In a decision to employ an additional work on machine
one needs to know the additional output expected from it.

• Resources should be allocated or hired in such a way, that ratio of marginal

return and marginal cost of various uses of a given resource or of various
resources in a given use is the same. In other words, the value added by the last
unit of the resource is the same in all the cases. This concept is known as equi -
marginal principle.
• The corresponding concept dealing with equilibrium of more than one
commodity or factor is called eqi - marginalism.
• Example: Multi product MR1=MR2=MR3, Multi plant MC1=MC.
Marginal & Incremental Concept
•The marginal concept measures the change in dependent variable (cost, revenue, profit) with respect to unit
change in independent variable.

•For example: The additional revenue earned by a business firm through increase in a single labour may be
termed as marginal revenue.
• MR= TR at 2nd unit of labour – TR at 1st unit of labour
L TR MR
1 Rs.5 Rs.5
2 Rs.12 Rs.7(12-5)

•But the output may change because of a change in process pattern or a combination of factors which may not be
measured in units terms. In such situation the concept of marginalism has to be replaced by incrementalism.

•Incremental concept involves the estimation of the impact of a decision. Two fundamental concepts in this
connection are incremental revenue and incremental cost. For example: The additional revenue earned by a
business firm through computerization may be termed as marginal revenue while the additional cost of installing
computer facilities may be termed as incremental cost. In fact all marginal concepts are incremental concept but
not vice versa.
Marginal & Incremental Concept
•As the output may change because of a change in process pattern or a combination of
factors which may not be measured in units terms. In such situation the concept of
marginalism has to be replaced by incrementalism.
•Incremental concept involves the estimation of the impact of a decision. Two
fundamental concepts in this connection are incremental revenue and incremental cost.
•For example: The additional revenue earned by a business firm through computerization
may be termed as incremental revenue while the additional cost of installing computer
facilities may be termed as incremental cost.
•In fact all marginal concepts are incremental concept but not vice versa.
Marginal Concept Incremental Concept

It is expressed in terms of a unit change. It is expressed in terms of bulk of change.

Here, the reference is to the one of the independent variable. Hence, more than one independent variable is considered.

It is more specific It is more general

All marginal concepts are incremental concepts All incremental concepts are not marginal concepts
Time value of money
Decision making involves coordination between past, present and future.

Whenever manager makes a decision ,he has to analyse the present problem with
reference to past data of facts and figures and observations, contemplating its future
implications. He must consider short and long run consequences of his decision.
There are 2 techniques for adjusting time value of money.
i) Compounding (Future value techniques)
ii)Discounting (Present value techniques)

• The value of money at future date with a given interest rate is called future value.
• The worth of money today that is receivable or payable at future date is called
present value.
Time value of money
Time value of money

Compounding and discounting

 The concept of compounding and discounting have relevance in view of the time
dimension involved in the decision-making process and planning.
 Any investment benefits after a certain period of time, this makes it essential to assess
the present value of the future gain by discounting it. It is common knowledge that Rs
1,000 today has more value compared to the Rs 1000 five years from now.
Time value of money
 It is relevant to the cost benefit involved in
the choice of investment decision. There is
an inbuilt risk and uncertainty attached to
the investment that if the project fails in
money will be lost. Money has time value
due to changing prices, uncertainty and its
earning power.
 If ‘i’ is the rate of interest, future value (A)
of a sum (P) can be calculated by
compounding formula, A=P(I+i)n. Thus, P
(present or discounted value) is equal to
A/(1 + i )n.
Opportunity cost
• All decision involving choices have a opportunity cost for optimal allocation of
resources. Opportunity cost is the cost associated with the next best alternative
sacrificed. As by choosing one course of action, the other alternative courses is
sacrificed, the chosen course of action can be evaluated in terms of sacrificed one.
• The costs associated with the best alternative which is foregone is called opportunity
cost. Ex: Budgetary allocation of first certain in region which is devoid of electricity as
well as roads is 500 Crores. People have voted for thermal power station, the
opportunity cost of money spent on power station is number of good roads
• If a machine produce 2 unit of product X or 10 unit of product Y then opportunity cost
of 1 unit of product X is equal to 5 units of Y .When no information about quantity is
available then the opportunity cost can be calculated in terms of ratio of respective
prices.