ECONOMICS AND ECONOMY

Economics is a subject matter that deals with economic

problems related to human life. Economic problem is a problem
of choice. It arises because of two reasons:
 Our resources are Scarce(limited) in relation to our wants.
 Resources have alternative uses.
• Micro Economics: Microeconomics is the study of the
economic behavior of individuals, households and firms’ in
decision making and allocation of resources.
• Microeconomics is concerned with:
• Supply and demand in individual markets
• Individual consumer behaviour. e.g. Consumer choice theory
• Individual producer behavior.
• Individual labour markets,E .g. demand for labour wage
determination in that individual market.
• Theory of price
• MACROECONOMICS
• Macroeconomics is the branch of economics that deals with
the behavior and performance of an economy as a whole.
• It is generally the study of central issues like
• Employment
• The growth rate of National output
• Theory related to equilibrium in the economy
• Theory related to disequilibrium in the economy
• Theory related to correction of disequilibrium in the economy
 POSITIVE AND NORMATIVE
ECONOMICS
• POSITIVE ECONOMICS: It deals with economic issues
related to past, present or future.

• NORMATIVE ECONOMICS: It is the economics of ‘ what

ought to be’. It deals with opinions of the economists related to
economic issues or economic problems.
Basis Positive Economics Normative economics
Meaning Studies with what is or how theStudies with what ought or how the
economic problem areeconomic problem should be
originally solved. solved.

Validity It can be verified with originalIt cannot be verified with original

data. data.

Aim It aims to provide originalIt aims to determine the principles.

description of an economic
activity.

Suggestive It is based on set of collectedIt is based on opinion of the

facts. individual.

Example Prices and inequalities ofGovernment should generate more

income level in an economy. employment opportunities.
ECONOMY: The system by which people of an area earn their
living.

It includes two basic elements:

• a. Nature of economic activities performed by the people
• b. level of economic activities performed by the people.

• TYPES OF ECONOMIES:
 Controlled or centrally planned economy
 Free economy or Market economy
 Mixed Economy
CENTRAL PROBLEMS OF AN ECONOMY

What to produce?
How to produce? and
 For whom to produce?
What to Produce?
(i)What goods are to be produced:
Broadly, goods are classified as –
(a) Capital goods, and
(b) Consumer goods.

(ii) In what quantity goods are to be produced:

(B) How to Produce?
How to produce’ refers to the technique of production.
Broadly, there are two techniques of production –
(i) Labour-intensive technique, and
(ii) Capital-intensive technique.
 Labour-intensive technique implies greater use of labour
than capital, while capital-intensive technique implies
greater use of capital (machines, etc.) than labour.
Capital-intensive technique promotes efficiency.
 It accelerates the pace of growth. On the other hand,
labour-intensive technique promotes employment. The
choice between the labour-intensive and capital-
intensive techniques becomes a problem because labour-
intensive technique helps reduce unemployment, while
capital- intensive technique accelerates GDP growth.
(C) For Whom to Produce?
Owing to limited resources, an economy cannot produce
goods for all sections of the society to the extent desired.
Broadly, every economy has two sections of the society –
(i) The rich, and
(ii) The poor.
 Social justice is promoted if more goods are produced for
the poor. It would reduce inequality or promote equality.
But, there is a hidden cost of doing it.
 By producing goods for the poor, the profits of the
producers would remain low. Low profits would mean
low investment which Implying low GDP growth. The
economy would remain backward for a long time to
come. Thus, there is a problem of choice: social equality
or GDP growth.
 Solution of Central Problems in Different
Economies
(i) Market Economy:
The decisions are taken as under:
a. What to Produce?
The producers will produce those goods which offer them high
profits.
b. How to Produce?
The producers will always use that technology which maximizes
efficiency and minimizes cost.
c. For Whom to Produce?
In a free economy, the producers will produce goods for those
people who can afford to pay high price. Poorer sections of the
society are often ignored. It causes the problem of Economic
Divide (the gulf between the rich and the poor).
(ii) Centrally Planned Economy:

 In a centrally planned economy, decisions relating to ‘what,

how and for whom to produce’ are taken by some central
authority of the government.

 All decisions are taken to maximise social welfare, not to

maximise profits. Those goods and services will be produced
which the central authority (or the government) finds as most
useful for the society. That technique of production will be
adopted which is socially most desirable.
(iii) Mixed Economy:

 Mixed economy shares the merits of market economies as well

as centrally planned economies. Decisions regarding ‘what, how
and for whom to produce’ are taken both to maximise profits as
well as social welfare. In certain areas of production, producers
are free to take their decisions with a view to maximising profits.

 In certain other areas, decisions are taken entirely on the basis of

social considerations.
 PRODUCTION POSSIBILITY CURVE
Production possibility curve is a curve showing different possible
combinations of two goods which can be produced with the
available resources.
The construction of PPC is based on these assumptions –
(i) Resources are given,
(ii) Given resources are fully & efficiently utilised, and
(iii) Technology (technique of production) remains constant.

 Production possibility curve is a graphic representation of

production possibility schedule.

 Production possibility curve is also called Production

Possibility Frontier or Transformation Curve.
 PPC AND CENTRAL PROBLEMS
(1) PPC and What to Produce:

Fig. shows that if production of Good-X is increased from OR to

OS, the production of Good-Y must reduce from OC to OE.
Because, some resources must be shifted from Y to X.
(2) PPC and How to Produce:

ab in Fig. is related to the use of labour-intensive technology

which is relatively less efficient; cd is related to capital-intensive
technology which is more efficient. In case we shift from labour-
intensive technology to capital- intensive technology, it would be
reflected as a shift from ab to cd. However, while the level of
output would rise, the problem of unemployment may also rise.
(3) PPC and for Whom to Produce:

If a country focuses on growth without caring for ‘equality’

(equal distribution of income), it may succeed in shifting from ab
to cd. However, economic divide would rise which may lead to
social unrest.
PPC and Underutilization of Resources:
Any point on AE (like point P) corresponds to fuller as well as efficient
utilisation of resources. It shows the potential level of output in the economy.
Any point inside AE (like point F or G) corresponds to –
(i) Under-utilisation, or
(ii) Inefficient utilisation of resources.
It shows that the actual level of output is less than the potential level of
output.
• PPC and Growth of Resources:

• When new resources are discovered, the economy would shift from ab to cd,
implying a higher level of potential output. However, higher level of potential
output is achievable only when all resources are fully and efficiently utilised.
 SLOPE OF PPC
PPC shows two characteristics(properties):
(i) It slopes downward from left to right.
 PPC slopes downward because with the given resources (and
constant technology) increase in output of Good-2 is possible only
when there is decrease in output of Good-1.

(ii) It is concave to the point of origin.

 (i) When a curve is concave to the origin, it means that it has an
increasing slope, as we move along this curve, from left to right.

 (ii) Since slope of PPC = Marginal opportunity cost, increasing

slope implies increasing marginal opportunity cost.

 Accordingly, it is concluded that PPC is concave to the origin,

because as more and more resources are shifted from Opportunity-1
to Opportunity-2, marginal opportunity cost tends to rise.
 PPC AND OPPORTUNITY COST
Opportunity cost may be defined as the cost of availing an
opportunity (Opportunity-2) in terms of the loss of other
opportunity (Opportunity-1).
Total Opportunity Cost:
It refers to total loss of output when the given resources are
shifted from Use-1 (Opportunity-1) to Use-2 (Opportunity-2).
Marginal Opportunity Cost (also Called MRT- Marginal Rate
of Transformation):
It refers to opportunity cost per unit of additional output of Crop-
2 when some resources are shifted from one opportunity to the
other (from Crop-1 to Crop-2).
Diagrammatic Illustration:
Total opportunity cost and marginal opportunity cost are diagrammatically
illustrated.

• Marginal opportunity cost (when some resources are shifted from

Opportunity-1 to Opportunity-2)
 Why does Marginal Opportunity Cost (or MRT)
tend to rise?
An economy produces tow goods- Maggi and Pasta. The
following table summarizes its production possibilities. Calculate
the marginal opportunity cost of producing more pasta in place of
maggi at various combinations. What does it indicate? Draw the
Production Possibility Curve. What is the shape of the curve?