Basics

1
Basics
Distinction between Economics and Economy
Economics is the social science that studies how individuals, businesses, governments, and
societies allocate resources to satisfy their unlimited wants and needs. It's essentially about
the production, distribution, and consumption of goods and services.
An economy, on the other hand, refers to the system by which these resources are organized
and managed within a speci>ic geographic area or community. Economies can vary greatly
depending on factors like the type of economic system (capitalism, socialism, mixed
economy), government policies, cultural in>luences, and more.
Classi3ication of Economics
Microeconomics: Microeconomics deals with the behavior of individual economic agents
such as households, >irms, and industries. It examines how they make decisions regarding the
allocation of scarce resources and how these decisions affect prices, quantities, and resource
allocation in speci>ic markets. Topics in microeconomics include supply and demand,
consumer behavior, production theory, market structures (such as perfect competition,
monopoly, oligopoly), and welfare economics.
Macroeconomics: Macroeconomics studies the economy as a whole, focusing on aggregate
phenomena such as national income, unemployment, in>lation, economic growth, and
monetary and >iscal policies. It analyzes the interactions among different sectors of the
economy and the impact of government policies on overall economic performance.
Macroeconomics also explores the causes and consequences of business cycles and
>luctuations in economic activity.
Classi3ication of Economies
Economies can be classi>ied into various types based on their organization, ownership of
resources, and the role of government. Here are some common types:
Market Economy: Also known as capitalism, in a market economy, the production and
distribution of goods and services are primarily determined by the interactions of buyers and
sellers in the marketplace. Private individuals and businesses own the factors of production
and make decisions based on market forces of supply and demand. Examples include the
United States, United Kingdom, and most Western European countries.
Command Economy: Also known as planned economy or socialism, in a command economy,
the government owns and controls the factors of production and makes decisions regarding
what goods and services will be produced, how they will be produced, and for whom. Prices
Courses Offered: UPSC, APPSC, TSPSC, IBPS, SSC CGL, RRB and RBI
GRADE B. HEAD OFFICE: MVP COLONY, VIZAG. CONTACT 7893899553
2
may be set by the government rather than by market forces. Examples include the former
Soviet Union, Cuba, and North Korea.
Mixed Economy: A mixed economy combines elements of both market and command
economies. Most modern economies are mixed economies, where there is a combination of
private enterprise and government intervention. Governments typically regulate certain
industries, provide public goods and services, and implement social welfare programs while
leaving other sectors to operate under market principles. Examples include India.
Traditional Economy: In a traditional economy, economic decisions are based on customs,
traditions, and cultural beliefs passed down from generation to generation. Production
methods are often primitive and technology is limited. Individuals typically work in
occupations determined by their familial or societal roles. Examples include some indigenous
communities and rural areas in developing countries.
Sectors of an Economy
The sectoral classi>ication of the economy divides economic activities into different sectors
based on the nature of the activities involved. The main sectors typically include the primary
sector, the secondary sector, and the tertiary sector. Here's a breakdown:
Primary Sector: This sector includes activities related to the extraction and production of
natural resources. It involves industries such as agriculture, forestry, >ishing, mining, and
quarrying. The primary sector is essential because it provides the raw materials needed for
other sectors of the economy. However, its importance tends to diminish as economies
develop and shift towards industrialization and services.
Secondary Sector: Also known as the industrial sector, the secondary sector involves
activities related to manufacturing and processing raw materials obtained from the primary
sector. This sector encompasses industries such as manufacturing, construction, and utilities
(e.g., electricity, gas, water supply). The secondary sector adds value to raw materials by
transforming them into >inished goods or intermediate products.
Tertiary Sector: The tertiary sector, also known as the service sector, encompasses a wide
range of activities that do not directly produce tangible goods but instead provide services to
individuals and businesses. This sector includes industries such as retail, transportation,
>inance, healthcare, education, hospitality, entertainment, and professional services (e.g.,
legal, consulting). The tertiary sector has become increasingly dominant in advanced
economies as they transition away from manufacturing towards service-based economies.
In addition to these main sectors, some classi>ications may include additional sectors:
Quaternary Sector: This sector involves activities related to knowledge-based services,
research and development, information technology, and intellectual services. It includes
3
industries such as information technology, telecommunications, biotechnology, and

education. The quaternary sector is characterized by its focus on creating, managing, and
disseminating knowledge.
Quinary Sector: The quinary sector comprises high-level decision-making and leadership
roles in government, business, academia, and other organizations. It includes top executives,
government of>icials, academic researchers, and other professionals who in>luence policy-
making, strategic planning, and organizational direction.
Real Sector Vs Financial Sector
The real sector and the >inancial sector are two fundamental components of an economy, each
serving distinct but interconnected roles:
Real Sector:
The real sector refers to the part of the economy involved in the production and distribution
of goods and services. It encompasses tangible economic activities that directly contribute to
the creation of wealth.
Key components of the real sector include industries such as agriculture, manufacturing,
construction, mining, and utilities.
The real sector is concerned with the production of goods and services, employment
generation, physical infrastructure development, and overall economic output.
It involves the utilization of resources such as land, labor, and capital to produce goods and
services that satisfy human needs and wants.
Financial Sector:
The >inancial sector, also known as the >inancial industry or >inancial services sector,
comprises institutions and markets involved in the management, allocation, and transfer of
>inancial resources.
Key components of the >inancial sector include banks, >inancial markets (such as stock
markets and bond markets), insurance companies, investment >irms, and other
intermediaries.
The >inancial sector facilitates the >low of funds between savers (individuals, businesses, and
governments) and borrowers (entities seeking capital for investment or consumption).
It provides a range of >inancial products and services, including lending, borrowing,
investment, insurance, and risk management.
4
The >inancial sector plays a critical role in allocating capital ef>iciently, mobilizing savings,
facilitating investment and economic growth, managing risk, and promoting liquidity and
stability in the economy.
While the real sector and the >inancial sector perform distinct functions, they are
interconnected and mutually dependent. The real sector relies on the >inancial sector for
funding investment and working capital needs, while the >inancial sector depends on the
performance and prospects of the real economy for its pro>itability and stability. Ef>icient
functioning of both sectors is essential for overall economic growth and development.
Concepts of Demand, Supply and Market Equilibrium
Law of Demand:
- The law of demand states that, all else being equal, as the price of a good or service increases,
the quantity demanded decreases, and vice versa.
- In other words, there is an inverse relationship between the price of a product and the
quantity demanded by consumers.
- This relationship is typically illustrated on a graph as a downward-sloping demand curve.
- Factors in>luencing demand include the price of the good, income levels, prices of related
goods, consumer preferences, and expectations about future prices.
Law of Supply:
- The law of supply states that, all else being equal, as the price of a good or service increases,
the quantity supplied increases, and vice versa.
- There is a direct relationship between the price of a product and the quantity that producers
are willing to supply to the market.
- This relationship is typically illustrated on a graph as an upward-sloping supply curve.
- Factors in>luencing supply include the price of the good, input prices (e.g., labor, raw
materials), technology, the number of >irms in the industry, and expectations about future
prices.
Equilibrium:
- Equilibrium occurs in a market when the quantity demanded by consumers equals the
quantity supplied by producers.
- At equilibrium, there is no tendency for prices or quantities to change because buyers and
sellers are satis>ied.
5
- Equilibrium price and quantity are determined by the intersection of the demand and supply
curves.
- If there is any imbalance between supply and demand, such as excess supply (surplus) or
excess demand (shortage), market forces will push prices towards the equilibrium level.
- Equilibrium is a key concept in economics as it helps in understanding market behavior and
predicting the effects of changes in demand or supply on prices and quantities traded.
6
7
Different Types of Goods
Goods can be classi>ied into different types based on various characteristics. Here are some
common classi>ications:
1. Consumer Goods: These are goods that are purchased for direct consumption by the
end-users. They can further be categorized into:
- Durable Goods: Goods that have a long lifespan and are used over an extended period,
like appliances, furniture, cars, etc.
- Non-Durable Goods: Goods that are consumed immediately or have a short lifespan, like
food, beverages, toiletries, etc.
2. Producer Goods: Also known as capital goods, these are goods used by producers to
manufacture other goods or provide services. Machinery, equipment, tools, etc., fall under this
category.
3. Public Goods: These are goods that are non-excludable and non-rivalrous in consumption.
This means that their bene>its are available to all and the consumption by one individual does
not reduce the availability of the good for others. Examples include street lighting, national
defense, public parks, etc.
4. Private Goods: These are goods that are excludable and rivalrous in consumption. Their
consumption can be restricted to paying customers, and the consumption by one individual
reduces the availability of the good for others. Most goods fall into this category.
5. Complementary Goods: These are goods that are typically consumed together because
the use of one good tends to enhance the use of the other. For example, printers and ink
cartridges, smartphones and apps, etc.
6. Substitute Goods: These are goods that can be used as replacements for each other. When
the price of one rises, the demand for the other increases. For example, butter and margarine,
tea and coffee, etc.
8
7. Free Goods: These are goods that are available in abundance and have no opportunity cost.
Examples include air, sunlight, etc.
8. Merit Goods: These are goods that the government or society deems bene>icial for
individuals to have, even if the individuals may not realize their bene>its. Education,
healthcare, etc., are often considered merit goods.
9. Inferior Goods: These are goods for which demand decreases as consumer income
increases. Examples include cheap, low-quality products that consumers switch from when
they can afford better alternatives.
These are some of the broad classi>ications, and goods can sometimes fall into multiple
categories depending on the context and criteria used for classi>ication.
Elasticity, in economics, refers to how responsive the quantity demanded or supplied of a

good is to a change in price or other factors. Goods can be classi>ied as either elastic or
inelastic based on their responsiveness to price changes:
1. Elastic Goods:
• These are goods for which the quantity demanded or supplied is very responsive
to changes in price.
• If the price of an elastic good increases, consumers tend to decrease their
quantity demanded signi>icantly.
• Examples of elastic goods include luxury items, certain types of electronics, and
non-essential services like dining out or vacations.
• Elastic goods typically have substitutes available, meaning consumers can easily
switch to alternative products if the price changes.
2. Inelastic Goods:
• Inelastic goods are those for which the quantity demanded or supplied shows
little response to changes in price.
• Even if the price of an inelastic good changes, consumers tend to continue
buying roughly the same quantity.
• Examples of inelastic goods include necessities like food, gasoline, and medical
services.
• Inelastic goods often lack close substitutes, so consumers have limited options
to switch to if the price changes.
9
Tangible assets and intangible assets are both crucial components of a company's
value,but they differ in their nature.
1. Tangible Assets:
• Tangible assets are physical assets that can be seen, touched, and quanti>ied.
Examples include land, buildings, machinery, equipment, vehicles, and
inventory.
2. Intangible Assets:
• Intangible assets are assets that lack physical substance but hold economic
value for a company. Examples include patents, trademarks, copyrights,
goodwill, brand recognition, and intellectual property
Opportunity Cost
De3inition: Opportunity cost is the value of the bene>its that are sacri>iced when one
alternative is chosen over another. It represents the foregone opportunity or the potential
bene>its that could have been obtained if the next best alternative had been chosen instead.
Example: Suppose you have a free evening and you're considering how to spend it. You could
either go to a concert or stay home and study for an upcoming exam. If you choose to go to
the concert, your opportunity cost would be the bene>it you would have gained from studying
for the exam (such as better grades or understanding the material more thoroughly).
Conversely, if you choose to study for the exam, your opportunity cost would be the
enjoyment and experience you would have gained from attending the concert.
Trade-offs: Opportunity cost highlights the idea of trade-offs in decision-making. Whenever

a choice is made, there are alternative options that must be sacri>iced. Individuals, businesses,
and societies must weigh the bene>its and costs of each option and choose the one that
maximizes their overall well-being or utility.
Scarcity: Opportunity cost is closely related to the concept of scarcity, which refers to the
limited availability of resources relative to unlimited wants and needs. Because resources are
limited, individuals and societies must make choices about how to allocate them, and
opportunity cost helps in evaluating these choices.
10
Decision-making: Understanding opportunity cost is crucial for effective decision-making in

various contexts, including personal >inance, business strategy, public policy, and resource
allocation. By considering the opportunity cost of different options, decision-makers can
make more informed choices and allocate resources ef>iciently.
Formal Economy vs Informal Economy

The formal economy refers to economic activities that are legally recognized and regulated
by the government, typically involving registered businesses, taxation, and adherence to
labor laws. Examples include large corporations, government agencies, and registered small
businesses.
On the other hand, the informal economy consists of economic activities that are not of>icially
recognized or regulated by the government. These activities often operate outside the formal
system, with participants typically not paying taxes or adhering to labor regulations.
Examples include street vendors, cash-in-hand jobs, and unregistered small businesses like
home-based enterprises.
11
Most Important Personalities
Adam Smith was an in>luential Scottish economist and philosopher, often regarded as the
father of modern economics. He lived during the 18th century and is best known for his
seminal work, "The Wealth of Nations," published in 1776. In this work, Smith laid out his
ideas on free-market capitalism, division of labor, and the role of self-interest in promoting
economic prosperity.
One of Smith's key concepts is the "invisible hand," which suggests that individuals, by
pursuing their self-interest in a free market, unintentionally promote the good of society as a
whole. He argued that the pursuit of pro>it leads individuals to produce goods and services
that others value, thereby contributing to the overall wealth and well-being of society.
Smith also emphasized the importance of division of labor in increasing productivity. He

famously illustrated this concept with the example of a pin factory, where specialization and
division of tasks among workers dramatically increased ef>iciency and output.
12
John Maynard Keynes was a British economist whose ideas had a profound impact on
economic theory and policy. He is best known for his revolutionary ideas on macroeconomics,
particularly during the Great Depression. Keynes argued that during economic downturns,
governments should intervene to stimulate demand through increased spending and
investment, even if it meant running budget de>icits. This approach, known as Keynesian
economics, challenged the prevailing classical economic theory of the time, which advocated
for minimal government intervention and believed in the self-correcting nature of markets.
Keynes's most famous work, "The General Theory of Employment, Interest, and Money,"
published in 1936, laid out his ideas on how government policies could mitigate economic
downturns and stabilize economies. His theories provided the intellectual foundation for
many of the policies implemented during the Great Depression and have since in>luenced
economic policymaking around the world.
In addition to his contributions to economics, Keynes was also heavily involved in public
policy and international affairs. He played a signi>icant role in the negotiations leading to the
establishment of the Bretton Woods system and the creation of institutions like the
International Monetary Fund (IMF) and the World Bank.
13
UPSC PYQs
1. If a commodity is provided free to the public by the Government, then (2018)

(a) the opportunity cost is zero.
(b) the opportunity cost is ignored.
(c) the opportunity costs is transferred from the consumers of the product to the tax-paying
public.
(d) the opportunity cost is transferred from the consumers of the product to the Government.
Answer- c
Opportunity cost is the cost of choosing one alternative over another and missing the bene>it
offered by the forgone opportunity, investing or otherwise. Opportunity cost refers to a
bene>it that a person could have received, but gave up, to take another course of action. Stated
14
differently, an opportunity cost represents an alternative given up when a decision is made.

Opportunity cost is also called the economic cost.
2. Consider the following statements: Other things remaining unchanged, market demand for
a good might increase if
1. price of its substitute increases
2. price of its complement increases
3. the good is an inferior good and income of the consumers increases
4. its price falls
Which of the above statements are correct? (2021)
(a) 1 and 4 only
(b) 2, 3 and 4
(c) 1, 3 and 4
(d) 1, 2 and 3
Answer – a
Law of Demand- Law of Demand states that other things being equal, there is a negative
relation between demand for a commodity and its price. In other words, when price of the
commodity increases, demand for it falls and when price of the commodity decreases,
demand for it rises, other factors remaining the same. Hence, statement 4 is correct.
The quantity of a good that the consumer demands can increase or decrease with the rise in
income depending on the nature of the good.
For most goods, the quantity that a consumer chooses, increases as the consumer’s income
increases and decreases as the consumer’s income decreases. Such goods are called Normal
Goods. Thus, a consumer’s demand for a normal good moves in the same direction as the
income of the consumer. However, there are some goods the demands for which move in the
opposite direction of the income of the consumer. Such goods are called Inferior Goods. As
the income of the consumer increases, the demand for an inferior good falls, and as the
income decreases, the demand for an inferior good rises.
Examples of inferior goods include low quality food items like coarse cereals. Hence
statement 3 is not correct.
The quantity of a good that the consumer chooses can increase or decrease with the rise in
the price of a related good depending on whether the two goods are substitutes or
complementary to each other. Goods which are consumed together are called complementary
goods.
Examples of goods which are complement to each other include tea and sugar, shoes and
socks, pen and ink, etc. Since tea and sugar are used together, an increase in the price of sugar
is likely to decrease the demand for tea and a decrease in the price of sugar is likely to increase
the demand for tea. Similar is the case with other complements. With the increase in price of
complement, demand reduces. Hence statement 2 is not correct.
In contrast to complements, goods like tea and coffee are not consumed together. In fact, they
are substitutes for each other. Since tea is a substitute for coffee, if the price of coffee
increases, the consumers can shift to tea, and hence, the consumption of tea is likely to go up.
On
15
the other hand, if the price of coffee decreases, the consumption of tea is likely to go down.
The demand for a good usually moves in the direction of the price of its substitutes. Hence
statement 1 is correct.
3. Which of the following activities constitute real sector in the economy?

1. Farmers harvesting their crops
2. Textile mills converting raw cotton into fabrics
3. A commercial bank lending money to a trading company
4. A corporate body issuing Rupee Denominated Bonds overseas
Select the correct answer using the code given below: (2022)
(a) 1 and 2 only
(b) 2, 3 and 4 only
(c) 1, 3 and 4 only
(d) 1, 2, 3 and 4
Answer – a
The real sector of an economy is the key section as activities of this sector persuade economic
output and is represented by those economic segments that are essential for the progress of
GDP of the economy. For instance, farmers harvesting their crops or textile mills converting
raw cotton into fabrics ensure increase of economic output and in turn progress of GDP. The
sector is crucial for the sustainability of the economy because of its productive capability to
meet nations’ aggregate demand. Hence statements 1 and 2 are correct.
On other hand, the >inancial sector is a section of the economy made up of >irms and
institutions that provide >inancial services to commercial and retail customers. The >inancial
sector generates a good portion of its revenue from loans and mortgages. This sector
comprises a broad range of industries including banks, investment companies, insurance
companies, and real estate >irms. Thus, a commercial bank lending money to a trading
company or a corporate body issuing rupee denominated bonds overseas constitute >inancial
sector activities and not real sector activities. Hence statements 3 and 4 are not correct.

Basics

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Basics

Uploaded by

Copyright:

Available Formats

1

industries such as information technology, telecommunications, biotechnology, and

Real Sector Vs Financial Sector

Different Types of Goods

Elasticity, in economics, refers to how responsive the quantity demanded or supplied of a

Trade-offs: Opportunity cost highlights the idea of trade-offs in decision-making. Whenever

Decision-making: Understanding opportunity cost is crucial for effective decision-making in

Formal Economy vs Informal Economy

Most Important Personalities

Smith also emphasized the importance of division of labor in increasing productivity. He

1. If a commodity is provided free to the public by the Government, then (2018)

differently, an opportunity cost represents an alternative given up when a decision is made.

3. Which of the following activities constitute real sector in the economy?

You might also like