Principles of Economics &

Management
Unit-1
Introduction to Economics
 Definition of Economics
• Economics is the study of the nature and
causes of wealth of nations. Acquisition of
wealth is the main objectives human activity,
how wealth is produced and consumed .
• Economics is a social science, deals with
human behaviour.
• Economics studies the problems due to the
scarcity of resources.
 Why economics to study
• Unlimited wants
• Scarce means (Resources)
• Alternative uses of means
• Choices in allocating these scarce resources
between alternatives relative their importance
 Nature of Economics
• Economics as a social science:-deals with living
element. Deals with economic behaviour and activities
of a human being.
• Economics as a Art as well as Science:-Establish cause
and effect relationships as well as it uses with
creatively considering sensitivity while dealing with
human behaviour.
• Micro as well as Macro economics:- Micro:- study
individual behaviour, individual firm or industries,
individual price, wages or income, individual consumer
and producer.
• Macro Economics:-Aggregate study, General study.
 Scope of Economics
• 1. Theory of Demand:- Demand Analysis and Demand
theory
• 2. Theory of Production:-Production and Cost analysis.
Determine the level of production at which average
cost of production is to be minimum.
• 3. Theory of Exchange or Price theory:-How the prices
are determined under different type of market
conditions?
• 4. Theory of Profit:- To earn maximum profit
(Profit=total revenue or total income-total cost)
• 5. Theory of Capital and Investment:-Selection of most
suitable investment project, most efficient allocation of
capital, efficiency of capital. Capital-resources should
be allocated in most efficient manner.
• 6. Environmental issues:- Environmental issues of
macro economics
 Basic Economic Problems:-
• 1.What should be produced?
• 2.How should things be produced?
• 3.Who should things be produced for?
 Unit -1

Economics as a Social Science

• Explain that Economics is a social science
• Outline the social scientific method.
• Explain the process of model building in economics.
• Explain that economists must use the ceteris paribus assumption when developing economic models.
• Distinguish between positive and normative economics.
• Examine the assumption of rational economic decision-making

Scarcity
• Explain that scarcity exists because factors of production are finite and wants are infinite.
• Explain that economics studies the ways in which resources are allocated to meet needs and wants.
• Explain that the three basic economic questions that must be answered by any economic system are: “What to
produce?”, “How to produce?” and “For whom to produce?”

Choice and Opportunity Cost

• Explain that as a result of scarcity, choices have to be made.
• Explain that when an economic choice is made, an alternative is always foregone.
• Explain that a production possibilities curve (production possibilities frontier) model may be used to show the
concepts of scarcity, choice, opportunity cost and a situation of unemployed resources and inefficiency.

Central Themes
• The extent to which governments should intervene in the allocation of resources
• The threat to sustainability as a result of the current patterns of resource allocation
• The extent to which the goal of economic efficiency may conflict with the goal of equity
• The distinction between economic growth and economic development.
 What is Economics?

A Riddle to start off your course

• You may not know it yet, but you are beginning a science
class. Yes, Economics is a science, and just like other
sciences, it deals with a fundamental problem of nature.
• Think of Aerospace Engineering. This is a science that
struggles to overcome a basic problem of nature, that of
GRAVITY. Aerospace Engineers are scientists whose
research and life’s work is aimed at overcoming the
problem of gravity and putting man in space.
• Economists are also scientists whose work attempts to
overcome a basic problem of nature.
Your Riddle:
What is the basic problem of nature that the science
of Economic attempts to overcome?

Hint: It arises because of the limited nature of earth’s

natural resources!
 Scarcity

Scarcity – the Basic Economic Problem

The problem that Economics, a social science, attempts to overcome is that of Scarcity.
Scarcity arises when something is
both limited in quantity yet desired
Some facts about scarcity
• Not all goods are scarce, but most are
• Some goods that humans consume are infinite, such as air
• Organize the following words under the correct category: Scarce or Not Scarce
 Scarcity

What makes something scarce?

Here’s another riddle for you…
• Nobody needs diamonds, yet they are considered extremely valuable
• Everybody needs water, yet they are considered extremely cheap

Why Are Diamonds So Expensive? Why Is Water So Cheap?

This is known as the “diamond / water paradox”. The answer lies in the fact that economic
value is derived from scarcity
• The more scarce an item, the more valueable it is Read more: The Diamond
Water Paradox
• The less scarce, the less value it has in society!
 Scarcity

Free Goods and Economics Goods

Goods in Economics are those things we like to consume. They are called “goods” because
consuming them makes us feel good!
• Free goods are those things that we desire but that are not limited
• Economic goods are those that we desire but that ARE limited

Economics as a Social Science: Economics is the social science that studies the interactions of humans in
the commercial realm. Economists examine the way societies allocate their scarce resources towards
competing wants and needs and seek to develop systems that achieve certain objectives, including:
• Growth in humans’ standard of living over time
• Sustainable development
• Employment and stability
 What is Economics?

What do Economists study?

The topics below are all some of the things you will study in your Economics course.
Follow the links to see some headlines from a blog relating to each of the topics

Some key topics from your Economics Course

Scarcity Cost/Benefit Environment Supply and
Resources Analysis Perfect Demand
Trade-offs Utility competition Trade
Opportunity cost maximization Game Theory Markets
Marginal analysis Price Theory Price Prices
Factors of Taxes discrimination Consumer
Production Market failure Income behavior
Exchange Rates Public goods distribution Firm behavior
Financial
Readmarkets
the followingRecession
blog post: Free Trade
Microeconomics vs. Macroeconomics
 What is Economics?

Economics is divided into two main fields of study

Microeconomics: Studies the behaviors of INDIVIDUALS within an economy:
Consumers and producers in particular markets. Examples of microeconomic topics:
• The Automobile market in Switzerland,
• the market for movie tickets in Zurich,
• the market for airline tickets between the US and Europe,
• the market for vacations to Spain,
• the market for international school teachers.

Macroeconomics: Studies the total effect on a nation's people of all the economic
activity within that nation. The four main concerns of macroeconomics are:
1. total output of a nation,
2. the average price level of a nation,
3. the level of employment (or unemployment) in the nation and
4. distribution of income in the nation
Examples of macroeconomic topics:
• Unemployment in Canada, inflation in Zimbabwe, economic growth in China, the
gap between the rich and the poor in America
 What is Economics?

Microeconomics vs. Macroeconomics

The two main units in your economics course can be broken down into many smaller
topics. Some of them are identified below.

Microeconomics examines Macroeconomics examines

• Individual markets • National markets
• the behavior of firms (companies) and • Total output and income of nations
consumers • Total supply and demand of the nation
• the allocation of land, labor and capital • Taxes and government spending
resources • Interest rates and central banks
• Supply and demand • Unemployment and inflation
• The efficiency of markets • Income distribution
• Product markets • Economics growth and development
• Supply and Demand • International trade
• Profit maximization
• Utility maximization
• Competition
• Resource markets
• Market failure
 What is Economics?

Fundamental Concepts
Weather we study micro or macro, there are some basic concepts that underly all fields of
Economics study

Economics is about the allocation of scarce resources among society’s

Scarcity: various needs and wants.
Economics is about the allocation of resources among society’s various
Resources: needs and wants.
Individuals and society as whole are constantly making choices involving
tradeoff between alternatives. Whether it’s what goods to consume, what
Tradeoffs: goods to produce, how to produce them, and so on.

Opportunit “The opportunity cost is the opportunity lost”.

y Cost: In other words, every economic decision involves giving up something.
NOTHING IS FREE!!
 The productive Resources

The Factors of Production

The production of all of the good we desire requires scarce resources. It is the allocation of
these resources between humans’ competing wants that Economics focuses on.

Land Labor Capital Entrepreneurship

Capital refers to the
tools and This refers to the
technologies that are innovation and
used to produce the creativity applied in
Labor refers to the
Land resources are goods and services the production of
human resources
those things that are we desire. Since goods and services.
used in the
"gifts of nature". The more and better The physical scarcity
production of goods
soil in which we grow tools enhance the of land, labor and
and services. Labor is
food, wood, minerals production of all capital does not
the human work,
such as copper and types of goods and apply to human
both physical and
tin and resources services, from cars to ingenuity, which
intellectual, that
such as oil, goal, gas computers to itself is a resource
contributes to the
and uranium are education to that goes into the
production of goods
scarce haircuts, yet the production of out
and services
 The Basic Economic
Questions

The Basic “Economic Problem”?

In a world of finite resources, the wants of man are virtually infinite. The basic Economic
Problem is how to allocate those limited, scarce resources between the unlimited wants of
man. This problem gives rise to three questions that any and all economic systems must
address. The Three Basic Econoimcs Questions are :

1.What should be produced? Given the resources with which

society is endowed, what combination of different goods and services should be
produced?
2.How should things be produced? Should production use
lots of labor, or should lots of capital and technology be used?
3.Who should things be produced for? How should the
output that society produces be distributed? Should everyone keep what he or she
makes, or should trade take place? Should everyone be given equal amounts of
the output, or should it be every man for himself?

These are the three guiding questions of any Economic system

Model Building in Economics
A popular tool in the Economist’s kit is the economic model. Just like scientists in other fields,
economists use models to represent something from the real world.

A Circular Flow Model: Allows

economists to illustrate in a simplified
model the relationships between
households and firms in a market
economy.

Ceteris Paribus: Like in other

scientists, when using economic
models we must assume “all else
equal”. This allows us to observe how
one variable in an economy will affect
another, without considering all the
other factors that may affect the
variable in question.
Positive and Normative Economics
Economists explore the world of facts and data, but also often draw conclusions or prescribe policies
based more on interpretation or even their own opinions. It is important to distinguish at all times
whether the focus of our studies is in the realm of positive or normative Economics

Positive economic statements: Each of the following statements above are statements of fact,
and each can be supported by evidence based on quantifiable observations of the world.
• Unemployment rose by 0.8 percent last quarter as 250,000 Americans lost their jobs in both
the public and private sectors.
• Rising pork prices have led to a surge in demand for chicken across China.
• Increased use of public transportation reduces congestion on city streets and lowers traffic
fatality rates.

Normative economic statements: Each of the statements above are based on observable, quantifiable
variables, but each includes an element of opinion
• Unemployment rates are higher among less educated workers, therefore government should include
education and job training programs as a component of benefits for the nation's unemployed.
• Rising pork prices harm low income households whose incomes go primarily towards food, therefore, to
slow the rise in food prices, the Chinese government should enforce a maximum price scheme on the
nation's pork industry.
• It is the government's obligation to provide public transportation options to the nation's people to relieve
the negative environmental and health effects of traffic congestion.
 Opportunity Cost

Opportunity Cost
Perhaps the most fundamental concept to Economics, opportunity cost is what must be
given up in order to undertake any activity or economic exchange.
• Opportunity costs are not necessarily monetary, rather when you buy something, the
opportunity cost is what you could have done with the money you spent on that thing.
• Even non-monetary exchanges involve opportunity costs, as you may have done
something different with the time you chose to spend undertaking any activity in your
life.

Examples of opportunity costs

• The opportunity cost of watching TV on a weeknight is the benefit you could have
gotten from studying.
• The opportunity cost of going to college is the income you could have earned by
getting a job out of high school
• The opportunity cost of starting your own business in the wages you give up by
working for another company
• The opportunity cost of using forest resources to build houses is the enjoyment
people get from having pristine forests.
 Theory of Demand
• What Is Demand Theory?
• Demand theory is an economic principle relating
to the relationship between consumer demand
for goods and services and their prices in the
market. Demand theory forms the basis for the
demand curve, which relates consumer desire to
the amount of goods available. As more of a good
or service is available, demand drops and so does
the equilibrium price.
• Demand theory highlights the role that demand
plays in price formation
 Demand Theory
• Understanding Demand Theory
• Demand is simply the quantity of a good or
service that consumers are willing and able to
buy at a given price in a given time period.
• Demand theory is one of the core theories
of microeconomics
 Demand theory
• Demand theory describes the way that
changes in the quantity of a good or service
demanded by consumers affects its price in
the market,
• The theory states that the higher the price of
a product is, all else equal, the less of it will be
demanded, inferring a downward sloping
demand curve.
 Law of Demand
• The Law of Demand and the Demand Curve
• The law of demand introduces an inverse
relationship between price and demand for a
good or service. It simply states that as the price
of a commodity increases, demand decreases,
provided other factors remain constant. Also, as
the price decreases, demand increases. This
relationship can be illustrated graphically using a
tool known as the demand curve.
 Law of Demand
• The law of Demand states that there is an
inverse relationship between quantity
demanded of a commodity and its price,
other factors being constant.
• Higher the price, lower the demand and vice-
versa, other things being constant.
• (other things constant:-income, price of
related of goods, taste & preferences,
expected price in future)
 Demand Curve: This curve illustrates the quantities of
apple juice demanded at each price ay all consumers in
the market.
Price of a Quantity
$3 bottle of demanded per
Price per bottle (in dollars)

Apple Juice week

$2
$0.75 800
$2 $1.00 650
Demand
Curve $1.25 500
$1
$1.50 350
$1
$1.75 200
$0 $2.00 50
50 200 350 500 650 800
Bottles of Apple Juice per
week
 A Change (Shift) in Demand
• If one of 5 other factors changes, the
entire demand curve will shift to the
left or right
• The curve does NOT shift if the price
of the good is the only change
A Change in Demand (Graph)-Shift in demand-
increase or decrease in demand-new demand
curve-due to other factors (other than price) like
income, related product, taste & preferences,
estimation of future price and number of
consumers.
 Demand Schedule:-
Price of a Individual Demand Market
dozen banana Demand
Rs. Demand by Demand by Demand by Mr. All Consumers
Mr.X Mr.Y Z

10 1 2 0 3
8 2 3 1 6
6 3 4 2 9
4 4 5 3 12
2 5 6 4 15
 Law of Supply
• The law of supply is the microeconomic law
that states that, all other factors being equal,
as the price of a good or service increases, the
quantity of goods or services that suppliers
offer will increase, and vice versa. The law of
supply says that as the price of an item goes
up, suppliers will attempt to maximize their
profits by increasing the quantity offered for
sale.
 Law of supply

• The law of supply says that a higher price will

induce producers to supply a higher quantity to
the market.
• Supply in a market can be depicted as an upward
sloping supply curve that shows how the quantity
supplied will respond to various prices over a
period of time.
• Because businesses seek to increase revenue,
when they expect to receive a higher price, they
will produce more
 Law of supply
• The supply of commodity depends upon
several factors. It is not possible to study the
influences of all factors determining supply.
• Therefore, we study the price of the
commodity is the major factor and it’s
relationship with supply.
 Law of Supply
• The law of supply states, other factors remain
constant(centeris paribus), more of a
commodity is supplied at higher price and less
of it is supplied at lower price.
• The law of supply relates to the functional
relationship between quantities that the firms
are willing to produce and sell
E.g. Supply schedule of Wheat (At price 50,
quantity supplied was 2.5 kg.)
Price rise of a commodity, supply of a
commodity rise and vice-versa, subject to
other factors remain constant.

Price (Rs.) Quantity Demanded

50 2.5

60 30

70 3.5

80 4

90 4.5
 Supply Curve
• A curve showing the relationship between
price and quantity that producers are willing
to sell during a particular time period
• The Law of Supply:-The higher the price, the
larger the quantity supplied. Change in
supply due to change in price of a product
subject to other factors remain constant.
• Positive relationship-Price rise, supply of that
commodity rise and vice-versa.
SUPPLY Price / Pound $0.40 $060 $080
SCHEDULE $$$

Quantity Demanded 10,000 20,000 30,000

(Pounds / Day)
$1.00
SUPPLY
Price
per $0.80

Pound
$0.60
of
Apples
$0.40
$$$ SUPPLY
CURVE
$0.20

10 20 30

Thousands of Pounds of Apples per day

 What Causes Supply Curve To Shift
Supply Change due to other Factors like, income, input price, price of relative
products, taste and preferences, future price estimation, number of firms etc.)

• Change (increase or decrease) in cost

of production – inputs price;
• Increase (or decrease) in the number
of producers-number of firms.
• Change (increase or decrease) in tax
rates.
• State of production technology.
 INCREASE IN SUPPLY

$1.00
SUPPLY
Price
per $0.80

Pound
$0.60
of RIGHTWARD
Apples SHIFT
$0.40
$$$
$0.20

16 26
10 20 30

Thousands of Pounds of Apples per day

 DECREASE IN SUPPLY
SUPPLY
$1.00
Price
per $0.80

Pound
$0.60
of LEFTWARD
SHIFT
Apples
$0.40
$$$
$0.20

13 23
10 20 30

Thousands of Pounds of Apples per day

 MARKET EQUILIBRIUM
The quantity of a product demanded is exactly
equal to the quantity supplied.
There is no pressure to change price.
 DEMAND
$1.00
SUPPLY
Price
per $0.80

Pound
$0.60 Market
of Equilibrium
Apples
$0.40
$$$
$0.20

10 20 30

Thousands of Pounds of Apples per day

 SURPLUS
• Occurs if market price exceeds equilibrium
price.
• Producers are willing to sell more, at this
higher price, than consumers are willing to
buy.
 SHORTAGE
• Occurs when the market price is below the
equilibrium price.
• Consumers are willing to buy more of the
product, at this lower price, than producers
are willing to sell.
 Elasticity of Demand
• Elasticity of Demand:
• Elasticity refers to how responsive the quantity
demanded is to a change in prices
• Elasticity:-To measure the proportion of change in
demand
• To know the proportion of change in Demand:-
• 1. Price elasticity of Demand
• 2. Income elasticity of Demand
• 3. Cross elasticity of Demand
 Elasticity of Demand
• 1. Price elasticity of Demand:-Proportion of changes
in demand due to changes in price, other factors
remain constant.
• 2. Income elasticity of Demand:- Proportion of
changes in demand due to changes in the income of
peoples, all other factors remain constant.
• 3. Cross elasticity of Demand:-Cross price elasticity of
Demand:- proportion of changes or percentage of
change in demand for goods due to changes in the
price of another goods-substitute of complementary
goods
 Price Elasticity of Demand
• An inelastic good will still sell about the same
quantity even if the price goes up or down
• An elastic good will have a higher change in
Qd-quantity demanded when there is a price
change
 Calculating Price Elasticity of
Demand
• Elasticity =
% change in quantity demanded
__________________________
% change in price
 Computing the Price Elasticity of
Demand
• Example: If the price of an ice cream cone
increases from Rs.2.00 to Rs.2.20 and the
amount you buy falls from 10 to 8 cones, then
your elasticity of demand would be calculated
as:Price elasticity of demand = Percentage change in quantity demanded
Percentage change in price

(10  8)
 100 20%
10  2
(2.20  2.00)
 100 10%
2.00
 The Variety of Demand Curves
• Perfectly Inelastic
– Quantity demanded does not respond to price
changes.
• Perfectly Elastic
– Quantity demanded changes infinitely with any
change in price.
• Unit Elastic
– Quantity demanded changes by the same
percentage as the price.
 Other Demand Elasticities
• Income Elasticity of Demand
– Income elasticity of demand measures how much
the quantity demanded of a good responds to a
change in consumers’ income.
– It is computed as the percentage change in the
quantity demanded divided by the percentage
change in income.
 Income Elasticity of Demand
• Computing Income Elasticity

Percentage change
in quantity demanded
Income elasticity of demand =
Percentage change
in income

Remember, all elasticities are

measured by dividing one
percentage change by another
 Income Elasticity
• Income Elasticity
– Types of Goods
• Normal Goods
• Inferior Goods
– Higher income raises the quantity demanded for
normal goods but lowers the quantity demanded
for inferior goods.
 Other Demand Elasticities
• Income Elasticity
– Goods consumers regard as necessities tend to be
income inelastic
• Examples include food, fuel, clothing, utilities, and
medical services.
– Goods consumers regard as luxuries tend to be
income elastic.
• Examples include sports cars, furs, and expensive foods.
 Other Demand Elasticities
• Cross-price elasticity of demand
– A measure of how much the quantity demanded of one good
responds to a change in the price of another good, computed
as the percentage change in quantity demanded of the first
good divided by the percentage change in the price of the
second good
%change in quantity demanded of good 1
Cross - price elasticity of demand 
%change in price of good 2
• Unit-1 Completed