Introduction to Economics

Pradeep K Panda
Professor & Dean (Academics)
IIHMR, New Delhi
Email:
pradeeppanda@iihmr.org
Session Plan
 After working through this session, you will be
better able to answer the following questions:
 What economics is all about?
 What problems does it seek to solve?
 What are the alternative uses of a resource?
 Why is trade beneficial to society?
 What are the basic concepts in economics
 What is the difference between Positive economics
and Normative economics
 What is the major difference between Micro-
economics and Macro-economics?

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What economics is all about?

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What economics is all about?
 The concept of economics has been changing
during different stages of developing
Economics as subject.
 Stages of developing economics as subject:
 Wealth concept
 Welfare concept
 Scarcity concept
 Development concept

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Wealth Concept
 During 18th and early 19th centaury, Adam
Smith and others defined Economics as the
science of wealth. Adam Smith, systematized
the concept in the form of the book which was
titled as “An enquiry into the nature and cause
of the wealth of nations.”
 Wealth concept of economics was excessively
criticized, by pioneers of Welfare concept,
because it assumed wealth as an end of human
activities.

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Welfare Concept
 According to this concept, Economics is not the
science of wealth, but it is concerned with
human welfare. It studies and emphasizes
wealth as a means of satisfying human wants,
not as an end of human activities. Marshal
was the pioneer of wealth concept of
economics.

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Welfare Concept
 According to Marshall, “Political Economy or
Economics is the study of mankind in the
ordinary business of life…..thus it is on the one
side a study of wealth and on the other, and
more important side of man.”
 Welfare concept was also criticized by the
pioneers of Scarcity concept.

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Scarcity
Concept
 Prof. Lionel Robbins was the promoter of
Scarcity concept. According him, “Economics is
the science which studies human behaviour as
a relationship between ends and scarce
means which have alternative uses”.

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Development Concept
 According to this concept, economist should
also suggest, how the scarce means should be
further increased to satisfy more wants and
attain good living. The propounder of this
concept is Professor Samuelson, who presented
the growth-oriented definition of Economics.

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 According to Samuelson “Economics is the
study of how people and society choose, with
or without the use of money, to employ scarce
productive resources, which could have
alternative uses, to produce various
commodities over time and distribute them for
consumption, now or in the future, among
various people and groups in society.

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Significance of Economics
 Economics can be applied to any social
behaviour or institutions where scarcity exists
and there is consequently a need for making
choices. Economics is thus described as the
study of scarcity and choice.
 It is related to production, consumption and
distribution of resources in the economy
among individuals and groups.

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Understanding economic problem

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Understanding Economic Problem
 If we analyze the definition of economics, it
lays down three basic propositions which
might be said to comprise the main structure
of economic science.

 Ends
 Scarce means
 Alternative applications of scarce means

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 Ends:

 Ends refers to human wants. Our wants are

unlimited in number. Since they are unlimited,
we have to choose between more urgent and
less urgent wants.

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 There are many things that people want. First,
they require food, clean water, housing,
clothing, and medicine but also they want
education, books, art, furniture, computer,
entertainment, transport, security, and many
more things..…..

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 To satisfy any one of these wants, a number of
resources will have to be required in the
process. Economists say that resources are
scarce. By this they mean that quantity of
resources available is very small compared
with all of their possible uses.

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 Scarce Means:
 The wants may be unlimited, but the means
which are available to satisfy these
unlimited wants are limited. The economic
problem arises because most of the goods
are scarce in relation to their demand.

 If the means are not scarce, there is no

problem at all.

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 The world scarcity is to be interpreted here in
a relative sense.

 The mere existence of short supply does not

make a commodity scarce, if there is no
demand for it. The scarcity of a commodity is
to be considered only in relation to its demand.

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 Alternative use of scarce means:

 It reflects that the scarce means at our

disposal should be capable of being put to
alternative uses.

 If a commodity can be put to one single use

alone and to non else, no economic
problem would arise.

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 The problem of choice arises because the
means are scarce in relation to the
unlimited ends.

 For example time is scarce.

 Because enough resources are not available to

meet all the wants of everybody, choices must
be made about which wants are to be satisfied.

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Opportunity Cost
 The concept of opportunity cost which is of great
importance in economic analysis is the direct outcome of
the above phenomenon, viz., scarcity of means in
relation to ends.

 Since all the ends cannot be satisfied with the scarce

means at our disposal, choice becomes inevitable.

 The choice of one alternative means that the other

alternative is forgone.

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Scale of Preferences
 The economic concept of scale of preferences is also
implicit in the ‘scarcity’ definition.

 In economics, it is assumed that when an

individual is faced with a particular situation, he will
always act rationally, means, choose the alternative
which yields the greatest satisfaction. This implies
that each
individual has a “scale of preferences” which is a list
of all his or her wants arranged in order of preference
(relative importance).

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Why do economic problems arise?
 Now, we know that wants are unlimited and means are
limited. In this way, one has to choose certain set of
wants from among unlimited wants, which are to be
satisfied by the limited resources.

 In economics, this problem of choice making is

called economic problem.

 Explaining it Prof. Friedmen has also said that whatever

limited resources are used to satisfy different
ends, economic problem arises.

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Why do economic problems
arise?...
 According to Prof. Eric Roll, the economic
problem is essentially a problem arising from
the necessity of choice: choice of the manner
in which limited resources with alternative uses
are disposed off. It is the problem of
husbandary of resources.

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Fundamental problems of
economy

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Fundamental Problems of Economy
 Three problems are central to the
economy:

a) Allocation of resources
b) Efficient use of resources
c) Growth of resources

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a. Allocation of Resources
 Because of scarcity, all economic choices can
be summarized in big questions about the
goods and services a society should produce.
These questions are:

 What to produce?
 How to produce?
 For whom to produce?

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What to produce?
 The first question every society faces is what to
produce. For example: Should a society build
more pharma firms or automobile firms;
hospitals or schools?
 Because of scarcity, society can not build
everything it wants. Choices have to be made.
Once a society determines what to produce it
then needs to decide how much should be
produced. In a market economy the "what"
question is answered in large part by the
demand of consumers.
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What to produce?...
 Who will decide that?
 The consumers decide, through their
preferences, what is to be
produced.
 This is called consumer sovereignty
(consumer is the king).
 How the consumers decide?
 Theory of Consumer Behaviour and Demand
 Maximization of Utility or Satisfaction

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How to produce?
 The next question a society needs to decide after
what to produce is how to produce the desired
goods and services. Each society must combine
available technology with limited resources to
produce desired goods and services. The
education and skill levels of the citizens of a
society will determine what methods can be used
to produce goods and services.
 For example, does a nation possess the
technology and skills to pick grapes with a
mechanized harvester, or does it have to pick the
grapes by hand?
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How to produce?...
 Once the issue of what is to be produced
resolved, the producers are in business.
 However, they also have an objective
which may be quite conflicting to that of
the consumers.
 Their problem is to find out the cheapest
way to produce the good or to sell it in the
market with highest profit.
 How will they do it?
 Theory of Production and Cost

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For whom to produce?
 The final question each society needs to ask is
for whom to produce. Who is to receive and
consume the goods and services produced?
Produced goods and services in a society will
be consumed by people in a variety of ways,
some of them consumed more quantity and
others less. Different groups will benefit from
the different ways that we choose to spend our
money.

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For whom to produce?...

 Once the produced goods are available, the

third problem is: who will get how much
share of these goods.
 The distribution of wealth in a society will
determine who will get what and how
much.
 Theory of Distribution

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b. Efficient Use of Resources
 As resources are limited, so they should be
properly used. There should not be wastage of
these resources.

 The problem with the economy is how to use

its available resources; i.e., land, labour,
capital and other resources so that maximum
production with minimum efforts be made
possible.

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 It has been accepted that the under-utilization
or unemployment of resources is a waste, so
the economy must ensure that the available
resources are efficiently utilized.

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c. Growth of Resources
 It becomes necessary that the rate of
economic development must be faster than the
rate of increase in population, so that the
economic development may take place and the
reasonable standard of living of the citizens
can be maintained.
 In this connection, the economy has to decide
about the rate of capital formation, investment
and savings.

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 Efforts are made for the economic development
of the society, so that it may be able to face
the real challenges of time. Problems
concerning the growth of resources are
discussed in the Development Economics.

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Basic concepts in economics

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Basic concepts in economics
 The Economy refers to all the economic
activities and institution within a geographically
defined are. So you might refer to the
performance of a specific national economy,
global economy or perhaps a regional
economy.
 Resources are every item within the economy
that can be used to produce and distribute
goods and services.

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 Alternative terms used for resources are
factors of production, or production inputs.

 Resources are classified as follows:

 Land
 Labour
 Capital
 Entrepreneurship

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Factors of production: Labour
 Labour refers to the human resources used to
produce goods and services. It includes all type
of human resources - skilled and unskilled –
required to produce good and services.

 The economic return on labor is called wages.

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Factors of production: Capital
 Capital refers to goods that are used to
produce other goods or services, for example:
machinery, buildings, tools, etc. Capital is
anything that is produced in order to increase
productivity in the future. Tools, machines and
factories can be used to produce other goods.

 The economic return on capital is called

interest.

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Factors of production: Land
 Land refers to all natural resources used to
produce goods and services. It includes
(physical) land, minerals, water, plants,
animals, etc.
 The economic return on land is called rent. For
example, a person could own land and rent it
to a farmer who could use it to grow crops. It
also refers to manufactured consumables like
paper, drugs, food, fuel and almost everything
else which does not fall under the category
of labour or capital.
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Factors of production: Entrepreneurship
 Finally, the fourth factor of production is called
entrepreneurship.

 Entrepreneurship refers to the ability of

people to combine the other factors in the
production process. The term also reflects their
willingness to take risks.

 The economic return on entrepreneurship is

profit.

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 Most resources are not, in themselves, useful
to us as individuals but they can be combined
to make something that is useful. This process
is called production.
 Commodities (or production outputs) are the
results of combining resources in the
production process. They are either final
product, which are then used to satisfy
people's wants, or else they are intermediate
products which are used to make other
commodities.
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 In economics, the terms utility (for individuals)
or welfare (for populations) is used to describe
the satisfaction provided by commodities.
 Commodities are either goods, which you can
hold or touch (for example a drug, a
stethoscope, a leaflet, etc.) or else they are
services which happen to you (for example a
vaccination, an appendectomy, a consultation,
etc.).

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Characteristic of distinguishing
different goods
 There are two essential characteristics that
distinguish different good

 Physical attributes: an ice-cream and cup of tea

are clearly different commodities because they
require different manufacturing techniques and
because they satisfy different wants.

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 Context in which the good is consumed –
for example
 A. The time in which the good is available -
an ice-cream that is available on a hot
summer’s day in a different good from one
available in the cold mild-winter
 B. The place where the good is available - a
cup of tea available in a fashionable café is
a different good from tea that sometimes
sold at road side Thadi

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What are the three ways of
employing resources
 There are three ways in which an individual can
benefit from the ownership of a good/service.
These are:

1. Consumption
2. Investment
3. Trade

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Consumption
 Consumption describes people using up a
commodity in order to increase their utility. For
example, eating (or 'consuming') a chocolate
bar might increase your utility by giving you a
pleasant taste and by satisfying your hunger.

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 Taking a paracetamol is an example of consumption
because it increases utility by relieving the pain of a
headache. Likewise the use of a non-disposable good
(i.e. not designed to be thrown away after use) such as
a walking stick provides direct utility for an individual
in terms of improved mobility

 Tennis players could be described as consuming a game

of tennis. The game provides utility for them through the
challenge, the excitement, the exercise and the
prospect of winning.

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Investment
 The second benefit individual can derive from
(some) goods is their investment value.
Although goods provide utility when consumed,
goods themselves can be used as inputs into a
production process
 A resource or commodity can be put towards
producing other commodities. This is called
investment. People invest resources because
they expect the utility they gain from the final
product to be greater than the utility they gain
from directly consuming these resources.
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 This involves an initial sacrifice followed by
subsequent benefits (the return). (The stricter
definition of investment requires the
accumulation of capital,).
 If you have some flour, yeast, water, an oven
and some time, then, you could forgo the
utility each would give you individually,
combine them to make bread and consume the
bread instead.

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Trade

 The third value derived from a good is

exchange value. If you do not invest or
consume a commodity then you can
trade it (that is exchange it) for some
other commodity or resource.

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 With this discussion, we are able to
understand the different ways of using a
resource (consumption, investment and
exchange)

 Whichever route is taken, the result will be

increased utility for the owner of the resource.
The route chosen by the owner should
depend on which one yields the largest
increase in utility for them

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 Alternative uses of resources
Resource or
commodity

Exchange Production
(Trade) (Investment)

Other Other
Commodities Commodities
(after trading) (after production)
Consumption

Increased utility

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Market
 In economics the term market is used to
describe any situation where people who
demand a good or service can come into
contact with the suppliers of that good. For it
to be a market the buyers and sellers do not
have to physically meet.
 For example, most obviously, trading on the
internet can involve networks in all parts of the
world who will never meet.

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Market…
 For example, people can buy or sell stocks and
shares from the Stock Market using
computers without ever leaving their offices.

 The amount of money that is exchanged for a

commodity is the price.

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Market…
 You will find out in the latter sessions how the
price is influenced by the number of suppliers
in the market and the amount of money they
are prepared to accept. The price is also
influenced by the number of buyers in the
market and the amount of money they are
prepared to pay.
 These influences are described as the market
forces of supply and demand.

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Flow of money, resources and
commodities
Household
Consumption
Investment

Production
Firms

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 Figure shows a simple model of the flow of
commodities, resources and money between
households and firms. Households own
resources (labour, land, shares in capital) and
supply them to firms in return for money
(wages, rent, interest and profit).

 Firms turn resources into commodities and

supply them to the households, again, in
return for money.

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 Households that supply more resources will
receive more money and therefore will be able
to consume more commodities.

 So far in this session you have gone through

about what are, essentially, free markets - that
is to say, markets that involve only firms and
individuals buying and selling goods, services
and resources.

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 In reality, most markets have some kind of
government intervention. Such intervention in
the market might involve levying taxes, fixing
prices, licensing suppliers, or setting
regulations regarding the quality of the
product.
 Alternatively, the government might decide to
take control of demand for a commodity,
perhaps law and order, and prohibit private
demand; or it might decide to take over supply
entirely and prohibit private supply.
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Positive v/s Normative Economics

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Positive v/s Normative Economics

 In order to understand positive economics and

normative economics, it would be essential to
know the meaning of the two terms ‘positive’
and ‘normative’.

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 A positive science may be defined as a body
of systematized knowledge concerning what is.
It is concerned with actual.

 A normative science or regulative science is

a body of systematized knowledge relating to
the criteria of what ought to be. It is
concerned with ideal.

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 Positive economics deals with causes and
consequences. For example, why do
people demand less of a commodity when
its price goes up.

 Normative economics is concerned with

questions involving value judgments. For
example, should mergers between two firms be
allowed, should efforts be made to discourage
the consumption of tobacco and alcohol, etc.

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Micro v/s Macro Economics

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Micro Economics
 It has been defined as that branch where the
unit of study is an individual, firm or
household. It studies how individual make their
choices about what to produce, how to
produce, and for whom to produce, and what
price to charge.
 It is also known as the price theory and is the
main source of concepts and analytical tools for
managerial decision making.

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Micro Economics
 Various micro-economic concepts such as
demand, supply, elasticity of demand and
supply, marginal cost, various market forms,
etc. are of great significance to managerial
economics.

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Macro Economics
 It’s not only individuals and firms that are
faced with having to make choices.
Governments face many such problems. For
example: How much to spend on health; How
much to spend on services; How much should
go in to providing social security benefits. This
is the same type of problem faced by all of us
in our daily lives but in different scales.

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Macro Economics
 Macro Economics studies the economics as a
whole. It is aggregative in character and
takes the entire economy as a unit of study.
Macro economics helps in the area of
forecasting. It includes National Income,
aggregate consumption, investments,
employment etc.

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Assignment

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Assignment
 What is a resource, how are resources
classified and what are the three ways of
employing a resource.
 Explain the concept of scarcity, opportunity
cost and scale of preference.
 Describe the difference between normative
economics and positive economics

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Various Terms
 Subsistence Economy
 Global Economy
 Barter Economy
 Mixed Economy
 Command Economy
 Market Economy

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Match the Terms with their
definitions
Term Definition
1. Subsistence Economy a. A system where exchange takes place
without the use of money
2. Global Economy b. The economic activities and institutions
around the world
3. Barter Economy c. A exchange economy with little government
intervention
4. Mixed Economy d. A economy with an absence of exchange
5. Command Economy e. A market economy with substantial
government intervention
6. Market Economy f. As economic system where resource
allocation decisions are directed by the state

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Match the Terms with their:
Answers
Term Definition
1. Subsistence Economy a. . A economy with an absence of exchange
2. Global Economy b. The economic activities and institutions
around the world
3. Barter Economy c. A system where exchange takes place
without the use of money
4. Mixed Economy d. A exchange economy with little government
intervention
5. Command Economy e. As economic system where resource
allocation decisions are directed by the state
6. Market Economy f. A market economy with substantial
government intervention

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Thanks