Positive and Normative Economics

• Economics is the study of how individuals, organizations, governments, and societies make decisions about allocating scarce resources to satisfy unlimited needs and wants.
• Economics examines how these decisions impact the production and exchange of goods and services, emphasizing welfare and efficiency.

Positive and Normative Economics

• Positive economics explains how the economy functions, describing "what is" based on facts and objective analysis.
• Normative economics suggests actions, focusing on "what ought to be" based on opinions, values, and judgments.
• Positive economics describes economic situations without judgments, like "Higher taxes reduce disposable income," or "India’s GDP grew by 7% last year".
• Normative economics evaluates situations and suggests improvements, like "The government should reduce income inequality," or "Healthcare should be free".
• Positive economics provides facts for making judgments; normative economics uses facts to suggest policies.

Branches of Economics

• Economics is divided into microeconomics and macroeconomics.
• Microeconomics studies individual units like households, firms, and industries.
• Macroeconomics studies the economy as a whole, focusing on national and global issues.
• Microeconomics deals with specific markets and individual economic agents' decisions.
• Macroeconomics deals with aggregate economic indicators like GDP, inflation, and unemployment.
• Microeconomics explains resource allocation and price determination in specific markets.
• Macroeconomics explains overall economic performance, trends, and policies.
• Microeconomics covers demand and supply, market structures, and production costs.
• Macroeconomics includes national income, monetary and fiscal policies, inflation, and growth.
• Microeconomics uses a bottom-up approach, building from individual units to a larger picture.
• Macroeconomics uses a top-down approach, examining the economy as a whole and its interrelated factors.
• Microeconomics helps businesses optimize decisions and consumers make better choices.
• Macroeconomics helps governments design policies for economic stability and growth.

Key Concepts of Microeconomics

• Demand refers to the quantity of a good or service consumers are willing and able to buy at different prices during a specific period, assuming other factors are constant.
• The law of demand states that as the price of a good decreases, the quantity demanded increases, creating an inverse relationship between price and demand.
• The demand curve is a graphical representation of the relationship between price and quantity demanded, typically sloping downward.

Factors Affecting Demand

• Higher prices reduce demand; lower prices increase it.
• For normal goods, higher income increases demand; for inferior goods, higher income decreases demand.
• Substitutes: If the price of one good rises, demand for its substitute increases.
• Complements: If the price of one good rises, demand for its complement may fall.
• Trends, advertising, and cultural factors can affect demand.
• More population or shifts in consumer demographics can impact demand.
• If people expect prices to rise, they may buy more now, increasing current demand.

Exceptions to the Law of Demand

• Giffen Goods: Demand increases as price increases, often staple foods for poor households.
• Veblen Goods: Luxury goods become more desirable as status symbols when priced higher.

Price Elasticity of Demand (PED)

• Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded to a change in the price of the good.
• Formula: Percentage Change in Quantity Demanded / Percentage Change in Price
• Elastic Demand (PED > 1): A small price change causes a large change in quantity demanded.
• Inelastic Demand (PED < 1): A price change causes a small change in quantity demanded.
• Unitary Elastic Demand (PED = 1): The percentage change in price equals the percentage change in quantity demanded.

Supply

• Supply refers to the quantity of a good or service producers are willing and able to offer for sale at different prices during a specific period, assuming other factors are constant.

Law of Supply

• The law of supply states that as the price of a good increases, the quantity supplied also increases, creating a direct relationship between price and supply.
• If the price of wheat rises, farmers are likely to grow more wheat to benefit from higher profits.
• The supply curve is a graphical representation of the relationship between price and quantity supplied, typically sloping upward.

Factors Affecting Supply

• Higher prices incentivize producers to supply more; lower prices reduce supply.
• If the cost of raw materials, labor, or machinery rises, supply may decrease.
• Technological advancements can increase supply by making production more efficient.
• Substitutes in Production: If the price of cotton increases, farmers may shift land from rice to cotton, reducing rice supply.
• Complements in Production: An increase in beef production may increase the supply of leather.
• Taxes, subsidies, and regulations can directly impact supply.
• Weather, climate, and natural disasters can affect the supply of agricultural and natural resources.
• If producers expect prices to rise in the future, they may hold back supply today.

Elasticity of Supply

• Elasticity of supply measures how responsive the quantity supplied is to a change in price.
• Elastic Supply: A small change in price leads to a large change in quantity supplied.
• Inelastic Supply: A large change in price leads to a small change in quantity supplied.

Exceptions to the Law of Supply

• Backward-Bending Supply Curve of Labor: At higher wages, individuals may work less, reducing labor supply.
• Perishable Goods: Producers may sell at any price rather than hold unsold stock.

Price Elasticity of Supply (PES)

• Formula: Percentage Change in Quantity Supplied / Percentage Change in Price
• Elastic Supply (PES > 1): A small price change leads to a large change in quantity supplied.
• Inelastic Supply (PES < 1): A price change leads to a small change in quantity supplied.
• Unitary Elastic Supply (PES = 1): Percentage change in price equals the percentage change in quantity supplied.

Factors of Production

• Factors of production are the essential inputs required to produce goods and services in an economy, classified into Land, Labor, Capital, and Entrepreneurship.

Land

• Land refers to all natural resources available for production, including physical land, minerals, forests, and water.
• Land has a fixed supply and is a passive factor requiring labor and capital to become productive.
• Rent is the reward for the use of land.

Labor

• Labor refers to the human effort (physical and mental) used in the production of goods and services.
• Labor is an active factor of production, with quality depending on skills, education, and training (human capital).
• Wages or salaries are the rewards for labor.

Capital

• Capital includes all man-made resources used in the production process, not money, but physical assets.
• Capital is created through investment, enhances productivity, and depreciates over time.
• Interest is the reward for the use of capital.
  • Fixed Capital: Long-term assets like machinery, buildings, and tools.
  • Working Capital: Short-term resources like raw materials and inventory.

Entrepreneurship

• Entrepreneurship is the ability to organize and combine the other factors of production to create goods and services while taking on risks.
• Entrepreneurs innovate, identify opportunities for profit, bear the risks of business failure, and efficiently combine land, labor, and capital.
• Profit is the reward for entrepreneurship.

Types of Goods

• Goods can be classified based on their characteristics, usage, and impact on the economy.

Based on Consumption or Use

• Consumer Goods: Goods used directly by consumers.
  • Durable Goods: Last for a long time (e.g., cars, furniture).
  • Non-Durable Goods: Consumed quickly (e.g., food, beverages).
  • Services: Intangible activities (e.g., education, healthcare).
• Capital Goods: Goods used in the production of other goods and services.

Based on Supply Elasticity

• Elastic Goods: Demand changes significantly with price changes (e.g., luxury items).
• Inelastic Goods: Demand does not change significantly with price changes (e.g., essential goods).

Based on Nature of Goods

• Normal Goods: Demand increases as income rises (e.g., branded clothes, cars).
• Inferior Goods: Demand decreases as income rises (e.g., low-cost food products).
• Luxury Goods: Demand rises faster than income (e.g., designer clothes, premium watches).

Based on Rivalry and Excludability

• Private Goods: Rival and excludable (e.g., food items, cars).
• Public Goods: Non-rival and non-excludable (e.g., streetlights, public property).
• Club Goods: Non-rival but excludable (e.g., Netflix, gym memberships).
• Common Goods: Rival but non-excludable, prone to overuse (e.g., fisheries, forests).

Based on Impact on Consumers

• Merit Goods: Positive externalities, under-consumed (e.g., education, healthcare).
• Demerit Goods: Negative externalities, over-consumed (e.g., tobacco, alcohol).

Based on Necessity

• Essential Goods: Necessary for survival, inelastic demand (e.g., food grains, water).
• Luxury Goods: Desired for comfort or status, elastic demand (e.g., jewelry, high-end gadgets).

Based on Tangibility

• Tangible Goods: Physical goods that can be seen and touched (e.g., furniture, smartphones).
• Intangible Goods: Non-physical goods like services or intellectual property (e.g., software, patents).

Types of Costs in Economics

• Fixed Costs
  • Costs that do not change with the level of output produced
  • Remain constant regardless of production levels; incurred even if no goods are produced.
  • Includes rent, salaries of permanent staff, insurance premiums.
• Variable Costs
  • Costs that vary directly with the level of production or output.
  • Change with the amount of goods produced; increase with higher output and decrease with lower output.
  • Includes raw materials, wages of hourly workers, utility costs.
• Total Cost
  • The sum of fixed and variable costs at any level of output.
  • Total cost = Fixed Costs + Variable Costs.
  • Example total cost for producing 100 units of a product
• Average Cost (AC)
  • The total cost per unit of output.
  • AC = Total Cost / Quantity of output.
  • Cost per unit when producing 100 units of a product.
• Marginal Cost (MC)
  • The additional cost incurred when producing one more unit of output.
  • MC = Change in Total Cost / Change in Quantity.
  • The cost of producing the 101st unit when 100 units are made.
• Opportunity Cost
  • The cost of the next best alternative foregone when making a decision.
  • Represents the value of the alternative not chosen.
  • Choosing to produce cars instead of trucks, missing out on truck sales.
• Explicit Costs
  • Direct, out-of-pocket payments made in the course of business activities.
  • Actual payments made for factors of production.
  • Includes wages, rent, and material expenses.
• Implicit Costs
  • Indirect costs that do not involve actual payment but represent the opportunity cost of using resources.
  • The value of resources used in production that could have been employed elsewhere.
  • Includes forgone salary from running a business instead of working elsewhere.
• Sunk Costs
  • Costs that have already been incurred and cannot be recovered.
  • Irrelevant for future decisions as they cannot be changed by any future actions.
  • Includes money spent on advertising that cannot be refunded.
• Controllable Costs
  • Costs that can be influenced or managed by a business in the short term.
  • Management can decide on the level of these costs based on production or operational decisions.
  • Includes advertising budget, overtime wages.
• Uncontrollable Costs
  • Costs that are beyond the control of the business or organization.
  • These costs are affected by factors outside the business’s direct control.
  • Includes taxes, natural disasters, or global price changes in raw materials.
• Fixed Plus Variable Costs
  • The total cost of both fixed and variable elements at any level of production.
  • Used to distinguish between cost categories for pricing and budgeting decisions.
  • Combination of rent (fixed) and raw materials (variable).

Fundamental Economic Problems

• Every economy faces fundamental problems due to scarcity.

Scarcity

• Definition: Scarcity refers to the limited availability of resources such as land, labor, capital, and raw materials to satisfy unlimited human wants.
• Scarcity exists for all economies, irrespective of their level of development.
• Compels societies to make decisions about resource allocation.

Choice

• Definition: Individuals and societies must choose how to allocate resources efficiently because resources are scarce.
• Involves trade-offs.
• The aim is to achieve the best possible satisfaction of needs within resource constraints.

Opportunity Cost

• Definition: Opportunity cost refers to the value of the next best alternative that is foregone when a choice is made.
• Highlights the trade-offs involved in decision-making.
• Measures the cost of not choosing an alternative option.
• Helps in evaluating the true cost of a decision.

Types of Economic Activities

• Economic activities include all actions involving production, distribution, exchange, and consumption of goods and services.

Production

• Definition: Production is the process of creating goods and services by combining inputs like land, labor, capital, and entrepreneurship.
• Focuses on transforming raw materials into finished goods or services.
• Involves decisions about what, how, and for whom to produce.

Consumption

• Definition: Consumption is the act of utilizing goods and services to satisfy human wants and needs.
• It is the end-use of goods and services.
• Includes both durable and non-durable goods.

Exchange

• Definition: Exchange refers to the process of trading goods and services, either through money or barter.
• Facilitates specialization and division of labor.
• Takes place in markets or directly between parties.

Distribution

• Definition: Distribution is the process of dividing the income generated by production among the factors of production.
• Land receives rent; labor earns wages; capital earns interest; entrepreneurship earns profit.
• Affects the level of income inequality in society.

Comparison of Economic Systems

• Capitalist Economy: Private ownership, market-driven decisions, profit motive, minimal government intervention (e.g., USA).
• Socialist Economy: State ownership, central planning, welfare motive, full government control (e.g., Cuba).
• Mixed Economy: Both private and state ownership, combination of market and planning, profit with welfare motive, moderate government intervention (e.g., India).

Sectors of Economy

• Primary: Natural resource exploitation (e.g., farming, fishing, mining).
• Secondary: Manufacturing and industry (e.g., steel plants, textiles, factories).
• Tertiary: Services and support (e.g., banking, education, healthcare).
• Quaternary: Knowledge-based activities (e.g., research, IT services).
• Quinary: Leadership and decision-making (e.g., CEOs, government officials).

Market Systems

• Perfect Competition: Many firms, identical products, no single firm influences price (e.g., agriculture markets).
• Monopoly: Single firm controls entire supply, unique product, high barriers to entry (e.g., utility companies).
• Monopolistic Competition: Many firms, similar but not identical products, product differentiation (e.g., restaurants, retail stores).
• Oligopoly: Few firms dominate, significant control over price, interdependence among firms (e.g., automobile industry, telecommunications).
• Mixed Economy: Combination of private and public sector involvement, government regulates some sectors (e.g., India’s economy).

GDP Deflator

• The GDP Deflator is a measure of inflation that reflects the change in prices of all goods and services produced in an economy during a specific period.
• It adjusts nominal GDP to real GDP, removing the effect of price level changes.
• Unlike CPI, the GDP Deflator includes all goods and services produced domestically and accounts for changes in the composition of goods and services produced.
• Provides a comprehensive view of inflation in the economy.
• Helps policymakers analyze real economic growth by adjusting for price level changes.
• Allows for the comparison of economic performance across years.

Potential GDP

• Potential GDP is the maximum output an economy can produce when all resources are utilized efficiently, without causing inflationary pressures.
• Helps identify the output gap
  • Positive Gap : Economy overheating (inflationary pressure).
  • Negative Gap : Economy operating below potential (recessionary conditions).
• Used by governments and central banks to design fiscal and monetary policies.
• Reflects the economy’s sustainable growth rate over the long term.