Basic Economic Concepts PDF

BASIC ECONOMIC CONCEPTS Samir K Mahajan  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS ❑ Subject matter of Economics is traditionally divided into two main branches – macroeconomics and microeconomics, where ‘macro’ means big, and ‘micro...

BASIC ECONOMIC CONCEPTS Samir K Mahajan  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS ❑ Subject matter of Economics is traditionally divided into two main branches – macroeconomics and microeconomics, where ‘macro’ means big, and ‘micro’ means small. ❑ These terms were firs coined by Ragner Frisch.  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS CONTD. MICROECONOMICS Microeconomics looks at the individual parts of the economy. Microeconomics studies the behavior of individual economic entities and small group of economic entities such as: households, business firms, markets and governments. The study of economy as a whole remains outside the domain of micro economics. Micro economic theory studies allocation of resources, product and factor pricing, theory of economic welfare/theory of economic efficiency. Subject matter MICROECONOMICS Theory of Demand Product Theory of Production and Cost Pricing Theory of Market Wages Micro Economic Factor Pricing Rent Theory (Functional Theory of Distribution) Interest Profits Theory of Economic Welfare/ Theory of Economic Efficiency  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS CONTD. MACROECONOMICS Macroeconomics looks at the economy as an organic whole. Macro economics studies economic aggregates such as: total output, total demand, aggregate income, total savings, total investment, total employment, rise and fall in general price level, interest rates. Study of economic growth or how governments use monetary and fiscal policy to seek growth with economic stability etc. also falls under the domain of macroeconomics. Macroeconomics focuses on the big picture and ignores the fine details.  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS CONTD. Subject matter MACROECONOMICS Theory of Consumption Theory of Income Theory of and Employment Investment Theory of General Theory of Trade Price Level and or Business Cycles Inflation Macro Economic Theory Theory of Econmic Growth Macro Theory of Distribution (Relative Share of Wages and Profits)  DIVIDING UP THE SUBJECT: MACRO ECONOMICS VS MICRO ECONOMICS CONTD. Difference between Microeconomics and Macro Economics BASIS FOR COMPARISON MICROECONOMICS MACROECONOMICS Meaning The branch of economics that studies the behavior of The branch of economics that studies the an individual consumer, firm, family is known as behavior of the whole economy, (both national Microeconomics. and international) is known as Macroeconomics. Deals with Individual economic variables Aggregate economic variables Business Application Applied to operational or internal issues Environment and external issues Tools Demand and Supply Aggregate Demand and Aggregate Supply Concerned with Theory of Product Pricing, Theory of Factor Pricing, Theory of National Income, Aggregate Theory of Economic Welfare. Consumption, Theory of General Price Level, Economic Growth. Scope Covers various issues like demand, supply, product Covers various issues like, national income, pricing, factor pricing, production, consumption, general price level, distribution, employment, economic welfare, etc. money etc. Importance Helpful in determining the prices of a product Maintains stability in the general price along with the prices of factors of production level and resolves the major problems (land, labor, capital, entrepreneur etc.) within of the economy like inflation, deflation, the economy. reflation, unemployment and poverty as a whole.  WHAT IS ECONOMICS contd. RESOURCES / MEANS OF PRODUCTION/ FACTORS OF PRODUCTION / INPUTS OF PRODUCTION Resources are the inputs into the production of goods and services which includes the followings: ❑Human Resources: Labour and Entrepreneurship. It All forms of human input, both physical and mental, into current production. The labour force is limited both in number and in skills. ❑ Natural Resources: Land, mineral resources and Raw Materials. These are inputs into production that are provided by nature: e.g. unimproved land and mineral deposits in the ground. The world’s land area is limited, as are its raw materials. ❑ Manufactured Resources: Capital. Capital consists of all those inputs in production that have themselves been produced: e.g. factories, machines, transport equipments and tools. The world has a limited stock/supply of capital: The productivity of capital is limited by the state of technology. Thus, Resources are scarce in supply.  WHAT IS ECONOMICS contd. NEED, WANT AND UTILITY ❑Need is something one have to have. Something one can't do without say food and water, shelter, clothing, basic health. ❑Want is something one would like to have/a specific feeling of desire. Everything that goes beyond need –say a big house, name-brand clothes, fancy foods and drinks, a new car – is a want. Human wants for goods and services are unlimited, and they have different priorities. That is we can rank our wants as per the priorities. ❑Utility is the capacity of a commodity to satisfy a want. In other words, utility is the want satisfying power of commodity.  SCARCITY The reasons for scarcity are: human wants are unlimited, and means (resources) available to satisfy these want are limited. ❑ Scarcity, thus, is the excess of human wants over what can actually be produced. Scarcity is the mother of all economic problems. ❑ Had resources been unlimited, economic problems would not have arrived. ❑ Economics thus studies how people deal with scarcity  ECONOMIC PROBLEMS : THE PROBLEM OF CHOICE The economic problems are the problems of choice. Problem of choice arise due to the following facts of life. ❑ Though human wants are unlimited, all wants are not equality important, and thus have different priorities. ❑ Limited means available to satisfy unlimited wants have alternative uses. Thus the mismatch between multiplicity wants having different priorities and limited means having alternative uses gives rise to the problem of choice and economic problem.  WHAT IS ECONOMICS??? The fact is that economics affects our daily lives. Virtually everyone agrees on the importance of economics but there is far less agreement on just what economics is.  WHAT IS ECONOMICS contd. A WIDELY ACCEPTED DEFINITION OF ECONOMICS (Robbin’s Definition) Economics is the science which studies human behaviour as a relationship between ends and scare means which have alternative uses An economy exists because two basic facts, such as: ❑ Multiplicity of wants (Human wants for goods and services are unlimited) having different priorities ❑ Scarcity of means of production (Productive resources which produce goods and services are limited). With our wants being virtually unlimited and resources scare, we cannot satisfy all our wants and desires by producing everything we want. At any one time the society can produce only a limited amount of goods and services. Goods are scarce because productive resources are scarce. Economics studies how society manages its scarce resources to satisfy unlimited human wants having different priorities.  Some principles of Economics Principle 1: People Face Trade-off “There is no such thing as a free lunch.” To get one thing we like, we usually have to sacrifice other things we like. Making a choice for one thing requires trading-off one thing against other. Trade-offs are all the alternatives that we give up / sacrifice whenever we choose one course of action or wants over others. ALL decisions thus (whether or production or consumption) involve trade-offs. Principle 2: Making a decision for a choice involves opportunity cost Because people face tradeoffs, making decisions requires comparing the costs and benefits of alternative courses of action. The most desirable alternative given up (sacrifice) as a result of a decision is known as opportunity cost. In other words, the sacrifice of best alternative in the production or consumption of a good is known as its opportunity cost. Principle 3: Rational people think at the margin Economists very often assumes that economic entities (such as individual consumers, producers, factor owners) behave rationally. The seek maximum benefits (gain) from minimum cost(pain). Consumers seeks the greatest level of satisfaction from the purchase of goods and services given their incomes and the prices they face. Firms want to produce the level of output that maximizes the profits.  Some principles of Economics (contd) Principles 4: Government can sometimes improve market outcomes Markets are good way to organize economic activity. The indivisible hand usually lead market to allocate resources efficiently. But for various reasons inadvisable hand may not work. There may be thus market failure – a situation in which a market left on its own fails to allocate resources efficiently. undesirable outcomes of market economy. Examples of Market Failure: Definition of externality: the impact of one person’s actions on the well-being of a bystander. (Ex.: Pollution) Definition of market power (monopoly) : the ability of a single economic actor (or small group of actors) to have a substantial influence on market prices. In-equality: because a market economy rewards people for their ability to produce things that other people are willing to pay for, there will be an unequal distribution of economic prosperity. There are two broad reasons for the government to interfere with the economy: the promotion of efficiency and equality. Government policy can be most useful when there is market failure.