Economics

- some of the
fundamentals
Economists
What Economics is All About

 Scarcity: the limited nature of society’s

resources
 Economics: the study of how society manages
its scarce resources, e.g.
 how people decide what to buy,
how much to work, save, and spend
 how firms decide how much to produce,
how many workers to hire
 how society decides how to divide its resources
between national defense, consumer goods,
protecting the environment, and other needs
People Face Tradeoffs People face trade-offs
which simply means
All decisions involve tradeoffs. that to get a thing A,
we will have to give
 Going to a party the night before your midterm up or sacrifice other
leaves less time for studying. things B, C, or D.
 Having more money to buy stuff requires
We have to make a
working longer hours, which leaves less time decision to choose
for leisure. one alternative out of
 Protecting the environment requires resources the many alternatives
that could otherwise be used to produce available to us.
consumer goods.
The common resources include land, labor, capital, If there is no other
and enterprise. Hence, we have to judicially use alternative for a
these scarce resources in the best possible manner choice, there will be
by choosing the best possible alternative. The
alternative that we choose should maximize the
no trade-off.
utility that we derive from our choice.
 People Face Tradeoffs……
• Society faces an important tradeoff:
efficiency vs. equality
• Efficiency: when society gets the most from its scarce resources
• Equality: when prosperity is distributed uniformly among
society’s members
• Tradeoff: To achieve greater equality,
could redistribute income from wealthy to poor.
But this may reduce incentive to work and produce, shrinks the
size of the income.
http://zalamsyah.staff.unja.ac.id/wp-content/uploads/sites/286/2018/02/1-principles-of-microeconomics-by-n-gregory-mankiw5th-ed.pdf
Principle 2: The Cost of an Item is What We Sacrifice to Get it

The Cost of Something Is What You Give Up to Get It

People have to regularly do a cost-
benefit analysis of the choices they
• Making decisions requires have before choosing or preferring a
comparing the costs and benefits particular course of action.
There is an opportunity cost to
of alternative choices. everything. It is the cost of the next
• The opportunity cost of any item is best choice one foregoes while
choosing between two or more
whatever must be given up to alternatives.
obtain it. The opportunity cost of spending
money on buying a television is
• It is the relevant cost for decision missing out on an opportunity to buy
some other household item or
making. spending that money on vacation.
People must always consider the
opportunity cost of any choice or item
before taking the final decision.
3. Economists all over the world
3. Rational
Rational People
People Think
Think at
at the
the Margin
Margin believe that people and
Look
Look to
to Maximize
Maximize their
their Utility
Utility businesses are rational. And
• When a student considers whether to go to college therefore, they all make the best
for an additional year, he compares the fees & possible decisions and have the
foregone wages to the extra income he could earn most rational choice among the
with the extra year of education. various options available at their
• When a manager considers whether to increase disposal. Moreover, it is also the
output, she compares the cost of the needed labor underlying assumption that the
and materials to the extra revenue. people are very much aware of
the scarcity of resources in the
Producers, sellers, and service providers often economy. And all this prompts
face the dilemma of selling a product at a them to maximize the utility or
price below their average cost. This is common the outcome out of all these
in industries such as aviation, entertainment, scarce resources. Consumers will
cinema, etc. Since people are rational, they go on consuming a product only
should continue to sell the product till the
and only until its marginal utility
marginal utility of the product becomes equal
to its marginal cost. is more than its marginal cost.
4: People Respond to Incentives

Participants in an economy are rational.

Hence, they respond to any extra benefit that they may get from the
consumption of a product or a service.
Incentives are a sort of reward for promoting the consumption of goods
and services. And these may be in the form of free additional units of the
product, or increased quantity of the product at the same price, or giving
price discounts on the product.

Consumers react positively to incentives as it allows them to maximize

their satisfaction levels. Thus, manufacturers and sellers give incentives to
buyers when the momentum in the economy is low, and their sales are
not up to the mark.
Also, incentives are helpful as a fighting force against the competition,
luring gullible customers to consume their product and drive the
competition out of the market.
 How People Interact with Each Other?
How people deal and interact in an economy is the focus point of the
next three principles of economics.

Principle 5: Trade Makes Everyone Better Off

Trade between people, businesses, and countries is essential for the
betterment and well-being of one and all. An individual cannot produce
each, and everything for his consumption need himself. He will be better
off in producing a few things in which he specializes and leaves the rest
for others to produce in which they have an edge or are better off.

Through this concept and rational decision, all the individuals and entities will ultimately do
what is best for them. And in this way, they all can enjoy the benefits of specialization and
economies of scale and scope. One can trade with other people and buy everything that one
does not produce himself. When we see this on a broad scale, keeping in mind the entire
economy, we will find that everyone is producing goods or providing a service as per his
specialized skills. The same applies to big businesses and even countries. All have to depend
upon each other for trading activities, and this is beneficial for society as a whole.
6: Markets are a Good Way of Organizing Economic Activity

Free and fair markets are a must for the success of any economy.
The market forces of demand and supply should act on their own to
give us the price and quantity equilibrium, where demand and
supplies are matched at a particular price point. It has been proven
historically that any government intervention in deciding the
quantity or pricing of goods and services has been always a failure
in the long run. Moreover, the authoritative system of fixing a price
of a product or service without studying the consumer demand
pattern, consumers’ tastes and preferences, their willingness to pay,
and the cost of production, etc., result in complete chaos and a
crash of the market.
A free-market economy is the best form of market. The participants
have the upper hand in deciding what, how, where, and how much
to produce and sell at the best possible price.
 7: Government has the Resources to Improve the Outcomes
of the Market

Government is the most important form of institutional body that

acts as an invisible hand to control the market forces. It works day
and night to ensure that the market participants follow its
regulations and play the game by its rules. The government
enforces property rights in the country. It encourages the people to
produce and sell and participate in economic activities without any
fear of being cheated or of suffering unfair losses.
A government provides us with the mechanism to enforce laws, rules, and regulations that guide the
key institutions in a market economy. The government enforces “property rights” so that market
participants know who legally owns a property, be it a piece of land, building, or automobile. The
individuals accordingly put their properties and scarce resources to the best possible use. We need the
government to act as the law-enforcing agency and protect our rights. For example, a cab driver will
work only if he has an assurance that he has legal recourse to it in case his cab gets stolen. A
shopkeeper will only function if he has an assurance that he will be paid for what he sells. A person will
buy a piece of land only if he knows that his ownership rights will be protected. Therefore, we need the
government to provide us with legal institutions in the economy.
How the Entire Economy Works?
The last three of the ten principles tell us how an economy works.

Principle 8: The Ability to Produce Goods & Services Decides the

Standard of Living of a Country
The countries of the world witness different standards of living. That, in turn,
decides their access to healthcare facilities, the standard of living, gadgets,
housing, consumption patterns, and life expectancy. The large variation in
the standard of living of people is because of the difference in their
productivity levels.
More the people produce in each hour of their work results in higher income
and standard of living. Similarly, countries with low productivity levels are
poor and still under-developed or developing. Good and proper education,
availability of adequate tools and infrastructure, and access to modern
technology are a must for a nation to improve its productivity levels and
hence its standard of living.
Principle 9: Excessive Printing of Money by the
Government Results in Rising Prices
Excessive printing of money by the government of a nation results
in the loss of value of that currency. The purchasing power goes
on reducing, resulting in a constant and spiraling price rise of
goods and services. The rise in prices results in inflation in the
economy. And due to reduced purchasing power, more and more
money is required to buy the same quantity of goods and
services. Therefore, a government needs to have a strict control
mechanism regarding printing and the supply of money in the
economy. And this is to ensure that inflationary trends in the
economy are temporary and stay under control.
Principle 10: Trade-Off between Unemployment & Inflation

Every country experiences a short-term trade-off between inflation and

unemployment. Inflationary trends in the economy result in higher demand for goods
and services. This is due to the excess money supply in the hands of the people.
Higher demand results in a further increase in prices as well as pressure on the
producers to supply more. In order to supply more, they hire more people. Therefore,
the unemployment level goes down in the economy.

The level of demand for goods and services usually remains in the control of the
government and its policymakers. By tweaking various policies, they can alter the
spending levels, taxation levels, the money supply in the market, etc., to influence the
demand for goods and services. A change in demand will also affect the trade-off
between inflation and unemployment.
Circular Flow Model
 LAND • RENT
LIMITED RESOURCES
LABOUR • WAGES

CAPITAL • INTEREST

ENTERPRISE • PROFIT

Factors of production: the resources the economy uses to produce goods & services, including
 labor
 land
 capital (buildings & machines used in production)
The Circular-Flow Diagram
Households:
 Own the factors of production,
sell/rent them to firms for income
 Buy and consume goods & services

Firms:
 Buy/hire factors of production,
use them to produce goods and services
 Sell goods & services
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
The Circular Flow Diagram
THE CIRCULAR FLOWS
Circular flow model (matrix) shows:
• The circular flow of expenditures and incomes that
result from decision makers’ choices and
• The way those choices interact in markets determines
what, how, and for whom goods and services are
produced.
Households and Businesses
Households and Businesses
• Households are
individuals or people
living together as
decision-making units.
• Firms (businesses) are
institutions that
organize production of
goods and services.
Markets
Markets
• A market is any
arrangement that brings
buyers and sellers together
and enables them to do
business.
• Product (goods) markets:
markets in which goods and
services are bought and
sold.
• Resource (factor) markets:
markets in which factors of
production are bought and
sold.
Real Flows and Money Flows
In factor markets:
• Households supply
factors of production
• Firms hire factors of
production.

In commodities
markets:
• Firms supply goods and
services produced.
• Households buy goods
and services.
 Real Flows and Money Flows, cont’d.

MONEY FLOWS
• Firms pay for the factors of
production and households
incomes for the services of factors
of production.
• Households pay firms for the
goods and services they buy
which creates revenue for
the businesses..
• These are the money flows.

• Green flows are

incomes.
• Red flows are
expenditures.
 Government in the Flow
The government’s major expenditures are to
provide
1. Goods and services INDIA-BUDGET DEFICIT
2. Social Security and welfare benefits • The budget shortfall
3. Transfers to state and local in 2022–23 is
governments expected to amount
• The federal government finances its to 6.4 % of GDP.
expenditures by collecting taxes. • For the fiscal year
• The main taxes are
2023-24, the deficit
1. Personal income taxes
is predicted to
2. Corporate (business) taxes
amount to 5.9 % of
3. Social Security taxes
GDP.
• In 2008, the government spent $3 trillion—
• By 2025-26, the
about 21 % of the total value of all the goods
and services produced in the United States in federal government
that year (GDP or Gross Domestic Product). hopes to reduce the
• Taxes raised less than $3 trillion—the budget deficit to less
government had a deficit. than 4.5 % of GDP.
Defining economics has always been a
controversial issue since time immemorial.
Different economists have different viewpoints
on economics.
Some economists had a viewpoint that
economics is a study of money, while others
believed that economics deals with problems,
such as inflation and unemployment.

Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune

 Pursuit of self
interest Adam Laissez-faire
Benefited individual No justification for
therefore society Smith govt. intervention
Best economic benefit for all can Classical except for
usually be accomplished when
Economist defence /justice /
individuals act in their own self-
interest. Scottish law&order
(1723 – 1790)
Division of “……The Wealth of
Labour Nations” Invisible hand
Increases productivity of
and a country’s wealth. competition
Eg. it takes 18 different Allows self
operations to make a pin! regulation to
operate ensuring
economic progress
Labour theory An Inquiry into the Nature and Causes of the Wealth of Nations, 1776
of Free Trade
Cannons of With no tariffs/tax,
value & wealth
The value of an item
Taxation markets operate
Fair tax system; equity effectively & trade
is equal to the economy
amount of labour to be spread
certainty
that goes into convenience
between nations
producing it
 Jean Baptiste Say (1767-1832)
Wrote: “Treatise on Political Economy”

- a French economist and businessman

- argued in favor of competition, free trade
-He is best known for Say's law

Say’s law

• “Supply creates it’s own demand”.

• People make products they are most efficient at.
• They exchange their surplus for money.
• They use this to buy goods that they want.
• Therefore the supply of goods creates a demand
for goods.
John Stuart Mill (1806-1873)
Wrote: “Principles of Political Economy”

• He advocated the following;

1. Demand & supply were important in
assessing the value of a product.
2. Law of diminishing marginal returns.
3. Predicted the emergence of dominant
firms.
4. Establishment of trade unions to
counteract the power of dominant firms.
Mill became disillusioned by the capitalist system
& began to lean towards a mild form of
socialism.
Economics is defined by taking four viewpoints

Wealth

Welfare

Scarcity

Growth
Wealth viewpoint

This is a classical viewpoint on economics

that was given by Adam Smith, who is
also considered as the father of modern
Economics.
According to him, Economics is “the study of the
nature and causes of nations’ wealth or simply
as the study of wealth.”
He stated that the main purpose of all economic
activities is to gain maximum wealth as possible.
In Smith’s view, the citizens of wealthy nations are
happy; thus, economics shows nations to be
wealthy. Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
An Inquiry into the Nature and Causes of the Wealth of
Nations (1776), generally referred to by its shortened
title The Wealth of Nations- Adam Smith, Scottish economist
One of the world's first collected descriptions of what
builds nations' wealth, and is today a fundamental work
in classical economics.
By reflecting upon the economics at the beginning of
the Industrial Revolution, the book touches upon such
broad topics as the division of labour, productivity, and free
markets.
An important theme throughout the work is the idea that the
economic system is automatic, and, when left with
substantial freedom, able to regulate itself. This is often
referred to as the “invisible hand.” The ability to self-
regulate and to ensure maximum efficiency, however, is
limited by externalities, monopolies, tax preferences,
lobbying groups, and other “privileges” extended to certain
members of the economy at theDr.expense ofNICMAR
J. C. Edison, Dean, others.
Business School, NICMAR University, Pune
 THEME OF WEALTH

In The Wealth of Nations, Adam Smith proves that free markets always create
more long-term prosperity than regulated markets.

THEME OF FAMILY
Capitalism can't survive unless it convinces people to believe in a strong family unit.
THEME OF WARFARE
War tends to crush economies by plunging governments into debt. War can be
good for an economy if it increases people's productivity.
THEME OF EDUCATION
An economy will collapse if the government doesn't collect taxes to pay for
universal education. Education would be much more efficient if it operated on the
principles of supply and demand.
THEME OF COMPETITION
Competition is the engine that drives all modern progress because it forces
everyone to up their game and produce better and better products. Governments
should play no role in the economy. Competition will take care of everything on its
own. Monopolies will take over and destroy competition in a free market. So the
government actually has to intervene to keepDr.competition up.NICMAR Business School, NICMAR University, Pune
J. C. Edison, Dean,
 Alfred Marshall

Founder of neoclassical economics Principles of Economics

1890
Neoclassical Economics is the name given to an economic
theory that was developed at the end of the 19th and the
beginning of the 20th Century in Europe. The main
contributors to this theory were Léon Walras (1834-1910), Alfred
Marshall (1842-1924) and Vilfredo Pareto (1848-1923).

The issue that Neoclassical economists dealt with was

the distribution of power between industrialists and
workers. It is an approach to economics focusing on the
determination of goods, outputs, and income distributions in
markets through supply and demand.
Workers produce value and this value-added is the
source of both the workers’ wages and the profit of the
capitalist
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
Welfare viewpoint

It is a neo-classical viewpoint on economics

that was given by Alfred Marshall. According
to Alfred Marshall, “Economics is a study of
man in the ordinary business of life. It
enquires how he gets his income and how he
uses it. Thus, it is on the one side, the study
of wealth and on the other and more
important side, a part of the study of man.”

He associated economics with the welfare of

men, who are responsible for generating
wealth. Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
Scarcity viewpoint
It is a pre-Keynesian thought of economics that
was given by Lionel Robins in his book ‘Essays on
the Nature and Significance of the Economic
Science’ (1932). According to Robins,
“Economics is a science which studies human
behaviour as a relationship between ends and
scarce means which have alternative uses”.
The definition focused on human behaviour in the
optimum utilisation of scarce resources.
It provides three basic features of human
existence, which are unlimited wants, limited
resources, & alternative uses of limited resources
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
Growth viewpoint
This is the modern perspective of economics mainly
given by Paul Samuelson, the growth-oriented
definition of Economics.
“Economics is a study of how men and society choose
with or without the use of money, to employ scarce
productive uses resource which could have alternative
uses, to produce various commodities over time and
distribute them for consumption, now and in the future
among the various people and groups of society.”
The definition outlines three main aspects, namely
• human behaviour,
• allocation of resources, and
• alternative uses of resources.
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
 John Maynard Keynes
According to J.M. Keynes,
Economics is defined as

“the study of the administration of

scarce resources and
of the determinants of
income and employment.”
Neoclassical economics dominates microeconomics, and together with Keynesian
economics forms the neoclassical synthesis which dominates mainstream
economics today.
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
The study of economics

The study of economics involves three

related investigations.
1. Why scarce resources are exchanged?
2. How consumers and producers behave
as they interact with each other in
markets, in their attempt to achieve
mutually beneficial exchange?
3. The role of government in compensating
for the limitations of markets in achieving
mutually beneficial exchange?
Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune
• An economy begins with the desires of the people in
the society for material goods and services.
• food, shelter, clothing, health care, recreation,
entertainment, …………
• Any product that satisfies people's desires is called a
"good" or a "service".
• The act of obtaining these material goods and services
is called “consumption”.
 two assumptions about people's desires
First, they are insatiable - not able to be satisfied
constantly wanting more

Second, they are rational -making choices that result in the most
optimal level of benefit or utility for the individual

To produce, people begin with natural resources

contribution made by the people is called labour
use of natural resources “capital”
Capital here refers to goods made by people for
the purpose of increasing production
A person who undertakes this activity is called an entrepreneur
Natural resources, labor, capital, and entrepreneurship are
called the factors of production. Dr. J. C. Edison, Dean, NICMAR Business School, NICMAR University, Pune