Unit I

Economics
The principal fact about Economics that we
must always remember is that it is a social
science.
If we forget this, we tend to get bogged down
with

questions

Economics.

that

are

not

relevant

to

MEANING OF ECONOMICS
The word Economics originates from the Greek
work Oikonomikos which can be divided into
two parts:
(a) Oikos, which means Home, and
(b) Nomos, which means Management.
Thus, Economics means Home Management.

MEANING OF ECONOMICS
Economics means the study of the way in which
mankind organizes itself to tackle the basic
problems of scarcity.
All societies have more wants than resources.
Hence, a system must be devised to allocate
these resources between competing ends.

DEFINITIONS OF
ECONOMICS
A general definition of Economics :
Economics is the social science that studies economic
activities.
Economic activities essentially mean production, exchange and
consumption of goods and services.
Economists at different times have emphasised different aspects of
economic activities, and have arrived at different definitions of
Economics.

DEFINITIONS OF
ECONOMICS
These definitions can be classified into four
groups:
1.
2.
3.
4.

Wealth definitions,
Material welfare definitions,
Scarcity definitions, and
Growth-centered definitions.

Adam Smith
Adam Smith, considered to be the founding
father

of

modern

Economics,

defined

Economics as
the study of the nature and causes of nations
wealth or simply as the study of wealth.

Adam Smith
The central point in Smiths definition is wealth creation.
Implicitly, Smith identified wealth with welfare.
He assumed that, the wealthier a nation becomes the
happier are its citizens.
Thus, it is important to find out, how a nation can be wealthy.
Economics is the subject that tells us how to make a nation
wealthy.
Adam Smiths definition is a wealth-centred definition of
Economics.

Alfred Marshall

Alfred Marshall also stressed the importance of wealth. But he

also emphasised the role of the individual in the creation and

the use of wealth.
He wrote: 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.
Marshall, therefore, stressed the supreme importance of

man in the economic system.

Marshalls

definition is considered to be

material-welfare

Prof. Lionel Robbins

In his book
Essays on the Nature and Significance of the
Economic Science, published in 1932, Robbins
gave a definition which has become one of the
most popular definitions of Economics.

Prof. Lionel Robbins

According

to

Robbins,

Economics

is

science which studies human behaviour

as

scarce

relationship
means

between

which

have

ends

and

alternative

uses.
It is a scarcity-based definition of Economics.

Professor Samuelson
Professor Samuelson writes,
Economics is the study of how people and society end up
choosing, with or without the use of money, to employ scarce
productive resources that could have alternative uses to
produce various commodities over time and distributing
them for consumption, now or in the future, among various
persons or groups in society. It analyses costs and benefits
of improving patterns of resource allocation.
A large number of modern economists subscribe to this broad
definition of Economics.

Economics as a Science
"Economics is the science which studies human
behavior as a relationship between given ends
and scarce means which have alternative
uses." (Robbins, 1932).

Economics aims to explain how economies work

and how economic agents interact.

Economic analysis is applied throughout society,

in business, finance and government, but also in

crime, education, the family, health, law, politics,
religion, social institutions, war, and science.
The expanding domain of economics in the social

sciences

has

been

described

as

economic

imperialism. (Iannaccone, L. R. 1998).

Economics as a political science

Economics is the study of how individuals and
societies choose to employ those resources:
what goods and services will be produced,
how they will be produced, and how they will
be distributed among the members of society.
Economics

is

customarily

divided

microeconomics and macroeconomics.

into

Microeconomics and
Macroeconomics
Microeconomics is the branch of economics which is

concerned with the behavior of individual entities such as

markets, firms, and households.
Macroeconomics

is

concerned

with

the

overall

performance of the economy. It examines areas such as

how total investment and consumption are determined,
how central banks manage money and interest rates,
causes of international financial crises, etc.

Basic economics
concepts

Business economics how it

differs from economics
Business economics specifically seeks to investigate and

analyze how and why businesses behave as they do,

and what the implications of their actions are for the
industry in which they operate, and for the economy as
a whole.
Businesses are constrained in their operations by many

factors, both internal to them and external.

Internal factors
The internal factors include:
the

types

of

resources

businesses

use,

their

availability, and how they are combined together in

the production process;
the nature and levels of the costs businesses incur

in producing their goods or services;

and the extent to which growth can be achieved

internally as opposed to by acquisitions or mergers.

External factors
Externally, businesses face constraints from the types of
market in which they operate:
how competitive are they, for example, and hence how

easy to enter or leave;

what is the level of demand for the products they produce,
Policies imposed by the government
competition,
minimum wages paid and so on.

Business outputs
Goods
Businesses, also known as producers,
manufacture goods and services.
Goods are classified by economists under two
main headings, consumer goods and producer
goods.
Services
Services consist of the provision of nonphysical items.

Business outputs
Ideas
An idea is intellectual property which can also be bought and sold.

Examples include the ideas in a novel or computer software.

Of course, the book and floppy disk containing the ideas are goods.

Externalities
The production process of a business also creates another type of

output which accrues to society as a whole but whose effect may not
be reflected in a companys accounts, whereas the wages of the
workforce, for example, will be.
Pollution caused by a factory is the obvious example of an externality

The production process is when a business uses its

resources, also known as inputs or factors of production, to
produce outputs of goods, services and ideas; it may also
produce externalities.
These consist of:
Land
Labour
Capital
Enterprise

Demand, Supply &

Market Equilibrium
P

D
Q

Demand
A relation between the price of a good and

the quantity that consumers are willing and

able to buy during a given period, other things
constant.
Willing: you want to buy the product
Able: you can afford the buy the product

Demand Schedule and

Curve
Demand curve:
a

curve

relation
price

of

quantity

showing

the

between

the

good

and

demanded

during a given period,

other things constant.
Suppose we are making

pizza.

Price of Quantity
Good
Demand
ed
$3
$4
$5
$6

200
150
100
75

$7

50

Law of Demand
States that a quantity of a good demanded

during a given period relates inversely to its

price, other things constant.
Price

increases

Quantity

Demanded

Quantity

demanded

decreases
Price

decreases

increases
Creates a downward sloping demand curve

Why?
Substitution Effect
Unlimited wants/scarce resources
When the price of a good falls, consumers

substitute that good for other goods, which

become relatively more expensive.
Reverse also holds true

Why?
Income Effect
Money income: is simply the number of dollars received

per period
Real income: your income measured in terms of what it

can buy.
A fall in the price of a good increases consumers real

income making consumers more able to purchase

goods; for a normal good, the quantity demanded
increases.

Demand Curve
A curve showing the relation
between the price of a good and
the quantity demanded.

Price
$6
$5

Point on the line that matches the schedule

Every point on the line matches the schedule
It is a price/quantity demanded that consume
are willing and able to buy.

$4
$3
0
50

75 100 150

Demand
Quantity
200

Movement Along the Demand

Curve
Caused by a change in price
Only a change in price

Move from one point to another on the same

graph
Called a
Change in quantity demanded.

Movement along the Demand Curve

Price

$6

$5

Demand
0

75

100

Quantity

Demand
Individual demand
The demand of an individual consumer

Market demand
Sum of individual demands of all consumers in

the market

Shifts in the Demand

Curve
A demand curve isolates the relation between

prices of a good and quantities demanded

when other factors that could affect demand
remain unchanged.
Factors called assumptions or determinants

Determinants of Demand
Changes in consumer income
Changes in prices of related goods
Changes in consumer expectations
Changes in the number or composition of

consumers
Changes in consumer tastes

Changes in determinants
Results

in

changes

to

the

RELATIONSHIP

BETWEEN PRICE AND QUANTITY DEMANDED.

At each and every price a DIFFERENT quantity is

demanded.
Results in a shift in the demand curve
New curve must be drawn

Changes in Demand
Increase in demand
At each and every

price MORE of the

good is demanded
Shifts to the right

Qd1 Qd2

$4 150

Price

$5

B
D2

200

$5 100

150

$6 75

100

D1
100

150

Quantity

Causes of Increase in
Demand
Increase

in

consumer

income
Causes consumers to buy

more of the product at

each and every price.
Normal goods
Inferior goods

Change in consumer
income
Normal goods
A good for which

demand increases as
consumer income rise

Inferior goods
A good which demand

increases as consumer
income falls

Changes in Price of Related Goods

Substitutes
Goods that are not consumed

jointly
Goods that are related in such

a way that an increase in the

price of one shifts the demand
curve for the other rightward.
Increase in price of Coke

leads

to

increase

demand for Pepsi

in

Changes in Price of Related Goods

Substitutes
Suppose that the price of Coke rises from $1 to
$1.50, then the demand for Pepsi will decrease
from 75 to 100.

$1

D1
75

100

D2

Changes in the price of related

goods
Complements
Goods that are related in a

such

way

that

an

increase in the price of one

shifts the demand of the
other leftward
Two

goods

that

are

consumed jointly.
An decrease in the price

of

one

will

increase

demand for the other

Changes in Price of Related Goods

Complements
An

decrease

in

the

price of DVD players,

increases the demand
for DVDs

$20

Suppose

players
price

that
decrease

from

$145

DVD
in
to

$100, now the demand

for DVDs will decrease
from 750 at $20 to 900.

D2

D
750

900

Changes in Consumer Expectations

Such as expectations in
Prices and income
Affect

spend

how
their

consumers
money

and

their demand
If product cheaper today

than

tomorrow,

increase in demand

then

Changes in consumer
tastes
Consumer preferences likes and

dislikes in consumption assumed

to be constant along a given
demand

curve

assumed

constant along a given demand

curve
Changes in taste will cause a

shift in the demand curve as

different

quantities

are

demanded at each and every

price.

Changes in taste
Consumers

prefer

platform
$50

shoes.
At $50, demand

increases
100 to 200.

from

D
100

200

D2

Change in the number and

composition of consumers
The market demand curve is the sum of the

individual demand curves.

If the number of consumers falls then the sum

will be smaller thus shifting the demand curve

Changes in Demand
Decrease

in

demand
At each and every
Price

price Less of the

good is demanded
Shifts to the Left

Qd1 Qd2

$4 150

$5

D1

110

$5 100

90

$6 75

60

D2
90

100

Quantity

Causes of Decrease in
Demand
Decrease in

consumer income
Causes consumers

to buy less of the

product at each and
every price.

Changes in Price of Related Goods

Substitutes
Goods that are not consumed

jointly
Goods that are related in such

a way that an increase in the

price of one shifts the demand
curve for the other rightward.
Decrease in price of Coke

leads

to

Decrease

demand for Pepsi

in

Changes in Price of Related Goods

Substitutes
Suppose that the price of Coke drops from $1 to
$0.50, then the demand for Pepsi will decrease
from 100 to 75.

$1

D2
75

100

Changes in the price of related

goods
Complements
Goods that are related in a

such

way

that

an

increase in the price of

one shifts the demand of
the other leftward
Two

goods

that

are

consumed jointly.
An increase in the price

of

one

will

decrease

demand for the other

Changes in Price of Related Goods

Complements
An

decrease

in

the

price of DVD players,

increases the demand
for DVDs

$20

Suppose

players
price

that
increase

from

$100

DVD
in

D2

to

$145, now the demand

for DVDs will decrease
from 900 at $20 to 750.

750

900

D1

Changes in Consumer Expectations

Such as expectations in
Prices and income
Affect how consumers spend

their

money

and

their

demand
If product more expensive

today

than

tomorrow,

then decrease in demand

Changes in consumer
tastes
Consumer

preferences likes

and dislikes in consumption

assumed to be constant along
a

given

assumed

demand
constant

curve
along

given demand curve

Changes in taste will cause a

shift in the demand curve as

different

quantities

are

demanded at each and every

price.

Change in the number and

composition of consumers
The market demand curve is the sum of the

individual demand curves.

If the number of consumers falls then the sum

will be smaller thus shifting the demand curve

Review of Demand
A change in quantity demanded is not a change in demand
Change in quantity demanded is caused by a change in

price
Change in quantity demanded is a movement along the

demand curve
Change is demand is caused by

a change in the

determinants
Change in demand shifts the demand curve

Supply
Producers side
A relation between the price of a good and

the quantity that the producers are willing and

able to offer for sale during a given period,
other things constant.

Law of Supply
The quantity of a good supplied during a

given period is usually directly related to the

price of the good
Increase in price leads to increase in quantity

supplied
Decrease

in

price

leads

to

decrease

quantity supplied.
Creates upward sloping supply curve

in

Supply Curve
Price of
Good

Quantity
Demanded

Price

6
$3

50

$4

75

$5

100

$6

150

$7

200

Supply

Quantity

Movement along the supply curve

A change in price and only in price
Causes a movement along the supply curve
Called a Change in

Quantity Supplied
Supply

$6
B
$4

100

150

Supply
Individual supply
The supply of an individual producer

Market supply
The sum of individual supplies of all producers

in the market

Determinants for the Supply Curve

Changes in technology
Changes in prices of relevant resources
Changes in the prices of alternative goods
Changes in Producer Expectations
Changes in the number of producers

Changes in Supply
Caused by changes in the determinants to

the supply curve

Results in

changes to the relationship

between the price and quantity supplied

At

each

and

every

price

quantity is supplied
New supply curve - shift in supply

different

Increase in Supply
At each and every price more of the good

is supplied

S1
$6

300

400

S2

Causes of increase in
Supply
Improvements in Technology
Changes in relevant resources
Decrease in the price of resources
Lowers costs

Changes in price of alternative goods

If price of alternative good increases, supply of the good increases

Changes in producers expectations

Changes in technology
Technology is the economys stock of

knowledge about how to combine resources

efficiently

Changes in Technology

Improvements in technology
Causes an increase in supply
More of the product is available at all prices

S1
$6

300

400

S2

Changes in Relevant
Resources
Decrease

in

resource prices
Increases

supply

S1

the
of

the

good at each and

every price.

$6

300

400

S2

Changes in prices of Alternative

Goods
Alternative goods
Other

goods

that

use

Price

some or all of the same

resources as the good in

S1

S2

$6

question
Beef and leather.

If the price of beef increases,

producers will supply more
beef

thus

increasing

supply of leather.

the

300

Q Leather
400

Above is the market for the

supply of leather

Changes in Producers Expectations

Expectation of future prices of resources or

their own product can cause producers to

change what they offer at each individual
price

Changes in the Number of

Producers
As the number of producers

change so does the supply

of the product
A decrease in the number

of producers will lead to a

decrease in supply

Decrease in Supply
At each and every price LESS of the good is

supplied

S2
400 600

S1

Causes of Decrease in
Supply
Backward movement in Technology
Changes in relevant resources
Increase in the price of resources
Raises costs

Changes in price of alternative goods

If price of alternative good decreases, supply of the good decreases

Changes in producers expectations

Changes in Relevant
Resources

Are those

$9

S2
500 600

S1

employed in the
production of the
good in question
Increase in price of
resources
Results in decrease

in supply
Less of the good is
available at all
prices

Changes in prices of Alternative

Goods
Alternative goods
Other goods that

use some or all of

the same resources
as the good in
question
Beef and leather.

If the price of beef

decreases, producers
will supply less beef
thus decreasing the
supply of leather.

Price
S1
$6

300

Q Leather
400

Above is the market for the

supply of leather

Producers Expectation
Nationalization
Expropriation

Supply Review
Change in Quantity Supplied
Caused by a change in the price of the product
Movement along the supply curve
Change in Supply
Caused by change in the determinants
Results in a shift in the supply curve

Market Equilibrium
Market
Includes all the
arrangements used to
buy and sell
Reduce transaction
costs
The place where
buyers and sellers
meet to determine
price and quantity

Equilibrium
At specific price where:

Quantity demanded = Quantity

supplied
Equilibrium price
market clearing price

Equilibrium quantity
D = S

Equilibrium
At specific price

where:
Quantity
demanded
Equals
Quantity
Supplied

P
S

$5

Equilibrium

D
Q
150

Reaching Equilibrium
P

If market price is

Surplus

ABOVE equilibrium
Qs > QD

S
$6

Economy is at a

SURPLUS
Market price will fall

$5

10
0

15 200
0

Reaching Equilibrium
If the market

price is BELOW
the equilibrium
price
QD > Qs
Shortage exists
Market price
rises to
equilibrium

P
S

$5
$4
D
Shortage
10
0

15 200
0

Shifts in Demand
Demand

increases

Equilibrium price

increases
Equilibrium
quantity increases

$6

$4

A
D1
D

10
0

15 200
0

Shifts in Demand
P

Decrease in demand
decrease in price
decrease in equilibrium

S
$6

$5

A
D1
D
200
10
0

Shifts in Supply
Price
S1

S2

$6
$5

300400

Q Leather

Increase in supply
Decrease in
equilibrium price
Increase in quantity

Shifts in Supply
Decrease in supply
Price increases
Quantity decreases

Simultaneous Shifts in Supply and

Demand
The change in equilibrium price and quantity

depends on which curve shifts the most.

S

S1

A
B

D
200

300

D1

Simultaneous Changes
Change in
Supply

Change in
Demand

Effect on
Equilibrium
Price

Effect on
Equilibrium
Quantity

Increase
Decrease
Increase

Decrease
Increase
Increase

Decrease
Increase
Indeterminate

Indeterminate
Indeterminate
Increase

Decrease

Decrease

Indeterminate

Decrease

Government Intervention
Government enters

the economy
Price Setting
Subsidies
Government

payments to reduce
the cost of product or
to limit production.

Price Floors
A minimum

legal price
below which
a good or
service
cannot be
sold
If above
equilibrium
causes
surplus

Surplus
S
$7
$6

10

15 200
0

Price Ceilings
A maximum legal

price above which

a good or service
cannot be sold
Below equilibrium
price
Shortage occurs

$5

D
Shortage
10
0

15 200
0