Introduction to Economics

• Global Oil Prices (Law of Demand and Supply)

• Campaigns to preserve natural resources . ( water, crude oil)

• Role of Banks and NBFC. ( CRR, SLR. Liquidity, Inflation , GDP)

• Why CEO’s of FMCG companies are hired on Board of other industries .

• Why Government does not print huge amount of money and make all of
us RICH. ( Germany and Hyperinflation of Zimbabwe)

• Why all vegetable venders are selling at almost same price, why
Barbeque nation charge high.
 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’

unlimited wants of the family members,
limited income of the family.
In fact, the same is true for a society also.

• DIFINITION
Economics is that branch of social science which is concerned with the
study of how individuals, households, firms, industries and government take
decision relating to the allocation of limited resources to productive uses,
so as to derive maximum gain or satisfaction.
 MEANING OF ECONOMICS

• Thus, 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

– Wealth definitions

– Material welfare definitions

– Scarcity definitions

– Growth-centered definitions
 Adam Smith’s Definition
Adam Smith ( J.B Say was another) father of modern Economics, defined
Economics as the study of wealth.
The central point in Smith’s definition is wealth creation.
He assumed that, the wealthier a nation becomes the happier are its citizens.
Important is to find out, how a nation can be wealthy.

Main Characteristics
Inquiry into the nature and causes of wealth of nation
Book Published in 1776
Wealth of a nation may be increased through raising the level of
production and export.

Nature of wealth-
Wealth of a nation includes only material goods (e.g., different
manufactured items, TANGIBLES ).
Non-material goods INTANGIBLES (services) are not considered as
‘wealth’.
Change in Wealth is economic development.
 Material Welfare Definition
• Alfred Marshall’s Definition
Too Much importance to Wealth , No mention of man welfare

No Consideration for National Problems

Wealth and Role of Individual in its Creation .

Focus shifted from Study of Wealth to Welfare of Man.

“Economics is a study of man’s action’s 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”.

FEATURES
Study of material requisites of well-being
Concentrates on the ordinary business of life
A stress on the role of man
 Scarcity Definition and its Features
• According to Lionel Robbins, “Economics is a science which studies human
behavior as a relationship between ends ( TARGETS, jeans , Pen) and scarce
means ( HOW I WILL GET) which have alternative uses ( use of money).”

FEATURES
• Economics is a science of Choice making . ( Messi or lionardo)
• “Nature and Significance of Economics book” , in 1931.
• Unlimited wants through limited means.
• Alternative uses of scarce resources
• Need for choice and optimization.
• Is Scarcity always a problem or sometime Abundance ( Poverty ,
Unemployment ) is a problem.
 Economic problem and Alternative Use
• Resources and no alternative use ( Land and only wheat)
• Resource and Alternative use ( Economic problem)
 Modern Growth-Oriented Definition of 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.

• Talks about future growth of Society.

 Features of the Modern Growth-Oriented Definition
• Growth-orientation - national output over time in future.

• Production and consumption

Growth depends on production and Consumption

• Distribution – Explicit importance to Distribution

• Improvement of resource allocation

Improvement of resource allocation and better distributive justice are
synonymous with economic development.
What to Produce
How much to produce
For Whom to produce
 Nature of Economics – Science or Art
• Economics as a Science
Cause and Effect ( Law of Demand)
Own methodology ( Induction and Deduction)
Measurement ( in terms of money)
Ability to forecast.
Different individuals have different Opinion , Human Behaviour.
• Positive and Normative Science
Positive Science
It tells only what is , no suggestion
Descriptive ( Data and Facts) in nature
Normative Science
It gives suggestions , Opinion for welfare
Prescriptive in nature
It is more of Positive and less of normative science

Example : Government framing economic policies

 Nature of Economics – Science or Art
• Economics as an Art
Best way to do a work is Art.
Art is Application and Practice of knowledge
Art teaches us to do, science let us know.
Example : Study of unemployment is science.
Eradicate unemployment is art
 Branches of Economics – Micro and Macro Economics
• Difference between Micro and Macro ( I and A)

No distinction , as Macroeconomics is aggregates of individual figures.

Yet the distinction is justified because what is true for individual in isolation
may not be true for the economy as a whole.

For example:
An individual saving , may become richer
However, if all individuals save more and spend less, the nation as a whole
does not become richer.

Microeconomics uses the ceteris paribus concept ( keeping all other

things constant ) .
Demand > Supply , Prices will increase ceteris paribus.
 Micro Economics

• Decision-making of a single unit of an Economic System.

• Example :
Price or General increase in price (price index )
Study of one firm or Industry
Individual Income or National Income

• How does an individual (or a family) decide on how much of various

commodities and services to consume?

• How does a business firm decide how much of its product (or products)
to produce?
 Usefulness of Microeconomics
• Working of a free market Economy ( Likes and dislikes of customer , what

,how much and when to Produce)

• Optimum allocation of Resources ( Max. Production , Min. Wastage)

• Price Determination ( Price and Demand)

• Economic policies and Policies ( Pricing , Distribution , Investment decision

of firms)

• Study Individual Economic Behavior

• International trade ( Exchange trade , Elasticity of Demand)

• Pubic Finance ( Direct and indirect taxes on economy)

 Macroeconomics
Economy performance as a whole, rather than individual
firms.

How different sectors of the economy relate to one another to

understand how the aggregate functions.

National Income instead Individual Income

Price level instead individual prices
National output instead individual output
 Importance of Macroeconomics
Macro Economics develops models and theory to explain Macro
Economic variables like :

National Income , Un Employment ,

Price level, Business cycles , GDP, GNP, National Income

Insights and forecast provided by these modals aids government

in framing monetary and Fiscal policies to complement economic
development

Limitation of Macro Economics

Theories are developed in Isolation
Doest not include real world details like Taxes , Transaction cost.
Difference between Micro and Macro Economics
Micro Macro

Individual economic Unit Whole or Aggregate

Price determination Income level , employment level

Bottom up approach Top down approach

Price theory Income and Employment theory

 Scope Of Economics
46 million out of 1.3 billion lives below poverty line.

2018-19 , GVA 169.61 lakhs cr.

Service 92.26 lacs cr ( 54%)
Industry ( 29%)
Agriculture ( 16%)

Fulfillment of unlimited wants with limited resources.

Prioritizing the requirements and fulfilling it.
Analyzing the causes to problems and their solution.

Production , Marketing , Finance , Distribution all functions are

guided by economic science.
Political or foreign relationship .
 Managerial Economics
“Managerial Economics can be defined as amalgamation of
Economic theory with Business Practices so as to ease decision-
making and future planning by management.”

According to Mc Nair and Meriam,

“Managerial Economics is the use of economic modes of thought
to analyse business situations.”

According to Prof Evan J Douglas.

“Economics is concerned with the application of Economic
Principles and methodologies to the decision making process with
in the firm or organisation , under conditions of uncertainty.
Managerial Economics
 Nature of Managerial Economics
• It is Realistic and Pragmatic . ( real Problem and their Solution)

• Various Tools to Aide in Decision Making . ( Demand Forecasting)

• Measures Various Economic Variable ( Income level, Demand Pattern)

• Managerial Economics has components of micro economics.

• Uses Macro economics variables ( Inflation , National income, GDP)

• Encourages study of Non Economic Variable ( Technology ,

Environmental issues, Socio political factors)

• Uses other tools like Statistics , Operations Research .

 Scope Of Managerial Economics in Decision Making
• New Product Launch ( Feasibility Analysis)

• Pricing Decisions ( Penetration , Skimming )

• Production Planning ( Batch Production , Mass Production )

• Cost Analysis ( Fixed Cost , Variable Cost, Inventory carrying , Order cost)

• Demand Analysis and Forecasting ( Economic Order Quantity, Inventory Level,

Quantity to be produced )

• Profit Management ( Break Even Analysis)

• Measures Elasticities ( Price , Cross , Advertisement Elasticity's)

• Capital Management or Capital Budgeting

 Some Important Principles
• Marginal Principle
• Incremental Principle,
• Opportunity Cost Principle
• Discounting Principle
• Concept of Time Perspective.
• Equi-Marginal Principle.
 Marginal Principle
• Marginal – Refers to change ( increase or decrease) in total quantity or
value , due to a one unit change in its determinant.

Marginal Cost = Change in Total cost because of 1 extra unit produced.

Marginal Revenue= change in Total revenue due to sale of 1 extra unit
Marginal Utility = Change in utility as a result of consumption of 1 extra
unit .

Total Cost of production for 100 unit TC 1= 2500 Rs.

Total cost of Production for 101 unit TC 2 = 2550 Rs.
Marginal Cost (MC) = TC 2 – TC1= 2550 – 2500 = 50 Rs.
Similarly
Revenue = Cost /Unit * Quantity
Marginal Revenue (MR) = TR2 –TR1
 Marginal Principle
If TC and TR are given in form of equation , like
TC = f (Q)
TR = f(Q)
then , MC and MR would be the first order derivative i.e slope of TC and
TR

Application of Marginal Principle

“How much to produce so that profit is maximum , Profit Maximizing

output.”

Business activity must be carried on as long as MR > MC

And that level of output where MR= MC , would be profit maximizing

output , output more than this will result into MR < MC

 Limitations of Marginality Principle
1. Can be applied only if management has data for TC and TR , for each
and every unit produced.
2. Marginal analysis can be applied to those situations where only
variable cost changes , as Marginality concept reduces change in TC to
change in VC only , as fixed cost remains constant and its differential
would be zero.
 Incremental Principle
• Marginal Principle is used when MC and MR can be calculated precisely
• Difficult as most business do it on bulk .
• Could be easily calculated airplanes , ship, turbines.
• When fixed and variable cost both can change , business apply
incremental principle.
• An increase in total cost (Incremental Cost )and total revenue
(Incremental Revenue).
Example : Installing new plant to increase production
Cost increases from 100 million to 115 million , Incremental cost =15 m
Revenue increases from 130 million to 150 million , incremental
revenue = 20 million
• Components of Incremental Cost
Present explicit cost – Fixed Cost and Variable Cost
Opportunity Cost
Future Cost ( Depreciation or Advertisement )
 Opportunity Cost Principle
• Scarcity and Alternative uses leads to Principle of Opportunity cost.
• A company has 100 m to be invested in three risk free alternative uses
and their corresponding annual returns.
A. Expansion 20 m
B. Diversification 18m
C. buying shares of other forms 16m
• Best decision A , i.e. company has to forgo 18m Rs, to earn 20m Rs.
• Thus Opportunity cost of earning 20m Rs. Is 18m Rs.
• Opportunity cost of an income It is the foregone income from 2nd best
alternative use.
 Discounting Principle
• Time Value of Money
Value of Money ( Buying Power, Inflation ) is different at different time
intervals.
In 2015 100 rs / kg , from 1000 rs , one can purchase 10 kg.
In 2018 200 Rs./kg , from 1000 rs, I can purchase 5 kg, just half i.e
money value has just come down to half.
Now to purchase 10 kg , one need 2000 Rs.
i.e 1000 Rs. In 2015 are same as 2000 in 2018
• Consider Return in light of inflation, Opportunity cost.
• To calculate EMI to be paid for any loan taken at present.
• Values at 10% interest rate
• 1000 1100 1210 1331 1464.10
 Time Perspective
• Time horizon for business decisions.

• Different time horizons for different business.

• Business Decisions which are profitable in long run

1. Investment for educational institute
2. Employees Welfare

• Business decision which are profitable in short run

1. Running a food joint.
2. Investment in explosive to make firecrackers.

Some business have short run payoffs or outcome while others may
have long run.
 Equi Marginal Principle
• Originally associated with consumption theory.
• Law of Equi Marginal utility
“A utility maximizing consumer distributes, his consumption expenditure
between various goods and services he consumes, in such a way , that
the marginal utility derived from each unit of expenditure on various
goods and services is same.”
Example :
Coffee 16/- , sandwich 12/- , Petties 8/- ,…….. ..How to invest 100 Rs.
MU (C) / P (c ) = MU (s) / P (s) = MU (p) / P (p)
Quantity MU Ratio MU Ratio MU Ratio
1 128 8 120 10 96 12
2 96 6 96 08 80 10
3 64 4 64 06 64 08
4 32 2 48 4 48 06
5 0 0 06 2 32 04
 Basis of Consumer Demand Utility
Demand of a commodity is because of its utility.
• Utility has two aspects
Product angle – want satisfying property of a commodity ( Absolute)
Consumer angle – feeling of satisfaction , pleasure , happiness from
consumption, possession or use of commodity. (subjective or Relative)
• In consumer analysis , only subjective concept is used.
• Total Utility
Assuming utility is measurable and additive
Total Utility U = u1 +u2+u3+u4
Marginal Utility
• Utility derived from consumption of one additional unit.
Utility ( Satisfaction , Pleasure , Happiness) is Measurable ?????
Cardinal Utility ( Quantitative , classical and Neo Classical Economist)
Ordinal Utility ( Qualitative , Modern Economist)
 Analysis of Consumer Behaviour : Cardinal Utility
• Central theme of consumption theory – Utility maximizing behaviour.
• Assumption:
Maximization of Satisfaction
Rationality ( need/ want satisfaction in priority)
Limited money income
Utility is cardinally measurable
Diminishing Marginal Utility
Constant marginal utility of Money
Utility is additive
 Law of Diminishing Marginal Utility
• “As the quantity consumed of a commodity goes on increasing , the
utility derived from each successive unit consumed goes on decreasing ,
consumption of all other commodities remaining constant.”
 Indifference/ Iso Utility / Equal utility Curve
Often consumer finds , one commodity can be substituted by other , this
substitution forms the basis of indifference curve.

An Indifference curve (IC) is the locus of points each representing a different

combination of two substitute goods, which yield the same utility or level of
satisfaction to the consumer.

Indifferent ( same level of satisfaction) between any two combinations of

two goods.
 INDIFFERENCE CURVES
24
22 A(1, 22)
20
INDIFFERENCE SCHEDULE 18
(Table Showing Different
16
Combinations giving Equal
Satisfaction) 14
Combinatio Apples Oranges
12
n 10
A 1 22 8
6
B 2 14
Oranges

4
C 3 10 2 Apples
D 4 8 0
E 5 7 1 2 3 4 5 6
 Indifference Map
• Indifference Plane ( Space between Axis X and Y , full of finite points
and each point representing a different combination of two goods)
• Indifference Map ( Set of no. of different , indifferent curves with
varying amount of satisfaction derived from it).
• IC1,IC2, IC3 IC 4 with varying utility u1,u2,u3 and u4
 Marginal Rate of Substitution
• Indifference curve is formed by substituting one good for another.
• The rate at which one good is substituted for another is called Marginal Rate of
Substitution.
• The marginal rate of substitution of X for Y (MRSxy) is defined as the amount of Y,
the consumer is just willing to give up to get one more unit of X and maintain the
same level of satisfaction.

MRSxy = Decrease in the Consum. of Y / Increase in the Consum. of X = - (∆Y / ∆X)

•
 Diminishing Marginal Rate of Substitution

24 A
22
20 MRS = -O/A = 8:1
18
16 MRS = 4:1
14
MRS is measured by 12 MRS = 2:1
the slope of the 10
indifference curve 8
6
Oranges

4 IC1

2
Apples
0
1 2 3 4 5
 Diminishing Marginal Rate of Substitution

Combination Apples Oranges MRS

A 1 22 ---
B 2 14 8:1
C 3 10 4:1
D 4 8 2:1
E 5 7 1:1

As the consumer increases the consumption of apples, then for getting every additional
unit of apples, he will give up less and less of oranges, that is, 8:1, 4:1, 2:1, 1:1
respectively This is the Law of Diminishing MRS.
Why MRS Decreases
Marginal Utility (MU) of a commodity increases , as its quantity decrease
and vive versa.

Since goods are not perfect substitute , the subjective value attached to the
additional quantity ( Subjective MU) of a commodity decreases fast in
relation to the other commodity whose total quantity is decreasing.

Therefore when the quantity of one commodity (X) increases and that of
other (Y) decreases, the subjective MU of Y increases and that of (X)
decreases.

Hence consumer become increasingly unwilling to sacrifice more units of Y

for one unit of X.
 Properties of Indifference Curve
1. An Indifference curve has Negative slope i.e. it slope downwards from left to
right.
(i) The two commodities can be substituted.
(ii) If quantity of one commodity decreases , quantity of other commodity must
increase for same level of Satisfaction.

2. Indifference curve is always convex to the origin. Convexity implies two things
(i) Two commodities are imperfect substitute for one another , else IC would
have been a straight line.
(ii) MRS decreases , as consumer moves along IC Curve.

3.
 Properties of Indifference Curve
3. Two Indifference curves can neither intersect nor be tangent with one another .
Because if it happens it yields two impossible conclusion
( i) same combination yields , two different level of satisfaction.
(ii) Two different combination ( b and c ) on different IC yields the same satisfaction.
 Properties of Indifference Curve

• 4. Higher indifference • 5. Indifference curve

curve represents higher touches neither X-axis
satisfaction. nor Y-axis.

Indifference map

More is
preferred to
Less