Great lakes Institute of Management
PGPM – Flex – 2018 -2020 Batch
Professional Summary of Dr.M.Muthuraj
He pursued his M.A Economics (Hons) from
Madurai Kamaraj Univeristy with second rank in
April 2000. He received Ph.D in Industrial
Economics, "A Study on Output, Growth, Inputs
Productivity and Technological Progress in the
Major Manufacturing Industries of Tamil Nadu" at
Madurai Kamaraj University in 2005. His doctoral
thesis earned him the Youngest Ph.D holder at
Madurai Kamaraj University’s history. At present he
is working as an Assistant Professor at Great Lakes
Institute of Management, since June 2009. In 2014
he finished his Executive MBA at Great Lakes
Institute of Management. His research areas include
Agricultural Economics, Environmental Economics,
and Rural Developmental Economics.
- Since 2004
He was previously associated with the Loyola College
as lecturer and University of Madras as Lecturer cum
Research Officer in the department of Economics and
Agro Economic Research Centre (AERC) from July
2006 - June 2007. During his tenure at the AERC, he
co-authored the final reports of two research projects
entitled “Factors Affecting Fertilizer Consumption in
Tamil Nadu” and “Estimation of Seed, Feed and
Wastage ratio for Major Food grains in Tamil Nadu”.
He was the keynote for Board of Studies for various
technical Universities. He has authored more than 10
articles in both International and National Journals. He
attended and presented more than 27 papers at National
level seminars.
 WELCOME
To
Microeconomics Class

2
 Economics

• What do you mean by economics?

• Why do we need to study Economics?

• Is Economics hard?
Intro Video
 Purpose of studying Economics….
“The Purpose of studying economics is not to
attain a set of ready-made answers to
economic questions
but to learn how to avoid being mislead by so
called our own
Economists”

“If you put two economists in a room, you

would get four opinions some times
more”
-John Robinson
5
The term “Economics” is derived from
the ancient Greek word

Which means “One who manages a

HOUSEHOLD”

6
• Economics - the study of the decisions
that go into making, distributing and
using goods and services.

• Economy - The way in which people

make, distribute, and use goods and
services
Economics is growing very rapidly as the years pass. As new ideas
are being discovered and the old theories are being revised,
therefore, it is not possible to give a definition of economics which
has a general acceptance.

For the sake of convenience, the set of definitions given by various

economists are generally classified under four heads:

– Economics as a science of wealth.

– Economics as a science of material welfare.
– Economics as a science of scarcity and choice.
– Economics as a science of growth and efficiency.
 Definitions of Economics

1. Wealth Definition
2. Welfare Definition and
3. Scarcity Definition

9
 1.Wealth
When we talk about wealth a lot of people think about

“Wealth is the number of days you can survive without working while
also maintaining your lifestyle.”
"the annual produce of the land and labour of the society“
Adam Smith
 His influence
He is father of the political economy

Father of Economics
Adam Smith

Great
thinker of
political
economy
 His influence
He wrote the wealth of nation
 His Theories
1.Modern free market
2. Self Regulating Market
3.The "invisible hand“

This is what I
believed.

Laissez-Faire = “let them alone”

 no government interference in the economy
 allows owners of business to set working
conditions. Government interference was
seen as a threat to economic growth.
 Free market
“a market which is free from government
intervention such as regulations, privileges,
tariffs, and subsidies”.
2.Markets are Self-regulating Systems for
the orderly coordination of the division
of labor.
 3. Where is the
invisible hand ??

The "invisible hand“

The “invisible hand” can play a role in
allocating resources in a free market.
3. Invisible Hand
 Wealth Definition Cont..

In other words Economics mainly deals

with production and consumption of
wealth.

“The Science of Wealth”

- Adam Smith

19
 2. Welfare Definition
Alfred Marshall (1842-1924) was the first Economist
who shifted the importance from Wealth to Welfare.
“Economics is the study of ordinary business of life; it
examines the part of individual and social action
which is most closely connected with the attainment
and with the use of material requisites of well being”.
Thus, it is on one side a study of wealth; and on other;
and more important side, a part of the study of man.
Principles of Economics – 1890.

20
 3.Scarcity

• Situation in which the amount of

something available is insufficient to
satisfy the desire for it.
• In other wards – Something is scarce if
it is desirable and limited.
• Humans’ wants and needs are infinite,
but the resources needed to meet
those wants are limited and scarce.
 3. Scarcity Definition
“An Essay on Nature and Significance of Economic
Science” - 1932
- Lionel Robbins
“The science which studies human behaviour as a relationship
between ends and scarce means which have alternative uses”

22
 3. Scarcity Definition

• Robbins’ definition is based on four

fundamental characteristics of human
existence. They are:

a. Unlimited Wants,
b. Scarce Means (resources),
c. Alternative uses of scarce means and
d. The economic problem.
 Scarcity Definition Cont….

Various Ends
He used a word ‘Ends’ which means
“Wants”
Since wants are unlimited, we have to
choose more urgent wants than less
urgent wants.

24
 Scarcity Definition Cont….

Scarce Means

The wants are unlimited but the means to

satisfy them are limited.
He used the word ‘Means’ to refer goods and
services which are used to satisfy our wants.
They are material or non-material goods like
money, resources, services etc.

25
Alternative Uses

The scarce means are capable of alternative uses.

They can be used for several purposes
For example land can be used for cultivation,
construction of factories, schools, colleges etc.
Similarly, all the economic means may be put to
alternative uses.

26
 What Economics Is All About
Economics
“Science of Scarcity”
Economics is the study of how to deal with the
problem of scarcity. , 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 allocate scarce resources
between society’s competing wants and needs.

27
Case Studies
 Scarcity
Chocolate Exercise
 Questions - Exercise
• What is the problem?
• Why does this problem exist?
• Figure out a way to resolve this problem!
• Decide how our limited number of chocolates will
be allocated.
 Economic concepts illustrated
by the Scarce Chocolate exercise:

• Scarcity exists:

a. When something is limited in supply and in demand, it is scarce.

b. Everyone wants to eat, but the Chocolates were scarce.
c. Scarcity is a function of both demand and supply. The greater
the demand relative to supply, the more scarce something is.

• Choices must be made:

a. Because scarcity exists, we must make choices about how to

allocate our scarce resources
b. We had to choose between competing systems for allocating
the chocolates.
• Rationing systems:

a. When faced with scarcity, a system must be decided upon to

ration the scarce items.
b. The systems we decided upon ranged from a lottery to first come
first serve to a merit-based system.

• Something that is scarce has value:

a. Everyone wanted a chocolate, yet they were limited. Because

the chocolate provide us with benefit, we value them, and are
therefore willing to pay to have one.

b. Value is a function of scarcity. The scarcer something is, the more

valuable it becomes (gold), while less scarce items are less
valuable (drinking water).
Video
Water Scarcity
Video
Water - Scarcity
Thirsty Crow
 HOW PEOPLE MAKE DECISIONS

Decision making is at the heart of

economics.
For Example: A household faces many decisions.
• Who cooks dinner?
• Who does the laundry?
• Who gets the extra sweet at dinner?
• what TV show to watch?
 What Economics Is All About Cont….
Scarcity Choices

CHOICES

Unlimited
Needs and Limited Natural
Wants Resources

DEMAND SUPPLY

39
 Food, clothing, shelter, Land, Labour, Capital and
Organization
IPhone, jewelry, iPod, projector, digital camera,
good health, children, camcorder, laptop
warmth, indoor plumbing, rollerblades,
a sense of personal worth, Plasma TV,
literacy, FREE TICKETS for RAJINI MOVIE etc

Unlimited Human Wants

Limited Resources

40
Three Basic Problems of Economy
Economic Questions
1. What to produce?

2. How to produce?

3. For whom?
 What are resources?

• The things used to make other goods

 BUT, there’s a
Fundamental Problem:
SCARCITY: unlimited wants and
needs but limited resources
 Choices, Choices
• Because ALL resources, goods, and services
are limited – WE MUST MAKE CHOICES!!!!
 Why Choices?

We make choices about how we spend

our money, time, and energy so we
can fulfill our NEEDS and WANTS.

What are NEEDS and WANTS?

 Wants and Needs,
Needs and Wants
• NEEDS – “stuff” we must have to
survive, generally: food, shelter,
clothing

• WANTS – “stuff” we would really like to

have (Fancy food, shelter, clothing,
big screen TVs, jewelry, conveniences .
. . Also known as LUXURIES
VS.
 The Economic Problem
• What goods and services should an economy
produce? – should the emphasis be on agriculture,
manufacturing or services?
• How should goods and services be produced? –
labour intensive, land intensive, capital intensive?
• Who should get the goods and services produced?
– even distribution? more for the rich? for those who
work hard?
 Three Big Microeconomic Questions

•What Goods and

Services are Produced?
–Figure 1.1 shows the
major items produced in
the Canadian economy
today.
–It emphasizes the
dominant place of
services in our economy.
 Three Big Microeconomic Questions
–Figure 1.2 shows the
trends in what the
Canadian economy
has produced over
the past 50 years.
–It shows the decline
of agriculture, mining,
construction, and
manufacturing, and
the expansion of
services.
1-50
 Production
To match the limited resources with the unlimited want
every society must make choices about the
economy inputs and outputs

Inputs: There are the commodities/services that are

used to produce goods and services.

Outputs: These are the various useful goods or services

that results from the production process and are
either consumed or employed in further production.
 Production

• In simple words production is an outcome

of an economic activity.

• Prof. J.R.Hicks defines Production as "any

activity directed towards the satisfaction of
other people’s wants through exchange."
 Three Big Microeconomic
Questions
How are Goods and Services Produced?
–Factors of production are the resources that
businesses use to produce goods and services.

 Anything that assist production is termed as

factor of production.

 It become a factor of production only when

it actually assist or contributes to production.
 Factors of Production

1) LAND

2) LABOUR

3) CAPITAL

4)ENTREPRENUER
1. Land is the starting point of all production.”
“Stuff” from which everything is made.
2. Without land the production process cannot
exceed further.
3. In Economics all the natural resources that are
available –

a) on the surface of the earth

b) below the surface of the earth
c) above the surface of the earth

and which are used in the production process is

called LAND.
 Features of Land

1. Land is a free gift of nature.

2. Land has no cost of production.
3. The supply of land perfectly inelastic.
4. Land is subject to Law of Diminishing
Return.
5. Land is immobile.
 Labour

1. Labour is a human factor of production.

2. In economics labour is defined as- “Economic
activity of man with
HEAD and
HAND.”

3. LABOUR is human factor of any kind, manual or

mental, skilled or unskilled, scientific or artistic
undertaken with a view of creating or adding utility.
1. Labour is a human factor.
2. Active factor.
3. Labour cannot be stored.
4. Labour is less mobile
5. No two labours are identical.
1. Capital is a man-made resource of production used to
produce further wealth.
2. It refers to the stock of capital assets such as factories,
machines, tools & equipments, raw material, transport
vehicles etc…
3. Therefore capital is defined as “Produced means of
production”
 Features of Capital

1. Capital is man-made factor of production.

2. Supply of capital is elastic.
3. Capital has mobility.
4. All capital is wealth but all wealth is not
capital.
 Entrepreneur
1. Entrepreneur is a person who brings in land, labour & apital
in one place & uses it for the production process.
2. He is the person who decides-
a) What to produce?
b) How to produce?
c) For whom and where to produce?
3. The person who takes these decisions along with the risk
associated with them is known as ‘Entrepreneur’.
 Features of Entrepreneur

1. He must be a good administrator.

2. He must possess complete knowledge.
3. He must be a person of imagination.
4. He must be a man of action.
Remuneration for Factors of Production
Land Labour Capital Entrepreneur
Rend Wage Interest Profit
 Scope of Economics

1. Economics is a subject matter of

economics
2. Economics is a Science or Art
3. Pure Science or Applied Science
4. Positive Science or Normative
Science
5. Economics is social science
 The subject Matter of Economics

• Man is a bundle of desires.

• Wants force us to do some work.
• Work undertaken for earning money is
called “Economic Activity”.
• Thus Wants are the fundamental basis of our
economic life.
• Wants – Efforts - Satisfaction
 Positive and Normative
• It is important as an Economist or Analyst that
you can distinguish between Positive analysis
and Normative Analysis.

• Positive Analysis is factual Analysis; the

analysis of what is. You can recognize a
positive statement because it can be tested;
it can be proven or disproven. There are no
personal judgments involved.
For example:
I can tell you that it is 72 degree outside today
and you can verify that my statement is true or
untrue.
Normative Analysis, on the other hand, is
opinion based analysis – the analysis of what
should be or ought to be. We can recognize a
normative statement because it involves
personal judgments or ideas; it can not be
proven or disproven.
Example:
When I tell you the orange is better than red; can you
verify this? Can you test it? Can you prove it or
disprove it?

In the end, we need both types to make policy.

Take a look at a headlines of news paper:

Can you distinguish the positive statements from the

normative statements?
He changed clothes 16 times in
the US: Rahul's attack on Modi
• Congress vice-president Rahul Gandhi on Wednesday
launched an attack on Prime Minister Narendra Modi,
accusing him of being more bothered about the presentation
of his foreign visits and his clothes than the plight of farmers or
the poor in India.
• "When Modiji goes to America, you will see him changing
clothes 16 times. He will wear one suit, then another, then
yellow clothes, then green, then blue, then pink... Have you
ever seen Nitishji in any other colour than white?" said Rahul
Gandhi, addressing an election rally in Bihar's Sheikhpura,
about 120 km from Patna.
• "When Modiji became Prime Minister, I called it a 'suit-boot ki
sarkar'. After that, he never wore a suit," he added.
• Source:TNN | Oct 7, 2015, 03.07 PM IST
 Positive vs. Normative
Economics
• A positive statement is a statement of
fact
• A normative statement is when we
make a
value-judgment

69
 Positive or Normative
Statements

POSITIVE
?
ANALYSIS
“In India the unemployment rate is
currently 7.8%”

?
70
 Positive or Normative
Statements
“Economic growth should be
?
continuing and consistent so that
poverty will be eliminated!”

NORMATIVE
ANALYSIS

?
71
 Positive or Normative
Statements

?
“An increase in the minimum wage
will cause a decrease in
employment among the least-
skilled”
? ?
72
 Positive or Normative
Statements

?
“The income gains from a higher
minimum wage are worth more than
any slight reductions in
employment”
? ?
73
 Micro Economics
MIC-MAC

Economics

Micro Economics Macro Economics

74
 Microeconomics

• Micro
– Micro comes from Greek word mikros,
meaning “small”
• Microeconomics
– Study of behavior of individual
households, firms, and governments
• Choices they make
• Interaction in specific markets Microscope
• Focuses on individual parts of an
economy, rather than the whole
75
 Macroeconomics
• Macro
– Macro comes from Greek word, makros,
meaning “large”
• Macroeconomics
– Study of the economy as a whole
• Focuses on big picture and ignores fine details

Telescope
76
 WHAT’S THE DIFFERENCE?

MICROECONOMICS MACROECONOMICS

I A
 MIcroeconomics = Individual /
Specific
Two major fields/divisions
1. Microeconomics = Parts, Trees
• About INDIVIDUAL economic units such as
CONSUMER and FIRM, INDUSTRY,
• How they make decisions and how they
interact in specific markets
• MARKET ECONOMICS
 MAcroeconomics = Aggregate, All ,
General
2. Macroeconomics = Whole, Forest
• Studies how the economy behaves as a whole
• Country’s output, general price level, national
income and employment and unemployment,
balance of payments and exchange rates
• NATIONAL ECONOMICS
 Micro vs Macro

• An individual or a family • All consumers’

decides to buy a laptop demands for all goods
• A firm’s production of a • Total production of
good goods of all firms
• The price of notebook, • The general price of all
pen, etc goods and services
 Microeconomics Vs Macroeconomics
Microeconomics is the branch of economics that
examines the individual economics units or particular
parts of the economy

Macroeconomics is the branch of economics that

examines the behavior of economic aggregates —
income, output, employment, and so on—on a national
scale

82
 The Principles of Economics
The study of economics is simply the study of economic
principles and their application.

What are the principles of economics? Below are list of 10

basic economic principles, inspired by great economists
like Adam Smith, and Greg Mankiew.

83
 Ten Principles of Economics

• How People Make Decisions (1 to 4)

• How People Interact ( 5 to 7)
• How The Economy As A Whole Works
(8 to 10)

84
 The principles of
HOW PEOPLE
MAKE DECISIONS

85
 DECISION MAKING
Decision-making is at the heart of economics.

The individual must decide how much to save for

retirement, how much to spend on different goods
and services, how many hours a week to work.

The firm must decide how much to produce, what

kind of labor to hire.

Society as a whole must decide how much to spend

on national defense (“guns”) versus how much to
spend on consumer goods (“butter”).
Video
People Face Trade Offs
Trade off is a situation
that involves losing one
quality or aspect of
something in return for
gaining another quality or
aspect.
• In other words
• Any situation in which one thing must
be decreased for another to be
increased.

• Ex: "I faced a trade-off between

eating and buying my medicine.
 HOW PEOPLE MAKE DECISIONS
Principle #1: People Face Tradeoffs

All decisions involve tradeoffs. Examples:

• Going to a party the night before your midterm leaves
less time for studying.
• Having more money to buy stuff requires working
longer hours, which leaves less time for leisure.
• Protecting the environment requires resources
that could otherwise be used to produce
consumer goods.

90
The word" "People face tradeoffs" means ”There is
no such thing as a free lunch!" or to get one thing,
we usually have to give up another thing.

Making decisions requires trading off one goal

against another.
 Trade-Offs
• Individuals and Trade-Offs – studying one subject vs.
another, college or work, watching TV or working out, et.
• Parents and Trade-Offs – buy food or clothing, save for
retirement or fund their children’s college education
• Society and Trade-Offs – “guns or butter”, military or
consumer goods
 Society faces trade off between
Efficiency & Equity
• Society faces an important tradeoff:
efficiency vs. equality
• Efficiency: when society gets the most from its scarce
resources
• Equality: Distributing economic prosperity fairly
among the individuals of the society.
• Tradeoff: To achieve greater equality,
could redistribute income from wealthy to poor.

93
 Life Example
A student faces a trade off between
studying for exam or to watch a much
awaited movie.
 Question for Review

• Describe some of the trade-offs faced by each of the

following:

A. a family deciding whether to buy a new car

A family faces a trade off whether to buy a car or spend
the money on savings for meeting the future needs
such as for higher education for their children.
B) a member of Congress deciding how much to spend
on national parks

In this case the member of congress faces a trade off

whether to spend much on national parks or to use the
money for the upliftment of other services by the
government to the society
People Face Tradeoffs
 HOW PEOPLE MAKE DECISIONS
The Cost of Something is What You Give
up to get it
Principle #2: The Cost of Something is
What You Give Up to Get It

Nothing comes for free in this world. You need to give up

some thing in order to gain something.

Making decisions requires comparing the costs and

benefits of alternative courses of action.

The OPPURTUNITY COST of an item is what you give up

to get that item.
• Making decisions requires comparing the costs
and benefits of alternative choices.
• The opportunity cost of any item is
whatever must be given up to obtain it.
• It is the relevant cost for decision making.

100
 HOW PEOPLE MAKE DECISIONS

Examples:
The opportunity cost of…
…going to college for a year is not just the education,
books, and fees, but also the predetermined wages.
…seeing a movie is not just the price of the ticket,
but the value of the time you spend in the theater.

101
 Opportunity cost
 The best alternative that we give up, when we make a
choice or a decision.

 Every decision means giving up something. Economists

are fond of trade-offs as a way of thinking about
decision making. Taking one action usually means
giving up something else.

102
Opportunity Cost

103
 Opportunity Cost

• The opportunity cost is the opportunity

lost.
• Example: Time
• Assume you have 16 hours in a day to
decide whether you will work or play.
The Production Possibilities Curve
• A basic economic model which shows
the tradeoffs society or an individuals
faces in how to use scarce resources.
 Example: Opportunity Cost

A B C D E F G H I
Work 16 14 12 10 8 6 4 2 0
Play 0 2 4 6 8 10 12 14 16

What we give up
OC = ---------------------------
What we Gain

The opportunity cost of spending time for work

is 12 hours and Play is 4 hours.

OC = 12/4 = 3

105
 Example: Opportunity Cost

16-A
14-
12- C
Work
10-
8- E
6-
D
4-
2-
B
0 4 6 8 10 12 14 16
2
Play

106
Athletes who can earn millions if
Life Example
they drop out of school and play
professional sports are well
aware that their opportunity
cost of college is very high

Cricketing god Sachin Tendulkar

decided to quit his education in
order to play professional cricket
for our country.
 Question for Review

You are trying to decide whether to take a

vacation. Most of the costs of the vacation (airfare,
hotel, and forgone wages) are measured in
dollars, but the benefits of the vacation are
psychological.

How can you compare the benefits to the costs?

SOLUTION : In a situation where benefits are psychological , it is difficult to
compare benefits to costs to determine whether it is worth it. In order to decide
whether going on a vacation is beneficial or not , we can either think how that
money can be spent somewhere else – like spending money to buy a new
mobile phone or we can think about the hard work we put in to earn the money
which is needed to be spent on the vacation. By doing this we can understand the
benefits of the vacation and think wisely before spending.
Video
 HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the
Margin

Rational people
– systematically and purposefully do the best they
can to achieve their objectives.
– make decisions by evaluating costs and benefits of
marginal changes – incremental adjustments to an
existing plan.

111
 Rational People Think at the Margin.
A rational decision-
maker takes action only
if the marginal benefit of
the action exceeds the
marginal cost.
 HOW PEOPLE MAKE DECISIONS
Principle #3: Rational People Think at the Margin
Examples:
• When a student considers whether to go to college for an
additional year, he compares the fees & foregone wages
to the extra income he could earn with the extra year of
education.
• When a manager considers whether to increase output,
she compares the cost of the needed labor and materials
to the extra revenue.

113
 Life Example
Ex : If you buy a used car, and plan to spend Rs10,0000,
but the car is only priced at Rs 6,0000, would you still buy
it if it needed Rs 4,0000 in repairs? of course not because

1) you are a rational thinker and

2) you would end up spending more than you planned to.
 Questions for Review
What does it mean to think at the margin?
It means to think about your next step forward. The word
"marginal" means "additional." The first glass of cool drinks on
a hot day reduces your thirst, but the next glass, maybe not so
much. If you think at the margin, you are thinking about what
the next or additional action means for you.
Thinking at the Margin
Slice Marginal Benefit
1 10
2 9
3 8
4 4
5 2
6 0
7 -2
8 -10
Video for 3
 HOW PEOPLE MAKE DECISIONS
Principle #4: People Respond to Incentives
• Incentive Incentives in economics are factors that can alter the
buying behavior of consumers. They can either be decisions by
governments or businesses, such as tax relief when buying
hybrid cars or changes dictated by the "invisible hand" of the
market, like a rise in oil's price.

Rational people respond to incentives.

Examples:
– When gas prices rise, consumers buy more hybrid cars and
fewer gas guzzling SUVs.
– When cigarette taxes increase,
teen smoking falls.
118
Incentives: Something that induces a person
to act
An incentive is something that motivates an
individual to perform an action. The study of
incentive structures is central to the study of
all economic activities .

Perhaps the most notable incentive in

economics is price. Price acts as a signal to
suppliers to produce and to consumers to
buy.
 Case Study – The incentive Effects of Gasoline Prices

• How does the increase in prices create an

incentive for workers, students, drivers or
Diddy to change their habits?
• Are there any indirect incentives of effects
that may have resulted from these rising gas
prices?
• When the gasoline prices declined after
2009, do you think everyone reverted to
their original ways of travel? Why or Why
not?
PEOPLE RESPOND TO INCENTIVES
VIDEO
The principles of
HOW PEOPLE
INTERACT
 HOW PEOPLE INTERACT

• Whether we’re talking about the U.S. economy or

the local economy, the term “economy” simply
means a group of people interacting with each
other.
• These interactions play a critical role in the
allocation of society’s scarce resources.
• For example, the interaction of buyers and sellers
determines the prices of goods and the amounts
produced and sold. These interactions are an
important part of what economists study.
 HOW PEOPLE INTERACT
Principle #5: Trade Can Make Everyone
Better Off

• Rather than being self-sufficient,

people can specialize in producing one good or
service and exchange it for other goods.
• Countries also benefit from trade.

124
Trade Can Make Everyone Better Off
Trade allows each person to specialize in the activities he or
she does best. By trading with others, people can buy a
greater variety of goods or services.
 Advantages

• Meeting our Needs

• Trade creates jobs,
• attracts investment,
• attracts new technology and
materials, and
• offers a wider choice in products and
services
Consider how trade affects your family.
When a member of your family for a job, he
or she competes against members of other
families who are looking for jobs.

Families also compete against one another

when they go shopping because each family
wants to buy the best goods at the lowest
prices.
For Example Let's say that you brought a
lot of onion rings for lunch and your
friend brought Tomato fries. After a
while, you get sick of only eating onion
rings and want to eat those Tomato fries
that your friend has; so, you make a deal
(trade).
"I'll give you 10 of my onion rings for your
10 Tomato fries"
 Questions For Review

Your roommate is a better cook than you are, but

you can clean more quickly than your roommate
can. If your roommate did all the cooking and you
did all the cleaning, would your tasks take you
more or less time than if you divided each task
evenly?
Give a similar example of how specialization and
trade can make two countries both better off.
 Answer
By specializing in each task you and your roommate can finish
the tasks more quickly. If you divide each task equally, it would
take more time to cook than it would take your roommate and it
would take him more time to clean than it would take you. By
specializing, you reduce the total time spent on tasks.

Similarly countries can specialize and trade making both better

off. For example, suppose it takes Spanish workers less time to
make clothes than French workers and French workers can make
wine more efficiently than Spanish workers. Then Spain and
France both benefit if Spanish workers produce all the clothes
and French workers produce all the wine then they exchange
some wine for some clothes.
Despite the competitive world that we live in, trade
between different countries can make each country
better off.
It allows them to take advantage of their strengths
and benefits without worrying about their weaknesses.
In other words, it allows them to specialize in whatever
they are best at while enjoying different varieties of
goods and services, imported from other countries.
video
 HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity
Market: a group of buyers and sellers
(need not be in a single location)
• “Organize economic activity” means
determining
– what goods to produce
– how to produce them
– how much of each to produce
– who gets them
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 HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity

• A market economy allocates resources through

the decentralized decisions of many
households and firms as they interact in
markets.
• Famous insight by Adam Smith in
The Wealth of Nations (1776):
Each of these households and firms
acts as if “led by an invisible hand”
to promote general economic well-being.
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 HOW PEOPLE INTERACT
Principle #6: Markets Are Usually A Good Way
to Organize Economic Activity
• The invisible hand works through the price system:
– The interaction of buyers and sellers
determines prices.
– Each price reflects the good’s value to buyers and
the cost of producing the good.
– Prices guide self-interested households and firms
to make decisions that, in many cases, maximize
society’s economic well-being.
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Video
Principle #7: Governments Can Sometimes
Improve Market Outcomes
When a market fails to
allocate resources
efficiently, the government
can change the outcome
through public policy.
Examples are regulations
against monopolies and
pollution.
 HOW PEOPLE INTERACT
Principle #7: Governments Can Sometimes
Improve Market Outcomes

• Market failure: when the market fails to allocate

society’s resources efficiently
• Causes:
– Externalities, when the production or consumption
of a good affects spectators (e.g. pollution)
– Market power, a single buyer or seller has substantial
influence on market price (e.g. monopoly)
• In such cases, public policy may promote efficiency.
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 Life Example
Tamil Nadu Government Orders Permanent Closure of Sterlite Plant

The Tamil Nadu government on Monday ordered the closure of

the Sterlite Copper factory in Thoothukudi, marking a significant
setback for the Anil Agarwal-owned Vedanta unit, which is at the
centre of a violent agitation led by residents who claim the
smelter has caused widespread pollution of air and water in the
southern city.

- Economic Times, May 29, 2018, 10.46 AM IST

Discussion Questions
In each of the following situations, what
is the government’s role? Does the
government’s intervention improve the
outcome?
1) GST
2) Why NEET needs to go?
3) Workplace safety regulations
- Moulivakkam building collapse
- June 28, killing 61 persons and injuring 27.
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The principles of
HOW THE
ECONOMY
AS A WHOLE
WORKS
 HOW THE ECONOMY AS A WHOLE WORKS
Principle #8: A country’s standard of living
depends on its ability to produce goods &
services.

• Huge variation in living standards across

countries and over time:
– Average income in rich countries is more than ten
times average income in poor countries.
– The U.S. standard of living today is about
eight times larger than 100 years ago.

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 HOW THE ECONOMY AS A WHOLE WORKS
Principle #8: A country’s standard of living
depends on its ability to produce goods &
services.
• The most important determinant of living standards: productivity,
the amount of goods and services produced per unit of labor.
• Productivity depends on the equipment, skills, and technology
available to workers.
• Other factors (e.g., labor unions, competition from abroad) have
far less impact on living standards.

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 HOW THE ECONOMY AS A WHOLE WORKS
Principle #9: Prices rise when the
government prints too much money.

• Inflation:
• increases in the general level of prices.
• In the long run, inflation is almost always caused
by excessive growth in the quantity of money,
which causes the value of money to fall.
• The faster the govt creates money,
the greater the inflation rate.

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 HOW THE ECONOMY AS A WHOLE WORKS
Principle #10: Society faces a short-run
tradeoff between inflation and unemployment

• In the short-run (1 – 2 years),

many economic policies push inflation and
unemployment in opposite directions.
• Other factors can make this tradeoff more or
less favorable, but the tradeoff is always
present.

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