Introduction to Economics

Dr. S.K. Shanthi

Chair-Professor
Union Bank Center for Banking Excellence
 Principles of Economics
• “Economy” comes from a Greek word for “one who
manages a household”
• Concept extends to societies
• Economics is a study of how society manages its
scarce resources.
• Managed not by a single planner but by the combined
actions of millions of households and firms.
• Economics also studies how these agents interact
with one another.
 How People make decisions
• Principle #1: People face trade-offs
– No free lunch
– Societies also face trade offs classic example of
Guns and butter.
– Another major trade-off a society faces is between
efficiency and equity.
– For example, a taxation policy, while beneficial in
terms of promoting equity, may have a cost in
terms of reduced efficiency (discouraging work)
 Principle # 2
• Cost of something is what you give up to get it

• Opportunity cost
 Principle # 3
• Rational People think at the margin (edge)

• Pay attention to marginal benefits versus

marginal costs
 Principle # 4
• People respond to incentives

• People’s behaviour changes when benefits

and costs change
• For example a discount offered on a product
• Law that makes wearing seat belts or helmets,
compulsory
 How people interact
• # 5 Trade can make everyone better off

• Why countries trade?

• Trade makes specialization possible
 #6
• Markets are usually a good way to organize economic
activity
• Collapse of communism in Soviet Union and the
Eastern Europe
• Adam Smith’s invisible hand leads firms and
households acting independently that leads them to
desirable market outcomes
• When markets are not allowed to function freely due
to government intervention, inefficiencies result (in
the form of price distortions)
 #7
• Governments can sometimes improve market
outcomes.
• The invisible hand can sometimes lead to a
market failure in the sense that the market
outcome may not be socially desirable
• Externality – example pollution
• Market power – monopoly, needs regulation
 How the economy as a whole works
• Principle # 8: A country’s standard of living
depends on its ability to produce good and
services
• The large variations in per capita incomes across
countries
• Richer countries also offer their citizens better
health care, education, infrastructure etc., thus
improving their living conditions
• Productivity
 #9
• Prices rise when the government prints too
much money
• It is generally believed that inflation is caused
by “too much money chasing too few goods”
• Empirically established that this is the case
• However there may be some counter
examples.
 # 10
• Society faces a short-run trade off between
unemployment and inflation
• “Phillips Curve”
• This is based on the premise that prices are
sometimes slow to adjust to changes in money supply.
• But in the long-run, when the prices have adjusted
fully, an increase in money supply will only result in
increased prices, leaving everything else, most
notably, the total output the same.