PRINCIPLES OF
ECONOMICS
Choices, Choices, Choices, . . .
What is Economics?
Economics is the study of how individuals
and societies use their scarce resources to
satisfy their unlimited wants.
Scarce = limited
Resources = things used to make other
things (goods & services)
What is scarce?
Everything is scarce because our wants
ALWAYS exceed the limited resources
available.
Simply put… Economics is:
Economics=Scarcity
And the definition of Scarcity is
Scarcity = wants > availability of
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 are items that we desire but are not
necessary for survival.
Needs are something like air, food, or
shelter that are necessary for survival.
How do we satisfy our wants and needs?
We buy goods and services.
What are “Goods”?
Ex: clothes or shoes
What are “Services” ?
activities that one person performs for another
such as those of a Doctor, Lawyer.
>>>>>>>>>>>>>>>>>>>>>
What is the difference between scarcity
and shortage?
Scarcity means that there is a limited
quantity of resources to meet unlimited
wants and needs.
Shortage is a situation where a good or a
service is temporarily unavailable.
What are resources?
Definition: The things used to make other
goods
All goods and services are produced
using resources.
Factors of Production = resources
that are used to make all goods and
services.
What are the factors of production?
Land, Labor, Capital, Entrepreneurship
Resources – Factors of Production
Natural resources (Land)– “free gifts of nature”
Land, minerals, oil, forests, air, and timber
Capital Resources – “manufactured aids to production”
Tools, machines, equipment, factories
Human Resources (Labor)– physical and mental talent”
These are the skills people have that are used to produce goods
and services.
Entrepreneur – the individual who combines the factors
of production in order to produce a good or service.
Risk taker, policy maker, and innovator
Resources
(Inputs)
Land Labor Capital
Consumers
Good or Sevice buys things
(Output) they need or
want.
Factors of Production
Model
LAND - cotton
LABOR -seamstress
ENTREPRENEUR – GOOD – t-shirt
designer, business owner
CAPITAL – thread, sewing machine.
Capital Goods and Consumer
Goods
Capital Goods: are
used to make other
goods
Consumer Goods:
final products that are
purchased directly by
the consumer
Factors of Production
Payments
to factors
Land Labor Capital Enterprise
of
Productio
n
Rent Wages Interest Profit
INCOME
PRODUCTION
Division of Labor –
different people
perform different jobs
to achieve greater You do your
efficiency (assembly job, and I
will do my
line). Job and we
will be
more
EFFICIENT
PRODUCTION
Specialization –
Goods are produced
efficiently
McDonald makes
burgers, not shoes!!
Nike makes shoes, not
hamburgers
The Circular Flow Model
Scarcity
To think like an Economist, you must
always remember that scarcity exists.
Scarcity is relative i.e. in relation to
unlimited wants
You may only have 100 Rs.in your pocket
but you can certainly think of many
different ways to spend it. E. Napp
Scarcity
Problem of choice making with rational
priority of wants
It also means optimum allocation of our
resources
Problem of economizing for maximum
satisfaction/maximum profit
Economics
Study of allocation of
scarce resources
and of the
determinants of
employment,
income and
economic growth
Basic Economic Terms
Economics The study of how individuals and societies use their scarce resources
to satisfy unlimited needs.
Scarcity Limited; time, money, resources.
Resources Factors of production; land, labor, capital, entrepreneur
Land Items found in nature
Labor Work done by people
Capital Tools, equipment, factory, building
Entrepreneur Risk taker
Goods Tangible items of value; computer
Services Intangible items of value; fixing a car
Producer Business who sells goods/services
Consumer People who buys goods/services
What is Economics?
Discusses how a society tries to solve the human
problems of unlimited wants and scarce resources.
Scientific study of the choices made by individuals and
societies with regard to the alternative uses of scarce
resources employed to satisfy wants.
A social science
Deals with the society as a whole and human behaviour in
particular
Studies the production, distribution, and consumption of
goods and services.
A science in its methodology, and art in its application.
Basic Assumptions
Ceteris Paribus
Latin phrase
“With other things (being) the same” or “all other
things being equal”.
Rationality
Consumers maximize utility subject to given money
income.
Producers maximize profit subject to given resources
or minimize cost subject to target return.
Types of Economic Analysis
Micro and Macro
Microeconomics (“micro” meaning small): study of
the behaviour of small economic units
An individual consumer, a seller/ a producer/ a
firm, or a product.
Focus on basic theories of supply and demand in
individual markets
Macroeconomics (“macro” meaning large):
study of aggregates.
Industry as a unit, and not the firm.
Focus on aggregate demand and aggregate
supply, national income, employment, inflation,
etc.
Types of Economics
Macroeconomics –deals with the economic
decisions of large bodies like the government.
Theories of Economics
Countries and their governments
Trade between countries
Microeconomics –deals with decisions of
smaller unit like individuals and firms.
Families = Households
Firms = Factories
Types of Economic Analysis
Positive and Normative
Positive economics: “what is” in economic matters
Establishes a cause and effect relationship between
variables.
Analyzes problems on the basis of facts.
Normative economics: “what ought to be” in
economic matters.
Concerned with questions involving value judgments.
Incorporates value judgments about what the economy
should be like.
Types of Economic Analysis
contd..
Short Run and Long Run
Short run: Time period not enough for consumers and
producers to adjust completely to any new situation.
Some inputs are fixed and others are variable
Long run: Time period long enough for consumers and
producers to adjust to any new situation.
All inputs are variable
Decisions to adjust capacity, to introduce a larger
plant, to change product lines.
Types of Economic Analysis
Partial and General Equilibrium
Partial equilibrium analysis: Related to micro analysis
Studies the outcome of any policy action in a
single market only.
Equilibrium of one firm or few firms and not
necessarily the industry or economy.
General equilibrium: explains economic phenomena
in an economy as a whole.
State in which all the industries in an economy are
in equilibrium.
State of full employment
Limited Resources & Unlimited Wants
Scarcity
Choices
Opportunity Cost
Human wants are unlimited, but resources
are limited.
Scarcity of resources necessity of
choices
Opportunity cost:
is the forgone value of the next best alternative
sacrificed
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.
Life Example
Sportperson who can earn
millions if they drop out of
school and play
professional sports are well
aware that their opportunity
cost of college is very high
XYZ Industries produces steel gates, fences, balcony and similar items
cut and welded from wrought iron. This firm does custom orders but
also produces standard gates and railings sold to retail hardware stores.
The firm finds that it can sell as much as it produces of the standard
items but preferred to do custom orders since the latter is more
profitable.
At present, the firm has no custom orders outstanding and is
producing standard items at the rate of Rs 10,000 per week sales
value. Material cost is Rs 2,000 per week. Suppose, now that a large
custom order arrives that would take a week to manufacture and would
cost Rs 4,000 in materials.
From the opportunity cost perspective, what is the cost of the order ?
+
Concept of opportunity cost
Opportunity cost is the benefit forgone
from the alternative that is not selected.
Highlights the capacity of one resource to
satisfy multitude of wants
Helps in making rational choices in all
aspects of business, since resources are
scarce and wants are unlimited
Production Possibilities Frontier:
Graph showing infinite number of
production points.
Each point represents a combination of
output for a fixed amount of inputs with
available technology.
More of one good less of another
Illustrates opportunity costs in production
TABLE2-1 Production Possibilities
Open to a Farmer
FIGURE 2-1 PPF for Production by
a Single Firm
A
Soybeans
40 Unattainable
region
B
30 Attainable
region C
20
D
10
0 E
10 20 30 38 52 60 65
Wheat
Shape: concave
Principle of increasing costs:
opportunity cost of producing
another good
Reason: Inputs tend to be specialized.
41
Production Possibilities Curve
Points on the curve : Attainable &
efficient.
Points inside the curve : attainable and
inefficient or underemployment
Points outside the curve are
unattainable at present.
•To increase production of one, must decrease
production of other product.
Economic growth = increase in production
of goods and services.
Outward shifts of the curve represent economic
growth.
production shift of the frontier
Labor Skills
Technology
Capital stock
Land
Economic Growth Allows for More
of Everything
Production Possibilities Curve
Shows the different combinations of the quantities of two
goods that can be produced (or consumed) in an
economy at any point of time.
Depicts the trade off between any two items produced
(or consumed).
Highlights the concepts of scarcity and opportunity cost
Indicates the opportunity cost of increasing one item's production
(or consumption) in terms of the units of the other forgone
Assumptions
The economy is operating at full employment.
Factors of production are fixed in supply; they can however be
reallocated among different uses.
Technology remains the same.
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.
Society faces trade off between Efficiency
& Equity
- Efficiency:- society getting the most from its scarce
resources.
- Equity:- Distributing economic prosperity fairly among the
individuals of the society.
Life Example
A student faces a trade off between
studying for exam or to watch a much
awaited movie.
