Introduction 15 Normative Economics (or Science) Normative economics tells us ‘what ought to be’, Normative Economics deals with what ought to be or how the economic problems should be solved. For example, India should not be overpopulated country or prices should not rise. Normative economics discusses what are desirable things and should be realised and what are undesirable things and should bi ided. It gives decisions regarding value judgements, ——_ POSITIVE SCIENCE NORMATIVE SCIENCE + What is? + What ought to be? + What was? + What should happen? + What wil be? ‘+ What should have happened? Difference between Positive Economics and Normative Economics Basis Positive Economics Normative Economics ‘Meaning Ideals with whatis orhow the economic | Itdeals with what ought to be or how the | problems are actually solved. ‘economic problems should be solved. Verification _| itcan be verfied with actual data. Itcannot be verified with actual data, Purpose It aims to make real description of an | Itaims to determine the ideals. economic activity Suggestive | It is based upon facts, and thus, not |Itis based upon individual opinion and suggestive. therefore, itis suggestive in nature. [Value Tt does not give any value judgements, | It gives value judgements. | Judgements _| ie itis neutral between ends, [Examples | 1. Prices in Indian economy are| 1, india should take steps to control | constantly rising rising prices. 2, There are inequalities ofincomeinour | 2. Income inequalities should be economy. reduced. 1.6 MICROECONOMICS AND MACROECONOMICS ‘The subject matter of economics has been studied under two broad branches: 1. Microeconomics (Price Theory) in detail. 2. Macroeconomics (Income Theory) ‘These two concepts have become of general use in economics. Let us discuss these concepts Microeconomics ‘Adam Smith is considered to be the founder of the field of microeconomics. The term ‘micro’ has been derived from Greek word ‘mikros’ which means ‘small’, Microeconomics deals with analysis of behaviour and economic actions of small and individual units of the economy, like a particular consumer, a firm ora small group of individual units. The concept of microeconomics is very importantas it supplies the foundation for most of our understanding of the functioning ‘of an economy.16 Microeconomics is that part of economic theory, which studies the behaviour of individual units of an economy. For eximp individual output, price of a commodity, ie, Individual income, ete. Its main tools are Demand and Suppliy Macroeconomics The term ‘macro’ has been derived from the Greek word ‘makros’ which means ‘large’. So, macroeconomics deals with overall performance of the economy. It is concerned with study of Introductory Microeconomics problems of the economy like inflation, unemployment, poverty, ete. Macroeconomics is that part of economic theary which studies the behaviour of aggregates of the economy as a whole. For example, National income, aggregate output, aggregate consumption, ggregate Demand and Aggregate Supply. ete. Its main tools are A Micro Vs Macro + In Microeconomics, the letter ‘I’ stands for ‘Individuals’, i.e. it studies the economic behaviour of individuals. ‘+ In Macroeconomics, the letter ‘A’ stands for ‘Aggregates’, ic. it studies the economy as a whole. Letus discuss the detailed differences between the two branches of economics. Difference between Microeconomics and Macroeconomics Basis Microeconomics at Macroeconomics Meaning ‘Wisroeconomicsis that partof economic | Macroeconomics is that part of theory which studies the behaviour of | economic theory which studies the individual units of an economy. behaviour of aggregates of the economy as awhole. Tools Demand and Supply. ‘Aggregate Demand and Aggregate Supply. Basic Objective _ | Itaimstodetermine price ofacommodity | It aims to determine income and or factors of production. ‘employment level of the economy. Degree of itinvolves limited degree of aggregation. [It involves the highest degree of ‘Aggregation _| Forexample, market demand is derived | aggregation. For example, aggregate by aggregating individual demands of | demand is derived for the entire ail buyers in the particular market. __| economy. Basic assumes all the macro variables tobe | It assumes that all the micro variables, Assumptions | constant, i, it assumes that national | ike decisions of households and firms, income, consumption, savings, etc. are | prices of individual products, etc. are constant constant. ‘Other Name itis also known as Price Theory. | It is also known as ‘Income and Employment Theory’. ‘Examples individual income, individual output, _ | National Income, National output. Interdependence of Microeconomics and Macroeconomics Economics is a single subject and the analysis of an economy cannot be split into two watertight compartments. It means, microeconomics and macroeconomics are not independent of cach other and there is much common ground between the two, It means, both microeconomics and macroeconomics are interdependent. aIntroduction 17 Let us elaborate their interdependence with the help of some examples: Microeconomics depends on Macroeconomics 1. Law of demand came into existence from the analysis of the behaviour of a group (aggregate) of people. 2. Price of a commodity is influenced by the general price level prevailing in the economy. Macroeconomics depends on Microeconomics 1, National income of a country is nothing but the sum total of incomes of ind: ual units of the country 2. Aggregate demand depends on demand of individual households of the economy. Micro-Macro Paradoxes Paradox is a seemingly absurd or contradictory statement, though, often a true statement. Sometimes, there are paradoxes seen in Micro and Macro activities. It means, an act which is beneficial for an individual, may prove to be harmful for the economy as a whole. Example: If an individual saves, his family will be benefitted, but if the whole economy starts saving, it will result in contraction of demand, output, employment and income. As a result, the whole economy will sutfer. Which is more Important — Microeconomics or Macroeconomics? Both, microeconomics and macroeconomics have a place of their own and none of them can be dispensed with. Microeconomics concentrates on the working of the individual components and macroeconomics studies the economy in general. While the former is concerned with structures of the aggregates, the latter is concerned with the aggregates themselves. So, both the approaches are supplementary to each other. The superiority of one approach over the other cannot be claimed. Need for a Separate Theory of Macroeconomics ‘Microeconomics failed to study the aggregates of the economy as a whole. Asa result, there was aneed for a separate theory, which could explain the working of the economy. Macroeconomics helps to understand the working of an economic system as well as to explain the various macroeconomic paradoxes. 1.7 CENTRAL PROBLEMS OF AN ECONOMY Production, distribution and disposition of goods and services are the basic economic activities of life. In the course of these activities, every society has to face scarcity of resources. Because of this scarcity, every society has to decide how to allocate the scarce resources. It leads to following Central Problems, that are faced by every economy: 1. What to produce 2. How to produce 3. For whom to produce These problems are called central problems because these are the most basic problems of an economy and all other problems revolve around them. ‘These 3 problems are studied under the problem of Allocation of Resources’18 Introductory Microeconomics Allocation of Resources (Stimdied wider Microeconontics) Allocation of resources refers to the problem of assigning the searce resources in stich a manner so that maximum coants of the society are fulfilled. As resources are limited in relation to the unlimited wants, it is important to economize their use and utilize them in the most efficient manner. The problem of allocation of resources is studied under 3 heads: (1) What to produce; (2) How to produce; (3) For whom to produce {In nutshell, an economy has to allocate its resources and choose from different potential bundles of goods (What to produce), select from different techniques of production (How fo produce), and decide in the end, who will consume the goods (For whom to produce). 1, What to Produce This problem involves selection of goods and services to be produced and the quantity to be produced of each selected commodity. Every economy has limited resources and thus, cannot produce all the goods. More of one good or service usually means less of others. For example, production of more sugar is possible only by reducing the production of other goods. Production of more war goods is possible only by reducing the production of civil goods. So, on the basis of the importance of various goods,'an economy has to decide which goods should be produced and in what quantities. This isa problem of allocation of resources among different goods. The problem of ‘What to produce’ has two aspects: (i). What possible commodities to produce: An economy has to decide, which consumer goods (rice, wheat, clothes, etc.) and which of the capital goods (machinery, equipments, etc:) are to be produced. In the same way, economy has to make a choice between civil goods (bread, butter, etc.) and war goods (guns, tanks, etc.). (ii) How much to produce: After deciding the goods to be produced, economy has to decide the quantity of each commodity, that is selected. It means, it involves a decision regarding the quantity to be produced, of consumer and capital goods, civil and war goods anid s0 on. [As this problem has two aspects, itis also termed as "What to Produce and in what Quantity’. Guiding Principle of ‘What to Produce’: Allocate the resources in a manner which gives maximum aggregate satisfaction. 2. How to Produce ‘This problem refers to selection of technique to be used for production of goods and services. A good can be produced using different teckniques of production. By ‘technique’, we mean which particular combination of inputs to be used. Generally, techniques are classified as: Labour intensive techniques (LIT) and Capital intensive techniques (CIT). ‘© In Labour intensive technique, more labour and less capital (in the form of machines, etc) is used. © In Capital intensive technique, there is more capital and less labour utilization, For’example, textiles can be produced either witha fot of labour and a litle capital or with less labour and more capital. Availability of factors and their relative prices helps in determining the technique to be.wused. = ~~Introduction 19 The selection of technique is made with a view to achieve the objective of raising the standard of living of people and to provide employment to everyone. For example, in India, LIT is preferred due to abundance of labour, whereas, countries like U.S.A., England, etc. prefer CIT due to shortage of labour and abundance of capital Guiding Principle of ‘How to Produce’: Combine factors of production in such a manner so that maximum output is produced at minimum cost, using least possible scarce resources. 3. For Whom to Produce This problem relates to the distribution of produced goods and services among the individuals within the economy, i.e, selection of the category of people who will ultimately consume the goods, ise. whether to produce goods for more poor and less rich or more rich and less poor. Since resources are scarce in every economy, no society can satisfy all the wants of its people. Thus, a problem of choice arises. Goods are produced for those people who have the paying capacity. The capacity of people to pay for goods depends upon their level of income. It means, this problem is concerned with distribution of income among the factors of production (land, labour, capital and enterprise), who contribute in the production process. The problem can be categorised under two main heads: (®) Personal Distribution: Itmeans how national income of an economy is distributed among different groups of people. (ii) Functional Distribution: It involves deciding the share of different factors of production in the total national product of the country. Guiding Principle of For whom to Produce’: Ensure that urgent wants of each productive factor are futflled to the maximum possible extent. : It must be noted that in addition to ‘Allocation of Resources’, there are two more Central Problems: () Problem of fuller and efficient utisation of resources; (i) Problem of Growth of resources. However, they are beyond the scope of syllabus of XI” class. 1.8 OPPORTUNITY COST As resources are scarce, the society is always forced to make choices. To produce more of one 004, a certain amount of other goods has to be sacrificed. The true cost of using economic resources in any given project is the loss of the alternative output which they might have produced. For example, if we use'a certain amount of land, labour and capital to build a factory, then the economic cost (or opportunity cost) of the factory might be the houses which these resources could have produced. Hence, Opportunity Cost is the cost of next best alternative foregone. For example, Suppose, you are working in a bank at the salary of & 40,000 per month. Further suppose, you receive two more job offers: © To work as an executive at ® 30,000 per month; or * To become a journalist at @ 35,000 per month.1.10 Introductory Microeconomics In the given case, the opportunity cost of working in the bank is the cost of next best alternative foregone, i.e. & 35,000. The amount of other goods and services, thal nust be sacrificed to obtain more of any one good, is called the opportunity cost of that good. One more Example Suppose you have & 20,000 and you want to purchase one laptop and a LED TV. With ® 20,000 only in hand, you cannot have both. You can either buy laptop or LED TV. If you decide to purchase laptop, then opportunity cost of choosing the laptop is the cost of the foregone satisfaction (from LED TV). This example clearly demonstrates a fundamental economic condition: As our resources are limited, we are always forced to make choices between alternate contmodities’. 1.9 PRODUCTION POSSIBILITY FRONTIER (PPF) Due to scarcity of resources, we cannot satisfy all our wants. Even if an economy uses all its resources in the best possible manner, its capabilities are restricted due to scarcity of resources. As we cannot have everything that we want, we are forced to make economic decisions. These decisions take the form of choices among alternate goods and services, that will best satisfy our wants. Thus, the society must decide, what to produce out of an almost infinite range of possibilities. As the choice is to be made between infinite possibilities, the economists assumed a very basic economy with only two goods (say, guns and butter). Economists have traditionally represented this range of choices by what they call a ‘Production Possibility Schedule’ (Table 1.1). When this schedule is graphically represented (Fig, 1.1), if is called “Production Possibility Frontier (PPEY' or Production Possibility Curve (PPC). Production Possibility Frontier (PPE) refers to graphical representation of possible combinations of two goods that can be produced with given resources and technology. Alternately, PPF is the locus of various possible combinations of two goods that car be produced with given resources and technology. Only 2 Goods are taken: The two goods have been taken just for the sake of simplicity and easy understanding. However, the analysis involved can be applied equally well, to any combination of goods. PPF is also known by the following names: + Production Possibility Curve * Production Possibility Boundary + Transformation Curve + Transformation Boundary + Transformation Frontier Assumptions for PPF Production possibility frontier is based on the following assumptions: 1. The amount of resources in an economy is fixed, but these resources can be transferred from one use to another; 2. With the help of given resources, only two goods can be produced; 3. The resources are fully and efficiently utilised;Introduction 11 4, Resources are not equally efficient in production of all products. So, when resources are transferred from production of one good to another, the productivity decreases; 5. The level of technology is assumed to be constant, The concept of PPF can be better understood with the help of following imaginary (hypothetical) schedule and diagram Table 1.1: Production Possibility Schedule Possibilities | Guns (in units) | Butter (in units) | _ MOC. wry <2 oa ‘AButer A 2 0 = = 8 20 1 1 16:18 c 18 2 2 26:18 D 18 3 3 36:18 E 1" 4 4 46:18 F 6 5 5 56:18 6 ° 6 6 66:18 Table 1.1 shows the various possibilities of guns and butter. This data is graphically represented in Fig. 1. + Ifthe economy uses all its resources to produce only guns, then maximum of 21 units of guns and no butter can be produced (point ‘A’). * On the other hand, ifall resources are used for butter, then maximum 6 units of butter and no guns can be produced (point ‘G’). * In between, there are various possibilities with different combinations of guns and butter. * When points A, B, C, D, E, F and G are joined, we get a.curve AG, known as ‘Production Possibility Frontier’ AG curve shows the maximum limit of production of guns and butter. Marginal Opportunity Cost (MOC) ‘Guns (in units) Y PF of Guns and Butter 2 a 45 Butter (in units) Fig. 1.1 MOC refers to the number of units of a commodity sacrificed to gain one additional unit of another commodity. In case of PPE, MOC is always increasing, have to be sacrificed to gain an additional unit of another commodity. .e. more and more units of acommodity4.12 Introductory Microeconomics Increasing MOC operates because productivity and efficiency of factors of production decrease as they ae shied from one use to another. Lel us understand thi withthe help of an example: Suppose an economy produces only two goods (say, gun and butter) ‘A worker is employed in production of guns because he is best suited for it. If economy decides to reduce production of guns and inerease production of bute, then worker wil be transferred to production of butter. However, he is not that efficient in production of butter as he was in guns. As result is produetviy In butter will be low and MOC wil increase. Marginal Rate of Transformation (MRT) MRT is the ratio of number of units of a commodity sacrificed to gain an additional unit of another A Units Sacrificed AGuns A Units Gained. A Butter commodity. MRT = In the given example of guns and butter, MRT= Example of MRT According to Table 1.1, 20 units of guns and 1 unit of butter (i.e. 20G + 1B) can be produced by utilising the resources fully and efficiently. If the economy decides to produce 2B, then it has to cut down production of guns by 2 units. In the given case, 2G is the opportunity cost of producing 1B, i.e. MRT is 2G:1B. Characteristics or Properties of PPF The two basic characteristics or features or properties of PPF are: 1. PPF slopes Downwards: PPF shows all the maximum possible combination of two goods, which can be produced with the available resources and technology. In such a case, more ofone ‘good can be produced only by taking resources avoay from the production of another good. As there exists an inverse relationship between change in quantity of one commodity and change in quantity of the other commodity, PPF slopes downwards from left toright (seeFig. 1.1) 2 PPF is Concave Shaped: PPF is concave shaped because of increasing marginal rate of transformation (MRT), i. more and more units of one commodity are sacrificed to gain an additional unit of another commodity. MRT increases because it is assumed that no resource is equally efficient in production of all goods As resources are transferred from one good to another, less and less efficient resources have to be employed. This raises cost and raises MRT. In the given example of, guns and butter, units of guns sacrificed keep on increasing each time to increase production of one unit of butter. Whether Economy will always operate on PPF? It must be remembered that PPF does not show the point at which the economy will actually. operate. It only shows the maximum available possibilities, which an economy can produce. The exact point of operation depends on how well the resources of the economy are used. 1. Economy will operate on PPF only wher resources are fully and efficiently utilised. 2. Economy will operate at any point inside PPF if resources are not fully and efficiently utilised.Introduction 1.43 3. Economy cannot operate at any point outside PPF as it is unattainable with the available productive capacity It means: * Economy can either operate on PPF or inside PPF, known as ‘Attainable Combinations’ * But, economy cannot operate outside PPF, known as ‘Unattainable Combinations’. Attainable and Unattainable Combinations Let us clear the concept of ‘Attainable and Unattainable Combinations’ with the help of Fig, 1.2: ‘any point Guns (in units) 723456 Buater (in units) Fig. 1.2 + Any point on PPF (Points to D) or ide PPC (Point E) are attainable combinations. + Any point outside PPF (point F) is ‘an unattainable combination. Attainable Combinations: It refers to those combinations at which economy can operate. There can be two attainable options: 1. Optimum utilisation of resources: Ifthe resources are used in the best possible manner, then economy will operate at any point (like, A, B, C or D) on PPF. 2. Inefficient utilisation of resources: However, the actual production can fall short of its capabilities. If there is wastage or inefficient utilisation of resources, then ‘economy will operate at any point inside the PPF (like E). Unattainable Combinations: With the given amount of available resources, it is impossible for the economy to produce any combination more than the given possible combinations i.e. an economy can never operate at any point outside the PPF (like F). Lee but not inside, a PF’, Y PPFand MRT 4 ane wt Be a8 32 2 S12 [\e g cr ao ge 3 ot x al e348 ‘Butter (in units) Fig. 1.34.14 PPF and MRT We can measure MRT on the PF. For example, MRT between the possibilities D and E is equal to DH/HE and between E and F, it is equal to EI/IF and so on. We know, PPF is concave shaped curve. The slope of PPF is a measure of the MRT. Since the slope of a concave curve increases as we move downwards along the curve, the MRT also rises as we move downwards along the curve. Introductory Microeconomics Can PPF be a straight line? PPF can be a straight line if we assume that MRT is constant, i.e. same amount of a commodity is sacrificed to gain an additional unit of another commodity. Itis possible only when we assume that all the resources are equally efficient in production of all goods. In such case, PF will be a straight line as shown in Fig. 1.4. Y y Goody [a Goody [A x B a Good X ol Good X Fig. 14 Fig.1.5 Can PPF be Convex to the Origin? PPF can be convex to the origin if MRT is decreasing, i.e. less and less units of a commodity are sacrificed to gain an additional unit of another commodity. In such case, PPF will be a convex shaped curve as shown in Fig. 1.5. ‘It must be noted that both these situations (i.e. PPF being a straight line or convex shaped) would not arise, as MAT always increases. So, PPF is always concave shaped. x PPF and Opportunity Cost Y The opportunity cost of a product is the alternative that must be given up to produce that product. PPF illustrates the concept of opportunity cost. The opportunity cost of producing more butter is fewer guns. As we move from ‘E’ to F (see Fig. 1.6 and Table 1-1), the production of butter rises from 4 units to 5 units, but the number of guns decreases from 11 units to 6 units, i.e. opportunity cost of the 5t* unit of butter is sacrifice of 5 units of guns. ‘Wfalithe resources af the economy are fuly and efficiently utilise, then more of one good can be produced only by taking resources a ‘away from the production of another good. The lost production ‘of such other good Is the opportunity cost of the first. PPF of Opportunity Gost Guns (in urits) a 4 Butter (in units) Fig. 1.6Introduction 1.45 PPF as Transformation Curve Slope of PPF indicates the ease or difficulty in transforming one good into another. In the ve, we transform guns into butter, 1use of this reasson, PPF is known given example (Table 1.1), when we move down the ci and when we move up, we transform butter into guns. Be as “Transformation Curve" Change in PPF PPF is based on the assumption, that resources of an economy are fixed. However, in this changing world, the productive capacity of an economy is constantly changing due to increase or decrease in resources. Such changes in resource lead to change in PP. The change in PPF indicates either an increase or a decrease in the productive capacity of the economy. The change in PPF can be of two types: 1. Shift in PPF: PPF will shift when there is change in productive capacity (resources or technology) with respect to both the goods. 2, Rotation of PPF: PPF will rotate when there is change in productive capacity (resources or technology) with respect to only one good. i. Shiftin Er Y Rightward Shift in PPF The PPF can shift either towards right or towards left, when there is change in resources or technology with respect to both the goods. () Rightward Shift in PPE: When there is PF shifts to the right from PP to P,P, when there is ‘growth of resources or/and Technological upgradation of Gune (in units) “ Advancement or Upgradation of Technology” +, both guns and butter or/and “Growth of Resources” in respect to both the goods, then PPF will shift to : the right. For example, if there is increase PBX Butter (in units) in resources for production of butter Fig. 17 and guns, we can produce more of both the goods. In such case, existing PPF (PP) will shift to the right, represented by P,P, in Fig. 1.7. “Growth of Resources” take place when: + Quantity of Resources increases, like: (i) Discovery of new natural resources; (i) Inflow of Foreign Capital: (il) Increase in labour force. * Quality of Resources increases, like: (i) “Skill Development of Human Resources” due to ‘establishment of Educational institutes or schemes like Pradhan Mantri Kaushal Vikas Yojana; (i) “improved Hygienic Environment’ due to ‘Clean India Mission’ (Swachh Bharat Mission). (ii) Leftward Shift in PPF: PPF will shift towards left, when there is a technological degradation and/or decrease in resources with respect to both the goods. For example, destruction of resources in an earthquake will reduce the productive capacity and as a result, PPF will shift to the left from PP to P,P, (Fig. 1.8). For, “How PPF willbe affected by massive unemployment, refer HOTS.—— 1.16 Introductory Microeconomics Y Leftward Shift in PPF PPF shifts tothe left from PP to P,P, ‘when there is decrease in resources or/and technological degradation of both guns and butter. Guns (in units) Py Butes (nuns) Fig. 1.8 2. Rotation of PPF Ithappens when there is change in productive capacity (resources or technology) with respect to only one good. The rotation can be either for the commodity on the X-axis or for commodity on the Y-axis. () Rotation for commodity on the X-axis: When there is a technological improvement or an increase in resources for production of the commodity on the X-axis (say, butter), then PPF will rotate from AB to AC. However, in case of technological degradation or decrease in resources for production of butter, PPF will rotate to the left from AB to AD (Fig. 1.9). Rotation for Commodity Rotation for Commodity Y ‘on the X-axis: 7 ‘on the Y-axis Rightward rotation > Guns (inunits) Guns (in units) Butter (in units) Butter in units) Fig. 1.9 Fig.1.10 (it) Rotation for commodity on the Y-axis: A technological improvement or an increase in resources for production of commodity on Y-axis (say, guns), will rotate the PPF from ’ ABtoCB. ‘However, in case of degradation in technology or a decrease in resources for production of guns, PPF will rotate to the left from AB to DB as shown in Fig, 1.10.Introduction 1.47 Overview of PPF Let us quickly revise the concept of PPF with the help of Fig, 1.11 P F. Unattainabie mee Point *, Outward ‘Shit Underuttization ofr iL al PPP, ‘Commodity - x Fig. 1.11 1. PPF slopes downwards, as an increase in production of one good requires decrease in production of the other. 2. PPF is concave shaped due to increasing MRT. 3. PPF shows transformation of one good into another, not physically, but by diverting resources from one use to the other. 4. PPF shows the maximum available possibilities. The exact point of operation depends on. how well the resources of the economy are used. 5. If the economy operates on PPF (like points A, B or C), it means resources are fully and efficiently utilised. 6. Ifthe economy operates at any point inside PPF (like point ‘D’), it means resources are not fully and efficiently utilised. 7. Economy cannot operate at any point outside PPF (like point ‘E’), as itis unattainable with the available productive capacity. 8. An outward shift in PPF from PP to P,P, means, that the economy can produce more of both the commodities, which was not possible earlier. 9. An inward shift in PPF from PP to P,P, means, that the economy's capacity to produce both the commodities has reduced. ‘Refer Power Booster for “Solution of Central Problems throtigh PPP". 1.10 SOLVED PRACTICALS Practicals on Opportunity Cost Example 1. Deepakis working as a sales manager ata salary of €1,00,000 per month. He received 2 more job offers. He got an offer of & 70,000 from Reliance Industry and offer of ® 85,000 from. Tata Industry. What is his opportunity cost for working as a sales manager?