Fundamentals of Economics: Concepts

Economics is the study of how people allocate scarce resources for production, distribution,
and consumption, both individually and collectively.
Economics is a part of social science which is associated with the study of production,
households, distribution, firms, consumption of goods and services, industries, government,
decision making, and more. It helps to understand how limited resources can be utilised to
satisfy consumers’ desire to obtain maximum satisfaction.
Economics is classified into two significant parts:
 Microeconomics
 Macroeconomics
Economics as a science:
Science is defined as a branch of knowledge that is associated with the cause and effect
relationship and analyses economic factors. Additionally, economics contributes in combining
various sections of science like statistics, mathematics, etc., to understand the relationship
between price, supply, demand, and various economic determinants.
The 5 basic economic principles
Scarcity
Supply
Demand
Marginal Costs
Marginal Benefits
Incentives.
Scarcity states that resources are limited, and the allocation of resources is based on supply and
demand. Consumers consider marginal costs, benefits, and incentives when purchasing
decisions.
Scarcity is one of the key concepts of economics. It means that the demand for a good or
service is greater than the availability of the good or service. Therefore, scarcity can limit the
choices available to the consumers who ultimately make up the economy.
What is an example of resource scarcity?
Natural resources like gold, oil, silver and other fossil fuels are naturally rare. When demand
exceeds the supply, these resources become scarce and prices can go up. Other commodities,
like diamonds, command a high price because of their limited availability and control of their
market.
What are the types and definition of scarcity?
There are two main types of scarcity: absolute and relative. Absolute scarcity refers to the
physical limitations of resources, while relative scarcity refers to the value we place on
resources. For example, diamonds are not absolutely scarce, but we as a society value them
highly, so they are relatively scarce.
Demand is an economic concept that relates to a consumer's desire to purchase goods and
services and willingness to pay a specific price for them. An increase in the price of a good or
service tends to decrease the quantity demanded.
Which definition best describes demand in economics?
Economists use the term demand to refer to the amount of some good or service consumers are
willing and able to purchase at each price. Demand is based on needs and wants—a consumer
may be able to differentiate between a need and a want, but from an economist's perspective
they are the same thing.
What is demand and its types?
Types of Demand. Demand is primarily classified based on several factors like the nature of a
product, its usage, number of consumers and suppliers, etc. Therefore, the need for products
will vary depending on the situation. These are – Individual Demand and Market Demand.
Market factors affecting demand of consumer goods
 Price of product.
 Tastes and preferences.
 Consumer's income.
 Availability of substitutes.
 Number of consumers in the market.
 Consumer's expectations.
 Elasticity vs. inelasticity.
In economics, supply is the number of products that a producer or seller is willing and capable
to provide to buyers. Its law states that supply will surge as price increases, as producers want
to maximize profits. Quantity is closely related to the price of an item.
Supply is the willingness. of sellers to offer a given quantity of a good or service for a given
price. Supply is the willingness. of sellers to offer a given quantity of a good or service for a
given price.
Why is supply and demand?
The law of supply and demand combines two fundamental economic principles describing
how changes in the price of a resource, commodity, or product affect its supply and demand.
As the price increases, supply rises while demand declines. Conversely, as the price drops
supply constricts while demand grows.
What is an example of supply?
Supply is the amount of a certain good that a seller is willing and able to provide to buyers. An
example of this is the total amount of apples a farmer is able to produce and offer to the market.
What is the law of supply?
DEFINITION-Law of supply states that other factors remaining constant, price and quantity
supplied of a good are directly related to each other. In other words, when the price paid by
buyers for a good rises, then suppliers increase the supply of that good in the market.
What is the full meaning of price?
the sum or amount of money or its equivalent for which anything is bought, sold, or offered for
sale.
What is price types?
Price type is a classification of price that could be defined for an item. An item can be
associated with more than one price, for example, along with the base price, there can be
additional prices like installation fee, activation charges, monthly fee, cancellation charges and
so on.

What is meant by marginal cost?

What Is Marginal Cost? In economics, the marginal cost is the change in total production cost
that comes from making or producing one additional unit. To calculate marginal cost, divide
the change in production costs by the change in quantity.
What is an example of a marginal cost?

Marginal cost is the added cost to produce an additional good. For example, say that to make
100 car tires, it costs $100. To make one more tire would cost $80. This is then the marginal
cost: how much it costs to create one additional unit of a good or service.
What is a fixed and variable cost?
Definition. Fixed cost is referred to as the cost that does not register a change with an increase
or decrease in the quantity of goods produced by a firm. Variable cost is referred to as the type
of cost that will show variations as per the changes in the levels of production.
What is meant by variable costs?
Variable costs are the expenses a business incurs that change with the amount of goods
produced or services provided. More specifically, when production or sales increase, variable
costs increase, and when production or sales decrease, variable costs decrease.
What is an example of a variable cost?
Variable costs are costs that change as the volume changes. Examples of variable costs are raw
materials, piece-rate labor, production supplies, commissions, delivery costs, packaging
supplies, and credit card fees. In some accounting statements, the Variable costs of production
are called the “Cost of Goods Sold.”
What are 2 differences between macro and micro?
The word macro describes something that is very large or something that is related to things
that are large in size or scope. Macro- is used as a combining form meaning “large” or “great.”
The word micro describes something that is very small or something related to things that are
small in size or scope.
Microeconomics and Macroeconomics Difference
Microeconomics and macroeconomics are related but separate approaches to studying the
economy. Microeconomics is concerned with the actions of individuals and businesses, while
macroeconomics is focused on the actions that governments and countries take to influence
broader economies.
What are the main tools of macroeconomics?
The key pillars of macroeconomic policy are: fiscal policy, monetary policy and exchange rate
policy. This brief outlines the nature of each of these policy instruments and the different ways
they can help promote stable and sustainable growth.
What are limitations of microeconomics?
The main limitations of microeconomics are as follows: Microeconomic studies assume that
other values are constant, which is not realistic. All factors are subject to change and are not
constant. One of the important limitations of Microeconomics is that it assumes full
employment.
What is gnp in economics?
Gross national product (GNP) refers to the total value of all the goods and services produced by
the residents and businesses of a country, irrespective of the location of production. GNP takes
into account the investments made by the businesses and residents of the country, living both
inside and outside the country.
National Income and its Components
The main concepts of national income are gross domestic product (GDP), net national income
(NNI), and disposable income. Domestic product (GDP) is the total value of all final services
and goods produced within a country's borders in a given period of time.
It comprises wages, interest, rent and profit obtained through various factors of production like
labor, capital, land and entrepreneurship of a nation. It is beneficial in determining the progress
of the country.
What are the largest components of national income?
Compensation of employees (wages and benefits). and, while estimating the national income
through income approach, the largest component is the compensation to employees in the form
of wages and other benefits associated with employee wages.
Which is the largest component of national income in India?
The service sector is the largest contributor to the national income of India.
Factors of National Income
GDP includes government expenditures, consumption, exports, imports, and investment of
India.
What are the components of national income in Indian economy?
It includes the incomes of all factors of production, such as rent, wages, profits, and interest.
The main concepts of national income are: Gross Domestic Product (GDP): This is the market
value of all final services and goods produced within a country in a given period of time.
What are the 3 rules of national income?
Three methods such as income method, value-added method, and expenditure method. Income
method is mainly based on the incomes generated by the factors of production such as labour
and land.

What are the three methods of national income calculation?

Product Method.
Income Method.
Expenditure Method.
Simple Keynesian Model of Income Determination
Keynes believed that there are two major factors that determine the national income of a
country. These two factors are Aggregate Supply (AS) and Aggregate Demand (AD) of goods
and services. In addition, he believed that the equilibrium level of national income can be
estimated when AD=AS.

https://www.economicsdiscussion.net/national-income/keynesian-theory-of-national-income-
determination/4029
According to Keynes, there can be different sources of national income, such as government,
foreign trade, individuals, businesses and trusts. For determining national income, Keynes
had divided the different sources of income into four sectors namely’ household sector,
business sector, government sector, and foreign sector.

Three models for the determination of national income, which are shown in Figure-1:

The two-sector model of economy involves households and businesses only, while three-
sector model represents households businesses, and government. On the other hand, the four-
sector model contains households, businesses, government, and foreign sector. Let us discuss
these three types of models of income determination given by Keynes.

Determination of National Income in Two-Sector Economy:

The determination of level of national income in the two-sector economy is based on an
assumption that two-sector economy is an economy where there is no intervention of the
government and foreign trade.
Apart from this, an economy can be a two-sector economy if it satisfies the following
assumptions:
a. Comprises only two sectors, namely, households and businesses. The households are the
owners of factors of production and provide factor services to businesses to earn their
livelihood in the form of wages, rents, interest, and profits. In addition the households are the
consumers of final goods and services produced by businesses. On the other hand, businesses
purchase factor services from households to produce goods and services and sell it to
households.
b. Does not have government interference. If government is there, it does not have any role to
play in the economic activity of a country. For example, in the two-sector economy, the
government is not involved in activities, such as taxation, expenditure, and consumption.
c. Comprises a closed economy in which the foreign trade does not exist. In other words,
import and export services are absent in such an economy.
d. Contains no profit that is undistributed or savings by the organization. In other words, the
profit earned by an organization is completely distributed in the form of dividends among
shareholders.
e. Keeps the prices of goods and services, supply of factors of production, and production
technique constant throughout the life cycle of organization.
Keynes believed that there are two major factors that determine the national income of a
country. These two factors are Aggregate Supply (AS) and Aggregate Demand (AD) of
goods and services.
In addition, he believed that the equilibrium level of national income can be estimated when
AD=AS. Before representing the relationship between AS and AD on a graph, let us
understand these two concepts in detail.
Aggregate Supply:
AS can be defined as total value of goods and services produced and supplied at a particular
point of time. It comprises consumer goods as well as producer goods. When goods and
services produced at a particular point of time is multiplied by the respective prices of goods
and services, it provides the total value of the national output. The national output is the
aggregate supply in the form of money value. The Keynesian AS curve is drawn based on an
assumption that total income is equal to total expenditure. In other words, the total income
earned is fully spent on different types of goods and services.
The correlation between income and expenditure is represented by an angle of 45°, as
shown in Figure-2:

According to Keynes theory of national income determination, the aggregate income is

always equal to consumption and savings.
Aggregate Income = Consumption(C) + Saving (S)
Therefore, the AS schedule is usually called C + S schedule. The AS curve is also named as
Aggregate Expenditure (AE) curve.
Aggregate Demand:
AD refers to the effective demand that is equal to the actual expenditure. Aggregate effective
demand refers to the aggregate expenditure of an economy in a specific time frame. AD
involves two concepts, namely, AD for consumer goods or consumption (C) and aggregate
demand for capital goods or investment (I).
Therefore, the AD can be represented by the following formula:
AD = C + I
Therefore, AD schedule is also termed as C+I schedule. According to Keynes theory of
national income determination in short-run investment (I) remains constant throughout the
AD schedule, while consumption (C) keeps on changing. Therefore, consumption (C) acts as
the major determinant or function of income (Y).
The consumption function can be expressed as follows:
C = a + bY
Where, a = constant (representing consumption when income is zero)
b = proportion of income consumed = ∆C/∆Y
By substituting the value of consumption in the equation of AD, we get:
AD = a + bY + I
Let us prepare an AD schedule by assuming that the investment is Rs.50 billion and
consumption function of a product is:
C = 50 + 0.5 Y
Therefore, aggregate demand would be:
AD = a +b Y + I
AD = 50 + 0.5 Y + 50
AD= 100 + 0.5 Y
The aggregate demand schedule at different income levels is represented in Table-1:

In Table-1, the column of income represents the aggregate supply and the column of
aggregate demand represents expenditure. In Table-1, it can be noticed that at Rs. 200 billion
of income level, aggregate supply and aggregate demand are equal. Therefore, Rs. 200 billion
is the equilibrium point for the two-sector economy.
Figure-3 represents the graphical representation of national income determination in the two-
sector economy:
In Figure-3, while drawing AS schedule it is assumed that the total income and total
expenditure are equal. Therefore, the numerical value of AS schedule is one. AD schedule is
prepared by adding the schedule of C and I. The aggregate demand and aggregate supply
intersect each other at point E, which is termed as equilibrium point.
The income level at point E is Rs. 200 billion, which represents the national income of the
economy. The schedule curve after point E represents that the AS is greater than AD (AS >
AD). In such a situation, the products and services are costing more than Rs. 200 billion;
therefore, households are not willing to buy them.
Therefore, the supply of products and services exceeds their demand. As a result, businesses
would have a pile of unsold stocks. For example, in Table-1, when the income or aggregate
supply is at Rs. 300 then the aggregate demand or expenditure is Rs. 250, which is less than
the aggregate supply.

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