ECONOMICS FOR

EVERYDAY LIFE
Module One: Introduction to economics

Dept of Commerce |Sacred Heart East Campus

Economics for everyday life Module 1

MODULE 1 SYLLABUS

Economics – micro and macroeconomics – deductive and inductive reasoning – basic

economic problems – production possibility curve. Utility - total and marginal. Law of
Demand – elasticity of demand – concept of elasticity –price- income and cross elasticity-
Law of supply. National income – meaning - components of national income

INTRODUCTION

Economics has a very significant position in all social sciences. To understand economics
properly, we need to analyse the nature and scope of the subject. Economics is a social
science that studies the production, distribution and consumption of goods and services and it
spans from mathematics to psychology. It studies how individuals, businesses, governments,
and nations make choices about how to allocate resources. Economics focuses on the actions
of human beings, based on the assumption that humans act with rational behavior, seeking the
most optimal level of benefit or utility.

• Economics is a science that deals with human wants and their satisfaction. Human
beings have unlimited wants and these wants are satisfied with the help of goods and
services. Human wants are unlimited but resources are limited.
• Economics is the social science of studying the production, distribution and
consumption of goods and services and It is a complex social science that spans from
mathematics to psychology.
• In economics resource means factors of production such as land, labour, capital and
organization. In economics we say that resources have alternative uses.
• The government of a country has to utilise its scarce resources for various
programmes (wants of the people) for the benefit of the people.

WHAT IS ECONOMICS?

• Economics is a subject which studies about problems arising out of unlimited wants
and scarcity of resources which satisfy these wants. It studies not only about the
problem of individuals but also about the problems of society. It studies how
individuals, businesses, governments, and nations make choices about how to allocate
resources.

ETYMOLOGY OF ECONOMICS

The word economics is derived from two Greek words ’oikos’ and ’nemein’ meaning ’house’
and ’manage.’ Economics is concerned with the management of of household through the
economic use of scarce resources available to the individuals or the whole society.

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DEFINITION OF ECONOMICS

Wealth Definition

The classical economists define economics as the “Science of Wealth” which deals with the
consumption, production, exchange and distribution of wealth. Adam Smith in his famous
work “Wealth of Nations” published in 1776, defined economics as “an enquiry into the
nature and causes of wealth of nations.” It is about wealth generating and wealth spending
activities of man.

Welfare Definition
According to Alfred Marshall, wealth is only a means to an end and the end is welfare.
Marshall in his famous book “Principles of Economics” published in 1890 defines economics
as follows: “Political economy or Economics is a study of mankind in the ordinary business
of life; it examines that part of individual and social action which is most closely connected
with the attainment and with the use of the material requisites of well being.”

Scarcity Definition
Prof. Lionel Robbins of the London School of Economics in his challenging book “An Essay
on the Nature and Significance of Economic Science” published in 1932 introduces his
scarcity definition of economics. According to him, “Economics is the science which studies
human behaviour as a relationship between ends and scarce means which have alternative
uses.”

Growth Definition
Economics is a fast growing and unfinished science. To define such a developing subject is
not an easy job. The definition which is acceptable today may become obsolete tomorrow.
The present day economists have however, evolved a fairly satisfactory and generally
acceptable definition of economics. According to them, “Economics is a study of the
allocation and development of scarce resources and the determinants of employment, output,
income and economic growth.”

Recently Prof. Samuelson has given a definition based on growth aspects which is known as
the Growth definition. “Economics is the study of how people and society end up choosing,
with or without the use of money, to employ scarce productive resources that could have
alternative uses to produce various commodities and distribute them for consumption, now or
in the future, among various persons or groups in society. Economics analyses the costs and
the benefits of improving patterns of resource use.”

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SUBJECT MATTER OF ECONOMICS

Subject Matter

Traditional Modern
approach approach

Economic Economic Economic Micro Macro

activities system policies economics economics

TRADITIONAL APPROACH
It considered economics as a science of wealth and divided it into several divisions and sub
divisions

Economic activities

All activities which we perform in exchange for money or things of value are economic
activities.
Put simply; economic activities are those which we undertake to earn income, money, or
wealth.

1. Consumption: It means the use of wealth to satisfy human wants. It also means the
destruction of utility or use of commodities and services to satisfy human wants.
2. Production: It is defined as the creation of utility. It involves the processes and
methods employed in transformation of tangible inputs (raw materials, semi-
1. finished goods, or subassemblies) and intangible inputs (ideas, information, know -
how) into goods or services.
2. Exchange: It implies the transfer of goods from one person to the other. It may
3. occur among individuals or countries. The exchange of goods leads to an increase in
the welfare of the individuals through creation of higher utilities for goods and
services.
4. Distribution: Distribution refers to sharing of wealth that is produced among the
different factors of production .It refers to personal distribution and functional
distribution of income. Personal distribution relates to the forces governing the
distribution of income and wealth among the various individuals of a country.
Functional distribution or factor share distribution explains the share of total income
received by each factor of production viz., land, labour, capital and organisation.

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5. Public finance: Public finance is the study of the role of the government in the
economy. It is the branch of economics that assesses the government revenue and
government expenditure of the public authorities and the adjustment of one or the
other to achieve desirable effects and avoid undesirable ones.

Economic system
• An economic system is a means by which societies or governments organize and
distribute available resources, services, and goods across a geographic region or
country.
• Economic systems regulate the factors of production, including land, capital, labor,
and physical resources
• An economic system encompasses many institutions, agencies, entities, decision-
making processes, and patterns of consumption that comprise the economic structure
of a given community

Major Classification
• Capitalism
• Socialism
• Mixed Economy
Capitalism is an economic system based on the private ownership of the means of
production and their operation for profit. Central characteristics of capitalism include capital
accumulation, competitive markets, price system, private property, property
rights recognition, voluntary exchange, and wage labor. In a capitalist market economy,
decision-making and investments are determined by owners of wealth, property, or ability to
maneuver capital or production ability in capital and financial markets—whereas prices and
the distribution of goods and services are mainly determined by competition in goods and
services markets.

In the 1840s a new type of economic theory emerged in the literary circles known as “The
Communist Manifesto”. Written by Karl Marx with Fredric Engels it propounded a new and
unique concept of an economy of a country. This came to be known as a socialist economy. In
a socialist economy, the setup is exactly opposite to that of a capitalist economy. In such an
economy the factors of production are all state-owned. So all the factories, machinery, plants,
capital, etc. is owned by a community in control of the State.
All citizens get the benefits from the production of goods and services on the basis of equal
rights. Hence this type of economy is also known as the Command Economy.
So basically in a socialist economy, private companies or individuals are not allowed to freely
manufacture the goods and services. And the production occurs according to the needs of the
society and at the command of the State or the Planning Authorities. The market and the
factors of supply and demand will play no role here.

The ultimate aim of a socialist economy is to ensure the maximization of wealth of a whole
community, a whole country. It aims to have an equal distribution of wealth amongst all its
citizens, not just the welfare of its richest companies and individuals.
The Mixed Economy is a system that combines capitalism and socialism. The Mixed
Economy incorporates the benefits of capitalism and socialism while avoiding their
drawbacks.
Under a Mixed Economy, the private and public sectors coexist. Economic activity is directed
by the government toward particular socially significant sectors of the Economy, and the
balance is determined by the operation of the pricing mechanism

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The public and private sectors collaborate to achieve social objectives within the framework
of a common Economic plan.
The private sector is a significant component of the Mixed Economy and is regarded as a
critical engine of Economic growth. India is widely recognized as the world's best example of
a Mixed Economy.

Economic Policies

• It implies a set of measures taken by monetary of public authorities to realise certain

specified goals.
• An economic policy is any activity that tries to influence or manage an economy.
• economic policy refers to government initiatives to influence the economy of a
particular region, state, or country. The setting of interest rates, tax rates and the
allocation of government funds are examples of such activities.

MODERN APPROACH
This approach divides subject matter of economics into two divisions i.e., micro economics
and macro economics. The terms „micro-„ and „macro-„ economics were first coined and
used by Ragnar Frisch in 1933.

Micro (price theory) and Macro ( Theory of income and employment) economics

Economics is divided into two different categories: Microeconomics and Macroeconomics.

Microeconomics is the study of individuals and business decisions, while Macroeconomics
looks at the decisions of countries and governments.
• While these two branches of economics appear to be different, they are actually
interdependent and complement one another. Many overlapping issues exist between
the two fields.
• Microeconomics studies individuals and business decisions, while macroeconomics
analyses the decisions made by countries and governments.
• Microeconomics focuses on supply and demand, and other forces that determine price
levels, making it a bottom-up approach.
• Macroeconomics takes a top –down approach and looks at the economy as a whole,
trying to determine its course and nature.
• Investors can use microeconomics in their investment decisions, while
macroeconomics is an analytical tool mainly used to craft economic and fiscal policy

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MICRO VS MACRO ECONOMICS

Micro economics Macro economics
Meaning it studies individuals units of an economy It studies the economy as a whole

Fields of study It studies individual economic unit such It studies national Aggregate such as:
as: a consumer, a firm, a household, an national income, national output, general
industry a commodity etc price level, level of employment etc.
Problems it deals with micro problems such as determination of: It deals with problems at a macro level
price of commodity, a factor of like problems of employment, trade
production, satisfaction of a consumer etc cycles, international trade, economic
growth etc.
Nature It is based on disaggregation of units. It It is based on aggregation of units It does
considers individual differences between not consider individual differences
different units between aggregates.

Objectives Maximize utility, Maximize profits, Full employment, Price stability, Economic
Minimize costs, Static analysis growth, Favourable balance of payment
situation
Methodology Does not explain the time element Dynamic analysis i.e. it is based on time
Equilibrium conditions are measured at a lags, rates of change, past and expected
particular period values of variables

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NATURE OF ECONOMICS

The nature of economics to be properly understood, certain basic questions should be

provided such as:

Is economics a science or an art?

Is economics a social science?
Is economics a positive or normative science?

ECONOMICS AS SCIENCE
Characteristics of Science are:

 Systematic knowledge: Economics attempts to provide a systematic study of its

subject matter.
 Comprehensive knowledge: Provides a complete knowledge about wealth earning and
spending activities of man.
 Cause and effect relationship: Economics explains the causes and effects of any
economic phenomenon.
 Scientific approach: Gathers facts, measures them, explains them, and verifies them.

ECONOMICS NOT A SCIENCE

 Inexact laws.
 Lack of universality.
 Inexact measurements.
 No possibility of laboratory experiments.
 Difficulty in making predictions.
 Disagreements among economists.

ECONOMICS AS AN ART

 Solution of economic problems: It not only understands problems but also suggests
solutions.
 Accumulation of wealth.
 Maximisation of Welfare.
 Verification of economic theories: Verification of economic theories can be done only
in day to day experience.
 Economic policies and plans.

ECONOMICS AS SOCIAL SCIENCE

Economics is regarded as a social science because it uses scientific methods to build theories
that can help explain the behaviour of individuals, groups and organisations. Economics
attempts to explain economic behaviour, which arises when scarce resources are exchanged.

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ECONOMICS: A POSITIVE OR NORMATIVE SCIENCE?

 “A positive science may be defined as a body of systematised knowledge concerning

what it is." (J M Keynes)
 “A normative science deals with what ought to be.”
 A positive statement is one that can establish hypotheses that can be empirically
tested.
 In contrast, a normative statement is instead based on opinion or subjective values.
 Positive economics eg:“Government-funded healthcare surges public expenditures.”
 A normative economics example is, “The government should make available
fundamental healthcare to every citizen”. You can understand that this statement is
based on personal perspective and satisfies the need for ‘should be’ or ‘ought to be’.

POSITIVE ECONOMICS V/S NORMATIVE ECONOMICS:

1. Positive economics is concerned with „what is‟ whereas Normative economics is

concerned with „what ought to be‟.
2. Positive economics describe economic behaviours without any value judgment while
normative economics evaluate them with moral judgment.
3. Positive economics is objective while normative economics is subjective.
4. The statement, “ Price rise as demand increase” is related to positive economics, whereas
the statement, “ Rising prices is a social evil” is related to normative economics.

SHORT RUN AND LONG RUN ANALYSIS

A short run is a time period during which consumers and producers have not had enough time
to make all the adjustments to the new situation. A long run is a time period during which
consumers and producers have enough time to make all the adjustments to the new situation.
We cannot exactly say, how short a short run is, and how long a long run is.
"The short run is a period of time in which the quantity of at least one input is fixed and the
quantities of the other inputs can be varied. The long run is a period of time in which the
quantities of all inputs can be varied.

SHORT RUN AND LONG RUN EFFECT

Consider, for instance, a sudden increase in the oil price by the OPEC. The immediate impact
would be an increase in the prices of oil and other products requiring oil. After some time,
consumers would adjust to this situation by using more energy-efficient cars and appliances,
building energy efficient homes and so on. These adjustments would eventually reduce
demand and bring the price of oil back, down.

DEDUCTIVE AND INDUCTIVE REASONING

Like any other science, Economics adopts two important methods in its investigations and
formulation of laws and principles. The two methods are

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1 Deductive Reasoning
2 Inductive Reasoning

DEDUCTIVE METHOD OF ECONOMIC ANALYSIS

Deductive reasoning starts with a general assumption, it applies logic, then it tests that logic
to reach a conclusion. With this type of reasoning, if the premises are true, then the
conclusion must be true.
Eg:
If A is B, and B is C, then A is C.
All racing cars must go over 80MPH; the Dodge Charger is a racing car, therefore it can go
over 80MPH.

Deduction Means reasoning or inference from the general to the particular or from the
universal to the individual. The deductive method derives new conclusions from fundamental
assumptions or from truth established by other methods. It involves the process of reasoning
from certain laws or principles, which are assumed to be true, to the analysis of facts.
Deduction involves four steps: (1) Selecting the problem. (2) The formulation of assumptions
on the basis of which the problem is to be explored. (3) The formulation of hypothesis
through the process of logical reasoning whereby inferences are drawn. (4) Verifying the
hypothesis.

INDUCTIVE METHOD OF ECONOMIC ANALYSIS

Inductive reasoning starts with a specific assumption, then it broadens scope until it reaches a
generalized conclusion. With inductive reasoning, the conclusion may be false even if the
premises are true.

Eg:
The left-handed people I know use left-handed scissors; therefore, all left-handed people use
left-handed scissors.
In the past, ducks have always come to our pond. Therefore, the ducks will come to our pond
this summer.

Induction “is the process of reasoning from a part to the whole, from particulars to generals
or from the individual to the universal.” Bacon described it as “an ascending process” in
which facts are collected, arranged and then general conclusions are drawn.
The inductive method involves the following steps: 1) The Problem; In order to arrive at a
generalisation concerning an economic phenomenon, the problem should be properly selected
and clearly stated. 2) Data; The second step is the collection, enumeration, classification and
analysis of data by using appropriate statistical tech- niques. 3) Observation; Data are used to
make observation about particular facts concerning the problem. 4) Generalisation; On the
basis of observation, generali- sation is logically derived which establishes a general truth
from particular facts. Thus induction is the process in which we arrive at a generalisation on
the basis of particular observed facts.

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BASIC ECONOMIC PROBLEMS

Scarcity of resources is broken down into four basic problems of an economy

What to Produce?
How to Produce?
For whom to Produce?
What provision should be made for economic growth?

WHAT TO PRODUCE?

What does a society do when the resources are limited? It decides which goods/service it
wants to produce. Further, it also determines the quantity required. For example, should we
produce more guns or more butter? Do we opt for capital goods like machines, equipment,
etc. or consumer goods like cell phones, etc.? While it sounds elementary, society must
decide the type and quantity of every single good/service to be produced.

HOW TO PRODUCE?

The production of a good is possible by various methods. For example, you can produce
cotton cloth using handlooms, power looms or automatic looms. While handlooms require
more labour, automatic looms need higher power and capital investment.
Hence, society must choose between the techniques to produce the commodity. Similarly, for
all goods and/or services, similar decisions are necessary. Further, the choice depends on the
availability of different factors of production and their prices. Usually, a society opts for a
technique that optimally utilizes its available resources.

FOR WHOM TO PRODUCE?

Think about it – can a society satisfy each and every human wants? Certainly not. Therefore,
it has to decide on who gets what share of the total output of goods and services produced. In
other words, society decides on the distribution of the goods and services among the
members of society.

WHAT PROVISION SHOULD BE MADE FOR ECONOMIC GROWTH?

Can a society use all its resources for current consumption? Yes, it can. However, it is not
likely to do so. The reason is simple. If a society uses all its resources for current
consumption, then its production capacity would never increase.
Therefore, the standard of living and the income of a member of the society will remain
constant. Subsequently, in the future, the standard of living will decline. Hence, society must
decide on the part of the resources that it wants to save for future progress.

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EQUILIBRIUM and DISEQUILIBRIUM

The word equilibrium is derived from the Latin word libra, meaning “weight” or “balance.”
In economics, equilibrium implies a position of rest characterized by absence of change. It is
a state where there is complete agreement of the economic plans of the various market
participants so that no one has a tendency to revise or alter this decision.
Disequilibrium is a situation where there is no complete agreement of the economic plans of
the various market participants.

SUPPLY AND DEMAND

Supply and Demand, in economics, deals relationship between the quantity of a commodity
that producers wish to sell at various prices and the quantity that consumers wish to buy. It is
the main model of price determination used in economic theory.
The price of a commodity is determined by the interaction of supply and demand in a market.
The resulting price is referred to as the equilibrium price and represents an agreement
between producers and consumers of the good.
In equilibrium the quantity of a good supplied by producers equals the quantity demanded by
consumers.
Suppose a continuous and constant supply of a commodity comes to market with a
prospective demand for it from the buyers, for this the market price must be such as to equate
the demand and supply of the commodity. When demand and supply are equal to a particular
price, it is the state of equilibrium. The price at which the commodity is bought and sold is
the equilibrium price and the quantity of the commodity bought and sold at the price is the
equilibrium quantity.
Disequilibrium is a situation where there is no complete agreement of the eco- nomic plans of
the various market participants.
In the figure, price is given in the Y axis and the quantity supplied is given in the X axis. The
curve DD shows demand and SS, supply in the market. At price 2 the corresponding points in
the demand and supply curves are D and C respectively. The quantity supplied is only 2 the
quantity demanded is 4 here we can say that there exists an excess demand or deficiency in
supply dc in the economy. In the same manner, at price 4 the corresponding points in the
demand and supply curves are a and b respectively. Here the quantity supplied is B, while the
quantity demanded is A. Here we could see an excess supply or deficiency of demand ab.
However, at Price 3 the corresponding points in the demand and supply curves are e. We

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could also note that at this point both the curves intersect each other. The quantity supplied at
this point is 3.

A B

D C

Here we can say that the point of equilibrium in the economy is at point e. The market forces
of supply and demand reach a point of balance or agreement at this
point. Any other point in the figure shows a point of disequilibrium or disagreement between
the forces of demand and supply.

PARTIAL AND GENERAL EQUILIBRIUM ANALYSIS

 Partial equilibrium analysis uses the ceteris paribus assumption.
 It was popularized by the English economist Alfred Marshall.
 The smaller the sector being considered better the possibility of that particular
equilibrium analysis can predict its behavior.
 Partial equilibrium analysis is used in two cases:
o the first case is when we are concerned with an event or occurrence that
affects only a given industry and its effect on others is negligible;
o the second case is when we are concerned with first order effects alone.

 General equilibrium analysis is concerned with the study of the effects of certain
changes and policies after all the interactions in the economy have taken place.

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 General equilibrium theory was first systematically studied by the French

mathematical economist, Leon Walras.
 General equilibrium is achieved only when all these industries are in equilibrium
simultaneously.

It is often the case that macroeconomic theories tend to be general equilibrium in

character and microeconomic theories tend to be partial equilibrium in character.

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THE PRODUCTION POSSIBILITIES CURVE

In every economic society, the economizing problem arises on account of the limited
resources in relation to unlimited wants. Prof. Samuelson has production possibility curve to
clear the problem of scarcity and choice.

Production possibility frontier or the transformation curve shows the alternative combinations
of commodities that a nation can produce by fully utilizing all of its resources with the best
technology available to it. Let us take a situation where the economy is producing just two
products- steel and wheat. Steel symbolizes a capital good and wheat consumer good. Since
the resources available in the economy are limited the output is also limited. Here more steel
can be produced only at the cost of less wheat and vice versa. Thus the economy cannot
increase the supply of both from its scarce resources. This is the economic problem that the
society has to face.

 The production possibilities curve shows the possible combinations of production

volume for two goods using fixed resources (Input)
 The input is any combination of the four factors of production: natural resources
(including land), labour, capital goods, and entrepreneurship.
 The production possibilities curve measures the trade-off between producing one
good versus another.
 The assumption is that production of one commodity decreases if that of the other one
increases.
Alternate name: Transformation curve, production possibility frontier
Acronym: PPC

Let us suppose that the economy can produce two commodities, cotton and wheat. Suppose
that the productive resources are being fully utilized and there is no change in technology.
The following table gives the various production possibilities.

If all available resources are employed for the production of wheat, 15,000 quintals of it can
be produced. If, on the other hand, all available resources are utilized for the production of
cotton, 5000 quintals are produced. These are the two extremes represented by A and F and in
between them are the situations represented by B, C, D and E. At B, the economy can
produce 14,000 quintals of wheat and 1000 quintals of cotton. At C the production
possibilities are 12,000 quintals of wheat and 2000 quintals of cotton, as we move from A to
F, we give up some units of wheat for some units of cotton For instance, moving from A to B,

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we sacrifice 1000 quintals of wheat to produce 1000 quintals of cotton, and so on. As we
move from A to F, we sacrifice increasing amounts of cotton.

This means that, in a full-employment economy, more and more of one good can be obtained
only by reducing the production of another good. This is due to the basic fact that the
economy’s resources are limited.

In this diagram AF is the production possibility curve, also called or the production
possibility frontier, which shows the various combinations of the two goods which the
economy can produce with a given amount of resources. The production possibility curve is
also called transformation curve, because when we move from one position to another, we are
really transforming one good into another by shifting resources from one use to another.

It is to be remembered that all the points representing the various reduction possibilities must
lie on the production possibility curve AF and not inside or outside of it. For example, the
combined output of the two goods can neither be at U nor H. (See Fig. 21.3) This is so
because at U the economy will be under-employing its resources and H is beyond the
resources available.

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THE PRODUCTION POSSIBILITY CURVE- PROPERTIES

The two basic property of production possibility curve are:

It slopes downward from left to right- Production possibility curve slopes downward
because both the variables involved in the equation are inversely related as one increase then
other one decreases and vice versa because the resources are constant.

The curve is concave to the origin- Since resources are use specific, therefore every time
when one more unit of a commodity is produced more units of the other commodity is
sacrificed that results in increasing marginal opportunity cost which leads to the concave
shape of production possibility curve.

UTILITY
People buy goods because they get satisfaction from them. This satisfaction which the
consumer experiences, when he consumes a good, when measured as number of utils is
called utility. The property of a good that enables it to satisfy human wants is called utility.

Total utility (TU) is the total satisfaction obtained from all units of a particular commodity
consumed over a period of time

For example, a person consume eggs and gains 50 utils of total utility. This total utility is the
sum of utilities from the successive units (30 utils from the first egg, 15 utils from the second
and 5 utils from the third egg).

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Marginal utility means an additional or incremental utility. Marginal utility is the change in
the total utility that results from one unit change in consumption of the commodity within a
given period of time.

For example, when a person increases the consumption of eggs from one egg to two eggs, the
total utility increases from 30 utils to 45 utils. The marginal utility here would be the 15 utils
of the 2nd egg consumed.

The relationship between total utility (TU) and marginal utility (MU) is now explained with
the help of following table or schedule and a graph.

The above table shows that when a person consumes no apples, he gets no satisfaction. His
total utility is zero. In case he consumes one apple a day, he gains seven units of satisfaction.
His total utility is 7 and his marginal utility is also 7.
In case he consumes second apple, he gains extra 4 utils (MU). Thus given him a total utility
of 11 utils from two apples. His marginal utility has gone down from 7 utils to 4 utils because
he has a less craving for the second apple
Same is the case with the consumption of third apple. The marginal utility has now fallen to 2
utils while the total utility of three apples has increased to 13 utils (7 + 4 + 2). In case the
consumer takes fifth apple, his marginal utility falls to zero utils and if he consumes sixth
apple, his marginal utility falls to negative. The relationship between total utility and
marginal utility is plotted in diagram, given as above

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CARDINAL UTILITY AND ORDINAL UTILITY

Cardinal utility means that an individual can attach specific values or numbers of ‘utils’ from
consuming each quantity of a good or baskets of goods. Ordinal utility is much weaker notion
than cardinal utility because it only requires that the consumer be able to rank goods in order
of his preference. In short ordinal utility only ranks various consumption bundles, whereas
cardinal utility provides an actual index or measure of satisfaction.

Difference between Cardinal utility and Ordinal utility

Cardinal Utility Ordinal Utility

Definition

It explains that the satisfaction level after It explains that the satisfaction level after consuming
consuming any goods or services can be any goods or services cannot be scaled in numbers.
scaled in terms of countable numbers. However, these things can be arranged in the order of
preference.

Example

Pizza gives Sam 60 utils of satisfaction, Sam gets more satisfaction from a pizza as compared
whereas burger gives him only 40 utils. to that of a burger.

Measurement

Utility is measured based on utils. Utility is ranked based on satisfaction.

Realistic

It is less practical. It is more practical and sensible.

Used By

This theory was applied by Prof. This theory was applied by Prof. J R Hicks
Marshall

Other Name

Utility Analysis Indifference Curve Analysis

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DEMAND

Demand indicates the quantities of a good or service which the household is willing and
financially able to purchase at various prices, holding other things constant

Demand may be defined as “the desire backed by ability and willingness to pay for a
commodity”

LAW OF DEMAND
Cetris Paribus (Latin expression for other things remaining constant), as the price increases,
quantity demanded falls, and vice versa.
Inverse relationship b/w price and quantity demanded.

The law of demand states that other factors being constant (cetris peribus), price and quantity
demand of any good and service are inversely related to each other. When the price of a
product increases, the demand for the same product will fall.

Assumptions of Law of Demand

No change in:
Taste and preferences.
Consumer's income
Price of substitutes and complementary goods.
Quality of product.
Number of buyers

Law of Demand

INDIVIDUAL DEMAND
We may define the demand for a commodity of the individual household as a list or schedule
of the quantities that will be bought at various prices.

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The demand for a commodity of an individual depends upon a number of factors such as
price of the commodity, income of the individual, tastes and preferences of the individual,
prices of other goods etc.

DEMAND SCHEDULE AND DEMAND CURVE

The individual demand schedule is a table which explains the relation between the price of a
commodity and the demand for it. Below we have a hypothetical individual demand schedule
for oranges. In the first column are given alternate prices per dozen oranges and in the second
column against each price is shown the quantity demanded of oranges. When we show the
household demand schedule graphically, we have a demand curve for oranges of the
household. On the Y axis is shown the price of oranges and on the X axis the quantity of
oranges demanded at each price.

Price Quantity Demanded

30 10

25 15

20 20

15 25

10 30

Demand Schedule and Demand Curve

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MARKET DEMAND
The market demand is the sum total of demands of all consumers in the market for a
commodity at various prices. We can derive the market demand for a commodity by adding
up the quantities demanded of the commodity at various prices by all the consumers that buy
the commodity in a period of time.
A market demand schedule is a table showing the quantity of a commodity that consumers
are willing and able to purchase over a given period of time at each price of the commodity,
while holding constant all other relevant economic variables on which demand depends.
Among the variables held constant are consumers income, their tastes, the prices of related
commodities and the number of consumers in the market.
The market demand is the sum total of demands of all consumers in the market for a
commodity at various prices. We can derive the market demand for a commodity by adding
up the quantities demanded of the commodity at various prices by all the consumers that buy
the commodity in a period of time. Table below gives the market demand schedule. If the
market has only three buyers for a commodity, their willingness to purchase the particular
quantities of the commodity at various prices is shown here.

Market Demand Schedule and Curve

Price Qty DD Qty DD by Qty DD by Market Demand

by A B C

10 20 17 13 20+17+13= 50

20 16 13 11 40

30 13 10 7 30

40 9 6 5 20

50 5 3 2 10

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Reasons for the law of demand

Demand curve has a negative slope; i.e., it slopes downward to the right. This negative slope
is the reflection of the law of demand or inverse price-quantity relationship. The two major
reasons are income effect and the substitution effect.

Income effect: when price of a commodity falls, the consumer can buy more quantity of the
commodity with his given income. In other words, as a result of fall in price of the
commodity, consumers real income or purchasing power increases. This increase in real
income induces the consumer to buy more of that commodity. This is called income effect of
the change in price of the commodity.

Substitution effect: When the price of a commodity falls, it becomes relatively cheaper than
other commodities. This induces the consumer to substitute the commodity whose price has
fallen for other commodities which have now become relatively dearer. As a result of this
substitution effect, the quantity demanded of the commodity, whose price has fallen, rises.

Exceptions to the law of demand

Law of demand is generally believed to be valid in most of the situations. However, some
exceptions to the law of demand are there.

Goods having prestige value: Veblen effect:

Thorstein Veblen has propounded the doctrine of conspicuous consumption. According to
him some consumers measure the utility of a commodity entirely by its price, i.e., for them,
the greater the price of the commodity greater the utility. This is called Veblen effect.
Examples of Veblen goods include designer jewellery, yachts, and luxury cars.
Goods with uncertain product quality:
In markets where prices act as signals of quality, people tend to assume that quality has gone
up when prices are raised and hence may demand more of the commodity at a higher price.
Giffen goods: This was pointed out by Robert Giffen. Goods in whose case there is a direct
price-demand relationship is called Giffen goods.
Giffen goods are low-priced products, the demand for which rises along with the price. These
products are necessary to fulfill the need for food, and they have only a few substitutes.
Bread, wheat, and rice are examples of Giffen goods.

Factors affecting demand

1. Tastes and preferences of the consumers,
2. Income of the people,
3. Changes in the prices of related goods,
4. Number of consumers in the market,
5. Consumers expectations, and
6. Income distribution.

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ELASTICITY OF DEMAND
Elasticity of demand is the measure of responsiveness or sensitiveness of demand for a
commodity to any of its determinants, viz., price of the commodity, price of the substitutes
and complements, consumers' income and consumer expectations regarding prices.

Types of elasticity of demand

1. Price Elasticity
a. Perfectly elastic demand
b. Perfectly inelastic demand
c. Relatively elastic demand
d. Relatively inelastic demand
e. Unit elasticity
2. Cross Elasticity
3. Income Elasticity

PRICE ELASTICITY
Degree of responsiveness or sensitivenss of demand of a commodity to a change in its price
Simply put, it is the ratio of % change in quantity demanded to the % change in price.

TYPES OF PRICE ELASTICITY OF DEMAND

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a. Perfectly elastic demand:

When a small or negligible change in price leads to an infinite / unlimited change in quantity
demand. Demand curve is a straight line parallel to x axis. It's practical applicality is limited
as it cannot be applied in a real-life situation.

b) Perfectly Inelastic Demand:

Demand is said to be perfectly inelastic when a change in price does not lead to any change in
quantity demanded. Here ep will be 0. Here the demand curve is a straight vertical line.
Though not a practical concept, it applies to essential commodities like Salt.

c) Relatively elastic Demand:

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When a change in price leads to a more than proportionate change in quantity demanded.
Here, the elasticity is greater than 1.

d) Relatively inelastic Demand:

When a change in price leads to a less than proportionate change in quantity demanded. Here,
the elasticity is less than 1.

e) Unit elasticity

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Change in price leads to an equal and proportionate change in quantity demanded The shape
of the demand curve in this case is a rectangular hyperbola.

INCOME ELASTICITY OF DEMAND

Degree of responsiveness of demand to a change in the income of consumer. Ratio of %
change in quantity dd to a % change in income.
Symbolically

CROSS ELASTICITY OF DEMAND

Measure of responsiveness of demand for a commodity to the changes in the price of its
substitute and complementary goods.
For eg: Cross elasticity of dd for Tea is the % change in its qty dd due to a change in the
price of its substitute Coffee.
Cross elasticity b/w 2 substitutes -> Positive.
Cross elasticity b/w 2 complementary goods -> Negative.
Cross elasticity b/w 2 unrelated goods -> Zero

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SUPPLY
In economics, supply is the amount of a resource that firms, producers, labourers, providers
of financial assets, or other economic agents are willing and able to provide to the
marketplace or to an individual.
Supply in economics is defined as the total amount of a given product or service a supplier
offers to consumers at a given period and a given price level.
Supply is a fundamental economic concept that describes the total amount of a specific good
or service that is available to consumers.
Supply is one of the two forces that determine the price of a commodity in the market. In
simple words supply means the quantity of a commodity offered for sale at a particular price
during a given period of time in the market. It refers to the schedule of quantities of a good
that the firms are able and willing to offer for sale at various prices.

SUPPLY FUNCTION
The supply function is expressed as, Sx = f (Px , P0 , Pf, St , T, O)
Where:
Sx = Supply of the given commodity x.
Px= Price of the given commodity x.
P0 = Price of other goods.
Pf = Prices of factors of production.
St= State of technology.
T = Taxation policy.
O = Objective of the firm.

Factors or determinants influencing supply

Price of the commodity: as the price increases, sellers would be willing to sell more and more
of their commodities and vice versa as this would help them increase their profit.
Price of the related goods: Supply depends also on the price of the related goods in the
market. If the price of a substitute good goes up, producers will increase the production of the
substitute commodity.
Cost of Production: The changes in the cost of production would also result in the increase or
decrease in the supply of the commodity.
New inventions: the development of technology help in raising the productivity and supply.
Natural factors: favourable natural factors help in boosting the production and supply.
Use of inputs: the use of inputs also affect the supply.
Development of transport and communication: the supply of the commodity depends on the
availability of transportation and communication facilities.
Future expectations: the expectations of the producers with regard to the changes in prices
also affect the supply of commodities.

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LAW OF SUPPLY
What Is the Law of Supply?
The law of supply is the microeconomic law that states that, all other factors being equal, as
the price of a good or service increases, the quantity of goods or services that suppliers offer
will increase, and vice versa. The law of supply says that as the price of an item goes up,
suppliers will attempt to maximize their profits by increasing the number of items for sale.

Supply of a commodity is functionally related to its price. The law of supply relates to this
functional relationship between price of a commodity and its quantity supplied. In contrast to
the inverse relationship between the quantity demanded and the changes in price, the quantity
supplied of a commodity generally varies directly with price. That is, the higher the price, the
larger is the quantity supplied of a commodity.

LAW OF SUPPLY- Exceptions

The law of supply does not apply to rare articles like ancient coins .
The law of supply does not hold good to speculators in the stock market as they buy and sell
on the basis of future expectations.
Sellers will be ready to sell in case of perishable goods.
In case the seller is in dire need for cash, he will like to sell his stock at the lower price.

SUPPLY SCHEDULE and SUPPLY CURVE

The supply schedule and the upward-sloping supply curve reflect the law of supply.
According to the law of supply, when the price of a commodity rises, the quantity supplied of
it in the market increases, and when the price of the commodity falls, its quantity supplied
decreases, other factors determining supply remaining the same. Thus, according to the law
of supply, the quantity supplied of a commodity is directly or positively related to price.
It is due to this positive relationship between price of a commodity and its quantity supplied
that the supply curve of a commodity slopes upward to right as seen from supply curve SS in
Figure below

Source: Advanced Economic Theory (Microeconomic Analysis), 21st Edition by Ahuja H.L.

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WHY DOES SUPPLY CURVE GENERALLY SLOPE UPWARD ?

Firms are driven by profit motive. The higher price of a product, given the cost per unit of
output, makes it profitable to expand output and offer more quantity of the product for sale.
Thus, higher price serves as an incentive for the producer to produce more of it. The higher
the price, the greater the incentive for the firm to produce and supply more of a commodity in
the market, other things remaining the same.
The basic reason behind the law of supply (i.e., positive relationship between price and
quantity supplied) is the way cost changes as output is expanded to offer more for sale. To
produce more of a product, firms have to devote more resources to its production. When
production of a product is expanded by using more resources, diminishing returns to variable
factors occur. Due to the diminishing returns, average and marginal costs of production
increase.
Therefore, at higher additional cost of producing more units of output; it is profitable to
produce and supply more units of output only at a higher price so as to cover the rise in
additional cost per unit.

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NATIONAL INCOME
National income of a country means the sum total of incomes earned by the citizens of that
country during a given period, say a year. National Income of any country can be defined as
the complete value of the goods and services produced by any country during its financial
year.

There are various concepts of National Income including GDP, GNP, NNP, NI, PI, DI, and
PCI which explain the facts of economic activities.

GDP at market price

It is money value of all goods and services produced within the domestic domain with the
available resources during a year.

GDP = PQ

Where, GDP = gross domestic product, P = Price of goods and services, and Q= Quantity of
goods and services.

GDP is made up of 4 Components: 1, Consumption 2, Investment 3, Government expenditure

4, Net foreign exports of a country

GDP = C + I + G + (X − M)

Where, C=Consumption, I=Investment, G=Government expenditure, and (X- M) =Export

minus import.

Gross National Product (GNP)

It is market value of final goods and services produced in a year by the residents of the
country within the domestic territory as well as abroad.

GNP is the value of goods and services that the country’s citizens produce regardless of their
location. (NFIA = Net factor income from abroad.)

GNP = GDP + NFIA

or,
GNP =C+I+G+(X−M)+NFIA

Net National Product (NNP)

It is market value of net output of final goods and services produced by an economy during a
year and net factor income from abroad.

NNP = GNP − Depreciation

or,
NNP = C + I + G + (X − M) + NFIA - Depreciation

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National Income at factor cost

NI is also known as National Income at factor cost which means total income earned by
resources for their contribution of land, labour, capital and organisational ability. Hence, the
sum of the income received by factors of production in the form of rent, wages, interest and
profit is called National Income.

NI = NNP + Subsidies − Indirect Taxes

or,
NI = C+G+I+(X-M) +NFIA-Depreciation-Indirect Taxes +Subsidies

PERSONAL INCOME

PI is the total money income received by individuals and households of a country from all
possible sources before direct taxes.

PI = NI−Corporate Income Taxes−Undistributed Corporate Profits−Social Security

Contribution + Transfer Payments.

Disposable Income

DI is the income left with the individuals after the payment of direct taxes from personal
income. It is the actual income left for disposal or that can be spent for consumption by
individuals.

DI = P I − Direct Taxes

Per Capita Income

PCI is calculated by dividing the national income of the country by the total population of a
country.
PCI = Total National Income /Total National Population

MEASUREMENT OF NATIONAL INCOME

There are three methods to calculate National Income:
1. Income Method
2. Product/ Value Added Method
3. Expenditure Method

Income Method

Under this method, we add all the incomes from employment and ownership of assets before
taxation received from all the production activities in an economy. In this National Income is
measured as flow of income.

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We can calculate NI as:

Net National Income = Compensation of Employees+ Operating surplus mixed (W +R +P +I)
+ Net income + Net factor income from abroad.
Where, W = Wages and salaries, R = Rental Income, P = Profit, and I = Mixed Income

Product/ Value Added Method

Under this method, we add the values of output produced or services rendered by the
different sectors of the economy during the year in order to calculate the National Income. In
this method, we include only the value added by each firm in the production process in the
output figure.
Here National Income is measured as flow of goods and services.

We can calculate NI as:

National Income = G.N.P – Cost of capital – Depreciation – Indirect taxes.

Expenditure Method
This method measures the total domestic expenditure of the economy. In this National
Income is measured as flow of expenditure. The expenditure method is one of the effective
ways of national income accounting in which the measurement of the same is taken as a flow
of expenditure from government consumption, net exports, and gross capital formation.
The Formula is –

National Income = C + G + I + NX

Where,
Household consumption is represented by C
Government expenditure is represented by G
Investment expense is represented by I
Net exports are represented by NX

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