1. 1. A Preliminary Introduction Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. Two major factors are responsible for the emergence of economic problems. They are: 1. The existence of unlimited human wants and 2. The scarcity of available resources
2. 2. Economics Economics word derived from two Greek words Oikos - a house Nemein - to manage means managing a household using the limited funds available, in the most satisfactory manner possible.
3. 3. Economics Definitions Emphasis on Contribution by Wealth Adam Smith (1723 1790) Welfare Alfred Marshall (1842 1924) Scarcity Lionel Robbins Growth Paul Samuelson
4. 4. Wealth Definition Adam smith (1723 1790) His book An Inquiry into Nature and Causes of Wealth of Nations (1776) defined economics as the science of wealth. He explained how a nations wealth is created. He considered that the individual in the society wants to promote only his own gain and in this, he is led by an invisible hand to promote the interests of the society though he has no real intention to promote the societys interests.
5. 5. Wealth Definition Criticism Smith defined economics only in terms of wealth and not in terms of human welfare. Ruskin and Carlyle condemned economics as a dismal science, as it taught selfishness which was against ethics. However, now, wealth is considered only to be a mean to end, the end being the human welfare. Hence, wealth definition was rejected and the emphasis was shifted from wealth to welfare.
6. 6. Welfare Definition Alfred Marshall (1842 - 1924) wrote a book Principles of Economics (1890) in which he defined 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.
7. 7. Welfare Definition The important features of Marshalls definition are as follows: a) Economics is a study of mankind in the ordinary business of life, i.e., economic aspect of human life. b) Economics studies both individual and social actions aimed at promoting economic welfare of people. c) Marshall makes a distinction between two types of things, viz. material things and immaterial things. Material things are those that can be seen, felt and touched, (E.g.) book, rice etc. Immaterial things are those that cannot be seen, felt and touched. In his definition, Marshall considered only the material things that are capable of promoting welfare of people.
8. 8. Welfare Definition Criticism a) Considered only material things. But immaterial things, such as the services of a doctor, a teacher and so on, also promote welfare of the people. b) Marshall makes a distinction between (i) those things that are capable of promoting welfare of people and (ii) those things that are not capable of promoting welfare of people. But anything, (E.g.) liquor, that is not capable of promoting welfare but commands a price, comes under the purview of economics. c) Marshalls definition is based on the concept of welfare. But there is no clear-cut definition of welfare.
9. 9. Welfare Definition. Lionel Robbins published a book An Essay on the Nature and Significance of Economic Science in 1932. According to him, economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.
10. 10. Welfare Definition The major features of Robbins definition are as follows: a) Ends refer to human wants. Human beings have unlimited number of wants. b) Resources or means, on the other hand, are limited or scarce in supply. There is scarcity of a commodity, if its demand is greater than its supply. c) The scarce means are capable of having alternative uses. Hence, anyone will choose the resource that will satisfy his particular want. Thus, economics, according to Robbins, is a science of choice.
11. 11. Welfare Definition Criticism a) Robbins does not make any distinction between goods conducive to human welfare and goods that are not conducive to human welfare. b) In economics, we not only study the micro economic aspects like how resources are allocated and how price is determined, but we also study the macroeconomic aspect like how national income is generated. But, Robbins has reduced economics merely to theory of resource allocation. c) Robbins definition does not cover the theory of economic growth and development.
12. 12. Growth Definition Prof. Paul Samuelson defined economics as the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time, and distribute them for consumption, now and in the future among various people and groups of society.
13. 13. Growth Definition The major implications of this definition are as follows: a) Dynamic definition because it includes the element of time in it. Therefore, it covers the theory of economic growth. b) Samuelson stressed the problem of scarcity of means in relation to unlimited ends. Not only the means are scarce, but they could also be put to alternative uses. c) The definition covers various aspects like production, distribution and consumption.
14. 14. Economics Definitions Of all the definitions discussed above, the growth definition stated by Samuelson appears to be the most satisfactory. However, in modern economics, the subject matter of economics is divided into main parts, viz., i) Micro Economics and ii) Macro Economics. Economics is, therefore, rightly considered as the study of allocation of scarce resources (in relation to unlimited ends) and of determinants of income, output, employment and economic growth.
15. 15. Scope of Economics Economics is a science. Economics is a social science. Economics is also an art. Positive science. Normative science.
16. 16. Nature of Economics Economics has to deal with the limited resources to satisfy the wants of the society. Even wealthy nations do not have enough resources to satisfy the needs of all persons. It is necessary to reduce the gap between more wants and limited resources. Economist does not prefer to reduce the wants but they believe to increase the availability of resources.
17. 17. Nature of Economics Economics limits its field up to exchangeable goods and these goods are called economic goods. All other goods are called non-economic goods. Further, these resources are of two classes, human and natural. If resources were so ample or wants so few that we could not have economics, but this happy situation can never happen.
18. 18. Nature of Economics In every society, critical decisions have to be made such as what to produce, how much to produce, how to produce, when to produce and who gets it, how much producer gets from production. The arrangements used to enforce these decisions in any society constitute the economic organization, or economic system, or that society having nature of providing scare resources to satisfy maximum needs of the society.
19. 19. Micro Economics The prefix micro means small, so it shouldnt be surprising that microeconomics is the study of small economic units. The field of microeconomics is concerned with things like: o Consumer decision making and utility maximization o Firm production and profit maximization o Individual market equilibrium o Effects of government regulation on individual markets o Externalities and other market side effects
20. 20. Macro Economics Macroeconomics can be thought of as the big picture version of economics. Rather than analyzing individual markets, macroeconomics focuses on aggregate production and consumption in an economy. Some topics that macroeconomists study are: o The effects of general taxes such as income and sales taxes on output and prices o The causes of economic upswings and downturns o The effects of monetary and fiscal policy on economic health o How interest rates are determined o Why some economies grow faster than others
21. 21. Difference between Micro and Macro Economics Micro Economics Macro Economics Microeconomics is the study of particular firm, particular household, individual prices, wages, incomes, individual industries, and individual commodities. Macroeconomics deals not with individual quantities as such but with aggregates of these quantities not with individual income but with national income, not with individual prices but with the price level not with individual output but with national output. Micro means very small or millionth part. Macro means large or whole. The subject or example of microeconomics is about person, an investor, a producer. The subject of macro economics is about national production, national income, income level. As it analyzes individually it provides a partial concept or partial figure of a country. As it analyzes overall it provides full figure or complete reflection of a country. Micro economics is concerned with the individual entities. Macroeconomics is concerned with the overall performance of the economy.
22. 22. Theory of Demand and Supply
23. 23. Theory of Demand The most powerful tools of economics for analyzing the way market forces determine price and production in a competitive market areDemand and Supply analysis. In an open economy it is demand for a good and its supply that jointly determine its prices. The term demand reflects consumer behaviour. It shows how much a consumer is willing to buy at a given income, price and time. A mere want is not demand in economics.
24. 24. Definition of Demand It is the amount of goods and services consumers are willing and able to buy at a given period of time. Thus desire for a good accompanied by enough purchasing power and willingness to pay determine the demand for that particular commodity.
25. 25. The Law of Demand The law of demand presents the functional relationship between price and quantity demanded. The statement of the law is as follows: Other things remaining constant, the quantity demanded increases when price falls and quantity demanded decreases when price rises. Thus price and quantity demanded are inversely related keeping other affecting variables constant.
26. 26. The Law of Demand The inverse relation between price and quantity demanded can be explained by two effects. Substitution Effect: suppose when prices of a particular good rises, the consumer find its substitutes comparatively cheaper and so they shift their demand to the substitute good which leads to the decrease it the demand of the original good. Income Effect: With the rise in price of goods or services, keeping the money income constant ,the consumers real income decreases i.e. their purchasing power decreases. Thus this leads to the decrease in the quantity demanded.
27. 27. Demand Analysis
28. 28. Demand Curve
29. 29. Theory of Supply The two main pillars of a market are consumers and suppliers. Their existence depends on each other. The terms supply determines the quantity of goods and services that a supplier is ready to supply at a given price. Before understanding the meaning of supply one should know a clear distinction between production, stock and supply. Production: It is a systematic process whereby inputs are converted into output. Stocks: A part or whole of the production produced during the production process, that is kept in the warehouse and not offered for sale is termed as stock.
30. 30. Definition of Supply Supply refers to the that quantity of goods that are bought into the market and offered for sale at a price at a given time. Thus it should not be mistaken with stock lying in the godown or quantity produced.
31. 31. The Law of Supply Other factors remaining constant, at higher prices the quantity supplied is high and at low price the quantity supplied is less. The law of supply states a direct relation between price and quantity supplied keeping other affecting factors constant. Price is the prime factor that affects supply just as it affects demand. With the cost of production remaining constant as price increases, the profit margin increases due to which the supplier is motivated to supply more. Similarly with decrease in price the supply reduces as the suppliers are demotivated by reduced profits. Thus price directly affects the quantity supplied by a supplier.
32. 32. Supply Analysis
33. 33. Supply Curve
34. 34. Equilibrium between Demand and Supply When supply and demand are equal (i.e. when the supply function and demand function intersect) the economy is said to be at equilibrium At this point, the allocation of goods is at its most efficient because the amount of goods being supplied is exactly the same as the amount of goods being demanded. Thus, everyone (individuals, firms, or countries) is satisfied with the current economic condition. At the given price, suppliers are selling all the goods that they have produced and consumers are getting all the goods that they are demanding.
35. 35. Equilibrium
36. 36. Equilibrium Equilibrium occurs at the intersection of the demand and supply curve, which indicates no allocative inefficiency. At this point, the price of the goods will be P* and the quantity will be Q*. These figures are referred to as equilibrium price and quantity. In the real market place equilibrium can only ever be reached in theory, so the prices of goods and services are constantly changing in relation to fluctuations in demand and supply.
37. 37. Disequilibrium Disequilibrium occurs whenever the price or quantity is not equal to P* or Q*. Excess Supply If the price is set too high, excess supply will be created within the economy and there will be allocative inefficiency.
38. 38. Excess Supply
39. 39. Excess Supply At price P1 the quantity of goods that the producers wish to supply is indicated by Q2. At P1, however, the quantity that the consumers want to consume is at Q1, a quantity much less than Q2. Because Q2 is greater than Q1, too much is being produced and too little is being consumed. The suppliers are trying to produce more goods, which they hope to sell to increase profits, but those consuming the goods will find the product less attractive and purchase less because the price is too high.
40. 40. Excess Demand Excess demand is created when price is set below the equilibrium price. Because the price is so low, too many consumers want the good while producers are not making enough of it.
41. 41. Excess Demand In this situation, at price P1, the quantity of goods demanded by consumers at this price is Q2. Conversely, the quantity of goods that producers are willing to produce at this price is Q1. Thus, there are too few goods being produced to satisfy the wants (demand) of the consumers. However, as consumers have to compete with one other to buy the good at this price, the demand will push the price up, making suppliers want to supply more and bringing the price closer to its equilibrium.
42. 42. Determinants of Demand The following determinants cause shifts in the entire demand curve: 1. Change in consumer tastes 2. Change in the number of buyers 3. Change in consumer incomes 4. Change in the prices of complementary and substitute goods 5. Change in consumer expectations
43. 43. Determinants of Supply The following determinants cause shifts in the entire supply curve: 1. Change in input prices 2. Change in technology 3. Change in taxes and subsidies 4. Change in the prices of other goods 5. Change in producer expectations 6. Change in the number of suppliers Any factor that increases/decreases the cost of production decreases/increases supply.
44. 44. Changes in Demand Demand of commodity may change. It may increase or decrease due to changes in certain factors. These factors are: 1. Price of a commodity 2. Nature of commodity 3. Income and wealth of consumer 4. Taste and preferences of consumer 5. Price of related goods 6. Consumer expectations 7. Advertisements etc
45. 45. Demand Function There is a functional relationship between demand and its various determinants. When this relationship expressed mathematically, it is called Demand function. D = f (P, Y, T, Ps, U) Where, D = quantity demanded P = price of the commodity Y = income of the consumer T = taste and preferences of consumers Ps = price of substitutes U = consumers expectations and others F = function of (indicates how variables are related)
46. 46. Extension and Contraction of Demand The change in demand due to change in price only, where other factors remaining constant, it is called extension and contraction of demand. When the quantity demanded of a commodity rises due to a fall in price, it is called extension of demand. When the quantity of demanded falls due to rise in price, it is called contraction of demand.
47. 47. Extension and Contraction of Demand
48. 48. Shift in Demand When the demand changes due to changes in other factors, like taste and preferences, income, price of related goods etc., it is called shift in demand. Due to changes in other factors, if the consumer buy more goods, it is called increase in demand or upward shift. If the consumer buy fewer goods due to change in other factors, it is called downward shift or decrease in demand.
49. 49. Shift in Demand
50. 50. Comparison between extension/contraction and shift in demand Extension/Contraction of Demand Shift in Demand Demand is varying due to changes in price. Demand is varying due to changes in other factors. Other factors like tastes, preferences, income etc remaining the same. Price of commodity remain the same. Consumer moves along with the same demand curve. Consumer may moves to higher or lower demand curve.
51. 51. Elasticity Of Demand
52. 52. Elasticity of Demand In market place for making real price decision, the business person needs to know the quantitative impact of price change on quantity demanded. Thus in the most real world situations economist and business analysts cannot just get away by saying if we raise our prices our sales will fall OR if income rises this quarter then our demand will increase. The question that needs to be answered is By how much. To measure this we use the concept ELASTICITY. Elasticity is the measure of responsiveness of one variable to the change in another.
53. 53. Elasticity of Demand The degree of responsiveness in quantity demanded to a change in price. It represents the rate of change in quantity demanded due to change in price. Thus it measures the effect of a change in any factor affecting demand on the total consumption expenditure on a product.
54. 54. Types of Demand Elasticity There are mainly three types of elasticity of demand. 1. Price Elasticity of Demand 2. Income Elasticity of Demand 3. Cross Elasticity of Demand
55. 55. Price Elasticity of Demand Price is one of the important determinants of demand that affects the quantity demanded. Price elasticity of demand measures the relationship between price and quantity demanded for a particular commodity. Price elasticity of demand is defined as a measure of the responsiveness of demand to the change in price. Thus price elasticity of demand shows the relative amount by which the quantity demanded will change in response to the change in price of a particular commodity.
56. 56. Price Elasticity of Demand Price Elasticity = (Proportionate change in quantity demanded)/ (Proportionate change in price) According to the theory of demand price and quantity demanded are inversely related to each other and so the co-efficient of price elasticity of demand shows a negative sign (-ve). Price elasticity is a relative amount as it is the ratio of two percentages.
57. 57. Types of Price Elasticity There are five types of price elasticity of demand. 1. Perfectly elastic demand (e = ) 2. Perfectly inelastic demand (e = 0) 3. Relatively elastic demand (e > 1) 4. Relatively inelastic demand (e < 1) 5. Unitary elastic demand (e = 1)
58. 58. Perfectly Elastic Demand (e = ) When an insignificant or extremely small change in price causes an extraordinary larger change in the demand then it is termed as perfectly elastic demand. Here a slight rise in price renders the demand zero and a slight fall in price raises the demand to infinity. It is a case of complete responsiveness.
59. 59. Perfectly Elastic Demand (e = )
60. 60. Perfectly Inelastic Demand (e = 0) Irrespective of any change in price, if the quantity demanded remains constant then such a demand is termed as perfectly inelastic demand. Thus in this type of elasticity change in price fails to bring about any change in the quantity demanded. It is also termed as zero elasticity and is a case of total unresponsiveness
61. 61. Perfectly Inelastic Demand (e = 0)
62. 62. Relatively Elastic Demand (e > 1) When percentage change in quantity demanded is more than percentage change in its price then such a demand is termed as elastic. Elastic demand is also termed as more elastic demand or relatively elastic demand.
63. 63. Relatively Elastic Demand (e > 1)
64. 64. Relatively Inelastic Demand (e < 1) When percentage change in quantity demanded is less than percentage change in price then such a demand is termed as inelastic demand. Inelastic demand is also termed as less elastic demand or relatively inelastic demand.
65. 65. Relatively Inelastic Demand (e < 1)
66. 66. Unitary Elastic Demand (e = 1) When the percentage change in quantity demanded is proportionate or equal to the percentage change in price then such a demand is termed as unitary elastic demand.
67. 67. Unitary Elastic Demand (e = 1)
68. 68. Income Elasticity of Demand It shows the change in quantity demanded as a result of a change in consumers income. Income Elasticity = (Proportionate change in quantity demanded)/ (Proportionate change in income)
69. 69. Types of Income Elasticity 1. Unitary income elasticity (y = 1) 2. Income elasticity greater than 1 (y > 1) 3. Income elasticity less than 1 (y < 1) 4. Zero income elasticity (y = 0) 5. Negative income elasticity (y < 0)
70. 70. Unitary Income Elasticity (y = 1) When percentage change in quantity demanded is equal to percentage change in income, it is termed as unitary income elasticity.
71. 71. Income Elasticity Greater than 1 (y > 1) Demand is income elastic or income elasticity is greater than 1 if the percentage change in quantity is greater than percentage change in income.
72. 72. Income Elasticity Less than 1 (y < 1) Demand is termed as income inelastic or less than 1 if the percentage change in quantity demanded is less than percentage change in income of the consumer.
73. 73. Zero Income Elasticity (y = 0) Sometimes any change in the income does not affect the quantity demanded of a particular product at all. The demand of such a product is zero income elastic. E.g., sugar, salt
74. 74. Negative Income Elasticity (y < 0) When rise in income of a consumer actually reduces the demand of a particular product, then such a product it said to have a negative income elastic demand. Usually inferior goods are negatively income elastic. When consumers of such product have a rise in their income, they tend to purchase lesser and lesser of inferior goods and move towards superior goods.
75. 75. Cross Elasticity of Demand Cross elasticity of demand measures the degree of responsiveness of demand of a commodity to the change in price of another related commodity (whether a substitute or complementary good). Thus cross elasticity measures the extent to which the price of a substitute or complementary good affects the demand of a particular good. Cross Elasticity = (Proportionate change in quantity demanded of a commodity / Proportionate change in the price of related commodity)
76. 76. Types of Cross Elasticity From business people to planners the concept of cross elasticity of demand is equally important as that of price and income elasticity. Following are the three types of cross elasticity: 1. Positive Cross Elasticity of Demand 2. Negative Cross Elasticity of Demand 3. Zero Cross Elasticity of Demand
77. 77. Positive Cross Elasticity of Demand (Substitute) Substitute goods reflect positive cross elasticity of demand. Positive cross elasticity of demand is the ratio of percentage increase(decrease)in the demand of A to the percentage increase(decrease) in the price of B. Example: With the rise in price of coffee ,the consumers of coffee find tea relatively cheaper and so shift to tea. Thus with the rise in price of coffee the demand of tea rise. Another example is coke and Pepsi.
78. 78. Positive Cross Elasticity of Demand (Substitute)
79. 79. Negative Cross Elasticity of Demand (Complementary) Complementary goods reflect negative cross elasticity between them. Negative cross elasticity of demand is the ratio of percentage increase(decrease) in demand of A to the percentage decrease(increase) in price of B. Example: Petrol and petrol car as complementary goods. With rise in price of petrol, there is a fall in demand for petrol cars.
80. 80. Negative Cross Elasticity of Demand (Complementary)
81. 81. Zero Cross Elasticity of Demand If two products are not at all related or zero relation exists between them then these goods are said to have zero cross elasticity. Thus when price of one product have no effect on the demand of another, then it is termed as zero cross elasticity. Example: price of cars and demand for books have no relation between them and so have zero cross elasticity of demand.
82. 82. Importance of Elasticity Production Price fixation Distribution International trade Public finance Nationalization Price discrimination Others
83. 83. Determinants of Elasticity Nature of commodity Availability/range of substitutes Extent/variety of uses Postponement/urgency of demand Income level Amount of money spend on the commodity Durability of commodity Purchase frequency of a product/time Range of prices Others
84. 84. Thank You