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. 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. Economics Definitions Emphasis on Contribution by Wealth
Adam Smith (1723 1790) Welfare Alfred Marshall (1842 1924) Scarcity
Lionel Robbins Growth Paul Samuelson
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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Scope of Economics Economics is a science. Economics is a
social science. Economics is also an art. Positive science.
Normative science.
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. 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. 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. 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. 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. 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. Theory of Demand and Supply
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. 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. 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. 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. Demand Analysis
28. Demand Curve
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. 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. 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. Supply Analysis
33. Supply Curve
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. Equilibrium
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. 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. Excess Supply
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. 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. 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. 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. 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. 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. 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. 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. Extension and Contraction of Demand
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. Shift in Demand
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. Elasticity Of Demand
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. 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. 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. 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. 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. 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. 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. Perfectly Elastic Demand (e = )
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. Perfectly Inelastic Demand (e = 0)
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. Relatively Elastic Demand (e > 1)
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. Relatively Inelastic Demand (e < 1)
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. Unitary Elastic Demand (e = 1)
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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Positive Cross Elasticity of Demand (Substitute)
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. Negative Cross Elasticity of Demand (Complementary)
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. Importance of Elasticity Production Price fixation
Distribution International trade Public finance Nationalization
Price discrimination Others
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