Introduction

Author: KRAsNA
CONTENTS
1. Learning Objectives 2. Introduction

3. What is an Economy? 4. Why Study Economics?

5. Scarcity 6. Economic Problem

7. Meaning of Economics 8. Positive Economics and Normative

Economics

10. Interdependence of Microeconomics

9. Microeconomics and Macroeconomics
and Macroeconomics

11. Central Problems of an Economy

12. Production Possibility Frontier (PPF)

13. Shift in PPF 14. Rotation of PPF

01

Learning Objectives
Learning Objectives
1 Introduction 2 Microeconomics and Macroeconomics

3 Scarcity 4 Central Problems of an Economy

5 Economic Problem 6 Opportunity Cost

7 Meaning of Economics 8 Production Possibility Frontier (PPF)

9 Positive Economics and Normative Economics 10 Solved Practicals

02

Introduction
Introduction
Every field of study has its own language and its own way of thinking. For example, mathematics talks about
algebra, science deals with experiments, accounts deal with profit and loss and so on. Economics is no
different. An Economist's language consists of terms like demand, supply, market, etc. In the coming
chapters, you will come across many new terms and some familiar words that economists use in specialized
ways.
The most important purpose of this book is to help you understand an economist's way of thinking. Of course,
as one cannot become a mathematician overnight, in the same way, learning to think like an economist will
take some time. Yet with a combination of theory, numericals and live examples, this book will give you
ample opportunity to develop and practice this skill.

Before we proceed to the meaning of economics, let us first understand the meaning of economy and reason
for studying economics.
03

What is an Economy?
What is an Economy?
You must have observed many activities happening around you in your daily life. For instance, you may have
seen factories, mines, shops, offices, flyovers, railways, etc. All these institutions have resources to produce
goods in agriculture, industry, transport, banking, etc.
Vital Processes of an Economy
Economy is a system which provides living to the people. For this objective to be fulfilled, it is necessary that
every economy should undertake three economic activities:

Production Consumption Investment or Capital Formation

These economic activities are known as the essentials or the vital processes of an economy.

On the basis of nature of economic activities, economies can be broadly classified as: Market Economy and
Centrally Planned Economy. It is given in Power Booster Section for knowledge enrichment.
04

Why Study Economics?

Why Study Economics?
We go to a cinema hall to watch a movie. We go to a restaurant to eat. We attend school to get educated or
to be able to earn a living. It means, every activity is conducted for a specific reason. Economics is studied
because it enables us to understand different aspects of the economy.
However, the main reason for study of economics can be simplified to a single word - Scarcity. We all know,
human wants are more than the available resources. So, there is a need to allocate these scarce resources for
the satisfaction of never-ending human wants. Hence, Economics is concerned with selection of resources
under conditions of scarcity.
Let us now understand the concept of 'Scarcity', the root of all economic problems.
05

Scarcity
Scarcity
Scarcity refers to the limitation of supply in relation to demand for a commodity.

It refers to the situation, when wants exceed the available resources. As a result, goods are not readily
available and society does not have enough resources to satisfy all the wants of its people. Scarcity is
universal, i.e. every individual, organisation and economy faces scarcity of resources. Scarcity of resources
calls for economizing of resources. Economizing of resources refers to making optimum use of the available
resources. There is a need to economize, as we have to satisfy our unlimited wants out of limited resources.
Scarcity is not the only problem!
Limitation of resources is not the only problem. In addition to being scarce, resources also have alternate
(different) uses. Alternate use of resources means that a resource can be put to more than one use.
For example, we all know, petrol is scarce in relation to its demand. But there is one more problem. In
addition to its scarcity, it is used not only in vehicles, but also in machines, railway engines, airplanes,
generators, etc.
Whenever, a commodity is chosen for one use, other valuable uses will have to be rejected. It gives rise to
the problem of choice.

For, "Scarcity and Choice go together."

06

Economic Problem
Economic Problem
As we know, human wants are unlimited, but the means to satisfy them are limited. Therefore, all our wants
cannot be fulfilled. In order to maximize satisfaction, every consumer exercises choice, as to which goods
should be consumed and in what quantity. An economic problem is basically a problem of choice.

Economic Problem is a problem of choice involving satisfaction of unlimited wants out of limited resources
having alternative uses.
Reasons for Economic Problem
The 3 main reasons for existence of economic problems are:
Unlimited Human Wants:
Scarcity of Resources: Alternate Uses: Resources are
Human wants are never-
Resources (i.e. land, labour, not only scarce, but they can
ending, i.e. they can never be
capital, etc.) are limited in also be put to various uses. It
fully satisfied. As soon as one
relation to their demand and makes choice among
want is satisfied, another new
economy cannot produce all resources more important. For
want emerges. Wants of the
what people want. It is the example, petrol is used not
people are unlimited and keep
basic reason for existence of only in vehicles, but also for
on multiplying and cannot be
economic problems in all running machines, generators,
satisfied due to limited
economies. Scarcity is etc. As a result, economy has
resources. Human wants also
universal and applies to all to make choice between the
differ in priorities, i.e. all
individuals, organisations and alternative uses of the given
wants are not of equal
countries. There would have resources.
intensity. For every individual,
been no problem, if resources
some wants are more
were not scarce.
important and urgent as
compared to others. Due to
this reason, people allocate
Reasons for Economic Problem
Resources Vs Human Wants
Features of Resources:

They are scarce, i.e. their supply is limited in They have alternative uses.
relation to demand.

Features of Human wants:

07

Meaning of Economics
Meaning of Economics
Economics is a social science which studies the way a society
chooses to use limited resources, which have alternate uses, to
produce goods and services and to distribute them among different
groups of people.
Why Economics is considered a Social
Science?
The term 'Science' stands for any systematic and organized body of knowledge. Economics is also a science
as it is a systematic and organized study of economic behaviour of human beings. However, it is not an exact
science like Physics and Chemistry as it deals with the study of human behaviour. Therefore, it is known as
social science.
What is Economics all about?
Economics is all about making choices in the presence of scarcity. It studies human behaviour as a
relationship between means (resources) and ends (human wants). Economics aims to ensure that the
resources are used in the best possible manner.
08

Positive Economics and Normative

Economics
Positive Economics (or Science)
Positive economics studies the facts of life, i.e., it deals with 'things as they are'. Positive Economics deals
with what are the economic problems and how are they actually solved. For example, India is an
overpopulated country or prices are constantly rising.

Positive Economics deals with economic issues related to past, present or future, i.e. Positive Economics
describes what was, what is or what will be under the given state of circumstances. These statements do not
pass any value judgements.
Positive Economics is neutral between ends
Positive economics remains strictly neutral with respect to ultimate ends. It avoids economic value
judgements. For example, a positive economic theory might describe that manufacturing and sale of
cigarettes is injurious to health, but it does not provide any instruction or judgement on what policy ought to
be followed to avoid cigarettes in an economy.
According to Robbins, economics is not concerned with moral or ethical questions and economists should
analyse the things as they are and has no right to give judgement.
Do not confuse statements of Positive
Economics as statements of truth
Positive economics statements should not be confused as statements of truth. They may be true or false. For
example, if Paras says that India is larger than China in terms of land area while Utkarsh says that China is
larger than India in terms of land area, then both are positive statements. However, Paras is wrong and
Utkarsh is right.
The point to be noted is that positive statements can be verified as true or false by comparing with actual data.
Normative Economics (or Science)

Normative economics tells us 'what ought to be'. Normative Economics deals with what ought to be or how
the economic problems should be solved. For example, India should not be an overpopulated country or
prices should not rise.
Normative economics discusses what are desirable things and should be realized and what are undesirable
things and should be avoided. It gives decisions regarding what should be done.
Difference between Positive Economics and
Normative Economics
Basis Positive Economics Normative Economics

Meaning It deals with what is or how the economic problems It deals with what ought to be or how the economic
are actually solved. problems should be solved.

Verification It can be verified with actual data. It cannot be verified with actual data.

Purpose It aims to make real description of an economic It aims to determine the ideals.
activity.

Suggestive It is based upon facts, and thus, not suggestive. It is based upon individual opinion and therefore, it
09

Microeconomics and Macroeconomics

Microeconomics and Macroeconomics
The subject matter of economics has been studied under two broad branches:

Microeconomics (Price Theory) Macroeconomics (Income Theory)

These two concepts have become of general use in economics. Let us discuss these concepts in detail.
Microeconomics
Adam Smith is considered to be the founder of the field of microeconomics. The term micro has been derived
from Greek word 'mikros' which means 'small'. Microeconomics deals with analysis of behaviour and
economic actions of small and individual units of the economy, like a particular consumer, a firm or a small
group of individual units. The concept of microeconomics is very important as it supplies the foundation for
most of our understanding of the functioning of an economy.
Microeconomics is that part of economic theory, which studies the behaviour of individual units of an
economy. For example, Individual income, individual output, price of a commodity, etc. Its main tools are
Demand and Supply.
Macroeconomics
The term 'macro' has been derived from the Greek word 'makros' which means large. So, macroeconomics
deals with overall performance of the economy. It is concerned with study of problems of the economy like
inflation, unemployment, poverty, etc.

Macroeconomics is that part of economic theory which studies the behaviour of aggregates of the economy
as a whole. For example, National income, aggregate output, aggregate consumption, etc. Its main tools are
Aggregate Demand and Aggregate Supply.
Micro Vs Macro
In Macroeconomics, the letter 'A' stands for
In Microeconomics, the letter 'I' stands for
'Aggregates', i.e. it studies the economy as a
'Individuals', i.e. it studies the economic
whole.
behaviour of individuals.

Let us discuss the detailed differences between the two branches of economics.

Basis Microeconomics Macroeconomics

Meaning Microeconomics is that part of economic theory Macroeconomics is that part of economic theory
which studies the behaviour of individual units of which studies the behaviour of aggregates of the
an economy. economy as a whole.

Tools Demand and Supply. Aggregate Demand & Aggregate Supply.

10

Interdependence of Microeconomics and

Macroeconomics
Interdependence of Microeconomics and
Macroeconomics
Economics is a single subject and the analysis of an economy cannot be split into two watertight
compartments. It means, microeconomics and macroeconomics are not independent of each other and there
is much common ground between the two. It means, both microeconomics and macroeconomics are
interdependent.
Let us elaborate their interdependence with the help of some examples:
Microeconomics depends on
Macroeconomics
1 Law of demand came into existence from the 2 Price of a commodity is influenced by the
analysis of the behaviour of a group general price level prevailing in the economy.
(aggregate) of people.
Macroeconomics depends on
Microeconomics
National income of a country is nothing but the
Aggregate demand depends on demand of
sum total of incomes of individual units of the
individual households of the economy.
country.
Micro-Macro Paradoxes
Paradox is a seemingly absurd or contradictory statement, though, often a true statement. Sometimes, there
are paradoxes seen in Micro and Macro activities. It means, an act which is beneficial for an individual, may
prove to be harmful for the economy as a whole.

Example: If an individual saves, his family will be benefitted, but if the whole economy starts saving, it will
result in contraction of demand, output, employment and income. As a result, the whole economy will suffer.
Which is more Important - Microeconomics
or Macroeconomics?
Both microeconomics and macroeconomics have a place of their own and none of them can be denied.
Microeconomics concentrates on the working of the individual components and macroeconomics studies the
economy in general. While the former is concerned with structures of the aggregates, the latter is concerned
with the aggregates themselves. So, both the approaches are complementary to each other. The superiority
of one approach over the other cannot be claimed.
11

Central Problems of an Economy

Central Problems of an Economy
In the course of these activities, this scarcity, every society has to decide how to allocate the scarce
resources. It leads to the following Central Problems, that are faced by every economy:

What to produce How to produce For whom to produce

These problems are called central problems because these are the most basic problems of an economy and
all other problems revolve around them.
Allocation of Resources (Studied under
Microeconomics)
Allocation of resources refers to the problem of assigning the scarce resources in such a manner so maximum
wants of the society are fulfilled. As resources are limited in relation to the unlimited wants, it is important to
economize their use and utilize them in the most efficient manner. The problem of allocation of resources is
studied under 3 heads:

What to produce How to produce For whom to produce

In nutshell, an economy has to allocate its resources and choose from different potential bundles or goods
(What to produce), select from different techniques of production (How to produce), and decide in the end,
who will consume the goods (For whom to produce).
What to Produce
This problem involves selection of goods and services to be produced and the quantity to be produced of
each selected commodity. Every economy has limited resources and thus, cannot produce all the goods. More
of one good or service usually means less of others.

For example, production of more sugar is possible only by reducing the production of other goods. Production
of more war goods is possible only by reducing the production of civil goods. So, on the basis of the
importance of various goods, an economy has to decide which goods should be produced and in what
quantities. This is a problem of allocation of resources among different goods.

The problem of 'What to produce' has two aspects:

What possible commodities to produce: An How much to produce: After deciding the goods to
economy has to decide, which consumer goods be produced, economy has to decide the quantity
(rice, wheat, clothes, etc.) and which of the capital of each commodity, that is selected. It means, it
goods (machinery, equipment, etc.) are to be involves a decision regarding the quantity to be
produced. In the same way, economy has to make produced, of consumer and capital goods, civil
a choice between civil goods (bread, butter, etc.) and war goods and so on.
and war goods (guns, tanks, etc.).
How to Produce
This problem refers to selection of technique to be used for production of goods and services. A good can be
produced using different techniques of production. By 'technique', we mean which particular combination of
inputs to be used. Generally, techniques are classified as: Labour intensive techniques (LIT) and Capital
intensive techniques (CIT).

In Labour intensive technique, more labour

1 2 In Capital intensive technique, there is more
and less capital (in the form of machines, etc.)
capital and less labour utilization.
is used.
For example, textiles can be produced either with a lot of labour and a little capital or with less labour and
more capital. Availability of factors and their relative prices helps in determining the technique to be used.
The selection of technique is made with a view to achieve the objective of raising the standard of living of
people and to provide employment to everyone. For example, in India, LIT is preferred due to abundance of
labour, whereas, countries like U.S.A., England, etc. prefer CIT due to shortage of labour and abundance of
capital.
Guiding Principle of 'How to Produce': Combine factors of production in such a manner so that maximum
output is produced at minimum cost, using least possible scarce resources.
For Whom to Produce
This problem relates to the distribution of produced goods and services among the individuals within the
economy, i.e. selection of the category of people who will ultimately consume the goods, i.e. whether to
produce goods for more poor and less rich or more rich and less poor. Since resources are scarce in every
economy, no society can satisfy all the wants of its people. Thus, a problem of choice arises. Goods are
produced for those people who have the paying capacity. The capacity of people to pay for goods depends
upon their level of income. It means, this problem is concerned with distribution of income among the factors
of production (land, labour, capital and enterprise), who contribute in the production process.
It must be noted that production is the result of combined efforts of factors of production. The output
emerging from production is distributed as factor income (rent, wages, interest and profit) on the basis of
their contribution in production. So, the problem of 'For Whom to Produce' is actually concerned with
distribution of income.
The problem can be categorised under two main heads:

Personal Distribution: It means how national Functional Distribution: It involves deciding the
income of an economy is distributed among share of different factors of production in the
different groups of people. total national product of the country.
12

Production Possibility Frontier (PPF)

Production Possibility Frontier (PPF)
Production Possibility Frontier (PPF) refers to graphical representation of possible combinations of two goods
that can be produced with given resources and technology. Alternately, PPF is the locus of various possible
combinations of two goods that can be produced with given resources and technology.
Synonyms of PPF
PPF is also known by the following names:

1 Production Possibility Curve 2 Transformation Boundary

3 Production Possibility Boundary 4 Transformation Frontier

5 Transformation Curve
Assumptions for PPF

Production possibility frontier is based on the following assumptions:

The amount of resources in an economy is fixed, but these resources can be transferred from one use to another.

With the help of given resources, only two goods can be produced.

The resources are fully and efficiently utilized.

Resources are not equally efficient in production of all products. So, when resources are transferred from
production of one good to another, the productivity decreases.

The level of technology is assumed to be constant.

The concept of PPF can be better understood with the help of the following imaginary (hypothetical) schedule
Characteristics or Properties of PPF

PPF slopes Downwards: PPF shows all the PPF is Concave Shaped: PPF is concave shaped
maximum possible combinations of two goods, because of increasing marginal rate of
which can be produced with the available transformation (MRT), i.e. more and more units of
resources and technology. In such a case, more of one commodity are sacrificed to gain an additional
one good can be produced only by taking unit of another commodity. MRT increases because
resources away from the production of another it is assumed that no resource is equally efficient
good. As there exists an inverse relationship in production of all goods. As resources are
between change in quantity of one commodity and transferred from one good to another, less and less
change in quantity of the other commodity, PPF efficient resources have to be employed. This
slopes downwards from left to right. raises cost and raises MRT.
Whether Economy will always operate on
PPF?
It must be remembered that PPF does not show the point at which the economy will actually operate. It only
shows the maximum available possibilities, which an economy can produce.

Economy will operate on PPF Economy will operate at any Economy cannot operate at any
only when resources are fully point inside PPF if resources are point outside PPF as it is
and efficiently utilized. not fully and efficiently utilized. unattainable with the available
productive capacity.

It means:

Economy can either operate on PPF or inside PPF, But, economy cannot operate outside PPF, known
known as 'Attainable Combinations'. as 'Unattainable Combinations'.
Attainable and Unattainable Combinations

Let us clear the concept of 'Attainable and Unattainable Combinations' with the help of illustrations.

Attainable Combinations: It refers to those combinations at which economy can operate. There can be two
attainable options:

Optimum utilization of resources: If the resources are used in the best possible manner, then the
economy will operate at any point (like, A, B, C or D) on PPF.
PPF and Opportunity Cost
The opportunity cost of a product is the alternative that must be
given up to produce that product. PPF illustrates the concept of
opportunity cost. The opportunity cost of producing more butter is
fewer guns. As we move from one point to another on the PPF, we
see that producing more units of one good requires sacrificing units
of another.
13

Shift in PPF
Shift in PPF

The PPF can shift either towards right or towards left, when there is change in resources or technology with
respect to both the goods.

Rightward Shift in PPF: When there is an advancement or upgradation of technology or/and growth of
resources with respect to both the goods, then PPF will shift to the right.
14

Rotation of PPF
Rotation of PPF
It happens when there is change in productive capacity (resources or technology) with respect to only one
good. The rotation can be either for the commodity on the X-axis or for commodity on the Y-axis.

Rotation for commodity on the X-axis: When there is a technological improvement or an increase in
resources for production of the commodity on the X-axis, then PPF will rotate accordingly.
15

Solved Practicals
Practicals on Opportunity Cost
Example 1: Deepak is working as a sales manager at a salary of 1,00,000 per month. He received 2 more job
offers. He got an offer of 70,000 from Reliance Industry and an offer of 85,000 from Tata Industry. What is his
opportunity cost for working as a sales manager?

Solution: In the given case, the next best offer for Deepak is that of 85,000 from Tata Industry. So, the
opportunity cost of Deepak for working as a sales manager is 85,000.

Example 2: A farmer produces 100 kg of wheat on a piece of land with the help of a given quantity of
resources. If this farmer can also produce 70 kg of rice with the same quantity of resources, then what is the
opportunity cost of producing wheat?

Solution: The opportunity cost of producing wheat is 70 kg of rice.

Practicals on PPF
Example 3: Calculate the marginal opportunity cost (MOC) of commodity A for the given combinations:

Commodity A 0 1 2 3 4 5

Commodity B 15 14 12 9 5 0

Solution: Fill in the MOC based on the changes in production.

Overview of PPF
Let us quickly revise the concept of PPF with the help of illustrations.

PPF slopes downwards, as an increase in PPF is concave shaped due to increasing MRT.
production of one good requires decrease in
production of the other.

PPF shows transformation of one good into

PPF shows the maximum available possibilities.
another by diverting resources from one use to
The exact point of operation depends on how
the other.
well the resources of the economy are used.

If the economy operates at any point inside PPF,

If the economy operates on PPF, it means
it means resources are not fully and efficiently
resources are fully & efficiently utilized.
utilized.

Economy cannot operate at any point outside An outward shift in PPF means that the economy
PPF, as it is unattainable with the available can produce more of both the commodities,
productive capacity. which was not possible earlier.
Thank You