Theories to understand the basics of Economics

1. Welcome For
2nd Semester

2. INTRODUCTION TO
ECONOMICS

3. The course has been
designed keeping in
mind economics
knowledge expected of
a media professional.
Economics shapes the world.
********
Through economics, people
and countries become
wealthy. Because buying and
selling are activities vital to
survival and success,
studying economics can help
one understand human
thought and behavior.

4. Why Study Economics?
• Economic Issues
• Unemployment
• Inflation
• Economic Growth
• Poverty
• International Trade
• Health Care
• Pollution
• Discrimination
• Immigration
• Education
Vital to Business
An understanding of how to make
economic decisions and the operation
of the economic system enables
business managers & executives to
increase profit.
New technology
Hire/Fire Employees
Recessions
Inflation
Economics helps consumers and
workers make better buying,
employment, & financial decisions

5. What is Economics?
 The term economics comes from the Greek word-
oikos (house) and
nomos (custom or law), hence
“Economics” means "rules of the house(hold)."
 Economics is the social science that studies the production, distribution, and
consumption of goods and services. and the transfer of wealth to produce and
obtain those goods.
 Economics explains how people interact within markets to get what they want or
accomplish certain goals.
 Since economics is a driving force of human interaction, studying it often reveals
why people and governments behave in particular ways.
• Economics – the study of how individuals and societies make decisions
about ways to use scarce resources to fulfill wants and needs.
• Economics can be defined as the Social Science concerned with the Problem
of administering or using Scarce Resources so as to attain the greatest or
maximum fulfillment of society’s Unlimited Wants.

6. "Economics" as "The science of how people make choices for
the allocation of scarce resources to satisfy their unlimited
desires.“
• W. Stanley Jevons who, in the late 19th century, wrote that
economics was: “the mechanics of utility(profit) and self
interest.”
• J.E. Cairnes: “Economics deals with the phenomenon of
wealth.
• F. A . Walker: Economics is that body of knowledge which
relates to wealth.
Definitions

7. Wealth Definition: The early economists like J.E. Cairnes, J.B.Say, and
F.A.Walker have defined economics as a science of wealth.
Adam Smith, who is also regarded as father of economics, stated that
economics is a science concerned with the nature and causes of wealth of
nations.
Adam Smith, known as the Father of Economics.
Established the first modern economic theory, called the Classical School, in
1776.
Smith believed that people who acted in their own self-interest produced goods
and wealth that benefited all of society.
He believed that governments should not restrict or interfere in markets
because they could regulate themselves and, thereby, produce wealth at
maximum efficiency.
Classical theory forms the basis of capitalism and is still prominent today.
Wealth Definition

8. Welfare Definition : Thus according to Marshall, economics not only analysis the
aspect of how to acquire wealth but also how to utilize this wealth for obtaining
material gains of human life.
Welfare Definition
The welfare definition of economics is an attempt by Alfred Marshall, a pioneer
neoclassical economist, to redefine his field of study.
This definition expands the field of economic science to a larger study of humanity.
Specifically, Marshall's view is that economics studies all the actions that people
take in order to achieve economic welfare.
In the words of Marshall, "man earns money to get material welfare."
This definition enlarged the scope of economic science by emphasizing the study
of wealth and humanity together, rather than wealth alone.
The following are the implications of this definition:
 Economics is a study of mankind.
 Human life has several aspects: social, religious, economic and political—but economics is concerned
only with the economic aspect of life.
 Promotion of welfare is the ultimate goal, but the term welfare is used in a narrow sense to meet
material welfare only.

9. Scarcity Definition: Lionel Robbins In his landmark essay on the nature of economics, Lionel Robbins defined
economics as “the science which studies human behaviour as a relationship between ends and scarce
means which have alternative uses”
Scarcity is the fundamental economic problem of having seemingly unlimited human wants and needs in a
world of limited resources. It states that society has insufficient productive resources to fulfill all human wants
and needs.
Features of Scarcity Definition
 Human wants are unlimited:
scarcity definition of Economics states that human wants are unlimited. If one want is satisfied, another want crops up.
Limited means to satisfy human wants:
Though wants are unlimited, yet the means for satisfying these wants are limited. The resources needed to satisfy
these wants are limited. For example, the money income (per month) required for the satisfaction of wants of an
individual is limited. Any resource is considered as scarce if its supply is less than its demand.
 Alternative uses of scarce resources:
Same resource can be devoted to alternative lines of production. Thus, same resource can be used for the satisfaction
of different types of human wants. For example, a piece of land can be used for either cultivation, or building a dwelling
place or building a factory shed, etc.
 Efficient use of scarce resources:
Since wants are unlimited, so these wants are to be ranked in order of priorities. On the basis of such priorities, the
scarce resources are to be used in an efficient manner for the satisfaction of these wants.
 Need for choice and optimisation:
Since human wants are unlimited, so one has to choose between the most urgent and less urgent wants.
Hence, Economics is also called a science of choice. So, scarce resources are to be used for the maximum
satisfaction (i.e., optimisation) of the most urgent human wants.
Scarcity Definition:

10. Modern Growth-Oriented Definition of Samuelson
In relatively recent times, more comprehensive definitions of Economics have been offered. Thus,
Professor Samuelson: “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 over time and
distributing them for consumption, now or in the future, among various persons or groups in society. It analyses costs and benefits
of improving patterns of resource allocation”.
A large number of modern economists subscribe to this broad definition of Economics.
Features of the Modern Growth-Oriented Definition
1. Growth-orientation:
Economic growth is measured by the change in national output over time. The definition says that, Economics is concerned with
determining the pattern of employment of scarce resources to produce commodities ‘over time’. Thus, the dynamic problems of
production have been brought within the purview of Economics.4 ACCOUNTING AND ECONOMICS
2. Dynamic allocation of consumption:
Similarly, under this definition, Economics is concerned with the pattern of consumption, not only now but also in the future. Thus,
the problem of dividing the use of income between present consumption and future consumption has been brought within the orbit
of Economics.
3. Distribution:
The modern definition also concerns itself with the distribution of consumption among various persons and groups in a society.
Thus, while the problem of distribution is implicit in the earlier definitions, the modern definition makes it explicit.
4. Improvement of resource allocation: The definition also says that, Economics analyses the costs and benefits of improving
the pattern of resource allocation. Improvement of resource allocation and better distributive justice are synonymous with
economic development. Thus, issues of development of a less developed economy have also been made subjects of the study of
Economics.
To put it summarily, the modern definition of Economics is the most comprehensive of all the
definitions. All the issues that were highlighted in the earlier definitions are included here.

11. Microeconomics
&
Macroeconomics

12. • Macroeconomics
– The big picture: growth,
employment, etc.
– Choices made by large
groups (like countries)
• Microeconomics
– How do individuals make
economic decisions

13. Microeconomics
• Meaning of microeconomics;
• Market
• Demand
• Supply;
• Law of Demand;
• Law of Supply;
• Law of Diminishing Marginal Utility;
• Elasticity of Demand;
• Consumer’s Surplus.
• Cost,
• meaning of cost;
• types of cost;
• cost curves;
• long run
• and short-run costs.
• Production;
• Production function;
• law of variable proportions;
• Law of Returns;
• Market analysis:
• Types of Market; perfectly competitive
market; monopoly; duopoly; oligopoly;
monopolistic market; price and output
determination in various types of markets

14. Meaning of microeconomics
Microeconomics (from Greek prefix mikro- meaning "small" and economics)
Micro- Macro Economics (Economics noble prize winner (1969), Ragner Frisch was
the first to use the terms micro and macro in economics in 1933.
It is a branch of economics that studies the behavior of individual households and
firms in making decisions on the allocation of limited resources.
'Microeconomics‘
The branch of economics that analyzes the market behavior of individual
consumers and firms in an attempt to understand the decision-making process
of firms and households.
It is concerned with the interaction between individual buyers and sellers and
the factors that influence the choices made by buyers and sellers. In particular,
microeconomics focuses on patterns of supply and demand and the
determination of price and output in individual markets
(e.g. coffee industry).

15. Examples of Microeconomic and Macroeconomic concerns
Production Prices Income Employment
Micro •Production/Output in
Individual Industries and
Businesses
•How much steel
•How many offices
•How many cars
•Price of Individual
Goods and Services
•Price of medical care
•Price of gasoline
•Food prices
•Apartment rents
•Distribution of
Income and Wealth
•Wages in the auto
industry
•Minimum wages
•Executive salaries
•Poverty
•Employment by
Individual Businesses
& Industries
•Jobs in the steel
industry
•Number of
employees in a firm
Macro •National
Production/Output
•Total Industrial Output
•Gross Domestic Product
•Growth of Output
•Aggregate Price Level
•Consumer prices
•Producer Prices
•Rate of Inflation
•National Income
•Total wages and
salaries
•Total corporate
profits
•Employment and
Unemployment in
the Economy
•Total number of jobs
•Unemployment rate

16. Market Demand and Market Supply
Market

17. Market means by which buyers and sellers are brought into contact with each
other and goods and services are exchanged.
Market: A public place where buyers and sellers make transactions, directly or
via intermediaries
"Harper Collins Dictionary of Economics" points out that economists use the
word "market" to describe a mechanism of exchange between buyers and
sellers of a good or service.
The term originally referred to a place where
products were bought and sold; today a market is
any arena, however abstract or far-reaching, in which
buyers and sellers make transactions.

18. Demand: The amount of a particular economic good or service that a consumer or
group of consumers will want to purchase at a given price.
Supply: A fundamental economic concept that describes the total amount of a
specific good or service that is available to consumers.

19. "Supply and Demand"
Supply and demand is perhaps one of the most fundamental concepts of
economics and it is the backbone of a market economy.
Demand refers to how much (quantity) of a product or service is desired by
buyers. The quantity demanded is the amount of a product people are willing to
buy at a certain price; the relationship between price and quantity demanded is
known as the demand relationship.
Supply represents how much the market can offer. The quantity supplied refers to
the amount of a certain good producers are willing to supply when receiving a
certain price.
The correlation between price and how much of a good or service is supplied to
the market is known as the supply relationship.
Price, therefore, is a reflection of supply and demand.

20. "Supply and Demand "
The relationship between demand and supply underlie the forces behind the
allocation of resources. In market economy theories, demand and supply theory
will allocate resources in the most efficient way possible.
How? Let us take a closer look at the
law of demand
&
law of supply
To Understand the theories
detail explanation
follows in coming slides

21. Meaning and Definition of Demand
• According to Benham: “The demand for anything, at a given price,
is the amount of it, which will be bought per unit of time, at that
price.”
• According to Bobber, “By demand we mean the various quantities
of a given commodity or service which consumers would buy in
one market in a given period of time at various prices.”
• Requisites:
a. Desire for specific commodity.
b. Sufficient resources to purchase the desired commodity.
c. Willingness to spend the resources.
d. Availability of the commodity at
• (i) Certain price (ii) Certain place (iii) Certain time.

22. Kinds of Demand
1. Individual demand
2. Market demand
3. Income demand
- Demand for normal goods (price –ve, income +ve)
- Demand for inferior goods
 4. Cross demand
- Demand for substitutes or competitive goods (eg.,tea & coffee, bread and
rice)
- Demand for complementary goods (eg., pen & ink)
 5. Joint demand (same as complementary, eg., pen & ink)
 6. Composite demand (eg., coal & electricity)
 7. Direct demand (eg., ice-creams)
 8. Derived demand (eg., TV & TV mechanics)
 9. Competitive demand (eg., desi ghee and vegetable oils)
 10.Demand of unrelated goods

23. FACTORS AFFECTING DEMAND
• 1. Prices of Goods
• 2.Income of Consumer
• 3.Prices of Related Goods
• 4.Population
• 5.Tastes,Habit
• 6.Expectation about future prices
• 7.Climatic Factors
• 8.Demonstration Effect
• 9.Distribution of national income

24. The Law of Demand
• Prof. Samuelson: “Law of demand states that people will buy more
at lower price and buy less at higher prices, others thing remaining
the same.”
• Ferguson: “According to the law of demand, the quantity demanded
varies inversely with price”.
• Chief Characteristics:
1. Inverse relationship.
2. Price independent and demand dependent variable.
3. Income effect & substitution effect.
• Assumptions:
1. No change in tastes and preference of the consumers.
2. Consumer’s income must remain the same.
3. The price of the related commodities should not change.
4. The commodity should be a normal commodity

25. As the price gets higher, people want less of a
particular product
Quantity
Price
RS.40
Rs.30
Rs.20
Rs.10
10 20 30 40 50 60 70

26. Demand Curve
Rs.3.00
2.50
2.00
1.50
1.00
0.50
2
1 3 4 5 6 7 8 9 10 12
11
Price of
Ice-Cream
Cone
Quantity of
Ice-Cream
Cones
0

27. Determinants of Demand
 Things other than price that cause the whole curve to shift
 Increase: shift to the right
 Decrease: shift to the left
 Change in consumer tastes
 Change in people’s income
 normal goods
 inferior goods

28. Why does the Demand Curve Slope Downward?
Law of Demand
– Inverse relationship between price and quantity.

29. Supply

30. 1) Write your own definition of supply
• Supply is the quantity of a good or service which a seller is willing to provide at a
particular price over a particular time period.
2) What is the law of supply?
• Write your own understanding of the law of supply
• The supply of a good is a function of its own price. Other things equal, the higher the
price of a product the more the sellers will supply. There is a positive relationship
between price and quantity supplied.
• LAW OF SUPPLY There is a direct relationship between price and quantity supplied.
Quantity supplied rises as price rises, other things constant Quantity supplied fails as
supply falls, other things constant.
• There is a direct relationship between price and quantity
supplied.
– Quantity supplied rises as price rises, other things constant
– Quantity supplied fails as supply falls, other things constant.

31. • Law of Supply
– As the price of a product rises, producers will be willing to
supply more.
– The height of the supply curve at any quantity shows the
minimum price necessary to induce producers to supply
that next unit to market.
– The height of the supply curve at any quantity also shows
the opportunity cost of producing the next unit of the good.
• The law of supply is accounted for by two factors:
– When prices rise, firms substitute production of one good for
another.
– Assuming firms’ costs are constant, a higher price means
higher profits.

32. SUPPLY CURVE
Price
Quantity
Rs.40
Rs.30
Rs.20
Rs.10
10 20 30 40 50 60 70
• P, Qs - When price
goes up, quantity
supplied goes up
• P, Qs - When price
goes down, quantity
supplied goes down
graphic representation of the law of supply
The supply curve slopes upward to the right.
The slope tells us that the quantity supplied varies directly – in the same direction – with the price.

33. CHANGE IN QUANTITY SUPPLIED
The supply curve
can be a straight
line or a curve line
but it is generally
upward sloping
Movement is along
the curve
This is applicable in
real life because
producers/sellers
generally want
bigger prices
because they want
bigger profits.

34. DETERMINANTS OF SUPPLY
(Causes of shift in SUPPLY CURVE)
Resource cost
technology
price expectations
Subsidies
taxes

35. 1. RESOURCE COST
If resource cost
decreases
supply
Increases
[making more ]
If resource cost
increases
supply
Decreases
[making more ]
When costs go up, profits go down, so that the
incentive to supply also goes down.

36. 2. TECHNOLOGICAL IMPROVEMENT
Advances in
technology reduce
the number of inputs
needed to produce
a given supply of
goods.
Costs go down,
profits go up,
leading to increased
supply.

37. 3.EXPECTATIONS
• If a change in the international
political climate leads many owners
to expect that oil prices will rise in
the future, they may decide to leave
their oil in the ground, planning to
sell it later when the price is higher.
• Thus, there will be a decrease in
supply; the supply curve for oil will
shift to the left.
If suppliers expect prices to rise in the
future, they may store today's supply to
reap higher profits later.

38. 4. SUBSIDIES
• Free money from
the government
(subsidies)
• induces suppliers
to supply more.
When government subsidies
go up, costs go down, and
profits go up, leading
suppliers to increase output.

39. 5. TAXES
If business have their taxes decreased,
it moves the supply curve to the right.
If business have their taxes increased,
it moves the supply curve to the left.
When taxes go up, costs go up, and
profits go down, leading suppliers
to reduce output.

40. Law of Diminishing Marginal
Utility

41. Law of Diminishing Marginal Utility
Utility is the extra satisfaction that one receives
from consuming a product.
Marginal means extra.
Diminishing means decreasing.

42. • The law of diminishing marginal utility describes a familiar and
fundamental tendency of human behavior.
• The law of diminishing marginal utility states that: “As a
consumer consumes more and more units of a specific
commodity, the utility from the successive units goes on
diminishing”.
• Mr. H. Gossen, a German economist, was first to explain this law
in 1854. Alfred Marshal later on restated this law in the following
words:
• “The additional benefit which a person derives from an
increase of his stock of a thing diminishes with every increase in
the stock that already has”.

43. LAW IS BASED UPON THREE FACTS
• First, total wants of a man are unlimited but each single want can
be satisfied. As a man gets more and more units of a commodity,
the desire of his for that good goes on falling. A point is reached
when the consumer no longer wants any more units of that good.
• Secondly, different goods are not perfect substitutes for each
other in the satisfaction of various particular wants. As such the
marginal utility will decline as the consumer gets additional units
of a specific good.
• Thirdly, the marginal utility of money is constant given the
consumer’s wealth.

44. This law can be explained by taking a very simple example.
Suppose, a man is very thirsty. He goes to the market and buys one glass of sweet
water. The glass of water gives him immense pleasure or we say the first glass of
water has great utility for him.
If he takes second glass of water after that, the utility will be less than that of the
first one.
It is because the edge of his thirst has been blunted to a great extent. If he drinks
third glass of water, the utility of the third glass will be less than that of second and
so on.
The utility goes on diminishing with the consumption of every successive glass
water till it drops down to zero. This is the point of satiety. It is the position of
consumer’s equilibrium or maximum satisfaction.
If the consumer is forced further to take a glass of water, it leads to disutility causing
total utility to decline.
Cont …

45. -…
The marginal utility will become negative.
A rational consumer will stop taking water at the point at which marginal utility
becomes negative even if the good is free.
In short, the more we have of a thing, ceteris paribus, the less we want still more
of that, or to be more precise.
“In given span of time, the more of a specific product a consumer obtains, the less
anxious he is to get more units of that product” or we can say that as more units
of a good are consumed, additional units will provide less additional satisfaction
than previous units.
The following table and graph will make the law of diminishing marginal utility more clear.
Cont …
Example for ceteris paribus : It's when you hold one variable constant to review how changes in
the economy would be effected. For instance if you're trying to look at unemployment and you
want to see how changes in pricing affect labor, then you'd need to hold (ceteris parabis) all
other factors the same such as supply of the labor force, market value of the item, etc. to see the
relationship between only unemployment and pricing.

46. SCHEDULE OF LAW OF DIMINISHING MARGINAL UTILITY
From the above table: it is clear that in a given span of time, the first glass of water to a thirsty
man gives 20 units of utility.
When he takes second glass of water, the marginal utility goes on down to 12 units; When he
consumes fifth glass of water, the marginal utility drops down to zero and if the consumption of
water is forced further from this point, the utility changes into disutility (-3).
Here it may be noted that the utility of then successive units consumed diminishes not because
they are not of inferior in quality than that of others.
We assume that all the units of a commodity consumed are exactly alike. The utility of the
successive units falls simply because they happen to be consumed afterwards.
Units Total Utility Marginal Utility
1st glass 20 20
2nd glass 32 12
3rd glass 40 8
4th glass 42 2
5th glass 42 0
6th glass 39 -3

47. Diminishing Marginal Utility
20
16
12
8
4
MU
0
1 2 3 4 5
DMU
X
Y
glass of water
6
-3
Cont…

48.  In the above figure, along OX we measure units of a commodity
consumed and along OY is shown the marginal utility derived from them.
 The marginal utility of the first glass of water is called initial utility. It is
equal to 20 units.
 The MU of the 5th glass of water is zero. It is called satiety point*.
 The MU of the 6th glass of water is negative (-3).
 The MU curve here lies below the OX axis.
 The utility curve MM/ falls left from left down to the right showing that the
marginal utility of the success units of glasses of water is falling.
*The condition of being full or gratified beyond the point of satisfaction
Diminishing Marginal Utility

49. ASSUMPTIONS OF LAW OF DIMINISHING MARGINAL UTILITY
 (i) Rationality: In the fundamental utility analysis, it is assumed that the consumer is balanced. He aims at
maximization of utility subject to availability of his income.
 (ii) Constant marginal utility of money: It is assumed in the theory that the marginal utility of money based
for purchasing goods remains constant. If the marginal utility of money changes with the increase or decrease
in income, it then cannot yield correct measurement of the marginal utility of the good.
 (iii) Diminishing marginal utility: Another important assumption of utility analysis is that the utility gained
from the successive units of a commodity diminishes in a given time period.
 (iv) Utility is additive: In the early versions of the theory of consumer behavior, it was assumed that the
utilities of different commodities are independent. The total utility of each commodity is additive.
 (v) Consumption to be continuous: It is assumed in this law that the consumption of a commodity should
be continuous. If there is interval between the consumption of the same units of the commodity, the law may
not hold good. For instance, if you take one glass of water in the morning and the 2nd at noon, the marginal
utility of the 2nd glass of water may increase.
 (vi) Suitable quantity: It is also assumed that the commodity consumed is taken in suitable and reasonable
units. If the units are too small, then the marginal utility instead of falling may increase up to a few units.
 (vii) Character of the consumer does not change: The law holds true if there is no change in the character
of the consumer. For example, if a consumer develops a taste for wine, the additional units of wine may
increase the marginal utility to a drunkard.
 (viii) No change to fashion: Customs and tastes: If there is a sudden change in fashion or customs or taste
of a consumer, it can than make the law inoperative.
 (ix) No change in the price of the commodity: there should be any change in the price of that commodity
as more units are consumed.

50. LIMITATIONS OF LAW OF
DIMINISHING MARGINAL UTILITY
There are some exceptions or limitations to the law of diminishing utility.
(i) Case of intoxicants: Consumption of liquor defies the low for a short period. The more a
person drinks, the more likes it. However, this is truer only initially. A stage comes when a
drunkard too starts taking less and less liquor and eventually stops it.
(ii) Rare collection: If there are only two diamonds in the world, the possession of 2nd diamond
will push up the marginal utility.
(iii) Application to money: The law equally holds good for money. It is true that more money
the man has, the greedier he is to get additional units of it. However, the truth is that the
marginal utility of money declines with richness but never falls to zero.
Summing up, we can say that the law of diminishing utility, like other laws of Economics, is
simply a statement of tendency. It holds good provided other factors remain constant.

51. Activity

52. END