MODULE 1

Definition of Economics
Economics is the study of how people, businesses, and governments make choices about using
limited resources like time, money, and materials to satisfy their needs and wants. It looks at how
these choices affect everyone and the world around us.

Common Definitions and Their Meanings

1. Wealth Definition (Adam Smith)

Economics is the study of wealth—how it is created, distributed, and used.
o Meaning: This focuses on understanding money, trade, and the economy's
growth.

Merits:

o Helps understand how countries become richer and develop.

o Emphasizes the importance of managing resources well.

Demerits:

o Ignores human well-being and other non-wealth factors like happiness or health.
o Over-focus on wealth can lead to unfair resource distribution.
2. Welfare Definition (Alfred Marshall)
Economics is about improving people's well-being and making life better through
resource management.
o Meaning: It studies how economic activities can make people happy and improve
their quality of life.

Merits:

o Focuses on human welfare, not just money.

o Recognizes the role of economics in improving living standards.

Demerits:

o Difficult to measure welfare, as happiness and satisfaction are subjective.

o May overlook the technical aspects of managing resources.
3. Scarcity Definition (Lionel Robbins)
Economics studies how to manage limited resources to meet endless wants.
o Meaning: It highlights that resources like money and materials are limited, so we
must choose wisely.

Merits:

o Emphasizes decision-making and prioritization.

o Helps understand trade-offs and opportunity costs.
 Demerits:

o Ignores social and human welfare aspects.

o Overly focused on limited resources without considering how to expand or
develop them.
4. Growth-Oriented Definition (Paul Samuelson)
Economics is about making decisions on resource use to ensure growth, development,
and improvement over time.
o Meaning: It focuses on how economies can grow and provide better futures for
people.

Merits:

o Balances welfare and resource management.

o Looks at long-term progress and sustainable development.

Demerits:

o May not address immediate human needs.

o Growth might sometimes come at the cost of environmental or social issues.
 Nature and Scope of Microeconomics and Economics
Nature and Scope of Microeconomics

Microeconomics focuses on small, individual parts of the economy, like households, businesses,
and specific markets. It looks at how these parts make decisions about resources, prices, and
production.

Nature of Microeconomics:

1. Individual Focus:
It studies the behavior of individuals or single entities like one consumer, one business, or
one market.
2. Decision-Making:
It explains how people or companies decide what to buy, what to sell, and how to use
their resources wisely.
3. Resource Allocation:
It shows how resources like money, time, and materials are distributed among competing
uses.
4. Price and Market Analysis:
It examines how prices are set in markets and how demand and supply influence these
prices.

Scope of Microeconomics:

1. Product Pricing:
Studies how prices of goods and services are determined.
2. Consumer Behavior:
Explores how people decide what to buy based on their preferences and budget.
3. Production and Costs:
Looks at how businesses produce goods and manage costs to maximize profits.
4. Market Types:
Analyzes different markets, like competition, monopoly, and others.
5. Economic Welfare:
Studies how economic activities improve people's satisfaction and well-being.

Nature and Scope of Economics

Economics is a broader subject that studies how individuals, businesses, governments, and
societies manage resources to satisfy needs and improve living standards.
Nature of Economics:

1. Social Science:
Economics deals with human behavior and decision-making about resource use.
2. Scarcity and Choice:
It focuses on managing limited resources and making choices to meet unlimited wants.
3. Dynamic and Evolving:
Economics changes over time as societies grow and face new challenges like technology,
trade, and climate change.
4. Problem-Solving:
Economics aims to solve issues like poverty, unemployment, inflation, and growth.

Scope of Economics:

1. Microeconomics and Macroeconomics:

Microeconomics looks at small parts of the economy, while macroeconomics focuses on
the economy as a whole, like national income, inflation, and unemployment.
2. Production, Distribution, and Consumption:
Economics studies how goods and services are made, shared, and used.
3. Economic Policies:
Helps governments and organizations create policies to improve living standards and
manage the economy.
4. International Economics:
Examines trade between countries, globalization, and foreign investments.
5. Development Economics:
Focuses on improving the economies of poor or developing countries.
 Economic Systems: Types, Characteristics, Merits, and Demerits
An economic system is the way a society organizes its resources and production to meet people's
needs and wants. Different societies have different systems based on their values, goals, and
resources.

1. Traditional Economy

• Definition: Based on customs, traditions, and historical methods of production and trade.
People produce what they need for survival.
• Examples: Indigenous tribes, rural areas in developing countries.

Characteristics:

• Relies on agriculture, hunting, fishing, and barter.

• Decisions are guided by customs and traditions.
• Little use of modern technology.

Merits:

• Strong community ties and cultural preservation.

• Sustainable and environmentally friendly.

Demerits:

• Limited progress and innovation.

• Poor standard of living and lack of access to modern goods and services.

2. Command Economy (Planned Economy)

• Definition: The government controls all economic decisions, including production,

pricing, and distribution.
• Examples: North Korea, former Soviet Union.

Characteristics:

• Centralized decision-making by the government.

• Focus on meeting national goals over individual preferences.
• Limited private ownership of resources.
Merits:

• Can ensure equal distribution of resources.

• Useful in achieving rapid industrialization.
• Reduces unemployment and poverty.

Demerits:

• Lack of personal freedom and choice.

• Inefficiency and wastage due to lack of competition.
• Slow to adapt to consumer needs and market changes.

3. Market Economy (Capitalist Economy)

• Definition: Decisions about production and distribution are made by private individuals
and businesses based on supply and demand.
• Examples: United States, Australia.

Characteristics:

• Resources are privately owned.

• Prices are determined by supply and demand.
• Minimal government interference.

Merits:

• Encourages innovation and efficiency.

• Consumers have a wide variety of choices.
• Higher economic growth and wealth generation.

Demerits:

• Can lead to income inequality.

• Exploitation of workers and resources.
• Neglects social welfare and environmental concerns.

4. Mixed Economy

• Definition: Combines elements of both market and command economies. Both

government and private individuals participate in economic decisions.
• Examples: India, United Kingdom, Canada.
Characteristics:

• Coexistence of private and public sectors.

• Government regulates key industries while allowing private ownership in others.
• Balances profit-making with social welfare.

Merits:

• Combines the best of both systems: innovation with regulation.

• Addresses income inequality and provides public goods like healthcare and education.
• Ensures economic stability and growth.

Demerits:

• Risk of inefficiency due to government interference.

• Can lead to corruption and bureaucracy.
• Balancing private and public interests can be challenging.
 Relationship Between Microeconomics with other Discipline
Microeconomics looks at small parts of the economy, like individual people, businesses, and
specific markets. It studies how they make decisions about using limited resources, like money
or materials. These ideas and methods are connected to and help understand other fields. Here's
how microeconomics relates to them:

1. With Macroeconomics

Microeconomics focuses on small details, while macroeconomics looks at the big picture. Small
decisions, like what a family spends or a business invests, add up to shape the whole economy.

2. With Business Studies

Microeconomics helps businesses figure out how to set prices, manage costs, and understand
customer behavior to make better decisions and earn more profit.

3. With Law

Laws about competition and protecting consumers often use microeconomics to ensure fair
practices, like preventing monopolies or making sure prices are reasonable.

4. With Politics

Governments use microeconomic ideas to make policies, like setting taxes or giving subsidies,
by understanding how these affect people and businesses.

5. With Sociology

Microeconomics overlaps with sociology when looking at how culture or social habits influence
what people buy and how they behave in markets.
6. With Psychology (Behavioral Economics)

Psychology helps explain why people don’t always act logically in economic decisions, like
spending on things they don’t need or avoiding savings.

7. With Environmental Studies

Microeconomics is useful for studying how people and companies use natural resources and how
to encourage better practices, like reducing pollution.

8. With Health Economics

It helps explain how people decide on healthcare, how hospitals set prices, and how insurance
changes what care people choose.

9. With Statistics/Math

Microeconomics uses math and data to predict trends, analyze markets, and test ideas, like
figuring out how much demand changes if prices go up or down.

10. With Ethics

Microeconomics connects with ethics when looking at fair treatment, like paying workers fairly
or making products that don’t harm people.
MODULE 2
 Demand and Determinants of Demand
What is Demand?

Demand is the quantity of a product or service that people are willing and able to buy at a
specific price during a certain period. For demand to exist, two things must happen:

1. Desire: The person must want the product or service.

2. Ability to Pay: The person must have enough money to buy it.

Determination of Demand

Demand for a product is influenced by several factors. These factors are known as determinants
of demand. Let’s explore them in more detail:

1. Price of the Product

• Law of Demand: When the price of a product goes down, demand usually goes up, and
when the price goes up, demand usually goes down (all other factors being constant).

2. Income of Buyers

• When people’s income increases, they can afford to buy more, and demand for goods
typically rises. This is true for normal goods (like clothes, cars).
• However, for inferior goods (like very cheap or lower-quality products), demand might
fall as income increases because people switch to better alternatives.

3. Prices of Related Goods

• Demand for a product is influenced by the price of other products. There are two types of
relationships:
o Substitutes: Products that can replace each other.
o Complements: Products that are used together.

4. Tastes and Preferences

• Changes in consumer preferences directly affect demand. Trends, advertisements, and

social influences can make products more or less desirable.
5. Expectations of Future Prices

• What people expect about future prices can change demand now:
o If buyers believe prices will increase in the future, they’ll buy more now to save
money.
o If they expect prices to fall, they’ll wait, reducing current demand.

6. Number of Buyers

• The total demand in a market depends on the number of people willing to buy the
product.

7. Seasonal Factors

• Certain products see changes in demand based on seasons or special events.

8. Government Policies

• Taxes, subsidies, or regulations can affect demand.

o If the government increases taxes on cigarettes, their price rises, and demand falls.
o Subsidies on electric vehicles make them cheaper, increasing demand.

9. Demographic Factors

• Age, gender, and other population characteristics influence demand.

 Law of Demand and Why Demand curve slopes Downward
The Law of Demand states that the quantity of a good or service demanded by people increases
when its price decreases, and decreases when its price increases, provided all other factors
remain constant (ceteris paribus).

In simpler terms, as things become cheaper, people buy more, and as they become expensive,
people buy less.

Why Does the Demand Curve Slope Downward?

The downward slope of the demand curve reflects the reasons people tend to buy more at lower
prices and less at higher prices. Let's explore the reasons in detail:

1. Substitution Effect

• When the price of a product decreases, it becomes relatively cheaper than other similar
products (substitutes). People will switch from the more expensive alternatives to the
cheaper product, increasing its demand.
• When the price increases, the opposite happens—people substitute the product with
cheaper alternatives.

2. Income Effect

• A decrease in the price of a product means people have more purchasing power—their
money can buy more goods. This makes people feel wealthier, so they tend to buy more
of the product.
• Conversely, if prices rise, people feel poorer because their money buys less, reducing
demand.

3. Diminishing Marginal Utility

• Utility means satisfaction or benefit from consuming a product. The more of a product a
person consumes, the less satisfaction they get from each additional unit. This is called
diminishing marginal utility.
• Because of this, people are only willing to buy additional units if the price is lower.
4. Law of Opportunity Cost

• As prices decrease, the opportunity cost (the value of what you give up) of buying the
product decreases, making it more attractive.
• For instance, when the price of a good falls, people find it easier to afford it without
giving up other items they value, increasing demand.

5. Market Expansion

• When prices drop, new buyers who couldn’t afford the product at higher prices enter the
market, increasing demand.
• When prices rise, some buyers may leave the market, decreasing demand.

Graphical Representation

The demand curve slopes downward from left to right because of the inverse relationship
between price (vertical axis) and quantity demanded (horizontal axis).

Key Points:

• At higher prices, fewer people are willing or able to buy, so quantity demanded is low.
• At lower prices, more people are willing or able to buy, so quantity demanded is high.
 Elasticity of Demand
Elasticity of Demand refers to how much the quantity demanded of a product changes when its
price changes. In simple terms, it's a measure of how sensitive people are to price changes. If the
demand for a product goes up a lot when the price goes down, we say the demand is elastic. If
the demand doesn’t change much when the price changes, the demand is inelastic.

Types of Elasticity of Demand:

• Elastic Demand: When the price of a product changes, and the quantity demanded
changes a lot (greater than the price change). For example, if a small price decrease
leads to a large increase in sales, the demand is elastic (e.g., luxury goods, non-essential
items).
• Inelastic Demand: When the price changes, but the quantity demanded doesn’t change
much. For example, if the price of salt or medicine increases slightly, people still buy
roughly the same amount. These products are necessary, and demand doesn’t change
easily.
• Unitary Elasticity: When the price changes, and the quantity demanded changes exactly
in the same proportion. For instance, if the price increases by 10%, the quantity
demanded decreases by exactly 10%.
• Perfectly Elastic Demand: This is a rare case where consumers will only buy at a
specific price, and any price increase will result in no demand at all.
• Perfectly Inelastic Demand: This is when the quantity demanded doesn’t change at all,
regardless of the price change. For example, life-saving medications might be perfectly
inelastic because people need them regardless of price.

Determinants of Elasticity of Demand:

• Availability of Substitutes: If there are many alternatives for a product, its demand is
likely to be more elastic. For example, if the price of a brand of chips goes up, people
might easily switch to another brand.
• Necessity vs. Luxury: Necessities, like food or medicine, tend to have inelastic demand
because people need them no matter the price. Luxuries or non-essential items have
elastic demand because people can live without them.
• Time Period: In the short term, demand tends to be less elastic because people may not
change their habits immediately. Over time, however, people might find alternatives or
adjust to price changes, making demand more elastic.
• Proportion of Income: If the price change for a product takes up a large portion of a
person’s income, the demand will likely be more elastic. For example, a significant price
increase for a car or house would likely make people think twice before purchasing.
• Brand Loyalty: If people are loyal to a brand, they may continue buying even if the
price increases, making the demand inelastic.
MODULE 3
 Diminishing and Equi-Marginal Utility
Diminishing Marginal Utility

Diminishing Marginal Utility is the idea that as you consume more of something, the
satisfaction (or pleasure) you get from each additional unit decreases. In simpler terms, the more
you have of something, the less you enjoy it each time.

Importance:

1. Explains Why We Get Less Satisfaction:

• The more of something you consume, the less satisfaction you get from each
additional unit. For example, eating one piece of cake is great, but eating five might
not be as enjoyable.

2. Helps Set Prices:

• Businesses know that people will only pay so much for more of the same thing. That’s
why discounts or deals are offered to encourage people to buy more.

3. Guides How We Spend Money:

• Because we get less satisfaction from extra units, we tend to spend our money on
things that give the most value first, instead of buying more of the same thing.

4. Affects What We Buy:

• As satisfaction from one product decreases, we might look for something else to buy
that gives us more happiness.

5. Shapes Market Demand:

• In the market, as people buy more of a product, they’re willing to pay less for each
extra unit because of diminishing utility.

Law of Equi-Marginal Utility

The Law of Equi-Marginal Utility states that when you have limited resources (like money or
time), you should spend them in a way that the last unit of money spent on each good gives you
the same amount of satisfaction. This means you should balance how you spend your money
across different things so you get the most happiness or value.

Importance:

1. Maximizes Happiness: It ensures you get the most enjoyment or value from your
spending.
2. Efficient Use of Resources: It helps you avoid wasting money by balancing what you
spend on different things.
3. Better Choices: It guides you to make smarter decisions about how to spend your money
or time.
4. Helpful in Budgeting: It helps you plan your budget wisely, ensuring you get the best
value for every dollar spent.
5. Business Understanding: It helps businesses price their products in a way that appeals to
consumers' needs.

Relationship Between the Two Concepts:

• Diminishing Marginal Utility explains that as you consume more of something, you
enjoy each additional unit less.
• Law of Equi-Marginal Utility builds on this by helping people make the best use of
their resources, ensuring that they get the most happiness by spending their money or
time in a balanced way. It prevents people from spending too much on something that
doesn't give them enough satisfaction compared to something else.
 The Price Effect is a summation of Income Effect
and Substitution Effect
The Price Effect is the overall change in the quantity demanded of a product when its price
changes. It combines two effects: the Substitution Effect and the Income Effect. Here’s a
detailed explanation of each:

1. Substitution Effect:

• What It Is: When the price of a product changes, people often change their buying
behavior by substituting that product with a similar one that is now cheaper (if the price
increases) or more expensive (if the price decreases). This effect happens because
consumers aim to maximize their satisfaction, and if one product becomes cheaper,
they’ll buy more of it instead of a more expensive one.

2. Income Effect:

• What It Is: When the price of a product changes, it affects how much of that product
people can afford to buy. If the price of a product rises, consumers feel like they have less
income or purchasing power because they can now afford fewer units of that product.
Conversely, if the price drops, their purchasing power increases, and they can afford to
buy more of that product.

The Price Effect:

• The Price Effect is the total change in the quantity demanded when the price of a good or
service changes. It is the sum of both the Substitution Effect and the Income Effect.
• When Price Falls:
o Substitution Effect: Consumers will likely buy more of the cheaper product
because it has become more attractive compared to alternatives.
o Income Effect: Consumers feel they have more money to spend, so they may
purchase more of the product or other goods.
o Overall Effect: The demand for the product increases because of both the
substitution of alternatives and the increased purchasing power.
• When Price Rises:
o Substitution Effect: Consumers will likely buy less of the more expensive
product and seek cheaper alternatives.
o Income Effect: Consumers feel poorer because the product has become more
expensive, so they may reduce consumption of that product and other things.
o Overall Effect: The demand for the product decreases because people substitute
away from it and feel they can no longer afford to buy as much.
Summary of the Price Effect:

• Substitution Effect: When the price of a good changes, consumers will substitute it with
a similar good if it becomes cheaper or switch to something else if it becomes more
expensive.
• Income Effect: When the price of a good changes, it affects consumers’ ability to buy it.
If the price rises, they feel like they have less income and may reduce their demand; if the
price falls, they feel like they have more income and may increase their demand.
 Indifference Curves (IC) Properties and
How it Achieve Equilibrium

Indifference Curves (IC)

An Indifference Curve (IC) represents all combinations of two goods that give a consumer the
same level of satisfaction or utility. It shows trade-offs between goods, helping to understand
consumer preferences and choices.

Properties of Indifference Curves (IC)

1. Downward Sloping:
o What It Means: An indifference curve slopes down from left to right. This shows
that if you get more of one good, you have to give up some of the other good to
keep the same level of happiness or satisfaction.
2. Convex to the Origin:
o What It Means: Indifference curves are curved inward, meaning as you get more
of one good, you're less willing to give up a lot of the other good for it. This
shows that people prefer balanced combinations of goods.
3. Higher ICs Represent Higher Satisfaction:
o What It Means: Indifference curves farther from the origin represent higher
levels of satisfaction. This is because, as you move away from the origin, you
have more of both goods, which leads to more happiness.
4. Indifference Curves Never Intersect:
o What It Means: Two indifference curves cannot cross each other because each
curve represents a different level of satisfaction. If they crossed, it would mean
that the same combination of goods gives two different satisfaction levels, which
is impossible.
5. Smooth and Continuous:
o What It Means: Indifference curves are usually smooth and don’t have sudden
jumps. This means that a consumer’s preferences change gradually and
consistently as they shift between different combinations of goods.

How Indifference Curves Achieve Equilibrium

Equilibrium means that the consumer is making the best possible choice given their budget and
preferences. Here’s how indifference curves help find that point:
1. Budget Constraint (BC):
o What It Means: The budget constraint shows all the combinations of goods a
person can afford based on their income and the prices of the goods. It’s usually
represented as a straight line on a graph.
2. Tangency Condition:
o What It Means: Equilibrium is found where the indifference curve touches (or is
tangent to) the budget line. At this point, the rate at which you are willing to trade
one good for another (how much you value each good) is equal to the market’s
rate of exchange (price ratio between goods).
3. Marginal Rate of Substitution (MRS):
o What It Means: The Marginal Rate of Substitution (MRS) is the rate at which
a consumer is willing to trade one good for another while maintaining the same
level of satisfaction. At equilibrium, the MRS (the slope of the indifference curve)
equals the price ratio (the slope of the budget line).
4. Optimal Choice:
o What It Means: The optimal choice occurs when the budget line is tangent to
the highest indifference curve. This means you’re getting the maximum
satisfaction possible given your budget. You’ve made the best decision on how to
spend your money.