COVER PAGE

CHAPTER - 1
INTRODUCTION
ECONOMICS, ECONOMY & CENTRAL PROBLEMS
OF AN ECONOMY

LEARNING OBJECTIVES
TO Differentiate between Microeconomics and Macroeconomics with relevant examples.

To explain the nature of Microeconomics and its importance in analyzing individual

economic behavior.

To analyse the central problems of an economy – what to produce, how to produce, and for
whom to produce.

To Identify the causes of economic problems, such as scarcity of resources and unlimited
wants.

To analyse the concept of opportunity cost and its role in decision-making.

 To draw and develop the concept of the Production Possibility Curve (PPC) and use it to
illustrate economic problems like efficiency, choice, and growth.
Task 1:Explain three factors that lead to an economic problem.

Answer: Economic problem arises because of scarcity of resources in relation to demand for
them.

1. Wants are unlimited:

(a)This is a basic fact of human life. Human wants are unlimited.
(b)They are not only unlimited but also grow and multiply very fast.
2. Resources are limited:
(a)The resources to produce goods and services to satisfy human wants are available in
limited quantities. Land, labour, capital and entrepreneurship are the basic scarce
resources.
(b)These resources are available in limited quantities in every economy, big or small,
developed or underdeveloped, rich or poor. Some economies may have more of one or
two resources but not all the resources.
(c)For example, Indian economy has relatively more labour but less capital and land. The
U.S. economy has relatively more land but less labour. No economy in the world is
comfortable in all the resources.
3. Resources have alternative uses:
(a)Generally a resource has many alternative uses.
(b)A worker can be employed in a factory, in a school, in a government office, self
employed and so on.
(c) Like this, nearly all resources have alternative uses. But the problem is that which
resource should be put to which use.

Task 2. Give reasons for the following statements:

1. Every economy has to make the decision relating to what to produce.

2. Problem of choice arises because available resources have alternative uses.

Answer:

1. As, we know there is no economy in this world which possesses infinite resources to
produce each and everything in infinite quantities.Therefore, if an economy decides to
produce a quantity of one commodity, then they have to sacrifice the production of
another commodity.
2. Resources in eveiy economy are always scarce. But the available resources can be put to
alternative uses. Therefore, an economy will always prefer to make use of its resources in
production of those goods and services that are most required and sacrifice the
production of less- required goods and services.

Task 3:Discuss the central problems of the economy.

The central problems of an economy are
i) What to produce?
ii) How to produce?
iii) For whom to produce?
 1. What to produce?
Every society faces a scarcity of resources. Because we live in a finite world, our resources have
to be allocated based on our collective ‘needs and wants’ as a society. This creates a problem
of choice, where we might have to choose between the different products that can be
produced with the same available resources. For example, consider the practice of agriculture
in a village. Food production and distribution depend upon agriculture.
ii) How to produce?
There are various techniques and methodologies that people and governments can choose
from when they are producing a good or service. For example, based on the way in which
capital and labour are utilized, production can happen through capital-intensive or labour-
intensive methods.
iii) For whom to produce?
Every society has some degree of inequality among its members. So, when we are asking ‘for
whom to produce?’, we are trying to determine who eventually benefits from the activity of
economic production. Producing more luxury good will mean that only the rich can afford to
consume them. In contrast, producing an extensive range of everyday goods at affordable
prices can benefit low-income groups.

Task 4. Distinguish between a Mixed Economy and a Capital economy.

Mixed Economy

● In a mixed economy, all the major economic decisions are taken by the government &
private sector both.
● The government & private owns the means of production and distribution both.
● Prices are set by the government as well as private enterprises.
● An example of a mixed economy would be India.

Capital economy

● In a market economy, the various economic decisions are left to the free market or the
laws of supply and demand.
● Private ownership of the means of production and distribution
● Prices are determined by the relative demand and supply of the products.
● An example of a market economy would be South Korea.

Task 5. Distinguish between microeconomics and Macro

Economics.
Microeconomics

● Deals with the behaviour, choices and incentives of individuals or individual companies.
● Pioneered by economists such as Alfred Marshall
● Can be used to explain consumer behaviour, the theory of price and marketing
principles.
Macroeconomics

● Deals with the economy as a whole, including governments, corporations and

regulatory institutions.
● Pioneered by economists such as J.M. Keynes
● Can be used to explain aggregate market performance, unemployment, growth and
overall market predictions.
Task 6. Explain the following Concepts :-
● A. Meaning of Opportunity Cost with the help of Production
Possibility Schedule.

● Opportunity Cost of any commodity is the amount of other good which has been

● given up in order to produce that commodity. Alternatively opportunity cost of a given

activity is the value of the next best activity.

●
● Initially at combination B, in order to produce one unit of X, the economy has to
sacrifice one unit of Y. So, at combination B, opportunity cost is 1 unit. At combination
C, for producing additional unit of commodity X, the economy has to sacrifice 2 units of
commodity Y. So, at combination C, opportunity cost is 2 units. Similarly, at combination
D, for producing additional unit of commodity X, the economy has to sacrifice 3 units of
commodity Y. So, at combination C, opportunity cost is 3 units and so on.
Task 7. Define Production Possibility Curve and state its properties.

Answer: Production possibility curve is a curve which depicts all possible combinations of two
goods which can be produced with given resources and technology in an economy. Properties
of Production Possibility Curve

1. PPC is downward sloping: The downward slope of PPC means if the country wants to
produce more of one good, it has to produce less quantity of the other goods.
2. PPC is concave to the point of origin: Concave shape of PPC implies that the slope of PPC
increases. Slope of PPC is defined as the quantity of goods Y given up in exchange for
additional unit of goods X.[Slope of Production Possibility Curve]
=ΔYΔX=Amount of Good Y lost Amount of Good X gained
[Slope of PPC] = MRT = [Marginal Opportunity Cost]

Task 8. State any three assumptions on which a production possibilities curve is based.

Answer: The concept of PP curve is based on the following assumptions:

1. First, the amount of resources in the economy is fixed.

2. Second, the technology is given and unchanged.
3. Third, the resources are efficient and fully employed.
Using the figure given below answer the following (Q.9 & Q.10).

Task 9. Does production take place only on PPC?

Answer: Both Yes and No.

Yes, production will take place on PPC, if the given resources are fully and efficiently
utilised. In such case, production will take place at any point on the curve AB, like point F.
No, production will take place on PPC, if the resources are either underutilised or
inefficiently utilised or both. In such case, production will take place on any point below
the curve AB, like point H. Any point below the PP curve, thus highlights the problem of
unemployment and inefficiency in the economy.
 .

Task 10. Why is Production Possibilities Curve concave? Explain.

Answer:

1. PPC is concave because of increasing marginal opportunity cost (MOC).

2. This behavior of the MOC is based on the assumption that all resources are not equally
efficient in production of all goods.
3. Rise in opportunity cost occurs when factors (resources) which are specialized or more
adopted for production of a piece of particular good (say, tanks), is transferred to the
production of another good (say, wheat) for which they are less productive or less
specialized.
4. Thus, transfer of resources from more productive to less productive uses indirectly means
fall in their productivity, with the result more of such resources are needed to produce an
additional unit of the other commodity. Thus marginal opportunity cost goes on increasing
making the PP curve concave in shape.

Critical thinking questions

- “Scarcity and choice go all together”. Defend or refute.

Answer:

1. We defend this statement because scarcity arises as resources are limited. The resources
to produce goods and services to satisfy human wants are available in limited quantities.
Land, labour, capital and entrepreneurship are the basic scarce resources.

2. These resources are available in limited quantities in eveiy economy, big or small,
developed or underdeveloped, rich or poor. Some economies may have more of one or
two resources but not all resources.

3. For example, the Indian economy has relatively more labour but less capital and land. The
U.S. economy has relatively more land but less labour. No economy in the world is
comfortable in all the resources.

4. Since resources are limited, then we have to make a choice because resources have an
alternative use. Generally a resource has many alternative uses. A worker can be
employed on a farm, in a factory, in a school, in a government office, self-employed and so
on. Like this nearly all resources have alternative uses. But the problem is that which
resource should be put to which use.