Basic economic concepts

Chapter # 01
 Twin theme of economics.

Economics the study of how

societies use scarce resources to
produce valuable commodities and
distribute them among different
people.

Behind this definition are two Key

ideas (themes) in economics: that
goods are scarce and that society
must use its resources efficiently.
Scarcity occurs where it's impossible to meet all
unlimited desires and needs of the peoples with
limited resources i.e; goods and services.

 Society must need to find a balance between

sacrificing one resource and that will result in getting
other.

 Efficiency denotes the most effective use of a

society's resources in satisfying peoples wants and
needs.

Thus, the essence (real meaning) of economics is to

acknowledge (admit) the reality of scarcity and then
figure out how to organize society in a way, which
produces the most efficient use of resources.
Emergence of economic problems
Two major factors are responsible for the
emergence of economic problems. They are:
i) the existence of unlimited human wants and
ii) the scarcity of available resources.

The numerous human wants are to be satisfied

through the scarce resources available in
nature.

Economics deals with how the numerous human

wants are to be satisfied with limited resources.
If the time or resources at our disposal are unlimited so
that we could satisfy all our wants, then no economic
problem would have arisen at all.

Or If we had Aladdin’s lamp with us so that we could

satisfy all our wants by rubbing it, then there would have
been no economic problem.

 The economic problem has arisen simply because as one

want is satisfied, another want appears on the scene.

We can liken (compare, associate) this to a see-saw with

on one hand the finite or limited resources and on the
other hand the unlimited or infinite wants.
As wants are unlimited and the means to satisfy
them are limited, therefore, in order to get maximum
satisfaction we are to choose our wards (area, zone,
region) by fixing up a list of priority.

The common meaning of scarcity refers to

unavailability ( i.e. not easily found) in the market of
a certain commodity.

 The conceptual meaning of scarcity, in economics, is

however different. A commodity is scarce because it
commands value. It commands price.

We have to pay for any goods and services we want

to consume. In addition, the resources that we have
are also always limited.
Economic problems arise because the goods we
need are scarce.

These scarce goods have many uses.

Again, these uses are tempting (persuasive,

attractive , appealing) and competing with each
other.

There is a problem of choice- choice between

alternative uses.

Therefore, scarcity and choice guide the whole

course of economic activities.
Let us have a clear concept of these two
important terms;
It is not just an individual problem. It is the
problem of national economy as well. Its
dimension changes when it is applied to
national economy. In other words, scarcity of
resources gives birth to national economic
problems.
Scarcity brings broad human problems in to
our notice.
There is a poverty and human misery (sadness,
depression) because of scarcity of resources.

 A poor man is poor because the resources

accessible to him are scarce. A country is poor
To understand and analyze the problem of
poverty of a man and a country, and to
eradicate it, proper understanding of the
problem of scarcity is of utmost importance.

Scarcity tells us about the importance of a

commodity as well. It tells us how valuable a good
is because a lot of scarce resources is being spent
to get it.

 If the resources were not used for the specific

purpose, these could be used elsewhere.

 The resources are not only scarce but they have

also alternative uses. These uses produce different
results – some use result into high values and
The resources is better used if it results into higher
return. Higher return signifies two meanings.

For an individual consumer, it means higher

level of satisfaction and for producers it means
higher level of profits.

In other words, all the economic units will aim at

optimization of their objectives.

By using available resources the aim of the

consumers, producers and government will be to
optimize satisfaction, profit and welfare of the
people.
Choice:
 The optimization objectives of the economic
actors necessitates making knowledgeable
choice in the use of available resources.

It also concerns individual and the state. The

problem of choice begins with an individual’s
liking of how much time he would allot for
work and how much for leisure.

The more time he assigns for work, lesser

time is available for leisure. At the same time
the more he works, the more he earns.
On the income earned, the choice is between how much
to consume now and how much to save for the future.

Choice in consumption means what to buy – food or

clothes, sweets or toys, or a combination of both in
limited quantity, etc.

 Similarly, choice in the income saved is between where

to deposit the saving – in bank or hold idle cash at home.

The bank too make choices about where to invest the

deposits it receives.

It invests, of course, in such sectors where it is more

profitable. That is the chain of choice goes on deeper and
deeper referring to the profitable use of resources at the
hand of economic actors.
Samuelson's three questions
America’s first Nobel Prize winner for
economics, the late Paul Samuelson, is often
credited with providing the first clear and
simple explanation of the economic problem -
namely, that in order to solve the problem of
scarcity all societies, no matter how big or
small, developed or not, must endeavor (try,
attempt, make an effort) to answer three
basic questions.
(i) What goods to be produce? The first function of the
society is to decide which goods are to be produced and in
how much quantity. Since the resources at the disposal of
the society are scarce, it has to make a choice between
“guns or butter”, or a choice between necessities and
luxuries.

The decision about the allocation of resources between

consumer goods and capital goods; their quality and
quantity is of utmost importance from the point of view of
economic growth.

 So, allocation is best which satisfies the most urgent need

of society .

The problem of what to produce and how much to produce

depends on the necessity of the citizens of the country.
(2) How to produce?
The second question also concerned with the method
of production.
In some cases, labor may play a major role. It is
called labor – intensive technology.

In others, capital may play a major role. It is called

capital – intensive.

Labor intensive method creates more job favoring

more employment. It helps in mitigating
unemployment problem.
Capital –intensive production goes for large volume
of production. It commands rapid growth rate.
The right decision depends on the current state of
3) For whom to produce :
Finally, all societies need to decide who will get the
output from the country’s economic activity, and
how much they will get. For example, who will get
the computers and cars that have been produced?
This is often called the problem of distribution.

Production for masses or productions for profit are

two major choices that every economy has to decide.

As the development level goes higher, production of

superior goods proceeds towards super profit.

Meeting the basic requirements of all segments of

population is the main criterion (principle, condition)
of resource allocation.
Nature of Economics
Economics as a Science
To consider anything as a science, first, we should
know what science is all about?

Science deals with systematic studies that signify

(indicate, indicate) the cause and effect relationship.

In science, facts and figures are collected and are

analyzed systematically to arrive at any certain
conclusion.

For these attributes, economics can be considered as

a science.
However, economics is treated as a social science because
of the following features:

It involves a systematic collection of facts and figures.

Like in science, it is based on the formulation of theories
and laws.
It deals with the cause and effect relationship.
Economics helps in integrating various sciences such as
mathematics, statistics, etc. to identify the relationship
between price, demand, supply and other economic
factors.

These points validate that the nature of economics is

correlated with science.

Just as in science, various economic theories are also

based on logical reasoning.
Economics is a positive or normative science?

Positive Economics: A positive science is one

that studies the relationship between two
variables but does not give any value judgment,
i.e. it states ‘what is’ or ‘what was’. It deals
with the facts about the entire economy.

Normative Economics: As a normative

science, economics passes value judgement,
i.e. ‘what ought to be’. It is concerned with
economic goals and policies to attain these
goals.
2. Economics as an Art
Art is a discipline that expresses the way things
are to be done, so as to achieve the desired end.

 It is said that “knowledge is science, action is

art.” Economic theories are used to solve various
economic problems in society.

Thus, it can be inferred that besides being a

social science, economics is also an art.

Hence, economics is concerned with both

theoretical and practical aspects of the economic
problems which we encounter in our day to day
life.
 Scope of Economics
 Economists use different economic theories to solve various
economic problems in society. Its applicability is very vast.
From a small organization to a multinational firm, economic
laws come into play.

 The scope of economics can be understood under two

subheads: Microeconomics and Macroeconomics.

 These two terms were at first used by Ragner Frisch in 1933.

But these two words became popular worldwide and most of
the economist using nowadays.
1. Microeconomics
The term micro was originated from Greek word
‘Mikros’ which means small. Hence,
microeconomics is concerned on small
economic units or individual units like as
individual consumer, households, firms, industry
etc.

Hence, microeconomics tries to explain how an

individual allocates his money income among
various needs as well as how an individual
maximize satisfaction level from the
consumption of available limited resources.
It is the study of individual tree not a whole
forest. Simply microeconomics is microscopic
Micro­economics seeks to explain and predict
such things as the prices and outputs of firms
and industries, the choices of consumers in
buying goods and services, production
efficiency and costs, the adjustment of
markets to new conditions, etc.

In microeconomics, we study two things:

(i) How prices of commodities and inputs are

determined; and
(ii) How resources are allocated in different
sectors of the economy.
2. Macroeconomics
The term macro- economics is derived from Greek
word “ Makros”, which means “ big”.

Hence, macro- economics studies not individual

units but all the units combined together or the
economy as a whole.

Since it studies the economy in aggregate. It studies

national income, national output, general price level,
total employment, total savings, total investment
and so on.

It is also called “aggregate economics” or the

“income theory”.
Definitions of economics
 The word ‘Economics’ was derived from two Greek words,
oikos (a house) and nemein (to manage) which would mean
‘managing a household’ using the limited funds available,
in the most satisfactory manner possible.

 Definition: Economics is that branch of social science

which is concerned with the study of how individuals,
households, firms, industries and government take decision
relating to the allocation of limited resources to productive
uses, so as to derive maximum gain or satisfaction.

 Simply put, it is all about the choices we make concerning

the use of scarce resources that have alternative uses, with
the aim of satisfying our most urgent infinite wants and
distribute it among ourselves.