Introduction

What is economics?
Economy comes from the Greek word oikonomos, which means
one who manages a household.
Like a household, a society face many decisions about how to
allocate resources and output in best possible ways.
Why do we need to manage societys resources?

Scarce

Economics is the study of how society manages its scare resources.

What is economics?
Society manage its resources via combined action of

Households Firms

Economists study how people make decisions and how people

interact with one another.
Economics at individual level
How do people make decisions?

Principle 1: People and society face trade-offs

At individual level trade off is between one goal Maximize
against another. Utility

At societal level trade off is between efficiency Maximize

and equity. Welfare
Economics at individual level
Principle 2: Cost of something is what you give up to
get it

Facing trade off means comparing costs Minimize

costs

Compare the cost of what we have chosen with Opportunity

what we have given up to come to a decision cost
Economics at individual level
Principle 3: Rational people think at the margin

Rational
Economist assume that individuals are rational people can
weigh the
trade-offs

Rational individuals take decisions by comparing Optimize the

marginal benefits and marginal costs outcomes

Rational individual takes an action when marginal benefits > marginal cost
Economics at individual level
Principle 4: People respond to incentives

Weighing benefits with cost, make rational individuals Behavioral

act to incentives trait

Incentives are crucial for analyzing how market works, an incentive for
a buyer may not be an incentive for a seller

Policy makers alter behavior of individual by incentivizing

Economics at collective level
How do people interact?

Principle 5: Market can make everyone better off

Market allows each individual to specialize in Greater
what they do best division of
labour

Market ensures greater variety of goods and Monopolistic

services competition

Goods and services are available at lower cost

Economics at collective level
Principle 6: Markets are a good way to organize
economic activity

Market economy allocate scarce resources in most efficient way

Firms decide whom to hire and what to make

Households decide which firm to work for and what to buy

Adam Smith has said interaction of households and firms are guided by
invisible hand of market.
Economics at collective level
Principle 7: Governments can improve market
outcomes

Government is necessary to enforce rules and to maintain institutions

key to a market economy.

Government facilitates the invisible hand.

Government enforce property rights so that individuals can own

and control scarce resources.
Economics at collective level
Principle 7: Governments can improve market
outcomes
Government is responsible for handling the societal trade off of
efficiency vs. equity.
Sometimes, the invisible hand of market is unable to allocate the
resources efficiently due to market failure.

There are two possible causes of market failures

Externality Market power

Economy as a whole
Principle 8: A countrys standard of living depends on
its ability to produce goods and services
Country GDP in USD Billion (2015) Per capital income USD
USA 18036.65 51638.10
China 11064.66 6497.50
UK 2861.10 41182.60
India 2088.80 1751.70
Brazil 1803.65 11211.89

Variation in per capita income is visible in various measures of quality of life.

Variation in per capital is observed due to differences in productivity which

in turn is a resultant of institutions.
Organization of economy
Revenue Market for goods Spending

Goods and and services Goods and

services Firms sell services
sold Households buy bought

FIRMS HOUSEHOLDS
Produce and sell goods
and services Buy and consume goods
and services
Hire factors of production
Sell factors of production
Market for factors Labour, land
Factors of Flow of
production of production and capital inputs and
Households sell outputs
Firms buy Income
Wages, rent, Flow of
money
and profit
Competitive versus Noncompetitive Markets

A perfectly competitive market has many buyers and sellers,

hence no single buyer or seller has a significant impact on price.
E.g. agricultural market
Indian airlines industry

A non-competitive market has a very few sellers, who can have

a significant impact on price.
E.g. World Oil market, OPEC cartel
Extent of a market
The boundaries of a market is important both geographically and
in terms of range of products.
For e.g. housing market in Delhi is separate from housing market of Rohtak,
Lucknow.
Petrol market is different in different states.
State Petrol price (1st
June, 2017) Understanding actual and
Delhi 67.12 Rs/Ltr potential competitors
Rohtak 67.13 Rs/Ltr
Lucknow 69.86 Rs/Ltr Understanding public policies
Kolkata 69.65 Rs/Ltr and regulations
Mumbai 78.49 Rs/Ltr
Chennai 69.84 Rs/Ltr
Interaction in market determine prices
Nominal price is the absolute price of a good.
Real price is the price adjusted for inflation; price of a good relative to an aggregate
measure of prices.
CPI- It measures how the cost of a large market basket of goods purchased by a typical
consumer changes over time.

Real price of goods in 2017 =

CPI2005/CPI2017 * nominal price
in 2017