Introduction to Economics Lecture 1

1. Introduction to EconomicsLecture 1

2. What is Economics? Economics is a social science. The big two concepts that Economics deals with are : Resources are scarce (limited) 2) Society has unlimited needs and want. In Economics we try to find the “best” way to allocate limited resources in society.

3. How Do Economists Study Human Behavior? • Economics is a social science that studies human behaviour. In Economics we study how individuals and groups make decisions about satisfying their wants and needs given that we have limited resources. • If we think Economics as a scientific method then we follow these steps: • Observation→Theory→Data→Testing • Economic Theory and Models In a model we do the following things: • We do simplification by assumption. • We use the concept “Ceteris Paribus” – Holding other factors constant. For example: The demand of a product is affected by many factors like price, income , taste , substitute good etc. But in the demand schedule we only look at the change in quantity demanded due change in price holding other factors constant.

4. The Economic Problem • Fundamental Questions of Economics - Scarcity requires all societies to answer the following questions: • What is to be produced? • How is to be produced? • For whom will it be produced • What goods and services should an economy produce? – should the emphasis be on agriculture, manufacturing or services, should it be on sport and leisure or housing? • How should goods and services be produced? – labour intensive, land intensive, capital intensive? • Who should get the goods and services produced? – equal distribution? more for the rich? for those who work hard?

5. Main Two Branches of Economics • Microeconomics is a branch of economics that studies the behaviour of individuals and firms in making decisions on the allocation of limited resources. Microeconomics examines how the decisions and behaviours of economic agents affect the supply and demand for goods and services, which determines prices. • Macroeconomics is the field of economics that studies the behaviour of the economy as a whole. It involves the "sum total of economic activity, dealing with the issues like growth, inflation, and unemployment etc.

6. Economic Agent • In economics, an agent is a decision maker in a model. Typically, every agent makes decisions by solving a optimization/choice problem. • In microeconomics there are two agents: • Consumer / buyer • Producer / seller • In macroeconomics there are four agents: • Consumers • Producers • Government • Foreign Country

7. Factor of Production • In economics, factors of production are the inputs that are usedto the production process. • There are three factors of production: • Labor ( Both physical and mental labor) • Capital ( Ex: machineries, buildings etc) • Land (not only the site of production but natural resources above or below the soil) All three of these are required in combination at a time to produce a commodity. Question: What are the returns of factors of production? • Wage is the return of labor. • Rent is the return of land. • Interest is the return of capital.

8. PPF Production Possibility Frontier: It shows the maximum amount of goods and services that can be efficiently produced in an economy by available inputs/resources and technology. All the points on the PPF are efficient. ( Here efficient means no more output can be produce from the given inputs/resources. That means there is no wastage of resources) All the points inside the PPF are inefficient. All the points outside the PPF are infeasible / impossible

9. D C 2,200 A 2,000 Production possibilities frontier B 1,000 300 600 700 The Production Possibilities Frontier Quantity of Computers Produced 3,000 Quantity of 0 1,000 Cars Produced

10. Shift of PPF Two factors can affect the PPF • Increase or Decrease in Resource/ input • Technological Change

11. Opportunity Cost • Opportunity cost of a choice is the value of the best alternative forgone. • It is the cost expressed in terms of the next best alternative sacrificed • It helps us view the true cost of a decision. • Example: The opportunity cost of labour/ work is leisure. For example if you are working then you cannot watch movie. So here the opportunity cost of working is watching movie.

12. Production Possibility Frontiers If the economy reallocates its resources (moving round the PPF from A to B) it can produce more consumer goods but only at the expense of fewer capital goods. The opportunity cost of producing an extra X1 – Xo consumer goods is Yo – Y1 capital goods. Capital Goods Ym A Yo B Y1 Consumer Goods Xo X1 Xm

13. Demand Curve The law of demand states that, holding all other factors constant, when the price of a product increases, quantity demanded decreases; likewise, as the price of a product decreases, quantity demanded increases. This implies that price of a product and its quantity demanded are negatively related. Demand Curve: It shows how price and quantity demanded are related. Demand curve is downward sloping. Why does demand curve slopes downward? For the initial units of a good an individual gets higher satisfaction from consuming that good. So he is willing to pay more initially. But as he consumes more of a good his satisfaction from consuming the good decreases and so he will be willing to pay less. So the willingness to pay/price is inversely related to quantity demanded. That’s why demand curve is downward sloping.

14. Example • Suppose we are considering a consumer who is very thirsty and wants to consume water. He will be willing to pay different prices for different units of glass of water. Initially he is very thirsty and so he will be willing to pay more. But as he drinks more water he is satisfying his thirst. So he will be willing to pay less for additional units of water.

15. Supply Curve • The law of supply states that, holding all other factors constant, when the price of a product increases, quantity supplied increases; likewise, as the price of a product decreases, quantity supplied decreases. This implies that price of a product and its quantity supplied are positively related. • Supply Curve: It shows the relationship between price and quantity supplied. • Why does it slope upward? • Higher prices embody greater incentives for firms to produce more output because profit opportunities are enhanced.

16. Example • Suppose a supplier wants to supply water in the market. If the price is low he will supply less. He will increase his supply of water if the price of water increases.