CHAPTER 1: INTRODUCTION

1. Define microeconomics.
Microeconomics is the study of individual decision-making units such as particular firms,
particular households, individual prices, wages, incomes of individual industries, particular
commodities etc. It is also known as Price Theory.
2. What is economics?
Economics is the study of how people, individually and collectively allocate their limited
resources to try to satisfy their unlimited wants.
3. What do you understand by positive economic analysis?
Positive economic analysis deals with things as they are. It describes what was, what is and
what should be under the given set of circumstances. It analyses cause and effect. It is capable
of empirical verification. These statements do not pass any value judgment.
For e.g. there is no value judgment in the statement that consumers tend to maximize their
satisfaction and the producers tend to maximize their profits.
4. What do you understand by normative economic analysis?
Normative economic analysis deals with ‘things as they ought to be’. Its objective is to
determine the norms or aims. These statements pronounce value judgment and therefore not
verifiable.
5. Give 3 examples of positive statements.
• India is a poor country.
• Population of India has been continuously rising during the last five decades.
• Unemployment is on rise in India.
6. Give 3 examples of normative statements.
• Government should encourage capital formation for removal of poverty.
• People should adopt small family norms.
• Rural industries should be promoted to remove unemployment.
7. What is meant by scarcity of resources?
Scarcity of resources means limited availability of resources in relation to demand. Goods
and services are scarce because there are not enough resources to produce all the goods and
services that people want to consume. Greater the scarcity higher the price of the goods.
8. Why does the problem of choice arise?
Economic problem or problem of choice occurs because:
• Resources are limited in relation to our demand.
• Resources have alternative uses.
9. Why does an economic problem arise?
Economic problem arises because the resources available in an economy (land, labor, and
capital) are limited in relation to the unlimited wants for goods and services which can be
produced and resources have alternative uses.

10. What is meant by economizing the use of resources?

Economizing the resources means that resources are to be used in a manner such that
maximum output is realized per unit of input. It also means optimum utilization of resources.
11. Explain how scarcity and choice go together.
Resources are not only scarce but also have alternative uses. Thus, land which is scarce can
be used for producing wheat or for constructing warehouses or factories. Hence, the problem
of choice arises. Man has to choose among the wants to the satisfaction of which resources
should be allocated. So scarcity of resources and choice go together. If the resources were
available in abundance, then there would have been no problem of choice.
12. Although water is useful, it is cheap. On that contrary a diamond is not of much use
but is very expensive. Give an economic reason for this paradox.
The economic reason for this paradox is scarcity. The test of scarcity is the price. Water is
cheap although it is useful and so high in demand, it is available in plenty. Diamonds are very
expensive because they are scarce in relation to their demand therefore people are ready pay
a high price.

CENTRAL PROBLEMS OF AN ECONOMY

1. What are the three central problems of an economy? Why do they arise?
Central problems of an economy are:
• What to produce – the problem of choice related to the production of different goods.
• How to produce – the problem of choice related to the techniques of production.
• For whom to produce – the problem of choice related to the distribution of output.
These problems are central to every economy. These arise because:
• Resources are scarce in relation to the unlimited wants, and
• Resources have alternate uses.
2. Explain the 3 central problems of an economy.

Central problems facing every economy are:

(i) What to produce and how much to produce?
(ii) How to produce?
(iii) For whom to produce?

i) “What to produce” refers to the choice of the product to be produced by the society
for that good which is in actual need of the society. We need to use the resources to
produce goods & services, & the common resources are used to produce two different
goods. For instance, during peace time, the society can avoid producing Guns and can
utilize more of the resources to produce other good which is actually needed by the society
(say Trucks). This kind of situation arises to all the countries because the limited
resources can’t be utilized to produce all the goods required by the society.
Now, after deciding about the production of a good, the society needs to take decision the
required quantity to be produced. This is inevitable as excess production may lead to the
problem of overproduction and further to wastage of resources, and less production may
lead to scarcity of the product which may further lead to the problems like inflation etc.
Thus, the society needs to estimate the requirement of a good to be produced.
ii) “How to produce” is related to the choice of technique to produce the goods &
services. The society need to make a choice between labour intensive and capital-intensive
technique of production. The overpopulated societies (like India) cannot choose the
 capital-intensive technique, other than few large-scale industries, because this may
aggravate the problem of unemployment in the society, and moreover the dearth of
capital is also a barrier too. But there is a need of using capital intensive technique for the
large-scale industries. On the contrary, the advanced nations can choose the method of
capital intensive technique since there is a dearth of labour and adequacy of capital. Thus,
every society need to choose an optimum mix combination of both labour & machines so
that maximum output can be produces at the least possible cost with
efficient use of resources.
iii) “For whom to Produce” is another problem which refers to choose of distribution
that needs to be focused for the equal distribution of the resources for the benefits of large
many people so as to reduce unequal distribution of the resources and create an
egalitarian society. This problem is concerned with the personal and functional
distribution of resources among the people in the society. The former refers to the
distribution of GDP among the different sections of the society, while the later refers to
the distribution of factor incomes to the factor owners in lieu of their factor services
towards the production of national output. This determines the purchasing power of the
people & accordingly the goods & services are produced in the society.
3. State the economic problems relating to the allocation of resources.
Every economy is faced with the fact of scarcity of resources. Available resources in any
economy are not sufficient to produce all the required commodities in adequate quantities
to meet the requirements of all. Therefore, a choice has to be made about:
• The type of goods to be produced – what to produce?
• The amount of factor resources to be used in production of each type of goods – how to
produce?
• Distribution of the produced goods among a large number of consumers, and
• Efficient use of available resources.
All these problems are collectively known as the problem of resource allocation.

PRODUCTION POSSIBILITY CURVE:

1. What is production possibility?

PPC graphically represents the various combinations of 2 goods which can be produced
with a given amount of resources assuming that:
• The resources are fully and efficiently employed.
• Technique of production remains constant.

This can be explained by the following illustration:-

Combination Production Production of Y MOC/MRT

of X =∆Loss/∆Gain

A 0 10 -
B 1 9 1
C 2 7 2
D 3 4 3
E 4 0 4
 From the above illustration we can see that when we go to produce one more
unit of the good X then we sacrifice one unit of Good Y initially, then the rate
of sacrifice of the good Y goes on increasing by 2, 3 and 4 units respectively.
Graphically
Y
P a
b
WHEAT
c

CLOTH P x
PPC is production possibility curve between cloth and wheat. It is generally concave to the
origin. Points a, b, and c which lie on PPC represent the situation when the given resources
are fully employed.
Any point below this curve indicates that the resources are not fully and efficiently used.
2. Why does PPC look concave to the origin?
PPC looks concave to the origin because of increasing marginal opportunity cost of
shifting resources from commodity Y to commodity X. Thus we have to sacrifice more and
more of good Y in order to increase the production of good X by a unit.
• As more and more of good X is produced, factors producing it become marginally less and
less productive. So more and more of other goods have to sacrifices to ensure a unit
increase of the former good.
• Initially the resources that are shifted to the production of good X are more suitable for
its production. But later, the resources are shifted from the production of good Y to
production of good X. Therefore, more of these resources are required for one unit
increase in the production of X.
• Concave to the origin – points a, b, and c which lie on PPC represent situation when the
given resources are fully employed. Any point below this curve indicates that the resources
are not fully and efficiently used.
3. Which central problem is highlighted by PPC?
The problem of what to produce and in what quantity.
4. What determines the shape of PPC?
Marginal opportunity cost.
5. Give 2 examples of under-utilization of resources.
• Unemployment
• Inefficient use of available resources.
6. Give 2 examples of growth of resources.
• Improvement in number and skills of laborers.
• Advancement of technology.
 7. What factors lead to rightward shift of PPC?
i) Technological progress
ii) Increase in literacy leading to more skilled labour.
8. When is allocation of resources in an economy considered ‘inefficient’?
Allocation of resources in an economy is considered as inefficient when the economy is
producing anywhere inside the PPC. This means when an alternative reallocation of
resources can increase the production of any goods.
9. Give 2 examples of under-utilization of resources.
• Labour is under-utilized in less developed countries leading to mass unemployment.
• Capital is under-utilized during depression due to lack of demand in capitalist country
leading to fall in production due to lack of demand.
10. A lot people died and many factories were destroyed because of a severe
earthquake in a country. How will it affect the country’s PPC?
With death of lot of people due to severe earthquake, amount of labor in a country will
fall. Similarly, destruction of factories causes a reduction in the stock of capital of a
country. Thus, earthquake causes destruction in labor and capital resources of a country.
This decrease in resources causes a shift of production possibility curve to the left showing
less of production of two goods than before.
11. ‘An economy always produces on, but not inside a PPC.’ Discuss.
An economy does not always produce on PPC. PPC shows the possibilities of producing
different combinations of two goods with a given amount of resources assuming that
resources are fully employed and most efficiently used. So, when the economy produces
on PPC it means there is not unemployment. If in reality there is unemployment and
inefficient use of resources, an economy will operate inside PPC.

y
a
b
k c

x
An economy always tries to produce on PPC. But it may produce at ‘k’ when there is under-
utilization of resources.

12. Draw a PPC and show the following situations on the diagram.
• Full employment of resources
• Under-utilization of resources
• Growth of resources.
 y A full employment of resources

.u b

Under-utilization of resources

P’
P
Growth of resources

p P’

We have drawn a production possibility curve in fig. 1. Points ‘a’ and ‘b’ which lie on the PPC represent
the situation when the given resources are fully employed. Point ‘u’ in fig.1 which lies inside the PPC
represents the situation on under-utilization of resources.

When the growth of resources (when there is improvement in technology), production possibility
curve PP shifts outward to P’P’ shown in fig.2.

13. What are the assumptions made while drawing PPC?

The assumptions are:
• There is given amount of resources.
• Resources are fully employed and most efficiently used.
• The technology of production remains constant.

OPPORTUNITY COST:

14. What is opportunity cost?

The opportunity cost of a good is the value of the next best alternative good forgone for it.
E.g. a farmer produces 50kg of wheat on an area of land by using a given quantity of resources.
He can also produce 40kg of potatoes with the same amount of factors of production. Here,
the opportunity cost of 50kg of wheat is 40kg of potatoes.

15. What is marginal opportunity cost?

Marginal opportunity cost of a good along a PPC is defined as the amount of one good that
needs to be sacrificed per unit increase in production of the other good.
 Marginal opportunity cost = ∆ loss of output of wheat
∆ Gain of output of cloth

16. Why does opportunity cost of a good increase as more units of a good are
produced?
The rise in marginal opportunity cost of a good occurs because various productive resources
are more suited of efficient for the production of different goods.
For e.g. land is more suited of efficient for the production of wheat than for the production of
cloth. On the other hand, textile machinery and automotive looms are more specialized or
efficient for the production of cloth than for wheat. As a result, some productivity is lost when
resources which are more productive for the production of one good are transferred to the
production of another good. This causes increase in opportunity cost of a good when more
quantity of it is produced.
Thus, the increase in marginal opportunity cost occurs as it becomes increasingly difficult to
substitute the resources which are used in the production of wheat to suit the production of
pencils. The difficulty in substituting factors of production from one good to another arises
because factors are specific to a certain production process. This increasing marginal
opportunity cost gives rise to the concave shape of the PPC.

17. Explain the different types of economy?

(i) Capitalist economy / Market economy
(ii) Socialist economy / Planned economy
(iii)Mixed economy
• Market Economy: It is an economic system, in which all material means of
production is owned and operated by the private with profit motive.
• Planned Economy: In this economy all material means of production are owned by the
government or by a centrally planned authority. All important decisions regarding
production, exchange and distributions, consumptions of goods and services are made by
the government or by a centrally planned authority

18. Distinguish between a centrally planned economy and a market economy.

S.No. Planned Economy Market Economy

1 All the materials mean of All the materials mean of production
production are owned by govt. are owned by private individuals.

2 Main objectives of production Main objectives of production are

is social welfare maximization of profit

3 Ownership of property is under There is no limit to private ownership

government control. of property.

4 All the economic problems are All the economic problems are solved
solved as per direction of the through price mechanism i.e., demand
planning commission. and supply
 Difference between Positive Economics and Normative Economics

POSITIVE ECONOMICS NORMATIVE ECONOMICS

it expresses what it is. it expresses what should be.
It is based on cause and effect of It is based on ethics.
facts.
It deals with actual or realistic It deals with idealistic situation.
situation.
It cannot be verified with actual data
In this value judgment are not In this value judgment is given.
given.
It deals with how an economy It deals with how an economy
problem can be solved. problem should be solved.
Economists of positive school are Economists of normative school are
Adam Smith and his followers. Marshall, Pigou, Hicks etc.

Microeconomics and Macroeconomics

1. Microeconomics deals with the behavior of individual decision-making units such as consumers,
resource owners, etc. It is also called Price theory.
2. Macroeconomics deals with aggregate such as national income, aggregate consumption, etc. It
is also called Theory of Income and Employment.
3. Both micro and macroeconomics are complementary and should be utilized for proper
understanding of an economy.

Sl No Micro economics Macro economics

1 It studies individual economic unit. It studies aggregate economic unit
2 It deals with determination of price and It deals with determination of general
output in individual markets price level and output in the economy.
3 Its central problems are price Its central problem is determination
determination and allocation of of level of Income and employment in
resources. the economy.

Higher Order Thinking Skill

1. When PPC slopes downward in straight line?
Answer- PPC can only slope downward in a straight line when factor inputs used in
production process is equally efficient. It makes MRT as unity on PPC by which it slopes
downward in a straight line.
2. Why microeconomics is called price theory?
Answer- It is subject matter of microeconomics which is determination of relative prices of
different goods and services. So it is called price theory.
3. What is meant by increasing marginal opportunity cost along a PPC mean?
Answer-Increasing MOC along a PPC means that as we produce more and more units of a
commodity, we have to forego quantity of another commodity at an increasing rate.
 4. What do you understand by attainable and unattainable combinations of output?
Answer- Attainable combinations refer to those combinations of output of goods which lie on
or inside the PPC of an economy. If the economy is able to make full and efficient utilization
of its resources and technology then it will be operating on the PPC and if it fails to make their
best utilization, it will lead to a point inside PPC. Any point outside the PPC shows
unattainable combinations of output of two goods.
5. How does PPC affected when manpower resources and natural resources become
scarce due to a natural calamity?
Answer- When some factor resources remain unemployed or factor inputs are due to a natural
calamity, PPC shift downward. It will mean a less amount of both the goods to be produced with the
given lesser resources.
6. Massive unemployment will shift the PPF to the left. Defend or refute.
Ans. The given statement is refuted. Massive unemployment does not decrease the capacity of
economy to produce. So, there will be no shift of PPF However, economy will operate at
some point inside the PPF due to un-utilization of human resources.
7. On the basis of given diagram, answer the following questions:
(i) On the production possibility curve AE, if the Economy decides to produce 50 million
tons of wheat, then how many tanks it can produce?
(ii) If there is growth in resources, what will happen to the production possibility curve?
(iii) Which point in the diagram represents underutilization of resources?
(iv) Which of the points in diagram is an unattainable Combination?
(v) Identify the point at which the economy will operate if resources are fully and efficiently
utilized.

Ans i) Zero Tanks.

ii) The Production possibility curve will shift towards right.
iii) Point F
iv) Point G
v) If resources are fully and efficiently utilized, then economy can operate at any point
(Like Point A, B, C, D, or E) on the production possibility curve.
 Value Based Questions

1. Indian economy is not utilizing its available resources to the maximum possible
extent. As a result, its PPC is placed at lower level compared to the potential level.
What needs to be done in this period?
Answer-(a) Economy has to identify the forces that prevent it from utilizing the resources
fully and efficiently.
(b) In most production areas especially in rural areas, techniques of production need to be
upgraded.

2. Production in an economy is below its potential due to unemployment. Government

starts employment generation schemes. Explain its effect on PPC.
Answer- Since economy is producing below the PPC, for example at point K in the following
diagram.
When government undertakes some employment generation schemes, the economy moves
up to reach the potential. The upward movement will be towards its PP curve. If
unemployment is fully removed. then the economy would starts operating on its PP curve.
3. A farmer is getting more profit in producing opium than in production of wheat. In
the situation of famine which crop should be produced?
Ans- Production of Wheat because in the situation of famine, food grain like wheat is
required more than opium. Value- Social Welfare
4. There are various sources of income a teacher has such as
1. He can earn Rs 40000 from teaching in school.
2. He can earn Rs 50000 by tuition/coaching
3. He earns Rs 60000 by writing help book guides.
What is the opportunity cost of teaching in school? Why should he choose teaching
profession?
Ans -Opportunity cost of teaching is writing books. He should choose teaching profession
because it provides maximum social welfare. Value- Social Welfare
5. What efforts should be made in an economy for the continuous use of exhaustible
`natural resources in production?
Ans – There are the various efforts-
1. To increase use of renewable resources
2. To explore the substitutes of resources
3. To reduce the wastage of resources.
4. To spread awareness about the effectively and optimum use of natural resources.
Value -Environmental Conservation