INTRODUCTION

SECTION 1

➢ MEANING OF AN ECONOMY
➢ BASIC ECONOMIC ACTIVITIES
➢ SCARCITY OF RESOURCE
 ▪ DIFFERENCE BETWEEN MICRO ECONOMICS AND MACRO ECONOMICS
 DIFFERENCE BETWEEN POSITIVE AND NORMATIVE ECONOMIC ANALYSIS
 CENTRAL PROBLEMS OF AN ECONOMY:
 WHAT TO PRODUCE
 HOW TO PRODUCE
 FOR WHOM TO PRODUCE.
 OPPORTUNITY COST AND MARGINAL OPPORTUNITY COST
 PRODUCTION POSSIBILITY CURVE/FRONTIER
 PPC TABLE AND GRAPHICAL PRESENTATION
 CHANGES IN PPC

•MICRO AND MACRO •POSITIVE

•ECONOMICS •AND
•NORMATIVE
•ECONOMICS

CENTRAL
PROBLEMS WHAT TO
OF AN PRODUCE
ECONOMY

FOR
HOW TO
WHOM TO
PRODUCE
PRODUCE
• PRODUCTION
••OPPORTUNITY COST •POSSIBILITY
••MARGINAL •FRONTIER / CURVE
•OPPORTUNITY COST

CONCEPT NOTES
❖ MEANING OF AN ECONOMY: THE TERM ECONOMY REFERS TO A SYSTEM OR A PROCESS WHICH HELPS
PEOPLE TO PRODUCE GOODS AND SERVICES WITH THE USE OF AVAILABLE RESOURCE AND HELPS PEOPLE
TO EARN THEIR LIVING.

❖ BASIC ECONOMIC ACTIVITIES: PRODUCTION, EXCHANGE AND CONSUMPTION OF GOODS AND SERVICES
ARE THE BASIC ECONOMIC ACTIVITIES.

❖ SCARCITY OF RESOURCE: THE WORD ‘SCARCITY OF RESOURCE’ REFERS TO SHORTAGE OF RESOURCES /

LIMITED RESOURCES. BUT IN ECONOMICS, THE WORD SCARCITY STANDS FOR LESS SUPPLY OF RESOURCE IN
RELATION TO MORE DEMAND. OF RESOURCE.

❖ MICRO ECONOMICS: MICROECONOMICS IS A BRANCH OF ECONOMICS THAT STUDY THE BEHAVIOR OF

INDIVIDUAL ECONOMIC AGENTS IN THE MARKETS FOR DIFFERENT GOODS AND SERVICES AND TRY TO FIND
OUT HOW PRICES AND QUANTITIES OF GOODS AND SERVICES ARE DETERMINED. THE WORD MICRO
MEANS SMALL.

❖ MACROECONOMICS: MACROECONOMICS IS A BRANCH OF ECONOMICS THAT STUDY THE BEHAVIOR OF

AN ECONOMY AS A WHOLE BY FOCUSING OUR ATTENTION ON AGGREGATE MEASURES SUCH AS TOTAL
OUTPUT, TOTAL EMPLOYMENT AND AGGREGATE PRICE LEVEL. THE WORD MACRO MEANS LARGE.

❖ POSITIVE ECONOMIC ANALYSIS: IN POSITIVE ECONOMIC ANALYSIS, WE STUDY HOW THE DIFFERENT
MECHANISMS OF SOLVING THE CENTRAL PROBLEMS (WHAT TO PRODUCE, HOW TO PRODUCE AND FOR
WHOM TO PRODUCE) OF AN ECONOMY FUNCTION. POSITIVE ECONOMIC STATEMENT CAN BE VERIFIED
BECAUSE THEY ARE BASED ON FACT. THEY DEAL WITH REALISTIC SITUATION.

❖ NORMATIVE ECONOMIC ANALYSIS: IN NORMATIVE ECONOMIC ANALYSIS, WE TRY TO UNDERSTAND

WHETHER THE DIFFERENT MECHANISMS OF SOLVING THE CENTRAL PROBLEMS (WHAT TO PRODUCE, HOW
TO PRODUCE AND FOR WHOM TO PRODUCE) OF AN ECONOMY ARE DESIRABLE OR NOT. THE NORMATIVE
ECONOMIC STATEMENT CANNOT BE VERIFIED BECAUSE THEY ARE NOT BASED ON FACT BUT SUGGESTIVE
ONLY.

❖ CENTRAL PROBLEMS OF AN ECONOMY: THERE ARE MAINLY THREE CENTRAL PROBLEMS RELATING TO
ALLOCATION OF RESOURCES.

❖ WHAT TO PRODUCE: WHAT TO PRODUCE IS ALSO CALLED THE PROBLEM OF RESOURCE ALLOCATION.
EVERY SOCIETY MUST DECIDE ON HOW MUCH OF EACH OF THE MANY POSSIBLE GOODS AND SERVICES
IT WILL PRODUCE. WHETHER TO PRODUCE MORE OF FOOD ITEMS OR CLOTHING, HOUSING OR TO HAVE
MORE OF LUXURY GOODS. WHETHER TO HAVE MORE AGRICULTURAL GOODS OR TO HAVE INDUSTRIAL
PRODUCTS AND SERVICES. WHETHER TO USE MORE RESOURCES IN EDUCATION AND HEALTH OR TO USE
MORE RESOURCES IN BUILDING MILITARY SERVICES. WHETHER TO HAVE MORE OF CONSUMPTION
GOODS OR TO HAVE CAPITAL GOODS WHICH WILL BOOST PRODUCTION AND CONSUMPTION OF AN
ECONOMY.

❖ HOW TO PRODUCE: THE PROBLEM OF HOW TO PRODUCE IS ALSO CALLED THE CHOICE OF TECHNIQUE

OF PRODUCTION. EVERY SOCIETY HAS TO DECIDE ON HOW MUCH OF WHICH OF THE RESOURCES TO USE

IN THE PRODUCTION OF EACH OF THE DIFFERENT GOODS AND SERVICES. GOODS AND SERVICES CAN BE

PRODUCED WITH THE HELP OF TWO TECHNIQUES; THEY ARE LABOR INTENSIVE TECHNIQUE AND CAPITAL

INTENSIVE TECHNIQUE. IN LABOR INTENSIVE TECHNIQUE WE USE MORE LABOR AND LESS CAPITAL.

WHEREAS IN CAPITAL INTENSIVE TECHNIQUE WE USE MORE CAPITAL AND LESS LABOR.

❖ FOR WHOM TO PRODUCE: THE PROBLEM OF FOR WHOM TO PRODUCE IS ALSO CALLED THE PROBLEM

OF DISTRIBUTION OF GOODS AND SERVICES. WHO GETS HOW MUCH OF THE GOODS THAT ARE PRODUCED

IN THE ECONOMY? HOW SHOULD THE PRODUCE OF THE ECONOMY BE DISTRIBUTED AMONG THE

INDIVIDUALS IN THE ECONOMY? WHO GETS MORE AND WHO GETS LESS? WHETHER OR NOT TO ENSURE

A MINIMUM AMOUNT OF CONSUMPTION FOR EVERYONE IN THE ECONOMY. WHETHER OR NOT

ELEMENTARY EDUCATION AND BASIC HEALTH SERVICES SHOULD BE AVAILABLE FREELY FOR EVERYONE IN

THE ECONOMY. THERE ARE TWO ASPECTS IN CONNECTION WITH THIS PROBLEM; ONE DEALS WITH THE

DISTRIBUTION OF PRODUCTION AMONG THE HOUSEHOLD AND SECOND IS ASSOCIATED WITH DISTRIBUTION

OF PRODUCTION AMONG LAND LABOR CAPITAL AND ORGANIZATION (FOUR FACTORS OF PRODUCTION).

❖ OPPORTUNITY COST: OPPORTUNITY COST IS AN IMPORTANT BASIC CONCEPT IN THE SUBJECT

ECONOMICS. THERE IS ALWAYS A COST OF HAVING A LITTLE MORE OF ONE GOOD IN TERMS OF THE
AMOUNT OF THE OTHER GOOD THAT HAS TO BE FORGONE. THIS IS KNOWN AS THE OPPORTUNITY COST OF

AN ADDITIONAL UNIT OF THE GOODS. IN SHORT, WE CAN DEFINE THE TERM OPPORTUNITY COST AS THE

VALUE OF THE BENEFIT THAT IS AVOIDED BY SELECTING AN ALTERNATIVE.

❖ MARGINAL OPPORTUNITY COST: SUPPOSE AN ECONOMY PRODUCES ONLY TWO GOODS X AND Y.

WE CANNOT INCREASE THE PRODUCTION OF BOTH GOODS. IF WE WANT TO INCREASE THE PRODUCTION

OF X GOOD (RICE), WE HAVE TO REDUCE THE PRODUCTION OF Y GOOD (WHEAT). THIS LOSS IS

CALLED MARGINAL OPPORTUNITY COST. IF THE RESOURCES ARE TRANSFERRED FROM ONE USE TO ANOTHER,

THE LESS AND LESS EFFICIENT RESOURCES WILL BE TRANSFERRED LEADING TO RISE IN THE MARGINAL

OPPORTUNITY COST WHICH IS TECHNICALLY TERMED AS MARGINAL RATE OF TRANSFORMATION. WE CAN

NOW DEFINE MRT IN GENERAL TERMS. MRT IS THE RATIO OF UNITS OF ONE GOOD SACRIFICED TO

PRODUCE ONE MORE UNIT OF THE OTHER GOOD.

❖ PRODUCTION POSSIBILITY CURVE/FRONTIER: THE PRODUCTION POSSIBILITY FRONTIER GIVES THE

COMBINATIONS OF TWO GOODS SAY X AND Y THAT CAN BE PRODUCED WHEN THE RESOURCES OF THE

ECONOMY ARE FULLY UTILIZED. THE PRODUCTION POSSIBILITIES (PP) CURVE IS A GRAPHICAL MEDIUM

OF HIGHLIGHTING THE CENTRAL PROBLEM OF 'WHAT TO PRODUCE' AN IN WHAT QUANTITY. THIS CURVE

SHOWS THE OPTIONS THAT ARE OBTAINABLE, OR SIMPLY THE PRODUCTION POSSIBILITIES.
Y (RICE)
PPC TABLE
10
POSSIBILITIES WHEAT RICE
9
A 0 10
B 1 9 7
C 2 7
D 3 4 4

E 4 0
0 1 2 3 4 X (WHEAT)

CHANGES IN PPC: THERE ARE TWO TYPES OF CHANGES IN PPC: 1. SHIFT IN PPC – PPC MAY SHIFT TO RIGHT OR LEFT,
WHEN THERE IS CHANGE IN RESOURCE OR TECHNOLOGY FOR BOTH THE GOODS, SAY X AND Y.
B
P P
GOOD Y

A
GOOD Y

GOOD X
B P A GOOD X P

ROTATION OF PPC – WHEN THERE IS CHANGE IN TECHNOLOGY OR RESOURCES FOR ONLY ONE GOOD, SAY Y OR X,
PPC WILL ROTATE.

B
A RIGHTWARD
C SHIFT
X
(WH T
LEFTWARD
SHIFT
X
 CONSUMER EQUILIBRIUM

CONCEPT OF UTILITY: UTILITY REFERS TO THE WANT SATISFYING POWER OF A COMMODITY. IN OTHER WORDS,
UTILITY REFERS TO SATISFACTION DERIVED FROM THE CONSUMPTION OF A COMMODITY.

TYPES OF UTILITY:1) CARDINAL UTILITY 2) ORDINAL UTILITY.

1) CARDINAL UTILITY: - UTILITY WHICH CAN BE MEASURED IN TERMS OF CARDINAL NUMBERS, LIKE 1,2,3 ETC. PROF.
ALFRED

MARSHALL BELIEVES IN CARDINAL UTILITY.

2) ORDINAL UTILITY: - UTILITY WHICH CAN’T BE MEASURED IN CARDINAL TERMS, BUT CAN BE ‘RANKED’ OR
‘PREFERRED.

PROF. HICKS BELIEVES IN ORDINAL UTILITY PRINCIPLES.

TOTAL UTILITY (TU):- SUM TOTAL OF UTILITY OBTAINED BY CONSUMING THE ENTIRE UNITS OF THE GIVEN
COMMODITY.

SUPPOSE A CONSUMER CONSUMES 2 UNITS OF APPLE, FIRST UNIT GIVES HIM 10 UTILS AND THE SECOND UNITS
GIVES HIM 8 UTILS, THEN THE TOTAL UTILITY WILL BE OBTAINED BY ADDING UP THE UTILITY OBTAINED FROM THE
1ST AND 2ND APPLES, I.E. ,10 UTILS + 8 UTILS, WHICH IS EQUALS TO 18 UTILS.

MARGINAL UTILITY (MU):- ADDITION MADE TO THE TOTAL UTILITY BY CONSUMING ONE MORE UNIT OF THE GIVEN
COMMODITY. IN THE ABOVE GIVEN EXAMPLE, BY CONSUMING THE 2ND UNIT OF APPLE, CONSUMER OBTAINED 8
UTILS, IT IS THE MU OF 2ND UNIT. IF HE CONSUMES THE 3RD UNIT AND OBTAINED 6 UTILS, THEN THE MU OF 3RD
UNIT WILL BE EQUAL TO 6 UTILS.

THUS:

MUX = TU N – TU N-1 OR MU = Δ TUX / Δ Q

AS WE CONSUME MORE AND MORE UNITS OF THE GIVEN COMMODITY, THE MU OBTAINED FROM EACH SUCCESSIVE
UNIT TENDS TO DIMINISH.

RELATION BETWEEN TU & MU

AS MORE AND MORE UNITS OF THE GIVEN COMMODITY ARE CONSUMED, THE MU OBTAINED FROM EACH
SUCCESSIVE UNIT TENDS TO DIMINISH.

 AS LONG AS MU FALLS AND TU REMAINS POSITIVE & RISES.

 TU REACHES ITS MAXIMUM, THEN MU BECOMES ZERO.
 WHEN TU FALLS, MU BECOME NEGATIVE.
TABULAR REPRESENTATION
FOLLOWING SCHEDULE SHOWS THE RELATIONSHIP BETWEEN TU & MU.
NO. OF UNITS CONSUMED TOTAL UTILITY (TU) MARGINAL UTILITY (MU)
1 10 10
2 18 8
3 24 6
4 28 4
5 30 2
6 30 0
7 28 2
FROM THE ABOVE TABLE IT IS CLEAR THAT;
 AS LONG AS TU RISES MU BECOME POSITIVE, THAT IS BY CONSUMING UP TO THE 5TH UNITS. WHEN TU
REMAINS CONSTANT AND IS ITS MAXIMUM, THEN MU BECOMES ZERO. BY CONSUMING THE 6TH UNIT, MU
BECOME ZERO.
 WHEN TU FALLS, THEN MU BECOMES NEGATIVE. BY CONSUMING THE 7TH UNIT, MU BECOMES NEGATIVE.

SINCE,
Y
MUX = TUN – TU (N-1)

MU (3) = TU3 – TU (3-1) T

TU
TU &
MU (3) = TU (3) – TU (2) MU
= 30-24
=6

0 N X NO. OF UNIT CONSUMED

- VE

LAW OF DIMINISHING MARGINAL UTILITY

LAW OF DMU STATES THAT AS LONG AS A CONSUMER CONSUMES MORE AND MORE UNITS OF THE GIVEN
COMMODITY, WITHOUT TIME GAP, THEN THE MU OBTAINED FROM THE EACH SUCCESSIVE UNIT ALWAYS DECLINES.
ALSO KNOWN AS –
 GOSSANS' FIRST LAW OF CONSUMPTION,
 ‘PSYCHOLOGICAL LAW OF CONSUMPTION’.
BASIC ASSUMPTIONS
 CONTINUOUS CONSUMPTION
 HOMOGENEOUS OR IDENTICAL UNIT.
 ONLY STANDARD UNIT OF THE COMMODITY ARE CONSUMED
 CONSUMER IS RATIONAL
 MARGINAL UTILITY OF MONEY REMAINS CONSTANT.

BY USING THE FOLLOWING TABLE, WE CAN EXPLAIN THE LAW OF DIMINISHING MARGINAL UTILITY.
No. of units consumed (Good X) Marginal Utility (Good X)
1 10
2 8
3 6
4 4
5 2
6 0
7 -2

FROM THE ABOVE TABLE IT IS CLEAR THAT BY CONSUMING THE 1ST UNIT, CONSUMER GETS 10 UTILS. AS HE CONSUME
MORE AND MORE UNITS HIS MARGINAL UTILITY OBTAINED FROM THE GIVEN COMMODITY DECLINES. AS HE
CONSUMES 6TH UNITS HE GETS ZERO UTILITY, IT IS KNOWN AS THE POINT OF SATIETY. WHEN HE CONSUMES 7TH UNIT,
HE GETS NEGATIVE UTILITY.
Y
THIS LAW CAN BE UNDERSTAND WITH THE HELP OF FOLLOWING
DIAGRAM
FROM THE DIAGRAM WE CAN SEE THAT BY CONSUMING MORE AND
MORE UNITS, MU IS DECLINING AND BY CONSUMING ‘ON’ UNITS, MU BECOME MU
ZERO AND AFTER THAT MU IS NEGATIVE.
N
0 X
- VE UNITS OF APPLE (
CONSUMED MU
FROM THE ABOVE TABLE AND DIAGRAM IT IS CLEAR THAT, WHEN CONSUMER CONTINUOUSLY CONSUMES MORE
UNITS OF APPLE HE WILL GET LESS AND LESS MARGINAL UTILITY. WHEN HE CONSUMES 5TH UNIT, HE GETS ZERO
UTILITY. THIS SITUATION IS KNOWN AS POINT OF SATIETY. AS HE CONSUMES 6TH UNITS HIS MARGINAL UTILITY WILL
BECOMES NEGATIVE.

CONSUMER’S EQUILIBRIUM
CONSUMER’S EQUILIBRIUM REFERS TO A SITUATION WHEN A CONSUMER ATTAINS MAXIMUM SATISFACTION BY
MINIMUM SPENDING. SO CONSUMER ALLOCATES HIS GIVEN INCOME TO THE PURCHASE OF DIFFERENT GOODS IN A
MANNER SUCH THAT HIS TOTAL SATISFACTION IS MAXIMISED

CONSUMER’S EQUILIBRIUM: (UNDER CARDINAL UTILITY ANALYSIS)

THIS CAN BE DISCUSSED UNDER THE TWO DIFFERENT SITUATIONS. THEY ARE
1. UNDER SINGLE COMMODITY CASE,
2. UNDER DOUBLE COMMODITY CASE.

CONSUMER’S EQUILIBRIUM (UNDER SINGLE COMMODITY CASE)

UNDER SINGLE COMMODITY, A CONSUMER REACHES EQUILIBRIUM WHEN THE FOLLOWING CONDITIONS ARE
ACHIEVED. I.E,
A) MU FALLS AS CONSUMPTION OF THE COMMODITY INCREASES. (LAW OF DMU)
B) MU(X) IS EQUAL TO THE PRICE PAID FOR THAT GOOD.
MU(X) = PRICE (X)

IF MU(X) IS MORE THAN THE PRICE PAID FOR IT, THEN CONSUMER WILL NOT BE IN EQUILIBRIUM. HE SHOULD
INCREASE THE CONSUMPTION TO REACH THE EQUILIBRIUM, TILL MU(X) BECOME EQUAL TO P(X).
ON THE OTHER HAND, IF MU(X) IS LESS THAN THE PRICE PAID FOR IT, AND THEN CONSUMER WILL NOT BE IN
EQUILIBRIUM. HE SHOULD DECREASE THE CONSUMPTION TO REACH THE EQUILIBRIUM, TILL MU(X) BECOME EQUAL
TO P(X).

UNITS OF SAMOSA CONSUMED PRICE MUSAMOSA

1 4 10
MUX > PX
2 4 6
3 4 4 CONSUMER EQUILIBRIUM POINT; MU (X) = P (X)

4 4 2
5 4 0 MUX < PRICEX
6 4 -2

FROM THE ABOVE TABLE WE CAN SEE THAT BY CONSUMING 3RD UNIT CONSUMER REACHES THE EQUILIBRIUM,
BECAUSE AT THIS SITUATION, CONDITION OF EQUILIBRIUM IS ATTAINED I.E, MU (X) = P (X)

MU (X) = PRICE (X)

MU &
PRICE E
PRICE
P

0 N NO. OF
- VE UNITS OF APPLE CONSUMED SAMOSA’S
CONSUMED
MU
BY CONSUMING ‘ON’ UNITS OF APPLE CONSUMER REACHES EQUILIBRIUM, BECAUSE THE CONDITION OF
EQUILIBRIUM IS FULFILLED AT THIS POINT.

CONSUMER’S EQUILIBRIUM – DOUBLE COMMODITIES CASE

UNDER DOUBLE COMMODITY CASE A CONSUMER REACHES EQUILIBRIUM WHEN THE FOLLOWING CONDITION IS
ACHIEVED. THAT IS:
MU(X) / = MU(Y) /
PRICE(X) PRICE (Y)
ON THE BASIS OF THE FOLLOWING ASSUMPTIONS, WE CAN EXPLAIN THE CONSUMER’S EQUILIBRIUM UNDER THE
DOUBLE COMMODITY CASE. THEY ARE:
 GOOD X & GOOD Y ARE THE TWO GOODS
 LAW OF DIMINISHING MARGINAL UTILITY IS APPLICABLE IN BOTH THE GOODS CASE.
 PRICE = RS. 1/UNIT (GOOD X, GOOD Y)
 INCOME = 5 RUPEE
 WITH THE HELP OF THE FOLLOWING TABLE, WE CAN SEE THE CONDITIONS OF CONSUMER’S EQUILIBRIUM

QUANTITY OF GOODS MUX MUY

1 20 12
2 16 10
3 10 6
4 3 3
5 2 1
FROM THE ABOVE TABLE WE CAN SEE THAT BY CONSUMING 2 UNITS OF GOOD ‘X’ AND3 UNITS OF GOOD ’Y’,
CONSUMER REACHES EQUILIBRIUM, BECAUSE AT THIS LEVEL CONDITION OF CONSUMERS EQUILIBRIUM IS ACHIEVED