What Economics Is All About

What economics is all about
• Economics is the study of the use of the scarce resources that

have alternative uses.
Three fundamental aspects that drive these decisions are:
• Scarcity: Resources limited relative to desires
• Opportunity costs: In an environment of scarcity, if one
chooses one it may mean giving up something else. Therefore,
the opportunity cost of the choice is the one you gave-up.
• Efficiency: An economy is efficient when all the demands are
optimally met. An economy already producing at an efficient
level can increase the economic welfare of an individual only
by decreasing the economic welfare of another individual.
What are the decisions we are referring?
• What products and services needs to be produced and what quantities? Should
you spend more on nutritious food or good books? Should ITC produce more
biscuits or more packets of “Aasirvaad Atta”? Should government spend more
money in subsidising rice or spend the same money in building canals to irrigate
the land?
• How would one produce these product and services? Should ITC use more
labour or expensive machine to produce biscuits?
• For whom these products and services are to be produced? Should ITC produce
Dark Fantasy (Rs.60) - to be purchased by the rich or glucose biscuits (Rs.5) to be
purchased by the poor. When ITC makes profit should it give more bonuses to
employees or more dividends to shareholders? Once government can see ITC
making lots of profit it can increase the tax and takes out a portion of the profit.
The increase in tax can be spent on building canal to increase the irrigation,
which will increase in productive of land and hence the income of the farmers.
Now we can distinguish between Macro &
Microeconomics
• Microeconomics questions: How much do you spend per month
and how much do you save per month? How would allocate
your money between food and travel or education? Will you
work more if your employer decides to pay you more per hour
of work? Will you change your job if paid more?

• Macroeconomics questions: What is the total savings of the
economy? How would enable consumers to spend more? How
would government allocate the spending between defence and
education? What should be done to make sure all the citizens
have jobs? How exchange rate affects export earnings? How
monetary policy affects investments?
The objective of macroeconomics
• Increasing level of economic activity: Public policy maker
need to work towards increasing the level of economic
activities to bring-in growth of output so that citizens
standard of living increases over time.
• High level of employment: The public policy makers need
to ensure that everybody who is interested in working
finds a job suitable for his/her skillsets.
• Stable price level: Higher inflation eats out the individual’s
ability to spend and save, hence the standard of living.
Therefore, individual’s will like to have a stable prices over
time.
How does a macro economy operate?
The Simple Circular-Flow Model for Households
and Firms
Circular flow
• It refers to a simple economic model which describes
the reciprocal circulation of income/
output/expenditure between producers and
consumers.
• Real Flow- In a simple economy, the flow of factor
services from households to firms and corresponding
flow of goods and services from firms to households
known to be as real flow.
• Money flow – is the flow of income and expenditure
in money terms
A three sector Model
A five sector model
what maximum could be produced ?
• It is important to understand what maximum could be
produced – earned and spent during a period – given
resources, factors and technology: Precisely, we are
talking about the production possibilities of a country.
• A production–possibility frontier(PPF)or production
possibility curve (PPC) is a graphical representation of
possible combination of two goods (hypothetically
two – because we can’t present more than that in a
graph; in real life its “n” number)with constant
resources and technology.
Production Possibility frontier(PPF)
CONSUMER CAPITAL
GOODS (Lakhs of GOODS(Lakhs
unit) of unit)
0 50
10 45
20 38
30 27
40 15
50 0
Plotting the above table we got this…
PPF
60
50
40
CAPITAL GOODS
30
20
10
0
0 1 2 3 4 5 6 7 8
CONSUMER GOODS
Increasing Opportunity Cost
• We are drawing possible combinations of consumer and
capital goods that can be produced using all resources
efficiently. These are the possible combinations that a
country can produce in an year. PPF shows increasing
opportunity cost.
• To produce First 10 consumer goods you are sacrificing 5
capital goods and to produce last 10 units you are sacrificing
15 capital goods.
WHY?
When will be the slope of PPC constant?
Some key questions
• What happens if given the resources, technology
moves in favour of capital goods only
moves in favour of consumer goods only
moves in favour of capital goods but against the
consumer goods
moves in favour of consumer goods but against
the capital goods
What are the major macroeconomic variables?
1. Total output produced

2. Potential output that can be produced
3. Composition of output
4. Growth rate of output
5. Unemployment rate
6. Inflation rate
7. Interest rate
8. Total export
9. Total import
10.Exchange rate
11.Savings
12.Investment etc.

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What economics is all about

• Economics is the study of the use of the scarce resources that

1. Total output produced

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