Basic Economics

The word ‘Economics’ is originated from the Greek word ‘Oikonomikos’ which can be divided into two parts: (a) ‘Oikos’, which means ‘Home’, and (b) ‘Nomos’, which means ‘Management’.

Economics is the social science that studies the production, distribution, and consumption of goods and services.

Adam Smith, considered to be the father of modern Economics, defined “Economics as the study of the nature and causes of nations’ wealth or simply as the study of wealth”.

Alfred Marshall wrote: “Economics is a study of man in the ordinary business of life. It inquires how he gets his income and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more important side, a part of the study of man”.

According to Prof. Lionel Robbins, “Economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”.

Economics is of two parts:

1. Micro Economics: analyzes basic elements in the economy, including individual agents and markets, their interactions, and the outcomes of interactions. Individual agents may include, for example, households, firms, buyers, and sellers.

2. Macro Economics: analyzes the entire economy (meaning aggregated production, consumption, savings, and investment) and issues affecting it, including unemployment of resources (labour, capital, and land), inflation, economic growth, and the public policies that address these issues (monetary, fiscal, and other policies).

Basic Concepts of Micro Economics

Capital: Capital is the money, credit, and other forms of funding that build wealth. Individuals use it to invest. In economics, capital is one of the four factors of production that drive supply. The other three are natural resources (the raw materials), labour (the number of employees), and entrepreneurship (the drive to profit from innovation).

Scarcity: Scarcity refers to the limited availability of a commodity, which may be in demand in the market.

Example: Water is scarce in the desert.

Equity: Equity means ownership; ownership in Business. For Ex. If you hold 10 shares of ABC Company out of the total 1000 shares floated by the company – you are 1% owner in ABC’s business.

Market Economy: In market economy, people exchange resources, such as money, for other resources, such as goods or services, on a voluntary basis in the market. The value of the resources, exchanged is based upon how scarce each resource is and how many people want the resource. If the supply of a resource is low and the demand is high, the price will tend to be high. If the demand is low and the supply is high, the price will tend to be low.

Inflation: Devaluation of a currency marked by a sustained trend of rising prices in the economy is called Inflation. In other words, the value of each rupee is less, which causes the general price of goods to increase. This is typically caused by an increase in the money supply relative to economic activity.

Inflation depresses the purchasing power of money, reinforces the unequal distribution of income, condenses the competitiveness of the economy, and encourages imports. Economists use the Consumer Price Index (CPI) to measure it by measuring the price changes in a determined market basket of core goods and services. This basket typically includes gasoline, food, clothing and automobiles.

Imports: Imports are goods produced in foreign countries and sold domestically.

Example India imports crude oil from Arab countries. Here crude oil is imported.

Exports: Exports are goods produced domestically and sold abroad.

Example India exports Wheat to Iran. Here wheat is exported.

Law of demand: Law of Demand states that when the price of a product decreases, consumer demand for that particular product increases and when the price of a product increases, consumer demand for that particular product decreases, provided that all other factors that affect consumer demand remain equal.

The other-factors -being-equal assumption is very important in law of demand because the demand for goods also varies with many factors other than price. The law of demand simplifies the price-demand relationship by assuming that all other demand-affecting factors are constant.

For example, we are likely to buy more oranges, i.e. 30 oranges when the price per orange is 5 and less oranges, i.e. 5 oranges when the price per orange is 30

The following graph shows the relation between price and quantity demanded for hypothetical buyer:

                       The graph shows that the quantity demanded decreased as the price goes up.

Law of supply: According to the law of supply, there is a direct relationship between supply and the price of a product or service. The law of supply states that the quantity of a product made available for sale by a producer varies directly with the price of the product respectively provided that other things remaining constant.
The law of supply applies only under the assumption that other things remain constant because supply is also affected by a number of factors in addition to price.

Example, a fruit vendor will try to make available more fruits for sale when the fruit prices are high and relatively less when the prices are low.

The law of supply can be presented in the form of a graph between the price and the quantity supplies of a product as shown below:

The above supply line has a positive slope, thus indicating that there is a direct relationship between the price of a product and the quantity supplied. As the price increases, producers and resource owners will supply more. You can observe this on the graph at points A B C & D i.e. at A where price is INR. 10 and quantity supplied is 10, whereas at D where prices increased to 40 the quantity supplied is also increased.

Equilibrium: Equilibrium is a market state where the supply in the market is equal to the demand in the market. The equilibrium price is the price of a good or service when the supply of it is equal to the demand for it in the market.

From the above graph we can understand that the point where the Demand and Supply lines are met (indicated with dot-lines) is called as Equilibrium.

Consumer surplus: It is the benefit obtained by consumers for paying a lower price for a good or service than the price they would be willing to pay.

Producer surplus: It is the benefit obtained from suppliers for selling a good or a service at a higher market price than they would be willing to sell.

Elasticity: In economics, elasticity is used to determine how changes in product demand and supply relate to changes in consumer income or the producer’s price. To calculate this change, we can use the following formula:

                                   Elasticity = % Change in Quantity / % Change in Price

The diagram here shows the changes in price (p) of Mabel’s Homemade Candy and the corresponding change in the quantity demanded (q). The red slanting line is called the demand curve. At a price of INR. 1.50, the quantity demanded is three units. When the price is lowered to INR. 0.50, the quantity in demand increased to five units. Ms. Mabel can then make the assumption that every increase in price will result in fewer purchases of her candy.

Cost denotes the amount of money that a company spends on the creation or production of goods or services.

From a seller’s point of view, cost is the amount of money that is spent to produce a good or product. If a producer were to sell his products at the production price, his costs and income would break even, meaning that he would not lose money on the sales. However, he would not make a profit.

From a buyer’s point of view the cost of a product is also known as the price. This is the amount that the seller charges for a product, and it includes both the production cost and the mark-up, which is added by the seller in order to make a profit.

Tariff: The tariff is a tax on goods produced abroad and sold domestically. In other words, the tariff is the tax imposed on imports.

Budget surplus: The budget surplus is simply having more income than expenses during a specific period of time, such as a financial quarter or year. Individuals, companies and governments can all have budget surpluses. In simple terms, Budget Surplus means the excess of government receipts over government spending.

For example, the government has received an income or receipts worth INR. 10,00,000 lakh and the expenses are of INR. 7,00,000 lakhs. Then the excess INR. 3,00,000 lakhs are termed as surplus.

Budget deficit: Budget deficit occurs when an individual, business or government budgets more spending than there is the revenue available to pay for the spending, over a specific period of time. Debt is the aggregate value of deficits accumulated over time.

For example, a company has the revenue of INR. 5,00,000 but budget spending is of INR. 6,50,000. The excess INR. 1,50,000 is what the company has borrowed from some other source. It is the debt that the company owes to pay back with an interest, if applicable.

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