1.

3 ECONOMIC PROBLEM
As we know, human wants are unlimited, but the means to satisfy them are limited. Therefore,
all our wants cannot be fulfilled. In order to maximise satisfaction, every consumer exercises
choice, as to which goods should be consumed and in what quantity. An economic problem is
basically a problem of choice.
Economic Problem is a problem of choice involving satisfaction of unlimited wants out of
limited resources having alternative uses.
Reasons for Economic Problem
The 3 main reasons for existence of economic problems are:
(i) Scarcity of Resources: Resources (i.e. land, labour, capital, etc.) are limited in relation to
their demand and economy cannot produce all what people want. It is the basic reason
for existence of economic problems in all economies. Scarcity is universal and applies
to all individuals, organisations and countries. There would have been no problem, if
resources were not scarce.
(ii) Unlimited Human Wants: Human wants are never ending, i.e. they can never be fully
satisfied. As soon as one want is satisfied, another new want emerges. Wants of the people
are unlimited and keep on multiplying and cannot be satisfied due to limited resources.
Human wants also differ in priorities, i.e. all ,vants are not of equal intensity. For every
individual, some wants are more important and urgent as compared to others. Due to
this reason,people allocate their resources in order of preference to satisfy some of their
wants. If all human wants had been of equal importance, then it would have become impossible
to make choices.
(iii) Alternate Uses: Resources are not only scarce, but they can also be put to various uses.
It makes choice among resources more important. For example, petrol is used not only
in vehicles, but also for running machines, generators, etc. As a result, economy has to
make choice between the alternative uses of the given resources.
Resources Vs Human Wants
Features of Resources:
(i) They are scarce, i.e. their supply is limited in relation to demand.
(ii) They have alternative uses.
Features of Human wants:
(i) They are unlimited, i.e. they can never be fully satisfied.
(ii) They differ in priorities.
1.4 MEANING OF ECONOMICS _________________
Economics is a social science which studies the way a society chooses to use its limited
resources, which have alternate uses, to produce goods and services and to distribute them
among different groups of people.

vVhat is Economics all about?

Economics is all about making choices in the presence of scarc ity. It studies human behaviour as a
relationship between means (resources) and ends (human wants). Economics aims to ensure
that the resources are used in the best possilble manner.

1.5 POSITIVE ECONOMICS AND NORMATIVE ECONOMICS ________

Positive Economics (or Science)
Positive economics studies the facts of life, i.e., it deals with 'things as they are'. Positive
Economics deals with what are the economic problems and how are they actually solved. For
example, India is an overpopulated country or prices are constantly rising.
Positive statements describe what was, what is or what will be under the given state of
circumstances. These statements do not pass any value judgements.
Normative Economics (or Science)
Normative economics tells us 'what ought to be'. Normative Economics deals with what
ought to be or how the economic problems should be solved. For example, India should not be
an overpopulated country or prices should not rise.
Normative economics discusses what are desirable things and should be realised and what
are undesirable things and should be avoided. It gives decisions regarding value judgements.

ECONOMICS AS A SCIENCE )

Positive Science OR Positive Economics Normative Science OR Normative Economics

(Deals with what are the economic problems (Deals with what ought to be or how the
and how are they actually solved) economic problems should be solved)

� Whatis? � What ought to be?

What was? What should happen?
What will be? What should have happened?

Difference between Positive Economics and Normative Economics

Basis Positive Economics Normative Economics
Meaning It deals with what is or how the economic It deals with what ought to be or how the
-
Verification
problems are actually solved.
It can be verified with actual data.
economic problems should be solved.
It cannot be verified with actual data.
Purpose It aims to make real description of an It aims to determine the ideals.
economic activity.
Suggeslive It is based upon facts, and thus, not It is based upon individual opinion and
suggestive. therefore, it is suggestive in nature.
Value It does not give any value judgements, It gives value judgements.
Judgements i.e. it is neutral between ends.
Examples 1. Prices in Indian economy are 1. India should take steps to control
constantly rising rising prices.
2. There are inequalities of income in our 2. Income inequal i ties should be
economy. reduced.

1.6 MICROECONOMICS AND MACROECONOMICS ___________

The subject matter of economics has been studied under two broad branches:
1. Microeconomics (Price Theory) 2. Macroeconomics (Income Theory)
These two concepts have become of general use in economics. Let us discuss these concepts
in detail.

Microeconomics
Adam Smith is considered to be the founder of the field of microeconomics. The term 'micro'
has been derived from Greek word 'mikros' which means 'small'. Microeconomics deals with
analysis of behaviour and economic actions of small and individual units of the economy, like a
particular consumer, a firm or a small group of individual units. The concept of microeconomics
is very important as it supplies the foundation for most of our understanding of the functioning
of an economy.
Microeconomics is that part of economic theory, which studies the behaviour of individual
units of an economy. For example, Individual income, individual output, price of a commodity,
etc. Its main tools are Demand and Supply.
Macroeconomics
The term 'macro' has been derived from the Greek word 'makros' which means 'large'. So,
macroeconomics deals with overall performance of the economy. It is concerned with study of
problems of the economy like inflation, unemployment, poverty, etc.
Macroeconomics is that part of economic theonJ which studies the behaviour of aggregates of
the economy as a whole. For example, National income, aggregate output, aggregate consumption,
etc. Its main tools are Aggregate Demand and Aggregate Supply.
Micro Vs Macro
• In Microeconomics, the letter T stands for 'Individuals', i.e. it studies the economic
behaviour of individuals.
• In M!}croeconornics, the letter 'A' stands for'Aggregates', i.e. it studies the economy as
a whole.

Difference between Microeconomics and Macroeconomics

Basis Microeconomics Macroeconomics
Meaning Microeconomics is that part of economic Macroeconomics is that part o f
theory which studies the behaviour of economic theory which studies the
individual units of an economy. behaviour of aggregates of the economy
as a whole.
Tools Demand and Supply. Aggregate Demand and Aggregate
Supply.
Basic Objective It aims to determine price of a commodity I t aims to determine income and
-� ctors of production . employment level of the economy.
Degree of It involves limited degree of aggregation. I t involves the highest degree of
Aggregation For example, market demand is derived aggregation. For example, aggregate
by aggregating individual demands of demand is derived for the entire
all buyers in the particular market. economy.
Basic It assumes all the macro variables to be It assumes that all the micro variables,
Assumptions constant, i.e., it assumes that national like decisions of households and firms,
income, consumption, savings, etc. are prices of individual products, etc. are
constant. constant.
Other Name It is also known as 'Price Theory'. It is also known as 'Income and
Employment Theory'.
Examples Individual income, individual output. National Income, National output.
Interdependence of Microeconomics and Macroeconomics
Economics is a single subject and the analysis of an economy cannot be split into [Link]
watertight compartments. It means, microeconomics and macroeconomics are not independent of
each other and there is much common. ground between the two. It means, both microeconomics and
macroeconomics are interdependent.
Let us elaborate their interdependence with the help of some examples:
Microeconomics depends on Macroeconomics
1. Law of demand came into existence from the analysis of the behaviour of a group
(aggregate) of people.
2. Price of a commodity is influenced by the general price level prevailing in the economy.
Macroeconomics depends on Microeconomics
1. National income of a country is nothing but the sum total of incomes of individual units
of the country.
2. Aggregate demand depends on demand of individual households of the economy.
Micro-Macro Paradoxes
Paradox is a seemingly absurd or contradictory statement, though, often a trne statement. Sometimes,
there are paradoxes seen in Micro and Macro activities. It means, an act which is beneficial for
an individual, may prove to be harmful for the economy as a whole.
1.7 CENTRAL PROBLEMS OF AN ECONOMY
Production, distribution and disposition of goods and services are the basic economic activities
of life. In the course of these activities, every society has to face scarcity of resources. Because of
this scarcity, every society has to decide how to allocate the scarce resources. It leads to following
Central Problems, that are faced by every economy:
1. What to produce
2. How to produce
3. For whom to produce

Allocation of Resources (Studied under Microeconomics)

Allocation of resources refers to the problem of assigning the scarce resources in such a manner so that
maximum wants of the society are fulfilled. As resources are limited in relation to the unlin1ited
\-\rants, it is important to economize their us ,e and utilize them in the most efficient manner.
The problem of allocation of resources is studied under 3 heads: (1) What to produce; (2) How
to produce; (3) For whom to produce.

1 . What to Produce
This problem involves selection of goods and services to be produced and the quantity to be
produced of each selected commodity. Every economy has limited resources and thus, cannot
produce all the goods. More of one good or service usually means less of others.
For exa111ple, production of more sugar is possible only by reducing the production of other goods.
Production of more war goods is possible only by reducing the production of civil goods. So, on
the basis of the importance of various goods, an economy has to decide which goods should be
produced and in vvhat quantities. This is a problem of allocation. of resources among different goods.
The problem of 'What to produce' has two aspects:
(i) What possible commodities to produce: An economy has to decide, which consumer goods
(rice, wheat, clothes, etc.) and which of the capital goods (machinery, equipments, etc.)
are to be produced. In the same way, economy has to make a choice between civil goods
(bread, butter, etc.) and war goods (guns, tanks, etc.).
(ii) How much to produce: After deciding the goods to be produced, economy has to decide
the quantity of each commodity, that is selected. It means, it involves a decision regarding
the quantity to be produced, of consumer and capital goods, civil and war goods and so on.
2. How to Produce
This problem refers to selection of technique to be used for production of goods and services.
A good can be produced using different techniques of production. By 'technique', we mean
which particular combination of inputs to be used. Generally, techniques are classified as:
Labour intensive techniques (LIT) and Capital intensive techniques (CIT).
• In Lnbour intensive technique, more labour and less capital (in the form of machines, etc.)
is used.
• In Capital [Link] technique, there is more capital and less labour utilization.

The selection of technique is made with a view to achieve the objective of raising the standard of
living of people and to provide employment to everyone. For example, in India, LIT is preferred
due to abundance of labour, whereas, countries like U.S.A., England, etc. prefer CIT due to
shortage of labour and abundance of capital.

3. For Whom to Produce

This problem relates to the distribution of produced goods and services among the individuals
within the economy, i.e. selection of the category of people who will ultimately consume the
goods, i.e. whether to produce goods for more poor and less rich or rnore rich and less poor.
Since resources are scarce in every economy, no society can satisfy all the wants of its people.
Thus, a problem of choice arises. Goods are produced for those people who have the paying
capacity. The capacity of people to pay for goods depends upon their level of income. It means,
this problem is concerned with distribution. [Link] among the factors of production (land, labour,
capital and enterprise), who contribute in the production process.
The problem can be categorised under two main heads:
(i) Personal Distribution: It means how national income of an economy is distributed among
different groups of people.
(ii) Functional Distribution: It involves deciding the share of different factors of production
in the total national product of the country.
1.8 OPPORTUNITY COST ___________________
As resources are scarce, the society is always forced to make choices. To produce more of one
good, a certain amount of other goods has to be sacrificed. The true cost of using economic
resources in any given project is the loss of the alternative output which they miglht have
produced.
For example, if we use a certain amount of land, labour and capital to build a factory, then the economic
cost (or opportunity cost) of the factory might be the houses which these resources could have produced.

Hence, Opportunity Cost is the cost of next best alternative foregone. For example, Suppose,
you are working in a bank at the salary of � 40,000 per month. Further suppose, you receive
two more job offers:
• To work as an executive at t 30,000 per month; or
• To become a journalist at t 35,000 per month.
In the given case, the opportunity cost of working in the bank is the cost of next best alternative
foregone, i.e. t 35,000. The amount of other goods and services, that must be sacrificed to obtain more
of any one good, is called the opportunity cost of [Link] good.

1.9 PRODUCTION POSSIBILITY FRONTIER (PPF)

Due to scarcity of resources, we cannot satisfy all our wants. Even if an economy uses all its
resources in the best possible manner, its capabilities are restricted due to scarcity of resources.
As we cannot have everything that we want, we are forced to make economic decisions.
These decisions take the form of choices among alternate goods and services, that will best
satisfy our wants. Thus, the society must decide, what to produce out of an almost infinite range of
possibilities.
As the choice is to be made [Link] infinite possibilities, the economists assumed a very
basic economy with only two goods (say, guns and butter). Economists have traditionally
represented this range of choices by what they call a 'Production. Possibility Schedule' (Table
1.1). When this schedule is graphically represented (Fig. 1.1), it is called' Production. Possibility
Frontier (PPF)' or 'Production. Possibility Curve (PFC).
r
Production Possibility Fontier (PPF) refers to graphical representation of possible co1nbi1iations
of two goods that can be produced with given resources and technology. Alternately, PPF is
the locus of various possible combinations of two goods that can be produced with given resources and
technology.
Only 2 Goods are taken: The two goods have been taken Just for the sake of simplicity and easy
understanding. However, the analysis involved can be applied equally well, to any combination of goods.

PPF is also known by the following names:

• Production Possibility Curve • Production Possibility Boundary
• Transformation Curve • Transformation Boundary
• Transformation Frontier

Assumptions for PPP

Production possibility frontier is based on the following assumptions:
1. The amount of resources in an economy is fixed, but these resources can be transferred
from one use to another;
2. With the help of given resources, only tvvo goods can be produced;
3. The resources are fully and efficiently utilised;
4. Resources are not equally efficient in production of all products. So, when resources are
transferred from production of one good to another, the productivity decreases;
5. The level of technology is assumed to be constant.
The concept of PPF can be better understood with the help of following imaginary (hypothetical)
schedule and diagram:

Table 1.1: Production Possibility Schedule

I Possibilities Guns (in units) Butter (in units) MOC MRT =

11 Guns
/1 Butter

A 21 0 - -

B 20 1 1 1G: 1B
C 18 2 2 2G: 1B
D 15 3 3 3G: 1B
E 11 4 4 4G: 1B
F 6 5 5 5G: 1B

G 0 6 6 6G: 1B
 • If the economy uses all its resources to produce only y PPF of Guns and Butter
guns, then maximum of 21 units of guns and no
21
butter can be produced (point 'A').
18
• On the other hand, if all resources are used for butter,
then maximum 6 units of butter and no guns can be ui" 15

produced (point 'G'). § 12

. .
:§.
.
• In between, there are various possibilities with UJ 9
C:
different combinations of guns and butter. (9 6 ---·---♦---•---·---

• When points A, B, C, D, E, F and G are joined, we get 3

a curve AG, known as 'Production Possibility Frontier'. =+--+---+---+-+--+----lf,"
G
'--+X
0 2 3 4 5 6
AG curve shows the maximum limit of production Butter (in units)
of guns and butter. Fig.1.1

Marginal Opportunity Cost (MOC)

MOC refers to the number of units of a commodity sacrificed to gain one additional unit of another
commodity. In case of PPF, J\10C is always increasing, i.e. more and more units of a commodity
have to be sacrificed to gain an additional unit of another commodity.
Why Increasing MOC operates?
Increasing MOC operates because productivity and efficiency of factors of production
decrease as they are shifted from one use to another. Let us understand this with the help
of an example: Suppose an economy produces only two goods (say, guns and butter).
A worker is employed in production of guns because he is best suited for it. If economy
decides to reduce production of guns and increase production of butter, then worker will be
transferred to production of butter. However, he is not that efficient in production of butter
as he was in guns. As a result, his productivity in butter will be low and MOC will increase.

Marginal Rate of Transformation (MRI)

MRT is the ratio of number of units of a commodity sacrificed to gain an additional unit of another
. Li Units Sacrificed . 6. Gw,s
commodity. MRT = - - - - - - - . In the given example of gW1S and butter, MRI
Li Units Gained Li Butter
MRT measures the slope of Production Possibility Frontier.
Example of MRI
According to Table 1.1, 20 units of guns and 1 unit of butter (i.e. 20G + 18) can be produced
by utilising the resources fully and efficiently. If the economy decides to produce 2B, then it
has to cut down production of guns by 2 units. In the given case, 2G is the opportunity cost of
producing 18, i.e. MRT is 2G:1B.

Characteristics or Properties of PPF

The tvvo basic characteristics or features or properties of PPP are:
1. PPF slopes Downwards: PPP shows all the maximum possible combination of tvvo goods,
which can be produced with the available resources and technology. In such a case, more ofone
Introduction 1.13

good can be produced only by taking resources awayfrom the production ofanother good. As there
exists an inverse relationship between change in quantity of one commodity and change
in quantity of the other commodity, PPP slopes downwards from left to right (see Fig. 1.1).
2. PPF is Concave Shaped: PPF is concave shaped because of increasing marginal rate of
transformation (MRT), i.e. more and more units of one commodity are snc1·ificed to gain an additional
unit of another commodity.
MRT increases because it is assumed that no resource is equally efficient in production
of all goods As resources are transferred from one good to another, less and less efficient
resources have to be employed. This raises cost and raises MRT. In the given example of
guns and butter, units of guns sacrificed keep on increasing each time to increase production
of one unit of butter.
Whether Economy will always operate on PPF?
It must be remembered that PPF does not show the point at which the economy will actually
operate. It only shows the maximum available possibilities, which an economy can produce.
The exact point of operation depends on how well the resources of the economy are used.
1. Economy will operate on PPP only when resources are fully and efficiently utilised.
2. Economy will operate at any point inside PPF if resources are not fully and efficiently utilised.
3. Economy cannot aperate at any point outside PPF as it is unattainable with the available
productive capacity.
It means:
• Economy can either operate on PPF or inside PPP, known as' Attainable Combinations'.
• But, economy cannot operate outside PPF, kn0vvn as 'Unattainable Combinations'.
Attainable and Unattainable Combinations
Let us clear the concept of'Attainable and Unattainable Combinations' with the help of Fig. 1.2:

Attainable Combinations: It refers to those combinations at which economy can operate. There
can be two attainable options:
1. Optimum utilisation ofresources: If the resources are used in the best possible manner, then
economy will operate at any point (like, A, B, C or D) on PPP.
 [Link] lneflllcienttil utilisation:llof!!lresources::ll However, the actual production can fall short of its
capabilities. If there is wastage or ineftilcient utilisation of resources, then economy will
operate at any point inside the PPF (like E).
Unattainable Combinations: With the given amount of available resources, it is impossible for
the economy to produce any combination more than the given possible combinations i.e. an
economy!kantilnevertiloperate:llattilany�pointri!outside!ilthe!ilPPFtil(Ii ke F).
For "An economy always produces on, but not inside, a PPF", refer HOTS.

PPF and MRT

We can measure MRT on the PPF. Fortilexample, MRT y PPF and MRT
between the possibilities D and E is equal to DH/HE
21
and between E and F, it is equal to El/IF and so on.
We know, PPF is concave shaped curve. The slope 18
of PPF is a measure of the MRT. Since the slope of a 2 1s
concave curve increases as we move downwards along ·§ 12
the curve, the MRT also rises as we move downwards
� 9
along the curve. §
0 6
Can PPF be a straight line?
PPFtik::anXbefuZstraight!JlinetiJftilweZassume@thatZMRUistik::onst�
G
i.e. same amount of a commodity is sacritilced to gain o=-+---+1-+---+
2 3-+-4 5-+-6"'---x
--+

an additional unit of another commodity. It is possible Butter (in units)

only when we assume that all the resources are equally Fig. 1.3
efilcient in production of all goods. In such case, PPF
will be a straight line as shown in Fig.1.4.
y y
GoodY A GoodY A

-+--------=B--x -+------___:::""'B'----X
0 Good X 0 Go�X
Fig.1.4 Fig.1.5

Can PPF be Convex to the Origin?

PPF:llcan!ilbe�convex!ilto:lltheri:origin:llirnMRT�isMdecreasing, i.e. less and less units of a commodity are
sacriri:ced to gain an additional unit of another commodity. In such case, PPF will be a convex
shaped curve as shown in Fig. 1.5.
It must be noted that both these situations (i.e. PPF being a straight line or convex shaped) would not
arise, as MRT always increases. So, PPF is always concave shaped.
 Fig.1.6
PPF as Transformation Curve
Slope of PPF indicates the ease or difficulty in transforming one good into another. In the
given example (Table 1.1), when we move down the curve, \-Ve transform guns into butter,
and when we move up, we transform butter into guns. Because of this reasson, PPP is known
as "Transformation Curve".

Change in PPF
PPP is based on the assumption, that resources of an economy are fixed. However, in this
changing world, the productive capacity of an economy is constantly changing due to increase
or decrease in resources. Such changes in resource lead to change in PPF. The change in PPF
indicates either an increase or a decrease in the productive capacify of the economy.
The change in PPP can be of two types:
1. Shift in PPP: PPF will shift when there is change in productive capacity (resources or
technology) with respect to both the goods.
2. Rotation of PPF: PPF will rotate when there is change in productive capacity (resources
or technology) with respect to only one good.
1. Shift in PPP
The PPP can shift either towards right or towards left, when there is change in resources or
technology with respect to both the goods.
1.16 Introductory Microeconomics

(i) Rightward Shift in PPF: When there y Rightward Shift in PPF

is "Advancement or Upgradation of
Technolofsl/' or I and "Growth of Resources" PPF shifts to the ri ght from
PP to P 1P1 when there is
in respect to both the goods, then PlPF growth of resources or/ and
will shift to the right. For example, technological upgradation of
both guns and butter.
if there is increase in resources for
V,
C
:::,

production of butter and guns, we can

produce more of both the goods. In
,-+-------:---►x
such case, existing PPF (PP) will shift 0 P P1
Butter (in units)
to the right, represented by P 1 P 1 in
Fig.1.7
Fig. 1.7.
"Growth of Resources" take place when:
• Quantity of Resources increases, like: (i) Discovery of new natural resources; (ii) Inflow of
Foreign Capital; (iii) Increase in labour force.
• Quality of Resources increases, like: (i) "Skill Development of Human Resources" due to
establishment of Educational Institutes or schemes like Pradhan Mantri Kaushal Vikas Yojana;
(ii) "Improved Hygienic Environment" due to 'Clean India Mission' (Swachh Bharat Mission).
(ii) Leftward Shift in PPF: PPF will shift towards left, when there is a technological
degradation and/or decrease in resources with respect to both the goods. For exmnple,
destruction of resources in an earthquake will reduce the productive capacity and as a
r esult, PPF will shift to the left from PP to P1 P1 (Fig. 1.8).
Y Leftward Shift i n PPF

p
PPF shifts to the left from PP to P1 P 1
P1 --•• when there is decrease in resources
or I and technological degradation of
both guns and butter.
C
=
V,
C

............·-.·---...... .
:::,

.
__

"'ot---------,,p•,--
1 �p=--- X
Butter (in units)
Fig.1.8

For, "How PPF will be affected by massive unemployment", refer HOTS.

2. Rotation of PPP
It happens when there is change in productive capacity (resources or technology) with respect
to only one good. The rotation can be either for the commodity on the X-axis or for commodity
on the Y-axis.
Introduction 1.17

(i) Rotation for commodity on the X-axis: When there is a technological improvement or
an increase in resources for production of the commodity on the X-axis (say, butter), then
PPF will rotate from AB to AC.
However, in case of technological degradation or decrease in resources for production
of butter, PPF •..vill rotate to the left from AB to AD (Fig. 1.9).
Rotation for Commodity Rotation for Commodity
y on the X-axis y on the Y-axis

A
.. ..
.. .. -- -._
-
-
(/)
C
:,
... · ....\,'. (/)
C
:,

\Rightward
Leftward rotation\.....- � ': rotation
' X
0 C ""'o+---------8.___ X
Butter (in units) Butter (in units)
Fig.1.9 Fig. 1.10

(ii) Rotation for cormnodity on the Y-axis: A technological improvement or an increase in

resources for production of commodity on Y-axis (say, guns), will rotate the PPP from
AB to CB.
However, in case of degradation in technology or a decrease in resources for production
of guns, PPF will rotate to the left from AB to DB as shown in Fig. 1.10.