Why Should We Learn Economics?

Definition and Importance: - Economics is the study of how individuals

and societies allocate limited resources to satisfy unlimited wants. - Key
Concepts: - Scarcity: Resources are limited compared to unlimited human
wants. - Choice: Decisions must be made due to scarcity. - Reason for
Learning Economics: To make wise choices and optimize resource
allocation.

Growth and Scope: - Economics has evolved significantly since Alfred

Marshall separated it from political economy. - The scope includes: -
Definitions of economics. - Whether economics is an art or science. -
Whether it is positive or normative.

Economics as an Art and Science

Economics as an Art: - Involves the use of theories, laws, and assumptions

to explain economic phenomena. - Uses tools like graphs, tables, and
equations to illustrate economic principles.

Economics as a Science: - A systematized body of knowledge that studies

economic facts and behaviors. - Has laws and theories that establish causal
relationships (e.g., the law of demand). - Examples of universal laws: - Law
of Demand: As price falls, demand increases (assuming other factors
remain constant). - Law of Diminishing Marginal Utility: As consumption
of a good increases, the additional satisfaction (utility) derived from each
unit decreases.

Criticism: - Some argue economics is not a science because it lacks precise

experimentation. - Economic phenomena are complex due to human
irrationality influenced by tastes, habits, and social institutions. - Economic
methods (statistical, mathematical, econometric) are not always accurate for
quantitative predictions.

Positive and Normative Economics

Positive Economics: - Focuses on what is (descriptive). - Objective: To

establish scientific laws and describe economic phenomena. - Examples of
positive statements: - “Growth creates pollution.” - “Inflation is caused by an
increase in the money supply.”

Normative Economics: - Focuses on what ought to be (prescriptive). -

Involves value judgments and ethical considerations. - Examples of
normative statements: - “The government should increase taxes on the rich.”
- “The minimum wage should be raised to reduce poverty.”

Combination: - Economics is both positive and normative. Positive

economics describes reality, while normative economics evaluates it.
Definition of Economics

1. General Definition:
◦ Economics studies human behavior as a relationship between
unlimited ends (wants) and scarce means (resources) with
alternative uses.
2. Alternative Definition:
◦ Economics studies how people use limited resources to fulfill
unlimited wants, involving choices and trade-offs.

Evolution in the Definitions of Economics

1. Wealth Definition (Adam Smith, 1776):

◦ Focuses on the creation and distribution of wealth.
◦ Example: “Economics is the science of wealth.”
2. Welfare Definition (Alfred Marshall, 1890):
◦ Emphasizes the welfare of society.
◦ Example: “Economics is the study of mankind in the ordinary
business of life.”
3. Scarcity Definition (Lionel Robbins, 1932):
◦ Highlights the relationship between unlimited wants and limited
resources.
◦ Example: “Economics is the science which studies human behavior
as a relationship between ends and scarce means which have
alternative uses.”
4. Growth Definition (P.A. Samuelson, 1948):
◦ Focuses on economic growth and development.
◦ Example: “Economics is the study of how people and societies use
resources to produce goods and services and distribute them
among different groups.”

Engineering Economics

Definition: - Engineering economics is the study of how engineers choose to

optimize designs and construction methods to produce efficient objects and
systems.

Key Concepts: - Engineering Economy: Economic decision-making for

engineering systems. - Collection of Techniques: Simplifies economic
comparison. - Systematic Evaluation: Involves formulation, estimation,
and evaluation of economic outcomes.

Origin: - Originated by A.M. Wellington in his book “The Economic Theory

of Railway Location” (1887). - Famous quote: “An engineer can do for a
dollar what any fool can do for two.”
Principles of Engineering Economy

1. Develop the Alternatives:

◦ Identify and define alternatives for analysis.
◦ Example: Choosing between two construction methods for a
bridge.
2. Focus on the Differences:
◦ Consider only the differences in expected future outcomes among
alternatives.
◦ Example: Compare the cost savings of using steel vs. concrete in
construction.
3. Use a Consistent Viewpoint:
◦ Develop outcomes from a defined perspective (e.g., the company’s
or society’s viewpoint).
4. Use a Common Unit of Measure:
◦ Enumerate outcomes using a common unit (e.g., cost in rupees).
5. Consider All Relevant Criteria:
◦ Use criteria for selecting a preferred alternative (e.g., cost,
durability, environmental impact).
6. Make Uncertainty Explicit:
◦ Recognize uncertainty in projecting future outcomes (e.g.,
inflation, market fluctuations).
7. Revisit Your Decisions:
◦ Compare initial projected outcomes with actual results to improve
future decisions.

Engineering Economy and the Design Process

• Involves a structured procedure and mathematical modeling

techniques.
• Economic results are used in decision situations involving multiple
alternatives and engineering knowledge.

Rational Decision-Making Process

1. Recognize a Decision Problem:

◦ Identify the need for a decision (e.g., choosing a car).
2. Define the Goals or Objectives:
◦ Set clear goals (e.g., mechanical security, minimum total cash
outlay).
 3. Collect All Relevant Information:

• Gather technical and financial data (e.g., car specifications, prices).

1. Identify a Set of Feasible Decision Alternatives:

• List possible options (e.g., Toyota vs. Honda).

1. Select the Decision Criterion:

• Choose the basis for decision-making (e.g., minimum total cash outlay).

1. Select the Best Alternative:

• Choose the optimal option based on the criterion (e.g., select Honda).

Example: Which Car to Lease? Toyota vs. Honda

1. Recognize a Decision Problem:

• Need a car.

1. Define Goals:

• Mechanical security and minimum total cash outlay.

1. Collect Relevant Information:

• Gather technical and financial data for Toyota and Honda.

1. Identify Alternatives:

• Toyota vs. Honda.

1. Select Decision Criterion:

• Minimum total cash outlay.

1. Select the Best Alternative:

• Choose Honda.

Microeconomics vs. Macroeconomics

Microeconomics: - Studies individual parts of the economy (individual

choices, business choices, personal choices). - Also called Price Theory. -
Examples: - Production of burgers by McDonald’s. - Prices of individual
items. - Wages of workers at McDonald’s.

Macroeconomics: - Studies the economic system as a whole (national

income, trade cycle, unemployment rate, inflation). - Also called Income
Theory. - Examples: - Total goods produced by India. - Aggregate prices of
all consumer goods. - Total wages and salaries in the economy.

Differences Between Micro and Macro Economics

Aspect Microeconomics Macroeconomics

Individual entities
Focus (individuals, households, Economy as a whole.
firms).

Explains relationships Explains national

Inter- between economic units income, aggregate
relationships (consumers, firms, demand and supply,
markets). general price level.

Analyzes conditions for

Efficiency efficiency in Analyzes economic
Analysis consumption and fluctuations and trends.
production.

Income and
Product pricing, factor
employment, general
Theories pricing, economic
price level, economic
welfare.
growth, distribution.

Helps in individual
Decision- Vital for government
decision-making
Making economic policies.
(managerial decisions).

Addresses production Includes study of

quantity, production national aggregates
Aggregates
procedures, and final (output, income,
consumers. expenditure, savings).

Basic Economic Concepts

1. Scarcity:

• Wants always exceed limited resources.

 • A universal problem faced by all nations.

1. Choice:

• Choices must be made when scarcity exists.

1. Opportunity Cost:

• The second-best alternative forgone for another choice that gives more
satisfaction.
• Example: The opportunity cost of choosing to buy a car is the money
that could have been spent on a vacation.

Classification of Goods

1. Necessaries:

• Things required to meet essential wants.

• Examples: Food, water, shelter.

1. Comforts:

• Things that make life easier and more pleasant.

• Examples: Nutritious foods, well-finished house, clothing for various
occasions.

1. Luxuries:

• Things needed for show.

• Examples: Costly dress, ornaments, air-conditioned cars, big
bungalows.

1. Consumers’ Goods:

• Final goods that directly satisfy consumers’ wants.

• Examples: Bread, milk, pen, clothes, furniture.
• Single-use: Foodstuffs, cigarettes.
• Durable-use: Pens, toothbrushes, clothes, scooters, TV sets.

1. Capital or Producers’ Goods:

• Goods that help in producing other goods.

• Examples: Machines, plants, raw materials.

1. Intermediate Goods:

• Goods sold by one firm to another for resale or further production.

• Example: Cotton → Thread → Cloth.

1. Free Goods:

• Goods with no production cost.

 • Examples: Sunlight, river water, air.

1. Public Goods:

• Goods for common use that benefit everyone.

• Examples: Government hospitals, schools, bridges.

Basic Economic Problems

1. What to Produce?

• Determine the quantity of a commodity to maintain stable equilibrium

price.
• Example: If the quantity produced is more or less than demand, prices
will fluctuate.

1. How to Produce?

• Choose techniques based on factor prices (labor-intensive vs. capital-

intensive).
• Example: If labor is cheap and capital is expensive, use a labor-
intensive technique.

1. For Whom to Produce?

• Determine who can consume based on purchasing power.

• Example: Goods are consumed by those with higher purchasing power.

Production Possibilities Curve (PPC)

Definition: - Shows various possible combinations of goods produced with

all resources fully and efficiently employed.

Assumptions: 34. Full employment and full production capacity. 35. Fixed
resources. 36. Constant technology. 37. No unemployment or
underemployment.

Example: - A table showing combinations of goods X and Y:

a b c d e

X 14 12 9 5 0

Y 0 2 4 6 8

• Graph plotting X good on the y-axis and Y good on the x-axis:

 PPC Graph

Opportunity Cost

Definition: - What must be given up to obtain something desired.

Examples:

1. Books vs. Pens:

a b c d e

Books 0 3 5 8 10

Pens 20 17 14 10 8

• Opportunity cost of moving from A to B: 3 Pens.

• Opportunity cost of moving from B to D: 7 Pens.
• Opportunity cost of moving from D to B: 5 Books.

1. Computers vs. Bikes:

a b c d e

Computers 0 2 4 6 8

Bikes 14 12 9 5 0

• Opportunity cost of moving from A to B: 2 Bikes.

• Opportunity cost of moving from B to D: 7 Bikes.
• Opportunity cost of moving from D to B: 4 Computers.

Factors Influencing the Shift of PPC

1. Economic Growth:

• Rightward Shift: Due to improved technology, increased savings,

investment, and capital formation.
 • Leftward Shift: Due to reduction in resources, unemployment, or
underutilization of resources.

Assignment

Example: - Table showing combinations of CDs and TVs:

PP A B C D E

CDs 0 5 10 15 20

TVs 20 18 15 6 0

1. Opportunity cost of 5 units of CD (B):

• 2 TVs.

1. Opportunity cost of 15 units of CD (D):

• 14 TVs.

1. Draw the PPC:

• Plot CDs on the y-axis and TVs on the x-axis.

Let’s dive into the Circular Flow of Income, which is a fundamental

concept in economics that illustrates how money flows through the economy.

Circular Flow of Income

The circular flow of income is a model that represents the flow of money and
goods/services between households and firms in an economy. It illustrates
how income is generated, distributed, and spent, creating a continuous cycle
of economic activity.

Basic Model

1. Households:
◦ Provide factors of production (land, labor, capital, and
entrepreneurship) to firms.
◦ Receive income (wages, rent, interest, and profit) from firms.
◦ Use this income to consume goods and services produced by
firms.
2. Firms:
◦ Use the factors of production provided by households to produce
goods and services.
 ◦ Pay income to households for the use of these factors.
◦ Sell goods and services to households in exchange for money.

Flow of Money and Goods/Services

• Money Flow:
◦ Flows from households to firms when households purchase goods
and services.
◦ Flows from firms to households as income for the factors of
production.
• Goods/Services Flow:
◦ Flows from firms to households as consumption.
◦ Flows from households to firms as factors of production.

Diagram of the Circular Flow

Here’s a simplified diagram to illustrate the circular flow of income:

Households --> Factors of Production --> Firms

^ |
| v
| Income (Wages, Rent, Interest, Profit) |
v |
Firms --> Goods and Services --> Households

Expanded Model

The basic model can be expanded to include other sectors such as the
government, financial institutions, and foreign trade.

1. Government:
◦ Collects taxes from households and firms.
◦ Provides public goods and services (e.g., infrastructure,
education, healthcare).
◦ Redistributes income through transfer payments (e.g., pensions,
unemployment benefits).
2. Financial Institutions:
◦ Facilitate the flow of money between households and firms.
◦ Provide savings and investment opportunities.
◦ Channel funds from savers to investors.
3. Foreign Trade:
◦ Involves imports (goods and services bought from other
countries) and exports (goods and services sold to other
countries).
◦ Affects the flow of income and expenditure in the economy.

Leakages and Injections

• Leakages:
◦ Savings: Money not spent on consumption but saved.
 ◦ Taxes: Money paid to the government.
◦ Imports: Money spent on foreign goods and services.
• Injections:
◦ Investment: Money spent by firms on capital goods.
◦ Government Spending: Money spent by the government on
goods and services.
◦ Exports: Money earned from selling goods and services to other
countries.

Equilibrium in the Circular Flow

For the economy to be in equilibrium, the total leakages must equal the total
injections:

Savings+Taxes+Imports=Investment+Government