Fundamentals of Economics

The first lesson in economics is our resources are limited; but wants are unlimited.
Economics in a subject which deals with how can we manage our unlimited wants by our limited
resources.
can be all agents economic
individuals , e.g. houesholds firms
or the government itself.

Economic analysis can be done in two lines:

Individual consumer wants
to maximize his/her utility 1) Microeconomics: is that branch of economics which deals
by minimizing expenditure. with the behavior of individual decision making units, for

A firm wants to maximize example the behavior of an individual consumer, a household,

his profit by minimizing a firm or the market for a commodity.
cost.

2) Macroeconomics: in that branch of economics which deals with aggregate economic

activities. For example, the behavior of all individuals. all firms, all households and market for
all commodities. It deals with the behavior of national output/income, unemployment, inflation,
price level, money supply, government’s income/expenditure, debt, etc.

In general microeconomics deals with the leaf of a tree while macroeconomics deals with the
whole tree.
In both microeconomics and in macroeconomics our analysis is positive, [that is what is? or what
is going on?] but not normative [that is what ought to be/]. Therefore, ethics or morality does not
play any role in our analysis. However, in now a days some normative criterion are used in
environmental policy decision.
Scarcity, choice, opportunity cost

Our resources are limited. In economics such limitation is our considered as

Scarcity since resources are scarce we donot get whatever we want;

therefore, we have to make a choice. That is scarcity implies

Choice If we make a choice that is if we want to get one thing we have to

sacrifice other thing, which is called the opportunity cost. that is if

we avail an opportunity .

Opportunity cost

Therefore, scarcity implies choice; choice implies opportunity cost.

Fundamental economic problems society

Due to the scarcity of the resources every human society faces different types of problems. All
these problems are categorized as the fundamental economic problems of the society. There
problem are.

1. What: What goods are to be produced and in what quantities?

2. How: How goods are to be produced? That is which technique is to be applied?
3. For whom: For whom goods are to be produced?

These problems are to be solved in different techniques in different societies.

Here we can consider two different types of economic systems Socialist/Command

economy and the Capitalist / Market economy.
 Socialist/command economy
Characteristics
1) There is on private ownership of the resources. All productive means are owned by
the central authority.
2) There is no freedom of enterprises.
3) Every individual works according to his/her ability and gets reward according to his
work.
Solution to the problem

1) Since all the productive resources are owned by the central authority, the central
government makes the decision what goods are to be produced and in what
quantities.
2) Among the alternative techniques, that technique will be chosen which entail the
least cost combination of inputs as well as the utilization of abundant factor.
3) In this society goods are to be produced and the services are to be provided to
maximize the welfare of the society.

Capitalist/ market economy

Characteristics

1) There is private ownership of the resources. Thus every individuals try to

achieve more resources.
2) There is freedom of enterprises.
3) Every individual is driven by his own optimizing behavior.

Maximization and/or minimization

Solution to the problem

1) What goods are to be produced and in what quantities in determined by consumer’s

preference. Consumers express their preference in the market and producers’ take the
signal from the market and makes the decision of what goods are to be produced and in
what quantities.
2) Among the alternative techniques that technique will be chosen which will entail the least
cost combination of inputs so that producers can maximize their profit.
3) In this society goods are to be produced for those whose has the ability to purchase
goods.

Production possibilities of the society

 is determined by the amount of resources in the economy and the available technologies.

Inputs

Factors o Production

In economics, factors of production are the inputs to the production process. All factors of
production like land, labor, capital and technology are required in combination at a time to
produce a commodity. Factors of production (or productive 'inputs' or 'resources') are any
commodities or services used to produce goods or services. 'Factors of production' may also refer
specifically to the 'primary factors', which are stocks including land, labor (the ability to work),
and capital goods applied to production.

Land :Land stands for all natural resources which yield income or which have exchange value.
Land is not created by mankind but it is a gift of nature. So, it is called as natural factor of
production. It is also called as original or primary factor of production. Land or natural resource
are naturally-occurring goods such as water, air, soil, minerals, flora and fauna that are used in
the creation of products. The payment for use and the received income of a land owner is rent.
Alfred Marshall defined land is meant no merely land in the strict sense of the word, but whole
of the materials and forces which nature gives freely for man’s aid in land, water, in air and light
and heat. Land as a factor of production is quite peculiar, it possess some importance feature,
they are-

1. Land is free gift of nature: Land is not produced or man-made resource (agent).
Therefore, that we have to accept is as it is. It is after all free gift of nature.
2. Land is limited in area: Land surface of the world is remaining unchanged. In Holland,
some land has been reclaimed from the sea. But these efforts have produced a negligible
result as compared with the total area already in existence.

3. Land is permanent: Land as factor of production is not easy to destroy. The other
factors are destructible but land can not be completely destroyed.

4. Land lacks mobility: Land can not move bodily from one place to another. It lacks
geographical mobility.

5. Land is of infinite variety: Land is not man-made. Land is of infinite variety. For
example, soil may be of different types, climate elements like temperature, rains received
in different part is always varying.

Labor: Any manual or mental work which is taken into monetary consideration is called labor.
Labor, human effort used in production which also includes technical and marketing expertise.
The payment for someone else's labor and all income received from ones own labor is wages.
Labor can also be classified as the physical and mental contribution of an employee to the
production of the good(s). Peculiarities of Labour: The important peculiarities of labour are as
under.
1. Labour is inseparable from labourer:Labour can not be separated from labourer. Worker
sells their service and doesn't sell themselves.
2. Labour is a perishable factor:Labour can not be stored. Once the labour is lost, it can not be
made up. Unemployed workers can not store their labour for future employment.
4. Labour is an active factor of production: Other factors like land, capital are passive, but
labour is an active factor of production. So without labour, we cannot imagine the smooth
conduct of production.
5. Labour is a heterogeneous factor: No two persons possess the same quality of labour. Skills
and efficiency differs from person to person. So, some workers are more efficient than
others in the same job.
6. Labour has imperfect mobility:Labour doesn't move easily from one occupation to another
because of several factors like family and cultural background, limited educational and
technical skills, lifestyle, housing and transport problems, language barrier, adaptability to
new environments, etc.
7. Labour supply is inelastic: Supply of labour depends upon many factors like size of
population, age and sex composition, desire to work, quality of education, attitude towards
work, etc. Thus, supply cannot be changed easily according to changes in demand. Hence,
in general, labour supply is inelastic. But for a particular industry, it may be relatively
elastic.
8. Labour is a human capital: Society makes investment in labour in the forms of education,
health, training, etc. This improves efficiency of labour. So, it is a human capital.

Capital: In economics, capital is that part of wealth which is used for production. Capital is a
produced means of production. The classical economists also employed the word "capital" in
reference to money. In much of economics, however, "capital" (without any qualification) means
goods that can help produce other goods in the future, the result of investment. It refers to
machines, roads, factories, schools, infrastructure, and office buildings which humans have
produced in order to produce goods and services. The characteristics or features of capital are:-

1. Man-made Factor : Capital is not a gift of nature. So it is not a primary or natural factor,
it is made by man in capital goods industry. It is secondary as well as an artificial factor
of production.
2. Productive Factor : Capital helps in increasing level of productivity and speed of
production.
3. Elastic Supply : Supply of capital depends upon capital formation process. Capital
formation depends upon savings and investment. By accelerating capital formation,
capital supply can be increased. But it is a long term process.
4. Durable : Capital is not perishable like labour. It has a long life subject to periodical
depreciation.
 5. Easy Mobility : Movement of capital from one place to another is easily possible.
6. Is a Wealth : Since capital has all features of wealth viz. utility, scarcity, transferability
and externality, capital is a wealth but wealth doesn't necessarily become capital.
7. Derived demand : As a factor of production, capital has a derived demand to produce
finished goods which have a direct demand. e.g. demand for raw cotton is derived from
demand for cotton cloth.

Entrepreneurship: Factors of production viz. land, labour and capital are scattered at different
places. All these factors have to be assembled together. This work is done by enterprise
through entrepreneur. This is an 'Organization Function'. Organization function is the
work of bringing the required factors together and making them work harmoniously.
Entrepreneur has to bear risks and uncertainties. For facing uncertainties he may get
profit or may incur loss. This is the 'Risk Bearing Function' and entrepreneur is the risk
bearer.

To be a successful and ideal entrepreneur, one should have certain qualities or skills as given
below :-

1. Ability to organize : He should be able to organize various factors effectively. He has to

understand all the aspects of the business.
2. Professional approach : He should be objective and professional in approach.
3. Risk bearer : He should be risk taker. He should be ready to bear risk and uncertainties.
4. Innovative :Organiser should be innovative. He should adopt modern techniques of
production. He should not be reluctant to changes.
5. Decision Making : One has to take right decision at a right time by showing his
promptness. Quick decisions are expected but hasty decisions shouldn't be taken. Delay
in decisions may increase cost of project and reduce the profits.
6. Negotiation skills : Businessman regularly comes into contact with various persons like
consumers, workers, government officials, etc. so he should communicate tactfully.

Following chart provides brief tabulated information on 4 factors of production.

Production Possibilities of a Society

Every economy has some amount of resources and also has an existing technology.
Amount of resources and technology determines the production possibilities of that
economy, which can be explained by the production possibility frontier (PPF).

A PPF shows the different combinations of the goods that an economy can produce by
using all of its resources and the available technologies.

Let us consider that an economy produce two goods gun and butter. Alternative
production possibilities of the economy can be represented by the following table.

Table: Alternative production possibilities

Possibilities Gun Butter Opportunity Cost

A 0 15
1
B 1 14
2
C 2 12
3
D 3 9
4
E 4 5

F 5 0 5

The above table can be shown in the following diagram

Butter
 Gun

Any point on the PPF is technically efficient because if we want to produce more of one
goods we have to sacrifice some of the other good. Points on the PPF indicate that
resources and technology have been fully utilized.

Points below the PPF are attainable but inefficient because resources and technology
have not been fully utilized.

Any points beyond the PPF are impossible at the present level resource and technology.

Changes of the PPF

due to

i) Resource invention
ii) Technological innovation

(Show the diagram)