For Undergraduate Students

Content
CHAPTER-1: INTRODUCTION:
1. Basic Concepts in Economics
1.1 Definition of Economics and Agricultural Economics
1.2 Basic Economic Concepts
1.3 Branches of economics
1.4 Basic Economic Problem and Economic Systems
1.5 Production Possibility Frontier and economic growth

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 1.1. Definition of Economics and Agricultural Economics
 Definition of Economics
 Literally, Economics is “rule of the household or managing of
household”.

 In-fact, there is no universally accepted definition of economics

o Adam Smith: causes of the wealth of nations. I.e., scope of economics
to an inquiry of material wealth and prosperity of the nations
o Jacob Viner: Economics is what economists do
o Alfred Marshall: it is a study of mankind in the ordinary business of
life
o Lionel Robbins: It is the science which studies human behavior
o Keynes: defined as a method rather than a doctrine

 Generally, however, economics can be defined as the study of

efficient allocation of scarce resources.

 So, we can say economics is the science of efficiency.

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 Definition of Agricultural Economics
 Agricultural economics is a phrase of two words:
Agriculture and Economics

 Agriculture, literally, is a filed of cultivation; in strict sense

tillage/ plowing of the soil.

 So, agriculture is the process of producing food, feed, fiber, fuel

and other goods by the systematic raising of plants and animals
NB. Production of crops and rearing of animals without cultivation are not
considered as activities of agriculture

 Hence, combining the concept of agriculture and economics,

 Agricultural Economics is the branch of economics which deals
with the application of economics principles to the production of
crops and livestock.
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1.2. Basic Economic Concepts
 Many people think that economics is about money!

 Well, to some extent this is true. Because, at large our lives are
concerned with money; like:
 how much money people are paid, and how much they spend;
 what it costs to buy various items;
 how much money firms earn; how much money there is in total in the
economy.

 But, practically, economics is more than just the study of money. It is

also concerned with the following concepts:
 The production of goods and services
 The consumption of goods and services
 The distribution of goods and services

 Still we have not quite got to the bottom of what economics is about.
Which means,
 there is one central problem faced by all societies; and from which all
the other economic problems are stem. WHAT IS THAT??????

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 This central economic problem is the problem of scarcity
 Does the world producing the amount of goods and services that
is needed? ____!! It is limited! Why?
 b/se the world only has a limited amount of Rs; and these resources in
economics, or factors of production, categorized in to four as land,
capital, labor and mag’t ability.

 Scarcity: What is the reason for scarcity?

 Human wants are virtually unlimited, whereas the resources
available to satisfy these wants are limited.
 So, Scarcity is the excess of human wants over what can actually
be produced.

 As a result, the need to balance the more or less unlimited wants

for goods and services with limited availability of resources has
led to the question of efficient utilization of scarce resources.

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Alternative
uses

B/c of Unlimited want

Limited Resource Choice involves
sacrifice, and leads

Is choosing items that give you Measured in terms of the

the best value for money; i.e., next best alternative forgone
greatest benefit relative to cost
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1.3. Branches of economics
 As noted above, economics is essentially the study of the process,
logic and technique of making choices and allocation of
resources aimed at maximizing the gains.

 So, it is not confined only to the study of decision-making process of

individuals; rather:
 It analyzes the determination of national S, I and growth of national
income, trends in general price level, SS and Dd for money and their
impact on the economy, public revenue and public expenditure,
economic policies and financial transactions etc

 In addressing such kinds of economic, economics is divided in to

two broad branches: microeconomics and macroeconomics.
 Microeconomics deals chiefly with the choice and decision making
behavior related to individual, HHs, firms and industries,
 Macroeconomics is chiefly concerned with the behavior related to the
national aggregates

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1.4. Basic Economic problem and Economic Systems
1.4.1. Basic Economic problem
 All types of economies have been faced with certain common
economic problems.

 All economic problems arise due to scarcity of available means

to satisfy endless human wants.

 The major economic problems faced by an economy may be

classified in to two broad groups: Micro and Macro pbms.
 The microeconomic problems will be discussed in this section as
they are immediately relevant for our simplified economic system.

 Thus, the economic system must solve the following three basic
micro-problems.

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1. What and how much to produce: It is the problem of choice
between commodities.
 This problem arises mainly for two reasons:
(a) scarcity of resources does not permit production of all Gds and Ss that people
would like to consume; and
(b) all the Gds and Ss are not equally valued in terms of their utility by the
consumers.
 In a free market economy, this problems is provided by the price system

2. How to produce: is the problem of choice of techniques or

methods or technology to be adopted in the production process
 The pbm arises mainly because of two reasons
(a) scarcity so must choose a method which uses resources most economically.
(b) Quantity of goods are produced with a number of alternative techniques

 The decisions on how to produce, therefore, clearly provided by the

efficiency with which we use our resources

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3. For whom to produce:
 Referred as the problem of distribution of goods among members of
the society.
 How should allocation of consumer goods among households take place
on the basis of exchange?
 How should allocation of capital goods take place according to the needs
of the private sector?
 In a free enterprise economy, it is the price system/the market system
which determines the distribution of the national output.

 The price system determines the price of each factor of production,

then the income of each factor is determined by the quantity of the
factor(s) which is sold in the factor market.
 Those who possess a larger amount of highly priced resources, are able
to earn higher incomes and consume a larger proportion of national
output than those who possess a small quantity of low-priced
resources.
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1.4.2. Alternative Economic Systems
 The economic system is a complex one, which comprises:
 Scarce resources (that produces a finite quantity of Gds and Svs)
 Producers (publicly and privately owned),
 Consumers,
 Governments, and
 Non-market institutions

 Economic system can be defined as “a group of economic institutions

that brings into being an organization”

 The major function of every organized society (economic system) is the

provision of solutions to the above three fundamental problems

 The agencies through which the economic activities are performed are
called the units of the economic system; in Simple model HHs & Firms.

 The primary objectives of each of the decision making units in conducting

economic activities is to optimize their own economic wellbeing.

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 Economic system is not the same in all countries.
 There are a variety of economic systems operating in the world but these can be
categorized in to three: market economy, command economy and mixed
economy.

(1) Market economy: It is also known as a free enterprise or capitalist system.

 It contains the following main characteristics.

 Private ownership: It means individuals have the right to own, control

and dispose of the productive resources. Plus, the right to the income
from that property in the form of interest, rent, and profits.

 Freedom of enterprise: It means individuals are free to buy or hire

economic resources, to organize them for production, and to sell their
outputs in markets of their own choice. Persons engaged in these
activities are known as entrepreneurs.

 Freedom of choice: It means consumers are free to buy whatever they

are willing to get and able to afford. Hence, it is consumers who dictate
what are to be produced; and so producers respond to the consumers’
preferences-i.e., they produce whatever consumers demand.
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 Control of the economy by the price system: The Gds and Srs that are
produced in a market economy are determined by consumer demand.
o Only those demanded by consumers are produced by the producers. The
spends money on a commodity treated as a vote for producing that good.

 Self-interest is the motivating force: Each decision making unit in the

economy attempts to do what is best for itself.
o Consumers will spend their incomes on those goods and services, which give
them the highest satisfaction.
o Firms will act in ways which will lead to maximize profit.

 Perfect competition: there exists a high degree of competition in both

product and factor markets.
 Perfect competition requires equality between competitors. So, there are many
sellers, many buyers, exactly similar products, freedom of entry and exit, perfect
information about the market, no collusion among buyers or sellers, and free
factor mobility.

 A very limited role of the government: Since the economy is regulated

by the market itself, government absent in controlling the economic
activities, particularly over prices and production.

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(2) Command Economy: is also called centrally planned or socialist
economy
 In general, command economy has the following main
features:
 Government ownership of factors of production: Most productive
resources are owned by the government on behalf of the society as a
whole.

 Centralized planning mechanism: Both pricing decisions and

resource allocation are undertaken by a central planning authority.
o The aim of production is consumption rather than profit (i.e., social welfare
is the guiding factor for economic activities).

 Redistribution of income: Imbalances in income distribution in the

society are corrected through proper adoption of economic policies.

 However, this does not mean that there would not be differences in income
distribution under such economic system.
 Differences will result from differences in skills and efficiency of individuals
in the society.
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(3) Mixed Economy Systems: is b/n the two economic system
 Pure market economy and pure command economy are at opposite ends. In-fact,
there is no pure market or command economy in the real world; Rather It is the
mixture of market and command economies, which is called mixed economy.

 The main characteristics of mixed economy are:

 Existence of private and public ownership: The government reserves
vital economic sectors for its ownership and leaves free others for the
private sector. Thus, production is organized in both the public and the
private sectors.

 Control over the price system: Prices of goods and services are allowed to
be determined freely by the market, but if they cross a limit then the
government regulates them.

 Control of monopoly business: Though freedom of enterprise exists in

the mixed economy this freedom is controlled in the national interest, for
which restrictions are imposed on the activities of monopoly firms.

 Development planning: Most mixed economies introduce development

plans for their rapid and balanced development.
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 1.5. Production Possibility Frontier and economic growth
 Production possibility frontier/curve (PPF/C)
• It is a curve showing all the possible combinations of two Goods
that an economy can produce when its Rss. are fully employed.

 In the analysis of PPF, the following four assumptions are vital.

 The quantity and quality of available economic resources are
fixed over the time period considered.

 All factors of production in an economy are fully employed (i.e.,

there is no unemployed and underemployed resources).

 Some resource inputs are better adapted to the production of one

type of good than to the production of the other.

 The technology does not change over the time period considered.

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 Let assume the economy possibly choose and devote the resources available
to the production of both wheat & cloth
 The figure below shows the hypothetical economy producing wheat on the
vertical axis and cloth on the horizontal axis
Wheat
If all Rss used for Wheat prodn, it is @ A;

A Point on the PPF reflects the maximum

output combinations: Called efficient points
B
But, if all Rss used for Cloth prodn , it is @ E
.F
C
.G
D

0 E Cloth
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Full production means that the employed Rss. should be utilized
in order to make the most valuable contribution to total output.
In our case, at when production of wheat and cloth is taking place
on the PPF
Points above the PPF are NOT attainable with
the given technology and available resources

Points below the PPF are inefficient: Means,

without reducing the production of wheat,
more of cloth can be produced, and vice-versa

So, @ Point ‘G’: Resources are either

 Unemployed (idle) or
 Employed inefficiently (underemployment)

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Note that:
 With the above four given assumptions, the PPF cannot expand (shift
to the right).
 But, if the PPF shifts to the right, there will be an economic growth.

 Economic Growth and the PPF: Economic growth or an

increase in the total output level occurs when one or both of the
following conditions occur.
 An increased quantities and quality of economic resources and

 Advances in technology.

 Economic growth is represented by outward shift of the PPF.

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Features of the PPF:
(1) PPF exhibits a trade-off; meaning to get more of one good,
you must get less of another good.
 The amount of other products that must be forgone (sacrificed)
to obtain a unit of any given product, is called the opportunity
cost of that good.

(2) PPF is not a straight line but displays a ‘bowed-out’

shape or Concave to the Origin.
 As we move along the PPF from point A to E, the slope of the
curve increases.

 Slope (also represents the opportunity cost) shows, to increase

the production of cloth by one unit, how many units of wheat are
sacrificed?

 It is clear that, for instance, if we move from A to B, the amount

of wheat sacrificed is less than if we move from B to C, which
reflects a similar change in the production of wheat.
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 PPF describes three important concepts
i) The concepts of scarcity: - the society cannot have unlimited
amount of outputs even if it employs all of its resources and
utilizes them in the best possible way.
ii) The concept of choice: - any movement along the curve
indicates the change in choice.
iii) The concept of opportunity cost: - when the economy produces
on the PPF, production of more of one good requires sacrificing
some of another product which is reflected by the downward
sloping PPF.

 Related to the opportunity cost we have a law known as the

law of increasing opportunity cost.

 This law states that as we produce more and more of a product, the
opportunity cost per unit of the additional output increases. This
makes the shape of the PPF concave to the origin.
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 The reason why opportunity cost increases when we produce
more of one good is that economic resources are not
completely adaptable to alternative uses (specialization
effect).
𝑡𝑕𝑒 𝑠𝑎𝑐𝑟𝑖𝑓𝑖𝑒𝑑 𝑎𝑚𝑜𝑢𝑛𝑡
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 =
𝑡𝑕𝑒 𝑎𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑡𝑕𝑒 𝑔𝑎𝑖𝑛𝑒𝑑 𝑔𝑜𝑜𝑑

Example: using the data in the Table 1.1 below, draw the PPF.

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Example-2: Referring the above table, if the economy is initially
operating at point B, what is the opportunity cost of
producing computer at C?

Solution: Moving from production alternative B to C we have:

320 − 420 −100
𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 = = = 0.2
1000 − 500 500

Interpretation: The economy gives up 0.2 metric tons of food

per computer

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 Chapter-1
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END!!

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