Notes

1.1 A Simple Economy

An economy is essentially a system of production, exchange, and consumption of goods and services. Let us begin by understanding a basic economy through the following key points:

A. Human Needs and Resource Limitations

1. Every person requires numerous goods and services in daily life—food, clothes, shelter, transport, healthcare, education, etc.
2. However, no individual has all the goods and services they need; they possess only limited resources or skills.
• A farmer may own land and tools.
• A weaver may have yarn and weaving tools.
• A teacher possesses knowledge and teaching skills.
• A labourer may offer only manual labour.

B. Resource Use and Exchange

3. Each person uses what they have (resources or skills) to produce something of value.
4. They consume part of what they produce and exchange the rest for other goods and services.
• Example: A farmer grows corn → eats some → trades the rest for clothes or housing.
• A teacher earns money by teaching → uses money to buy necessities.
5. This mutual exchange builds interdependence in the economy.

C. Scarcity and Choice

6. Resources are limited compared to wants. This leads to:
• Scarcity → Need for choice.
• Trade-offs → Gaining one good requires sacrificing another.
• E.g. To buy better education, a family might reduce spending on luxuries.

D. Collective Production and Demand

7. Society must align what is produced with what people want:
• If too much corn is produced but less is needed, resources are wasted.
• If too little is produced, there’s a shortage.
8. Therefore, production must match societal preferences.

E. Basic Economic Problems

9. Every economy faces two fundamental issues:
• Resource Allocation – What to produce and how to use resources efficiently.
• Distribution – Who gets what share of the goods and services.

1.2 Central Problems of an Economy

Due to limited resources and unlimited wants, every economy must solve some central problems:

A. What to Produce and in What Quantities?

1. Choices must be made among:
• Food, clothing, housing, education, luxury goods, etc.
• Agricultural goods vs. industrial goods.
• Consumption goods vs. investment goods (e.g., machines).
2. These decisions reflect societal priorities.

B. How to Produce?

3. Decisions must be taken regarding:
• Use of labour-intensive or capital-intensive techniques.
• Which technology or method to use.

C. For Whom to Produce?

4. The economy must decide:
• How the total output is distributed.
• Who receives more or less.
• Whether to ensure basic needs like education and healthcare for all.

Conclusion: The central problems revolve around optimal allocation of resources and fair distribution of goods and services.

1.3 Organisation of Economic Activities

Economic problems can be addressed in two ways:

1.3.1 The Centrally Planned Economy

1. A central authority (government) makes all major economic decisions.
2. The government decides:
• What and how much to produce.
• Who gets how much.
3. If essential goods/services (like education/healthcare) are underproduced, the government can:
• Encourage production or
• Directly produce them.
4. It may also intervene to ensure equitable distribution, especially to protect the vulnerable.

1.3.2 The Market Economy

1. Economic decisions are taken by individuals through free interaction in markets.
2. A market refers to:
• Any arrangement (physical or virtual) that allows buying and selling.
• Interaction can happen in bazaars, malls, or online platforms.
3. Price Mechanism:
• Prices guide production and consumption.
• Higher demand → Higher price → Signals producers to increase supply.
4. This price signal ensures coordination among millions of decisions without central direction.

Reality: Mixed Economies

5. Most modern economies are mixed economies, where:
• Market forces handle most activities.
• The government steps in for regulation, welfare, and planning.
• Examples:
• USA – Predominantly market-based.
• China – Historically centrally planned.
• India – Mixed, with increased market role post-1990s liberalization.

1.4 Positive and Normative Economics

Economics is both a science of analysis and evaluation.

A. Positive Economics

1. Describes and explains how the economy functions.
2. Answers questions like:
• What happens when prices rise?
• How does demand respond to income changes?

B. Normative Economics

3. Evaluates whether outcomes are desirable.
4. Addresses questions like:
• Should education be free for all?
• Is income inequality acceptable?

Note: Though separated conceptually, positive and normative analysis are closely linked.

1.5 Microeconomics and Macroeconomics

Economics is divided into two broad branches:

A. Microeconomics

1. Focuses on individual units like consumers, firms, and markets.
2. Studies:
• How prices and outputs are determined in individual markets.
• How individuals make choices under constraints.

B. Macroeconomics

3. Focuses on the economy as a whole.
4. Studies aggregate indicators such as:
• Total output
• Employment and unemployment
• Inflation and price levels
• National income
5. Important macroeconomic questions:
• What is the GDP?
• What causes inflation or unemployment?
• How does the economy grow?

Key Concepts Summary