Economics is the study of mankind in the ordinary business of life, Economics is a science of wealth

 Alfred Marshall provides a still widely-cited definition in his textbook Principles of Economics (1890) that extends analysis beyond wealth and from the societal to the macroeconomic level:

"Economics is a study of man's action in the ordinary business of life it inquires how he gets his income and how he uses it. It examines that part of individual and social actions which is mostly closely connected with the attainment and with the use of material requisites of well being. Thus economics is on one side a study of wealth and on the other and important side a part of the study of man ".

From the definition of economics by Alfred Marshall, we see that he lays emphasizes on the below points.

 1. Study of an ordinary man: According to Alfred Marshall, economics is that study of an ordinary man who lives in society. It is not concerned with the lives of only rich persons or who is cut away from the society. Its subject matter is a particular aspect of human behaviour i.e. earning and spending of incomes for the normal material needs of human beings.

2. Economics is not a useless study of wealth: Economics does not regard wealth as the be-all and end-all of economics activities wealth is not of primary importance. It is earned only for promoting human welfare economics is studied to analyze the causes of material prosperity of individuals and nations.

3. Economics is a social science: It does not study the behaviour of isolated individuals but the actions of persons living in society. When people live together they interact and cooperate to work at firms, factories, shop and offices to produce and exchange goods or services. The problems about these activities are studied in economics.

4. Study of material welfare: According to Alfred Marshall, economics studies only material requisites of well being or causes of material welfare. It is cleared from this definition that it is materialistic aspect and ignores non-material aspects. Alfred Marshall stressed that the man’s behaviour and activities to produce and consume maximum number of goods and services are the main object of study wealth is not an end or final aim, but only a means to achieve a higher objective of welfare.

Differences between Perfectly Competitive market & monopoly Market

 The Difference between Perfectly Competitive market & monopoly Market are given Below:

Perfectly Competitive market	Monopoly Market
1. Perfectly Competitive market is the market in which there is a large number of buyers and sellers. The goods sold in this market are identical. A single price prevails in the market	1.  Monopoly is a type of imperfect market. The number of sellers is one but the number of buyers is many. A monopolist is a price-maker. In fact monopoly is the opposite of perfect competition.
2. The average revenue (price) curve under perfect competition is a horizontal straight line parallel to OX-axis	2. The average revenue curve under monopoly slopes downward and its corresponding marginal revenue curve lie below the average revenue curve
3.under perfect competition price equals marginal cost at the equilibrium output	3. under monopoly equilibrium price is greater than marginal cost
4. Under perfect competition marginal revenue is the same as average revenue at all levels of output	4. Under monopoly both the AR and MR curve slope downward and MR curve lies below AR curve. Thus average revenue is greater than marginal revenue at all levels of output
5. A competitive firm makes only normal profit in the long run	5. monopolist can make super normal profits even in the long run
6. a competitive firm earns only normal profit	6. monopoly firm continues earning supernormal profits
7. A perfectly competitive Market Cannot discriminate prices for his product.	7.  A monopolist can discriminate prices for his product.
8.  a competitive firm cannot change different prices from different buyers .	8. Elastic ties of demand are different in different markets.

Trade, Comparative Advantage and Absolute Advantage

 An economy can focus on producing all of the goods and services it needs to function, but this may lead to an inefficient allocation of resources and hinder future growth. By using specialization, a country can concentrate on the production of one thing that it can do best, rather than dividing up its resources.

For example, let's look at a hypothetical world that has only two countries (Country A and Country B) and two products (cars and cotton). Each country can make cars and/or cotton. Now suppose that Country A has very little fertile land and an abundance of steel for car production. Country B, on the other hand, has an abundance of fertile land but very little steel. If Country A were to try to produce both cars and cotton, it would need to divide up its resources. Because it requires a lot of effort to produce cotton by irrigating the land, Country A would have to sacrifice producing cars. The opportunity cost of producing both cars and cotton is high for Country A, which will have to give up a lot of capital in order to produce both. Similarly, for Country B, the opportunity cost of producing both products is high because the effort required to produce cars is greater than that of producing cotton.

Each country can produce one of the products more efficiently (at a lower cost) than the other. Country A, which has an abundance of steel, would need to give up more cars than Country B would to produce the same amount of cotton. Country B would need to give up more cotton than Country A to produce the same amount of cars. Therefore, County A has a comparative advantage over Country B in the production of cars, and Country B has a comparative advantage over Country A in the production of cotton.

Now let's say that both countries (A and B) specialize in producing the goods with which they have a comparative advantage. If they trade the goods that they produce for other goods in which they don't have a comparative advantage, both countries will be able to enjoy both products at a lower opportunity cost. Furthermore, each country will be exchanging the best product it can make for another good or service that is the best that the other country can produce. Specialization and trade also works when several different countries are involved. For example, if Country C specializes in the production of corn, it can trade its corn for cars from Country A and cotton from Country B.

Determining how countries exchange goods produced by a comparative advantage ("the best for the best") is the backbone of international trade theory. This method of exchange is considered an optimal allocation of resources, whereby economies, in theory, will no longer be lacking anything that they need. Like opportunity cost, specialization and comparative advantage also apply to the way in which individuals interact within an economy.

Absolute Advantage  

Sometimes a country or an individual can produce more than another country, even though countries both have the same amount of inputs. For example, Country A may have a technological advantage that, with the same amount of inputs (arable land, steel, labor), enables the country to manufacture more of both cars and cotton than Country B. A country that can produce more of both goods is said to have an absolute advantage. Better quality resources can give a country an absolute advantage as can a higher level of education and overall technological advancement. It is not possible, however, for a country to have a comparative advantage in everything that it produces, so it will always be able to benefit from trade.

Opportunity Cost

 Opportunity cost is the value of what is foregone in order to have something else. This value is unique for each individual. You may, for instance, forgo ice cream in order to have an extra helping of mashed potatoes. For you, the mashed potatoes have a greater value than dessert. But you can always change your mind in the future because there may be some instances when the mashed potatoes are just not as attractive as the ice cream. The opportunity cost of an individual's decisions, therefore, is determined by his or her needs, wants, time and resources (income).

This is important to the PPF because a country will decide how to best allocate its resources according to its opportunity cost. Therefore, the previous wine/cotton example shows that if the country chooses to produce more wine than cotton, the opportunity cost is equivalent to the cost of giving up the required cotton production.

Let's look at another example to demonstrate how opportunity cost ensures that an individual will buy the least expensive of two similar goods when given the choice. For example, assume that an individual has a choice between two telephone services. If he or she were to buy the most expensive service, that individual may have to reduce the number of times he or she goes to the movies each month. Giving up these opportunities to go to the movies may be a cost that is too high for this person, leading him or her to choose the less expensive service.

Remember that opportunity cost is different for each individual and nation. Thus, what is valued more than something else will vary among people and countries when decisions are made about how to allocate resources. 

Opportunity cost refers to the value forgone in order to make one particular investment instead of another.For example, let's assume you have $15,000 that you could either invest in Company XYZ stock or put toward a graduate degree. You choose the stock. The opportunity cost in this situation is the increased lifetime earnings that may have resulted from getting the graduate degree -- that is, you choose to forgo the increase in earnings when you use the money to buy stock instead.

Here's another example. Let's say you have $15,000 and your choice is to either buy shares of Company XYZ or leave the money in a CD that earns only 5% per year. If the Company XYZ stock returns 10%, you've benefited from your decision because the alternative would have been less profitable. However, if Company XYZ returns 2% when you could have had 5% from the CD, then your opportunity cost is (5% - 2% = 3%).

Opportunity cost is all about the most basic of economic concepts: trade-offs. It's a notion inherent in almost every decision of daily life and of investing: if you make a choice, you forgo the other options for now. And what's been given up can sometimes turn out to have been the wiser choice, which is why opportunity cost is best measured in hindsight -- after all, it is impossible to know the end outcome of any investment. Opportunity costs are a factor not only in consumer decisions, but in production decisions, capital allocation, time management, and lifestyle choices. 

Production Possibility Frontier (PPF)

 Under the field of macroeconomics, the production possibility frontier (PPF) represents the point at which an economy is most efficiently producing its goods and services and, therefore, allocating its resources in the best way possible. If the economy is not producing the quantities indicated by the PPF, resources are being managed inefficiently and the production of society will dwindle. The production possibility frontier shows there are limits to production, so an economy, to achieve efficiency, must decide what combination of goods and services can be produced.

Let's turn to the chart below. Imagine an economy that can produce only wine and cotton. According to the PPF, points A, B and C - all appearing on the curve - represent the most efficient use of resources by the economy. Point X represents an inefficient use of resources, while point Y represents the goals that the economy cannot attain with its present levels of resources.

As we can see, in order for this economy to produce more wine, it must give up some of the resources it uses to produce cotton (point A). If the economy starts producing more cotton (represented by points B and C), it would have to divert resources from making wine and, consequently, it will produce less wine than it is producing at point A. As the chart shows, by moving production from point A to B, the economy must decrease wine production by a small amount in comparison to the increase in cotton output. However, if the economy moves from point B to C, wine output will be significantly reduced while the increase in cotton will be quite small. Keep in mind that A, B, and C all represent the most efficient allocation of resources for the economy; the nation must decide how to achieve the PPF and which combination to use. If more wine is in demand, the cost of increasing its output is proportional to the cost of decreasing cotton production.

Point X means that the country's resources are not being used efficiently or, more specifically, that the country is not producing enough cotton or wine given the potential of its resources. Point Y, as we mentioned above, represents an output level that is currently unreachable by this economy. However, if there was a change in technology while the level of land, labor and capital remained the same, the time required to pick cotton and grapes would be reduced. Output would increase, and the PPF would be pushed outwards. A new curve, on which Y would appear, would represent the new efficient allocation of resources.

When the PPF shifts outwards, we know there is growth in an economy. Alternatively, when the PPF shifts inwards it indicates that the economy is shrinking as a result of a decline in its most efficient allocation of resources and optimal production capability. A shrinking economy could be a result of a decrease in supplies or a deficiency in technology.

An economy can be producing on the PPF curve only in theory. In reality, economies constantly struggle to reach an optimal production capacity. And because scarcity forces an economy to forgo one choice for another, the slope of the PPF will always be negative; if production of product A increases then production of product B will have to decrease accordingly.

Net National Product - NNP

 The monetary value of finished goods and services produced by a country's citizens, whether overseas or resident, in the time period being measured (i.e., the gross national product, or GNP) minus the amount of GNP required to purchase new goods to maintain existing stock (i.e., depreciation).

Alternatively, net national product (NNP) can be calculated as total payroll compensation + net indirect tax on current production + operating surpluses.

In other words, NNP is the amount of goods that can be consumed within a nation each year without reducing the amount that can be consumed in following years.

Gross national income

 The Gross national income (GNI) consists of: the personal consumption expenditure, the gross private investment, the government consumption expenditures, the net income from assets abroad (net income receipts), and the gross exports of goods and services, after deducting two components: the gross imports of goods and services, and the indirect business taxes. The GNI is similar to the gross national product (GNP), except that in measuring the GNP one does not deduct the indirect business taxes.

A measure of the wealth earned by nations through economic activites all around the world.

Gross National Income comprises the total value of goods and services produced within a country (i.e. its Gross Domestic Product), together with its income received from other countries (notably interest and dividends), less similar payments made to other countries. Also known as GNP.

It can be calculated as follows :

GNI = Gross Domestic Product + Net property income from abroad.

GDP vs GNP

 

	GDP	GNP
Stands for:	Gross Domestic Product	Gross National Product
Definition:	An estimated value of the total worth of a country’s production and services, on its land, by its nationals and foreigners, calculated over the course on one year	An estimated value of the total worth of production and services, by citizens of a country, on its land or on foreign land, calculated over the course on one year
Formula for Calculation:	GDP = consumption + investment + (government spending) + (exports − imports)	GNP = GDP + NR (Net income inflow from assets abroad or Net Income Receipts) - NP (Net payment outflow to foreign assets)
Uses:	Business, Economic Forecasting	Business, Economic Forecasting
Application (Context in which these terms are used):	To see the strength of a country’s local economy	To see how the nationals of a country are doing economically
Layman Usage:	Total value of products & Services produced within the territorial boundary of a country	Total value of Goods and Services produced by all nationals of a country (whether within or outside the country)
Country with Highest Per Capita (US$):	Luxembourg ($87,400)	Luxembourg ($45,360)
Country with Lowest Per Capita (US$):	Liberia ($16)	Mozambique ($80)
Country with Highest (Cumulative):	USA ($13.06 Trillion in 2006)	USA (~ $11.5 Trillion in 2005)

An indifference curve shows combination of goods between which a person is indifferent

 The main attributes or properties or characteristics of indifference curves are as follows:

(1) Indifference Curves are Negatively Sloped:

The indifference curves must slope down from left to right. This means that an indifference curve is negatively sloped. It slopes downward because as the consumer increases the consumption of X commodity, he has to give up certain units of Y commodity in order to maintain the same level of satisfaction.

In fig. 3.4 the two combinations of commodity cooking oil and commodity wheat is shown by the points a and b on the same indifference curve. The consumer is indifferent towards points a and b as they represent equal level of satisfaction.

At point (a) on the indifference curve, the consumer is satisfied with OE units of ghee and OD units of wheat. He is equally satisfied with OF units of ghee and OK units of wheat shown by point b on the indifference curve. It is only on the negatively sloped curve that different points representing different combinations of goods X and Y give the same level of satisfaction to make the consumer indifferent.

(2) Higher Indifference Curve Represents Higher Level:

A higher indifference curve that lies above and to the right of another indifference curve represents a higher level of satisfaction and combination on a lower indifference curve yields a lower satisfaction.

In other words, we can say that the combination of goods which lies on a higher indifference curve will be preferred by a consumer to the combination which lies on a lower indifference curve.

In this diagram (3.5) there are three indifference curves, IC¹, IC² and IC³ which represents different levels of satisfaction. The indifference curve IC³ shows greater amount of satisfaction and it contains more of both goods than IC² and IC¹ (IC³ > IC² > IC¹).

(3) Indifference Curve are Convex to the Origin:

This is an important property of indifference curves. They are convex to the origin (bowed inward). This is equivalent to saying that as the consumer substitutes commodity X for commodity Y, the marginal rate of substitution diminishes of X for Y along an indifference curve.

In this figure (3.6) as the consumer moves from A to B to C to D, the willingness to substitute good X for good Y diminishes. This means that as the amount of good X is increased by equal amounts, that of good Y diminishes by smaller amounts. The marginal rate of substitution of X for Y is the quantity of Y good that the consumer is willing to give up to gain a marginal unit of good X. The slope of IC is negative. It is convex to the origin.

(4) Indifference Curve Cannot Intersect Each Other:

Given the definition of indifference curve and the assumptions behind it, the indifference curves cannot intersect each other. It is because at the point of tangency, the higher curve will give as much as of the two commodities as is given by the lower indifference curve. This is absurd and impossible.

In fig 3.7, two indifference curves are showing cutting each other at point B. The combinations represented by points B and F given equal satisfaction to the consumer because both lie on the same indifference curve IC₂. Similarly the combinations shows by points B and E on indifference curve IC₁ give equal satisfaction top the consumer.

If combination F is equal to combination B in terms of satisfaction and combination E is equal to combination B in satisfaction. It follows that the combination F will be equivalent to E in terms of satisfaction. This conclusion looks quite funny because combination F on IC₂ contains more of good Y (wheat) than combination which gives more satisfaction to the consumer. We, therefore, conclude that indifference curves cannot cut each other.

(5) Indifference Curves do not Touch the Horizontal or Vertical Axis:

One of the basic assumptions of indifference curves is that the consumer purchases combinations of different commodities. He is not supposed to purchase only one commodity. In that case indifference curve will touch one axis. This violates the basic assumption of indifference curves.

In fig. 3.8, it is shown that the in difference IC touches Y axis at point C and X axis at point E. At point C, the consumer purchase only OC commodity of rice and no commodity of wheat, similarly at point E, he buys OE quantity of wheat and no amount of rice. Such indifference curves are against our basic assumption. Our basic assumption is that the consumer buys two goods in combination.

What is supply

 Supply is the amount of commodity that is offered for sale. Supply schedule shows the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period.

Supply depends on technology, the prices of the inputs necessary to produce the commodity, tax and subsidy, and for agricultural commodities, climate and weather conditions.

 

What are the determinants of demand? Or: What are the factors that affect demand? Or: What cause shift in demand curve? Or: What cause change in demand?

 The price is the most important influence on the amount of any product purchased. But economists know that other factors can and do affect purchases. These factors, called determinants of demand are assumed to be constant when demand law is discussed. When any of these determinants changes, the demand curve will shift to right or left.

 For this reason, determinants of demand are sometimes referred to as demand shifters. The basic determinants are briefly discussed below.

a) Tastes: A favourable change in consumer tastes for a product or a change that makes the product more desirable means that more of it will be demanded at each price. Demand will increase; the demand curve will shift rightward. An unfavourable change in consumer preferences will decrease demand, shifting the demand curve to the left.

b) Number of buyers: An increase in the number of buyers in a market increases demand. A decrease in the number of buyers in a market decreases demand.

c) Income: If consumers’ income rises, demand for commodities will also rise and if income decreases, demand will also decrease. Products whose demand varies directly with money income are called superior goods or normal goods. Goods whose demand varies inversely with money income are called inferior goods.

d) Prices of related goods: When two products are substitutes, the price of one and the demand for the other move in the same direction. When two products are complements, the price of one good and the demand for the other good move in opposite direction. When two products are independent, price change of one may have very little or no change in demand for the other.

e) Expectations: An expectation of higher future prices may cause consumers to buy now in order to beat the anticipated price rises, thus increasing current demand. Again, a change in expectations concerning future income may prompt consumers to change their current spending.

Why demand curve slopes downward

 Why is the inverse relationship between price and quantity demanded?

The reasons for why there is an inverse relationship between price and quantity demanded or for demand curve being downward sloping are as follows.

a) Consistency with common sense: Price is an obstacle that deters consumers from buying. The higher that obstacle, the less of a product they will buy; the lower the price obstacle, the more they will buy.

b) Diminishing marginal utility: Consumption is subject to diminishing marginal utility. And because successive units of a particular product yield less and less marginal utility, consumers will buy additional units only if the price of those units is progressively reduced.

c) Income effect: The income effect indicates that a lower price increases the purchasing power of a buyer’s money income, enabling the buyer to purchase more of the product than she or he could buy before. A higher price has the opposite effect.

d) Substitution effect: The substitution effect suggests that at a lower price buyers have the incentive to substitute what is now a less expensive product for similar products are now relatively more expensive.

What are the exceptions to the law of demand

 The law of demand shows the negative relationship between price and quantity demanded of a commodity if other things remain constant. The exceptions to the law of demand are as follows.

a) Inconsistency of ceteris paribus assumption: Law of demand has an assumption those other things (include the number of consumers in the market, consumer tastes or preferences, prices of substitute goods, consumer price expectations, and personal income) than price will remain constant. If any of those factors changes, demand law will not work.

b) Giffen goods: The lowest quality category of a necessary commodity is classified as Giffen goods according to the name of Sir Robert Giffen. When price of a commodity rises, quantity demanded of Giffen goods increases.

c) Veblen goods: According to economist Thorstein Veblen, some consumers measure the utility of a commodity entirely by its price. The greater the price will be, the greater the utility. Diamond as prestigious goods is an example of this category.

d) Inferior goods: The commodities that have a very low price and use a very small portion of income do not follow the law of demand.

e) Change in product quality: If there is a change in product quality, the demand for that will be affected irrespective of price change.

Explain the law of demand. Or: The law of downward sloping demand curve.

 A fundamental characteristic of demand is this: Ceteris paribus (All else equal), as price falls, the quantity demanded rises, and as price rises, the quantity demanded falls. In short, there is a negative or inverse relationship between price and quantity demanded. Economists call this inverse relationship the law of demand. The other-things-equal assumption means that anything that affects demand other than price like income or taste of consumer will not change.

Law of demand is illustrated below with the help of schedule and figure.

Let,       Q_D = 22 - 2P      where, Q_D is quantity of demand and P is price.

 

Demand schedule
Price (P)	Demand (QD)
4	14
5	12
6	10

 

 

In the schedule we can see the inverse relationship between price and quantity of demand which is shown in figure by negative sloped demand curve.

What is demand

 Demand is human wants backed by buying power. So, three features are essential to be demand in the view point of economics. These are as follows.

a) Want or desire to consume, b) Ability to purchase and c) Willingness to spend.

Therefore, demand is a set of various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time.

Demand depends on the price of the commodity, the person’s money income, the prices of other commodities, and individual tastes

Discuss circular flow of income

The circular flow model implies a complex, interrelated web of decision making and economic activity. In monetary economy, there are two decision makers; households and businesses. Government is added as a third decision maker in open economy.

Households and businesses participate in both basic markets, resource and product market, but on different sides of each. Businesses are on the buying or demand side of resource markets and households, as resource owners, are on the selling or supply side. In the product market, these positions are reversed. Households, as consumers, are on the demand side, and businesses are on the supply side.

 

The interaction of firms and households in product and factor markets generates a flow of expenditure and income. Factor services are sold by households through factor markets. This leads to a flow of income from firms to households. Commodities are sold by firms through product markets. This leads to a flow of payments from households to firms.

Government makes purchases in both product and resource markets and pays for this. It provides public goods and services to both businesses and households. Government collects taxes from businesses and subsidies. It also collects taxes from households and makes available transfer payments.

Households do not spend all their income. Some of their income is saved and it is invested to businesses through financial market. If government has a surplus budget, the surplus amount also goes to businesses through financial market. If the opposite happens, government collects the deficit amount from the same.

Intrahousehold and intrabusiness economic activities are avoided for simplicity.

Write notes on production possibility curve/frontier (PPC/PPF)

 A production possibility curve shows the different combinations of various commodities that producers can turn out, given the available resources and existing technology.

 

All combinations of commodities on the curve (a, b) represent maximum quantities attainable only as the result of the most efficient use of all available resources. Points lying inside the curve (u) are also attainable, but are not desirable as points on the curve. These points imply a failure to achieve full employment and full production. Points lying outside the production possibilities curve (w) would be superior to many points on the curve; but such points are unattainable, given the current supplies of resources and technology. The barrier of limited resources prohibits production of capital and consumer goods lying outside the production possibilities curve.

Since resources are scarce, a full employment, full production economy cannot have an unlimited output of goods and services. As a result, choices must be made on which goods and services to produce and which to forgo. Production possibility curve helps us to solve this basic problem.

Assumptions:

a) The economy is operating at full employment and achieving full production.

b) The available supplies of the factors are fixed in both quantity and quality.

c) The state of the technological arts is constant.

d) Economy produces two commodities.

Properties/Features:

a) Downward slope: The downward slope of the curve implies the notion of opportunity cost.

b) Concavity: The concavity of the curve reveals increasing opportunity cost.

Expanding resources supplies, improvements in resource quality, and technological progress cause economic growth, that is, an outward shift of the production possibility curve.