Chapter 1 Introduction to Economics

1.1 A Simple Economy

Every society needs many goods and services in everyday life. Key points:

Goods: Physical, tangible objects (e.g., food, clothing)
Services: Intangible activities (e.g., teaching, medical care)
Resources: Goods and services used to produce other goods and services (e.g., land, labor, tools)

Key Observations:

No individual has all the goods and services they need
Everyone faces scarcity of resources compared to their needs
Choices must be made between alternative uses of limited resources
There must be compatibility between what people want and what is produced

1.2 Central Problems of an Economy

Every society faces three fundamental economic problems due to scarcity of resources:

1. What is produced and in what quantities?

Decisions about types and quantities of goods/services to produce
Choices between:
- Essential vs luxury goods
- Agricultural vs industrial products
- Education/health vs military services
- Basic vs higher education
- Consumption vs investment goods

2. How are these goods produced?

Decisions about resource allocation in production
Choices between:
- Labor-intensive vs capital-intensive methods
- Different available technologies

3. For whom are these goods produced?

Decisions about distribution of goods/services among individuals
Issues to consider:
- Equitable distribution
- Minimum consumption levels
- Access to basic education and health services

The allocation of scarce resources and the distribution of final goods and services are the central problems of any economy.

Production Possibility Frontier (PPF)

The PPF shows all possible combinations of two goods that an economy can produce given its resources and technology, assuming all resources are fully and efficiently utilized.

Example:

An economy producing corn and cotton:

Possibilities	Corn	Cotton
A	0	10
B	1	9
C	2	7
D	3	4
E	4	0

Key points about PPF:

Points on the curve represent efficient production
Points inside the curve represent underutilization of resources
Points outside the curve are unattainable with current resources
The slope represents opportunity cost

Opportunity Cost

The cost of having a little more of one good in terms of the amount of the other good that has to be forgone. Also called economic cost.

1.3 Organisation of Economic Activities

Basic economic problems can be solved through two main approaches:

1.3.1 The Centrally Planned Economy

Government/central authority plans all important economic activities
Decides on production, exchange, and consumption
Aims to achieve desirable resource allocation and distribution
Government may intervene to:
- Produce essential goods/services (education, healthcare)
- Ensure equitable distribution
- Address survival needs of disadvantaged groups
Example: China (major part of 20th century)

1.3.2 The Market Economy

Economic activities organized through markets
Market: Institution organizing free interaction of individuals pursuing economic activities
Prices serve as signals:
- Reflect society's valuation of goods/services
- Higher prices indicate greater demand
- Producers respond to price signals
Example: United States (minimal government role)

Mixed Economy

Most real-world economies are mixed
Combination of government planning and market mechanisms
Varies by extent of government involvement
Example: India (reduced government role in recent decades)

1.4 Positive and Normative Economics

Positive Economic Analysis	Normative Economic Analysis
Studies how different economic mechanisms function	Evaluates whether mechanisms are desirable
Describes "what is" or "what would be"	Prescribes "what ought to be"
Objective, fact-based	Subjective, value-based
Example: Studying how price signals affect production	Example: Deciding whether price system is fair

The distinction between positive and normative analysis is not sharp - they are closely related in studying economic problems.

1.5 Microeconomics and Macroeconomics

Microeconomics	Macroeconomics
Studies behavior of individual economic agents	Studies economy as a whole
Focuses on specific markets for goods/services	Focuses on aggregate measures
Examines price and quantity determination	Examines total output, employment, price levels
Key questions: How do consumers make choices? How do firms decide production? How are prices determined?	Key questions: What determines national income? Why do resources remain unemployed? What causes price inflation?

1.6 Plan of the Book

This book focuses on microeconomics, covering:

Consumer behavior
Production and cost concepts
Producer behavior
Price and quantity determination in perfect competition
Other market forms

Key Terms

Goods
Services
Resources
Scarcity
Production possibilities
Opportunity cost
Market
Market economy
Centrally planned economy
Mixed economy
Positive analysis
Normative analysis
Microeconomics
Macroeconomics

Chapter Summary

Every society faces scarcity of resources relative to needs
Three central problems: What to produce? How to produce? For whom to produce?
Production Possibility Frontier shows trade-offs and opportunity costs
Economic activities can be organized through central planning or markets
Most economies are mixed with varying degrees of government involvement
Positive economics studies how systems work; normative evaluates outcomes
Microeconomics studies individual behavior; macroeconomics studies aggregates

Review Questions

Discuss the central problems of an economy.
What do you mean by the production possibilities of an economy?
What is a production possibility frontier?
Discuss the subject matter of economics.
Distinguish between a centrally planned economy and a market economy.
What do you understand by positive economic analysis?
What do you understand by normative economic analysis?
Distinguish between microeconomics and macroeconomics.