Section A

Module 1: Basic Concepts

Introduction
Market Demand Analysis
➡ Sales Forecasting (Production, Inventory, Investments)
➡ Demand Manipulation (Advertising, Pricing, Product Enhancements)
Why Important?
Seasonal Fluctuations Controlled by Firm

Cost Analysis & Estimation

Cost Analysis
├─ Production Planning
├─ Investment Decisions
├─ Plant Size Optimization

Cost Function:
Formula: C = a + bX₁ + cX₂ + u
Variables:

● C = Total Cost
● X₁ = Output Level
● X₂ = Plant Size
● U = Other Factors

Conclusion

Better demand & cost analysis = Business Growth

The Fundamentals of Economics

Core Problem: Limited Resources vs. Unlimited Wants

 Key Players:
Firms → Producers (Goal: Profit Max.)
Households → Consumers (Goal: Satisfaction )

The Four Key Areas of Economics

Economics Divided Into:

1⃣ Consumption – Using goods/services
2⃣ Production – Making goods/services
3⃣ Exchange – Trading goods/services
4⃣ Distribution – Income division

Examples:
✔ Buying a house to live = Consumption
✔ Buying a house to rent = Investment

Factors of Production

Land ➡ Natural Resources

Labour ➡ Human Effort
Capital ➡ Machinery & Investments
Organization ➡ Business Leadership

Income Distribution

How Income is Shared?

Two Types of Distribution

Modern Extensions of Economics
Economics Expands To:

● Employment
● Income Distribution
● Economic Planning & Development
● International Trade

Definitions of Economics & Their Criticism

Microeconomics

Meaning: "Micro" (Greek: Mikros) = Small

Studies individual economic units:
Consumer – Maximizes satisfaction
Producer – Maximizes output
Firm – Maximizes profit
Industry – Functions within the economy

Definition (K.E. Boulding):

"Microeconomics is the study of particular firms, households, individual prices,
wages, incomes, industries, and commodities."

Uses & Significance:

1⃣ Understanding Economic Operations – Individual market functions
2⃣ Promoting Economic Welfare – Optimal choices by consumers &
producers
3⃣ Application in Managerial Economics – Helps businesses make
decisions

Macroeconomics
Meaning: "Macro" (Greek: Makros) = Large
Studies the economy as a whole:
National Income
Full Employment
Total Output
Total Investment
Total Consumption

Definition (Gardner Ackley):

"Macroeconomics is concerned with aggregate output, employment, national
income, and the general price level."

Scope of Macroeconomics:
1. National Income – GDP, GNP, NNP
2. Employment & Output – Full employment & production levels
3. Economic Fluctuations – Trade cycles, recessions, inflation &
deflation
4. Theories of Economic Growth – Long-term growth factors &
policies
5. Macroeconomic Distribution – Income distribution at a national
level

Is Economics an Art or a Science?

Is Economics a Positive or Normative Science?

Positive Science
Describes "what is"
No value judgments
 Just states facts
Defined by Lionel Robbins

Normative Science
Describes "what ought to be"
Involves value judgments
Suggests policies based on right/wrong
Defined by Alfred Marshall

Conclusion: Economics is both Positive & Normative Science .

Deductive & Inductive Methods in Economics

Deductive Method = Static Analysis

Inductive Method = Dynamic Analysis

Or

Deductive Method:
Assumptions → General Laws → Applied to Specific Cases

Inductive Method:
Real-World Data → Observations → General Economic Laws

Central Problems of All Economies

1⃣ What to Produce?

● Essential Goods (Food, Medicine) vs. Luxury Items (Cars, Jewelry)

● Decided by government & market forces

2⃣ How to Produce?

● Labor-Intensive Method ( More human labor, less machinery)

 ● Capital-Intensive Method ( More machinery, less labor)
● Depends on available resources & technology

3⃣ For Whom to Produce?

● Distribution of goods between rich & poor

● Government policies influence who benefits
● Example: Public transport vs. luxury cars

Conclusion: Scarcity of Resources ➡ What to Produce? ➡ How to

Produce? ➡ For Whom to Produce?

Utility & Production

Utility → Satisfaction from consuming goods & services

Higher Utility = Higher Consumer Preference

Production → Output from combining factors of production

Wealth Classification

Wealth (Main branch) → Splits into:

Personal Wealth

● Physical Assets → Houses, buildings, land

● Financial Assets → Cash, shares, stocks
● Other Commodities → Gold, jewelry
● Intangible Assets → Goodwill, intellectual property
Note: Only transferable goods are considered wealth.

National Wealth

● Natural Resources → Forests, minerals

● Infrastructure → Roads, bridges
● Public Services → Schools, hospitals
● Common Property → Public institutions

Government Bonds

Government Bond Owned by Citizen → Personal Wealth

Government Bond from Govt. Perspective → Liability (Not
National Wealth)
 Wealth & Welfare

Welfare = Well-being & Happiness

Relationship Between Wealth & Welfare:

More Wealth = More Welfare (Generally )
But two concerns arise:
Uncontrolled Wealth Creation → No focus on health & mental well-being

Unequal Distribution → Wealth gap leads to lower overall welfare

Production

Definition: Creating goods & services for sale

Simple Formula: Production = Creation of Utility

Example:
Not Production: Child making a doll for personal play
Production: Doll maker selling dolls in the market

Factors of Production

Definition: Inputs used to produce goods & services.

Inputs = Factors of Production
Output = Goods & Services

Four Factors of Production:

Land → Natural resources (land, water, minerals)
Labour → Human effort (workers, employees)
Capital → Man-made resources (machines, tools, money)
Organization (Entrepreneurship) → Coordinating land, labor & capital
efficiently

Production Possibility Curve (PPC)

Also Known As:

Production Possibility Frontier (PPF)
Production Possibility Boundary
Production Transformation Curve

Definition:
The PPC curve shows the maximum possible combinations of two
goods that an economy can produce with its available resources &
technology.

Production Possibility Curve (PPC) – Key Points

1⃣ Downward Sloping PPC

PPC slopes downward from left to right because producing more of one
good means sacrificing another due to limited resources.

2⃣ Marginal Rate of Transformation (MRT)

Slope of PPC = MRT (Marginal Rate of Transformation)
MRT = Opportunity Cost → The cost of producing one more unit of a
good in terms of another good forgone.

3⃣ Concave Shape of PPC

PPC is concave to the origin because MRT increases as we move along
the curve.
Example: Moving from D → Right (Increasing butter , reducing guns
).
Why? Specialized resources for gun production may not be efficient for
butter, making trade-offs costlier.

Key Takeaway: As we move along PPC, opportunity cost rises,

making the curve concave.

Money: Definition & Evolution

Definition:

● Money = Anything widely accepted for exchange or debt settlement.

Evolution of Money:

1. Barter System – Goods exchanged for goods (e.g., 1 kg rice for 2 kg

wheat).
2. Problem of Indivisibility – Difficulties in splitting large goods (e.g., 2
goats for 1 cow).
3. Customary Money – Commodities like cowries were used as money.
4. Modern Monetary System – Includes currency & digital payments.

Constituents of Money Supply:

 Rupee notes & coins
Credit cards
Traveler’s cheques

Income, Saving & Market

1⃣ Income ( )

● Net money inflow over time.

● Examples: Daily, weekly, monthly, or yearly income.

2⃣ Saving ( )

● Formula: Saving = Income – Consumption

● Comes from both current & past income.

3⃣ Market ( )

Ordinary Meaning – A place for buying & selling goods.

Economic Meaning – A system where buyers & sellers interact.

Functions of the Market:

Determines prices
Determines quantity of goods supplied

Market Mechanism:

● Total of all markets in an economy.

● Determines prices & quantities of goods & services.

Types of Investment
1⃣ Real Investment

Investment in physical capital (machines, raw materials, buildings).

2⃣ Portfolio Investment

Buying new shares of a company.

Buying existing shares is not investment (doesn’t increase capital stock).
 Savings & Investment Relationship in
Macroeconomics
Equation:

Y=C+I
Y = National Income
C = Consumption Demand
I = Investment Demand

Savings-Equilibrium Condition:

C+S=C+I
S = Savings
I = Investment
At equilibrium: S = I

Key Point:

S ≠ I always because:

● Households save .
● Businesses invest .
● Their motives differ.
Foreign investment can also cause S ≠ I.

Gross & Net Investment

1⃣ Gross Investment

Total investment in an economy in a year.

Includes:

● Inventory Investment (raw materials, unfinished goods).

● Fixed Investment (machines, buildings, factories).

2⃣ Net Investment

Formula: Net Investment = Gross Investment – Depreciation

Depreciation = Wear & tear of capital.
Net Investment shows the actual increase in productive assets.
 "Meaning of Demand"
"Demand" in Economics
➤ Desire + Purchasing Power + Willingness to Pay
➤ Example: A student wanting a book but lacking money ≠ Demand
➤ Effective Demand = Desire + Money

"Determinants of Demand"
What influences demand?
Price of the Good → Price = Demand, Price = Demand
(Law of Demand)
Price of Substitutes → Price of Coffee = Demand for Tea
(Positive Relation)
Price of Complements → Petrol Price = Demand for Cars
(Inverse Relation)
Income of Consumers →

● Income = Demand (Normal Goods)

● Income = Demand (Inferior Goods)
Tastes & Preferences → Favorable = Demand,
Unfavorable = Demand
Population Size → More People = Demand
Climate & Weather → Seasonal variations affect demand
(Cold Drinks in Summer, Umbrellas in Monsoon)

"Law of Demand"
Demand Curve (Price on Y-axis, Quantity on X-axis)
Downward Sloping: Higher Price → Lower Demand & Vice Versa

Table for "Impact of Different Factors on Demand"

Why is the Demand Curve Downward Sloping?

 Law of Diminishing Marginal Utility – More consumption = Less
satisfaction → Buy more only at lower prices.

Substitution Effect – Higher price of one good → Shift to a cheaper

alternative.

Income Effect – Lower prices = More purchasing power → Buy more.

New Buyers Effect – Price drop attracts new buyers → Higher

demand.

Old Buyers Effect – Lower price = Existing buyers buy more.

Result: Price → Demand (Downward Sloping Demand Curve)

Exceptions to the Law of Demand

1⃣ Giffen Paradox (Essential Goods)

Example: Bread, rice

Why? → Poor consumers buy more when price rises because they can't
afford substitutes.
Demand Curve: Upward sloping

2⃣ Speculation Effect

Example: Real estate, gold

Why? → Expecting future price rise, people buy more even at high
prices.

3⃣ Conspicuous Consumption

Example: Luxury cars, designer brands

Why? → Higher prices = Higher prestige
"More expensive, more desirable!"

4⃣ Stock Market Effect

Example: Shares, crypto

Why? → Investors buy at rising prices, fearing they will miss out on future
gains.

5⃣ Bandwagon Effect
 Example: Trends (fashion, gadgets)
Why? → People buy because everyone else is buying, regardless of
price.

6⃣ Veblen Effect

Example: High-end watches, exclusive memberships

Why? → Consumers believe higher price = higher quality

Demand Types

Types of Demand

1. Price Demand → Inverse relation ( )

2. Income Demand → Direct/Inverse relation ( or )

● Normal Goods → Income = Demand

● Inferior Goods → Income = Demand

3. Cross Demand → Related goods (Substitutes & Complements)

Cross Demand → Shows relationship between two goods.

1⃣ Substitute Goods
Definition: Can replace each other to satisfy the same need.
Rule: Price of A → Demand for B
Examples: Tea & Coffee, Pen & Pencil
Graph: Upward-sloping curve ( Direct relationship)

2⃣ Complementary Goods
Definition: Used together to satisfy a need.
Rule: Price of A → Demand for B
Examples: Car & Petrol, Bricks & Cement
Graph: Downward-sloping curve ( Inverse relationship)

Change in Demand vs. Change in Quantity Demanded

Changes in Demand
Two Types
1. Extension & Contraction of Demand
 Reason: Change in price ONLY (all other factors constant).
Effect: Moves along the same demand curve.
Rules:
Price → Demand Increases (Extension)
Price → Demand Decreases (Contraction)
Graph: Movement along the same curve.

2. Increase & Decrease of Demand

Reason: Change in external factors (Income, Preferences, etc.), NOT
price.
Effect: Entire demand curve shifts (new curve).
Rules:
Increase in Demand → Curve shifts Right
Decrease in Demand → Curve shifts Left
Graph: New demand curves form.

Types of Elasticity of Demand (Flowchart)

Elasticity of Demand
➝ Price Elasticity (PED) – How demand reacts to price changes
➝ Income Elasticity (YED) – How demand changes with income
➝ Cross Elasticity (XED) – How demand changes with the price of
related goods

Price Elasticity of Demand

Income Elasticity of Demand (Eᵧ)

Measures how demand changes with income.

Formula: Proportionate change in Demand/ Proportionate change in
Income
 Types of Income Elasticity of Demand

Methods of Measurement of Elasticity of Demand

1. Percentage Method
Formula:

Key Idea: Compares % change in demand to % change in price.

Use Case: Most commonly used method.

2. Total Outlay Method

Key Idea: Relationship between price & total expenditure.

Elasticity Rules:

● EP > 1 → Price ↓, Total Exp. ↑

● EP = 1 → Price change, Total Exp. constant
● EP < 1 → Price ↓, Total Exp. ↓
Use Case: Helpful in pricing decisions.
3. Point Method

Key Idea: Measures elasticity at a specific point on demand curve.

auerdeg
Formula:
Use Case: Precise calculations for small price changes.

4. Arc Method Upper seg

Key Idea: Measures elasticity over a range of prices.
Formula:

Use Case: Used when price changes are large.