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Unit 1
What is Economics?
Economics is a social science. Its basic function is to study
and analyze the choice-making behavior of people as
individuals, house-holds, firms or nations, in-relation to
optimizing the allocation of available limited resources and
opportunities to maximize their gains.Thus, the basic task
of the economy of any society is to allocate or ration the
available goods and services to its consumers to derive the
maximum utility.
Making a choice, i.e. taking an “economic decision” in the
economic world is often very complex, because most of
these decisions may have to be taken under the conditions
of imperfect knowledge, risk and uncertainty.
(Ex): Economics studies and analyzes how households with
their limited income decide ‘what to consume’ and ‘how
much to consume’ with the aim of maximizing total utility.
Micro-economics looks at what happens in particular parts of
the economy. It is concerned with what determines the prices of
individual goods and incomes of particular factors of production.
It studies and analyses the internal issues of individual firms or
business organizations which produce goods or services, at their
operational level.The management of these business enterprises
often makes the choices or takes the decisions related to these
issues, which include:
(i) Choice of business and nature of the product (what to produce?)
(ii) Choice of size of the firm (how much to produce?)
(iii) Choice of technology (how to produce?)
(iv) Choice of location (where to produce?)
(v) Choice of market segment (whom to sell?)
(vi) Choice of price (how much to sell for?)
(vii) Choice of marketing (how to sell & where to sell?)
(viii) Choice of sales promotion (how to advertise?)
(ix) Choice of strategy for facing competition,
(x) Choice of managing profit and capital,
(xi) Choice of managing stock and inventory (raw materials and finished
goods)
(xii) Choice of managing new investments.
Macro-economics looks at the economy as a whole. It shows what are the causes of
high and low levels of unemployment and economic activity. It studies and analyses
how nations formulate their economic policies and allocate their resources, i.e. men
and material, between competing needs of the society so that welfare of the society
can be maximized. It is concerned with the environmental or large scale issues
related to the economic, social and political atmosphere of a country, in which
individual firms and organizations are operating.
The way in which the individual firms and business organizations conduct their business is
influenced by these macro-economic factors or business parameters, which include:
(i) The type of economic system in the country,
(ii) General trends in national income, employment, prices, saving and investment, etc.,
(iii) Structure of and trends in the working of financial institutions, e.g. banks, financial
corporations, insurance companies, etc.,
(iv) Magnitude of and trends in foreign trade,
(v) Trend in labour supply and strength of the capital market,
(vi) Government’s economic policies, e.g. industrial policies, foreign trade policies etc.,
(vii) Social factors like value system of the society, property rights, customs and habits,
(viii) Socio-economic organizations like trade unions, consumers’ associations, consumer
cooperatives and producers’ unions,
(ix) Political environment and political system, i.e. democratic, authoritarian, socialist or
otherwise,
(x) Government’s attitude towards private business, size and working of the public sector and
political stability,
(xi) The degree of the globalization of the economy and the influence of MNCs on domestic
market.
Price:
Is the rate at which a goods/service can be exchanged for anything else. Price for
any goods/service is determined in the market because of its usefulness and scarcity
based on the rate of demand of buyers and the rate of supply by sellers in a
competitive market. If scarcity of goods does not exist, there would be no economic
system. Individual prices show which goods are more plentiful and cheaper, and
which are scarcer and more expensive.
Goods or commodities can be divided into Consumer goods or Capital goods or
Services.
Consumer goods are eat, wear, burn and consume.
Capital goods assist in the production of consumer goods.
The Market:
A market is a mechanism by which buyers and sellers
interact to determine the price and quantity of a
good or service during a period of time.
Market for a particular commodity consists of the
buyers and sellers of that commodity who interact to
settle its price and quantity to be transacted during a
given time.
Every buyer and seller in the market knows what
every other buyer and seller is doing so that the
same price will rule throughout the market at any
given time for a given quantity.
The buyers and sellers may be individuals, firms,
factories, dealers or agents.
Functional market concepts:
A market need not be situated in a particular place or locality.
All the buyers & sellers should be able to get in touch with each
other whenever the market is open.
All the available goods are for sale & all buyers have the capacity to
buy.
Sufficiently large no. of sellers & buyers are available, and all the
products are homogenous.
Every buyer & seller in the market knows what every other buyer
& seller is doing.
Buyers do not appear also as sellers & vice versa.
The Sellers prefer higher prices whereas the Buyers prefer lower
prices. The demand and supply relationship determines the price
for any goods. Supply of any goods depends on the scarcity in
relation to its demand.
Demand side of the Market:
The demand side of the market for a product refers to all its consumers and the price that
they are willing to pay for buying a certain quantity of the product during a period of time.
The quantity that consumers buy at a given price determines the market size. It is the size
of the market that determines the business prospects of a firm and an industry. The law of
demand is: all other things remaining constant, the quantity demanded of a commodity
increases when its price decreases and decreases when its price increases.The demand
and price are inversely related.
Consumer Demand:
Consumer demand is the basis for all productive activities.The ‘demand’ implies a ‘desire
for a commodity backed by the ability and willingness to pay for it’.
The consumer wants/needs remain unchanged throughout the market period.
He has a fixed amount of money available, and he can, if he wishes, spend his money in very small
amounts.
He is one of the many buyers, and knows the prices of all goods, each of which is homogenous.
He acts ‘rationally’.
Effective Demand:
A want with three attributes, ‘desire to buy’, ‘willingness to pay’, and ‘ability to pay’.
Market Demand: The aggregate demand of all the individual consumers.
Supply side of the Market:
Supply means the quantity of a commodity that its producers or
sellers offer for sale at a given price, per unit of time. Market
supply is the sum of supplies of a commodity made by all its
producers at a given price, per unit of time.The supply of a
commodity depends on its price and cost of its production.
Supply:
The supply depends on scarcity. Scarcity always means scarce in
relation to the demand. For many goods, the supply is fixed in
numbers, because supply requires at least two or more of factors
of production, i.e. ‘land’, ‘labour’, ‘capital’ and ‘enterprise’, must be
used.
The law of supply is:
The supply of a product increases with the increase in its price
and decreases with decrease in its price, other things remaining
constant.The supply of a commodity and its price are positively
related.
Market Equilibrium:
It is a state of a market in which quantity demanded of a commodity
equals the quantity supplied of the commodity. The equality of demand
and supply produces an ‘Equilibrium Price’, the price at which the
quantity demanded of a commodity equals the quantity supplied of that
commodity.
For any goods, ‘normal price’ is the one towards which its actual prices
expect to tend.
The ‘average price’ for any goods is the arithmetic average of its ‘actual
price’.
The market system for a product is governed by the laws of demand and supply
for that product, which play a crucial role in determining the price of that
product and the size of its market.
Impact of Prices –
Buyer side:
There will be some high prices at which no buyer will purchase anything; and
there will be some very low prices at which all buyers will buy large quantities.
Seller side:
When the prices are very high, all the sellers are very keen to sell as much as
goods as possible. When the prices are too low, then the sellers will try to hold
back their supplies, in the hope that the prices will rise. When the prices are
high, more anxious sellers will be trying to dispose off their supplies while the
prices are high.
‘Maximum prices’ will lead to shortages whereas ‘Minimum prices’ will lead to
surpluses.
Any change in the income level of the consumers will have a direct implication on the
demand side, and eventually on the supply side. However, since the income of the
individual buyers is limited, some rise in any essential commodity’s price is likely to have
an impact on the consumption rate of the other less essential goods.
The prices of the markets of related commodities will tend to follow the same trend,
because of the cascading effect. If meat prices increase, fish prices also tend to increase,
because some of the meat buyers will opt to go the fish because of the rise in the price of
meat. Therefore, market for every goods/service is related in some degree, sometimes
quite great, sometimes very small, to all other markets.
Purchase Price and Purchase Quantity Selling Price and Sales Quantity
– Factors influencing: (buyer side) – Factors influencing: (seller side)