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Introduction To Economics

This document provides an introduction to economics. It discusses key concepts like scarcity, different economic systems including central planning and market economies, and the role of prices and supply and demand. Central planning allocates resources through government but has issues with information and incentives. Market economies use price signals through supply and demand but have problems with equity and market failures. Most modern economies are mixed systems that balance market forces with government intervention.

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40 views12 pages

Introduction To Economics

This document provides an introduction to economics. It discusses key concepts like scarcity, different economic systems including central planning and market economies, and the role of prices and supply and demand. Central planning allocates resources through government but has issues with information and incentives. Market economies use price signals through supply and demand but have problems with equity and market failures. Most modern economies are mixed systems that balance market forces with government intervention.

Uploaded by

siddhesh
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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INTRODUCTION TO

ECONOMICS NARASINHA SAWAIKAR


WHAT IS ECONOMICS?
One definition: Economics studies the allocation of scarce resources to competing
ends.
Scarcity is pervasive: at the individual, corporate and national level.
At the level of the economy:
Limited factors of production: land, labour and capital.
What do you produce?
How do you produce it?
How do you distribute it?
The answers define the nature of a system.
TYPES OF ECONOMIC
SYSTEMS
We can think of two extreme systems: central planning and the pure market
economy.
In central planning, the government owns the means of production.
It allocates resources through some kind of top-down mechanism involving central
planning
Effectively the entire economy is like a gigantic public sector company.
The Soviet Union was the closest example among major economies. Other
communist countries including China before 1980 also adopted similar models
The Indian economy was a mixed economy which adopted elements of this model
like planning in the 1950s and 1960s.
PROBLEMS WITH CENTRAL
PLANNING
The Soviet Union collapsed in 1991 and China moved away from this model in the
1980s.
Two problems : information and incentives
In practice it was extremely difficult to centralize all the scattered information which
was necessary to make decisions rationally
Providing strong incentives was very difficult in an economy without private
ownership.
PURE MARKET ECONOMY
The other extreme we can call the pure market economy. This means an economy
where the government plays an extremely limited role: establishing property rights,
maintaining law and order and providing national defense.
All factors of production are private owned. There is little or no regulation of the
economy.
Leading economies of the world in 1900: UK, US were quite close to this model.
PRICE MECHANISM
There is no central direction in a pure market economy. Allocation of resources is done
through the price mechanism ( aka invisible hand).
Prices are determined through some process of interaction between buyers and sellers
without any interference by the government
These prices act as a signal which shape the decisions of other actors in the economy.
There are markets and prices for all markets including factor markets where individuals
can sell or rent their labour, land and capital
Example of price mechanism. Suppose there are lemon and orange farmers and initially
the price of lemons and oranges is the same, say Rs 100 per kg. Then suppose the
demand for oranges increases perhaps because people start drinking more orange juice.
What will happen?
LIMITS OF THE MARKET
MODEL
Equity (fairness): There is nothing in the price mechanism that will guarantee a
“fair” distribution of income. Everyone’s income is determined by the prices they
can obtain in the market for the factors of production they control.
Many people may not be able to earn enough to afford basic healthcare and
education.
Over the course of the 20th century countries like the UK and US greatly expanded
the scope of government to ensure their citizens had basic education, healthcare and
retirement benefits.
MARKET FAILURE
The price mechanism does not always work well. In particular it fails when:
Imperfect competition: There isn’t adequate competition in the industry in which cases prices
may be higher than optimal
Imperfect information: Either the buyer or seller is not well-informed about the product in which
case markets will not work well
External effects: Market transactions have a significant effect beyond the buyer and seller. E.g.
environmental pollution.
In each of these cases there is a role for government regulation to improve the outcomes of the
market.
Despite these market failures, it is important not to go overboard in suppressing market forces too
much. The price mechanism still remains a powerful tool for economic efficiency. It’s about
finding the right balance.
MIXED ECONOMIES
Clearly there are serious problems with both the central planning model and the pure
market model.
In practice almost every country that has tried something like one of these extreme
models has moved away from it
Most economies are mixed economies where market forces work together with
extensive government spending and regulation
Where exactly to lie on the spectrum from pure market to central planning is a matter
of political debate in most countries . In the 1980s and 1990s most countries moved
in a more market oriented direction. Since the global financial crisis of 2008 there
has been something of a reversal of these trends.
OIL PRICES
Suppose the price of crude oil increases because of some production problems in oil-
producing countries. The prices of petroleum products including petrol will also
increase
List all the ways that consumers and adjust to these prices changes
List all the ways in which companies can react to these price changes, both in the
petroleum sector and generally.
DEMAND AND SUPPLY
SCHEDULES
Price Quantity Demanded Quantity Supplied

10 80 20

20 70 30

30 60 40

40 50 50

50 40 60

60 30 70
DEMAND AND SUPPLY
Demand and Supply
70

60

50

40
Quantity Demanded
Price

Quantity Supplied
30

20

10

0
10 20 30 40 50 60 70 80 90

Quantity

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