BASIC CONCEPTS AND
• Contents: (6 Hrs)
• 1.1 Definition
• 1.2 Nature and Scope of Economics-Micro Economics and Macro Economics.
• 1.3 Managerial Economics and its relevance in business decisions.
• 1.4 Fundamental Principles of Managerial Economics –
a) Incremental Principle,
b) Marginal Principle,
c) Opportunity Cost Principle,
d) Discounting Principle,
e) Concept of Time Perspective.
f) Equi-Marginal Principle.
• 1.5 Utility Analysis. Cardinal Utility and Ordinal Utility.
• In General way, economics is a social science which deals with the
production, distribution and consumption of goods and services.
There are a large number of economist give their different
definitions. Some say that there is no requirement of definition of
economics this is because economics growing continuously. But most of
the economists agree with the view that defining economics is must.
On the basis of these economist, the definition of economics is
divided into four parts such as:
Definition of Economics
J S Say
L C Mill
C E Fergeuson
Prof. J K Mehta
• Adam Smith says “The self-interested pursuit of wealth may not be
individually satisfying but leads to an aggregate increase in wealth
that is in the best interests of a nation.”
• Adam Smith- Economics is an enquiry into the nature and causes of
wealth of nation.
• J.B. Say- Economics is the science which treats of wealth.
• J.S. Mill-Economics is the practical science of the production and
distribution of wealth.
• Senior- The subject treated by political economics is not happiness
• Alfred Marshall was born in London, on26 July 1842. Professor of Political
Economy at the University of Cambridge from 1885 to 1908, he was the
founder of ·the Cambridge School of Economics which rose to great
eminence in the 1920s and 1930s. Alfred Marshall’s magnum opus, the
Principles of Economics was published in 1890. Marshall relates the
definition of economics with material welfare.
• Marshall-Economics is the study of mankind in the ordinary business of life;
it examines that part of individual and social action which is most closely
connected with the attainment and with the use of material requited for well
• Cannan-The aim of political economy is the explanation of general causes
on which the material welfare of human being depends.
• Beveridge-Economics is the study of the general methods by which men co-
operate to meet their material needs.
• Penson-Economics is the science of material welfare.
• Lionel Robbins was a peculiar Englishman in the economics world of the
1920s. His tools were the London School of Economics and a famous 1932
essay on economic methodology. It was his 1932 Essay on the Nature and
Significance of Economic Science where Robbins made his Continental
credentials clear. He redefines the scope of economics to be “the science
which studies human behavior as a relationship between scarce means which
have alternative uses.”
• Lionel Robbins-Economics is a science which studies human behaviour as a
relationship between ends and scarce means which have alternative uses.
• Scitovosky-Economics is the science concerned with the administration of
• Stonier & Hague-Economics is the fundamentally a study of scarcity and the
problem which gives rise.
• Harvey-Economics is the study of how men allocate their resources to
provide for their wants.
• Paul A. Samuelson has personified mainstream economics in the
second half of the twentieth century. Paul Samuelson has not been
unjustly considered the incarnation of the economics ‘establishment’-
and as a result, has been both lauded and vilified for virtually
everything right and wrong about it. Paul Samuelson’s most famous
piece of work, “Foundations of Economic Analysis” (1947), one of the
grand tomes that helped revive neoclassical economics and launched
the era of the mathematization of economics. Samuelson was one of
the progenitors of microeconomics and the Nee-Keynesian Synthesis
in macroeconomics during the post-war period.
• Prof. Samuelson-Economics is the study of how people and society end up
choosing with or without the use of money, to employ scarce productive
resources that could have alternative uses, it produce various commodities
over time and distributes them for consumption, now or in the future, among
various persons and groups in society. It analyses cost and benefits of
improving patterns of resource allocation.
• Benham-Economics is the study of the factors affecting employment and
standard of living.
• C. E. Ferguson-Economics is the study of the economic allocation of scarce
physical and human means (resources) among competing ends, an allocation
that achieves a stipulated optimizing or maximizing objectives.
• Porf. J.K. Mehta-Economics is a science which studies human behaviour as a
means to reach in a situation free of wants.
1.2 NATURE AND SCOPE OF ECONOMICS-MICRO ECONOMICS
AND MACRO ECONOMICS
• Economics as a Science:
• if it is so, is it a positive or a normative science?
• A science is a systematised body of knowledge ascertainable by observation and
experimentation. It is a body of generalisations, principles, theories or laws which traces
out a causal relationship between cause and effect.
• For any discipline to be a science;
• (i) it must be a systematized body of knowledge;
• (ii) have its own laws or theories;
• (iii) which can be tested by observation and experimentation;
• (iv) can make predictions;
• (v) be self-corrective; and
• (vi) have universal validity.
• If these features of a science are applied to economics, it can be said that economics is a
NATURE OF ECONOMICS
• Economics as an Art:
• Art is the practical application of scientific principles. Science lays
down certain principles while art puts these principles into practical
use. To analyze the causes and effects of poverty falls within the
purview of science and to lay down principles for the removal of
poverty is art. Economics is thus both a science and an art in this
• “Economics should not be considered as a tyrannical oracle whose
word is final. But when the preliminary work has been truly done,
Applied Economics will at certain times on certain subjects speak with
the authority to which it is entitled.” Economics is thus regarded both
a science and an art, though economists prefer to use the term
applied economics in place of the latter.
SCOPE OF ECONOMICS
• International economics
• Public finance
• Development economics
• Health economics
• Environmental economics
• Urban and rural economics
• Subject- matter of economics can be sub- divided in to
Microeconomics and Macroeconomics.
• These terms were first coined and used by Ragnar Frisch.
• Acc. To K E Boulding:
• “Microeconomics is the study of particular firms, particular households,
individual prices, wages, incomes, individual industries, particular
• “Macroeconomics deals not with individual quantities as such but with
aggregates of these quantities, not with individual incomes but with
national income; not with individual prices but with general price level;
not with individual output but with national output.”
1.3 MANAGERIAL ECONOMICS AND ITS
RELEVANCE IN BUSINESS DECISIONS.
• To quote Mansfield, "Managerial Economics is concerned with the
application of economic concepts and economic analysis to the problems of
formulating rational managerial decisions."
• According to McNair and Meriam, "Managerial economics is the use of
economic modes of thought to analyse business situations."
• "Managerial Economics is concerned with the application of economic
principles and methodologies to the decision making process within the firm
or organisation under the conditions of uncertainty," says Prof. Evan J
• Spencer and Siegelman define it as "The integration of economic theory
with business practice for the purpose of facilitating decision making and
forward planning by management."
• According to Hailstones and Rothwel, "Managerial economics is the
application of economic theory and analysis to practice of business firms
and other institutions."
• An activity or an ongoing
• A purposive process
• An art of getting things
done by other people.
• Human wants are virtually
unlimited and insatiable,
• Economic resources to
satisfy these human
demands are limited.
Economics • Thus managerial economics
is the study of allocation of
resources available to a
firm or a unit of
management among the
activities of that unit.
SCOPE OF MANAGERIAL ECONOMICS
There are four groups of problem
in both decision making and
RELATIONSHIP OF MANAGERIAL
ECONOMICS WITH DECISION SCIENCES
• Economics is linked with various other fields of study
• Operation Research
• Theory of Decision Making
• Management Theory and Accounting
• Satisficing instead of maximizing
• Managerial Accounting
Economics and other Disciplines
1.4 FUNDAMENTAL PRINCIPLES OF
MANAGERIAL ECONOMICS –
a) Incremental Principle,
b) Marginal Principle,
c) Opportunity Cost Principle,
d) Discounting Principle,
e) Concept of Time Perspective.
f) Equi-Marginal Principle.
• Incremental concept is similar to the concept of marginal value, but
with a difference. Marginal principle is theoretical while incremental
concept is practical in nature.
• Marginal concept is used when calculating per unit costs for bulk
purchases, the principle of incrementalism comes in to play when the
inputs are large units like in case of airplane.
• The use of incremental concept in business decision making is known
as incremental reasoning.
• IC is used more often in business decision making than MA.
OPPORTUNITY COST PRINCIPLE
• The idea is that anything you must give up in order to carry out a particular
decision is a cost of that decision. This concept is applied again and again
throughout modern economics.
• Scarcity: According to modern economics, scarcity exists whenever there is
an opportunity cost, that is, where-ever a meaningful choice has to be
• Production Possibility Frontier: The production possibility frontier is the
diagrammatic representation of scarcity in production.
• Comparative Advantage: A very important principle in itself and a key to
understanding of international trade the principle of comparative
advantage is at the same time an application of the opportunity cost
principle to trade.
• Discounting of Investment Returns: Another application of the opportunity
cost principle that is very important in itself, this one tells us how to handle
opportunities that come at different times.
1.5 UTILITY ANALYSIS. CARDINAL
UTILITY AND ORDINAL UTILITY.
• Utility Analysis
• The decision of a consumer depends upon the concept of individual benefit,
also known as utility. If consumer gets more benefit from the product he will
ready to spend more on the product and the vice-versa.
• Consumers are able to order their preference depending on the utility they
get from the consumption of the particular product. Utility can be difficult to
• No consumer is able to measure the utility in quantitative terms. But he can
order his preference according to the satisfaction from the consumption
goods. Thus, there are two class of thoughts about the measurement of
• One states that utility can be measured in numbers or monetary terms,
another says that satisfaction utility derived from the consumption of goods
can only be ordered. These two distinctions are called cardinal utility and
CARDINAL UTILITY AND
• Utility is an economic term referring to the total
satisfaction received from consuming a good or service.
For example, satisfaction you get by consuming a cup of
tea is the utility of that cup of tea. If this measure is
given, one may think of increasing or decreasing utility,
and thereby explain economic behavior in terms of
attempts to increase one’s utility. Changes in utility are
sometimes expressed in fictional units called utils. There
are mainly two kinds of measurement of utility
implemented by economists: cardinal utility and ordinal
CARDINAL UTILITY AND
• Utility was originally viewed as a measurable quantity,
so that it would be possible to measure the utility of
each individual in the society with respect to each good
available in the society, and to add these together to
yield the total utility of all people with respect to all
goods in the society. Society could then aim to maximise
the total utility of all people in society, or equivalently
the average utility per person. This conception of utility
as a measurable quantity that could be aggregated
(summed up) across individuals is called cardinal utility.
• Cardinal utility quantitatively measures the preference of an
individual towards a certain commodity. Numbers assigned to
different goods or services can be compared.
• Example: For a coffee addict, a utility of 100 utils towards a
cup of cappuccino is twice as desirable as a cup of tea with a
utility level of 50 utils.
• The concept of cardinal utility suffers from the absence of an
objective measure of utility.
• For example, the utility gained from consumption of a
particular good by ‘A’ will be different than ‘B’.
• Ordinal utility represents the utility, or
satisfaction derived from the consumption of
goods and services, based on a relative
ranking of the goods and services consumed.
With ordinal utility, goods are only ranked only
in terms of more or less preferred, there is no
attempt to determine how much more one good
is preferred to another.
• Example: You may prefer to consume or buy more apples than bananas
while your friend may prefer to consume or buy more bananas than apple.
• The modern economists have discarded the concept of cardinal utility and
have instead employed the concept of ordinal utility for analysing consumer
behaviour. The concept of ordinal utility is based on the fact that it may not
be possible for consumers to express the utility of a commodity in absolute
terms but it is always possible for a consumer to tell introspectively whether
a commodity is more or less or equally useful as compared to another.
• Example: A consumer may not be able to tell that an ice cream gives 5 utils
and a chocolate gives 2 utils. But he or she can always tell whether
chocolate gives more or less utility than ice cream.
• This assumption forms the basis of the ordinal theory of consumer behaviour.
Ordinal utility is the underlying assumption used in the analysis of
MARGINAL UTILITY ANALYSIS
• Marginal utility is the additional amount of satisfaction
obtained from consuming one additional unit of a good. Total
utility is the overall amount of satisfaction obtained from
consuming several units of a good. While the maximization of
total utility represents the ultimate goal of consumption, the
analysis of consumer behaviour gives greater emphasis on the
marginal utility. As consumer proceeds with his consumption
total utility increases as more of a good is consumed, but the
marginal utility decreases with the consumption of each
additional unit. The decrease in marginal utility with an
increase in the consumption of a good reflects law of
diminishing marginal utility.
THE LAW OF DIMINISHING
MARGINAL UTILITY: MARSHILLIAN
• Marginal utility refers to the change in satisfaction which results when
a little more or little less of that good is consumed.
• The law of diminishing marginal utility says that with the increase in
the consumption of a good there is a decrease in the marginal utility
that person derives from consuming each additional unit of that
• An indifference curve may be defined as the locus of points.
Each point represents a different combination of two substitute
goods, which yields the same utility or level of satisfaction to
the consumer. Therefore, he/she is indifferent between any two
combinations of goods when it comes to making a choice
between them. Such a situation arises because he/she consumes
a large number of goods and services and often finds that one
commodity can be substituted for another. This gives him/her an
opportunity to substitute one commodity for another, if need
arises and to make various combinations of two substitutable
goods which give him/her the same level of satisfaction. If a
consumer faced with such combinations, he/she would be
indifferent between the combinations.
FIGURE BELOW SHOWS THE INDIFFERENCE CURVE DRAWN ON THE BASIS
OF THE FIGURE GIVE IN TABLE. IT DEPICTS, IN GENERAL, ALL
COMBINATIONS OF TWO GOODS WHICH YIELD THE SAME LEVEL OF
SATISFACTION TO THE CONSUMER. THE CONSUMER IS INDIFFERENT ABOUT
ANY TWO POINTS LYING ON THIS CURVE.
• The following assumptions about the consumer psychology are
implicit in indifference curve analysis:
• Transitivity: If a consumer is indifferent to two combinations of two
goods, then he is unaware of the third combination also.
• Diminishing marginal rate of substitution: The rarer the availability of
a good, the greater is its substitution value. For example, water has a
high substitution value as it is a scarce resource.
• Rationality: The consumer aims to maximise his total satisfaction and
has got complete market information.
• Ordinal utility: Utility in this approach is not measurable. A consumer
can only specify his preference for a particular combination of two
goods, he cannot specify how much.
PROPERTIES OF INDIFFERENCE CURVE
• Indifference curves have the four basic characteristics:
• 1. Indifference curves have a negative slope
• 2. Indifference curves are convex to the origin
• 3. Indifference curves do not intersect nor are they tangent to one
• 4. Upper indifference curves indicate a higher level of satisfaction.
• These characteristics or properties of indifference curves, in fact,
reveal the consumer’s behaviour, his choices and preferences. They
are, therefore, very important in the modern theory of consumer
behaviour. Now, we will observe their implications.
• THE BUDGET CONSTRAINT Having described preferences,
next we determine the consumer’s alternatives. The amount of
goods he can purchase depends on his available income and
the goods’ prices. Suppose the consumer sets aside Rs. 200
each week to spend on the two goods. The price of good X is
Rs. 40 per unit, and the price of Y is Rs. 20 per unit. Then he is
able to buy any quantities of the goods (call these quantities X
and Y) as long as he does not exceed his income. If he spends
the entire Rs. 200, his purchases must satisfy:
40X + 20Y = 200
• If we superimpose the indifference map
and budget line as in Figure shown above,
we find that a consumer has to decide to
purchase a particular combination (C) as
it falls on his budget line, though a
different combination (D) would be more
desirable as it will give a higher level of
satisfaction. At his point of equilibrium C,
the price line is touching the indifference
line tangentially meaning that the slopes
are equal. The slope of indifference curve
indicates the marginal rate of substitution
between X and Y, and the slope of
budget line indicates the ratio of price of
X to that of Y. Thus the principle of
consumer's equilibrium works out; the
marginal rate of substitution between X
and Y must be proportional to the ratio of
price of X to that of Y.