Basic Concepts of Economics

Basic Concepts of Economics


Economics is a social science. It starts with the assumption that human beings will work towards fulfilling their self interest. The study of modern economics was first started by Adam Smith who examined the reasons for some nations prospering while others not being able to do so well.

Basic Economic Concepts

Economy starts when you try to manage your pocket money, specially when you take a decision how you are going to spend it! You have so many choices: see a movie, save the money for another day, lend it to your friend or purchase a laptop for your study assignments. Why do you have to take a decision? Because there is not enough money for everything you want to do. Similarly a household, a firm, an industry, a country and the complete world has certain available resources (labor, land and capital.). As these resources are limited there is a need for a smart decision to utilize these scarce resources  in the best possible manner (a manner which will produce maximum profitable output for society).  This is called ‘Economics’. So economics is the study of how a society manages its scarce resources to fulfill our unlimited wants.

The principles of economics are:


What to produce and in what quantities

As all people can not produce all things so to produce or get one thing we have to give up another, it is called production tradeoff. The classical example of tradeoff is “guns versus butter”. If we spend more to protect our frontiers, we have less to spend on consumer goods.

How to produce and for whom to produce

A society must consider the methods of production using its scarce resources so that it gets the maximum output. This is called efficiency. But at the same time society would like to not ignore the fair and equal distribution of economic prosperity among its members. This process is named as equity. To choose the ratio of efficiency and equity is another trade-off.

Economy of production

When there is a trade-off, selecting one thing and giving up another, there is some benefit over another. The gains which we ignore! to select one option over another is called opportunity cost. For example, if you have one scarce hour and have to choose between study and work in a pizza shop at $10 per hour and you choose to study then the opportunity cost of study is $10. The opportunity cost is also called implicit costs.

Marginal Thinking

Generally, we think in terms of absolute or average costs or profit, but this may not be the best way always. Suppose you have taken your first cup of coffee in the morning and then you decide to take three more. Naturally each successive cup of coffee gives you less pleasure than the previous one. Similarly if a firm has invested a good fixed cost to produce dancing-dolls, increase in each additional unit in production will decrease its production cost. A rational consumer or firm thinks at the margin. Marginal thinking means, thinking about costs and profit received by consuming, producing and selling an additional successive unit.

Let’s try –

Question 1.  Scarcity is best defined as?

a.  The difference between limited wants and limited economic resources.

b.  The difference between the limited wants and unlimited economic resources.

c.  The difference between unlimited wants and limited economic resources.

d.  The opportunity cost of pursuing a given course of action.

Question 2.  John and Mary can both cook and both also pull weeds in the garden on a Sunday afternoon. For every hour of cooking, John can pull 50 weeds and Mary can pull 120 weeds. Based on this information:

a.  Mary will cook because her opportunity cost is more in garden.

b. The opportunity cost of cooking is 120 weeds for John.

c.  The opportunity cost of working in garden is 120 for Mary.

d.  The opportunity cost of cooking is more for Mary.

Scroll down for the answers ————









c. The difference between unlimited wants and limited economic resources

. The opportunity cost of cooking is more for Mary.