LECTURE – 2

BASICS OF ECONOMICS

• This lecture will essentially introduce you to a few basic economic concepts to give you a taste of the subject – which may also be handy while getting into finance.

What is economics?Essentially a subject which deals with production, consumption and management of wealth and resources.One of its basic principles is that someone’s gain is someone else’s loss.

Some economic terminologies

Demand• Demand – The willingness and ability to buy something at a particular price and time.

• Law of Demand – Keeping everything else constant, price and demand share an inverse relationship.

However, sometimes it gets violated – like in the case of Gold – you’d have observed that as gold prices rise people buy more and more of it because they expect the rise of price even further.

A demand curve

Supply The willingness and ability to sell something at a particular price and time.• Law of Supply - Keeping everything else constant, price and supply share a direct relationship.

This too, sometimes gets violated – like in the case of agricultural goods, where without proper storage facility, the goods will go stale so they’ll have to be sold before they go stale.

A supply curve.

Other terms• Scarcity – A condition when demand exceeds supply. Scarcity is the whole reason behind trade. A product or a share in the stock market has a price because there is only limited quantity of it.

• Opportunity cost – The cost of the next best alternative that is forgone to buy a product. Example – The opportunity cost of buying shares worth X is probably Government bonds worth X.

• Equilibrium – A condition in which trade/business is feasible. Here, the producer and consumer agree to a price and desired quantity to be bought/sold. When this happens, the producer gets the money and the consumer gets the good. This is termed as a business transaction.

Equilibrium – When demand meets supply

But how does producer guess the price at which he/she should sell the good?• Here , a concept called price elasticity of demand is used. • Basically, it shows how consumer demand responds to changes in price.

-> If demand does not change much with change in price, it is inelastic-> If demand changes to a decent extent with change in price, it is elastic . Thus the producer varies the price accordingly.

Income and Revenue• Income – What is earned as a result of labour/efforts.• Disposable Income – Income which you are free to spend after deducting tax and other liabilities like EMI.

• Another source of income is dividends – which is a return earned when money is invested in stocks. Companies as per their choice can declare dividend when it earns profit

• Revenue – Money earned from sales of a product. When cesses like corporate tax, property tax etc is removed then it is called income of a firm

In foreign countries, revenue is also called turnover. Profit – the excess of revenue over costs incurred.

So…what’s really happening out there?

Controllers of money flow in an economy• The Central Bank(RBI in India)• The Government (Through finance ministry)

Role of RBI-> The major role of RBI is to mint currency notes and coins as per its wish.-> Other than that its role is to control inflation rates. Inflation is defined as a state of steady rise in prices. – one of its causes being rise in disposable income. A mild inflation, however, is necessary for growth.-> To curb this, it instructs banks to increase interest rates so that people borrow less – hence disposable income falls and inflation starts getting under control. RBI adjusts interest rates in terms of basis points – 1/100 of a percent.-> RBI also helps banks save themselves during financial turmoil so that the banking system does not crash.

Basic types of market structures• Perfect competition – One in which there are large number of buyers and sellers, uniform price and no advertising costs. Firm is price taker.

• Monopoly – Single seller , who is the price maker. Can be regulated by Govt.

Indian Railways is one example of a Govt. monopoly Monopolistic competition – Large number of buyers and sellers, product differentiation and huge advertising cost. This type of market is what is realistically seen.