Basic Economics: For IIFT, other Entrance exams and GDPIs

Economics play an important part in our day to day lives as well as in most of the GK based entrance exams. In order to have a good understanding of Economics, we need to have a good understanding of the basic terms and what they mean. Here is a list of some of the most important basic terms in economics.

Two vantage points from which economics is observed

‘Macro’ refers to large, so macroeconomics deals with performance, allocation of resources, decision making, structure, maximization of production level, promotion of trade of an entire economy.

It deals with smaller issues at the level of individual or firm in the economy since micro here refers to small. It analyzes human behaviour responses when price of commodities changes and how they affect supply and demand for goods and services.

Invisible hand
Coined by Adam Smith, it means that every individual works towards his own benefit and tries to maximise his wealth which in turn leads to a better off society. It thus describes the self regulating nature of market through forces of supply and demand. Government intervention is not needed because invisible hand is the best guide.

Demand and supply
Demand refers to product or service desired by buyers and supply is the total amount of product or service available in market. Equilibrium Price and quantity are determined by the equilibrium point of demand and supply curve i.e. where demand equals supply.

When supply is unchanged,

• As demand increases rice and quantity increases
• As demand decreases: Price and quantity decreases

When demand is unchanged,

• As supply increases: Price decreases and quantity increases
• As supply decreases: Price increases and quantity decreases


Production Possibility Frontier (PPF)
Production Possibility Frontier, in macroeconomics is the point at which economy is producing its goods and services efficiently with optimum allocation of resources.

Absolute Advantage
If a country or firm produces more of a product or service, then they have absolute advantage over other country or firm.

Capital market,
It is a market where private firms and government can raise long term funds (for more than one year).It includes stock market and bond market.

Comparative advantage
When a country or firm can produce a good or service at a lower opportunity cost, then it has comparative advantage over others. Suppose country A and B produce cars and computers both. Country A can produce more computers using same resources and efforts as compared to B, while B can produce more number of cars with same resources and effort. Then the trade between the two will make both countries better off. Comparative advantage is about identifying which activities a country is most efficient in doing.

Complimentary goods
Those goods for which increase in demand of one leads to increase in demand of other. Example: computer hardware and software

Theory invented by Karl Marx who said that feudalism and capitalism will be succeeded by dictatorship of proletariat. It leads to superabundance of material wealth, allowing for distribution based on need and social relations. It aims for a classless and stateless society structured on common ownership of means of production.

Deflation is a persistent fall in the general price level of goods and services. It should not be confused with a decline in prices in one economic sector or with a fall in inflation rate .

Economies of scale
When a firm grows bigger and produces goods at a large scale, then its output increases and average cost of production of each unit falls. This is because overheads and fixed cost can be spread over more units of output. This results in more profit through economies of scale.

It is a measure of the responsiveness of one variable with change in another.

• Price elasticity: it measures quantity change in supply or demand of a good with change in price. If percentage change in quantity is more than that in price then good is price elastic, if less it is inelastic.
• Income elasticity: Change in quantity of goods demanded with change in income
• Cross elasticity: It measures change in quantity of one good with change in price of other. For substitute goods it is positive while for complementary it is negative. It is zero for unrelated goods.

Factor cost
It is a measure of output reflecting the costs of the factors of production used, rather than market prices. The factors of production are: land, labour, capital and enterprise.

Fiscal policy
It is one of the instruments of macroeconomic policy. It comprises public spending and taxation, and any other government income or assistance to the private sector (such as tax breaks). It can be used to influence the level of demand in the economy, usually with the twin goals of achieving unemployment as low as possible without triggering excessive inflation.

Game theory
Game theory is a technique for analysing how people, firms and governments should behave in strategic situations and in deciding what to do, it must take into account what others are likely to do and how others might respond to what they do. It helps firms in deciding optimal strategy for pricing and quantity of production

Giffen goods
It is named after Robert Giffen (1837-1910), refers to a good for which demand increases as its price increases.

Gini coefficient
The Gini coefficient measures the inequality of income distribution within a country. It varies from zero ( perfect equality), with every household earning exactly the same, to one (absolute inequality), with a single household earning a country’s entire income

Hedging involves deliberately taking on a new risk that offsets an existing one.

Horizontal equity
Horizontal equity means that people with a similar ability to pay taxes should pay the same amount.

Horizontal integration
It refers to merging of two similar firms. For example: Two biscuit makers becoming one.

Vertical integration
It refers to merging with a firm at a different stage in the supply chain.

Human Development Index
Calculated since 1990 by the United Nations Development Programme, the Human Development Index quantifies a country’s development in terms of such things as education, length of life and clean water, as well as income.

Indifference curve
A curve that joins together different combinations of goods and services that would each give the consumer the same amount of satisfaction. Here consumers are indifferent to which of the combinations they get.

When supply or demand of a product is insensitive to change in another variable, like price then it is said to be inelastic.

Inferior goods
Products that are less in demand as consumers get richer. Whereas for normal goods, demand increases as consumers have more money to spend.

Inflation erodes the purchasing power of a unit of currency. Inflation usually refers to consumer prices, but it can also be applied to other prices (wholesale goods, wage, assets etc). It is usually expressed as an annual percentage rate of change on an index number.

It is a branch of economics which is based on the ideas of KEYNES, which is characterised by a belief in active GOVERNMENT and suspicion of market outcomes. It was dominant in the 30 years following the second world war especially during the 1960s, when fiscal policy became bigger-spending and looser in most developed countries as policymakers tried to kill off the business cycle.

It is the belief that an economy functions best when there is no interference by government.

Leading indicators
Also known as cyclical ¬indicators, these are groups of statistics that point to the future direction of the economy and the business cycle.

Leveraged buy-out
It is buying a company using borrowed money to pay most of the purchase price. The debt is secured against the assets of the company being acquired. The interest will be paid out of the company’s future cashflow.

Short for London interbank offered rate, the rate of interest that top-quality banks charge each other for loans

A company’s debt expressed as a percentage of its equity; also known as gearing.

Mixed economy
It is a market economy in which both private-sector firms and firms owned by government take part in economic activity.

It is an economic doctrine that says government that control of foreign trade is of paramount importance for ensuring the prosperity and security of a state.

Monetary policy
Central bank controls money supply and demand through this policy. It involves open market operations, reserve requirements and changing short term rate of interest.

Money markets
Any market where money and other liquid assets (such as TREASURY BILLS) can be lent and borrowed for a few hours and a few months is called money market.

When the production of a good or service with no close substitutes is carried out by a single firm with the market power to decide the price of its output, that single firm is said to have monopoly.

Nominal value
The value of anything expressed simply in the money of the day is called nominal value. Since inflation means that money can lose its value over time, nominal figures can be misleading when used to compare values in different periods. It is better to compare their real value, by adjusting the nominal figures to remove the inflationary distortions.

Nash equilibrium
It is an important concept in game theory, and occurs when each player is pursuing their best possible strategy in the full knowledge of the strategies of all other players.

New Trade Theory (NTT)
It is a collection of economic models in international trade which focus on the role of increasing returns to scale and network effects.

It occurs when a few firms dominate a market. Often they can together behave as if they were a single monopoly, by forming a cartel.

Open economy
It is an economy that allows the unrestricted flow of people, capital , goods and services across its borders; it’s opposite is CLOSED ECONOMY.

Open-market operations
Operations in which Central bank buys and sells securities in the open market, as a way of controlling interest rates or the growth of money supply. By selling more securities, they can mop up surplus money; buying securities adds to the money supply.

Opportunity cost
It is the value of what has been forgone to gain something else.

Pareto efficiency
It is a situation in which nobody can be made better off without making somebody else worse off.

Perfect competition
It is a situation in which no single firm can affect the price of what it produces.

Private equity
When a firm’s shares are held privately and not traded in the public markets. Private equity includes shares in both mature private companies and, as venture capital, in newly started businesses.

It is policy to pump up demand and thus boost the level of economic activity. Monetarists fear that such policies may simply result in higher inflation.

It is an agreement in which one party sells a security to another party and agrees to buy it back on a specified date for a specified price.

It includes some collective ownership of the means of production and a strong emphasis on equality, of some sort.

Stagflation is a situation in which the inflation rate is high and the economic growth rate is low.

Money paid, usually by govt., to keep prices below what they would be in a free market, or to keep alive businesses that would otherwise go bust, or to make activities happen that otherwise would not take place

Substitute goods
They are opposite of complimentary goods. Increase in demand of one leads to fall in demand of other. Eg. MS windows and Apple Mac, coffee and juice etc.

Systematic risk
The risk that remains after diversification, also known as market risk or un- diversifiable risk is called as systematic risk.

Systemic risk
It is the RISK of damage being done to the health of the financial system as a whole.

The annual income from a security, expressed as a percentage of the current market price of the security.

Zero-sum game
When the gains made by winners in an economic transaction equal the losses suffered by the losers. It is identified as a special case in game theory.