Economics - Introduction

Economics

1.1 Economics

The Term ‘Economics’ is obtained from Greek words OIKOS and NEMEIN, meaning the rule or law of the household. Primarily it dealt with the way in which a housewife made the most efficient utilisation of the scarce resources at her disposal. Later, this concept was used to analyse how best the resources, i.e. manpower, raw material and capital must be managed to get the maximum benefit from them.

Economics, therefore,  is concerned with not just how a nation distributes its resources to various uses, but it also deals with the process, by which the productive capacity of these resources can be further enhanced.  

Definition of Economics in the eyes of Econmists

i)          Adam Smith : According to Adam Smith Economics means “the study of the nature and causes of generation of wealth of a nation”. He denied the role of state in economic affairs.

ii)        J.B. Say : According to J.B. Say” Economics is the science, which deals with wealth”.

iii)       Marshall : Marshall has defined economics, as 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 requisites of well being.

iv)       Robbins : As per Robbins definition “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. 

v)         Samuelson : According to Prof. Samuelson ‘Economics is the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time and distribute them for consumption now and in the future, amongst various people and groups of society. Paul A Samuelson defines Economics in terms of Dynamic growth and development.

vi)       Keynes : As per Keynesian theory, the economy consists of labour market, money market and goods market.

The definition thus recognizes the dynamic change taking place, both in the means, as well as in the ends. It has, therefore, called as growth-oriented definition of economics.

 Importance of Economics

a.     Price fixation: It assists the firm in price fixation, which is influenced by a number of other factors.

b.    Maximize profits: Economics gives the methods to producers maximize their profits by utilising various factors of production.

c.     Demand and supply: The reward or return given to a factor of production is ascertained by the forces of demand and supply in the market, explaining that a factor of production must be paid according to its marginal productivity.

d.    Utilisation  of resources to optimum capacity: Economics gives the requisite information to the planners to utilise the resources to their optimum capacity.

e.     Working of economy: Economics assists the academician to study the working of the economy.

Characteristics of Economics

(i)        Object of study: Economics focuses on the study of activities, which assist in the acquisition of wealth.

(ii)       Economic liberty and free trade: Economics advocates liberty and free trade (called the policy of laissez-faire).

(iii)      Systematized body of knowledge: Economics is the science of exchange value of wealth. It is a systematized body of knowledge, rather than a technique of managing the household, or of raising the revenues for the state.

1.2 Economics - Science or Arts.

a)     Economics considered as Science

i)      The term ‘ science’ means the systematized body of knowledge, which traces the relationship between cause and effect. As per this definition, Economics is that branch of knowledge where various relevant facts have been systematically compiled, classified and analyzed, Judged from this stand point, Economics is a full-fledged science because it makes use of the scientific techniques in its researches and investigations.

ii)    Economics is considered as science, because-

−      Like science, its knowledge is systematized.

−      Like science, it establishes the cause and effect relationship between two economic phenomena.

−      Like science, its study depends on estimations.

−      Its laws have the ability to predict events with reasonable degree of exactness.

However, Economics cannot predict as accurately as the physical science economics deals with human behaviour, which is highly uncertain. Further, controlled experiment is not possible on human behaviour.

b)    Economics considered as Art

i)      An art is a systematized body of knowledge, which lays down precepts or specific solutions for specific problems. The aim of art is to formulate the precepts immediately applicable to policy.

ii)    Economics is also an art, because-

−      Personal Skill: Like other art, economics develops the skills of solving economic problem (for example, preparation of the budget and formulation of budgetary policies).

−      Practical Know How: Like other artists, economist also applies his knowledge and skill to solve basic economic problems. More ever, an economist has to make various graphs and diagrams, such as demand curve, supply curve etc, which are in fact, a part of art.

c)     Conclusion: Thus it is clear from the above analysis that economics can be treated both as a science as well as an art:

-         To analyse the causes and effects of poverty and wealth, economics falls within the purview of Science.

-         To lay down policies for the removal of poverty, through personal skills and practical know how, it falls within the purview of Arts.

-         This provides a balanced attitude.

1.2.1 Economics – Normative or Positive Science

a)     Economics as a Positive Science

i)      The classical Economists considered Economics as a positive science and that the economists should not look into rightness or wrongness of economic events. For example, a person can spend his money any way he likes (liquor, drugs, or milk). An economics should not direct him.

ii)    A positive science deals with things as they actually happen. It describes their causes and effects, but remains neutral as regards ends; without passing moral judgments, or how the economics theories may be applied in practice (beneficial or harmful to the society).

b)    Economics as a Normative Science: A normative science, deals with things, as they ought to be, explaining the moral rightness or wrongness of things. Economics as a normative science, not only interprets facts as they are, but also justifies them. It would work for searching out and prescribing certain course of action to attain certain desired goals. In view of present day problems due to large scale production, ecological degradation, price control, unemployment, etc. the significance of normative economics has considerably increased.

c.Conclusion

·         Economics thus has both positive and normative aspects.

·         While laying down theories, Economics may be treated as pure and Positive Economics, but as a method of practical application, it includes Normative Economics, i.e. welfare propositions also.

d.Distinction  between Positive & Normative Economics

Positive Economics	Normative Science
(i)    It expresses what is	(i)   It expresses what should be
(ii)   It based on logical cause & effect of facts	(ii) It is mainly based on ethics
(iii)  It deals with realistic situation	(iii)  It deals with idealistic situation
(iv)  It can be ascertained from facts and data	(iv)It cannot be ascertained verified with data
(v)   It deals with how an economic problem is solved	(v)  It deals with how an economic problem should ideally be solved

1.3 Micro Economics

Micro Economics deals with a small part of the national economy of a country. Micro Economics is the branch of economic analysis, which studies the economic behaviour of the individual unit (a specific person, a household, or a firm) in the national economy.

Maximization of profits: In Micro Economics, we study the various units of the economy; how they work and how they attain their equilibrium. So, Micro Economics is the study about how a particular person maximizes satisfaction, or how a firm maximizes its profits.

Price Theory: It is also termed Price Theory. It explains the composition or allocation of total production, why some things are produced more than that of others.

Micro Economics deals with :

(a)   Product Pricing,

(b)   Consumer Behaviour, 

(c)   Factor Pricing,

(d)   Economic conditions of a section of society

(e)   Study of firms,

(f)    Location of Industry, etc.

Examples of micro economics issues:

Examples of micro economics issues are like, Price Fixation by a Producer Firm, Location of an industry at a particular place, etc.  

 1.4 Macro Economics

Macro Economics is the study of the economic system as a whole, the overall conditions of an economy (like total production, total consumption, total saving and total investment, averages and aggregates) of the whole system rather than with the particular units.It gives a bird’s eye-view of the entire economic system. It helps in devising economic policies for the nation as a whole.

Macro Economics deals with:

a)     National Income and Output,

b)    General Price Level,

c)     Balance of Trade and Payments

d)    External Value of Money,

e)     Saving and Investment,

f)      Employment and Economic Growth etc.

Examples of, macro-economic issues

Value of Rupee vis-à-vis Dollar, Balance of Payments Deficits, Reasons for saving rates being high or low, etc.  

 Distinction between Micro and Macro Economics

	Micro Economics	Macro Economics
(1)   Scope	It is study of individual economic units. It is narrow in scope.	It is study of the economic system as a whole. It is wider in scope.
(1)   Range	It deals with individual income,   individual prices, individual output etc.	It deals with national income, price level, national output etc.
(3)   Focus	Its main focus of study is demand and supply of a particular commodity.	Its main focus of study are aggregate demand and aggregate supply of the economy as a whole.
(4)   Price Determinative	Determines ‘relative prices’	Determines ‘absolute prices’.
(5)   Analysis	Makes partial Equilibrium Analysis.	Makes general equilibrium analysis.

1.5 Economic Laws

Economic laws are those social laws, which relate to branches of study to measure the strength of the motives by money and price.

Economic laws are statements about the cause and effect relationship between two economic phenomena. Economic laws are only prediction of an economic phenomenon to behave in a particular manner in response to a particular positive factor (e.g. ‘The law of Demand’). It influences human behaviour regarding the application of scarce resources for the fulfillment of unlimited human wants.

Features of Economic Laws

(i)        Temporary and general: These laws are temporary in nature, framed in a particular social and institutional setup. As the setup changes, the established law may change.

(ii)       Predicted and hypothetical: Economic laws are hypothetical because they are based on human behaviour, which is highly changeable and uncertain. They are just prediction as human behaviour cannot be experimented in a laboratory, or expressed in mathematical formula.

(iii)      Conditional: The economic laws pre-suppose some conditions (sometimes idealistic), which may not happen in real situations.

(iv)      Relative: Economic laws cannot be universally applied as they are relative to time and place. However, general economic. Laws, based on the human behaviour, may be universal.

Object of Economic Laws

Every economic system has scarce resources and unlimited human wants, with problem of distribution of resources, in regard to:

-         Item of production

-         Method of production

-         Allocation of production

i)      Item of production: Every economy has only limited resources. Therefore, it has to make a conscious choice and set up priorities of items of production to satisfy the maximum wants of the major section of people.

ii)    The production method: The economy has to decide how the goods and services will be produced, with best possible quality and price.

iii)   Consumers: Goods produced in the economy are to be allocated amongst:

-         different individuals

-         different factors of production.

1.7 Economic Model

An economic model is an organized set of relationship that explains the function of an economic entity (a household, a single industry or a national economy), under a set of simplified assumption.

Advantage of an Economic Model

(i)    Discreet scientific expression: It helps communication by transforming theories into discreet scientific expression (e.g. graph, equation, diagram etc.).

(ii)   Complex economic environment: It helps to study the complex economic environment.

(iii)  Analysis and interpretation: It facilities proper analysis and interpretation.

(iv)  Economic solution: It is applied for economic solution for problems like unemployment, poverty, slow development etc.

(v)   Prediction: It can be applied for predictions.

Types of Economic Models

a)     Physical model: These models shows representation or economic aspect in form of photographs, paintings, sketches, etc. However, such models are not much effective.

b)    Analog models: In such models, one set of properties are shown with the other set of whole system process in form of graphs, charts, etc. showing relationship of the variables.

c)     Symbolic models: In such models, the inter-relationships are expressed through mathematical symbols. There are different types of such economic models: -

(i)     Quantitative models : Based on statistical data.

(ii)    Allocation models : Used for timing optimised solution(e.g. profit maximization)

(iii)   Scheduling model : Determining best sequence of performing operations.

(iv)  Queuing models: Minimising the time & cost of servicing & waiting.

(v)   Simulation model: Use of random number as basis for observing  behaviour of economic entity.

(vi)  Inventory models: To estimate cost of holding and ordering and determining optimum inventory level.

1.8 Economic system

It refers to mode of production exchange, distribution, consumption and the role of Government  in economic activity

Types of Economic System

a.     Capitalist Economy

b.    Socialist Economy

c.     Mixed Economy

1.8.1 Capitalist Economy

Under capitalist economy system, factors of production (land, labour, capital and organisations) are owned by private individuals. Profit is the sole motive.

a.Features of Capitalistic economy

(i)    Minimum Government restriction: Government does not intervene in day-to-day economic activities of an individual. Producers as well as consumers take their independent decisions.

(ii)   Private ownership: Factors of production e.g. machines, mines, factories, farmhouses etc. are owned by private entrepreneurs. They are free to use these to produce commodities, the way they like to. 

(iii)  Consumer sovereignty: Consumers have total freedom to consume any product, according to their choice. The producers, therefore, produce as per the consumer demand.

(iv)  Free market: The entrepreneurs have freedom to take decision regarding production and profitability on their own. The price is determined  by demand and supply in the market.

Under free market economy, when consumers increase their purchase of a gods and the level of demand exceeds supply, then price will start to increase. Capitalist economy uses price as the principal means of allocating resources.

(v)   Profit motive: The prime motive is to maximize profit. So, people tend to take up assignments that would generate profit, and avoid non profitable ventures.

(vi)   

b.Merits & Demerits of Capitalist Economy

Merits	Demerits
(i)    Self adjusting economy	(i)      Inequality of income
(ii)   Competition	(ii)     Class Struggle
(iii)  Efficient utilisation of resources.	(iii)   Neglect of social welfare
(iv)  Consumer freedom	(iv)    Economic insecurity
(v)   Availability of products, lower price	(v)     Monopolist tendencies

1.8.2 Socialist Economy

In socialist economy, the means of productions are owned, managed and centralized by whole community represented by the state. Government is the main decision maker regarding allocation, exchange, price fixation, production of goods.

Features of Socialist economy

(i)    Economic equality: The motive of such economics is to bring economic equality of people by reducing the gap between different sections of the society.

(ii)   Social Welfare: Unlike capitalist economics, the economic and other activities are directed towards social welfare and not profit making, like :

(ii)    Equitable allocation of National income,

(iii)   Enhancement of Economic Development,

(iv)  More employment

(v)   Reduction of Poverty,

(iii)  State ownership: The means of production are owned by the government. Key economic institutions like bank, transport and communication etc. are normally owned and managed by the government.

(iv)  Government Control: Decisions regarding allocation & distribution of resources, price determination, production, consumption and saving levels are taken by the central body, who chalks out a long-term economic development plan, and  delegates to smaller bodies for implementation.  

Merits & Demerits of Socialist Economy

Merits	Demerits
(i)    Completely regulated	(i)      Lower quality
(ii)   Equitable	(ii)     Bureaucratic
(iii)  Satisfaction of consumers needs	(iii)   Concentration of economic & political powers.

1.8.3 Mixed Economy

In mixed economy, the characteristics of both the economy are present. It is a golden mixture of capitalism and socialism.

Features of Mixed Economy

(i)    Individual freedom: The consumer enjoys total sovereignty, have freedom to choose the goods to consume & produce accordingly. However, government can control the prices in public interest, through public distribution system.

(ii)   Economic development: The main motive is economic development, reduce inequalities and provide adequate employment opportunities. The price policy is governed by public welfare motive, rather than making profit.

(iii)  Co-existence of public and private sectors: Public sector mostly controls industries of national importance, (like defence, power generation etc.), while in private sector, industries producing consumption goods are established. The objective is to strengthen both sectors and help each other. Government helps to boost both the sectors simultaneously.

iv) Planned Economy System: The mixed economic system is a planned economic system, laying down certain goals for the development of whole economy. The public sector runs to reach their goals. The Govt. creates a conducive atmosphere that the private sector also has to runs to reach the preplanned goals. In India, planning commission works as the central planning authority.

Merits & Demerits of Mixed Economy

Merits	Demerits
(i)    Proper allocation of resources	(i)      Inefficiency & corruption.
(ii)   Economic stability.	(ii)     Concentration of economic power
(iii)  Rapid economic development.	(iii)   Inequality of income cannot be completely removed.

1.8.4  Central Problems of Economy

The different economics adopt different techniques for solving their central problems.

i)      The Capitalistic Economy: Capitalistic economy being a free economy, solves the problem through price mechanism, through relative price structure for different kinds and qualities of goods and services.

To maximise their revenue, producers will produce relatively high price goods, and will tend to produce goods and services for those buyers who will pay them maximum price.

ii)    The socialistic economy: In a socialistic economy, the government tries to maximize social welfare, government will encourage to produce those goods which are most useful for the society. Socially beneficial (e.g. labour intensive technique in case of mass unemployment) technique of production will be applied.

Goods will be produced for poor & weak classes even when it implies loss on production.

iii)   Mixed Economy: Since mixed economy takes up the merits and avoids the demerits of capitalistic economics, decisions regarding what, how and for whom to produce are considered on the basis of price mechanism as well as social consideration.

1.9 Production Possibility Curve

“Production Possibility Curve shows alternative production possibilities of two sets of goods, with the given resources and technique of production.

Another name of production possibility curve is production possibility frontier.

Assumptions: PPC curve is constructed on following assumptions:

-        There are only two types of goods to be produced (e.g. TV and wheat).

-        There are limited amount of productive resources, which remain fixed.

-        Resources are neither unemployed nor underemployed.

-        Technology does not change.

a.Example data of production possibilities

Production Possibilities	TV (in thousand pcs)	Wheat (in thousand quintals)	Opportunity Cost in terms of Wheat forgone
A	0	16
B	1	15	16 - 15 = 1
C	2	13	15 - 13 = 2
D	3	10	13 - 10 = 3
E	4	6	10 - 6 = 6
F	6	0	6 – 0 = 6

The above table depicts that at extreme levels, (A & F) applying all esources for Wheat, 16 thousand quintals of Wheat can be produced, on the other hand employing all resources, six thousand TV sets can be produced.

 b.The PPC diagram

Fig 1 : Production Possibilities Curve

a)     The PPC Curve AF, shows the various combinations of two goods which the economy can produce with a given amount of resources. b)    Since the given resources are fully employed and utilized, the combination of two goods produce can lie anywhere on the PPC but not inside or outside it. c)      Point U (inside the curve) means that the economy would not be utilizing its resources fully. d)    Point I (outside the curve) means that economy would not have the capability to produce with the given technology and resources. e)     When the economy grows, there will be an outward shift in the PPC f)      The type of sloping indicated in the PPC is called Concave Slope to the origin.

c.Opportunity Costs

a)     Since resources are limited and they are fully employed, the economy has to give up something of one to obtain some more of the other. This sacrifice (i.e., giving up) is called as the Opportunity Cost.

b)    The table shows the opportunity Cost, in terms of Wheat not produced, for every thousand units of TV sets produced.

c)     Opportunity Costs generally show an increasing trend. This is because a given resource is suitable more for the production of one goods than another. For example, resources like land is more useful for Wheat than TV sets production. So, greater sacrifice of Wheat would be made for Wheat for each additional production of TV sets.

d. Nature of PPC

a)     The curvature of PPC depends upon the nature of Opportunity Costs, as under-

Opportunity Costs Trend	PPC Pattern
Increasing Trend	Concave to the Origin
Constant Trend	Straight Line
Decreasing Trend	Convex to the Origin

b)    PPC is negatively sloped, i.e. downwards from left to right, due to scarcity of resources.

c)     All points on the PPC, (i.e. Points A to F) represents full utilization of the resource. These points show that goods and services are produced at least cost and no resource is wasted, i.e. an the economy is productivity efficient.

e.Economic Growth and shift in PPC

When an economy is at PPC curve, it is ‘productively efficient’. But there is also scope of progress and one PPC can shift to another PPC on the right, indicating Economic Growth. PPC can shift to the right, or economic growths are possible in the following circumstances- 1.     Improvement in overall technology 2.     Greater capital formation 3.     Increase in population growth/labour force. If a point falls inside the production possibility curve it means both resources are under utilised or there is unemployment in the economy. Improvement in technology, greater capital formation, increase in population brings rightward shift of the PPC curve.