UNIT-1
Definition of economics:
Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The central focus of economics is on scarcity of resources and choices among their alternative uses.
The word 'Economics' was derived from two Greek words, oikos (a house) and nemein (to manage)which would mean managing an household using the limited funds available, in the most satisfactory manner possible.
1.1 Definition by Adam Smith, Marshall and Robbins
1.1.1 Adam Smith
Adam smith defined economics as the science of wealth.
Main points
- Economics is the study of wealth only.
- Only such material commodities constitute wealth as are scarce and useful. Non material goods like services and free goods like air, water are not wealth.
Criticism
- Too much importance to wealth (more importance to wealth than man)
- Smith defined economics only in terms of wealth and not in terms of human welfare.
- Restricted meaning of wealth as wealth means only material goods ignoring the non material goods like services
- No study of means for carning wealth
1.1.2 Marshall
According to Marshall, "Economics is a 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 the material requisites of wellbeing".
Main points
- A study of mankind i.c. studies of economic activities that are connected with the material welfare of mankind.
- Ordinary business of life.
- Economics studies both individual and social actions aimed at promoting economic welfare of people.
- Marshall considered only the material things that are capable of promoting welfare of people
Criticism
- Marshall considered only material things. But immaterial things, such as the services of a doctor, a teacher and so on, also promote welfare of the people.
- Marshall's definition has no clear-cut definition of welfare. The meaning of welfare varies from person to person, country to country and one period to another. For instance, cigarette, non-smoker: harmful to health and source of negative welfare for him and smoker: need and promotes his welfare.
- Definition is classificatory in nature not analytical.
- Robbins criticizes this definition of normative nature giving view that economics is a positive science.
1.1.3 Robbins
According to Robbins, "economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses".
Main points
- Ends refer to human wants Human beings have unlimited number of wants.
- Resources or means, on the other hand, are limited or scarce in supply.
- The scarce means are capable of having alternative uses. Hence, anyone will choose the resource that will satisfy his particular want and there exists problem of choice Thus, economics, according to Robbins, is a science of choice.
Criticism
Robbins does not make any distinction between goods conducive to human welfare and goods that are not conducive to human welfare. In the production of rice and alcoholic drink, scarce resources are used. But the production of rice promotes human welfare while production of alcoholic drinks is not conducive to human welfare. However, Robbins concludes that economics is neutral between ends.
Concealed (hide/secret) the concept of welfare. As Robbins rejected Marshall's welfare definition but welfare (satisfaction as a sign of welfare) has entered in his definition through backdoor.
Confusion between ends and means in practical life: For instance, a T-SLC Agriculture student's aim is getting such degree and after completion, this degree is the means of getting employment.
Robbins definition does not cover the theory of economic growth and development
1.2 Subject matter and nature of economics
1.2.1 Subject matter of economics
Up to the development of economics to Adam Smith, wealth formed the subject matter of economics Marshall updated this view to material welfare whereas, Robbins stated as science of choice In economics, we study the circular flow of efforts made to satisfy wants the resulting satisfaction from these efforts. Thus, subject matter of economics centers on
want-effort-satisfaction.
The subject matter of economics can be studied through
a) Traditional approach: Economics is studied under five major divisions namely consumption, production, exchange, distribution and public finance.
(b) Modern approach. Includes microeconomics which analyses the economic behavior of any particular decision making unit such as a household or a firm and macroeconomics which studies the behaviour of the economic system as a whole or all the decision-making units put together.
1.2.2 Nature of economics
The nature of economics involves whether economics is:
- A science or an art
- A positive science or a normative science
Economics as a pure science:
Science is a systematized body of knowledge that traces the relationship between cause and effect: Another attribute of science is that its phenomena should be amenable to measurement. Applying these characteristics, we find that economics is a branch of knowledge where the various facts relevant to it have been systematically collected, classified terms of money. Thus, economics is a science.
Economics as a social science:
The process of satisfying wants is not only an individual process, but also a social process. In economics, one has, thus, to study social behaviour ie, behaviour of men in-groups.
Economics as an art:
An art is a system of rules for the attainment of a given end. A science teaches us to know, an art teaches us to do. Applying this definition, we find that economics offers us practical guidance in the solution of economic problems.
Science and art are complementary to each other and economics is both a science and an art.
Economics as a positive science:
Positive science only describes what it is. It does not indicate what is good or what is bad to the society. It will simply provide results of economic analysis of a problem.
Economics as a normative science: Normative science prescribes what it ought to be. It makes distinction between good and bad.
It prescribes what should be done to promote human welfare.
1.3 Basic concepts
1.3.1 Goods
Anything that is capable of satisfying human wants and provides utility is called good. A common distinction is made between 'goods' that are tangible property and services, which are non-physical
Characteristic features of goods:
- Goods are tangible in nature
- Goods are the material outcome of production
Types of goods
i) Free goods and economic goods.
Free goods are the free gift of nature and are plentiful in supply as compared to demand. For example, air, sunshine, water falls etc. Economic goods are the goods produced or shaped by man and have price in the market. The supply of such goods in market is limited as compared to demand. For example, food items, clothing etc.
ii) Material goods and non-material goods
Material goods are those which can be transferred from one person to another. These are tangible in nature. Examples are scooter, cooler, refrigerator etc. Non-material goods are the services done by teachers, doctors, lawyers etc.
iii) Private goods and public goods
Private goods are the goods owned by the private bodies. E.g. Car, house, motorbike, books Public goods are the goods collectively owned by society, public or government. E.g. road, bridge, hospitals etc.
iv) Consumer goods and producer goods
Consumer goods are meant for direct consumption. They may be durable (e.g TV, car etc.) or perishable (e.g milk, fruit etc.)
Producer goods are those which are bought by producers of goods and services. These goods need investment. Examples are engines, plants of various size, raw materials, coal etc.
v) Necessary goods: food, shelter, clothing
vi) Comfortable goods: car, washing machines
vii) Luxury goods: car with AC, jewelry
viii) Inferior good: Goods for which demand decreases as consumer income rises.
E.g inexpensive foods such hamburger, and frozen dinners. ix) Normal good: Goods for which demand increases as consumer income rises. Most goods are normal goods, hence the name "normal"
1.3.2 Utility
Want satisfying power of good is called utility. Cold drinks have utility in a sense that they can quench thirst, books have utility for students.
Utility is not necessarily usefulness. Drugs have utility for their purchases but are not useful for their consumers. Utility does not always mean pleasure. Medicines are having utility but these are not always pleasant to take. Utility cannot be easily measured. It is something subjective. Utility is also relative. It differs for the same good from time to time and place to place.
Types of utility
Form utility: By changing the form of a good, we can create utility. For example,
manufacturing a chair create form utility of woods, logs.
Place utility: By transportation, place utility can be obtained. For example, transporting a chair from one place to another at which it will be useful. >Time utility: By storage, time utility can be obtained. For example, storing a chair until a time on which it will be useful. Ownership utility: By marketing, ownership utility can be obtained. For example, buying and selling a chair leads to be owned by a certain owner.
1.3.3 Value and wealth
Value
The value of a commodity means its power of securing other commodities in exchange. Actually, value of a good its purchasing power. Economics deals with value in exchange rather than value in use. Natural air and water have value in use but not value in exchange. The value in exchange of a good is called its price. In order that a commodity has a price, it must have following three things:
- It must have utility for the consumer
- It should be scarce
- It must be transferable.
Wealth
All material and non-material goods that have market value are called wealth. It is the stock of all those things which have a market price, Bonds, shares, cars, houses, land etc. are wealth,
Sometimes, knowledge or skills are also referred to as wealth if these can bring some income upon use. But in economics, these are known as human capital. All those goods which can produce income when used in production are called capital. Thus all capital is wealth but all wealth is not capital.
Characteristics of wealth
- It should possess utility
- It must be scarce It must be transferable
- It must be external to person
Types of wealth
Individual wealth: land, buildings, cash etc.
Personal wealth: Knowledge, skill etc.
Social wealth: roads, bridge etc.
National wealth: rivers, mountains etc.
International wealth: oceans etc.
1.3.4 Equilibrium
The word equilibrium is derived from the Latin word 'aequilibrium' which means equal balance. In economics, equilibrium implies a position of rest characterized by absence of change which may be static or dynamic, short term or long term and partial or general. Market equilibrium, for example, refers to a condition where a market price is established through competition such that the amount of goods or services bought by buyers is equal to the amount of goods or services produced by sellers. It is the point at which quantity. demanded and quantities supplied are equal.
In figure above, E is the market equilibrium condition.
1.3.5 Margin/Marketing margin
The marketing margin is the difference between the price received by the producer and that paid by the consumer or it is the price spread between various agencies or intermediaries in the marketing chain.
Figure. Marketing margin
1.3.6 Cost
The term 'cost' means the amount of expenses incurred on or attributable to specified thing or activity. Cost is defined as the total outlay that a producer is to make in order to take the services of different factors of production. Elements of cost are material, labour and expenses. Types of cost are real cost, opportunity cost, explicit cost, implicit cost, money cost.
1.4 Price effect and income effect
Price effect shows the reaction of the consumer to changes in the price a commodity, other things remaining the same. It measures the change in amount demanded of commodity with change in its price, while price of other commodity with which it is being combined remains the same. Thus the extension or contraction in demand in response to fall or rise in price is price effect. Price effect is the result of other two effects: i) income effect and ii)
substitution effect Income effect measures the change in amount demanded of the commodity due to change in real income of the consumer resulting from the change in price. When the price falls, it means a rise in real income of the consumer and vice-versa. By fall in price, a consumer demands more of the commodity due to the increased purchasing power. This is called income effect.
1.5 Law of demand and law of supply
1.5.1 Law of demand
Demand means the various quantities of goods that would be purchased per time period at different prices in a given market. For demand to exist, there should be: i) price of a commodity, ii) amount of commodity which consumer is prepared to buy and ii) point of time
According to law of demand, other things being equal, if the price of a commodity falls, the quantity demanded of it rises and if the price of the commodity rises, the quantity demanded declines. There is an inverse relationship between quantity demanded of a commodity and its
price.
Assumptions of the law.
- No change in income of consumers.
- No change in the price of commodities related to the commodity in demand.
- There is no change in quality of product.
- The prices of related commodities remain the same. No change in taste and preference of consumers.
Explanation of the law
The demand schedule shows response of quantity demanded to change in price of that commodity. The demand of one person is called individual demand. The demand of many persons is known as market demand. The market demand schedule means 'quantities of given commodity which all consumers want to buy at all possible prices at a given moment of time. The demand schedules of all individuals can be added up to find out market demand schedule. The table below shows the demand of all the consumers in a market. When the price decreases there is increase in deman Exceptions to the law ‣ Inferior goods d for goods and vice versa.
In the figure above, price and quantity demanded are measured along the y-axis and x-axis respectively. By plotting various combinations of price and quantity demanded, we get a demand curve DD, derived from points A, B, C, D and E. This is a downward sloping demand curve showing inverse relationship between price and quantity demanded.
Exceptions to the law ‣ Inferior goods
The law of demand does not apply in case of inferior goods. When price of inferior commodity decreases and its demand also decrease and amount so saved in spent on superior commodity. The wheat and rice are superior food grains while maize inferior food grain