ChapterI Introduction to Economics

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General Economics 1.1 Introduction to Economics.

CHAPTER-IINTRODUCTION TO ECONOMICS

Introduction:The term Economics is originally derived from the ancient Greek Word Oiks

which means household and Nemein which means management. Thus, it refers tomanaging of a household using the limited funds. The Greeks then applied this term tothe city-state, which they called polis.Many experts have defined economics in a number of ways; however, all the definitionsgiven by experts are classified into four categories.

A. Adam Smiths wealth definitionB. Marshalls welfare definitionC. Lionel Robbinss scarcity definitionD. Samuelsons growth-oriented definitionA.Wealth Definition:The classical economists like Adam Smith, J.S. Mill, Ricardo, Senior and others were thefirst to give a systematic definition of economics. Among them the prominent definitionwas given by Adam Smith, father of political economy in the year 1776 in his famous bookAn enquiry into the Nature and Causes of Wealth of Nations defined economics asThe science of wealth This means that economics studies about wealth. It examineshow people earn wealth and spend wealth.Senior opined that, the subject treated by political economy is not happiness but wealth.According to J.S. Mill, Economics or political economy is the practical science ofproduction and distribution of wealth in the economy.

According toJ.B, Say,Political Economy makes known the nature of wealth

Characteristics and implications:1. Study of wealth:According to wealth definition, economics is the study of wealth only. It is the practicalscience of the production and distribution of wealth. Thus, the subject matter ofeconomics is production and expansion of wealth.

2. Concept of wealth:Adam smith, J.B. say and others defined wealth as material commodities such as landand buildings, gold, silver and whole of production of goods that can be consumed.

3. Causes of wealth:Economics is considered as study of causes of wealth accumulation which bringseconomic development. Wealth can be created by increasing the production of materialcommodities.

4. Based on Economic liberty and free trade:Wealth definition is based on laissez faire in trade and industry; it implies that there is no

state intervention in trade and commerce in the country.

5. Highlights the economic man:Wealth definition view human beings as the economic man who is always aware of his

self-interest. Self interest leads to material gains. Economic man gives primaryimportance to wealth and secondary importance to other motives.


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6. Treats Economics as a science:Wealth definition considered economics a science of creation and expansion of wealth.

Merits:1.Highlights creation and expansion of wealth:Wealth definition highlights the most basic issue of creation, accumulation and

expansion of wealth encountered by every economy.

2.Wealth as solution to economic problems:Problems of economy such as poverty, unemployment etc can be solved only with thehelp of money or wealth. So, wealth is the basis for economic development andprosperity.

3.Separates Economics from politics:Adam smith separated economics from politics and gave a separate and distinct identityto economics.

4.Examines the causes of wealth:This definition seeks to examine the causes which lead to increase in wealth in theeconomy.

Demerits:1)Narrow definition of wealth:Wealth definition fully ignored the non-material items such as services of doctors,Engineers, chartered Accountants etc., which are important source of wealth in the presentsituation.

2)Ignores human social welfare:Wealth definition ignored the ultimate objective of Economics which is the promotion ofhuman and social welfare. Wealth is not an end in itself it is only a means to attain theends. i.e. human and social welfare.

3)A dismal and mean science:Many economists described wealth definition as a dismal science because undue andexcessive emphasis on wealth creates unrest and disharmony in the society. Humanbeings tend to become highly selfish and self-centered by giving primary importance towealth.

4)Ignored Scarcity of resources:Wealth definition ignored the scarcity of material and non-material resources in theeconomy which makes attainment of objective of economics even if wealth is abundantlyavailable.

B.Welfare Definition:Dr. Marshall, in 1890 in his book, principles of Economics, defined Economics thus:Economics is a study of mankind in the ordinary business of life, it examines that partof individual and social action which is most closely connected with the attainment andthe use of material requisites of well-being. Thus, it is on one side a study of wealth;on the other and more important side a part of the study of man.


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According to A.C. Pigou, The range of our inquiry becomes restricted to that part ofsocial welfare that can be brought directly or indirectly into relation with the measuringrod of money.

Characteristics and implications:1.Study of mankind:According to Marshall, economics is the study of mankind rather than of wealth. Hegave prominent place to human being and secondary place to wealth. He emphasized theimportance of human being because wealth was for human being human being was notfor wealth.

2.Study of ordinary man:Economics is the study of economic aspects of life of human begins. It is a study of howhuman beings earn and spend their income to get maximum satisfaction. Thus, it is astudy of economic activities only and not concerned with social, religious activities ofhuman beings. The fulfillment of economic needs is a very important business which

every human being ordinarily does.3.Studies human welfare:Economics studies the economic or material human welfare. It explores the materialmeans which promote human welfare. Due to this reason this definition is also known aswelfare definition of economics.

4.Wealth is only a means:In Marshalls definition, wealth is given secondary place and importance, it is notconsidered as an end in itself but as a means to welfare as a source of the betterment of thehuman life. Wealth leads to material welfare of human beings and society.

5.Study of social man:Economics studies a real or social man who possesses several qualities and is influencedby economic and non-economic factors in society. His or her decisions are in the interestof self and society which leads to social welfare.

6.Study of science and Art:This definition by merging human beings and social welfare with wealth makeseconomics a social and normative science. So According to Marshall, economics is bothscience as well as an art.

7.Money as a measuring rod:Marshall believed that welfare can be measured with the help of money. Money isgeneral measure of income by use of which economics can be explained.

Merits:1.Primary place to human welfare:Welfare definition completes Adam Smiths wealth definition by adding human being andwelfare to wealth as the subject matter of economics.

2.Proper explanation of relationship between welfare and wealth:Marshall defines economics as a noble science. He explained how wealth is a means to

achieve the objective of Economics, The human welfare. Prior to Marshall Economicswas a dismal science hated by many.3.Made economics Meaningful:


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Marshall made economics not only a science but also a social and normative science bydoing so he made economics a life giving discipline. As a social and normative scienceeconomics became the basis for human welfare and social development.

4.Made economics a fruit bearing science:Welfare definition clearly classifies economic activities into two parts as material and

non-material welfare. It gives importance to material welfare which in turn leads toprosperity in the society. Non-material welfare is excluded from the scope of economics.

Demerits:1.Ignores immaterial things:Marshalls definition includes only material things and completely ignores immaterialthings used in promotion of human welfare. The services of teachers, lawyers, doctors,chartered Accountants, Architects etc are non-material goods which have been excludedby Marshall in his welfare definition.

2.Concept of welfare is vague:According to Robbins, the concept of welfare is not fixed and definite one, if differs indifferent countries and at different times. Welfare is a subjective thingand it varies fromperson to person. Therefore, it cannot be said in objective terms which things wouldpromote welfare and which will not. In addition to this, economics included manyeconomic activities which are generally thought to be harmful to human welfare butcannot be ignored due to their effect on economic conditions in the economy.

3.Welfare cannot be quantitatively measured:The critics point out that welfare cannot be quantitatively measured. Even if money priceis used as an instrument for measurement of welfare, it is only a rough and not asatisfactory measurer of welfare. When two persons pay the same price for acommodity, it would not mean that both are getting an equal amount of utility orwelfare. Utility or welfare is a subjective phenomenon and differs from person to personand measurement is not possible.

4.Limits the scope of economics:Marshall assumes economics as a social science rather than human science. A socialscience studies the activities of those individuals who are members of society, whilehuman science studies all human beings, whether they live in an organized community orlive outside society. Marshall narrowed the subject matter of economics to the study of

persons living in ht society. Broadly speaking the fundamental laws of economics applyto all human beings and therefore economics should be treated as human science andnot just a social science which limits its scope.

5.Ignored the problem of scarcity:Welfare definition does not emphasize the importance of scarcity of resources thatcauses economic problem.

C. Scarcity Definition:


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According to Robbins Economics is a science which studies human behaviour as arelationship between ends and scarce means which have alternatives uses.In the words of Stonier and Hague, Economics is fundamentally a study of scarcityand the problems which of scarcity give rise to.According to Scitovosky, Economics is a science concerned with the administration of

scarce resources.

Characteristics and implication:1.Unlimited wants:The fundamental fact on which Robbins definition is based is that human wants areunlimited. In the definition Ends implies human wants. Human wants provide themotives for all the human activities. Human wants are unlimited is a very important andfundamental fact of economic life of people. It can be observed in the real life of thepeople that there is no limit to their wants, when one want gets satisfied, another wantcrops up, and it is an unending process. All human wants are not of equal intensitysome are more intense than others.It is because of difference in intensities people areable to allocate the resources to satisfy different types of wants.

2.Scarcity of means or resources:The second important fact in scarcity definition is that resources are scarce in relation tounlimited human wants. Thus, scarcity is a relative concept and it should be understoodin relation to demand, a commodity may be available in small quantity but if nobodydemands it, then it is not scarce. Means or resources refer to goods and services whichpeople use to satisfy their wants. They include both material and Man-made goods suchas oil, minerals, iron-ore, capital goods, consumer goods, money, time, and ideas etcwhich are at our disposal. Scarcity of means is the basis for all economic problems.

3.Alternative uses of Means:The third important fact on which Robbinss Scarcity definition is based is that resourcesor means have various alternative uses. i.e. the resources can be put to various uses. Forexample, land which is scarce can be used for cultivation, house construction, playgroundetc. Thus, in practical life the goods can be put to alternative uses of varying importance.

4.Explains clearly the economic problem:Robbins explains clearly the cause of economic problem. According to him, themultiplicity of wants, the scarcity of means and application of scarce resources ormeans for the alternative uses impose an economic problem. The problem is how to

satisfy the unlimited wants with limited means which have alternative uses. Robbinsdescribes this problem as the problem of economizing scarce resources. In other words,it is the choice of making an economic activity. Thus, economics is a study of economicproblem and means of solving the economic problem.

5.Economics studies science of choice:According to Robbins, economics is a science of choice. The problem of economizingresources leads to another problem i.e. the problem of choice. Since wants are numbersand resources are scarce, we have to choose the most urgent wants from the numerouswants and satisfy them first with scarce resources other wants can be satisfied later.Thus economics deals with how the resources of society should be allocated or chosen for

the satisfaction of different wants.6.Economics is natural between ends:


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According to Robbins, economics should study all the goods and services which cansatisfy the wants, whether the goods and services are favourable to human welfare ornot. Robbins emphasized that economics does not deal with the question as to what endsshould be achieved, i.e. what wants should be satisfied and what not because in thisregard human beings themselves have to decide. Economics itself does not make a choice.

It only tells in what ways the given ends or wants can be achieved with the minimumpossible resources. What ends or wants should be selected by human beings forsatisfaction is not the concern of a economists. Whether the wants chosen by humanbeings are good or bad, moral or immoral, economics should study them, because thetask of economics is not to praise or condemn but only to analyze and explain. Todecide about the desirability or otherwise of a thing is beyond the scope of economics.

Merits:1.Scientific presentation of economics:Marshall explains one kind of behaviour as distinct from another in economics, so his

definition is criticized as unscientific. But the scarcity definition analyzing humanbehavior explains any behavior under one aspect. In this way, this definition isscientific.

2.Widens the scope of economics:Marshall in his definition limits the scope of economics to the material means of welfare.But Robbins on the other hand by studying any behavior connected with the problem ofscarcity widens the scope of economics from the boundaries of material welfare.

3.Universal in nature:Scarcity definition is more precise and comprehensive and is considered universal. It isapplicable to all individuals, groups and society. Moreover, it deals with the problem ofunlimited wants and scarce means. This problem is common everywhere.

4.Makes economics clear and definite:According to Marshall, economics should involve value judgment; however, this will leadto difference of opinions and endless controversy among economists thereby renderingeconomics indefinite and fruitless. But when economics is neutral between ends itbecomes free from all these controversies and confusion then economics will be clearand definite and understanding will easy and simple.

5.Gives Logical explanation of economic problem:Robbins definition is highly logical in explaining the economic problem. According to

him, economic problem arises due to scarcity of means in relation to their demand. It isnot concerned with material well being.

6.Analytical study of human behavior:Robbins analyses human behaviour and states that human behaviour is the subjectmatter of the science of economics. This definition studies the human behavior of anindividual as well as of a society.

Demerits:1.Makes economics meaningless by ignoring normative aspect:According to many economists, economics can play an important role in promoting socialwelfare and economic growth only if it considers and takes into accounts the value

judgment, i.e. it has to give its decisions regarding what is good and what is bad in


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deciding ends. If economics is to serve as an engine of social betterment, it has to tellwhat is good or bad, noble or ignoble for welfare and progress and whether efforts shouldbe made to attain some given ends or not.

2.Ignored welfare aspect:According to many economists, the end of human activities is human welfare. Andeconomics should be a means in achieving human welfare. However , Robbins opposedthe idea of making economics a means in achieving human welfare and believed thatthe end of human behaviour was to get maximum satisfaction by the use of limitedresources at his/her disposal. Maximum satisfaction without value Judgments need notbe maximum welfare always.

3.Restricts economics to allocation of resolves, factor and product pricing:According to Robbins, economics should study only the allocation of resources amongthe production of various goods and consequently how the prices of goods and factors aredetermined. However, in reality economics is not restricted just to these; it also considers

and studies national income, output, employment etc in order to provide solutions toovercome instability and fluctuations in these at macro level in the economy. Thus,Robbinss definition does not explain about the macroeconomic concepts which are also ofsignificance in solving economic problems.

4. Ignored theory of economic growth and development:Robbins takes the resources as given and discuss about their allocation however, there isno mention in his definition about reducing the scarcity of resources. The theory ofeconomic growth is concerned with reducing the scarcity of resources through raising thelevel of national income and creating more capital and wealth. Economic growth is themeans to reduce poverty and raise the standard of living of people in the economy.

Economic growth and development is the primary objective of every economy. Robbinsfully ignored this aspect which makes his definition incomplete.

5.Does not explain problem of unemployment:Robbins definition deals with the problem of scarcity, however the problem ofunemployment is not the problem of scarcity but one of excess of human resource inrelation to demand for it. Thus, it is clear that there is no definite positive correlationbetween scarcity and economic problem always as claimed by Robbins in his definition ofeconomics.

6.Considers only deductive method:Robbins definition considers only deductive method while explaining problem of scarcity.It ignores inductive method which is more practical and empirical in nature in solvingeconomic problems.

D. Growth-Oriented Definition:According to Prof. Samuleson,Economics is the study of how people and society a endup choosing with or without the use of money, to employ scarce productive resourcesthat could have alternative uses to produce various commodities over time anddistributing them for consumption, now or in the future, among various persons andgroups in society. It analyses costs and benefits of improving patterns of resource

allocation.


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According to Benham,Economics is the study of the factors affecting employment andstandard of living.According to Henry smith, Economics is the study of how in a civilized society oneobtains the shares of what other people have produced and how the total product ofsociety changes and is determined.

Characteristics and implications:1.Economics deals with growth and development of economy:Growth definition incorporates the theory of economic growth and development. Itstates that economics should study and explain the factors which determine economicgrowth of the country. In other words, it should state the means and ways of increasingnational product over a long period of time.

2.Studies distribution of income and level of employment:Growth definition studies how distribution of income among the various members ofthe society takes place and how level of employment is determined in the economy.

3.Stresses the problem of scarcity:The growth definition stresses on the problem of scarcity of resources in relation tounlimited ends and alternative uses of resources.

4.Studies the problem of choice:This definition deals with the problem of choice which relates not only to present butalso to future. It considers economics to be the study of the allocation of scarce resourcesin relation to unlimited ends.

5.Economics is science as well as an Art:According to Samuelson, economics is both science as well as an art. It is the oldest

among arts and newest among the groups of sciences. In fact it is the queen of socialsciences. It means that economics studies both the theoretical and practical aspect of theeconomic problem.

6.Not natural as regards ends:According to Growth definition, economic welfare forms part of the study of economics.Economics welfare is that part of general welfare which is measured in terms of money.Economics studies both material and non-material means of economic welfare.

Merits:1.Growth definition covers all aspects of economic problems:Growth definition covers both micro as well as Macroeconomic aspects. It studiesallocation of resources, product and factor pricing which are micro in nature andnational income or product distribution of national income and level of employmentdetermination which are macro in nature. It makes economics comprehensive andcomplete.

2.Dynamic in natural:This definition has an element of time in it which makes it dynamic in nature. It talksabout efficient allocation and optimum utilization of resources in the present and thefuture. In addition to this, it emphasizes on reducing the scarcity of resources by

discovering and creating new resources by discovering and creating new resources inthe economy.


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3.Makes economics meaningful and fruit bearing :By considering both the positive and normative aspect of economic problems, it makeseconomics meaningful, purposeful and fruit bearing.

4.Proper explanation of economic problems:The growth oriented definitions provide proper explanation of economic problems.

Economic problems arise because human wants are unlimited but means to satisfy themare scarce. They have alternative uses this gives birth to the problem of choice making i.e.efficient allocation of scarce resources. This in turn accelerates the rate of economicgrowth.

5.Widens the meaning and scope resources:Growth definitions widened the meaning of economic resources by including naturalhuman or physical resources which can be used to satisfy human wants. They are scarcebut have alternative uses.

General Meaning of economics:

Economics is the study of the individual and social choice in the face of scarcity. Thelaw of scarcity implies that consumers wants will never be completely satisfied.Economics is the systematic and comprehensive of economic activities of rationalindividuals, firms and the economy in order to attain the objectives effectively andefficiently in a consistent manner.

SCOPE OF ECONOMICSThe scope of economics can be systematically studied under the following heading. Scopemeans area covered by the subject under its study.A. Subject Matter of economics.B. Nature of Economics.C. Relationship of Economics with other sciences.D. Limitations of economics.A.Subject Matter of Economics:The subject-matter of economics is connected to those economic activities of human beingswhich they perform for a proper utilization of the scarce means in order to get themaximum satisfaction of their wants. These economic activities are called consumption,production, exchange and distribution. The subject matter of economics can be studiedfrom two points of view in economics.

A. Classical View:Thus, the subject matter according to traditionalists views is the study of humanbehaviour relating to allocation of scarce resources among competing ends. However,Prof. Boulding classified the entire subject matter of economics into five branches of Consumption, Production, Exchange, Distribution and Public Finance.

1. Consumptionstudies the consumers behaviour and laws of consumption.2. Production deals with the factors, organization and laws of production of goods and

services.3. Exchange connecting consumption and production discusses the exchange of goods

for money and the underlying principles of price determination.


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General Economics 1.10 Introduction toEconomics.

4. Distribution explains the division of national income among the four factors ofproduction.

5. Public Finance deals with public income, public expenditure and public debt of stateand Central Government.

B. Modern View:Criticizing the traditional views of economics as artificial and overlapping, Moderneconomists like Stonier and Hague have divided economics into:1. Economic Theory2. Applied Economics and3. Descriptive Economics1. Economic theory:Economic theory is a hypothesis that has been successfully tested. Its purpose is to predictand explain. Economic theory includes all those laws and principles which explain,analyses, predict and establish the cause and effect relationship among economic

variables. It is derived by logical analysis in a scientific way. Economic theory describeswhat, why and how of an economic phenomena.Economic theory is built around three thingsa. Definition of variablesb. Assumptions relating to variables and situationsc. Predictions about future events.2. Applied economics:Applied economics attempts to apply the result of economic analysis to solve problems.Applied economics is art of using conclusion of economic theory to solve different

economic problems. For example, Business economics is an applied economics whereeconomic tools are used to solve the problems of business.

3. Descriptive economics:Descriptive economics is the systematic and comprehensive study of a particular area ortopic by collecting relevant facts about that particular topic. It involves in-depth studyand analysis of a particular sphere or area of study. Indian Economics is an example ofdescriptive economics.

Micro and Macro EconomicsAnother view of studying the subject matter of economics was put forward by Prof.

Ragnar in the year 1933. He divided subject matter of economics into Micro and Macroeconomics.

Meaning and scope of Microeconomics:The word micro is derived from the Greek word mikros meaning small. Microeconomicsdeals with small segments of the society. Micro economics is defined as the study ofbehaviour of individual decision making units such as consumers, resource owners andfirms. It is also known as Price Theory since its major subject matter deals with thedetermination of price of commodities and factors.Microeconomics has both theoretical and practical importance. It solves the three centralproblems of an economy i.e. what, how and for whom to produce. Scope of

microeconomics is vast and includes the following topics:


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Importance of MicroeconomicsMicroeconomics has both theoretical and practical importance . It is clear from thefollowing points:1. Microeconomics helps in formulating economic policies which enhance productive

efficiency and results in greater social welfare.

2. Microeconomics explains the working of a capitalist economy, where individual unitsi.e., producers and consumers are free to take their own decisions.

3. Microeconomic describes how, in a free enterprise economy, individual units attainequilibrium position.

4. It helps the government in formulatingcorrect price policies.5. It helps in efficient employment of resources by the entrepreneurs.6. It helps business economists to make conditional predictions and business forecasts.7. It is used to explain gains from trade, disequilibrium in the balance of payment

position and determination of international exchange rate.

Limitations of Microeconomics:Microeconomics fails to explain the functioning of an economy as a whole. It cannotexplain unemployment, poverty, illiteracy and other problems prevailing at the countrylevel.

Meaning and scope of MacroeconomicsThe word Macro is derived from the Greek word makros meaning large.Macroeconomics deals with aggregative economics. Macroeconomics is defined as thestudy of overall economic phenomena, Such as problem of full employment, GNP,savings, investment, aggregate consumption, aggregate investment, economic growthetc. It is also known as theory of Income and Employment since its major subject matterdeals with the determination of income and employment.The study of macroeconomics is used to solve many problems of an economy like,monetary problems, economic fluctuations, general unemployment inflation,disequilibrium in the balance of payment position etc. The scope of macroeconomicsincludes the following topics:

Importance of Macroeconomics:Macroeconomics has emerged as the most challenging branch of economics. In the wordsof Samuelson, No area of economics is today more vital and controversial than

macroeconomics. The importance of macroeconomics on theoretical and practicalreasons is clear from the following points.

1. It gives an overall view of the growing complexities of an economic system. Itprovides powerful tools to explain the workingof the complex economic systems.

2. It provides the basic and logical framework for formulating appropriatemacroeconomic policies e.g. for inflation, poverty, unemployment etc. to direct andregulate economy toward desirable goals.

3. It helps in analyzing the reasons for economic fluctuations and provides remedies.Limitations of Macroeconomics

Some of the major limitations macroeconomics is:


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1. Macroeconomics ignores structural changes in an individual unit of the aggregate.The conclusions drawn on the basis of aggregate variable may be misleading.

2. Most of macro magnitudes which figure so largely in economic discussions are subjectto errors and ambiguities.

Difference between Microeconomics and Macroeconomics

Microeconomics Macroeconomics

1. It studies individual economic units.2. Examples,

a.Consumer demand.b.Per Capita income.

3. It may assume full employment.4. It is also called Price Theory.

1.It studies aggregative economic units.2.Example,

a.Aggregate demand.b.National Income.

3.It does not assume full employment4.It is also called theory of income and

Employment.

Interdependence of micro and macroeconomics:

It is difficult to demarcate or differentiate between micro and macro economics. What ismacro from an economys point is micro in the context of the world. It is difficult to saywhich is more important. Both have their own significance. According to Professor,Samuleson, knowledge of both is absolutely vital and there is no competition betweenmacro and micro economics. Both are complementary and should be fully utilized forunderstanding of an economy.

B.Nature of Economics:Nature of economics implies whether it is science or art or both science and art. Thequestion whether economics is a science or an art, there are different vies. The English

economists of the classical school hold the view that economics is a science. But theecumenicists of Continent Europe, Germany and India regard economics as an art. In thewords of Prof. Samuleson, Economics is the oldest of the arts, the newest of sciences-indeed the queen of all the social sciences. Let us discuss the views of both and seeexactly what economics is.

Is Economics a Science?Whether Economics is a science or not? It depends upon what we consider a science tobe. According to some scholars, Economies is not a science because the laws ofEconomics are not universal and definite as those of the natural sciences like Physics,Chemistry, etc. Contrary to it, some consider it has a social Science. A Social sciencestudies various human activities. Therefore, it is not necessary for its laws to beuniversal and definite. Because reaching a definite conclusion regarding Economics as ascience or an art, let us first know what science is.

What is Science?In simple words, science is a systematic body of knowledge in which scientific laws areapplied. In other words, it is a systematic body of knowledge about a particular branch ofthe universe. This implies that a science is a study of a branch of learning and not of thewhole universe. It studies the branch of learning and not of the whole universe. It studiesthe branch systematically and orderly.


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Thus, it deals with those main facts about a subject that are interdependent. Scientificlaws are those laws which show the relationship between the causes and effects of anevent.In Economics; economic activities of man are systematically studied. Economic laws arealso scientific because these laws establish causal relationship between economic events.

Judged by this standard, it can be said that economics is a science. Prof Poincare hasrightly said A science is built upon facts as a house is built of stones.

Arguments in favour of Economics as a Science:1. It involves systematic study.2. Its laws are Scientific in nature.3. Validity of the Laws4. It has cause and effect relationship for e.g. law of demand5. It is capable of measurement in terms of money.6. It has its own methodology of study (induction and deduction) and7. It forecasts the future market condition with help of various statistical and non-

statistical tools.

Arguments against Economics being a Science:1. There exists difference among Economists regarding its application. It doesnt have

uniform opinion about a particular event.2. The laws of economics are not exact Laws.3. The laws of economics are not Universal Laws.4. Verification of Economic Laws is not possible.5. The subject matter of economics is Human Behaviour which is highly

unpredictable.

6. Money, which is measurement of economy, is itself a dependent variable.7. It is not possible to make correct predictions about the behaviour of economic

variable.

Is Economics A Positive or Normative Science?Another question regarding the Nature, whether economics is a positive or normativescience has been discussed for very long time. There are different views on the issue. Theeconomists like Robbins and Friedman advocated economics as a positive science. Butscholars including Marshall and pigou etc. maintained the view that economics is both apositive and normative science.

A.Economics is a Positive Science:A positive science is that science in which exactness of the subject is studied. Almost allthe classical economists declared that science of economics should be concerned only withWhat is and not what ought to be In other words they maintained economics as only apositive science. They said that economics should not explain rightness or wrongness ofthings and should not pass any moral judgement. Senior thought that economists couldnot add even a single word of advice.Carines said that economics should stand neutral as mechanic stands between rivalschemes of railway construction. Prof Stigler observes, Strictly speaking, words likeought and bad; cannot occur in economic discussion. Lionel Robbins reaffirmed the

view that economics is nothing but a positive science. According to Robbins Economics


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is neutral between ends. It does not pass value judgments. Anyone with the limitedamount of money may use it for buying liquor and not milk.

Arguments in favour of Economics as a Positive Science:a. More Logicalb. More Efficiencyc. More uniformityd. More Neutralitye. Formulation of TheoriesExamples of positive science:1. Planned economics allocate resources via government departments2. Most transitional economics have experienced problems of falling output and rising

prices.3. There is a greater degree of consumer sovereignty in the market4. Faster economic growth should result if an economy has a higher level of investment5.

Higher levels of unemployment will lead to higher levels of inflation6. The average level of growth in the economy was faster in the 1990s than the 1980s

7. Analysis of the relationship between the price and quantity demandedB.Economics as a Normative Science:It refers to What ought to be or it makes an assessment of an activity and offers advice.It is based on welfare economics (Marshall & pigou). Complete neutrality between endsis, however, neither feasible nor desirable. It is because in many matters the economist hasto suggest measures for achieving certain socially desirable ends.Challenging the views of the classical school, Marshall, pigou and historical school put the

argument that economics is a normative science, According to Marshall, economic is anormative science because it has a norm or aims viz, welfare, Macfile remarks thateconomics is fundamentally a normative science, not merely a positive science likechemistry. Prof Hawtrey feels that economics is a normative science because there is aneconomies what ought to be as it is in ethics. Its objective is to determine the norms oraims. This science also offers suggestions for solving the problems, as a normativescience, Economics will offer several kinds of suggestions, such as there should be theeconomic development of the country, there should be stability in prices, there should befull employment, and there should be an equitable distribution of income. etc. Economicsdoes not deal only with the study of facts, rather is also determines the economic facts.

Arguments in favour of Normative Economics:a. More Practical.b. More Realistic.c. Useful Science.d. Maximum Welfare.e. Growth Oriented.Examples of normative science:1. Reducing inequality should be major priority for mixed economy.2. Changing the level of interest rates is a better way of managing the economy than using

taxation and government expenditure.


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3. Govt. ought to guarantee that farmers income will not fall if harvest is poor .4. India should not take loan from foreign countries.5. Rich people should be taxed more.6. Free education should be given to poor.7. India should spend more money on defence.8. The demand for productive commodities should be encouraged in the society.Thus Economics is both positive science and normative science.Difference between Positive and Normative Economics:

Positive Economics Normative Economics

It expresses What is. It expresses What Should be.

It is based on cause and effects of facts. It is based on ethics.

It deals with actual or realistic situation. It deals with Idealistic situation.

It can be verified with actual data. It cannot be verified with actual data.

In this value judgements are not given. In this value judgements are given.

It deals with how an economic problemis solved. It deals with how an economic problem shouldbe solved.

Economists of Positive school are AdamSmith, Robbins and their followers.

Economists of Normative school are Marshall,Pigou, Hicks and others.

Economics as an art:Economics as an art is a systematized body of knowledge where the relationship betweencause and effect cannot be rigidly defined. The effect changes due to application ofdifferent talents of different people to solve same problems. An art is a system of rules forthe given end. It is a collection or body of rules for the execution of external works.

Arguments in favour of economics as an Art:1. Economics provides different solutions to solve same economic problems2. Economics as an art studies problem in realistic situation.3. It can remove doubts that arise with regard to the real nature of economic laws.4. As an art it facilitates the verification of economic theories.Arguments against economics as an Art:1. One subject cannot be science as well as art at the same time.2. Economics as an art cannot be effective because problems are not just economic

problems, they economic, social and political at a time.3. Different economists will frame different policies and uncertainty increases.4. Lack of immediate solution to the problems.Economic is both science and an art: Economic is both science and an art. It is science inits methodology and art in its application.

Methods of Economic Theory:Meaning of economic theory:Economic theory is a hypothesis that has successfully tested. Its purpose is to predict andexplain. Economic theory includes all those laws and principles which explain, analyse,predict and establish the cause and effect relationship among economic variables. It is

derived logically in a scientific way.


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Two methods used in construction of an economic theory are:1.Deductive Method2.Inductive Method1.Deductive method:Deductive method is also known as the analytical or abstract method or a priori. Thismethod accepts certain universal truths or axioms and tries to deduce inference aboutthe particular events though a process of logical reasoning. The predictions are made onthe basis of certain assumptions. Once predictions are empirically tested and verified fortheir accuracy, they are accepted as an economic theory. Otherwise predictions are eitheramended or rejected. In economics, this method was developed by Ricardo, Robbins,

J.S.Mill and others. Deductive method is the process of reasoning from general toparticular or universal to individual, this method is called abstract, hypothetical or apriori because it is based on abstract reasoning and not on actual facts.Example: Let the general assumption be that man is rational. The prediction is that heaims to earn maximum wages. When this prediction is empirically tested, it is found thatworkers are moving from lower wage jobs to higher wage jobs. The general assumptiongets verified and, thus becomes an economic theory.

Types1. Mathematical2. Non-mathematicalMerits of Deductive Method:The advantages of this method are as follows:1. It is a simple method which does not involve much collection of data.2. It is based on basic facts of human nature and is, thus, universally applicable.3. It brings accuracy and exactness to economic generalizations with the use of logic and

mathematics.

Demerits of Deductive MethodThe disadvantages of this method are as follows:1. The conclusions have limited applicability as the underlying assumptions keep on

changing.

2. The results are not dependable.3. Conclusions drawn are generally not based on facts. Thus, there is every possibility

that they may not exist is real life.4. It is a static approach.Inductive Method:It is also known as a posteriori, historical or empirical method, in inductive method; westart with particular facts and then make general theory based on the analysis of facts. Itis the process of reasoning from particular to general or from individual to theuniversal. The generalizations are based on observations of individual instances. Themethod involves use of the following three steps in a systematic order.1.Collection of data2.Analysis of data3.Formulation of general principles.


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The general theory is arrived at by collecting large number of observations or data. Someexamples of theories or laws based on this method are Malthusian theory of Populationand Engels Law.Example: Particular fact observed is that when two persons are sent to the market to buy agood, they both buy more at a lesser price. From this particular behaviour we generalize

that all men buy more at lesser price and vice versa. This established the general law ofdemand which states that price and quantity demanded of a commodity are inverselyrelated.

Merits of Inductive method:The advantages of this method are as follows:1. The method is precise, realistic and reasonable because it takes into consideration the

changes in the conditions surrounding an economic activity.

2. The method tests and verifies economic facts.3. It is a scientific method as facts are subject to scientific analysis.4.

It is Dynamic. It is based on previous experiments and observations.

Demerits of Inductive method:The disadvantages of this method are as follows:1. The method is complex and difficult.2. It is an expensive and time consumingmethod.3. Chances of personal bias of the investigators in the process of collection and analysis

of data are present.

Interdependence of Deductive and inductive methods:Both deductive and inductive methods have their merits and demerit. Deductive method

was popular among classical economists. Modern economists prefer inductive method ofconstructing an economic theory. The methods are not alternative of each other.Deductive method is more useful where facts and data are not available and inductivemethod is more suitable where facts and data are available. According to prof. Marshall, Induction and deduction are both needed for scientific thoughts as the right and leftfoot both are needed for walking.

Methods of Constructing Economic Theory

Basis of distinction Deductive Method Inductive method

Processing of

reasoning

From general to particular From particular to general

Terms used todescribe

A priori, Abstract, Analytical. A posteriori, Historical,Empirical.

Popularity Popular among classicaleconomists

Popular among Moderneconomists

Merits Simple, universal and accurate. Precise, realistic, scientific andverifiable

Suitability More suitable when facts anddata are not available

More suitable when facts anddata are available


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Central Problems of Economy:Human beings have wants which are unlimited. Wants get satisfied by consuming goodsand services, but new wants keep cropping up. The amount of goods and services thatcan be produced depends on the amount of resources available.Resources are scarce, i.e. they are available in limited quantities. Resources are not only

limited but they also have alternative uses. All this necessitates a choice between whichwants to satisfy first, where to use the resources and in what quantities. Individuals,business firms and societies must decide how to use limited resources.Economic problem is the problem of choice or the problem of economizing. It is theproblem of utilizing the limited resources to satisfy the maximum number of wants. Theclash between the limitations of nature and the unlimited and non-saturating humanwants is the basis of economic problems.The scarcity of resources creates this situation.If we employ more resources for production of good A, we will have to forego theproduction of B. Hence, we have to choose which of the two goods gives us moresatisfaction. Any issue arising out of the existence of scarcity which compels people to

choose out of a range of alternative economic possibilities is an economic problem.This fundamental economic problem is reflected in an economy in the form of threeproblems which are called the Central Problems, of an economy. Any economy -whethercapitalist, Socialist, agricultural, mixed, and undeveloped, etc has to face these problems.According to P.A, Samuelsson there are three fundamental and interdependentproblems in an economic organization -what, how and for whom. these are groupedtogether allocation of resources problem. These are:

1. What goods to produce and How much to produce.2. How to produce.3. For whom to produce.4. Economic Growth.1. What goods to produce and How much to produce:This is the problem of allocation of resources. Due to limited resources, every economyhas to decide what goods to produce and in what quantities. If the means were unlimited,then according to Frideman, it would lead to as stage of salvation. But the means arelimited and the economy must decide the proportion of resources that would go into theproduction of civilian goods and the proportion of resources that would go into theproduction of defence goods. This is essentially the problem of efficient allocation ofscarce resources so that both output and output-mix are optimum. The Problem of how

much to produce is the problem of determining the quantity of each good to beproduced. In economics, the problem of what to produce is studied under price theory.

2. How to produce:It is the question of choice of technique of production. Since resources are scare, aninefficient technique of production, which would lead to wastage and high costs, cannotbe applied. A technique of production which would maximize output or minimize costshould be used. Every economy has to choose the most efficient technique of producing acommodity. In economics, the problem of choice of technique of production is studiedunder the theory of production.


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3. For whom to produce:This is the question of how to distribute the national product among various sections ofthe society. National product is total output generated by the firms. Total outputultimately flows to the household in the form of income, i.e., wages, rent, profits andinterest. There are millions of people in a society. Each one cannot get sufficient income

to satisfy all his wants. This raises the problem of distribution of national product amongdifferent household, in economics, the problem of distribution of national product isstudied under the theory of distribution.

4. Economic Growth:This is the question of whether the economys capacity to produce goods and services isgrowing from year to year or is it remaining static. Economic growth is induced bysavings and investments i.e. economic development is induce by large amount of capitaland advance techniques to production. Problems of this type are studied under the theoryof Economic theory.

Central Problems Branch of Economics which deals with it.1.Allocation of resources: Price Theory

a.What and how much to produce? Theory of Productionb.How to produce? Theory of Distributionc. For whom to produce?

2.Economic growth Growth EconomicsProduction Possibility Curve:The concept of production possibility curve (PPC) was put forward by Prof. Samuelson.According to him PPC is that curve which represents the maximum amount of a pair of

goods and services that can both be produced with an economys given resources andtechnique, assuming that all resources are fully employed.Production Possibility Curve may be defined as a curve which shows the variouscombinations of two goods or services that can be produced in any economy with a givenamount of resources and technology. PPC is also known as Production PossibilityFrontier (PPF) and Transformation curve.

Assumptions:While drawing PPC we assume the following:1.Two types of goods cloth and wheat produced.2.Productive resources remain fixed.3.Resources are not specific, i.e., they can be shifted from the production of one good tothe other good.4.Full employment of productive resources No unemployment of resources.5.No change in technology.It is assumed that there are only two types of goods cloth and wheat. The resources ofeconomy can be alternatively used in both the commodities. If the production of acommodity is increased then the production of the other commodity will be decreased.Following table shows the production possibilities of production.

Production Possibilities Cloth Wheat Increasing Opportunity


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Cost

A 0 15 ----

B 1 14 1

C 2 12 2

D 3 9 3

E 4 5 4F 5 0 5

From the above table, it is clear that when production of cloth increases then production offood decreases and it will give concave shape of PPC because opportunity cost areincreasing.

PPC and Productivity EfficiencyAll points on PPC curve like A, B, C, D, E and F show that goods and services produced atleast cost and no resource is wasted and the economy is Productively Efficient.

Opportunity Cost and PPCOpportunity cost may be defined as the value of the next best alternative. It is also calledForegone cost and Trade off. In the context of PPC since there are only two goods,therefore opportunity cost of producing one good is in terms of sacrifice made of the othergood. PPC is downward sloping because more production of one good is associated withless of the other good.

PPC Concave to the Origin Due To Increasing Opportunity Cost.PPC looks concave to the origin because of increasing marginal opportunity cost. Theincreasing marginal opportunity cost means that for additional unit of a good, the sacrifice

of unit of other good goes on increasing. Principle of increasing opportunity cost themakes the PPC concave to the origin or makes bowed-out shape. PPC may be straight lineif opportunity cost is constant. PPC is negative sloped not due to increasing opportunitycost but due to scarcity because at any point of time we have limited resources.

Unemployment and PPC.When an economy produces on PPC, it means that there is no unemployment and all theresources are being used efficiently. But if an economy operate inside the PPC then thereis unemployment or underemployment and/or inefficient use of resources.In the figure given below point U inside the PPC indicate underutilization of resources.

In other words economy would not be utilizing its resources fully. Point S indicate thatan economy could not produce with the given resources and technology. If economymoving from U to A and B point, it indicates resources which were lying unutilizedare now being utilized fully.

Economic Growth and shift in PPC.When an economy produced at PPC curve it is productively efficient> but there is alsoscope of progress and one PPC can shift to another PPC one the right, It indicatesEconomic Growth PPC can shift to the right or economic growths are possible in thefollowing circumstances.

1. Improvement in overall technology


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2. Greater capital formation3. Increase in population growth labour force

Properties of PPC:1. It is also called transformation curve or production possibility frontier.2. PPC slopes downwards from left to right.3. PPC is concave to the point of origin.Different Economic Systems:Meaning of Economic system:Economic system is defined as an arrangement by which the central problems of theeconomy of an economy are solved. There are many different forms of an economicsystem.It refers to the mode of production, exchange and distribution and the role which govt.plays in economic activity. It may be of three types.1. Capitalist Economy.

2. Socialist Economy.3. Mixed Economy.

1.Capitalist economy (free market economy):Capitalist economy is one in which the factors of production are privately owned andmanaged and in which production takes place on the initiative for private profits. It is afree economy in which government interference is not found.

Characteristics: The following are its main characteristics

1.Right of Private Property: The right of private property means that factors ofproduction such as land, factories, machines and mines etc., are under the privateownership. An individual has the right to acquire, use, control and dispose in many washe likes.

2.Freedom of Enterprise: Freedom of enterprise means that every body is free to engagein whatever economic activity he pleases. In other words, he is free to work in anyindustry he likes to adopt any occupation or trade he desires.3.Freedom of choice by consumer: In capitalist economy there is a freedom of choice bythe consumers. People are free to spend their incomes, as they like. In an economy peoplehave the freedom to buy or not to buy the goods offered in the market place, and thisfreedom to choose what they buy dictates what producers will ultimately produce. This

is known as principle of consumer sovereignty. In a free market economy the allocation ofresources is determined by the consumer preference.4.Profit Motive: Under capitalism, producers or entrepreneurs in their productiveactivities are guided by their profit motives. Those goods and services are produced toensure greater profits to the producers.5.Competition: In a capitalist economy, competition exists among sellers or producers ofsimilar goods in the form of advertisement, price-cutting, discount etc.,6.Price mechanism: In a free market economy (Capitalist economy) prices are decided bythe price mechanism i.e., forces of demand and supply and price will be decided at thepoint where demand is equal to supply. In a free market economy, when consumers


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increase their purchase of a good and the level of demand exceeds supply then price tendto rise. A capitalist economy uses Price as the principal means of allocating resources.

7.Inequalities of Income: There is wide gap of income between the rich and poor, whichmainly arises due to unequal distribution of property. It is disadvantage of the capitalisteconomy that income will tend to be unevenly distributed.

Solution of Central Problems in Capitalist Economy:The main aim of capitalist economy is to earn maximum profits. All the central problemsare solved with the help of Price Mechanism (forces of the market demand and supply).What, how and for whom to produce are decided by the private sectors: -

1.Deciding what to produce: To earn more and more profits the entrepreneurs producedonly those goods, which are demanded by the consumers. In a free market economy theallocation of resources is determined by the consumer preference.

2.Deciding how to produce: To earn more and more profit the entrepreneurs use thattechnique of production in which cost of production is minimum. There are two

methods of production technique a.Labour intensive methodb.Capital Intensive method

3.Deciding for whom to produce: Goods and Services are produced only for those whohave the buying capacity. Higher the income higher will be his buying capacity.

4.Deciding about consumption, saving and investment: Higher the rate of interest andhigher will be the savings and higher the rate of return higher will be the investment.

2. Socialist Economy:In a Socialist economy, all material means of production i.e., land, capital and mines etc.,are owned by the whole community represented by the STATE. All the members beingentitled to the benefits from the fruits of such socialized planned production on the basisof equal rights. State decides the size and direction of the investment. The state works forthe welfare of the society and profit motive is not important for it.

Characteristics:1. Collective ownership of means of production: In a socialist economic system, all themeans of production are state-owned. Accordingly, the firms producing goods andservices such as factories, banks, insurance, and transport etc., are owned and managed bystate. Small farms, workshops and trading firms may, however, remain in the private

hands.2. Centrally Planned Economy: All the basic decisions pertaining to the what, how andfor whom to produce are decided by the centrally planned authority. In India it is by thePlanning Commission.

3. Economic Equalities: A socialist state strives to achieve economic equally, but it doesnot mean that everyone earns the same amount of income that there is no socialdifferentiation. The society is divided into various functional strata. Since therequirements of the workers from different strata are unequal, their wages cannot beequal. Skilled and unskilled workers from different strata of the society, and hence arepaid different wages. Socialism only guarantees equality of opportunity and equal pay for

equal work.


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4. Social welfare: Social welfare becomes the guiding light in such a system. Since all theenterprises are state-owned, no individual or private profit accrues. Price policy is guidedby the aims of social welfare rather than profit motive.5. Lack of competition: One of the basic tasks of economics planning is to avoidduplication of efforts and wastage of resources. Since the state has the monopoly of

production and investment, it avoids all sorts of competition and rivalry as betweendifferent production units.6. Elimination of exploitation: Since property is state-owned, class distinction do notexists in Socialism. In the absence of class-distinction, there is no exploitation of employeesin the hands of employers.

3. Mixed EconomyAn economic system, which contains elements of both private and public sectors, is calledmixed economy. It permits coexistence of controlled market economy.

Characteristics:

1.Coexistence of both private and public sector: In the mixed economy both private andpublic enterprises exists. So in a mixed economy all the economic decisions are partlytaken by the state and partly taken by the private entrepreneurs.

2.Planned Economy: It is planned economy. The government has a clear and definiteeconomic plan. The government create necessary atmosphere for the private sector todevelop on its own.

3.Balanced regional development: Public sector enterprises may be located in thebackward regions so as to ensure its development. Subsidies may be offered to privatesector to establish and develop industries in backward regions.

4.Dual system of pricing: In private sector price is decided by the help of pricemechanism on the other hand in govt. sector prices are fixed by the govt. Thegovernment may also fix the prices of certain essential commodities, which are used bythe common man. Over-all planning is done by the State Authority called PlanningCommission.

Features of three Economic systems:Features Capitalism Socialism Mixed Economy

Ownership ofproperty

PrivateOwnership

Public Ownership Both private and publicOwnership

Freedom ofenterprise

Exits No freedom Freedom in private sectoronly

Motive ofproduction

Profit Motive Social welfare Profit motive in privatesector only

Who governsproduction

PriceMechanism

PlanningMechanism

Both price and planningmechanism

Competition Exists No competition Exists only in privatesector

Distribution ofIncome

Very unequal Quite equal Considerable inequalitiesexists

Role ofGovernment

No role Complete role Full role in public sectorand limited role in private

sector


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G l E i 1 24 I t d ti t

Documents

ChapterI Introduction to Economics