BASIC ASSUMPTION OF ECONOMICS

Economic Rationality: Economics deals with economic behaviour of man, which is highly
unpredictable and uncertain. Man is not a machine, which will work according a set pattern. He
has a free will. It is, thus, very hard to predict which taste individuals have (why some prefer
cake to ice cream, white to red cars and so on) and in which way they will respond to various
economic stimuli. Despite this empirical truths there are also, however, distinct regularities about
human behaviour. For example, if the price of a commodity the good increases and all other
things remaining same, people will tend to buy less, if inflation takes place, workers will ask for
more money wages for the same work. These regularities indicate normal behaviour or normal
responses and considered any deviation as abnormal such as buying less when price falls. While
deducing any theory, economists assume that human being acts in a normal rational manner.
Rationality in economics means maximization of gains. It means that a consumer will allocate
his scares resources towards various wants in such a manner that his satisfaction is maximum,
producer being rational will try to maximize his profits. Rational human behaviour is thus the
most basic assumption in economics. If we did not make this assumption, we would never “reach
anywhere” in economics.

Ceteris paribus is another assumption, which is often made. Ceteris paribus means other things
being equal. By other things we mean factors other than the one under observation. For example,
if we are studying demand of coffee in relation to its price, we assume other factors; which affect
the demand for coffee, such as income of consumers, taste and preference etc., as given. If we
allow these factors also to change, we will not be able to measure the effect of price of tea on its
demand correctly and objectively. Therefore we make the assumption – ceteris paribus.

Perfect Competition: Another as very common assumption amongst economists is the

assumption of perfect competition. Economists, especially classical economists, assumed that
competition was perfect. However, this assumption was introduced more for theoretical
convenience than for practical utility.

Equilibrium: Another common assumption, which forms the basis of most of the economic
theories, is that of ‘equilibrium’. Equilibrium is a condition from which no deviation is desired. It
is the optimal position for decision making.

Capitalist Economy: Economic 'analysis, especially price theory, has been developed in the
context of a developed capitalist economy. Such an economy assumes the existence of private
property, freedom of enterprise, profit motive, private initiative, perfect competition and absence
of government interference. The existence of free market conditions with free demand and
supply is a necessary feature of a capitalist system. These conditions may not be present in any
other economic system, particularly in backward and developing economies. Hence the
conclusion and policy formulations applicable to developed capitalist .economies cannot be
applied to developing and underdeveloped economies which are partially or fully controlled
economies.

Static Economy: Economics studies the problem of allocation of limited resources as between
different goods and services on the assumption that the technology and resources are given in an
economy. The economy is producing maximum amount of national income with the given
technology and resources. In other words, economics studies a static economy with a given
system of wants, resources and technology. Naturally, the conditions and policy formulations
derived from static economy will have to be changed for a dynamic economy.