THE FUNDAMENTALS OF ECONOMICS

Economics

 The word economy comes from the Greek word for “One who manage a household.” At first,
this origin might seems peculiar. But like a household, a society faces many decisions.
 Such as a society must decide what jobs will be done and who will do them. Once society has
allocated people (as well as land, building, and machines) to various jobs, it must also
allocate the output of goods and services that they produce.
 Society faces scarcity problem, when it allocate the resources. Then we find Economics.

Scarcity

 Scarcity is a central concept in economics. In fact, neoclassical economics, the dominant

school of economics today, defines its field as involving scarcity: following Lionel Robbins'
definition, it is the study of the allocation of scarce goods among competing ends.
 Scarcity means not having sufficient resources to produce enough to fulfill unlimited
subjective wants
 No society has reached a utopia of limitless possibilities. Alternatively, scarcity implies that
not all of society's goals can be attained at the same time, so that we must trade off one good
against others.
 In this world, our desires are unlimited. Our ability to meet these desires are, however, limited.
This concept is popularly known as scarcity.
 A situation of scarcity is one in which goods are limited relative to desires.

Scarcity and definition

 The limited nature society’s resources is a problem.

 Resources are limited but wants are unlimited.
 Economics is the study of how society manages its scarce resources.

Definition:
 Economics is the study of how societies use scarce resources to produce valuable
commodities and distribute them among different people.

Efficiency

 Where goods are scarce it is necessary for society to make choices as to how they are
allocated and used. Economists study (among other things) how societies perform the optimal
allocation of these resources – it is called efficiency.
 Efficiency is one of the central concepts of economics. Efficiency means absence of waste, or
using the economy’s resources as effectively as possible to satisfy people’s need and
desires.
 More specially, the economy is producing efficiently when it cannot produce more of one
good without producing less of another –when it is on the production possibility frontier (PPF).

Efficiency and definition

 An economy make the best use of its limited resources.

 Efficiency denotes the most effective use of a society’s resources in satisfying people’s wants
and needs.

Microeconomics and Macroeconomics

 Adam Smith is usually considered the founder of the field of Microeconomics, it examine the
behavior of individual entities such as markets, firms and households.
 Smith considered how individual prices are set, studied the determination of prices of land,
labor and capital, and inquired into the strengths and weakness of the market mechanism.
Microeconomics

 Microeconomics deals with the behavior of individual economic units, such as a consumer or
a business firm.
 We deal primarily with microeconomics, since we are addressing how economic analysis can
be used to make decisions within a firm or organization.

Macroeconomics

 Macroeconomics did not even exist in its modern form until 1935, when John Maynard
Keynes published his revolutionary General Theory of Employment, Interest and Money.
 Most of the countries those were effected by great depression held on 1930 got relief through
applied the prescription given by Keynes.
 These prescriptions and applications were related to the matters/concepts of
Macroeconomics.
 Keynes developed an analysis of what causes business cycle, with alternating spells of high
unemployment high inflation.
 Today, macroeconomics examines of wide variety of areas, such as how total investment and
consumption are determined, how central banks manage money and interests, etc.
 Macroeconomics focuses on the study of the economy as a whole and deals with issues such
as the level of overall activity (gross domestic product or GDP), interest rates, federal
budgets, international trade and currency questions, and federal taxes.
 # DIFFERENCES BETWEEN MACROECONOMICS & MICROECONOMICS

Basis for
Microeconomics Macroeconomics
Comparison
The branch of economics that studies The branch of economics that studies the
the behavior of an individual consumer, behavior of the whole economy, (both
Meaning
firm, family is known as national and international) is known as
Microeconomics. Macroeconomics.
Deals with Individual economic variables Aggregate economic variables
Business Applied to operational or internal
Environment and external issues
Application issues
Tools Demand and Supply Aggregate Demand and Aggregate Supply
It assumes that all macro-economic It assumes that all micro-economic variables
Assumption
variables are constant. are constant.
Theory of Product Pricing, Theory of Theory of National Income, Aggregate
Concerned
Factor Pricing, Theory of Economic Consumption, Theory of General Price Level,
with
Welfare. Economic Growth.
Covers various issues like demand,
Covers various issues like, national income,
supply, product pricing, factor pricing,
Scope general price level, distribution, employment,
production, consumption, economic
money etc.
welfare, etc.
Helpful in determining the prices of a Maintains stability in the general price level
product along with the prices of factors and resolves the major problems of the
Importance
of production (land, labor, capital, economy like inflation, deflation, reflation,
entrepreneur etc.) within the economy. unemployment and poverty as a whole.
It has been analyzed that 'Fallacy of
It is based on unrealistic assumptions,
Composition' involves, which sometimes
i.e. In microeconomics it is assumed
Limitations doesn't proves true because it is possible that
that there is a full employment in the
what is true for aggregate may not be true for
society which is not at all possible.
individuals too.
Three problems of economic organization

 Every human society must confront and resolve three fundamental economic problems.
 Society must have a way of determining

1) what commodities are produced (allocation of limited resources)

2) how these goods are made (production methods) and
3) for whom they are produced (distribution mechanism).

1. What commodities are produced?

 what commodities are produced and in what quantities? A society must determine how much
of each of the many possible goods and services it will make and when they will be produced.
 Example: Will we produce pizzas or shirts today?

2. How these goods are made?

 How are goods produced? A society must determine who will do the production, with what
resources, and what production techniques they will use.
 Example: Is electricity generated from oil, from coal or from the sun. Will factories run by
people or robots?

3. For whom they are produced?

 For whom are goods produced?

 Who gets to eat the fruit of economic activity?
 Is the distribution of income and wealth fair and equitable?
 How is the national product divided among different households?
 Are may people poor and a few rich?

Societies take over the problems

 What are the different ways that a society can answer these questions of what, how and for
whom? Different societies are organized through alternative systems.

 We generally distinguish two fundamentally different ways of organizing an economy. On one

hand, a Market Economy is one in which al these three questions are answered through the
market. In this extreme case, the government does not interfere in the market and it is called
laissez –faire economy.

 In contrast, a command economy is one in which the government makes all important
decisions about production and distribution through its ownership of resources and its power
to enforce decisions.

 No contemporary society however falls completely into either of these polar categories.
Rather all societies are mixed economies, with elements of market and command economies.

Positive & normative approach

 Often economists are asked to explain the causes of economic events. In thinking about
economic questions, we must distinguish questions of fact from questions of fairness.
 Positive economics describes the facts of an economy while normative economics involves
value judgments.

Positive economics

 Positive statements claims that attempt to describe the world as it is.

 Positive economics are descriptive.
 Example: minimum wage laws cause unemployment.
Normative economics

 Normative statements claims that attempt to prescribe how the world should be
 Normative economics involves ethical precepts and norms of fairness.
 Example: The government should raise minimum wage.
Should poor people be required to work if they are to get government assistance.

# NATURE OF ECONOMICS: ECONOMICS AS A SCIENCE AND AN ART

There is a great controversy among the economists regarding the nature of economics, whether the
subject ‘economics’ is considered as science or an art.

Economics as a Science:

Before start discussing whether economics is science or not, it becomes necessary to have a clear
idea about science. Science is a systematic study of knowledge and fact which develops the
correlation-ship between cause and effect. Science is not only the collection of facts. In reality, all the
facts must be systematically collected, classified and analyzed.

There are following characteristics of any science subject, such as;

a. It is based on systematic study of knowledge or facts;

b. It develops correlation-ship between cause and effect;
c. All the laws are universally accepted
d. All the laws are tested and based on experiments;
e. It can make future predictions;
f. It has a scale of measurement.

According to all these economists, ‘economics’ has also several characteristics similar to other
science subjects.

(i) Economics is also a systematic study of knowledge and facts. All the theories and facts related with
both micro and macro economics are systematically collected, classified and analyzed.

(ii) Economics deals with the correlation-ship between cause and effect. For example, supply is a
positive function of price, i.e., change in price is cause but change in supply is effect.

(iii) All the laws in economics are also universally accepted, like, law of demand, law of supply, law of
diminishing marginal utility etc.

(iv) Theories and laws of economics are based on experiments, like, mixed economy to is an
experimental outcome between capitalist and socialist economies.

(v) Economics has a scale of measurement. According to Prof. Marshall, ‘money’ is used as the
measuring rod in economics. However, according to Prof. A.K. Sen, Human Development Index (HDI)
is used to measure economic development of a country.

Economics as arts:
Economics is also considered as an art. In other way, art is the practical application of knowledge for
achieving particular goals. Science gives us principles of any discipline however, art turns all these
principles into reality. Therefore, considering the activities in economics, it can claimed as an art also,
because it gives guidance to the solutions of all the economic problems.
# POSITIVE AND NORMATIVE APPROACH OF ECONOMICS

The most important question is whether economics is a positive science or a normative science?

Positive science deals with all the real things or activities. It gives the solution what is? What was?
What will be? It deals with all the practical things.

On the contrary, normative science deals with what ought to be? What ought to have happened?
Normative science offers suggestions to the problems. The statements dealing with these suggestions
are coming under normative statements. These statements give the ideas about both good and bad
effects of any particular problem or policy.

Economics and Positive Science:

i) Logically based:
The ideas of economics are based on absolute logical clarifications and moreover, it develops
relationship between cause and effect.
(ii) Labour Specialisation:
Labour law is an important topic of economics. It is based on the law of specialisation of labour
Economists must concern with the causes and effects of labour-division.
(iii) Not Neutral:
Economics is not a neutral between positive and normative sciences. According to most economists,
economics is merely positive science rather than normative science.

Economics and Normative Science:

The following statements can ensure economics as a normative science, such as,

(i) Emotional View:

A rational human being has not only logical view but also has sentimental attachments and emotional
views regarding any activity. These emotional attachments are all coming under normative
statements. Hence, economics is a normative science.
(ii) Welfare Activity:
Economics is a science of human welfare, All the economic forwarded their theories for the
development of human standard of living Hence, all the economic statements have their respective
normative views.
(iii) Economic Planning:
Economic planning is one of the main instruments of economic development. Several economists
have given their personal views for the successful implementation of economic plan. Hence,
economics is coming under normative science.

All these lead us to the conclusion that ‘Economics’ is both positive and normative science. It does not
only tell us why certain things happen however, it also gives idea whether it is right thing to happen.

# ECONOMICS AS A SCIENCE OF WEALTH

Economics is considered as science of wealth as it is a study of the factors which are responsible for
wealth generation. Thus in Economics we study a body of knowledge which relates to wealth. Adam
Smith is known as a Father of Modern Economics and 1776, he has written a book called “An Enquiry
into Nature and causes of wealth of Nation”.

What is Wealth in Economics

Those material things which are produced by labor, can satisfy human wants and must have an
exchange value.

Characteristics of Wealth
 Wealth must have the following characteristics
 Wealth is material, we will not consider human skill and mental ability as wealth.
 It produced by labor. If we consider land have all the characteristics of except one that it is not
produced by labor.
 Capability to satisfy human desire. For instance money is not wealth but a medium of exchange
 Wealth must have Exchange value

Features of Economics as a Science of wealth has following features

(i) Nature of wealth: Economics study only material goods which we can see or touch. It does
not include and free goods.
(ii) causes of wealth: Economics study how to increase wealth by a) making production on large
scale after saving and b) extending market in order to increase the demand.
(iii) Economic man: Economics study a man who is aware of his self interest and try to satisfy his
selfish ends.

Criticism of Economics as a Science of wealth:

Criticism of Economics as a science of wealth is given by Alfred Marshall. According to him wealth is
important but more important is human welfare. Wealth is for man not man is for wealth.

Lionel Robbins criticized on the ground that economics used only material goods but in real life it also
uses immaterial goods like services of teachers, doctors are also responsible for the growth of the
Nation.

Moreover economics is not only a study of economic man rather it’s a study of social man who keep
social welfare in his mind.

These are the features and criticism of economics as science of wealth.

# ECONOMICS IS STUDY OF MANKIND IN THE ORDINARY BUSINESS OF LIFE

According to Alfred Marshall-

“Economics is a study of man's action in the ordinary business of life.” It inquires how he gets
his income and how he uses it. It examines that part of individual and social actions which is mostly
closely connected with the attainment and with the use of material requisites of well being. Thus
economics is on one side a study of wealth and on the other and important side a part of the study of
man.

From the definition of economics by Alfred Marshall, we see that he lays emphasizes on the below
points:

Study of an ordinary man:

According to Alfred Marshall, economics is that study of an ordinary man who lives in society. It is not
concerned with the lives of only rich persons or who is cut away from the society. Its subject matter is
a particular aspect of human behavior i.e. earning and spending of incomes for the normal material
needs of human beings.

Economics is not a useless study of wealth:

Economics does not regard wealth as the be-all and end-all of economics activities wealth is not of
primary importance. It is earned only for promoting human welfare economics is studied to analyze
the causes of material prosperity of individuals and nations.

Economics is a social science:

It does not study the behavior of isolated individuals but the actions of persons living in society. When
people live together they interact and cooperate to work at firms, factories, shop and offices to
produce and exchange goods or services. The problems about these activities are studied in
economics.
Study of material welfare:
According to Alfred Marshall, economics studies only material requisites of well-being or causes of
material welfare. It is cleared from this definition that it is materialistic aspect and ignores non-material
aspects. Alfred Marshall stressed that the man’s behavior and activities to produce and consume
maximum number of goods and services are the main object of study wealth is not an end or final
aim, but only a means to achieve a higher objective of welfare.

# ECONOMIC DEFINITION BY L. ROBBBINS

“Economics is a science which studies human behavior as a relationship between ends and scarce
means which have alternative uses.” – Prof. Lionel Robbins

Important Characteristics of Robbins’ Definition:

(i) Unlimited Wants:

Human wants are unlimited in number. Whenever one want is satisfied, then automatically several
wants grow up. Hence it is endless. With the progress in civilization and development science and
technology numerous wants are developed. Again several human wants are reoccurring too. Hence,
wants are ‘ever growing and never ending’.

(ii) Limited Means:

Human wants are unlimited but resources or means to satisfy them are limited. The means refer to
goods and services which we use to satisfy our wants. They are material and non- material goods like
time, money, services, resources etc. These resources are scarce.
Here the term scarcity is used not in the absolute sense but in the relative sense i.e., in relation to
demand. A commodity may be available in small quantity but if nobody demands, it then it is not
scarce. Hence, the scarce means are the basis of all economic problems. Because, if all these means
or resources are not scarce, then there will be no problem in economics.

(iii) Alternative Use of Resource:

All the scarce means can be used in more than one purpose. In other words, they can be used in
several purposes. For instance, land is very scarce, but land can be used for construction of buildings,
cultivation, playground etc. Likewise, all these economic resources are used for various purposes.
Thus, in reality goods can be put to alternative uses of varying importance.

iv) Economizing Resources:

The main problem of economics is how to satisfy the unlimited wants with limited means which
have alternative uses. Robbins describes this problem as the problem of economizing scarce means.
In other words, it is the choice of making of an economic activity. According to Cassel, “Economics is
the science of Scarcity.” Economics is thus a study of certain kind of economics that is economizing
the resources.

(v) Problem of Choice:

The problem of economizing resources leads to the problem of choice. Since wants are numerous
and means are scarce, we have to choose the most urgent wants from these unlimited wants.
Hence, the consumer will select few wants from the numerous wants according to his preference
pattern. Thus, scarcity of resources makes the choice necessary. Hence, Economics is termed as a
science of choice.

Criticism:
Scarcity definition is more scientific than both wealth and welfare definitions, but still it has
following criticisms:
(i) Static:
Prof Samuelson pointed correctly that Robbins’ definition is not dynamic in nature, because it has
only discussed about the problems of present generation, not anything about future generation.
Hence the definition suffers with the problem of economic growth.

(ii) Too Vast:

It discussed with the scope of economics to all the activities of mankind that are related to the
problem of choice. The problem of choice is found in both social and unsocial beings. Thus it has no
social significance in real world.

(iii) Economic Problems also arise from more supply:

Some economists claimed that economic problem also arises from the plenty of goods as well. The
Great Depression of 1930s in USA was due to abundance of goods, but not due to scarcity of
resources.

(iv) Not fit for socialistic economy:

Prof. Maurice has criticized Robbins’ definition that his definition is not applicable for a socialistic
economy, because in this type of economy, the Government takes all the initiatives for supplying all
the basic necessities of life among the citizens. For the betterment of whole society the Government
usually launches several beneficiary activities.

(v) Not fit for Rich Country:

The economic problem for a rich and sound economy is different from the underdeveloped or poor
economy. Here the resources are not limited. In fact, resources are plenty in this type of economy.

(vi) Relation with Welfare:

Robbins’ criticized Marshall’s definition on the ground of welfare. However limited means are used
to fulfill unlimited wants. Thus, it means that maximizing satisfaction will lead to more welfare.
Hence, Robbins’ definition is related with welfare also.

#SCARCITY AND EFFICIENCY: THE TWIN THEMES OF ECONOMICS

 Economics explores the behavior of the financial markets, including interest rates, exchange
rates, and stock prices.
 The subject examines the reasons why some people or countries have high incomes while
others are poor; it goes on to analyze ways that poverty can be reduced without harming the
economy.
 It studies business cycles—the fluctuations in credit, unemployment, and inflation—along
with policies to moderate them.
 Economics studies international trade and finance and the impacts of globalization, and it
particularly examines the thorny issues involved in opening up borders to free trade.
 It asks how government policies can be used to pursue important goals such as rapid
economic growth, efficient use of resources, full employment, price stability, and a fair
distribution of income

Economics is the study of how societies use scarce resources to produce valuable goods and
services and distribute them among different individuals.
Scarcity and Efficiency

If we think about the definitions, we fi nd two key ideas that run through all of economics: that goods
are scarce and that society must use its resources efficiently. Indeed, the concerns of economics will
not go away because of the fact of scarcity and the desire for effi ciency.

Consider a world without scarcity. If infinite quantities of every good could be produced or if human
desires were fully satisfi ed, what would be the con-sequences? People would not worry about
stretching out their limited incomes because they could have everything they wanted; businesses
would not need to fret over the cost of labor or health care; governments would not need to struggle
over taxes or spending or pollution because nobody would care. Moreover, since all of us could have
as much as we pleased, no one would be concerned about the distribution of incomes among
different people or classes.

In such an Eden of affluence, all goods would be free, like sand in the desert or seawater at the
beach. All prices would be zero, and markets would be unnecessary. Indeed, economics would no
longer be a useful subject.

But no society has reached a utopia of limit-less possibilities. Ours is a world of scarcity, full of
economic goods. A situation of scarcity is one in which goods are limited relative to desires. Given
unlimited wants, it is important that an economy make the best use of its limited resources. That
brings us to the critical notion of efficiency.

Efficiency denotes the most effective use of a society’s resources in satisfying people’s wants and
needs. By contrast, consider an economy with unchecked monopolies or unhealthy pollution or
government corruption. Such an economy may produce less than would be possible without these
factors, or it may produce a distorted bundle of goods that leaves consumers worse off than they
otherwise could be either situation is an inefficient allocation of resources. Economic efficiency
requires that an economy produce the highest combination of quantity and quality of goods and
services given its technology and scarce resources.

An economy is producing efficiently when no individual’s economic welfare can be improved unless
someone else is made worse off. The essence of economics is to acknowledge the reality of scarcity
and then fi gure out how to organize society in a way which produces the most efficient use of
resources. That is where economics makes its unique contribution.

Microeconomics and Macroeconomics

Economics is today divided into two major subfields, microeconomics and macroeconomics. Adam
Smith is usually considered the founder of microeconomics, the branch of economics which today is
concerned with the behavior of individual entities such as markets, firms, and households. In The
Wealth of Nations(1776), Smith considered how individual prices are set, studied the determination of
prices of land, labor, and capital, and inquired into the strengths and weaknesses of the market
mechanism. Most important, he identified the remarkable efficiency properties of markets and
explained how the self-interest of individuals working through the competitive market can produce a
societal economic benefit. Microeconomics today has moved beyond the early concerns to include
the study of monopoly, the role of international trade, finance, and many other vital subjects.

The other major branch of our subject is macro-economics, which is concerned with the overall
performance of the economy. Macroeconomics did not even exist in its modern form until 1936, when
John Maynard Keynes published his revolutionary General Theory of Employment, Interest and
Money. At the time, England and the United States were still stuck in the Great Depression of the
1930s, with over one-quarter of the American labor force unemployed. In his new theory Keynes
developed an analysis of what causes business cycles, with alternating spells of high unemployment
and high inflation. Today, macroeconomics examines a wide variety of areas, such as how total
investment and consumption are determined, how central banks manage money and interest rates,
what causes international financial crises, and why some nations grow rapidly while others stagnate.
Although macroeconomics has progressed far since his first insights, the issues addressed by Keynes
still define the study of macroeconomics today.
Positive Economics versus Normative Economics

When considering economic issues, we must carefully distinguish questions of fact from questions of
fairness.

Positive economics describes the facts of an economy, while normative economics involves value
judgments. Positive economics deals with questions such as: Why do doctors earn more than
janitors? Did the North American Free Trade Agreement (NAFTA) raise or lower the incomes of most
Americans? Do higher interest rates slow the economy and lower inflation? Although these may be
difficult questions to answer, they can all be resolved by reference to analysis and empirical evidence.
That puts them in the realm of positive economics.

Normative economics involves ethical precepts and norms of fairness. Should unemployment be
raised to ensure that price inflation does not become too rapid? Should the United States negotiate
further agreements to lower tariffs on imports? Has the distribution of income in the United States
become too unequal? There are no right or wrong answers to these questions because they involve
ethics and values rather than facts. While economic analysis can inform these debates by examining
the likely consequences of alternative policies, the answers can be resolved only by discussions and
debates over society’s fundamental values.

THE THREE PROBLEMS OF ECONOMIC ORGANIZATION

Every human society—whether it is an advanced industrial nation, a centrally planned economy, or an
isolated tribal nation—must confront and resolve three fundamental economic problems. Every
society must have a way of determining what commodities are produced, how these goods are made,
and for whom they are produced. Indeed, these three fundamental questions of economic
organization— what, how, and for whom —are as crucial today as they were at the dawn of human
civilization. Let’s look more closely at them:
● What commodities are produced and in what quantities?
A society must determine how much of each of the many possible goods and services it will make and
when they will be produced. Will we produce pizzas or shirts today? A few high-quality shirts or many
cheap shirts? Will we use scarce resources to produce many consumption goods (like pizzas)? Or will
we produce fewer consumption goods and more investment goods (like pizza-making machines),
which will boost production and consumption tomorrow?
● How are goods produced?
A society must deter-mine who will do the production, with what resources, and what production
techniques they will use. Who farms and who teaches? Is electricity generated from oil, from coal, or
from the sun? Will factories be run by people or robots?
● For whom are goods produced?
Who gets to eat the fruit of economic activity? Is the distribution of income and wealth fair and
equitable? How is the national product divided among different households? Are many people poor
and a few rich? Do high incomes go to teachers or athletes or autoworkers or venture capitalists? Will
society provide minimal consumption to the poor, or must people work if they are to eat?

INPUTS AND OUTPUTS

To answer these three questions, every society must make choices about the economy’s inputs and
out-puts. Inputs are commodities or services that are used to produce goods and services. An
economy uses its existing technology to combine inputs to produce outputs. Outputs are the various
useful goods or services that result from the production process and are either consumed or
employed in further production. Consider the “production” of pizza. We say that the eggs, fl our, heat,
pizza oven, and chef’s skilled labor are the inputs. The tasty pizza is the output. In education, the
inputs are the time of the faculty and students, the laboratories and classrooms, the text-books, and
so on, while the outputs are informed, productive, and well-paid citizens. Another term for inputs is
factors of production. These can be classified into three broad categories: land, labor, and capital.
● Land—or, more generally, natural resources—represents the gift of nature to our societies. It
consists of the land used for farming or for under-pinning houses, factories, and roads; the energy
resources that fuel our cars and heat our homes; and the non energy resources like copper and iron
ore and sand. In today’s congested world, we must broaden the scope of natural resources to include
our environmental resources, such as clean air and drinkable water.
 ● Labor consists of the human time spent in production—working in automobile factories, writing
software, teaching school, or baking pizzas. Thousands of occupations and tasks, at all skill levels,
are performed by labor. It is at once the most familiar and the most crucial input for an advanced
industrial economy.
● Capital resources form the durable goods of an economy, produced in order to produce yet other
goods. Capital goods include machines, roads, computers, software, trucks, steel mills, automobiles,
washing machines, and buildings. As we will see later, the accumulation of specialized capital goods
is essential to the task of economic development.

Restating the three economic problems in these terms, society must decide (1) what outputs to pro-
duce, and in what quantity; (2) how, or with what inputs and techniques, to produce the desired out-
puts; and (3) for whom the outputs should be produced and distributed.