ECONOMICS - I

INTRODUCTION
 Economics was formerly called political economy. The term Political economy means
the management of the wealth of the state. “Adam Smith, the father of modem
Economics, in his book entitled 'An Enquiry into the Nature and Causes of the Wealth
of Nations’ (Published in 1776) defined Economics as a study of wealth. Smith
considered the acquisition of wealth as the main objective of human activity.
According to him the subject matter of Economics is the study of how wealth is
produced and consumed. Smith's definition is known as wealth definition.
 Later economists held that apart from man they said study of wealth has no meaning
Economics is concerned not only with the production and use of wealth but also with
man. It deals with wealth as serving the purpose of man. Wealth is only a means to
the end of human welfare. We cannot consider the desire to acquire wealth as the
inspiring factor behind every human endeavor. Nor can it be expected to be the sole
cause of human happiness. The emphasis has now shifted from wealth to man. Man
occupies the primary place and wealth only a secondary place.
 Economics is the science that deals with production, exchange and consumption of
various commodities in economic systems. It shows how scarce resources can be used
to increase wealth and human welfare. The central focus of economics is on the
scarcity of resources and choices among their alternative uses.
 In the meaning of economics, the term ‘Economics’ owes its origin to the Greek word
‘Oikonomia’, which can be divided into two parts: oikos means home and nomos
means management.
 Thus, in earlier times, economics was referred to as home management where the
head of a family managed the needs of family members from his limited income. Till
the 19th century, Economics was known as ‘Political Economy.’ The book named
‘An Inquiry into the Nature and Causes of the Wealth of Nations’ (1776) usually
abbreviated as ‘The Wealth of Nations’, by Adam Smith is considered as the first
modern work of Economics.

1|Page
 ECONOMICS - I

 DEFINITIONS OF ECONOMICS
Several definitions of Economics have been given. For the sake of convenience let us
classify the various definitions into four groups:
1. Science of wealth (Wealth Oriented definition)
2. Science of material well-being (Welfare oriented definition)
3. Science of choice making and (Science oriented definition)
4. Science of dynamic growth and development (growth oriented definition)
We shall examine each one of these briefly.

2|Page
 ECONOMICS - I

1) Wealth Oriented definition : Wealth Definition (Classical definition) Adam

Smith
 Some earlier economists defined Economics as follows:
 Adam Smith defined Economics in his book “An inquiry into the nature and
causes of wealth of nation” published in 1776. Title itself was the definition of
economics. He has given so much important to physical wealth. So economics is
also known as “Science of wealth.
 “Science which deals with wealth" by J.B. Say.
 In the above definition wealth becomes the main focus of the study of Economics.
 The definition of Economics, as science of wealth, had some merits. The important
ones are:
1. Study of Wealth
 According to the definition of Adam Smith,
economics is only concerned with wealth earning
activities. Every human living in the society needs
wealth to fulfill their basic requirements. All the
human beings living in the society are concerned to
earn more and more wealth. It means economic
deals with production, distribution, exchange and
consumption of wealth
2. Secondary Place to Mankind
 The wealth centered definition of economic has given first priority to wealth and
secondary priority to mankind. Adam Smith assumed that mankind is for wealth
but wealth cannot be for mankind.
3. Source of Wealth
 According to the definition of Adam Smith, salary or wages earned by labourers is
only the source to earn the wealth. Adam Smith has suggested that the active
labourers can earn high amount of wages through the division of labour. It

3|Page
 ECONOMICS - I

increases the productivity and distribution of the goods. In this way, a wealth of
Nation can be increased
4. Study of Economic - Man
 Adam Smith claimed that economic studies the behavior of that person whose
main objective is to earn more and more money by hook or crook. Human of such
nature, in the word of Adam Smith, is “Economic - man ".
 Criticisms of Wealth Definition
 The wealth definition of economics given by Adam Smith was strongly criticized
on several grounds by a famous economist like Carlyle, Ruskin, and Marshall
They criticized this definition by saying “Science of bread and butter “However
the major criticisms of Adam Smith’s definition are briefly explained below.
1) Narrow Definition
 The wealth centered definition of economic has given stress on only those
activities which are related to wealth earning activities. This definition excludes
those human beings who are not related to wealth earning activities. So, this
definition could not study the activity of those people who are engaged in social
service. It justifies that wealth definition has a narrow definition
2) Over emphasis on Wealth
 The wealth definition has over emphasized on wealth rather than human beings.
Adam Smith extremely emphasized wealth by giving primary importance to
wealth and secondary importance to mankind. The critics pointed out that wealth
is for human beings but human beings are not for wealth. Therefore, human life
cannot be sacrificed for wealth rather wealth should be used for the betterment of
mankind.
3) Single Source of wealth
 Adam Smith said that wages earned by laborer are only one source of wealth of
nation. But, the critics pointed out that the natural resources, human resources,
capital resources and physical resources are also the sources of wealth of nations.
All these resources together can be utilized to earn maximum wealth by the nation.
4|Page
 ECONOMICS - I

4) Unrealistic Concept of Economic - Man

 Adam Smith assumed that every human being who wants to earn money by hook
or crook is known as Economic - man. The critics pointed out that almost all
human beings have their own qualities of human life such as a feeling of life ,
experience , self - esteem , respect trust , etc which provide greater satisfaction
rather than wealth in their life . So, the pure economic man does not exist in real
life.

5|Page
 ECONOMICS - I

2) Welfare oriented definition:

Welfare Definition (Neo - classical definition) Alfred Marshall
 Under this group of definitions the emphasis is on welfare as compared with
wealth in the earlier group. Two important definitions are as follows:
 Marshall published his first book “Principles of economics” in 1890. In this
book, he defined economics or political economy “is a study of mankind in the
everyday business of life”.
 "Economics is a study of mankind in the ordinary business of life. It examines that
part of individual and social action which is most closely connected with the
attainment and with the use of the material requisites of well-being. Thus, it is on
the one side a study of wealth and on the other and more important side a part of
the study of the man"
 "The range of our inquiry becomes restricted to that part of social welfare that can
be brought directly or indirectly into relation with the measuring rod of money".
A.C. Pigou.
 In the first definition Economics has been indicated to be a study of mankind in
the ordinary business of life. By ordinary
business we mean those activities which occupy
considerable part of human effort. The
fulfillment of economic needs is a very
important business which every man ordinarily
does. Professor Marshall has clearly pointed that
Economics is the study of wealth but more
important is the study of man. Thus, man gets
precedence over wealth. There is also emphasis on
material requisites of well-being. Obviously, the material things like food, clothing
and shelter, are very important economic objectives.

6|Page
 ECONOMICS - I

 The second definition by Pigou emphasizes social welfare but only that part of it
which can be related with the measuring rod of money. Money is general measure
of purchasing power by the use of which the science of Economics can be
rendered more precise.
 The Marshallian definition as a science of material welfare has been further
explained below:
1. Primary importance to Mankind
 According to Alfred Marshall, economics is the study of wealth in relation to
wealth. He explains how a man in the ordinary business earns wealth and utilizes
to achieve maximum satisfaction. He further added that wealth is for the
betterment of mankind but mankind is not for wealth. He also suggested that
primary importance should be given to mankind and the secondary importance to
wealth.
2. Study of Ordinary human beings
 The welfare definition given by Alfred Marshall has given highly stress on
ordinary human beings rather than economic man of Adam Smith. In the view of
Alfred Marshall, ordinary human beings are those who get involved not only in
accumulating more and more wealth but also try to experience love, sympathy.
Goodwill, respect, honor, prestige and co - operation.
3. Study of Material Welfare
 Alfred Marshall has highly focused on material welfare le satisfaction or utility
obtained from physical goods or materials goods rather than human welfare. The
satisfaction derived by a consumer by consumption of basic goods ( food , cloth ,
shelter , etc ) or luxury goods ( TV , Mobile , Laptops Computers , etc ) or habitual
goods ( Alcohol , Cigarette , etc ) is called material welfare.
4. Social Science
 According to Alfred Marshall, economics studies those human lives in the society.
It does not study the isolated person not belonging to the society such as beggars,

7|Page
 ECONOMICS - I

sages, hermits, monks, saints, etc. As economics studies the economic behavior of
people living in the society it is called social science.
5. Normative science
 According to Alfred Marshall economics is a normative science Marshall said that
wealth should be utilized for human welfare.
 Criticisms:
 Robbins has criticized the Marshalls definition of economics and introduced the
modern definition economics in 1932 A.D. The major criticisms made by Robbins
are as follows:
1. Classificatory in Nature
 Alfred Marshall classified human activities into material and non – material
welfare, ordinary and other business. However, he could not clarify the differences
between these terms. Therefore, in the view of Robbins, this definition is
classificatory in nature rather than analytical in nature.
2. Narrow or Limited Scope
 Alfred Marshall stressed that economics studies just about material welfare
obtained from materials activities carried out by human beings. On the other hand,
critics pointed out that there is some other non - material welfare which fulfills
human desires and needs that come under the subject matters of economics.
3. Lack of Clear Concept about Welfare
 Marshall has highly focused on material welfare rather than human welfare in his
definition. Lionel Robbins pointed out that the concept of welfare differs
according to time, place and circumstances. A smoker and alcohol lover considers
smoking and alcohol and promotes his welfare. On the other hand, same
commodities such as harmful drugs, tobacco and alcohol are harmful to other non
- smokers because they cannot promote their welfare in any form.

8|Page
 ECONOMICS - I

4. Excludes Human Science

 According to Alfred Marshall, economics studies about those people who are
living in society. But the critics of this definition argued that economics should
study total human beings whether they are actively participating in social functions
or they are isolated from society.
5. It involves value judgments
 The word "welfare" in Marshall Definition involves value judgments and relates
"Economics" to the branch of ethics. But economics should be neutral regarding
moral judgments and about what is good and what is bad.

9|Page
 ECONOMICS - I

3. Science of choice making (Scarcity oriented)

Lionel Robbins gave a more scientific definition of
Economics. Robbins well-known book “An essay on
the Nature and Significance of Economics” published
in 1932. He defined economics as “a science which
studies human behaviour as a relationship between ends
and scarce means which has alternative uses.
 The definition deals with the following four aspects:
1. Economics is a science:

 Economics studies economic human behaviour scientifically. It studies how

humans try to optimize (maximize or minimize) certain objective under given
constraints. For example, it studies how consumers, with given income and prices
of the commodities, try to maximize their satisfaction.
2. Unlimited ends:
 Ends refer to wants. Human wants are unlimited. When one want is satisfied, other
wants crop up. If man's wants were limited, then there would be no economic
problem.

10 | P a g e
 ECONOMICS - I

Human wants are never ending, i.e. they can never be fully satisfied. As soon as
one want is satisfied, another new want emerges.

3. Scarce means:
 Means refer to resources. Since resources (natural productive resources, man-made
capital goods, consumer goods, money and time etc.) are limited economic
problem arises. If the resources were unlimited, people would be able to satisfy all
their wants and there would be no problem.

11 | P a g e
 ECONOMICS - I

Scarcity refers to the limitation of supply in relation to demand for a

commodity. Economics is concerned with selection of resources under
conditions of scarcity

ECONOMIC PROBLEM It is a
FACTORS OF PRODUCTION
problem of CHOICE involving
Resources are limited in relation to
satisfaction of unlimited wants out
their demand and economy cannot
of limited resources having
produce all what people want.
alternative uses.

12 | P a g e
 ECONOMICS - I

Resources are not only scarce, but they can also be put to various uses. It
makes choice among resources more important.

4. Alternative uses:

ALTERNATIVE USES: Resources are not only scarce, but they can also be put
to various uses. It makes choice among resources more important

 Not only resources are scarce, they have alternative uses. For example, coal can be
used as a fuel for the production of industrial goods, it can be used for running

13 | P a g e
 ECONOMICS - I

trains, it can also be used for domestic cooking purposes and for so many
purposes. Similarly, financial resources can be used for many purposes. The man
or society has, therefore, to choose the uses for which resources would be used. If
there was only a single use of the resource then the economic problem would not
arise. It follows from the definition of Robbins that Economics is a science of
choice. An important thing about Robbin's definition is that it does not distinguish
between material and non-material, between welfare and non-welfare. Anything
which satisfies the wants of the people would be studied in Economics. Even if a
good is harmful to a person it would be studied in Economics if it satisfies his
wants.
 No doubt, Robbins has made Economics a scientific study and his definition has
become popular among some economists. But his definition has also been
criticized on several grounds. Important ones are:
 Limitations of Robbins’ definition:
 “Economics is a science” is challenge and emphasized by many economists that
economics is also an art.
 Economics is not only a positive science but also a normative science.
 Idea of human welfare is implicit even in a scarcity of resources.
 According to Robertson, Robbins definition is too narrow and too broad. Scarcity
is not only problem even plenty too.
 Economics is also a social science.
a. Robbins has made Economics quite impersonal and colourless. By making it a
complete positive science and excluding normative aspects he has narrowed down
its scope.
b. Robbins' definition is totally silent about certain macro-economic aspects such as
determination of national income and employment.
c. His definition does not cover the theory of economic growth and development.
While Robbins takes resources as given and talks about their allocation, it is

14 | P a g e
 ECONOMICS - I

totally silent about the measures to be taken to raise these resources i.e. national
income and wealth.

15 | P a g e
 ECONOMICS - I

Difference between Positive Science Normative

Science

Positive Science Normative Science

Economics is a Positive science which
study “what is” or the facts about how which study “what out to be” or how
economy operates
It is based on factual information and
uses statistical data and scientific
formula in determining how an
economy should be.
Economics is neutral between ends.
It deals with the relationship between
cause and effect and can be tested.
Since it is science, it is not concern
with moral or ethical question.
Positive statements are always based
on what is actually going on in the
economy either they can be accepted
or rejected depending on the facts
presented.
For instances, what is the rate of
interest? What are the factors affecting and take interest or not, or what
interest rate etc. are the statement of
positive science.
Economics is a normative science
the economy should be.
It is also known as policy economy
where in normative statements,
opinion and judgements are used.
Economics is not neutral between
ends.
When we test and predict economic
events, subjectivity always enters.
It concerned with the evaluation of
economics events from the ethical
view point.
People state their opinions and
judgements without considering the
facts so they cannot be tested.
For example, weather we should give
should be the ideal interest rete etc.
are the statement of normative
science.

4. Science of dynamic growth and development.

 (Modern Definition of Economics)

16 | P a g e
 ECONOMICS - I

 Although the fundamental economic problem of scarcity in relation to needs is

undisputed it would not be proper to think that economic resources - physical,
human, financial are fixed and cannot be increased by human ingenuity,
exploration, exploitation and development. A modern and somewhat modified
definition is as follows:
 "Economics is the study of how men and society choose, with or without the
use of money, to employ scarce productive resources which could have
alternative uses, to produce various commodities over time and distribute
them for consumption now and in the future amongst various people and
groups of society". Paul A. Samuelson
 The above definition is very comprehensive because it does not restrict to material
well-being or money measure as a limiting factor. But it considers economic
growth over time.
 'Economics is a social science concerned chiefly with the way society chooses to
employ its resources, which have alternative uses, to produce goods and services
for present and future consumption'.
 The above definition is general in nature. There are many common points in the
definitions of Robbins and Samuelson.
 Samuelson's definition tells us that economics is a social science and it is mainly
concerned with the way how society employs its limited resources for alternative
uses. All this we find in the definition of Robbins. But Samuelson goes a step
further and discusses how a society uses limited resources for producing goods and
services for present and future consumption of various people or groups.
 An interesting point that Samuelson tells is that the society may or may not make
use of money.
 Net Economic Welfare (NEW)
 Samuelson has coined the concept of Net Economic Welfare.

17 | P a g e
 ECONOMICS - I

 'According to Samuelson, 'Net Economic Welfare (NEW) is an adjusted measure of

total national output that includes only consumption and investment items that
contribute directly to economic welfare'.
 As we become rich, generally, we prefer leisure to income. When we allocate more
time for leisure, gross national product (GNP) may come down. But welfare goes
up. So when we estimate GNP, we must include satisfaction, derived from leisure
by giving it a value in Net Economic Welfare.
 Women do a lot of work at home and it is not taken into account while calculating
GNP. But we must include that while estimating GNP. Only then, we will get a
correct picture of NEW.
 In any society, there will be some illegal activities. (eg. drug trade). We should not
include it in NEW. They are 'social bads'
 There are some underground activities. Those who earn huge incomes (eg. lawyers,
accountants, actors) may not report actual income for tax purposes.
 This unaccounted money (black money) must somehow be included in GNP
estimates. Otherwise, we will get a lower figure for GNP.
 During the process of economic growth, there will be environmental pollution. To
get NEW, we should deduct the cost of pollution from the G.N.P.
 The concept of Net Economic Welfare has become very important in the study of
National Income.

18 | P a g e
 ECONOMICS - I

NATURE OF ECONOMICS
 Under this, we generally discuss whether Economics is science or art or both and if
it is a science whether it is a positive science or a normative science or both.
A. Economics - As a science and as an art:
 Often a question arises - whether Economics is a science or an art or both.
1. Economics is a science: A subject is considered science if It is a systematized
body of knowledge which studies the relationship between cause and effect.

 It is capable of measurement.
 It has its own methodological apparatus.
 It should have the ability to forecast.
 If we analyses Economics, we find that it has all the features of science. Like
science it studies cause and effect relationship between economic phenomena. To
understand, let us take the law of demand. It explains the cause and effect
relationship between price and demand for a commodity. It says, given other
things constant, as price rises, the demand for a commodity falls and vice versa.
Here the cause is price and the effect is fall in quantity demanded. Similarly like
science it is capable of being measured, the measurement is in terms of money. It
has its own methodology of study (induction and deduction) and it forecasts the
future market condition with the help of various statistical and non-statistical tools.

19 | P a g e
 ECONOMICS - I

 But it is to be noted that Economics is not a perfect science. This is because

Economists do not have uniform opinion about a particular event. The subject
matter of Economics is the economic behaviour of man which is highly
unpredictable.
 Money which is used to measure outcomes in Economics is itself a dependent
variable.
 It is not possible to make correct predictions about the behaviour of economic
variables.
2. Economics is an art:
 Art is nothing but practice of knowledge. Whereas science teaches us to know art
teaches us to do. Unlike science which is theoretical, art is practical. If we analyse
Economics, we find that it has the features of an art also. Its various branches,
consumption, production, public finance, etc. provide practical solutions to various
economic problems. It helps in solving various economic problems which we face
in our day-to-day life.
 Thus, Economics is both a science and an art. It is science in its methodology and
art in its application. Study of unemployment problem is science but framing
suitable policies for reducing the extent of unemployment is an art.

20 | P a g e
 ECONOMICS - I

 Economics as Positive Science and Economics as Normative Science

1) Positive Science:

 As stated above, Economics is a science. But the question arises whether it is a

positive science or a normative science. A positive or pure science analyses cause
and effect relationship between variables but it does not pass value judgment. In
other words, it states what is and not what ought to be. Professor Robbins
emphasized the positive aspects of science but Marshall and Pigou have
considered the ethical aspects of science which obviously are normative.
 According to Robbins, Economics is concerned only with the study of the
economic decisions of individuals and the society as positive facts but not with the
ethics of these decisions. Economics should be neutral between ends. It is not for
economists to pass value judgments and make pronouncements on the goodness or
otherwise of human decisions. An individual with a limited amount of money may
use it for buying liquor and not milk, but that is entirely his business. A
community may use its limited resources for making guns rather than butter, but it
is no concern of the economists to condemn or appreciate this policy. Economics
only studies facts and makes generalizations from them. It is a pure and positive
science, which excludes from its scope the normative aspect of human behaviour.

21 | P a g e
 ECONOMICS - I

 Complete neutrality between ends is, however, neither feasible nor desirable. It is
because in many matters the economist has to suggest measures for achieving
certain socially desirable ends. For example, when he suggests the adoption of
certain policies for increasing employment and raising the rates of wages, he is
making value judgments; or that the exploitation of labour and the state of
unemployment are bad and steps should be taken to remove them. Similarly, when
he states that the limited resources of the economy should not be used in the way
they are being used and should be used in a different way; that the choice between
ends is wrong and should be altered, etc. he is making value judgments.
2) Normative Science:
 As normative science, Economics involves value judgments. It is prescriptive in
nature and described 'what should be the things'. For example, the questions like
what should be the level of national income, what should be the wage rate, how
the fruits of national product are distributed among people - all fall within the
scope of normative science. Thus, normative economics is concerned with welfare
propositions. Some economists are of the view that value judgments by different
individuals will be different and thus for deriving laws or theories, it should not be
used.

22 | P a g e
 ECONOMICS - I

23 | P a g e
 ECONOMICS - I

SCOPE OF ECONOMICS:
 The Subject matter of economics can be broadly be studied under different heads
of consumption, production, exchange, distribution and public finance.
1. Consumption:

 Since the starting point of all economic activity is the existence of human wants, it
is logical that the theory of wants or consumption of wealth should from the first
branch of economics. Consumption refers to the use of wealth for the satisfaction
of wants and desires or material and non material things. It implies the consuming
of the utility of an article and not the article itself. The study of consumption
includes among other things a study of characteristics and classification of human
wants, law of Diminishing Marginal Utility, Law of Demand, Elasticity of
Demand, Consumer ‘s surplus, Engle’s Law of Family expenditure and so on.

24 | P a g e
 ECONOMICS - I

2. Production:

 The process that converts factors of production into goods and services.

 Next comes the study of production of wealth. Man of course, cannot produce or
create matter anymore than he can destroy it. All that he can do is to transform,
adjust or arrange the matter or materials supplied by nature so as to impart utility

25 | P a g e
 ECONOMICS - I

in it and thereby satisfy his wants. Production, therefore, means creation or

addition of utilities. Under production we study the main factors of production,
namely land, labor, capital, and organization, the law of returns. Namely
Diminishing, Increasing, and Constant Returns, forms of industrial organization
like combinations, trusts, pools, cartels, etc. scale of production, division of labor
and localization of industries.
3. Exchange:

 Under the modern complex economic organization with a high degree of

specialization, it is not possible for an individual to satisfy all his wants by his own
efforts. Each individual is ordinarily dependent on others for the satisfaction of his
wants. What he does not produce for himself, he obtains from others in exchange
and thus satisfies his wants. Exchange, thus, becomes a vital part of our economic
system and has come to be regarded as a connecting link between production and
consumption. In this branch of economics we study the mechanism of exchange
markets, money, credit, instruments, banking, international trade and problems
relating to foreign exchange transactions.

26 | P a g e
 ECONOMICS - I

4. Distribution:

Rent Wages Interest Profit

 The appointment of the wealth produced amongst the different factors of

production that have contributed in its production is known as distribution. Under
it we study the share of the various factors of production in the rent, wages,
interest and profit accruing respectively to land, labor capital and enterprise.
5. Public finance:

 Modern state is no longer a “police state”, it is becoming “welfare state”, and there
has been a tremendous expansion, during recent years, in the functions, activities
and responsibilities of modern governments. The state body bears the
responsibility not only for the defense of the country against external aggression
and the maintenance of law and order at home, but also undertakes various plans

27 | P a g e
 ECONOMICS - I

for economic and social development. For this, it requires increasing revenue.
Public finance otherwise known as the economics of government studies how the
government obtains its revenue and how it spends it. it deals with the income and
expenditure of public authorities and with the adjustment of one to the other.
Under this branch of economics, we study the principle of taxation, public
expenditure and public debt.
6. Micro Economics:

Micro Economics Macro Economics

 This is considered to be the basic economics. Microeconomics may be defined as

that branch of economic analysis which studies the economic behaviour of the
individual unit, may be a person, a particular household, or a particular firm. It is a
study of one particular unit rather than all the units combined together. The
microeconomics is also described as price and value theory, the theory of the
household, the firm and the industry. Most production and welfare theories are of
the microeconomics variety.
7. Macro Economics:
 Macroeconomics may be defined as that branch of economic analysis which
studies behaviour of not one particular unit, but of all the units combined together.
Macroeconomics is a study in aggregates. Hence, it is often called Aggregative
Economics. It is, indeed, a realistic method of economic analysis, though it is
complicated and involves the use of higher mathematics. In this method, we study

28 | P a g e
 ECONOMICS - I

how the equilibrium in the economy is reached consequent upon changes in the
macro-variables and aggregates. The publication of Keynes’ General Theory, in
1936, gave a strong impetus to the growth and development of modern
macroeconomics.

Difference between Micro & Macro Economics

Micro Economics Macro economics
According to M L Seth, Micro Macro Economics is that branch of
Economics is that branch of economics economics which dealt with
which studies individual units like aggregates like total saving,
individuals, households, firms, investment, production, employment,
industries etc. inflation etc.
It studies economic motives and It study the changes of national
behaviours of consumers and income, employment, trade cycles
producers. For instances, how prices, theories, pattern of saving and
wages, interest rates are determined in investment fall in the macro
different market conditions. economics studies.
Law of demand and supply, marginal Aggregate demand and supply,
utility, consumer behaviours, cost, consumption function, interest rate
revenue are also studied in micro and exchange rate are also studied in
economics. macro economics.
In recent times micro economic Macro economics studies are very
analysis is being widely used in much useful while making economic
business so it is also known as policies of state and central
managerial economics. government.

29 | P a g e
 ECONOMICS - I

8. International Economics:
 As the countries of the modern world are realizing the significance of trade and
commerce with other countries, the role of international economics is getting more
and more significant nowadays.
9. Development Economics:
 After the Second World War many countries got freedom from the colonial rule,
their economics required different treatment for growth and development. This led
to emergence of new branch of economics known as development economics.
10. Health Economics:
 A new realization has emerged from human development for economic growth.
Therefore, branches like health economics are gaining momentum. Similarly,
educational economics is also coming up.
11. Environmental Economics:
 Unchecked emphasis on economic growth without caring for natural resources and
ecological balance, now, economic growth is facing a new challenge from the
environmental side. Therefore, Environmental Economics has emerged as one of
the major branches of economics that is considered significant for sustainable
development.
12. Urban and Rural Economics:
 Role of location is quite important for economic attainments. There is also much
debate on urban-rural divide. Therefore, economists have realised that there should
be specific focus on urban areas and rural areas. Therefore, there is expansion of
branches like urban economics and rural economics. Similarly, regional economics
is also being emphasised to meet the challenge of geographical inequalities. There
are many other branches of economics that form the scope of economics. There
are welfare economics, monetary economics, energy economics, transport
economics, demography, labour economics, agricultural economics, gender
economics, economic planning, economics of infrastructure, etc.

30 | P a g e
 ECONOMICS - I

RELATIONSHIP WITH OTHER SCIENCES

31 | P a g e
 ECONOMICS - I

32 | P a g e
 ECONOMICS - I

33 | P a g e
 ECONOMICS - I

 This is a review of economics and its relationships with other social sciences and
subjects, such as philosophy, politics, maths, physics, anthropology, psychology
and sociology. Also, to what extent does economics benefit from expanding into
other subjects?

 What is economics?

 Economics a social science that studies the production, consumption and

distribution of goods and services. Economics develops models and theories to try
and understand decision making by firms, consumers and governments. For
example, how an individual chooses to spend their income.

 Microeconomics is a branch of economics that focuses on individual markets and

individual decisions, for example, factors that determine the price of oil and how
changes in price affect consumers and firms.

34 | P a g e
 ECONOMICS - I

 Macroeconomics is a branch of economics concerned with the whole economy.

For example, macroeconomics is concerned with economic growth,
unemployment and the rate of inflation (how fast general prices are increasing.)

 However, whilst economics has a clear subject matter, it frequently overlaps with
other subjects and in recent years, there has been a trend to expand the horizons of
economics and take on board insights from other disciplines from psychology to
anthropology and sociology. J.M. Keynes wrote in an essay on Alfred Marshall.

 “The study of economics does not seem to require specialized gifts of an unusually
high order. Is it intellectually regarded, a very easy subject compared with the
higher branches of philosophy and pure science?

 Yet good, or even competent, economists are the rarest of birds. An easy subject,
at which very few excel! The paradox finds its explanation, perhaps, in that the
master economist must possess a rare combination of gifts… He must be
mathematician, historian, statesman, philosopher in some degree.” “Essay on
Alfred Marshall”, J.M.Keynes: ‘Essays in Biography.’

1. Economics and Psychology

 In recent decades, economics has seen more overlap with the subject of
psychology. Traditional economics was dismissive of psychology assuming that
individual agents were rational and sought to maximise utility/profit. Classical
economics of Alfred Marshall assumed the average consumer would make choices
to maximise their utility.

 However, from the 1970s, more economists became interested in the effect of
psychology in decision making. Termed behavioural economics, these new
economists challenged the assumption individuals were always rational, but
actually could be heavily influenced by psychological factors. For example

35 | P a g e
 ECONOMICS - I

 Irrational exuberance – people get caught up in bubbles and rising asset prices
 The power of nudges and framing – people respond to stimuli and make easy
decisions
 Endowment effects – in classical economics we should value £100 the same, but
behavioural economics noticed that we are much more attached to the £100 asset
we already have. There is a greater sense of loss losing what we have, rather than
not getting it in the first place.
 In 2002, American psychologist Daniel Kahneman was awarded the Nobel Prize
in economics for his work on cognitive bias, loss aversion and prospect theory.

2. Economics and sociology

 Sociology is a social science concerned with understanding social structures and

the interaction of people in society. One aspect of sociology is the economic
perspective of how differences in income affect life chances.

 Economist William Stanley Jevons coined the term ‘economic sociology’ in 1879
to describe the work on class and social norms on economic decisions and
outcomes. The famous sociologist Max Weber made an important contribution to
economics through his classic. “The Protestant Ethic and the Spirit of Capitalism”
(1905). Weber suggested that the prevailing Protestant belief in hard work, virtue
and frugality have an important effect in shaping western European economies. It
broadened the scope of economics – to examine how cultural and social factors
can shape economies in the long-run.

3. Economics and Statistics:

 One major function of an economist is to conduct research. The job of the

company economist is to investigate economic aspects of various decisions
Government agencies and private business firms generate a vast array of economic

36 | P a g e
 ECONOMICS - I

statistics on such matters as income, employment, prices and expenditure patterns.

A two-way street exists between statistical data and economic theory.

 Statistics can be used to test the consistency of economic theory and measure the
responsiveness of economic variables to changes in policy. At the same time,
economic theory helps to explain which economic variables are likely to be related
and why they are linked. Statistics do not tell their own story.

 We must utilise economic theory to properly interpret and better understand the
actual statistical relationships among economic variables.

4. Economics and Mathematics

 Mathematics has been an important element of economics since the introduction of

marginal utility theory in the late nineteenth century. In 1871, W.S Jevons
published “The Principles of Political Economy” He stated an important element
of economics “must be mathematical simply because it deals with quantities.”
Over the years, mathematics has been incorporated into many aspects of economic
from statistical analysis to equilibrium models and explaining decision making.

 Some economists have become wary of the influence mathematics has on

economics. They argue that the innumerable variables affecting the economy can
make modelling the economy on a mathematical basis prone to missing the bigger
picture.

 1988 Nobel Laureate Maurice Allais was critical of the state of maths in
economics

 “For almost fifty years contemporary economic literature had developed too often
in a totally erroneous direction with the construction of completely artificial
mathematical models detached from reality; and too often it is dominated more

37 | P a g e
 ECONOMICS - I

and more by a mathematical formalism which fundamentally represents and

immense regression.” [1989]

5. Economics and Philosophy

 There is a strong link between philosophy and economics. Economists may try and
be neutral about the study of economics. Some economists say ‘economics is not a
morality play’ but at the same time, economic choices are influence by
philosophy. For example, the extent to which governments intervene is influenced
by philosophic beliefs over which is most important – equality of individual
freedom. Adam Smith noted how individual self-interest could lead to the
common good – despite selfish interest rather than because of. However, Smith
was also a moral philosopher and felt that principles of justice and fairness were
intrinsic to civil society.

6. Economics and Politics

 The nature of economics is that many decisions are inherently political. To what
extent should the government intervene in the economy? Should taxes be cut or
increased? Free markets schools of economics are closely related to centre-right
political parties. Whilst schools which are supportive of government intervention
and greater income distribution are closely allied to centre-left political parties.

 In theory, there are elements of economics which should be non-political, the

production of data, evaluating the state of the economy and economic theories.
Whilst economists may disagree on the extent of government intervention there is
more consensus on issues such as the effects of tariffs and free-trade. However,
even the presentation of data can become political. For example, the controversial
paper on optimal debt levels Reinhart, C M and Rogoff, K S (2010) “Growth in a
time of debt” was seized on by politicians who wished to push austerity. The link
between economics and politics can be seen in issues such as making the Central
38 | P a g e
 ECONOMICS - I

Bank independent. – taking policy decisions from politicians and giving to

economists.

7. Economics and Anthropology

 A classical view in economics is that before money, economic interactions were

often part of the barter economy. However, insights from anthropology and history
suggest there is little if any examples of a real barter economy in history.
Anthropologists, such as Karl Polanyi and Chris Gregory suggest a better
explanation is the idea of a gift economy. In other words, social ties and
community peer pressure encourages people to offer goods and services without
expectation of immediate payback. This kind of cultural sharing of resources
doesn’t fit into a limited economic model, but therefore does expand economics
beyond the traditional western view of the market interchange.

8. Economics and Biology

 The link between biology and economics may seem quite tenuous, but there is a
subject of biological economics. This examines issues such as the average height
of chief executives, and whether biological differences such as height, weight and
metabolism have an impact on economic outcomes. Some economists have
suggested that differences in sex should be studied for explaining different
decisions and behaviours of people. (Cox Biology)

 Biology and economics also share an interest in game theory for explaining
different potential outcomes.

9. Economics and Demography

 Demography is the study of populations and population change. The most

influential economic study on demographics was Thomas Malthus whose dire

39 | P a g e
 ECONOMICS - I

warnings about the problems of population growth could cause the demand for
food to outstrip supply. Though Malthus’s gloomy predictions have so far proved
overly pessimistic, the subject is still relevant for economic modelling.

 In the 1960s, Gary Becker studied the economics of families, crime and
relationships. Becker argued that family ties were important for explaining many
economic decisions about work, saving, how many children to have.

10. Economics and Ecology

 Economics is traditionally concerned with human decisions and maximising

human welfare. Ecological economics is interested in widening the study of
economics to make the welfare of the environment – intrinsic to economic
decisions. This brings in issued of long term sustainability. Economics and
environment.

11. Economics and physics

 This is a field of study that uses theories and methods originally developed in
physics to the study of economics. For example, an earlier proponent of utility
theory, Daniel Bernoulli was a mathematician and physicists who applied maths to
economic theories, such as risk aversion. In modern terms, econophysics uses
tools developed in physics, such as uncertainty and nonlinear dynamics to
investigate economic issues, especially related to the performance of markets.

12. Economics and Decision Sciences:

 Economics is also part of a group of disciplines called decision sciences which

includes some branches of statistics, applied mathematics, operational research,
and some areas of management and engineering. All of these disciplines deal with
how individuals and groups make decisions.

40 | P a g e
 ECONOMICS - I

 Economists are specifically interested in those decisions relating to production

consumption and resource use. As a decision science, economics is closely related
to business and management courses.

13. Economics and History

 Economics and history are closely related. History is a record of the past events. In
history, we survey economic, political and social conditions of the people in the
past. To a student of history, love affairs, marriages and even murders of kings are
important subjects of study. For example, the murder of Julius Caesar is important
for a student of Roman history. In our country, the religious policy of Mughal
emperors is important for a student of history. But we are interested in history only
to the extent that it will help us in understanding economic problems of the past.
 As students of economics, we are interested in things like taxation and other
sources of revenue and standard of living in the past.
 In economics, we make use of historical data to formulate economic laws. We
make use of history in economics to study the material conditions of people in the
past. There is a separate branch of economics known as 'Economic History'.
 We may say economics is the fruit of history and history in the root of economics:
 'Economics without history has no root; History without economics has no fruit'.

14. Economics and Ethics

 Ethics is a social science. It deals with moral questions. It discusses the rules that
govern right conduct and morality. It deals with questions of right and wrong. It
aims at promoting good life.
 There is connection between economics and ethics. While economics, according to
Marshall, aims at promoting material welfare, ethics aims at promoting moral
welfare. When we discuss economic problems, often we consider ethical issues.

41 | P a g e
 ECONOMICS - I

The government introduced prohibition in many states for ethical reasons, though
there was heavy loss of revenue to it.
 But Lionel Robbins strongly believes that an economist as an economist should
not consider ethical aspects of economic problems. But many economists do not
agree with him. They believe that economics cannot be dissociated from ethics.
Even Marshall considered economics as a handmaid of ethics. He looked at
economics as a study of means to better the conditions of human life.

15. Economics and Ecology

 Chemistry is study of nature, composition, properties, laws and classification of
matter. In simple words economics is chemistry of wealth. Every principle or law
in chemistry holds good for economics too. For example : Law of demand and
supply , Quantity Theory , Law of Diminishing Marginal returns / utility of
economics are other way of putting chemistry's Law of Mass Action .

16. Economics and Jurisprudence

 Jurisprudence is the science of law. The economic progress of a nation depends to

a great extent on its legal system. Good laws promote economic progress and bad
laws act as an impediment to growth. For example, in the past when we welcomed
foreigners to invest in our country, they used to say our taxation was complex and
not good. Of course, now things have improved. So we must have simple and clear
laws in the fields of taxation and labour legislation to promote economic progress.

17. Stocks and flows

 Stocks and flows are basic concepts in economics. Stocks can be measured at a
given point of time. A flow is a quantity that can be measured only in terms of a
specified period of time. In other words, it has a time dimension. For example,
wealth is a stock and income is a flow.
 https://prezi.com/fkrasgrt_bp7/economics-and-its-relation-to-other-sciences/
 http://www.brainkart.com/article/Economics-in-relation-to-other-social-sciences_1514/

42 | P a g e
 ECONOMICS - I

 https://www.economicshelp.org/blog/160955/economics/sciences-and-subjects-related-
to-economics/
 https://www.economicsdiscussion.net/relationship/relationship-of-economics-with-other-
subjects/25099

43 | P a g e
 ECONOMICS - I

MEANING OF ECONOMIC ACTIVITIES

 Economics is a social science which deals with the production, distribution and
consumption of goods and services. It is the study of how individuals, businesses,
governments and countries make choices on allocating resources to motivate their
needs and wants and attempt to determine how these categories should gather and
correlate attempts to attain maximum output. Economic analysis certainly
advances through analytical procedures, like mathematical logic, where the
44 | P a g e
 ECONOMICS - I

conjectures of different human activities are envisaged in a “means-ends”

structure.

 What are Economic Activities?

 Economic activity is an activity of providing, making, buying or selling

commodities or services by people to satisfy day-to-day needs of life. Any activity
that includes manufacturing, distributing or utilising products or services.

 Activities that involve money or the exchange of products or services are

economic activities. The three types of economic activities are. 
 Types of Economic Activities
 Economic activities are undertaken to earn money. Generally, people engage
themselves in such activities on a regular basis and are said to be engaged in their
occupation. Occupations may be classified into three categories based on the
following:
A. Employment
B. Profession
C. Business
A. Employment
 It refers to the occupation in which people work for others and get remuneration in the
form of wages or salaries. The one who is employed by others are called employees
and the one who employs others is called employer.
 Managers, Clerks, Bank officials, Factory workers etc., are examples of employees.

 Business – This economic activity provides goods and services to satisfy human
needs on a daily basis with the aim of earning profits.
 Profession – It can also be defined as an occupation or a professional job that
offers specialised services in return for professional charges.

45 | P a g e
 ECONOMICS - I

 Employment – The activity is based on a contract between the company and the
employee. Here, the employee performs duties for the company, and are paid
(wages or salary) in return.

 Characteristics

 There is a contract existing between the employer and the employee. Employee
performs according to assigned task. Remuneration is given to employees for
delivering value of services. An employee must abide by the rules and regulations
of the organization.
B. Profession
 Professions are those occupations which involve rendering of personal services of
a special and expert nature. A profession is something which is more than a job. It
is a career for someone who is competentin their respective areas. It includes
professional activities which are subject to guidelines or codes of conduct laid
down by professional bodies. Those engaged in a profession are called
professionals and they earn income by charging professional fee.
 Characteristics
 There should be a systematic body of knowledge. There should be formal
acquisition of knowledge by the members. There should be a code of conduct
governing the conduct and behaviour of professionals. Service motive should be
uppermost in the minds of people rendering professional service. 

C. Business

 Business refers to any human activity undertaken onaregular basis with the object
to earn profit through production, distribution, purchase and sale of goods and
services.

46 | P a g e
 ECONOMICS - I

 Business may be defined as “an activity involving regular production or purchase

of goods and services for sale, transfer and exchange with an object of earning
profit”. 
 According to James Stephenson business refers to “Economic activities
performed for earning profits.”
 According to H.Haney, “Business may be defined as a human activity directed
towards producing or acquiring wealth through buying and selling of goods”.
 Business activities are connected with raising, producing or processing of goods.
Industry creates form utility to goods by bringing materials into the form which is
useful for intermediate consumption (i.e., further use of material in order industry)
or final consumption by consumers. 

 Features / Characteristics of Economic activities

1. Income Generation

 All economic activities will generate some form of income. It is not compulsory
that such income is in monetary terms, it can be in different kinds. So, if the
activity is a form of livelihood for the person, and it generates him any form of
income then it is an economic activity. For example, a labourer who toils the land
and gets paid in crops, this is an economic activity.

 So when you employ any one of the factors of production (land, capital, labour,
entrepreneur) and in return earn an income in form of wages, salary, rent, royalty,
profit, etc, we will classify such an activity as an economic activity. For example,
rent earned on a property.

2. Productive in Nature

 If the activity is a means of livelihood it means it implies that there was some
element of the production process involved. So an economic activity must be

47 | P a g e
 ECONOMICS - I

productive in nature, it must involve some aspect of the production of goods

and/or services.

 Let us see some examples. A worker in a factory is producing goods, a software

engineer is providing services, a teacher also produces services. Similarly, farming
is an economic activity as again it helps in production.

 One point to note is that even if the production is for self-consumption it is still a
productive activity and so it is an economic activity. Because it will still add to the
overall supply of the market. Also, all other activities like warehousing,
transporting, etc which help bring the products to the market are also productive
economic activities.

3. Consumption is also an Economic Activity

 Consumption is the demand side of the market. It is what generates the production
and the supply of goods and services. The consumption of goods promotes
competition and introduction of better products in the market. So consumption
encourages production activities, so it is in itself an economic activity.

4. Savings, Investment, Wealth

 Savings is the income that is not spent. Such savings are invested in a variety of
instruments such as savings account, term deposits, the stock market, mutual
funds, real estate, gold, etc. So such investment turns to wealth. Then the private
and public companies borrow such monies to invest in their business and further
economic activities in the country.

 Classification of Business activities

 Business activities are classified on the basis of size, ownership and function.
1. Activities on the Basis of Size
48 | P a g e
 ECONOMICS - I

 On the basis of size, business activities may be broadly grouped into two
categories.
a. Small Scale
 Small scale units require less capital. They employ small number of workers and
produce the goods on small scale. Example: Manufacturing textiles in handlooms
or power looms.
 Extraction of edible oil from seeds like groundnut, sesame, through traditional
wooden churner.
b. Large Scale
 Large scale units require huge capital. They employ large number of workers and
produce the goods on large scale.
 Examples
 Manufacturing Textiles in a large Textile mill. Example. Raymonds, Ramraj
Cotton.
 Extraction of edible oil from oil seeds in oil mills. Example. Suffola, Sunflower
2. Activities on the Basis of Ownership
 On the basis of ownership business activities may be broadly grouped into three
categories.
a. Private Enterprises
 An enterprise is said to be a private enterprise where it is owned, managed and
controlled by persons other than Government.
 Sole proprietorship. Example - Sundar Stationeries
 Partnership firms. Example - Ramesh Bros.
b. Public Enterprises
 An enterprise is said to be a public enterprise where it is owned, managed and
controlled by Government or any of its agencies or both. Public enterprises may be
organized in several forms such as,
 Departmental undertaking - Public Works Department (PWD)

49 | P a g e
 ECONOMICS - I

 Public Corporation - Oil and Natural Gas Corporation (ONGC)

 Government Company - State Trading Corporation (STC)
C. Joint Enterprises
 An enterprise is said to be a joint enterprise where it is owned, managed and
controlled by Government and private entrepreneurs. Example - Maruti Suzuki 

3. Activities on the Basis of Function

 On the basis of functions, business activities may be broadly grouped into two
categories.

50 | P a g e
 ECONOMICS - I

a. Industry
 Industry includes all those business activities which are connected with raising,
producing or processing of consumer goods. Example - bread, butter, cheese,
shoes, or capital goods like machinery.
b. Commerce
 It establishes a link between the producers and consumers of goods and maintains
a smooth and uninterrupted flow of goods from producers to consumers.

 https://byjus.com/commerce/meaning-of-economic-and-non-economic-activities/
 https://www.toppr.com/guides/commercial-knowledge/business-and-commercial-
knowledge/what-are-economic-activities/
 https://www.economicshelp.org/microessays/equilibrium/elasticity-supply/
 https://prezi.com/r39asf1p9tgs/economic-activity/
 http://www.brainkart.com/article/Types-of-Economic-Activities_34823/

51 | P a g e
 ECONOMICS - I

UTILITY: MEANING AND TYPES

 Meaning of Utility:
 The want satisfying power of a commodity is called utility. It is a quality
possessed by a commodity or service to satisfy human wants. Utility can also be
defined as value-in-use of a commodity because the satisfaction which we get
from the consumption of a commodity is its value-in-use.

 Types of Utility:

52 | P a g e
 ECONOMICS - I

 Utility may take any of the following forms:

1. Form Utility:

 When utility is created and or

added by changing the shape or
form of goods, it is form utility.
When a carpenter makes a table
out of wood, he adds to the
utility of wood by converting it
into a more useful commodity
like furniture. He has created
form utility.

53 | P a g e
 ECONOMICS - I

2. Place Utility:

 When the furniture is taken from the factory to the shop for sale, it leads to place
utility. This is because it is transported from a place where it has no buyers to a
place where it fetches a price.
3. Time Utility:

 When a farmer stores his wheat after harvesting for a few months and sells it when
its price rises, he has created time utility and added to the value of wheat.
4. Service Utility:
 When doctors, teachers, lawyers, engineers, etc. satisfy human wants through their
services, they create service utility. It is acquired through specialized knowledge
and skills.

54 | P a g e
 ECONOMICS - I

5. Possession Utility:

 Utility is also added by changing the possession of a

commodity. A book on economic theory has little
utility for a layman. But if it is owned by a student
of economics, possession utility is created.
6. Knowledge Utility:
 When the utility of a commodity
increases with the increase in
knowledge about its use, it is the
creation of knowledge utility
through propaganda, advertisement,
etc.
7. Information Utility :
 Information utility is the
communication that companies
engage in with customers to
trigger buying activity and to
manage purchasing processes.
Companies use promotional
messages delivered through
advertising and public relations to
share company, product or service information. The goal is to attract interested

55 | P a g e
 ECONOMICS - I

buyers. Salespeople in a high-priced or complex business environment are also

important in answering customer questions and addressing concerns through the
sharing of information. Car dealerships, appliances stores and electric stores all
commonly rely on sales associates to share useful information with customers
8. Natural Utility:
 All free goods such as water, air, sunshine, etc., possess natural utility. They have
the capacity to satisfy our wants.

56 | P a g e
 ECONOMICS - I

 BASIC / CENTRAL PROBLEMS OF AN ECONOMICS

Central problems of an economics

 The problem of scarcity of resources which arises before an individual consumer also
arises collectively before an economy. On account of this problem and economy has
to choose between the following:
 Which goods should be produced and in how much quantity?
 What technique should be adopted for production?
 For whom goods should be produced?
 These main three problems are known as the central problems or the basic
problems of an economy. This is so because all other economic problems cluster
around these problems.
Production, distribution and disposition of goods and services are the basic
economic activities of life. In the course of these activities, every society has to
face scarcity of resources. Because of this scarcity, every society has to decide
how to allocate the scarce resources. It leads to following Central Problems of
an Economy.

57 | P a g e
 ECONOMICS - I

1. What to produce:

This problem involves selection of goods and services to be produced and the
quantity to be produced of each selected commodity Guiding Principle:
Allocate the resources in such a manner which gives maximum aggregate
satisfaction.

 This problem refers to the decisions regarding the selection of different

commodities and the quantities that need to be produced. Labor, land, machines,
capital, equipment, tools and natural means of resources are limited. So, it is not
possible to fulfill society's every demand. Therefore, it needs to be decided what
goods and services are required to be produced and what should be the quantity.
 Furthermore, the central problems of an economy also depend on the classification
of commodities based on their degree of necessity - luxury and essential. In an
economy, the produced goods are further classified into two segments, namely
consumer goods and producer goods or capital goods. Moreover, both these
segments are again divided into single use goods and durable goods.

58 | P a g e
 ECONOMICS - I

 What types of Goods to be produced for example, every economy needs to decide
on what consumer goods like rice, clothes, etc. And what producer goods like
tools, machinery, etc. Are required to be produced to meet demand adequately.
 How Much Amount of Goods to be produced. The next challenge is to decide, in
what quantity goods should be produced. It is an important aspect of any
economy, as proportionate distribution of resources for the production of different
goods to maximally satisfy wants is quintessential.
2. How to produce:
 This problem is about the choice of techniques that need to be adopted and used in
the production of goods and services. The two majorly - used techniques are

This problems refers to selection of technique to be used for production of goods

and services. Generally, techniques are classified as LIT & CIT.
Guiding Principle: Combine FOP in such a manner so that maximum output is
produced at minimum cost, using least possible scarce resources.

 LIT or Labor Intensive Techniques this technique is used with the help of more
number of labor and less involvement of capital.
 CIT or Capital Intensive Techniques on the other hand, the CIT technique involves
more capital involvement and less utilization of labor. For instance, footwear can
be manufactured either in factories where a large portion of manufacturing is
carried out by machines or by skilled teams of cobblers.
 DIY: In the Above Example, Which Option is Labor Intensive, and Which
Option is Capital Intensive?

59 | P a g e
 ECONOMICS - I

 The relative price and availability of labor and capital are the determining factors
while selecting the production technique. Moreover, some socio - economic
objectives also need to be fulfilled by choosing the techniques.
 Such objectives are providing employment and enhancing the standard of living in
society. For example, in countries like China, LIT is favored as an ample number
of labors are available. Contrarily, the United Kingdom will prefer CIT due to the
availability of capital and scarcity of labor.
3. For whom to produce:

This problem refers to selection of category of people who will ultimately

consume the goods, i.e. Whether to produce goods for more poor and less rich
or more rich and less poor. Guiding Principle: Ensure that urgent wants of each
productive factor are fulfilled to the maximum possible event.

 The third problem is the production should be made for whom and how
much because in any economy there are three classes person residing
 Poor class
 Middle class.
 Upper class
 Production should be made in such a way that each and every class of society gets
up to maximum what every they want.
 One of the most critical problems of the economy is to decide which commodities
shall be produced for which sections of society.

60 | P a g e
 ECONOMICS - I

 For instance, essential goods and services are in demand from all sections of
society, but only certain sections of society have a demand for luxury
commodities. At the same time, choices of goods and services rest on prevalent
tastes and preferences in an economy.
 Hence, considerations regarding the socio - economic conditions of a country or
market are highly pertinent to this problem.
 Lastly, it is important to know that other than resource allocation, central problems
of an economy have two more aspects - efficient utilization of the resource and
development of resources. Thus, to explain central problems of an economy, one
needs to delve into its core, i.e. Choices concerning the limited resources available
to maximize socio - economic utility.
4. How efficiently is the resource being utilized?
 Next, the society has to see whether the resources it owns are being utilized fully
or not. In case the resources of the economy are lying ideal, it has to find out ways
and means to utilize them fully. If the idleness of resources, say manpower, land
or capital is due to their mal - allocation, the society will have to adept such
monetary, fiscal or physical measures whereby this is corrected in an economy
where the available resources are being fully utilized, it is characterized by
techniques efficiency or full employment. To maintain it us this level, the
economy must always be increasing the output of some goods and services by
giving something of others.
5. Is the economy growing or stagnant?
 The last and the most important problem are to find out whether the resources of
the economy are growing through time or are stagnant. If the economy is stagnant
or growing slowly. Its growth should he accelerated through a higher rate of
capital formation which consists by adopting. More efficiency of production
techniques of through innovations.

61 | P a g e
 ECONOMICS - I

MARKET FORCES IN SOLVING ECONOMIC PROBLEMS

Solution to the Basic Economic Problems: Capitalistic, Socialistic and Mixed

Economy!

 Uneven distribution of natural

resources, lack of human
specialization and technological
advancement etc., hinders the
production of goods and services in
an economy. Every economy has to
face the problems of what to
produce, how to produce and for whom to produce. More or less, all the
economies use two important methods to solve these basic problems.

 HOW BASIC ECONOMIC PROBLEMS ARE SOLVED IN DIFFERENT

ECONOMIES
 Factors of Production
 There are 4 factors of Production;
1. Land
2. Labour
3. Capital
4. Organisation / Entrepreneur
 On the basis of ownership of these factors of production, economies are
classified into;
1. Capitalist Economy
2. Socialist Economy
3. Mixed Economy

62 | P a g e
 ECONOMICS - I

 Basic Economic Problems

1. What to Produce?
2. How to Product?
3. For whom to Produce?
 We are trying to understand how these basic economic problems are solved in
these 3 types of economies.
1. Capitalist Economy- factors of production are owned and controlled by private
individuals. • Eg: USA
2. Socialist Economy- factors of production are owned and controlled by state or
government. • Eg: China

3. Mixed Economy- co-existence of private and public sectors. • Eg: India

 However, how a capitalist, a socialist and a mixed economic system solve their
basic problems is given below:

1. Solution to Basic Problems in a Capitalistic Economy:

 Capitalist Economy deals with economic problem through price mechanism.

 Price Mechanism: It is a system where price is determined by the interaction of
market forces and it is adjusted automatically.
 Prices play a key role in directing the activities of producers, consumers and
resources suppliers.
 There are two components of price mechanism: prices and market.
 Price: determined by the forces of demand and supply.
 Market: goods market and factor market.
 Price mechanism acts as the coordinating agency.
 Economic decisions are taken and implemented through price mechanism.

63 | P a g e
 ECONOMICS - I

 Under capitalistic economy, allocation of various resources takes place with the
help of market mechanism. Price of various goods and services including the price
of factors of production are determined with help of the forces of demand and
supply. Free price mechanism helps producers to decide what to produce.

 The goods which are more in demand and on which consumers can afford to spend
more, are produced in larger quantity than those goods or services which have
lower demand. The price of various factors of production including technology
helps to decide production techniques or methods of production. Rational producer
intends to use those factors or techniques which has relatively lower price in the
market.
 Factor earnings received by the employers of factors of production decides
spending capacity of the people. This helps producers to identify the consumers
for whom goods could be produced in larger or smaller quantities. Price
mechanism works well only if competition exists and natural flow of demand and
supply of goods is not disturbed artificially.
1. What to Produce?
 The consumer is supreme.
 The basic objective of the producers is to earn maximum profits.
 Producers will like to produce those goods and services which yield higher profits.
 An increase in the demand for a particular commodity will lead to a rise in its
price. A rise in the price of a commodity, given the cost of production, will lead to
more profits.
2. How to Produce?

 The basic objective of the producers is to earn maximum profits.

 A producer must minimize the cost of production.
 The cost of a technique of production is determined by the prices of inputs and the
input prices are determined by price mechanism in the factor market.
 The producer chooses that technique of production which is least costly.
64 | P a g e
 ECONOMICS - I

65 | P a g e
 ECONOMICS - I

3. For whom to Produce?

 Distribution of total output of goods and services depends upon the distribution of
income.
 As a result of this unequal distribution of income, the distribution of goods is also
very much unequal.
 The rich people get a larger share of the national product.
 The poor people with low incomes receive a smaller share of the national product.

2. Solution to Basic Problems in a Socialistic Economy:

 Socialist economy is an economic system wherein all the means of production are
controlled by state or planning authority and social welfare is the only objective.
 All the decisions including economic aspects are taken by public authority.

 Under socialistic economy, the government plays an important role in decision

making. The government undertakes to plan, control and regulate all the major
economic activities to solve the basic economic problems. All the major economic
policies are formulated and implemented by the Central Planning Authority.

 In India, Planning Commission was entrusted with this task of planning. The
Planning Commission of India has now been replaced by another central authority
NITI Ayog (National Institution for Transforming India). Therefore, the central
planning authority takes the decisions to overcome the economic problems of what
to produce, how to produce and for whom to produce.

 The central planning authority decides the nature of goods and services to be
produced as per available resources and the priority of the country. The allocation
of resources is made in greater volume for those goods which are essential for the
nation. The state’s main objectives are growth, equality and price stability. The
66 | P a g e
 ECONOMICS - I

government implements fiscal policies such as taxation policy, expenditure policy,

public debt policy or policy on deficit financing in order to achieve the above
objectives.

 The methods of production or production techniques are also determined or

selected by the central planning authority. The central planning authority decides
whether labor intensive technique or capital intensive technique is to be used for
the production. While deciding the appropriate method, social and economic
conditions of the economy are taken into consideration.

 Under socialistic economy, every government aims to achieve social justice

through its actions. All economic resources are owned by the government. People
can work for wages which are regulated by the government as per work efficiency.
The income earned determines the aggregate demand in an economy. This helps
the government in assessing the demand of goods and services by different income
groups.
 Basic economic problems are solved here through economic planning.
1. What to Produce?
 Planning authority makes an estimation of the available economic and human
resources.
 It estimates the requirement of the economy for various goods and services.
 It evaluates the needs of the people and the national priorities.
 It makes necessary arrangements for adequate amount of commodities to be made
available to the people.
2. How to Produce?
 It considers the economic efficiency of the techniques and the social objectives
and development goals.
 The country has to ensure that economic resources are fully utilised.
3. For whom to Produce?

67 | P a g e
 ECONOMICS - I

 All productive resources are owned by the government.

 People work only as labours and earn income in the form of wages only.
 a skilled worker gets higher wages than an unskilled worker.
 Administered price mechanism operates in a socialist economy.
 The government also distributes various goods, particularly essential goods at
fixed or controlled prices through ration shops or fair price shops.

3. Solution to Basic Problems in a Mixed Economy:

 Mixed economy is an economic system wherein all the economic decisions are
taken by both state and private sector.
 The objective is to earn profit with maximising social welfare.
 Government and private together solve the central problems in mixed economy.
 The government takes decisions to maximise social welfare while the private
sector aims at maximising profits.

 Practically, neither capitalistic economy nor socialistic economy exists in totality.

Both the economic systems have limitations. Consequently, a new system of
economy has emerged as a blend of the above two systems called mixed economy.
Therefore, mixed economy is defined as a system of economy where private
sectors and public sectors co-exist and work side by side for the welfare of the
country.

 Under such economies, all economic problems are solved with the help of free
price mechanism and controlled price mechanism (economic planning).

 Free price mechanism operates within the private sector; hence, prices are allowed
to change as per demand and supply of goods. Therefore, private sector can
produce goods as per their demand and their price in the market. The government

68 | P a g e
 ECONOMICS - I

may control and regulate production of the private sector through its monetary
policy or fiscal policy.

69 | P a g e
 ECONOMICS - I

1. What to Produce?
 Consumers’ preferences influence the production decisions of the firms.
 Production in the private sector is also controlled and regulated by the government
through the monetary, fiscal and price control policies.
 In the public sector, it is the planning authority that decides what to produce and
how much to produce keeping in mind the overall national objectives.
 There will be fiscal policy and monetary policy.
2. How to Produce?
 In the private sector it is the price mechanism that solves the problem of how to
produce.
 Firms will choose the method of production on the basis of factor prices. Profit
motive motivates them to choose the least costly or the most efficient technique of
production.
 In the public sector, the problem of how to produce is solved by the planning
authority and the government.
 The planning authority is influenced not only by the input prices, but also by the
objectives of generating more employment opportunities, promoting economic
growth, etc.
3. For whom to Produce?
 The decision for whom to produce is taken by the government.
 The main objective of the government is that adequate quantity of necessities
must be produced.
 The government controls production in the private sector as well to achieve
this objective so as to ensure the availability of necessities.

70 | P a g e