Eco I Uni 1 Model Paper Eco I Uni 1 Model Paper

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Eco I Uni 1 Model Paper
Economics (Karnataka State Law University)
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Unit 1
Model Paper based on previous years’ question papers
16 markers
1. What is demand? Explain the determinants of demand.
Synopsis:
Introduction – Determinants of demand – Conclusion
Introduction
Demand may be defined as the amount of the commodity an individual is willing to buy at a particular
price and at a particular time.
q = f(p) It means quantity demanded is a function of Price
Here q= quantity demanded and P = price of the commodity.
The relationship between demand and Price can be understood by the following table:
The above table represented in the form of graph is called Demand curve.

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Thus we can see that other factors remaining constant price of a product and its quantity demanded is
inversely related. This relation is called the law of demand.
Determinants of Demand
Demand is a multivariate function. It is determined by many variables. Traditionally the most important
determinants of the market demand are considered to be the price of the commodity in question, the
prices of other commodities, consumers’ income and tastes. Apart from these factors, demand is affected
by numerous other factors such as distribution of income, total population and its composition, wealth,
credit availability and habits.
1. Income of the consumer:
A consumer’s demand is influenced by the size of his income. With increase in the level of income, there
is increase in the demand for goods and services. A rise in income causes a rise in consumption. As a
result, a consumer buys more. For most of the goods, the income effect is positive. But for the inferior
goods, the income effect is negative. That means with a rise in income, demand for inferior goods may
fall.
2. Price of the commodity:
Price is a very important factor, which influences demand for the commodity. Generally, demand for the
commodity expands when its price falls, in the same way if the price increases, demand for the
commodity contracts. It should be noted that it might not happen, if other things do not remain constant.
3. Changes in the prices of related goods:
Sometimes, the demand for a good might be influenced by prices changes of other goods. There are two
types of related goods. They are substitutes and complements. Tea and Coffee are good substitutes. A rise
in the price of coffee will increase the demand for tea and vice versa. Bread and butter are complements.
A fall in the price of bread will increase the demand for butter and vice versa.
4. Tastes and preferences of the consumers:
Demand depends on people’s tastes, preferences, habits and social customs. A change in any of these
must bring about a change in demand. For example, if people develop a taste for tea in place of coffee, the
demand for tea will increase and that for coffee will decrease.
5. Change in the distribution of income:
If the distribution of income is unequal, there will be many poor people and few rich people in society.
The level of demand in such a society will be low. On the other hand, if there is equitable distribution of
income, the demand for necessaries commonly consumed by the poor will increase and the demand for
luxuries consumed by the rich will decrease. However, the net effect of an equitable distribution of
income is an increase in the level of demand.
6. Price expectations:
Expectations of people regarding the future prices of goods also influence their demand. If people
anticipate a rise in the prices of goods in future due to some reasons, the demand for goods will rise to
avoid more prices in future. Contrarily, if the people expect a fall in price, the demand for the commodity
will fall.

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7. State of economic activity:

The state of economic activity is major determinant influencing the demand for a commodity. During the
period of boom, prosperity prevails in the economy. Investment, employment and income increase. The
demand for both capital goods and consumer goods increase. But in period of depression demand declines
due to low investment and low income.
The level of demand for a commodity is also influenced by other factors like population, composition of
population, taxation policy of the government, advertisement, natural calamities, pattern of saving,
inventions and discoveries and outbreak of war, emergencies, weather, technical progress etc.
Conclusion
These are some of the determinants of demand. But of these determinants of demand, price of the product
is regarded as the most important determinant.
2. State the law of supply with an illustration and diagram.

Synopsis:
Introduction – Law of Supply – Conclusion.
Introduction
Supply is the quantity of a product that a producer is willing and able to supply onto the market at a given
price in a given time period.
Law of Supply
The law of supply expresses the relationship between the supply and price of a product. It states the direct
relationship between the price of a product and its supply while other factors are kept constant. The law of
supply can be stated as “other things remaining the same, the supply of a commodity expands with the
rise in price and contracts with the fall in price.”
The concept of law of supply can be explained with the help of a supply schedule and a supply curve.
Supply Schedule
Supply schedule represents the relationship between prices and the quantities that the firms are willing to
produce and supply. In other words, at what price, how much quantity a firm wants to produce and
supply.
Suppose the following is an individual’s supply schedule of oranges.
Table 1
Price Per Dozen ($) Quantity Supplied (in dozens)

4 3
6 6
8 9

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Price Per Dozen ($) Quantity Supplied (in dozens)

10 12
12 13
The supply curve is a graphical representation of the law of supply. The supply curve has a positive slope,
and it moves upwards to the right. This curve shows that at the price of $6, six dozens will be supplied
and at the higher price $12, a larger quantity of 13 dozens will be supplied.
Conclusion
The law of supply states that other things being equal, the supply of a commodity extends with a rise in
price and contracts with a fall in price. There are however a few exceptions to the law of supply, viz.,
Exceptions of a fall in price, Sellers who are in need of cash, When leaving the industry, Agricultural
output and Backward sloping supply curve of labour.
3. What is cost? Explain cost of production in short period and long period through cost curves.
Synopsis:
Introduction – Short run Cost and Long run costs in traditional theory – Short run and long run concepts
in modern theory – Conclusion.
Introduction
Cost of production refers to the total sum of money needed for the production of a particular quantity of
output. When commodities and services are produced, various expenses have to be incurred, e.g.,
purchase of raw materials, payment to labour, landlord, capitalist, etc. The sum total of the expenses
incurred plus the normal profit expected by the producer is called the cost of production.
Short run is the time period when there is only one variable factor and all the factors are kept constant,
whereas, long run is the time period when all the factors of production are variable.
Traditional theory of Cost
Short-run Cost

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Total Fixed Cost: It refers to the total obligations incurred by the firm per unit of time for all fixed inputs.
Total Variable Cost:the total obligations incurred by the firm per unit of time for all the variable input it
uses.
Total cost = TFC + TVC
TFC is a straight line parallel to the output axis. The TVC has an inverse S- shape which reflects the law
of variable proportions. TC is also inverse S-shaped.
Short-Run Average Costs:

In the short run analysis of the firm, average costs are more important than total costs. The short-run
average costs of a firm are the average fixed costs, the average variable costs, and the average total costs.
1. Average Fixed Costs or AFC
AFC equal total fixed costs at each level of output divided by the number of units produced:
AFC = TFC /Q
The average fixed costs diminish continuously as output increases. This is natural because when constant
total fixed costs are divided by a continuously increasing unit of output, the result is continuously
diminishing average fixed costs. Thus the AFC curve is a downward sloping curve which approaches the
quantity axis without touching it, as shown in Figure 3. It is a rectangular hyperbola.
2. Short-Run Average Variable Costs (or SAVC)
SAVC equals total variable costs at each level of output divided by the number of units produced:
SAVC = TVC/Q
The average variable costs first decline with the rise in output as larger quantities of variable factors is
applied to fixed plant and equipment. But eventually they begin to rise due to the law of diminishing
returns. Thus the SAVC curve is U-shaped, as shown in Figure 3.

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3. Short-Run Average Total Costs (or SATC or SAC)

They are arrived at by dividing the total costs at each level of output by the number of units produced:
SAC or SATC = TC/Q TFC/Q + TVC/Q = AFC+ AVC
Average total costs reflect the influence of both the average fixed costs and average variable costs. At
first average total costs are high at low levels of output because both average fixed costs and average
variable costs are large. But as output increases, the average total costs fall sharply because of the steady
decline of both average fixed costs and average variable costs till they reach the minimum point.
This results from the internal economies, from better utilization of existing plant, labour, etc. The
minimum point В in the figure represents optimal capacity. The rising portion of the SAC curve results
from producing above capacity and the appearance of internal diseconomies of management, labour, etc.
Thus the SAC curve is U- shaped due to the operation of the law of variable proportions, as shown in
Figure 3.
4. Short Run Marginal Cost:
A fundamental concept for the determination of the exact level of output of a firm is the marginal cost.
Marginal cost is the addition to total cost by producing an additional unit of output:
SMC = ∆ТС/∆Q
Algebraically, MCn= TCn- TCn-1. Since total fixed costs do not change with output, therefore, marginal
fixed cost is zero. So marginal cost can be calculated either from total variable costs or total costs. The
result would be the same in both the cases. As total variable costs or total costs first fall and then rise,
marginal cost also behaves in the same way. The SMC curve is also U-shaped, as shown in Figure 3.
Relationship between the cost curves
1. The minimum point of ATC curve lies to the right of the minimum point of AVC curve.
2. The MC curve cuts AVC and ATC curves at their lowest points.
Long-run Cost Curves of the traditional theory
Long –run AC curve:

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Long-run cost curve is a planning curve. It is a guide to the entrepreneur in his decision to plan the future
expansion of his output. The long-run AC curve is derived from the short-run cost curves. Each point on
the LAC corresponds to a point on a short-run cost curve, which is tangent to the LAC at that point. The
point of tangency occurs to the falling part of the SAC curves for the points lying to the left of M the
point of tangency occurs to the rising portion of SAC curves for points lying to the right of M. Only at the
minimum point M of the LAC is the corresponding SAC also at a minimum. Each point of LAC shows
the minimum cost for producing the corresponding level of output. In the traditional theory of the firm,
the LAC curve is U-shaped and it is often called the ‘envelope curve’ because it envelopes the SRC
curves. The U- shape of the LAC curve reflects the laws of returns to scale. The U-shaped LAC curve
implies that each plant size is designed to produce optimally a single level of output. The plant is
completely inflexible. Any departure leads to increasing costs. There is no reserve capacity.
Long-run MC curve:
The long-run MC is derived from the SRMC curves. The LRMC is formed from the points of intersection
of the SRMC curves with vertical lines drawn from the points of tangency of the corresponding SAC
curve and the LAC curve. The LMC must be equal to SMC for the output at which the corresponding
SAC is tangent to LAC.

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Modern Cost Theory

As early as 1939, George Stigler, suggested that the short-run AVC has a flat stretch over a range of
output which reflects the fact that firms build plants with some flexibility in their productive capacity.
Short-run Cost curves
Here also, AFC is a rectangular hyperbola but it has some reserve capacity.
The SAVC curve in modern theory has a saucer-type shape, i.e., it is broadly U-shaped but has a flat
stretch over a range of output, corresponding to the built-in-the-plant reserve capacity. Over this stretch,
the SAVC is equal to the MC, both being constant per unit of output. To the left of the flat stretch, MC
lies below the SAVC while to the right of the flat stretch the MC rises above the SAVC.
The reserve capacity makes it possible to have constant SAVC within a certain range of output. It should
be clear that this reserve capacity is planned in order to give the maximum flexibility in the operation of
the firm.X1X2 reflects the planned reserve capacity which does not lead to increase in costs. On an
average the entrepreneur expects to operate his plant within X 1X2 range.
ATC is obtained by adding the AFC and AVC at each level of output. The ATC curve falls continuously
up to the level of output X 2 at which the reserve capacity is exhausted. Beyond that level ATC will start
rising. The MC will intersect the ATC at its minimum point.
Long-run cost Curves

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The long-run costs in the modern cost theory may be classified into production costs and managerial
costs. All costs are variable in the long run and they give rise to a long-run cost curve which is roughly L-
shaped. The production costs fall continuously with increases in output. At very large scales of output
managerial costs may rise. But the fall in production costs more than offsets the increase in the
managerial costs so that the LAC curve falls smoothly or becomes flat at very large scales of output,
thereby giving rise to the L-shape of the LAC curve.
This curve does not turn up at very large scales of output It does not envelope the SAC curves but
intersects them at the optimal level of output of each plant.
In the modern theory of costs, if the LAC curve falls smoothly and continuously even at very large scales
of output, the LMC curve will lie below the LAC curve throughout its length, as shown in the Figure.
If the LAC curve is downward sloping up to the point of a minimum optimal scale of plant or a mini mum
efficient scale (MES) of plant beyond which no further scale economies exist, the LAC curve becomes
horizontal. In this case, the LMC curve lies below the LAC curve until the point M is reached, and
beyond this point the LMC curve coincides with the LA С curve, as shown in the Figure below.

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4. What is demand? State the law of demand with an illustration and diagram.
OR
Explain the law of demand with the help of a schedule and curves.
Synopsis:
Introduction: Meaning and definition of demand – Law of Demand – Exceptions to the law of demand –
Conclusion.
Introduction
The demand for a commodity is essentially consumer’s attitude and reaction towards that commodity.
Precisely stated, the demand for a commodity is the amount of that commodity an individual will
purchase or willing to take off from the market at various given prices in a given period of time. Thus,
demand in economics implies both the desire to purchase and the ability to pay for a good. A mere desire
for a commodity does not constitute demand for it, if it is not backed by the ability to pay.
Demand for a good is determined by several factors such as price of the commodity, tastes and desires of
the consumer for a commodity, income of the consumer, and the prices of related goods – substitutes or
complements, price expectations, state of economic activity etc.
Demand might be represented by a linear demand function such as
Q(d) = a - bP
Q(d) represents the demand for a good
P represents the price of that good.
The Law of Demand
The law of demand expresses the functional relationship between price and quantity of the commodity
demanded. According to the law of demand, other things being equal, if the price of a commodity

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falls, the quantity demanded of it will rise and if the price of the commodity rises, its quantity
demanded will increase. Thus, according to the law of demand, there is an inverse relationship between
price and quantity demanded, other things remaining the same (ceteris paribus).
The law of demand can be explained with a demand schedule and a demand curve. A demand schedule is
represented in the table given below. It can be seen from this demand schedule that when the price of the
commodity X is Rs.12, the quantity demanded of X is 10, when price falls to Rs.10, the quantity
demanded increases to 20 and so on. We can convert this demand schedule into a demand curve
graphically by plotting the various price-quantity combinations. This has been done in the figure below
where we plot price along the Y- axis and quantity demanded along the X- axis.
Price Quantity Demanded
12 10
10 20
8 30
6 40
4 50
2 60
14
12
10
8
price
0
0 10 20 30 40 50 60 70
Quantity
The demand curve is a graphic representation of quantities of a good which will be demanded by the
consumer at various possible prices at a given moment of time. The downward sloping demand curve is

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in accordance with the law of demand, which describes an inverse relationship between price and
demand.
By summing up the various quantities demanded by all the consumers in the market at various prices we
get the market demand and its graphical representation is the market demand curve which also slopes
downward to the right as it is the lateral summation of individual demand curves.
Exceptions to the Law of Demand:
As a general rule, demand curve slopes downwards, showing the inverse relationship between price and
quantity demanded. However, in certain special circumstances, the reverse may occur, i.e. a rise in price
may increase the demand. These circumstances are known as ‘Exceptions to the Law of Demand’.
Some of the Important Exceptions are:
1. Giffen Goods:
A Giffen good is a good for which demand increases as the price increases, and falls when the price
decreases. A Giffen good has an upward-sloping demand curve, which is contrary to the fundamental law
of demand which states that quantity demanded for a product falls as the price increases, resulting in a
downward slope for the demand curve. A Giffen good is typically an inferior product that does not have
easily available substitutes, as a result of which the income effect dominates the substitution effect. Giffen
goods are quite rare, to the extent that there is some debate about their actual existence. The term is
named after the economist Robert Giffen.
The most commonly cited example of a Giffen good is that of the Irish potato famine in the 19 th century.
During the famine, as the price of potatoes rose, impoverished consumers had little money left for more
nutritious but expensive food items like meat (the income effect). So even though they would have
preferred to buy more meat and fewer potatoes (the substitution effect), the lack of money led them to buy
more potatoes and less meat. In this case, the income effect dominated the substitution effect, a
characteristic of a Giffen good.
2. Goods having Prestige Value: Veblen Effect:
One exception to the law of demand is associated with the name of the economist, Thorstein Veblen who
propounded the doctrine of conspicuous consumption. According to Veblen, some consumers measure
the utility of a commodity entirely by its price i.e., for them, the greater the price of a commodity, the
greater its utility.
For example, diamonds are considered as a prestige good in the society and for the upper strata of the
society the higher the price of diamonds, the higher the prestige value of them and therefore the greater
utility or desirability of them. Some consumers will buy less of the diamonds at a lower price because
with the fall in price its prestige value goes down. On the other hand, when price of diamonds goes up,
their prestige value goes up and therefore their utility or desirability increases. As a result at a higher price
the quantity demanded of diamonds by a consumer will rise. This is called Veblen effect. Besides
diamonds, other goods such as mink coats, luxury cars have prestige value and Veblen effect works in
their case too.
3. Fear of Shortage:

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If the consumers expect a shortage or scarcity of a particular commodity in the near future, then they
would start buying more and more of that commodity in the current period even if their prices are rising.
The consumers demand more due to fear of further rise in prices. For example, during emergencies like
war, famines, etc., consumers demand goods even at higher prices due to fear of shortage and general
insecurity.
4. Ignorance:
Consumers may buy more of a commodity at a higher price when they are ignorant of the prevailing
prices of the commodity in the market.
5. Fashion related goods:
Goods related to fashion do not follow the law of demand and their demand increases even with a rise in
their prices. For example, if any particular type of dress is in fashion, then demand for such dress will
increase even if its price is rising.
6. Necessities of Life:
Another exception occurs in the use of such commodities, which become necessities of life due to their
constant use. For example, commodities like rice, wheat, salt, medicines, etc. are purchased even if their
prices increase.
7. Change in Weather:
With change in season/weather, demand for certain commodities also changes, irrespective of any change
in their prices. For example, demand for umbrellas increases in rainy season even with an increase in their
prices. It must be noted that in normal conditions and considering the given assumptions, ‘Law of
Demand’ is universally applicable.
Conclusion
Thus the demand for a commodity varies inversely with price provided other factors which determine
demand remains the same. But there are also some exceptions to it.
5. What is cost? What are the various concepts of cost?

Synopsis:
Introduction – Concepts of Cost – Conclusion.
Introduction
Cost of production refers to the total sum of money needed for the production of a particular quantity of
output.
When commodities and services are produced, various expenses have to be incurred, e.g., purchase of
raw materials, payment to labour, landlord, capitalist, etc. The sum total of the expenses incurred plus the
normal profit expected by the producer is called the cost of production. The various concepts of cost are
discussed below:

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Nominal Cost and Real Cost:
Nominal cost is the money cost of production. The real costs of production are the pain and sacrifices of
labour involved in the process of production.
Explicit and Implicit costs:
Explicit costs are the accounting costs or contractual cash payments which the firm makes to other factor
owners for purchasing or hiring the various factors. Implicit costs are the costs of self-owned factors
which are employed by the entrepreneur in his own business. These implicit costs are the opportunity
costs of the self-owned and self-employed factors of the entrepreneur, that is, the money incomes which
these self-owned factors would have earned in their next best alternative uses.
Accounting Costs and Economic Cost:
Accounting costs are the actual or explicit costs which are paid by the entrepreneurs to the owners of
hired factors and services. On the other hand, economic costs not only include the explicit costs but also
the implicit costs of the self-owned factors or resources which are used by the entrepreneur in his own
business.
Opportunity Cost:
The opportunity cost (or transfer earnings) of any good is the expected return from the next best
alternative good that is forgone or sacrificed. For example, if a farmer who is producing wheat can also
produce potatoes with the same factors. Then, the opportunity cost of a quintal of wheat is the amount of
output of potatoes given up.
Business Cost and Full Cost:
Business costs include all the expenses which are incurred in carrying out a business. The concept of
business cost is similar to the accounting or actual cost. The concept of Full cost includes two other costs:
the opportunity cost and normal profit. Normal profit is a necessary minimum earning which a firm must
get to remain in its present occupation.
Private costs and Social Costs:
Private costs are the economic costs which are actually incurred or provided for by an individual or a
firm. It includes both explicit and implicit costs. Social cost, on the other hand, implies the cost which a
society bears as a result of production of a commodity. Social cost includes both private cost and the
external cost. External cost includes (a) the cost of free goods or resources for which the firm is not
required to pay for its used, e.g., atmosphere, rivers, lakes etc. (b) the cost in the form of ‘disutility’
caused by air, water, and noise pollution, etc.
Total, Average and Marginal Costs:
Total cost refers to the total outlays of money expenditure, both explicit and implicit on the resources
used to produce a given output. Average cost is the cost per unit of output which is obtained by dividing
the total cost (TC) by the total output (Q), i.e., TC/Q = average cost. Marginal cost is the addition made to

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the total cost as a result of producing one additional unit of the product. Marginal cost is defined as ∆TC/
∆Q.
Fixed Costs and Variable Costs:
Fixed costs are the expenditure incurred on the factors such as capital, equipment, plant, factory building
which remain fixed in the short run and cannot be changed. Therefore, fixed costs are independent of
output in the short run i.e., they do not vary with output in the short run. Even if no output is produced in
the short run, these costs will have to be incurred. Variable costs are costs incurred by the firms on the
employment of variable factors such as labour, raw materials, etc., whose amount can be easily increased
or decreased in the short run. Variable costs vary with the level of output in the short run. If the firm
decided not to produce any output, variable costs will not be incurred.
Sunk costs:
Expenditure that has been incurred and cannot be recovered is called sunk cost. E.g., painting a building.
Short run and Long run Costs:

Short run is the time period when there is only one variable factor and all the factors are kept constant,
whereas, long run is the time period when all the factors of production are variable.
Traditional theory of Cost
Short-run Cost
Total Fixed Cost: It refers to the total obligations incurred by the firm per unit of time for all fixed inputs.
Total Variable Cost:the total obligations incurred by the firm per unit of time for all the variable input it
uses.
Total cost = TFC + TVC
TFC is a straight line parallel to the output axis. The TVC has an inverse S- shape which reflects the law
of variable proportions. TC is also inverse S-shaped.
Short-Run Average Costs:

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In the short run analysis of the firm, average costs are more important than total costs. The short-run
average costs of a firm are the average fixed costs, the average variable costs, and the average total costs.
1. Average Fixed Costs or AFC
AFC equal total fixed costs at each level of output divided by the number of units produced:
AFC = TFC /Q
The average fixed costs diminish continuously as output increases. This is natural because when constant
total fixed costs are divided by a continuously increasing unit of output, the result is continuously
diminishing average fixed costs. Thus the AFC curve is a downward sloping curve which approaches the
quantity axis without touching it, as shown in Figure 3. It is a rectangular hyperbola.
2. Short-Run Average Variable Costs (or SAVC)
SAVC equals total variable costs at each level of output divided by the number of units produced:
SAVC = TVC/Q
The average variable costs first decline with the rise in output as larger quantities of variable factors is
applied to fixed plant and equipment. But eventually they begin to rise due to the law of diminishing
returns. Thus the SAVC curve is U-shaped, as shown in Figure 3.
3. Short-Run Average Total Costs (or SATC or SAC)

They are arrived at by dividing the total costs at each level of output by the number of units produced:
SAC or SATC = TC/Q TFC/Q + TVC/Q = AFC+ AVC
Average total costs reflect the influence of both the average fixed costs and average variable costs. At
first average total costs are high at low levels of output because both average fixed costs and average
variable costs are large. But as output increases, the average total costs fall sharply because of the steady
decline of both average fixed costs and average variable costs till they reach the minimum point.
This results from the internal economies, from better utilization of existing plant, labour, etc. The
minimum point В in the figure represents optimal capacity. The rising portion of the SAC curve results
from producing above capacity and the appearance of internal diseconomies of management, labour, etc.

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Thus the SAC curve is U- shaped due to the operation of the law of variable proportions, as shown in
Figure 3.
4. Short Run Marginal Cost:
A fundamental concept for the determination of the exact level of output of a firm is the marginal cost.
Marginal cost is the addition to total cost by producing an additional unit of output:
SMC = ∆ТС/∆Q
Algebraically, MCn= TCn- TCn-1. Since total fixed costs do not change with output, therefore, marginal
fixed cost is zero. So marginal cost can be calculated either from total variable costs or total costs. The
result would be the same in both the cases. As total variable costs or total costs first fall and then rise,
marginal cost also behaves in the same way. The SMC curve is also U-shaped, as shown in Figure 3.
Relationship between the cost curves
1. The minimum point of ATC curve lies to the right of the minimum point of AVC curve.
2. The MC curve cuts AVC and ATC curves at their lowest points.
Long-run Cost Curves of the traditional theory
Long –run AC curve:
Long-run cost curve is a planning curve. It is a guide to the entrepreneur in his decision to plan the future
expansion of his output. The long-run AC curve is derived from the short-run cost curves. Each point on
the LAC corresponds to a point on a short-run cost curve, which is tangent to the LAC at that point. The
point of tangency occurs to the falling part of the SAC curves for the points lying to the left of M the
point of tangency occurs to the rising portion of SAC curves for points lying to the right of M. Only at the
minimum point M of the LAC is the corresponding SAC also at a minimum. Each point of LAC shows
the minimum cost for producing the corresponding level of output. In the traditional theory of the firm,
the LAC curve is U-shaped and it is often called the ‘envelope curve’ because it envelopes the SRC
curves. The U- shape of the LAC curve reflects the laws of returns to scale. The U-shaped LAC curve
implies that each plant size is designed to produce optimally a single level of output. The plant is
completely inflexible. Any departure leads to increasing costs. There is no reserve capacity.

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Long-run MC curve:
The long-run MC is derived from the SRMC curves. The LRMC is formed from the points of intersection
of the SRMC curves with vertical lines drawn from the points of tangency of the corresponding SAC
curve and the LAC curve. The LMC must be equal to SMC for the output at which the corresponding
SAC is tangent to LAC.
Modern Cost Theory
As early as 1939, George Stigler, suggested that the short-run AVC has a flat stretch over a range of
output which reflects the fact that firms build plants with some flexibility in their productive capacity.
Short-run Cost curves
Here also, AFC is a rectangular hyperbola but it has some reserve capacity.
The SAVC curve in modern theory has a saucer-type shape, i.e., it is broadly U-shaped but has a flat
stretch over a range of output, corresponding to the built-in-the-plant reserve capacity. Over this stretch,
the SAVC is equal to the MC, both being constant per unit of output. To the left of the flat stretch, MC
lies below the SAVC while to the right of the flat stretch the MC rises above the SAVC.

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The reserve capacity makes it possible to have constant SAVC within a certain range of output. It should
be clear that this reserve capacity is planned in order to give the maximum flexibility in the operation of
the firm.X1X2 reflects the planned reserve capacity which does not lead to increase in costs. On an
average the entrepreneur expects to operate his plant within X 1X2 range.
ATC is obtained by adding the AFC and AVC at each level of output. The ATC curve falls continuously
up to the level of output X 2 at which the reserve capacity is exhausted. Beyond that level ATC will start
rising. The MC will intersect the ATC at its minimum point.
Long-run cost Curves

The long-run costs in the modern cost theory may be classified into production costs and managerial
costs. All costs are variable in the long run and they give rise to a long-run cost curve which is roughly L-
shaped. The production costs fall continuously with increases in output. At very large scales of output
managerial costs may rise. But the fall in production costs more than offsets the increase in the
managerial costs so that the LAC curve falls smoothly or becomes flat at very large scales of output,
thereby giving rise to the L-shape of the LAC curve.
This curve does not turn up at very large scales of output It does not envelope the SAC curves but
intersects them at the optimal level of output of each plant.
In the modern theory of costs, if the LAC curve falls smoothly and continuously even at very large scales
of output, the LMC curve will lie below the LAC curve throughout its length, as shown in the Figure.

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If the LAC curve is downward sloping up to the point of a minimum optimal scale of plant or a mini mum
efficient scale (MES) of plant beyond which no further scale economies exist, the LAC curve becomes
horizontal. In this case, the LMC curve lies below the LAC curve until the point M is reached, and
beyond this point the LMC curve coincides with the LA С curve, as shown in the Figure below.
6. Discuss the scarcity definition of economics.

Synopsis:
Introduction – Scarcity Definition – Its Merits – Criticisms – Conclusion
Introduction
Economics is the study of how people choose to use resources. Economics is a social science that studies
how rational individuals, groups, and organizations (called economic actors, players, or agents), manage
scarce resources which have alternative uses, to achieve desirable ends.
The term economics comes from the ancient Greek word (oikonomia, "management of a household,
administration") oikos, meaning "house" and nomos, meaning "custom" or "law", hence "rules of the
house (hold)".
There is no one definition of Economics which has a general acceptance.
Scarcity Definition

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Marshall’s definition of economics remained an article of faith with all economists from 1830 to 1932.
However, with the publication of Robbins book 'Nature and Significance of Economic Science' (1932),
there developed a fresh controversy in regard to the definition of economics. Lionel Robbins, after
criticizing the definitions given by the Classical and Neo-classical economists, gave his own definition of
Economics. Lionel Robbins claiming his definition Economics precise, scientific and superior, defines
Economics in his book ‘Nature and Significance of Economic Science' (Published in 1932):
"A science which studies human behaviour as a relationship between ends and scarce means which have
alternative uses".
This definition is based on the following four pillars:
(i) The Human wants or ends are unlimited: Human wants referred to as ends by Robbins are
unlimited. They increase in quantity and quality over a period of time. They vary among individuals and
overtime for the same individual. It is not possible to find a person who will say that his wants for goods
and services have been completely satisfied. This is because of the fact that when one want is satisfied, it
is replaced by another and there is then no end to it.
(ii) The ends or wants vary in importance: The ends or wants are of varying importance. They are
ranked in order of importance as: (a) necessaries (b) comforts and (c) luxuries. Man generally satisfies his
urgent wants first and less urgent afterwards in order of their importance.
(iii) Scarcity of resources: Resources are the inputs used in the production of things which we need. The
resources (Land, labour, capital and entrepreneurship) at the disposal of man are scarce. They are not
found in as much quantity as we need them. Scarcity means that we do not and cannot have enough
income or wealth to satisfy our every desire. Scarcity exists because human wants always exceed what
can be produced with limited resources and time that Nature makes available to man at any one time.
Scarcity is a fact of life. It occurs among the poor and among the rich. The richest person on earth faces
scarcity because he too cannot satisfy all his wants with the limited time available to him. According to
Robbins, the unlimited ends and the scarce resources provide a foundation to the field of Economics.
Since the human wants are innumerable and the means to satisfy them are scarce or limited in supply,
therefore, an economic problem arises. If all the things were freely available to satisfy the unlimited
human wants, there would not have arisen any scarcity, hence no economic goods, no need to economic
and no economic problem. Scarcity, thus, can be defined as the excess of human wants over what can be
actually produced in the economy.
(iv) Economic resources have alternative uses: The fourth important proposition of Robbins definition
is that the scarce resources available to satisfy human wants have alternative uses. They can be put to one
use at one time. For instance, if a piece of land is used for the production of sugarcane, it cannot be
utilized for the growth of another crop at the same time. Man, therefore, has to choose the best way of
utilizing the scarce resources which have alternative uses.
The choices to be made by it are:
 What goods shall be produced and in what quantity?
 How should the various goods and services be produced?
 How should the goods and services be distributed?
Summing up the foundation of economic science according to Robbins, is based on satisfaction of
human wants with scare resources which have alternative uses.
Merits of Robbins’s Definition of Economics:

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There are many admirers of Robbins definition. It has the following merits:
(i) Status of a positive science: Robbins tries to make economics a more exact science. According to
him, economics has nothing to do with ends. They may be noble or ignoble, material or non-material.
Economics is not concerned with them as such.
(ii) An analytical definition: Robbins definition makes study of economics analytical. It studies the
particular aspect of human behavior which is imposed by the influence of scarcity.
(iii) A universal definition: Robbins definition is applicable everywhere. It is concerned with unlimited
wants and limited resources which is the problem facing every economy socialistic or capitalistic.
(iv) Clear on the nature and scope of economics: Robbins definition serves to specify the nature, scope
and subject matter of economics. According to him, an economic problem is characterized by the
possibility of exercising choice between ends and scarce means which have alternative uses.
(v) Valuation is the central problem: According to Robbins, valuation is the central problem of
economics. Wherever the ends are unlimited and the resources scarce, they give rise to an economic
problem Marshall’s definition does not identify this valuation process.
Criticisms:
Robbins definition of economics has been bitterly criticized by eminent writers Hicks, Durbin,
Frazer, etc., on the following grounds:
(i) Reduced economics merely to a theory of value: Robbins’s definition restricts the scope of
economics by treating it as a positive Science only while in reality it is both a positive and a normative
science.
(ii) Economics has become a colourless science: Robbins’s made economics colourless, impersonal and
abstract. It is in fact a definition of economics for economist only.
(iii) Study of economic growth: The study of economic growth process remains outside the scope of
economics while it is through economic growth that living standards improve.
Conclusion
The definition of economics given by Robbins has no doubt certain flaws. However, it is more
comprehensive in describing the problem of resource utilization.
7. Discuss Welfare definition with criticisms.

Synopsis:
Introduction – Welfare Definition – Its Characteristics – Criticisms – Conclusion
Introduction

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house (hold)".
There is no one definition of Economics which has a general acceptance
Welfare Definition
The neo-classical school led by Dr. Alfred Marshall gave economics a respectable place among social
sciences. He was the first economist who lifted economics from the bad repute to which it had fallen. Dr.
Alfred Marshall (1842 - 1924) in his book, 'Principles of Economics' defined Economics as:
“Study of mankind in the ordinary business of life; it examines that part of individual and social actions
which is closely connected with the attainment and with the use of material requisites of well-being”.
This definition clearly states that Economics is on the one side a study of wealth and on the other and
more important side a part of the study of man. Marshall’s followers like Pigou, Cannon and Baveridge
(the Neo-classical writers) have also defined Economics as:
“Study of causes of material welfare”.
For example, according to Cannon, the aim of Political Economy is the explanation of the general causes
on which the material welfare of the human being depends.
Characteristics:
The definitions given by Welfare School of Economists have the following main features of Economics
as Material Welfare:
(i) Wealth is ‘not the be all and the end all’ of human activities: Economics does not regard wealth as
the be all and the end all of the human activities. It is only a mean to the fulfilment of an end which is
human welfare. Welfare and not wealth, is therefore, of primary importance to man.
(ii) Study of an ordinary man: Economics is a study of an ordinary man who lives in free society. A
person who is cut away from the society is not the subject of study of Economics.
(iii) It does not study all activities of man: Economics does not study all the activities of man. It is
concerned with those actions which can be brought directly or indirectly with the measuring rod of
money.
(iv) Study of material welfare: Economics is concerned with the ways in which man applies his
knowledge, skill to the gifts of Nature for the satisfaction of his material welfare.
For a long time, the definition of Economics given by Alfred Marshall was generally accepted. It
enlarged the scope of economics by taking emphasis that it studies wealth and man rather than wealth
alone.
However, Marshall’s definition was criticized by Lionel Robbins. He in his book “Essay on the Nature
and Significance of Economic Science” gave a critical review of the welfare definitions of economics.
These criticisms are summed as under:
Robbins’s Criticism:

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(i) Narrows down the scope of economics: According to Robbins, the use of the word “Material” in the
definition of Economics considerably narrows down the scope of Economics. There are many things in
the world which are not material but they are very useful for promoting human welfare. For example, the
services of doctors, lawyers, teachers, dancers, engineers, professors, etc., satisfy our wants and are scarce
in supply. If we exclude these services and include only material goods, then the sphere of economics
study will be very much restricted.
(ii) Relation between economics and welfare: The second objection raised by Robbins on welfare
definition is on the establishment of relation between Economics and Welfare. According to him, there
are many activities which do not promote human welfare, but they are regarded economic activities, e.g.,
the manufacturing and sale of alcohol goods or opium, etc. Here Robbins says, “Why talk of welfare at
all? Why not throw away the mask altogether”?
(iii) Welfare is a vague concept: The third objection levied by him was on the concept of ‘welfare’. In
his opinion welfare is a vague concept. It is purely subjective. It varies from man to man, from place to
place and from age to age. Moreover, he says what is the use of a concept which cannot be quantitatively
measured and on which two persons cannot agree as to what is conducive to welfare and what is not. For
example, the manufacturing and sale of guns, tanks and other war heads, production of opium, liquor etc.,
are not conducive to welfare but these are all economic activities. Hence, these cannot be excluded from
the study of economics.
(iv) Impractical: The definition of welfare is of theoretical nature. It is not possible in practice to divide
man’s activities into material and non-material.
(v) It involves value judgment: Finally, the word ‘Welfare' in the definition involves value judgment
and the economists according to Robbins, are forbidden to pass any verdict.
Conclusion
Welfare definition rescued economics from the disgrace that it has been suffering due to the wealth
definition and it was considered universally as the definition of economics for a very long time.
8. Critically explain scarcity definition and explain growth oriented definition.
Synopsis:
Introduction – Scarcity Definition – Its Characteristics – Criticisms – Growth Definition- Conclusion
Introduction
house (hold)".
There is no one definition of Economics which has a general acceptance
Scarcity Definition

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Marshall’s definition of economics remained an article of faith with all economists from 1830 to 1932.
However, with the publication of Robbins book 'Nature and Significance of Economic Science' (1932),
there developed a fresh controversy in regard to the definition of economics. Lionel Robbins, after
criticizing the definitions given by the Classical and Neo-classical economists, gave his own definition of
Economics. Lionel Robbins claiming his definition Economics precise, scientific and superior, defines
Economics in his book ‘Nature and Significance of Economic Science' (Published in 1932):
"A science which studies human behaviour as a relationship between ends and scarce means which have
alternative uses".
This definition is based on the following four pillars:
(i) The Human wants or ends are unlimited: Human wants referred to as ends by Robbins are
unlimited. They increase in quantity and quality over a period of time. They vary among individuals and
overtime for the same individual. It is not possible to find a person who will say that his wants for goods
and services have been completely satisfied. This is because of the fact that when one want is satisfied, it
is replaced by another and there is then no end to it.
(ii) The ends or wants vary in importance: The ends or wants are of varying importance. They are
ranked in order of importance as: (a) necessaries (b) comforts and (c) luxuries. Man generally satisfies his
urgent wants first and less urgent afterwards in order of their importance.
(iii) Scarcity of resources: Resources are the inputs used in the production of things which we need. The
resources (Land, labour, capital and entrepreneurship) at the disposal of man are scarce. They are not
found in as much quantity as we need them. Scarcity means that we do not and cannot have enough
income or wealth to satisfy our every desire. Scarcity exists because human wants always exceed what
can be produced with limited resources and time that Nature makes available to man at any one time.
Scarcity is a fact of life. It occurs among the poor and among the rich. The richest person on earth faces
scarcity because he too cannot satisfy all his wants with the limited time available to him. According to
Robbins, the unlimited ends and the scarce resources provide a foundation to the field of Economics.
Since the human wants are innumerable and the means to satisfy them are scarce or limited in supply,
therefore, an economic problem arises. If all the things were freely available to satisfy the unlimited
human wants, there would not have arisen any scarcity, hence no economic goods, no need to economic
and no economic problem. Scarcity, thus, can be defined as the excess of human wants over what can be
actually produced in the economy.
(iv) Economic resources have alternative uses: The fourth important proposition of Robbins definition
is that the scarce resources available to satisfy human wants have alternative uses. They can be put to one
use at one time. For instance, if a piece of land is used for the production of sugarcane, it cannot be
utilized for the growth of another crop at the same time. Man, therefore, has to choose the best way of
utilizing the scarce resources which have alternative uses.
The choices to be made by it are:
 What goods shall be produced and in what quantity?
 How should the various goods and services be produced?
 How should the goods and services be distributed?
Summing up the foundation of economic science according to Robbins, is based on satisfaction of
human wants with scare resources which have alternative uses.
Merits of Robbins’s Definition of Economics:

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There are many admirers of Robbins definition. It has the following merits:
(i) Status of a positive science: Robbins tries to make economics a more exact science. According to
him, economics has nothing to do with ends. They may be noble or ignoble, material or non-material.
Economics is not concerned with them as such.
(ii) An analytical definition: Robbins definition makes study of economics analytical. It studies the
particular aspect of human behavior which is imposed by the influence of scarcity.
(iii) A universal definition: Robbins definition is applicable everywhere. It is concerned with unlimited
wants and limited resources which is the problem facing every economy socialistic or capitalistic.
(iv) Clear on the nature and scope of economics: Robbins definition serves to specify the nature, scope
and subject matter of economics. According to him, an economic problem is characterized by the
possibility of exercising choice between ends and scarce means which have alternative uses.
(v) Valuation is the central problem: According to Robbins, valuation is the central problem of
economics. Wherever the ends are unlimited and the resources scarce, they give rise to an economic
problem Marshall’s definition does not identify this valuation process.
Criticisms:
Robbins definition of economics has been bitterly criticized by eminent writers Hicks, Durbin,
Frazer, etc., on the following grounds:
(i) Reduced economics merely to a theory of value: Robbins’s definition restricts the scope of
economics by treating it as a positive Science only while in reality it is both a positive and a normative
science.
(ii) Economics has become a colourless science: Robbins’s made economics colourless, impersonal and
abstract. It is in fact a definition of economics for economist only.
(iii) Study of economic growth: The study of economic growth process remains outside the scope of
economics while it is through economic growth that living standards improve.
Growth Definition
Paul .A. Samuelson (1915), an eminent Professor of Economics, has given a growth-oriented definition to
Economics. In his famous book, ‘Economics’, Samuelson defines Economics as:
“Economics is the study of how men and society end up choosing, with or without the use of money, to
employ scarce productive resources that could have alternative uses, to produce various commodities and
distribute them for consumption, now or in the future, among various people and groups in society. It
analyses the cost and benefits of improving patterns of resource allocation.”
Paul .A. Samuelson has pointed out three fundamental aspects in this definition:
1. Human behaviour
2. Allocation of resources
3. Alternative use of resources.
Human behaviour may be the behaviour of individuals or of firms, or of the government. The behaviour
of an individual may relate to the study of how he allocate his income between food, education, transport
and other uses. The behaviour of firms may relate to the allocation of resources among various inputs, the
products to be produced, the techniques of production to be adopted, the sources of finance and their uses.
The behaviour of the government may relate to the allocation of resource s between agriculture, industry,
law and order, defence, social service, etc.

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The problem of allocation of resources arises because of the relative scarcity of resources compared to
their uses. If resources are unlimited there would be no problem of allocating them among various uses.
Resources can be put to alternative uses. If the alternative uses of resources are limited the task of choice
to be made is relatively simple.
The growth definition given by Samuelson is based on Robbins’ definition. As such, there are similarities
between the two definitions. But Samuelsson has improved the definition and made it dynamic. Finally,
economics is defined as a social science concerned with proper use and allocation of resources for the
achievement and maintenance of growth with stability.
Conclusion
The definitions of Adam Smith, Alfred Marshall, Lionel Robbins and Paul .A. Samuelson have made
their respective contributions to the nature and scope of the subject in emphasizing the wealth, welfare,
scarcity and growth aspects. There is a great element of truth in each of these views. In one sense or the
other, economics is only a science of wealth. But wealth assumes its significance only from its aspect of
scarcity. However, wealth should be related to welfare as a social necessity. As such economics cannot be
neutral between ends but must gear up for economic growth coupled with social welfare. Hence a true
comprehension of the content of economics must be a synthesis of all the definitions.
9. Discuss Wealth Definition.
Synopsis:
Introduction – Wealth Definition – Its Characteristics – Criticisms - Conclusion
Introduction
house (hold)".
There is no one definition of Economics which has a general acceptance. The formal roots of the
scientific framework of economics can be traced back to classical economists.
Wealth Definition
The pioneers of the science of economics defined economics as the science of wealth.
Adam Smith (1723 -1790), the founder of economics, described it as a body of knowledge which relates
to wealth. Accordingly to him if a nation has larger amount of wealth, it can help in achieving its
betterment. He defined economics as:
“The study of nature and causes of generating wealth of a nation”.
Adam Smith in his famous book, “An Enquiry into the Nature and Causes of the Wealth of Nations”
published in the year 1776, emphasized the production and expansion of wealth as the subject matter of
economics.
Features of Wealth Definition by A. Smith:

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 Significance of Wealth:
Adam Smith assumed that wealth is the only important factor in human society. It can fulfill all the
desires of human beings in society. He also assumed that the entire efforts of human society is found to be
directed towards earning more and more wealth.
 Role of Economic Man:
Smith claims that economics studies behaviour of those human beings who have only one objective. That
objective is earning of more and more wealth at any cost and by any means. Human being of such nature
in the words of Smith is an "Economic Man".
 Priority Given in Definition:
In this definition of economics first priority is given to wealth and the second priority to mankind. He
assumes that mankind is for wealth but wealth is not for mankind. He also believed and argued that
wealth and only wealth can give higher satisfaction to all mankind. Therefore, wealth is of a primary
importance in his definition.
 Sources of Wealth:
Adam Smith in his definition of economics assumed that, wages earned by active human resources to
be the only one and most important source of income of a nation. He also suggested that the active
labours can earn high amount of wages only through the division of labour in production and distribution
of goods and services. He conclude that apart from wages, there is nothing else which can be regarded as
sources of wealth of a nation.
Criticisms
The wealth definition of economics given by Adam Smith has been criticized on several grounds. It is
strongly criticized by eminent scholars like Carlyle Ruskin, Alfred Marshall, etc. In short, the critics
dubbed economics as the "Bread and Butter Science", "the Gospel of Mammon" and " a Dismal Science".
The major points of criticisms of wealth definition are discussed below:
 Narrow Definition
Adam Smith considered that economics is the science that deals only with wealth and material goods.
Contrary, to this definition’s concept the critics pointed out that economics studies not only material
goods and wealth but also some non-material goods such as services of doctor, teacher, and lecturer
which also fulfill the human wants. Therefore, services provided by professional human resources also
constitute aspects of wealth.
 Unnecessary Emphasis on Wealth

Adam Smith highly emphasized the importance of wealth in economic life rather than human beings. He
assigned primary role to wealth and only secondary place to mankind. On the contrary, the critics pointed
out that human life cannot be sacrificed for wealth rather wealth should be used for the betterment of
mankind.
 Single Source of Wealth

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In the view of Adam Smith, the amount of wages that is earned by employed labourers could be the only
one source of wealth of nation. The critics of the definition are however of the view that natural
resources, human resources, physical resources and capital resources also are sources of wealth. All these
resources put together can be utilized to earn maximum wealth by a nation.
 Assumption of Economic Man is Wrong
Smith assumed that every human being who wants to earn money by hook or crook is known
as economic man. The critics of the definition instead pointed out that almost all human beings also own
the qualities of human life such as feelings of love, respect, self-esteem, sympathy, co-operation,
friendship, trust which might provide greater satisfaction rather than wealth in their lives.
 No mention of man’s welfare
The 'Wealth' definitions ignore the importance of man’s welfare. Wealth is not be all and the end all of all
human activities.
 It does not study means:
The definitions of economics lay emphasis on the earning of wealth as an end in itself. They ignore the
means which are scarce for the earning of wealth.
Conclusion
In conclusion, A. Smith considered human wants as unlimited. It is important that these wants be fulfilled
and wealth is the only thing that can fulfil human needs or wants. The definition of economics as the
'science of wealth' has been supported by classical economists such as: F.A. Walker, J. B. Say, J.S. Mill
and David Ricardo.
Ricardo, another British classical economist shifted the emphasis from production of wealth to the
distribution of wealth in the study of economics.
J.B. Say, a French classical economist, described economics as: “The science which treats of wealth”.
J.S. Mill in the middle of 19th century looked upon economics is as: “Practical science of production and
distribution of wealth”.
According to Malthus: “Man is motivated by self Interest only. The desire to collect wealth never leaves
him till he goes into the grave”.
The definitions of economics given by classical economists were unduly criticized by the literacy writers
of that time. The fact is that what Adam Smith wrote in his book ‘Wealth of Nations' (1776 ) still holds
well. The central argument of the book that market economy enables every individual to contribute his
maximum to the production of wealth of nation still not only holds good but is also being practiced and
advocated throughout the capitalistic world. Since the word 'wealth' did not have clear meaning, therefore
the definition economics became controversial. It was regarded unscientific and narrow.
10. Discuss the nature and scope of economics

Synopsis:
Introduction – Nature of economics – Scope – Conclusion

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Introduction
Nature of Economics
Is the nature of economics like an art or a science?
Economics as a science: Economics is considered to be as social science. A social science is a science
which studies human activities. A subject is called a science if:
a) There is a systematic body of knowledge which traces the relationship between cause and effect.
b) There is observation of facts, systematic collection, classification and analysis of facts.
c) There is a making of generalization on the basis of relevant facts and formulating laws and theories.
d)These theories are subjected to real world observations.
Subjects like Chemistry and Physics are called science because it meets all the above characteristics.
Economics can also be called a science since it meets these features of a science. Like in other sciences,
economic theories are deduced by logical reasoning. For example, like in Newton’s Law of Gravitation in
Physics, in economics, the Law of Demand states that, other things remaining the same, there will be an
increase in demand if there is a reduction in the price.
Like in other sciences, in economics too there is observation of facts and an analysis of the same. Like
other sciences in economics too theories are subjected to real world observations. The truth of economic
theories can be challenged when these are subjected to real world observations. Since the methods of
economics are scientific it is called a science. Economics is a Positive Science and a Normative Science.
This is because it is concerned not only with the cause and effect relationship but also with the cause and
desired effect relationship.
However, like in other sciences, laboratory experiments are not possible. Also the laws of economics are
not universally applicable like other sciences. Therefore while economics is a science, it is not an exact
science.
Positive Science and Normative Science
Is Economics a positive science or normative science?
Positive Science
Positive statements are objective statements dealing with matters of fact or they question about how
things actually are. Positive statements are made without obvious value-judgements and emotions.
Positive economics can be described as “what is, what was, and what probably will be” economics. It
studies economic behaviour without making judgements. It describes what exists and how it works.
Statements are based on economic theory rather than raw emotion. Often these statements will be
expressed in the form of a hypothesis that can be analysed and evaluated.
e.g.: Lower taxes may stimulate an increase in the active labour supply.
Normative Science
Normative statements are subjective - based on opinion only - often without a basis in fact or theory.
They are value-laden, emotional statements that focus on "what ought to be".

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Normative Economics, also called Policy Economics, analyses outcomes of economic behaviour,
evaluates them as good or bad, and may prescribe them courses of action.
There is a difference of opinions among economists whether economics is a positive or normative
science. Lionel Robbins, Senior and Friedman have described economics as a positive science. They
opined that economics, is based on logic. It is a value theory only. It is, therefore, neutral between ends.
Marshall, Pigou, Hawtrey, Keynes and many other economists regard economics as a normative science.
According. to them, the real function of the Science is, to increase the well-being of man. They have
given suggestions in their works for promotion of human welfare. For example, Malthus has given
suggestions of checking the rising population. J.M. Keynes has ‘suggested measures to remove
unemployment.
An economist must come forward to give advice to the problems facing the human being like depression,
unemployment, high prices, etc., for increasing his welfare. Economics, to conclude, has both
theoretical as well as practical side. In other words, it is both a positive and a normative science.
Economics as an Art: Economics is also an art. It is an art. It is an art because it is not only theoretical
but also practical. Science is about knowledge. Art is the application of knowledge.
Applying this definition of art we can say economics is an art because the various branches of economics
like consumption, distribution, money banking provide us with rules which can be used to solve the
economic problems of society. Economics is an art because it uses the laws of economics (science) to
solve every day economic problems.
Thus, economics is both a science and an art.
Scope of Economics
The horizon of economics is gradually expanding. It is no more a branch of knowledge that deals only
with the production and consumption. However, the basic thrust still remains on using the available
resources efficiently while giving the maximum satisfaction or welfare to the people on a sustainable
basis. Given this, we can list some of the major branches of economics as under:
1. Microeconomics: 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.
2. Macroeconomics: 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.
3. International economics: As the countries of the modern world are realizing the significance of
trade with other countries, the role of international economics is getting more and more
significant nowadays.
4. Public finance: The great depression of the 1930s led to the realization of the role of
government in stabilizing the economic growth besides other objectives like growth,

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redistribution of income, etc. Therefore, a full branch of economics known as Public Finance or
the fiscal economics has emerged to analyse the role of government in the economy.
5. Development economics: As after the Second World War many countries got freedom from the
colonial rule, their economics required different treatment for growth and development. This
branch developed as development economics.
6. 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.
7. 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.
8. 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 realized 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
emphasized 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, economics of planning etc.
Conclusion
Economics is both a science and an art and its scope is so wide that is applied in all spheres of life these
days.
11. Explain the Central problems of an economy.
Synopsis:
Introduction – Central problems of an economy – Conclusion
Introduction
An economy exists because of two basic facts: First, human wants for goods and services are unlimited,
and secondly, productive resources with which to produce goods and services are scarce. With our wants
being virtually unlimited and resources scarce, we cannot satisfy all our wants and desires by
producing everything we want. That being the case, a society has to decide how to use its scarce resources
to obtain the maximum possible satisfaction of its members. It is this basic problem of scarcity which
gives rise to many of the economic problems.
Since it is not possible to satisfy all wants with the limited means of production, every society must
decide some way of selecting those wants which are to be satisfied. Goods are thus scarce because the
productive resources are scarce. Thus a society is faced with the problem of choice – choice among the
vast array of wants that are to be satisfied. If it is decided to use more resources in one line of production,
then resources must be withdrawn from the production of some other goods. The scarcity of resources

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thus compels us to choose among the different channels of production to which resources are to be
devoted. In other words, we have the problem of allocating scarce resources so as to achieve the
greatest possible satisfaction of wants. This is the economic problem.
Often, people appear to use their resources to improve their well-being. Well-being includes the
satisfaction people gain from the products and services they choose to consume, from their time spent in
leisure and with family and community as well as in jobs, and the security and services provided by
effective governments.
Central Problems of an economy
Thus the problem of scarcity gives rise to some problems generally known as central problems of an
economy which a society has to solve so as to promote material well-being of its people:
(i) Which goods should be produced and in how much quantity?
(ii) What technique should be adopted for production?
(iii) For whom goods should be produced?
These 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.
1. What to produce?
The first and foremost basic problem confronting an economy is “What to produce?” so as to
satisfy the wants of the people. The problem of what goods are to be produced and in what
quantities arises directly from the scarcity of resources. If the resources were unlimited, the
problem of ‘what to produce?’ would not have arisen. But because resources are in fact scarce
relative to human wants, an economy must choose among various goods and services.
If the society decides to produce a particular type of good in larger quantity, it will then have to
withdraw some resources from the production of other goods and to devote them to the
production of the good to be produced in larger quantity. The question of what goods to be
produced and in what quantities is thus a question about the allocation of scarce resources
between the alternative uses.
Thus with the given scarce resources, if the society decides to produce one good more, the
production of some other goods would have to be cut down.
2. How to produce?
There are various alternative methods of producing goods and society has to choose among them.
For example, cloth can be produced either with automatic looms or with power looms or with
handlooms. Similarly fields can be irrigated by building small irrigation works like tube wells and
tanks or by building large canals and dams. Therefore, it has to be decided whether cloth is to be
produced by handlooms, power looms or automatic looms. Similar is the case with irrigation
methods also. Obviously, it is a problem of the choice of production techniques. Different
methods or techniques of production would use different quantities of various resources. For
instance, the production of cloth with handlooms would make use of relatively more labour and
less capital and hence labour-intensive. Production with automatic loom is capital-intensive.
Thus, a society has to choose whether it wants to produce with labour-intensive or capital-
intensive technique of production.

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More generally, the problem of ‘how to produce’ means which combination of resources is to be
used for the production of goods and which technology is to be made use of for their production.
Scarcity of resources, demands goods to be produced in the most efficient method. The choice
between different methods of production depends on the availability of resources and prices of
the factors of production.
3. For whom to produce?

The main objective of producing a commodity in a country is its consumption by the people of
the country. However, even after employing all the resources of a country, it is not possible to
produce all the commodities which are required by the people. Therefore, an economy has to
decide as to for whom goods should be produced. This problem is the problem of distribution of
produced goods and services. Therefore, what goods should be consumed and by whom depends
on how national product is distributed among various people.
Distribution of national product depends upon the distribution of money income. Those people
who have larger incomes would have larger capacity to buy goods. Those who have low incomes,
would have less purchasing power to buy things and will therefore be able to obtain a small share
of output. More equal is the distribution of income, more equal will be distribution of national
product.
All the three central problems arise because resources are scarce. Had resources been unlimited,
these problems would not have arisen.
Besides, what, how and for whom there are three more problems which are also regarded as basic
problems.
4. The Problem of Economic Efficiency
Resources being scarce, it is desirable that they should be most efficiently used. It is therefore
important to know whether a particular economy works efficiently, i.e., whether the production
and distribution decisions of an economy are efficient. Resources will be deemed to be better
utilized when by reallocating them in various uses, production of a commodity can be increased
without adversely affecting the production of other commodities. Likewise, distribution of
national product is efficient if it is impossible to make one individual or some individuals better
off without making at least one person worse off, through any redistribution of goods.
5. The Problem of Full Employment of Resources.

Whether all available resources of a society are fully utilized is a highly significant question
because answer to it would determine whether or not there exists involuntary unemployment of
labour as well as capital stock.
In many economies, especially in developing economies, there is a tendency towards
underutilization of resources. Resources lying idle or not being utilized fully is a recurring
problem in many economies. This problem is particularly acute in labour-abundant economies
like that of India where large scale unemployment exists. In many economies, a vital resource
like land too remains under-utilized. Resources being relatively scarce, they should not be
allowed to remain idle as it is a waste.
6. The Problem of Economic Growth
The last problem is of growth. Every economy strives to increase its production for increasing
standards of living of its people. Economic growth of a country depends upon the fact as to what

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extent; it can increase its productive capacity. This problem is not confined to developing
economies alone. It is also faced by developed economies which strive for increasing their
productive capacity in order to increase the material comforts of their technically advanced
societies.
Conclusion
Had our resources been unlimited there wouldn’t have been the question of choice and hence the central
problems of an economy. But since the resources are limited, we have to choose between our needs on the
basis of priority.
12. What is macroeconomics? Define scope and importance of macroeconomics.

Synopsis:
Introduction – what is macroeconomics? – Scope – importance – Limitations - Conclusion
Introduction
The study of economics is divided by the modern economists into two parts viz. Micro
economics and Macroeconomics. Micro economics and Macroeconomics, both the terms were used in
1933 by Prof. Ragnar Frisch from Oslo University of Norway.
The word micro has been derived from the Greek word `Mikros' i.e. small and the word macro has been
derived from Greek word `Makros' i.e. large.
An economic system may be looked at as a whole or in terms of its innumerable decision-making units
such as consuming units e.g., individual consumers and households, producing units (firms) individual
factors of production etc. when we are analyzing the problems of the economy as a whole it is
macroeconomic study. While an analysis of the behaviour of any particular decision-making unit such as
a firm and industry, a consumer, constitutes micro-economics.
Macroeconomics
Macroeconomics (Greek makro = ‘big’) describes and explains economic processes that concern
aggregates. An aggregate is a multitude of economic subjects that share some common features. By
contrast, microeconomics treats economic processes that concern individuals. Example: The decision of a
firm to purchase a new office chair from company X is not a macroeconomic problem. The reaction of
Austrian households to an increased rate of capital taxation is a macroeconomic problem.
Macroeconomics is the study of aggregates or averages covering the entire economy, such as total
employment, national income, national output, total investment, total consumption, total savings,
aggregate supply, aggregate demand, and general price level, wage level, and cost structure.
In other words, it is aggregative economics which examines the interrelations among the various
aggregates, their determination and causes of fluctuations in them. Thus in the words of Professor Ackley,
“Macroeconomics deals with economic affairs in the large, it concerns the overall dimensions of
economic life. It looks at the total size and shape and functioning of the “elephant” of economic
experience, rather than working of articulation or dimensions of the individual parts. It studies the
character of the forest, independently of the trees which compose it.”

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Macroeconomics is also known as the theory of income and employment, or simply income analysis. It is
concerned with the problems of unemployment, economic fluctuations, inflation or deflation,
international trade and economic growth. It is the study of the causes of unemployment, and the various
determinants of employment.
Scope and Importance of Macroeconomics:
As a method of economic analysis macroeconomics is of much theoretical and practical importance.
(1) To Understand the Working of the Economy:
The study of macroeconomic variables is indispensable for understanding the working of the economy.
Our main economic problems are related to the behaviour of total income, output, employment and the
general price level in the economy.
These variables are statistically measurable, thereby facilitating the possibilities of analysing the effects
on the functioning of the economy. As Tinbergen observes, macroeconomic concepts help in “making the
elimination process understandable and transparent”. For instance, one may not agree on the best method
of measuring different prices, but the general price level is helpful in understanding the nature of the
economy.
(2) In Economic Policies:
Macroeconomics is extremely useful from the point of view of economic policy. Modern governments,
especially of the underdeveloped economies, are confronted with innumerable national problems. They
are the problems of overpopulation, inflation, balance of payments, general underproduction, etc.
The main responsibility of these governments rests in the regulation and control of overpopulation,
general prices, general volume of trade, general outputs, etc. Tinbergen says: “Working with
macroeconomic concepts is a bare necessity in order to contribute to the solutions of the great problems
of our times.” No government can solve these problems in terms of individual behaviour. Let us analyse
the use of macroeconomic study in the solution of certain complex economic problems.
(i) In General Unemployment:
The Keynesian theory of employment is an exercise in macroeconomics. The general level of

employment in an economy depends upon effective demand which in turn depends on aggregate demand
and aggregate supply functions.
Unemployment is thus caused by deficiency of effective demand. In order to eliminate it, effective
demand should be raised by increasing total investment, total output, total income and total consumption.
Thus, macroeconomics has special significance in studying the causes, effects and remedies of general
unemployment.
(ii) In National Income:

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The study of macroeconomics is very important for evaluating the overall performance of the economy in
terms of national income. With the advent of the Great Depression of the 1930s, it became necessary to
analyse the causes of general overproduction and general unemployment.
This led to the construction of the data on national income. National income data help in forecasting the
level of economic activity and to understand the distribution of income among different groups of people
in the economy.
(iii) In Economic Growth:
The economics of growth is also a study in macroeconomics. It is on the basis of macroeconomics that the
resources and capabilities of an economy are evaluated. Plans for the overall increase in national income,
output, and employment are framed and implemented so as to raise the level of economic development of
the economy as a whole.
(iv) In Monetary Problems:
It is in terms of macroeconomics that monetary problems can be analysed and understood properly.
Frequent changes in the value of money, inflation or deflation, affect the economy adversely. They can be
counteracted by adopting monetary, fiscal and direct control measures for the economy as a whole.
(v) In Business Cycles:
Further macroeconomics as an approach to economic problems started after the Great Depression. Thus
its importance lies in analyzing the causes of economic fluctuations and in providing remedies.
(3) For Understanding the Behaviour of Individual Units:
For understanding the behaviour of individual units, the study of macroeconomics is imperative. Demand
for individual products depends upon aggregate demand in the economy. Unless the causes of deficiency
in aggregate demand are analysed, it is not possible to understand fully the reasons for a fall in the
demand of individual products.
The reasons for increase in costs of a particular firm or industry cannot be analysed without knowing the
average cost conditions of the whole economy. Thus, the study of individual units is not possible without
macroeconomics.
Limitations of Macroeconomics:
There are, however, certain limitations of macroeconomic analysis. Mostly, these stem from attempts to
yield macroeconomic generalizations from individual experiences.
(1) Fallacy of Composition:
In Macroeconomic analysis the “fallacy of composition” is involved, i.e., aggregate economic behaviour
is the sum total of individual activities. But what is true of individuals is not necessarily true of the
economy as a whole.

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For instance, savings are a private virtue but a public vice. If total savings in the economy increase, they
may initiate a depression unless they are invested. Again, if an individual depositor withdraws his money
from the bank there is no ganger. But if all depositors do this simultaneously, there will be a run on the
banks and the banking system will be adversely affected.
(2) To Regard the Aggregates as Homogeneous:
The main defect in macro analysis is that it regards the aggregates as homogeneous without caring about
their internal composition and structure. The average wage in a country is the sum total of wages in all
occupations, i.e., wages of clerks, typists, teachers, nurses, etc.
But the volume of aggregate employment depends on the relative structure of wages rather than on the
average wage. If, for instance, wages of nurses increase but of typists fall, the average may remain
unchanged. But if the employment of nurses falls a little and of typists rises much, aggregate employment
would increase.
(3) Aggregate Variables may not be Important Necessarily:
The aggregate variables which form the economic system may not be of much significance. For instance,
the national income of a country is the total of all individual incomes. A rise in national income does not
mean that individual incomes have risen.
The increase in national income might be the result of the increase in the incomes of a few rich people in
the country. Thus a rise in the national income of this type has little significance from the point of view of
the community.
Prof. Boulding calls these three difficulties as “macroeconomic paradoxes” which are true when applied
to a single individual but which are untrue when applied to the economic system as a whole.
(4) Indiscriminate Use of Macroeconomics can be misleading:
An indiscriminate and uncritical use of macroeconomics in analyzing the problems of the real world can
often be misleading. For instance, if the policy measures needed to achieve and maintain full employment
in the economy are applied to structural unemployment in individual firms and industries, they become
irrelevant. Similarly, measures aimed at controlling general prices cannot be applied with much advantage
for controlling prices of individual products.
(5) Statistical and Conceptual Difficulties:
The measurement of macroeconomic concepts involves a number of statistical and conceptual difficulties.
These problems relate to the aggregation of microeconomic variables. If individual units are almost
similar, aggregation does not present much difficulty. But if microeconomic variables relate to dissimilar
individual units, their aggregation into one macroeconomic variable may be wrong and dangerous.
Conclusion:
We may conclude that macroeconomics enriches our knowledge of the functioning of an economy by
studying the behaviour of national income, output, investment, saving and consumption. Moreover, it

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throws much light in solving the problems of unemployment, inflation, economic instability and
economic growth.
13. Explain revenue analysis relation between AR and MR curves.
Synopsis:
Introduction – Relation between AR and MR Curve under perfect and imperfect competition –
Conclusion
Introduction
Average revenue is the revenue per unit of the commodity sold. It is found by dividing total revenue by
the number of units sold. But since, different units of a commodity are sold at the same price, in the
market, average revenue equals price at which the commodity is sold. Thus, average revenue means
price. Since, the consumer’s demand curve is a graphic relation between price and the amount demanded,
it also represents the average revenue or price at which the various amounts of a commodity are sold,
because the price offered by the buyer is the revenue from seller’s point of view. Therefore, average
revenue (AR) curve of the firm is really the same as demand curve of the consumer.
Marginal revenue at any level of firm’s output is the net revenue earned by selling an additional unit of
the product. Algebraically, MR is equal to TR n – TR n-1.
Thus, MR n = TR n – TR n-1.
Thus, Marginal Revenue is less than Average Revenue or price.
Relationship between AR and MR
Let us consider the relationship between marginal, average and total revenue with the help of the
following table.
No. of Units sold Price/AR TR= AR x Q MR
1 22 22 22
2 21 42 20
3 20 60 18
4 19 76 16
5 18 90 14
6 17 102 12
7 16 112 10
8 15 120 8
9 14 126 6
10 13 130 4

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In the above table, Column 2 shows the Average Revenue, while Column 4 shows the Marginal Revenue.
Marginal Revenue has been derived from the Total Revenue column of the table. It can be seen from the
table that when average revenue is falling, marginal revenue is less than average revenue.
(i) Total Revenue = Price x Quantity
TR = P x Q
(ii) Average Revenue = Total Revenue

Quantity
AR = TR
Q
(iii) Marginal Revenue = Change in Total Revenue

Change in Quantity
MR = ▲TR
▲Q
1) Under Pure/Perfect Competition:
The average revenue curve is a horizontal straight line parallel to the X-axis and the marginal revenue
curve coincides with it. This is because under pure (or perfect) competition the number of firms selling an
identical product is very large.
The price is determined by the market forces of supply and demand so that only one price tends to prevail
for the whole industry, as shown in Table 1.
Price is OP as shown in panel (A) of Figure 1. Each firm can sell as much as it wishes at the market price
OP. Thus the demand for the firm’s product becomes infinitely elastic. Since the demand curve is the
firm’s average revenue curve, the shape of the AR curve is horizontal to the X-axis at price OP, as shown
in panel (B) and the MR curve coincides with it. This is also shown in Table 1 where AR and MR remain
constant at Rs.20 at every level of output. Any change in the demand and supply conditions will change
the market price of the product, and consequently the horizontal AR curve of the firm.

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(2) Under Monopoly or Imperfect Competition:

The average revenue curve is the downward sloping industry demand curve and its correspond ing
marginal revenue curve lies below it. The relation between the average revenue and the marginal revenue
under monopoly can be understood with the help of Table 2. The marginal revenue is lower than the
average revenue.
Given the demand for his product, the monopolist can increase his sales by lowering the price, the
marginal revenue also falls but the rate of fall in marginal revenue is greater than that in average revenue.
In Table 2, AR falls by Rs.2 at a time whereas MR falls by Rs.4. This is shown in Figure 2, in which the
MR curve is below the AR curve and lies half way on the perpendicular drawn from AR to the X-axis.
MR has twice the slope of AR. That is, in the figure, MR curve passes through the point B, where, AB =
BC. This relation will always exist between straight line downward sloping AR and MR curves.
Conclusion

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Thus under perfect competition AR and MR curves are straight lines parallel to output axis and under
imperfect competition they’re downward sloping lines.
14. Discuss the Features of Capitalism.
Synopsis:
Introduction –Capitalism - Features – Merits – Demerits – Conclusion
Introduction
An economic system is a system of production, resource allocation, exchange, and distribution of goods
and services in a society or a given geographic area.
Capitalism
Under capitalism all farms, factories and other means of production are the property of private individuals
and firms.
Although all modern states do impose certain restrictions on economic freedom in the interest of general
welfare, yet even these restrictions leave much latitude to the propertied class to use their property in any
manner they like, to start any business they think profitable to themselves, and to enter into contracts they
think necessary in their own interest.
What to produce, how to produce and for whom to produce – all these central problems of economics are
settled by the free working of the forces of demand and supply.
Features of Capitalism
The principal features of capitalism are discussed below.
(1) Private Property:
Capitalism thrives on the institution of private property. It means that the owner of a firm or factory or
mine may use it in any manner he likes. He may hire it to anybody, sell it, or lease it at will in accordance
with the prevalent laws of the country. The state’s role is confined to the protection of the institution of
private property through laws.” The institution of private property induces its owner to work hard, to
organize his business efficiently and to produce more, thereby benefiting not only himself but also the
community at large. All this is actuated by the profit motive.
(2) Profit Motive:
The main motive behind the working of the capitalist system is the profit motive. The decisions of
businessmen, farmers, producers, including that of wage-earners are based on the profit motive. The
profit motive is synonymous with the desire for personal gain. It is this attitude of acquisitiveness which
lies behind individual initiative and enterprise in a capitalist economy.
(3) Price Mechanism:

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Under capitalism, the price mechanism operates automatically without any direction and control by the
central authorities. It is the profit motive which determines production. Profit being the difference
between outlay and receipt, the size of profit depends upon prices. The larger the difference between
prices and costs, the higher is the profit. Again, the higher the prices, the greater are the efforts of the
producers to produce the varied quantities and types of products. It is the consumers’ choices which
determine what to produce, how much to produce, and how to produce. Thus capitalism is a system of
mutual exchanges where the price-profit mechanism plays a crucial role.
(4) Role of the State:
During the 19th century, the role of the state was confined to the maintenance of law and order, protection
from external aggression, and provision for educational and public health facilities. This policy of laissez-
faire—of non-intervention in economic affairs by the state—has been abandoned in capitalist economies
of the West after the Second World War. Now the state has important tasks to fulfil. They are monetary
and fiscal measures to maintain aggregate demand; anti-monopoly measures and nationalized monopoly
corporations; and measures for the satisfaction of communal wants such as public health, public parks,
roads, bridges, museums, zoos, education, flood control, etc.
(5) Consumers’ Sovereignty:
Under capitalism, ‘the consumer is the king.’ It means freedom of choice by consumers. The consumers
are free to buy any number of goods they want. Producers try to produce variety of goods to meet the
tastes and preferences of consumers. This also implies freedom of production whereby producers are at
liberty to produce a vast variety of commodities in order to satisfy the consumer who acts like a ‘king’ in
making a choice out of them with his given money income. These twin freedoms of consumption and
production are essential for the smooth functioning of the capitalist system.
(6) Freedom of Enterprise:
Freedom of enterprise means that there is free choice of occupation for an entrepreneur, a capitalist, and a
labourer. But this freedom is subject to their ability and training, legal restrictions, and existing market
conditions. Subject to these limitations, an entrepreneur is free to set up any industry, a capitalist can
invest his capital in any industry or trade he likes, and a person is free to choose any occupation he
prefers. It is on account of the presence of this important feature of freedom of enterprise that a capitalist
economy is also called a free enterprise economy.
(7) Competition:
Competition is one of the most important features of a capitalist economy. It implies the existence of
large number of buyers and sellers in the market who are motivated by self-interest but cannot influence
market decisions by their individual actions. It is competition among buyers and sellers that determines
the production, consumption and distribution of goods and services. There being sufficient price
flexibility under capitalism, prices adjust themselves to changes in demand, in production techniques, and
in the supply of factors of production. Changes in prices, in turn, bring adjustments in production, factor
demand and individual incomes.
Merits of Capitalism

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The protagonists of capitalism advance the following arguments in favour of capitalism.
(1) Increase in Production:
Arthur Young wrote’ “The magic of property turns sand into gold.” This observation of Young holds
good in a free enterprise economy where every farmer, trader or industrialist can hold property and use it
in any way he likes. He brings improvement in production and increases productivity because the
property belongs to him. This leads to increase in income, saving, and investment, and to progress.
(2) Quality Products at Low Costs:
The twin freedoms of consumers and producers lead to the production of quality products, and lowering
of costs and prices. Thus the society as a whole stands to gain under capitalism.
(3) Progress and Prosperity:
The presence of competition under capitalism leads to increase in efficiency, encourages producers to
innovate and thereby brings progress and prosperity in the country. As pointed out by Seligman.” If
competition in biology leads only indirectly to progress, competition in economics is the very secret of
progress.”
(4) Maximizes Welfare:
The automatic working of the price mechanism under capitalism brings efficiency in the production and
distribution of goods and services without any central plan, and promotes the maximum welfare of the
community.
(5) Optimum use of Resources:
Under capitalism, producers undertake the production of only those goods which appear to yield
maximum profits in anticipation of demand. This leads to optimum use of resources.
(6) Flexible System:
A capitalist economy operates automatically through the price mechanism. If there are shortages or
surpluses in the economy, they are corrected automatically by the forces of demand and supply. As such,
capitalism is a highly flexible system which can adapt itself to changing economic conditions. That is
why it has survived many depressions, recessions and booms.
Demerits of Capitalism
The following arguments are advanced against capitalism.
(1) Leads to Monopoly:
Competition which is regarded as the very basis of capitalism contains within itself the tendency to
destroy competition, and leads to monopoly. It is the profit motive under capitalism which leads to cut-
throat competition, and ultimately to the formation of trusts, cartels, and combinations. This brings about

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a reduction in the number of firms actually engaged in production. As a result, small firms are eliminated
in this process.
(2) Inequalities:
The institution of private property creates inequalities of income and wealth under capitalism. The price
mechanism through competition brings huge profits to big producers, the landlords, the entrepreneurs,
and the traders who accumulate vast amount of wealth. While the rich roll in wealth and luxury, the poor
live in poverty and squalor.
(3) Consumers’ Sovereignty a Myth:
Consumers’ sovereignty is a myth under capitalism. Consumers have to buy only those commodities
which are manufactured and supplied by the producers in the market. The majorities of consumers are not
rational buyers and are often ignorant about the utility and quality of the products available at the stores
or shops. They are also misled by advertisement and propaganda about the usefulness of the products.
Products which are produced by monopoly concerns are often of an inferior quality and are priced high.
Thus there is no consumers’ sovereignty in a seller’s market.
(4) Depression and Unemployment:
Capitalism is characterized by business fluctuations and unemployment. Excessive competition and

unplanned production lead to over production and glut of commodities in the market and ultimately
depression and unemployment.
(5) Inefficient Production:
Capitalism fails to produce goods in keeping with the society’s requirements. Frivolous luxury goods and
obnoxious articles are produced to satisfy the wants of the few rich at the expense of the necessities
needed by the poor. Thus there is social wastage of economy’s resources.
(6) Non-utilization of Resources:
The price mechanism under capitalism fails to employ the country’s resources fully. Free and unfettered
competition, inequalities of income distribution, over production, and consequent depression lead to
wastage of productive resources. Besides, there is mass unemployment and freedom of occupation has
little meaning under capitalism.
(7) Class Conflict:
A capitalist society is characterized by class conflict. The poor are exploited by the rich. This leads to
mutual distrust between the workers and the employers and to social unrest.
The above defects of capitalism have led the free enterprise economies of the West to modify this system
by regulating and controlling the institutions of private property and freedom of enterprise to serve the
best interests of the community at large.

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Conclusion
In the present day world most of the countries are moving towards a capitalistic type of economic system,
though it has got so many demerits and are highly prone to fluctuations in business activities.
15. Discuss the Features of Socialism.
Synopsis:
Introduction –Socialism - Features – Merits – Demerits – Conclusion
Introduction
Socialism
A socialist economy is an economic organization in which the means of production are owned and
regulated by the state. The production and distribution of goods and factors of production are done by the
state under the direction of the planning commission.The decisions as to how much to produce, which
methods of production to employ and for whom to produce are taken by the planning authority. That is
why a socialist economy is also called a planned economy. Such economies are China, Cuba, Vietnam,
and North Korea. They possess the following common features.
Features of Socialism
The main features of this system are detailed below.
(1) Public Ownership:
A socialist economy is characterized by public ownership of the means of production and distribution.
There is collective ownership whereby all mines, farms, factories, financial institutions, distributing
agencies (internal and external trade, shops, stores, etc.), means of transport and communications, etc. are
owned, controlled, and regulated by government departments and state corporations. A small private
sector also exists in the form of small business units which are carried on in the villages by local artisans
for local consumption.
(2) Central Planning:
A socialist economy is centrally planned which functions under the direction of a central planning
authority. It lays down the various objectives and targets to be achieved during the plan period. Central
economic planning means “the making of major economic decisions—what and how much is to be
produced, how, when and where it is to be produced, and to whom it is to be allocated—by the conscious
decision of a determinate authority, on the basis of a comprehensive survey of the economic system as a
whole.”

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And the central planning authority organizes and utilizes the economic resources by deliberate direction
and control of the economy for the purpose of achieving definite objectives and targets laid down in the
plan during a specified period of time.
(3) Definite Objectives:
A socialist economy operates within definite socio-economic objectives. These objectives “may concern
aggregate demand, full employment, satisfaction of communal demand, allocation of factors of
production, distribution of the national income, the amount of capital accumulation, economic
development…and so forth.” For achieving the various objectives laid down in the plan, priorities and
bold targets are fixed covering all aspects of the economy.
(4) Freedom of Consumption:
Under socialism, consumers’ sovereignty implies that production in state- owned industries is generally
governed by the preferences of consumers, and the available commodities are distributed to the
consumers at fixed prices through the state-run department stores. Consumers’ sovereignty under
socialism is confined to the choice of socially useful commodities.
(5) Equality of Income Distribution:
In a socialist economy, there is great equality of income distribution as compared with a free market
economy. The elimination of private ownership in the means of production, private capital accumulation,
and profit motive under socialism prevent the amassing of large wealth in the hands of a few rich persons.
The unearned incomes in the form of rent, interest and profit go to the state which utilizes them in
providing free education, public health facilities, and social security to the masses. “As far as wages and
salaries are concerned, most modern socialists do not aim at complete and rigid equality. It is now
generally understood that the maintenance offered choice of occupation implies wage differentials.”
(6) Planning and the Pricing Process:
The pricing process under socialism does not operate freely but works under the control and regulation of
the central planning authority. There are administered prices which are fixed by the central planning
authority. There are also the market prices at which consumer goods are sold. There are also the
accountings prices on the basis of which the managers decide about the production of consumer goods
and investment goods, and also about the choice of production methods.
Merits of Socialism
Prof. Schumpeter has advanced four arguments in favour of socialism: one. greater economic efficiency;
two, welfare due to less inequality; three, absence of monopolistic practices; and four, absence of
business fluctuations. We discuss these merits of socialism one by one.
(1) Greater Economic Efficiency:
Economic efficiency under socialism is greater than under capitalism. The means of production are
controlled and regulated by the central planning authority towards chosen ends. The central planning
authority makes an exhaustive survey of resources and utilizes them in the most efficient manner.

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Increased productivity is secured by avoiding the wastes of competition and by undertaking expensive
research and production processes in a coordinated manner. Economic efficiency is also achieved by
utilizing resources in producing socially useful goods and services which satisfy the basic wants of the
people, like cheap food, cloth, and housing.
(2) Greater Welfare due to Less Inequality of Income:
In a socialist economy there is less inequality of income as compared with a capitalist economy because
of the absence of private ownership of the means of production, private capital accumulation, and private
profit. All citizens work for the welfare of the state and each is paid his remuneration according to his
ability, education and training. All rents, interests and profits from various sources go to the state which
spends them for public welfare in providing free education, cheap and congenial housing, free public
health amenities, and social security to the people.
(3) Absence of Monopolistic Practices:
Another advantage of socialism is that it is free from monopolistic practices to be found in a capitalist
society. Since under socialism all means of production are owned by the state, both competition and
monopoly are eliminated. The exploitation by the monopolistic is absent. Instead of private monopoly,
there is the state monopoly of the productive system but this is operated for the welfare of the people. In
the state-owned factories, socially useful commodities are produced which are of high quality and are also
reasonably priced.
(4) Absence of Business Fluctuations:
A socialist economy is free from business fluctuations. There is economic stability because production
and consumption of goods and services are regulated by the central planning authority in accordance with
the objectives, targets and priorities of the plan. Thus there is neither overproduction nor unemployment.
Demerits of Socialism
A socialist economy has also certain disadvantages:
1. Loss of Consumers’ Sovereignty:
There is loss of consumers’ sovereignty in a socialist economy. Consumers do not have the freedom to
buy whatever commodities they want. They can consume only those commodities which are available in
department stores. Often the quantities which they can buy are fixed by the state.
2. No Freedom of Occupation:
There is also no freedom of occupation in such a society. Every person is provided job by the state. But
he cannot leave or change it. Even the place of work is allotted by the state. All occupational movements
are sanctioned by the state.
3. Misallocation of Resources:
Under socialism, there is arbitrary allocation of resources. The central planning authority often commits
mistakes in resource allocation because the entire work is done on trial and error basis.

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4. Bureaucratic:
A socialist economy is said to be a bureaucratic economy. It is operated like a machine. So it does not
provide the necessary initiative to the people to work hard. People work due to the fear of higher
authorities and not for any personal gain or self-interest.
Conclusion
There is no doubt that a socialist economy is better than a capitalist economy because of its overwhelming
merits. But it is disliked for the loss of political, economic and personal freedoms.
16. Discuss the Features of Mixed Economy.
Synopsis:
Introduction –Mixed Economy - Features – Merits – Demerits – Conclusion
Introduction
Mixed Economy
A mixed economy is a golden mean between a capitalist economy and a socialist economy. It is an
economic system where the price mechanism and economic planning are used side by side. There is
mixture of private and public ownership of the means of production and distribution. Some decisions are
taken by households and firms and some by the planning authority. All developing countries like India are
mixed economies.
Features of Mixed Economy
A mixed economy possesses the following features:
1. Public Sector:
The public sector is under the control and direction of the state. All decisions regarding what, how and for
whom to produce are taken by the state. Public utilities, such as rail construction, road building, canals,
power supply, means of communication, etc., are included in the public sector. They are operated for
public welfare and not for profit motive. The public sector also operates basic, heavy, strategic and
defence production industries which require large investment and have long gestation period. But they
earn profits like private industries which are utilized for capital formation.
2. Private Sector:
There is a private sector in which production and distribution of goods and services are done by private
enterprises. This sector operates in farming, plantations, mines, internal and external trade, and in the
manufacture of consumer goods and some capital goods. This sector operates under state regulations in

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the interest of public welfare. In certain fields of production, both public and private sectors operate in a
competitive spirit. This is again in the interest of the society.
3. Joint Sector:
A mixed economy also has a joint sector which is run jointly by the state and private enterprises. It is
organized on the basis of a joint stock company where the majority shares are held by the state.
4. Cooperative Sector:
Under a mixed economy, a sector is formed on cooperative principles. The state provides financial
assistance to the people for organizing cooperative societies, usually in dairying, storage, processing,
farming, and purchase of consumer goods.
5. Freedom and Control:
A mixed economy possesses the freedom to hold private property, to earn profit, to consume, produce and
distribute, and to have any occupation. But if these freedoms adversely affect public welfare, they are
regulated and controlled by the state.
6. Economic Planning:
There is a central planning authority in a mixed economy. A mixed economy operates on the basis of
some economic plan. All sectors of the economy function according to the objectives, priorities and
targets laid down in the plan. In order to fulfill them, the state regulates the economy through various
monetary, fiscal and direct control measures. The aim is to check the evils of the price mechanism.
7. Social Welfare:
The principal aim of a mixed economy is to maximize social welfare. This feature incorporates the merits
of socialism and avoids the demerits of capitalism. To remove inequalities of income and wealth, and
unemployment and poverty, such socially useful measures as social security, public works, etc. are
adopted to help the poor. On the other hand, restrictions are placed on the concentration of monopoly and
economic power in the hands of the rich through various fiscal and direct control measures.
Merits of Mixed Economy:
A mixed economy possesses certain merits which are as under:
(1) Best Allocation of Resources:
Since a mixed economy incorporates the good features of both capitalism and socialism, the resources of
the economy are utilized in the best possible manner. The price mechanism, the profit motive, and the
freedoms of consumption, production, and occupation lead to the efficient allocation of resources within
the economy. But where the possibility of mal-allocation of resources appears, the state regulation and
control rectifies it. Thus shortages are avoided, productive efficiency increases, and cyclical fluctuations
are eliminated.
(2) General Balance:

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A mixed economy maintains a general balance between the public sector and the private sector. There is
competition as well as cooperation between the two sectors which are conducive for achieving a high rate
of capital accumulation and economic growth. Further, an estimate of the successes and failures of the
two sectors can be made by comparing their respective performances, and corrective measures are
adopted accordingly. Thus the inconsistencies of the private enterprise economy and the ‘paper guesses’
of the planned economy are avoided in a mixed economy. By maintaining a higher level of production in
the two sectors, the state is able to achieve the targets laid down in the plan.
(3) Welfare State:
A mixed economy contains all the features of a welfare state. There is no exploitation either by the
capitalists as under a free enterprise economy or by the state as under a socialist economy. The workers
are not forced to work, Workers are provided monetary incentives in the form of bonus and cash rewards
for inventions. Labour laws are passed fixing minimum wages, hours of work, and laying down the
working conditions of workers in factories and on farms.
Social security is also provided to workers in the event of unemployment, disablement, death, illness, etc.
The production and sale of noxious articles are banned, while those of essentials are increased for the
benefit of the people at large. Legislative measures are adopted to remove the concentration of economic
power in the hands of the few rich, and to lessen inequalities of income and wealth.
Demerits of Mixed Economy
A mixed economy has also certain defects which are discussed below:
(1) Non-Cooperation between the Two Sectors:
The experience of the working of mixed economies reveals that the public sector and the private sector do
not see eye to eye with one another. The private sector is treated like a step-child and groans under the
various restrictions imposed upon it by the state. The private sector is taxed heavily, while the public
sector is given subsidies and preference over the former in the supplies of inputs. Thus a sense of
bitterness and non-cooperation develops between the two sectors.
(2) Inefficient Public Sector:
The public sector of a mixed economy is a big burden on the economy because it works inefficiently.
Bureaucratic control brings in inefficiency. There is over-staffing of the personnel, red-tapism, corruption
and nepotism. As a result, production falls and losses emerge.
(3) Economic Fluctuations:
The experience of the working of the mixed economic system in the developed countries also reveals that
they have not been able to remove economic fluctuations. This is because of the improper mixture of
capitalism and socialism. The private sector is allowed to operate freely under a loose system of
government regulations and controls. The public sector also does not operate under the rigid conditions
which are laid down under a planned economy.

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It has to depend for its supplies of raw materials, intermediate products and factors on the vagaries of the
market mechanism. If in the market, the prices of inputs are increasing due to their shortages, the public
sector will be equally experiencing these shortages and price increases. Hence economic fluctuations
which are a characteristic feature of a capitalist economy are equally experienced in a mixed economy.
Conclusion
But the defects of the mixed economy enumerated above are not so acute that they cannot be overcome.
Given efficient and honest administrative machinery, the defects of the public sector can be removed. The
private sector can be made to work more efficiently by proper control and direction. By adopting fiscal,
monetary and physical control measures, economic fluctuations can be eliminated.

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Economics (Karnataka State Law University)

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7. State of economic activity:

2. State the law of supply with an illustration and diagram.

Price Per Dozen ($) Quantity Supplied (in dozens)

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Price Per Dozen ($) Quantity Supplied (in dozens)

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Short-Run Average Costs:

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3. Short-Run Average Total Costs (or SATC or SAC)

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Modern Cost Theory

Long-run cost Curves

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Demand might be represented by a linear demand function such as

Q(d) represents the demand for a good

P represents the price of that good.

The Law of Demand

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Price Quantity Demanded

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Exceptions to the Law of Demand:

Some of the Important Exceptions are:

2. Goods having Prestige Value: Veblen Effect:

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5. Fashion related goods:

5. What is cost? What are the various concepts of cost?

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Nominal Cost and Real Cost:

Explicit and Implicit costs:

Accounting Costs and Economic Cost:

Business Cost and Full Cost:

Private costs and Social Costs:

Total, Average and Marginal Costs:

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Fixed Costs and Variable Costs:

Short run and Long run Costs:

Short-Run Average Costs:

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3. Short-Run Average Total Costs (or SATC or SAC)

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Long-run cost Curves

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6. Discuss the scarcity definition of economics.

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7. Discuss Welfare definition with criticisms.

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