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Unit – 1
Nature of Economics
Basis of economics
 The scarcity of resources in a country and unlimited wants of the people, form the basis of
economics.
 If the resources were unlimited, we can go on producing goods to satisfy our unlimited wants. But
the resources are limited, i.e., scarce.
 Therefore, we have to make some decisions in utilizing the limited resources efficiently and
maximizing the satisfaction.
Decision making
 Decision making is the process of selecting one action from two or more alternative courses of
action.
 Choice is due to scarcity of resources.
 In business land, labour, capital and management is limited. Therefore, these resources should be
used optimally to maximize profits.
 In business, decision making is regarding:
 Product (what to produce? design to be developed?)
 Capital (from where to get?,and at what rate of interest?)
 Number and type of labourers to be used in production
 Number of machines to be used (new machines to be employed, size of machines)
 Price
 Marketing strategies
Forward planning
 It means establishing plans for the future.
 But the problem in decision making and forward planning is uncertainty about the future.
Definitions of Economics
There are four broad definitions of economics;
 Wealth definition
 Welfare definition
 Scarcity definition
 Growth definition
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(1) Wealth Definition

 Adam Smith (1723-1790), in his book, “An inquiry into the Nature and Causes of the Wealth of
Nations” defined economics as, “a science which studies the nature and causes of wealth of
nations”.
 According to the definition, the scope of Economics is limited to earning and spending of wealth.
 Therefore, Economics is described as dismal/ gloomy science.
(2) Welfare Definition
 Prof. Alfred Marshall (1842 – 1924) defined Economics in the welfare context as follows: “Political
economy or Economics is a study of mankind in the ordinary business of life; it examines that
part of individual and social action which is most closely connected with the attainment and
with the use of material requisites of well-being”.
 In the welfare definition the emphasis shifts from wealth to welfare, because it studies how man
earns and spends to improve the material welfare.
(3) Scarcity Definition
 Lionel Robbins defined Economics as follows: “Economics is a science which studies human
behaviour as a relationship between ends (wants) and scarce means which have alternative
uses”.
Three fundamental propositions of the definition are:
i. Ends/Unlimited human wants
 If one need is satisfied other need arises. E.g. Cycle, scooter, car, etc.,
ii. Scarce means/scarcity of resources
 Resources are limited (money, time, etc).
 Therefore choice has to be made (i.e., most urgent need is given importance i.e., food or
cinema). Priority to most urgent need.
iii. Alternative uses of scarce means
 Land may be used for building houses or theatres (but most urgent need is given
importance).
 The outcome of this definition is opportunity cost - it is the benefit/ value of something that must
be given up to get something else.
(4) Growth Definition
 Prof. Paul. A. Samuelson, a Nobel Laureate defines Economics as, “the study of how men and
society choose, with or without the use of money, to employ scarce productive resources
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which could have alternative uses to produce various commodities overtime and distribute
them for consumption now and in future among various people and groups of society”.
 Samuelson says that, scarce resources can be put to alternative uses.
 Time element is included. Therefore, it is dynamic.
 Application to barter economy also (i.e., with or without the use of money).
Economics as a positive science and a normative science
Positive science
 Positive science studies ‘what is’.
 Positive science deals with things as they are.
o Eg: The Indian unemployment rate is 9.5 per cent.
Normative science
 Normative science studies ‘What ought to be’.
 Normative science deals with the rightness or wrongness of a phenomenon.
 It makes value judgment (good or bad; right or wrong).
o Eg: Indian unemployment rate should be lower.
 So, Economics is considered as a normative science.
Significance of Economics for Engineers
1. Demand analysis and Demand forecasting
 Estimate demand and then produce.
 Topics covered are:
 Law of demand and demand determinants
 Elasticity of demand
 Demand forecasting
2. Cost analysis and Revenue analysis
 Estimate cost of production.
 Compare estimated cost with actual cost.
 Cost control.
 Topics covered are:
 Cost concepts
 Cost-output relationship
 Revenue concepts and curves
 Break-even point (BEP)
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3. Supply analysis
 After cost estimation, goods are produced and supplied.
 Topics covered are:
 Law of supply
 Factors influencing supply
4. Pricing decisions, policies and practices
 Success and revenue of firms depends on price.
 Topics covered are:
 Price determination in various market forms (Perfect competition, monopoly, monopolistic
competition, oligopoly and duopoly)
5. Market failure
 Market failure is a situation in which the allocation of goods and services is not efficient.
 Topics covered are:
 Types of goods (excludable, non-excludable, rivalrous, non-rivalrous)
 Market failure – causes
 Government intervention
6. Money and Banking
 Banks mobilize funds and channel them to productive uses.
 Topics covered are:
 Money and its functions
 Quantity theory of money
 Supply of money
 Role and functions of central bank and commercial banks
7. Foreign exchange
 Foreign exchange plays an important role in export and import.
 Topics covered are:
 Terms of trade
 Balance of payments
 Exchange rate determination
 Methods of foreign payments and exchange control
 International Institutions – IMF, IBRD
8. Business cycle
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 It refers to the fluctuations in economic activity that an economy experiences over a period of
time.
 Topics covered are:
 Phases of business cycle
 Measures to control the effects of business cycle
9. National income
 National income is the total value a country's final output of all new goods and services produced
during a particular year.
 Topics covered are:
 National income - concepts
 Methods of calculating national income
 Problems in calculating national income
10. Inflation and Deflation
 Inflation - A general increase in prices and fall in the purchasing value of money.
 Deflation - A reduction in the general level of prices in an economy.
 Topics covered are:
 Inflation and deflation – causes and control measures
Approaches to Economic analysis
 Classical economists analysed economic problems through consumption, production, exchange,
distribution and public finance.
 Modern economists analysed Economics through Micro and Macro analysis.
 Prof. Ragnar Frisch in 1933, introduced Micro and Macro analysis.
Micro Economics
 According to Prof. Boulding, Micro economics is, “the study of particular firms, particular
households, individual prices, wages, incomes, individual industries, particular commodities”.
 The fields covered by micro economics are:
 Theory of product pricing - Theory of demand, theory of production and cost (how resources
are allocated to production of goods and services and how it is distributed).
 Theory of factor pricing - Theories of rent, wages, interest and profits.
 Theory of economic welfare
 Major part of micro study relates to pricing of products and factors of production.
Therefore, micro economics is also known as ‘Price theory’
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Macro Economics
 According to Prof. Boulding, “Macro economics deals not with individual quantities as such, but
with the aggregates of these quantities, not with individual incomes, but with national income;
not with individual prices but with the price level; not with individual outputs but with the
national output”.
 The areas covered by macro economics are:
 Theory of employment and income - Consumption function, investment function and
business cycles.
 Theory of general price level - Inflation and Deflation
 Theory of economic growth (GDP)
 Macro theory of distribution - Share of wages and profits in total National income.
 Macro study is mainly concerned with economy’s income and employment. Therefore, macro
economics is also called as ‘Income Theory’ or ‘Income and Employment theory’.
Economic terms
(a) Utility
 Stanley Jevons conceived the concept.
 Utility is the want satisfying power of a commodity.
 It determines the demand for a commodity (↑U; ↑D)
(b) Wealth
 Goods are classified as Free goods and Economic goods.
 Free goods are those which can be obtained freely or without any price being paid. Eg: Air,
Sunshine etc.
 Economic goods are those which can be obtained only at a price. Eg: Machines, Vehicles etc.
 Wealth refers only to economic goods.
 Goods which possess utility, which are scarce and which are transferable or marketable can
be described as wealth.
(c) Capital
 Capital is wealth which aids in the production.
 All capital is wealth, but all wealth is not capital.
(d) Value
 The term value is used in Economics as value in use and value in exchange.
 By value in use, we mean the use value of an article.
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 Value in exchange means, the rate at which a given article can be exchanged for other
commodities.
 Eg: Water; Diamond
 Water has more value in use and less value in exchange.
 Diamond has less value in use and more value in exchange (due to scarcity).
Economic Assumptions
 Economic theories are based on certain assumptions which are classified into four categories:
(1) Psychological or Behavioural Assumptions
 Behavioural assumptions pertain to rational and irrational behavior of individuals (consumers
and producers).
o Rational behaviour is systematic and purposive
o Irrational behaviour is unpredictable and erratic
 A rational consumer aims to maximize the satisfaction from a given money income.
o Eg: Rational behavior - When price falls demand increases (consumers)
 A rational producer aims at maximizing profits.
o Eg: Rational behavior - When price rises supply rises (producers)
 Another assumption is that, all markets are in equilibrium (ie., equilibrium price and equilibrium
quantity (demand=supply) – no consumer or producer is dissatisfied).
(2) Institutional Assumptions
 All economic theories have been developed on the assumption of a capitalist economy (in which
production and distribution are privately owned).
(3) Structural Assumptions
 The structural assumptions are used in production functions of various types.
 Static economy - In the short run, economic theories are based on the assumptions of given
resources and technology.
 Dynamic economy - In the long run, labour, capital and other resources and technology are
assumed to change.
 Most economic theories are based on the assumption of a static economy.
(4) Ceteris Paribus Assumption
 Another important assumption made in economics is the ceteris paribus or other things being
constant.
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o Eg: Law of demand (Demand changes due to price; all other factors are assumed to be
constant).