UNIT

Introduction to Economics

1.0 Introduction

1.1 Definitions of Economics

1.2 Fundamental Problems ofan Economy

1.3 Nature and Scope of Economics
1.4 Microeconomics and Macroeconomics
1.5 Positive and Normative Economics

1.6 Basic Concepts of Economics

1.7 Summary

1.8 Model Questions

1.9 Glossary

1.0 Introduction

All economic activities are for satisfying human wants. In the society, all people to
satisfy their wants they use various goods and services. In order to purchase goods or services,
they require money, which they can get by participating in different economic activities.
This is clear that today money plays a significant role in almost all economic activities.
Economics is the study ofrelationship between satisfying unlimited human wants and limited
resources, which have alternative uses. Economics deals with how an individual as well as

society allocate their scarce resources to satisfy their needs in the order of preference to
maximise satisfaction. The present unit describes the origin of economics, various
 Economics - 1

definitions of economcis, fundamental problems of an economy, nature and scope of

economics, different study methods used in economics and various basic concepts of
economics.

1.1 Definitions of Economics

If we look around, we find people engaged in different activities like agriculture,

trade, business and industry. The motive behind these activities is to earn money to satisfy
their wants. The activities performed for earning and spending money are called economic
activities. Economic activities form the subject matter of economics.
1.1.1 Meaning of Economics

Economics is a social science which studies how the individuals and organizations
engaged in production, distribution and consumption of goods and services. Economics is
the systematic study of the never ending efforts of man to satisfy his unlimited wants with
limited resources.

The words 'economics' and 'economy' both came from two greek terms - oikos and
nemein mean "household management" - the management of the household being the most
familiar field in the economy. With the publication of Adam Smith's famous book “An
Inquiry into the Nature and Causes of Wealth of Nations" in 1776, Economics saw the
light of the day.

Since it is not possible to satisfy all the unlimited wants with the limited resources,
every society must decide some way of selecting those wants which can be satisfied. Thus,
a society is facing the problem of choice - choice among the unlimited wants that are to be
satisfied. The scarcity of resources therefore compels us to choose among the different
uses ofthe factors to which resources are to be devoted. The problem of allocating scarce
resources so as to get the maximum satisfaction assumes importance.
The nature and scope of economics are related to 'What is economics? Is it a study of
wealth or human behavior or scarce resources? The scope of economics is very wide. It
includes the subject matter of economics, whether economics is a science or an art and
whether it is a positive or a normative science. A study of definitions of economics throws
light on the nature of economics.

1.1.2 Definitions of Economics

Various definitions of economics emerged during the course of history. It is not

possible to study all these definitions individually. For simplicity purpose, all these
definitions can be studied under the following categories :
 3
Introduction to Economics

1. Wealth definitions.
II. Welfare definitions.

III. Scarcity definition of Lionel Robbins.

IV. Growth definition of Prof. Samuelson.
I. Wealth Definitions

Wealth definitions are related to the classical view of Adam Smith

and his contemporaries. The classical economists beginning with Adam
Smith defined economics as the science of wealth. He defined it in his
famous book 'Wealth of Nations', as "an enquiry into the nature and
causes of wealth of nations". Besides Adam Smith, other classical
economists have also regarded economics as the study of wealth. In the
words of J.B.Say, "the aim of political economy is to show the way in Adam Smith

which wealth is produced, distributed and consumed". "Economics is

1723-1790)
that body of knowledge which relates to wealth" to F.A. Walker in
America. According to J. S.Mill "it is the nature of wealth and the laws

which govern its production, distribution and exchange".

1. Important Features of Wealth Definition

(i) The main objective of human activity is the acquisition of wealth.

(ii) Wealth refers to goods produced.

(iii) Man is treated as selfish whose objective is to accumulate more and more wealth.

(iv) Economics deals with the activities of wealth production, consumption, preservation
and increasing.

2. Criticism

(i) Economics as a science of wealth laid stress on material wealth. This led it to be

science of Mammonism, a dismal science. The classicals narrowed the scope of

economics.

(ii) Many economists like Bailey, Carlyle, Ruskin, Jevons and Edgeworth have criticized
this definition. Carlyle, Ruskin and others criticized that economics must discuss
ordinary man's activities and not those ofthe economic man. Edgeworth regarded it
as " dealing with the lower elements ofhuman nature".

(iii) Marshall criticized that wealth is only a mean to an end,welfare, but not an end itself.
 $

Economics- I

(iv) Adam Smith's definition covers only materialistic human activities and not the non
materialistic activities like the services of teachers and doctors. Due to this the
scope of economics is limited.

(v) This definition concentrated mainly on the production side and neglected the
distribution side.

II. Welfare Definition

Alfred Marshall raised economics to a dignified status by

advancing a new definition in 1890. He shifted emphasis from production
of wealth to distribution of wealth (welfare). In the words of Marshall,
"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 the material requisites of well-being. Thus, it is on the one side, a Alfred Marshall

study of wealth and on the other and more important side, a part of the (1842-1924)

study of man."

Economists who followed the foot-prints of Marshall like A.C.Pigou and Edwin
Cannan have given the same type of definitions. In the words of Pigou "The range of enquiry
becomes restricted to that part of social welfare that can be brought directly or indirectly
into relation with the measuring rod of money". Edwin Cannan, defined it as "The aim of
political economy is the explanation of the general causes on which the material welfare of
human beings depends".

1. Important Features of Welfare Definition

i.
Economics is related to man's wealth getting and wealth using activities. It examines
that part of individual and social action which is closely connected with acquisition
and use of material wealth which promotes human welfare.

ii. Economics is a social science. Economics studies only economic aspects of social
life and it has no conce
ncern with the socially undesirable activities.

iii. Marshall's definition considered those economic activities which promote material
welfare. Non-economic activities and activities with ignoble ends are excluded. Ex.
political, social and religious aspects of life.

iv. Marshall used the term "Economics" for "Political economy" to make it similar to
physics. He assumed that economics must be a science even though it deals with the
ever changing human nature.
 Introduction to Economics 5

This definition has given importance to man and his welfare and recognised wealth
as a mean for the promotion of human welfare.
2. Criticism

Marshall's definition is not free from critics. Robbins in his "Essay on the Nature
and Significance of Economic Science" finds fault with the welfare definition of economics.
i.
Economics is a human science rather than a social science. The fundamental laws of
economics apply to all human beings and, therefore, economics should be treated as
a human science and not as a social science.
ii.
Lionel Robbins criticized it as classificatory. It distinguishes between materialistic
and non materialistic goods and not given any importance to non-materialistic goods
which are also very important. Therefore, it is incomplete. Robbins regards all goods
and services which have a price and enter into the exchange whether they are material
or non-material.

iii. Another serious objection is about the quantitative measurement of welfare. Welfare
is a subjective and relative concept and changes according to time, place and persons.
Robbins regards Economics as neutral between ends and it is nothing to do with
Ethics.

iv. Marshall includes only material activities which promote material welfare. To
Robbins, the production of alcohol and drugs do not promote human welfare. Yet
economics deals with the production and consumption of these goods, because

they are scarce and have utility and value.

V. Robbins has taken serious objection for not considering 'scarcity of resources'.
According to Robbins' economic problem arises due to limited resources which are
to be used to satisfy unlimited wants.

III. Scarcity Definition

Marshall's welfare definition played more important role until

the publication of Lionel Robbins' book "An Essay on the Nature and
Significance ofEconomic Science" in 1932. Robbins' definition brought
outthe logical inconsistencies and inadequacies of the earlier definitions
and formulated his own definition of economics. He has given a more
scientific definition of economics. In the words ofRobbins, "Economics
is the science which studies human behaviour as a relationship between Lionel Robbins

ends and scarce means which have alternative uses.""

"1898-1984( )
 1. Main Features

i. Human Wants are Unlimited: We remain busy throughout our life inorder to satisfy
these wants. The fulfillment of one want gives rise to a number of new wants. Thus,
wants are unlimited. Therefore, more important wants only have to be fulfilled.
ii. Means are Scarce: The means by which wants may be satisfied are scarce or limited.
It leads to economic problems as all wants cannot be satisfied by these limited means.
iii. Alternative Uses of Scarce Means: Resources are not only scarce but also have
multiple uses. For example, electricity can be used in homes and also in industries,
a piece of land can be used to produce paddy or wheat. Ifa scarce factor is used for
the satisfaction of one want, less of it will be available for other wants. Hence, man
has to make a decision regarding the alternative uses of resources.
iv.
The ends are of varying importance. Man has, therefore, to choose between wants
in order of their preference. Problem of choice arises.

2. Superiority of Robbins' Definition

Robbins' definition is superior to the earlier definitions in more than one way. The
reasons are given below:

1. It is non-classificatory, as it includes all human activities whether they promote

human welfare or not. It focuses on scarcity. Therefore, Robbins definition is
analytical.

2. This is a universally accepted definition. It is applicable to all types of societies,

because the scarcity of resources is felt by individuals as well as societies.

3. Robbins' definition of economics is neutral between ends. The ends may be noble
or ignoble, material or non materail, economic or non economic, economics is not

concerned with them. Thus, Economics has nothing to do with Ethics. Being a positive
science it does not pass any value judgments regarding ends.

3. Criticism

Some followers of Marshall like Durban, Fraser, Beveridge and Barbara Wootton

have criticised Robbins' definition by saying that it lacks human touch and that it is personal,
neutral and devoid of any normative or ethical element. He does not seek to make economics
a study ofhuman welfare. Some of them criticized as "barren scholasticism", while others
accused him of "behaviourism".

TH
i. Even though Robbins criticized Marshall's welfare definition, he has introduced the
welfare concept indirectly in his definition. The idea of maximum satisfaction is
implict in the scarcity definition. Therefore, the criticism of welfare definition is
equally applicable to it.

ii. Another criticism of Robbins' definition is that it is difficult to separate ends from
means. Immediate ends may be the means of further ends, and means may be the
ends of earlier actions.

iii. Scarcity definition has been criticized by economists as to say "economics is neutral
between ends". But economics cannot be neutral between ends. Economics is not
concerned with matter but with human behaviour.

iv. Robbins made economics a positive science. As per Lawrence Macfie, "economics
is fundamentally a normative science, not merely a positive science like chemistry".
Many economists regard it not only a positive science but also a normative science.
V.
Robbins' definition is not applicable to a dynamic society where changes take place
and we can overcome the problem of scarcity of resources with the passage oftime.

vi. Joan Robinson took serious objection to scarcity of resources. How best you utilize
them is more important than the idle resources. It fails to analyse the causes of
general unemployment of resources. Unemployment is caused not by scarcity of
resources but by their abundance.

vii. Robbins' scarcity definition neglects the more important problems of growth and
stability.

Despite these criticisms, most modern economists have defined economics

in Robbins' sense with slight modifications.

IV. Growth Definition

Growth definition of economics is given by Paul A.Samuelson,

an American Economist and Economics Nobel Prize winner in 1970.
Samuelson's definition includes the time element and is dynamic in
nature. Hence it is called a growth oriented definition of economics.
In the words of Samuelson," Economics is the study how people and
society choose, with or without the use of money, to employ scarce
and productive resources which could have alternative uses, to produce
various commodities over time and distribute them for consumption,
now and in the future, among various people and groups in the society. Paul A Samuelson
analyses the benefits of improving patterns of resource allocation".
 Important Points

Some ofthe important points in Samuelsons' definition are:

i.
His definition like Robbins' agreed that resources are not only limited but also have
several uses.
ii.
Samuelson's definition is dynamic in nature as it considers both the present and
future onsumption, production and distribution.
iii. Growth definition deals with the problem of choice in a dynamic society. Hence,
this definition broadened the scope of economics.
iv.
Samuelson's definition is superior to that of Robbins' because he shifted the emphasis
from the scarcity of resources to income, output and employment and later to the
problems of economic growth.

Samuelson's definition appers to be the most acceptable at the moment.

1.2 Fundamental Problems of an Economy
There are certain fundamental problems in any type of economy with which
conomists are concerned. The following are the basic economic prolems. These are
terrelated and interdependent.
1.
What type of goods are to be produced and in what quantities?
2.
How to produce these goods?
3.
For whom to produce these goods and services?
4.
How efficient the productive resources are in use? Whether available resources are
fully utilized?

Is the economy growing or static over a period of time?

Choice of Goods and Quantum of Goods: Goods are of many types. These may
be necessary goods, comfortable goods and luxury goods; or consumption goods
and capital goods. Available resources are not enough to produce all these goods at
a point of time. That is why, what type of goods have to be produced is a problem.
Once the type of goods to be produced is decided, then their quantities are to be
decided. Similarly, if we produce more than the demand, this leads to decrease in
the price and if less quantity is produced than the demand, it results in price increase.
To decide the amount of production, both demand and supply aspects have to be
taken in to account. The problem of the type of goods and their quantities has to be
decided on the basis of preferences of the society.
Introduction to Economics

2. Choice of Techniques: There are different methods to produce goods i.e., labour

intensive techniques and capital intensive techniques. In a labour surplus economy

capital intensive techniques cannot be applied because this creates unemployment
problem for labourers and capital is not sufficient. Hence, on the basis of availability
ofresources, production method has to be selected and used. If labour is in abundance,

it may use labour - intensive techniques and if capital is in abundance, capital -

intensive techniques may be used.
3.
Distribution of Goods: In any country welfare of the people is more important,
whether they are rich or poor. While producing goods, goods which are useful for
poor have to be produced but not for rich community. So distributional aspects have
to be taken care of.

4. Optimum Utilisation of Resources: Scarcity of resources is the main problem.

Hence, efficient use of resources is must. Even underutilization of scarce resources

is also a problem. There is a need to overcome this underutilization of resources

and optimum utilization of scarce resources is the need. In an economy where the

available resources are fully utilised, this indicates technical efficiency or full
employment.

5. Continuous Change in the Economy: Continuous change in the economy over a

period of time without any static or stationary situation is essential. Dynamism in
the economy is required for development.

The solution to these problems lies in the price mechanism.

1.3 Nature and Scope of Economics

Economics is an extensive and vast subject. To know the scope, subject matter and
nature of the subject, it is necessary to know the views expressed by economists belonging
to classical and modern thinkers on the subject. According to the social scientists Turgot
and Quesnay, all economic activities start to satisfy human wants. They believed that the
primary principle for economic activities is attaining maximum satisfaction with less effort.
This they called as economic motive, the objective of which is satisfying human wants.
It is observed that in the society money plays a significant role in economic activities.
Thus, it is proposed that economics is a study ofthe part played by money in human affairs.
However, there was no clarity whether economics is limited to trade activities or to money
matters.
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Economics - I

The nature of economics took a definite shape with the writings of Adam Smith,
known as Father of Economics, made a beginning in defining economics and its scope with
the publication of his famous book on the Wealth of Nations. Then a number of economists
defined economics and its subject matter in different ways.
The majority of economic thinkers from Adam Smith to Pigou have defined the
subject matter as the study of the causes of materail welfare or as the science of wealth.
Marshall confined it to the consumption, production, exchange and distribution of wealth.
Robbins finds this economics is concerned with a special aspect of human behaviour -
allocating scarce means among competing ends.

The scope ofany science explains what the science is concerned with. In economics,
traditional economic theory is divided into various branches like consumption, production,
exchange, distribution, income, employment, planning and development; where as modern
economic theory is divided into two branches viz. microeconomics and macroeconomics.
1. Consumption: Consumption can be defined as 'extracting utility from the goods
and services'. Consumption is the act of using final goods and services to satisfy
current wants. Consumption is the basis for production, exchange and distribution.
2. Production: In economics production is the process of conversion of raw materials
into final goods by adding form, place and time utility to the raw materials. John
Hicks writes, "Production is any activity directed to the satisfaction of other people's
wants through exchange". The factors which participate in production are called factors
ofproduction. They are land, labour, capital and organization.
3. Exchange: It is concerned with exchange of a good. A good may be exchanged for
another good or for money. Before the evolution of money when barter system was
in practice, goods were exchanged for goods. There were many problems in barter
system. With the introduction of money, value of every good is expressed in terms
of money and can be exchanged for money and exchange is very easy.

Distribution: Distribution is another important activity in economics. It explains

how goods and services are distributed amongst the various factors of production
which are responsible for the production. Each factor of production gets its reward.
Various theories are there to determine the factor prices.
Income: Individuals earn income by participating in various economic activities.
The activities are related to production of material goods or the services. Income is
a continuous flow. Various concepts of national income and the measuring methods
ofnational income are discussed as part of macro economics for analysing economic
growth and economic development.
Introduction to Economics

6. Employment: This includes the study of the volume of employment, causes of

unemployment and steps for its removal i.e., achieving full employment. The level
of employment in an economy depends on the demand for consumption goods and
demand for investment goods. Full employment means employment of all those
who are able and willing to work at the prevailing wage rates.
7. Planning and Economic Development: Economic planning is essential for proper
and efficient utilization of the available resources. By economic planning we mean
achieving the various predetermined targets systematically in a specific period of
time. Economic planning is the method by which an optimum allocation of scarce
resources amongst the various sectors is made in order to achieve speedy
development of the economy and improve the welfare of the people.

Microeconomics studies the economic actions and behaviour of individual units of

individuals and small groups. Microeconomics also examines whether the resources are
effectively allocated to individual consumers and producers in the economy. This is related
to the study of welfare economics. The scope of microeconomics is concerned with product
pricing, factor pricing and theory of economic welfare.

Macroeconomics deals with the general price level and its fluctuations over a time
instead ofdealing with relative prices of goods and services. It studies aggregates like national
income, total consumption, total savings and employment. The theory of economic growth
is another important area of study in macroeconomics. Most of the modern economics is
concerned with economic growth, particularly of developing countries, whose main objective
is to achieve high rate of economic growth and development. The scope of macroeconomics
is concerned with the theories of income, employment, general price level, inflation,
economic growth and macro theory of distribution.
Science lays down certain principles while art puts them into practical use. Then,
economics is also a science because it has theories and laws which establish a relation
between cause and effect. Its laws possess universal validity and these are self-corrective.
Economic laws have practical application in solving economic problems. Thus, economics
is both a science and an art.

Economics not only explains things as they are (Positive science), but also elucidates
with what it ought to be(Normative science). For example, economics discusses the existing
level ofwages, prices and tax rates in the economy and also suggests how they ought to be.
Economics is thus, both a positive and a normative science.
12
Economics - I

1.4 Microeconomics and Macroeconomics

Traditionally, the subject matter of economics has been divided into five groups i.e.
consumption, production, exchange, distribution and public finance, where as modern
economc theory divided it into two branches, first one is micro economics and second one
is macro economics. Ragnar Frisch of the University of Oslo, first used these two terms to
explain the study of economics in 1933.

1.4.1 Microeconomics

The term 'micro' is derived from the Greek word mikros, meaning "small."
Microeconomics is that branch of economics, which studies an economic or decision
making unit and considers in detail the behaviour of that particular unit. So it studies the
economic actions and behaviour of individual units and small groups of individual
units. Microeconomics is also known as partial analysis. According to K.E.Boulding
"microeconomics is the study ofparticular firms, particular households, individual prices,
wages, incomes, individual industries and particular commodities". Shapiro says,
"microeconomics has got relation with the study of small segments of the society".
1. Scope of Microeconomics

Marshall popularized microeconomics. Microeconomics is based on the assumptions

of "full employment” and “marginal analysis". The three major fields covered by
microeconomics are: (i) theory of product pricing, (ii) theory of factor pricing and (iii)
theory of welfare. It studies how the prices of various goods and services are determined
and what quantities of different factors of production should be used to minimize the cost
of production. Microeconomics is also called "price theory" because it explains pricing in
product markets as well as factor markets. It also examines whether the resources are
efficiently allocated to individual consumers and producers in an economy. This is related
to welfare economics. The chart-1.1 explains the scope of microeconomics.

Chart-1.1: Scope of Microeconomics

Product Pricing Factor Pricing Theory of Economic Welfare

1
(Theory of Distribution)

Theory of Theory of Rent, Wage, Interest, Profit

Demand Production

and Costs
 13
Introduction to Economics

2. Importance of Microeconomics

The following aspects explain the importance of microeconomics.

1.
Microeconomics explains how a free market economy works to decide about the
allocation of productive resources among many producers to produce goods and
services.

2.
This analysis is useful to the Government to frame suitable policies for the efficient
use of scarce resources to promote economic efficiency to achieve economic growth
and stability.

3. Microeconomics can be used to examine the conditions of economic welfare and it

suggests the required changes to bring maximum social welfare.

4.
This analysis is also applicable in the field of international trade and in the
determination of exchange rates.
5. Microeconomics is used to explain the factors which determine the distribution of
the incidence or burden of a commodity tax between the producers and the consumers.

6. Moreover despite the fact that the models of microeconomic theory are only crude
approximations to the real world, there is a value in studying analytical techniques.

1.4.2 Macroeconomics

The term 'macro' is derived from the Greek word 'makros' which means 'large'. The

modern developments in macroeconomics are most closely associated with the work of
J.M. Keynes. Macroeconomics is also known as income and employment theory or
aggregative economics. It studies aggregates like national income, total consumption, total
savings and total employment etc. According to K.E. Boulding, "macroeconomics studies
national income, not individual income, general price level instead of individual prices and
national output instead of individual output".

1. Scope of Macroeconomics
Boulding has rightly said that it has become popular only after the publication of
J.M. Keynes' "General Theory of Employment, Interest and Money" in 1936.
Macroeconomics deals with the general price level and its fluctuations over a period of
time instead of dealing with relative prices of goods and services. Macroeconomics studies
the causes of inflation and suggests measures to control it. The problems faced by modern
economies like poverty, unemployment, population, economic development are studied in
macroeconomics.
 14 Economics - I

It also deals with the theory of distribution. The causes of business cycles, the
monetary and fiscal policies which are used to control the business cycles for economic
stability are studied in macroeconomics. We can easily understand the scope of
macroeconomics with the chart-1.2.

Chart-1.2 :Scope of Macroeconomics

Theory of Income, Theory of General Theory ofEconomic Theory of Macro Theory of

and Distribution Business
Price Level and Growth

Employment Inflation Cycles

Theory of Theory of

Consumption Investment

2. Importance of Macroeconomics

Macroeconomic analysis has acquired great importance after 1930. The study of
macroeconomics is useful for various reasons as explained below :

1. The study of macroeconomics is more useful to the governments for formulation

and execution of policies for achievement of maximum social benefit.

2. Macroeconomics suggests how developing countries can use their resources to

maximise their growth.
3. The study of macroeconomics helps to understand the problems of unemployment
and inflation etc. and suggests how to solve them.

4. It helps to evaluate the overall functioning of an economy in order to distribute

national income among the different sections of the society.

5. Macroeconomics provides solutions to overcome business cycles and helps to

understand their occurance.

6. The study of macroeconomics facilitates international comparisons by

examining information on national income, consumption and investment for
different countries.

1.4.3 Differences between Microeconomics and Macroeconomics

Both (micro and macro) are interdependent. Neither of the two is complete without
the other. In spite of close relationship between the two branches of economics,
fundamentally they differ from each other. The following table explains the differences in
brief.

U
 15
Introduction to Economics

Table-1.1: Differences between Microeconomics and Macroeconomics

Microeconomics Macroeconomics

1. The word micro derived from the Greek 1. The word macro derived from the Greek
word "mikros" means "small". word "makros" means "large".

2. Microeconomics is the study ofindividual 2. Macroeconomics is the study ofeconomy as

units ofthe economy. a whole.

3. It is known as 'price theory'. 3. It is known as 'income and employment

theory'.

4. It explains price determination in both 4. It deals with national income, total

commodity and factor markets. employment, aggregate savings and
investment, general price level and economic
development etc.

5. It is based on price mechanism which depends 5. It is based on aggregate demand and

on demand and supply. aggregate supply.
6. It is based on partial equilibrium analysis 6. It is based on general equilibrium analysis
which explains the equilibrium ofan individual which explains the simultaneous equilibrium
unit.
in all the sectors ofthe economy.

7. It is a static analysis with out time element. 7. It is a dynamic analysis with time element.

1.5 Positive and Normative Economics

1.5.1 Positive Economics

According to J.N.Keynes, "A positive science may be defined as a body of

systematized knowledge concerning what it is". The classical school economists were of
the opinion that economics is purely a positive science which had no right to comment
upon the rightness or wrongness of economic policy. Further, economist cannot give any
final judgment on any matter. Robbins regards economics as a pure science ofwhat is,it is
not concerned with moral questions. He opines that "the function of economists consists
in exploring and not advocating and condemning". The manufacture and sale ofcigarettes

and wine may be injurious to health and therefore morally unjustifiable. But the economist
has no right to pass judgment on this, since both satisfy human wants and involve economic
activity. Friedman also considers economics as a positive science like any other natural
science. It explains what actually happens and not what ought to happen.

RS OF
16 Economics - I

1.5.2 Normative Economics

According to J.N. Keynes, "a normative science may be defined as a body of

systematized knowledge relating to the object ofwhat ought to be, and concerned with the
ideal as distinguished from the actual". The historical school of Germany has introduced
this in economics. As a normative science, economics is concerned with the evaluation of
economic events from the ethical view point. Marshall, Pigou, Hawtrey, Frazer and other
economists argue that economics is a social science which involves value judgments. It is
not an objective science like natural sciences. Economics is concerned with human welfare
and involves ethical considerations. It is not enough for the economist to explain and analyse
the economic problems, he has to offer solutions for these problems.

The conclusions ofpositive economics are relevant to normative problems, to decide

what ought to be done. Though positive economics is free from value judgments, normative
economics cannot be independent of positive economics. Therefore, economics is not only
a positive science but also a normative science.

1.6 Basic Concepts of Economics

1.6.1 Goods

In economics, all things that have value and satisfy human wants are called goods.

These goods are classified as material goods and non-material goods.

Material goods and Non-material goods: Material goods are tangible. These can
be seen, touched and transferred. For example, water, books, pens, cell phones etc. On the
other hand, non- material goods are intangible. These do not possess any shape or weight
and cannot be seen, touched and transferred. All types of services are non-material goods
such as the services of teachers, doctors, engineers, lawyers, actors, etc. Material goods
are further divided into non-economic(free) and economic goods.

1. Free Goods: Non- economic goods are called free goods. Goods which are freely
supplied by the nature and without prices are known as free goods. The supply of these
goods is always abundantly greater than their demand and therefore, do not have any price.
Free goods possess only value in use, but no exchange value. Examples are air, water and
sunshine. Now-a-days, some of these also became economic goods due to several reasons
and these goods are priced. Thus, the concept of free goods is relative to place and time.
Sand near the river is a free good but it is an economic good in the town.

2. Economic Goods: Aneconomic good is any physical object, natural or man made or
service rendered that can be commanded a price in a market. They always fall short ofthe
Introduction to Economics

demand forthem. These economic goods have both value in use and value in exchange such
as pens, books, computers etc. Economic goods possess three important characteristics
i.e., utility, scarcity and transferability. Economic goods are also divided into three types,
i.e. consumer, producer and intermediary.
Differences Between Free Goods and Economic Goods: The differences between free
goods and economic goods are briefly pointed out in Table - 1.2.
Table 1.2 Differences between free and economic goods

S.No. Free Goods S.No. Economic Goods

1. Free goods are nature's gift. 1. Economic goods are man made.

2. Their supply is abundant. 2.

Supply is always less than their demand.
3. They do not have price. 3. These goods have prices.

4. There is no cost of production. 4. These goods have cost of production.

5. They have value in use and do 5. These goods have value in use and also
not have value in exchange. value in exchange.

6. Their values are not 6. Their values are included in national income.

included in national income.

3. Consumer Goods: A consumer good is an economic good purchased by households

for final consumption. Thus, consumer goods are those final goods which directly satisfy
human wants. For example fruits, milk, pens, clothes, etc. Consumer goods are divided into
two types :(i) Perishable goods and (ii) durable goods.
(i) Perishable Goods: These are also known as single use consumers' goods. They
lose their value in single use. For example milk, fruits, etc.
(ii) Durable Goods: These are also known as durable use consumers' goods. The durable
goods yield service or utility over a time rather than being completely used up at the
moment of consumption. Hence, utility from these goods can be derived for a long
time. Examples are televisions, computers and fans..

Consumer goods can also be classified into three groups: (i) necessary goods, (ii)
comfortable goods and (iii) luxury goods. Necessary goods are much essential to continue
our life and without using these goods survival is questionable. Generally its utility will be

DIYE
more than its price. Example: rice. Comfortable goods are not necessary for our day to day
living. But these goods will make life comfortable and enhance our efficiency. For example,

"T 10
18 Economics - I

fan, chair and table. Luxury goods are neither required as essential goods, nor useful as
comfortable goods. Generally its utility will be less than its price. For example, BMW car.
Luxuries will not increase our efficiency, simply gives us pleasure.
4. Producer or Capital Goods: Goods which are used in the production of other goods
are called producer or capital goods. They satisfy human wants indirectly. For example
machines, buildings etc. are capital goods. A good can be classified into consumer good or
capital good depending on the nature of its use. For example, when paddy is used for food it
becomes a consumer good and when used as seed in cultivation, it becomes a capital good.

Producer or capital goods are divided into two types:

1. Single Use Capital Goods: These goods are used only once in the production
process. For example, raw materials, coal and electricity.

2. Durable Use Capital Goods: These goods are used for long time in the process of
production. Machines, tools etc. are the durable capital goods.

5. Intermediary Goods: Goods which are under the process of production and semi
finished goods are known as intermediary goods. Examples are cement, bricks and steel

etc. used as intermediary goods in construction work. The goods which are not yet finished
and under different stages of production are known as intermediary goods. On the other
hand, goods sold for consumption or for investment are called final goods.

1.6.2 Wealth

Wealth means stock of assets held by an individual or institution that has the potential
for yielding income in some form. Wealth may be held in various forms. These include
money, shares of companies, land etc. The important characteristics of wealth are: (i)
utility, (ii) scarcity, (iii) value in exchange, and (iv) transferability. Wealth in physical form
is tangible wealth. Diamonds, factories and houses are examples of physical assets. Human
capital is intangible wealth. Wealth is classified into personal wealth, social wealth, national
wealth and international wealth.

1.6.3 Income

Income is a flow from wealth, where as wealth is a stock. In every economy income
flows from households to firms and vice versa. Thus the factor market and the product
market are closely related to each other. The process of circular flow of income makes to
understand that income flows from households to firms and firms to households. The same
can be understood from the diagram-1.1.
 19
Introduction to Economics

Expenditure on Goods and Services

Goods and

Services

HOUSEHOLDS FIRMS

Factors of

Production

Wages, Rent, Interest and Profit

Figure-1.1: Circular Flow of Income

1.6.4 Utiliy

The concept of utility has great importance in economics. The want

satisfying capacity of a commodity at a point of time is known as utility. It is a
subjective and a relative concept. Only consumer can judge the utility of a
commodity. Bentham described it as that which appears 'to augment or diminish
the happiness of the party whose interest is in question'. Utility and usefulness
are not same. The consumption of wine is harmful for health, it is not useful, but it
has utility.

Types of Utility: Utility is divided into four types. They are :

1. Form Utility: If a commodity satisfies a consumer by its shape it is known as

'form utility'. For example, conversion of wooden log into a chair or a table.

2. Place Utility: When goods acquire utility with the change of their place, it is
known as 'place utility'. For example, vegetables at the production place have no
utility but when they are brought to the market they gain utility.

3. Time Utility : Goods acquire utility because of time. Businessmen may store the
goods and they may sell when the demand is high. For example,coffee and tea in the
winter and cool drinks in summer.

4. Service Utility Services also have the ability to satisfy human wants. For example,
the teaching of a good teacher directly helps a student to build his career. This is
known as service utility. It is acquired through specialised knowledge and skills.

1.6.5 Value

In economics, the value ofany good or service is the power to command other article
or service in exchange. 'Value' in economics is classified into two concepts. They are:
(i) value in use and (ii) value in exchange.
20
Economics - I

(i) Value in Use: It refers to the capacity of the good to satisfy human wants. Thus,
utility is the value in use of a good. Free goods have value in use and they do not have
any value in exchange. For example, water has a greater value in use but no value in
exchange.

(ii) Value in Exchange: It refers to the quantity of other good(or more usually money)
a good can be exchanged for. All economic goods have value in use and value in
exchange. For example if one pen can be exchanged for one book, then the value of
one pen is equal to one book. For a good to have value in exchange must possess the
qualities ofutility, scarcity and transferability.
1.6.6 Price

In economics, the meaning of price is different from that of value. The value of a
commodity / service expressed in terms of money is known as price. In other terms the rate
at which a commodity is exchanged is called its price. For example, if a pen is exchanged
for 10 rupees, then the price of the pen is 10 rupees. Value is expressed in terms of other
goods.

1.6.7 Wants

A desire can become a want only when a consumer has the means to purchase the
thing and he is also ready to spend the means. Human wants are the basis for all economic
activities. They depend on economic and social status of individuals. The nature of human
wants can be understood by considering the following characteristics.

1. Unlimited Wants : Human wants are unlimited. If you satisfy one want, another one
crops up. In this way, wants arise one after another throughout human life.

2. A Particular Want is Satiable: As wants are unlimited, a person can satisfy a

particular want at a point of time. For example if a person is thirsty he can satisfy it
by drinking a glass ofwater.

3. Competition: Wants are unlimited whereas resources to satisfy them are limited.
Therefore, a scale of preference is essential to satisfy wants.

4. Complementary : Satisfaction of a single want requires the use of various

commodities. For example writing need is satisfied only when we have a pen, ink
and paper together.

5. Substitution : A person can satisfy his want with various commodities. For example
if a person is hungry, he can eat rice or fruits to satisfy his hunger.
 21
Introduction to Economics

6. Recurring: Wants recur. When you satisfy a particular want at a point of time it may
reappear at another time. We take food and our hunger is satisfied. But after a few
hours, we again feel hungry.

7. Habits: Wants change into habits. For example smoking cigarettes for casual results
into a habit if it is not controlled.

8. Wants Vary with Time, Place and Person : Wants are dynamic in nature. Hence,
they are changing from time to time, place to place and person to person.
Certain wants are more intense whereas other wants are less intense. On this

basis, human wants are divided into : (i) necessities, (ii) comforts and (iii) luxuries.

1.6.8 Welfare

Welfare is an important concept in economics. It refers to the satisfaction that an

individual or society derives from wealth and can be attributed to the standard of living of
individuals or societies. Welfare is a subjective concept and cannot be measured objectively.
Wealth and welfare are inter-related. Welfare depends on the distribution of wealth and
income among different sections of people in the society. As an economy grows, the living
conditions of its people improve, which can be taken as an indicator of improvement in
welfare. In the words of A.C.Pigou "economic wellbeing is that part of social welfare that
can be brought directly or indirectly into relation with the measuring rod of money".

1.7 Summary

Economics is a social science which studies individuals and organisations engaged

in consumption, production, exchange and distribution of goods and services. Several

economists defined the subject of economics in different ways keeping in view of
contemporary changes. Adam Smith defined economics as the science of wealth. Later
Alfred Marshall and Lionel Robbins gave welfare and scarcity definitions respectively. Lionel
Robbins gave a more scientific definition of economics. The growth definition given by
Paul Samuelson includes the time element in the nature and scope of economics. The nature
and scope of economics covers all aspects of economic activities.
Microeconomics studies the behaviour of individual units. In contrast,

macroeconomics deals with the study of whole units of economy. Positive and normative
analyses are some of the important methods developed by economists. The basic concepts
of economics such as free goods, economic goods, consumer goods, capital goods,
intermediary goods, wealth, income, utility, value, price and welfare help us to understand
the subject of economics.

AND
 M.Ioeconomics is the study of individual
units such as
house holds , firms and industries
.
2. Macroeconomics
: Macroeconomics is the study of aggregates
like national
income employment
business cycles ,growth
,
and
,
development .
3. Positive economics
: It is a body of systematized
knowledge concerning
" what
it "
is . It isnot concerned with moral
questions . It explains
what actually happens
.
4. Normative economics : It is a body of systematized
knowledge relating to the
object of w
' hat ought
to be " . It is concerned with the

1
evaluation of economic
events from the ethical view point
.
5. Free goods : These g o o d s a r e freely supplied by
the nature .The supply
of these goods is unlimited and therefore
do not have ,
prices Their value
.
isnot included in the national income
.
6 .
Economic goods : These goods are man made The supply of these goods
.
is
limited and will have prices Their value
. is included in the
national income .
 24
Economics - I

7. Consumer goods : These are the final goods which directly satisfy the wants
of consumers.

8. Capital goods : Capital goods are those goods which are used for the pro

duction of other goods. They satisfy the wants of con

sumers indirectly.
9. Intermediary goods
: Intermediary goods are those goods which are in various
stages of production process.
10. Utility
: Utility is the wants satisfying capacity of goods and ser
vices.

11. Exchange value

: Exchange value is the purchasing power of one commod
ity. All economic goods have value in exchange.
12. Price

: Price is the value of a commodity expressed in terms of

money.