UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.

M)
TOPIC 1: ECONOMICS

Specific Objectives
By the end of topic unit, the trainee should be able to;
a) Define the term economics
b) Explain the concept of economics
c) Discuss the concept of production
d) Discuss the term utility and values
e) Recognize utility and values in production
f) Discuss the basic factors of production
g) Discuss the concept of, division of labour, specialization, mechanization and automation in production

INTRODUCTION

Economics is about making choices. We make all kinds of choices every day. How much should I spend on gas? What’s
the best route to work? Where should we go for dinner? Which job or career should I go for? What are the pros and
cons of finishing college versus taking a job or inventing the next, best Internet startup? Which roommate should take
care of washing the dishes? Can I get that dog as a pet? Should I get married, have children, and if so, when? Which
politician should I vote for when they all claim they can improve the economy or make my life better? What is “the
economy,” anyway? What if my personal or religious principles conflict with what people tell me is in my best
economic interest?

Economics is not just about money. It is about weighing different choices or alternatives. Some of those important
choices involve money, but most do not. Most of your daily, monthly, or life choices have nothing to do with money,
yet they are still the subject of economics. For example, your decisions about whether it should be you or your
roommate who should be the one to clean up or do the dishes, whether you should spend an hour a week
volunteering for a worthy charity or send them a little money via your cell phone, or whether you should take a job so
you can help support your siblings or parents or save for your future are all economic decisions. In many cases, money
is merely a helpful tool or just a veil, standing in for a partial way to evaluate some of the goals you really care about
and how you make choices about those goals.

You might also think economics is all about “economizing” or being efficient–not making foolish or wasteful choices
about how you spend or budget your time and money. That is certainly part of what economics is about. However,
that’s just the tip of the iceberg. We all know that we can save money or time by being more efficient in our planning.
A trip to the supermarket can be coordinated with a trip to take your child to school or to deposit a check at the bank
across the street to save on gas. But we sometimes don’t choose the most efficient options. Why not? Economics is
also about plumbing the depths of why we sometimes do and sometimes don’t make what seem like the most
economizing or economical choices.

DEFINITIONS

The standard definitions of economic can be grouped into three:

1. Smith’s Wealth definition;
2. Marshall’s Welfare definition; and
3. Robbins’ Scarcity definition.

1. Adam Smith’s Wealth Definition:

The formal definition of economics can be traced back to the days of Adam Smith (1723-90) — the great Scottish
economist. Following the mercantilist tradition, Adam Smith and his followers regarded economics as a science of
wealth which studies the process of production, consumption and accumulation of wealth.
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UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

His emphasis on wealth as a subject-matter of economics is implicit in his great book— ‘An Inquiry into the Nature and
Causes of the Wealth of Nations or, more popularly known as ‘Wealth of Nations’—published in 1776.

According to Smith:
“The great object of the Political Economy of every country is to increase the riches and power of that country.” Like
the mercantilists, he did not believe that the wealth of a nation lies in the accumulation of precious metals like gold
and silver.

To him, wealth may be defined as those goods and services which command value-in- exchange. Economics is
concerned with the generation of the wealth of nations. Economics is not to be concerned only with the production of
wealth but also the distribution of wealth. The manner in which production and distribution of wealth will take place in
a market economy is the Smithian ‘invisible hand’ mechanism or the ‘price system’.

Other contemporary writers also define economics as that part of knowledge which relates to wealth. John Stuart Mill
(1806-73) argued that economics is a science of production and distribution of wealth. Another classical economist
Nassau William Senior (1790-1864) argued “The subject-matter of the Political Economics is not Happiness but
Wealth.” Thus, economics is the science of wealth. However, the last decade of the nineteenth century saw a scathing
attack on the Smithian definition and in its place another school of thought emerged under the leadership of an English
economist, Alfred Marshall (1842-1924).

Criticisms:

Following are the main criticisms of the classical definition:

i. This definition is too narrow as it does not consider the major problems faced by a society or an individual.
Smith’s definition is based primarily on the assumption of an ‘economic man’ who is concerned with wealth-
hunting. That is why critics condemned economics as ‘the bread-and-butter science’.
ii. Literary figures and social reformers branded economics as a ‘dismal science’, ‘the Gospel of Mammon’ since
Smithian definition led us to emphasise on the material aspect of human life, i.e., generation of wealth. On the
other hand, it ignored the non-material aspect of human life. Above all, as a science of wealth, it taught
selfishness and love for money. John Ruskin (1819-1900) called economics a ‘bastard science.’ Smithian
definition is bereft of changing reality.
iii. The central focus of economics should be on scarcity and choice. Since scarcity is the fundamental economic
problem of any society, choice is unavoidable. Adam Smith ignored this simple but essential aspect of any
economic system.

2. Marshall’s Welfare Definition:

Alfred Marshall in his book ‘Principles of Economics published in 1890 placed emphasis on human activities or human
welfare rather than on wealth. Marshall defines economics as “a study of men as they live and move and think in the
ordinary business of life.” He argued that economics, on one side, is a study of wealth and, on the other, is a study of
man.
Emphasis on human welfare is evident in Marshall’s own words: “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, “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.” According to Marshall, wealth is not an end in itself as was thought by classical authors; it is a means to an
end—the end of human welfare.

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 UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

This Marshallian definition has the following important features:

i. Economics is a social science since it studies the actions of human beings.
ii. Economics studies the ‘ordinary business of life’ since it takes into account the money-earning and money-
spending activities of man.
iii. Economics studies only the ‘material’ part of human welfare which is measurable in terms of the measuring rod of
money. It neglects other activities of human welfare not quantifiable in terms of money. In this connection A. C.
Pigou’s (1877- 1959)—another great neo-classical economist—definition is worth remembering. Economics is “that
part of social welfare that can be brought directly or indirectly into relation with the measuring rod of money.”
iv. Economics is not concerned with “the nature and causes of the Wealth of Nations.” Welfare of mankind, rather
than the acquisition of wealth, is the object of primary importance.

Criticisms:
Though Marshall’s definition of economics was hailed as a revolutionary one, it was criticized on several grounds.

i. Marshall’s notion of ‘material welfare’ came in for sharp criticism at the hands of Lionel Robbins (later Lord)
(1898- 1984) in 1932. Robbins argued that economics should encompass ‘non- material welfare’ also. In Teal
life, it is difficult to segregate material welfare from non-material welfare. If only the ‘materialist’ definition is
accepted, the scope and subject-matter of economics would be narrower, or a great part of economic life of
man would remain outside the domain of economics.
ii. Robbins argued that Marshall could not establish a link between economic activities of human beings and
human welfare. There are various economic activities that are detrimental to human welfare. The production
of war materials, wine, etc., are economic activities but do not promote welfare of any society. These
economic activities are included in the subject-matter of economics.
iii. Marshall’s definition aimed at measuring human welfare in terms of money. But ‘welfare’ is not amenable to
measurement, since ‘welfare’ is an abstract, subjective concept. Truly speaking, money can never be a
measure of welfare.
iv. Marshall’s ‘welfare definition’ gives economics a normative character. A normative science must pass on value
judgments. It must pronounce whether a particular economic activity is good or bad. But economics, according
to Robbins, must be free from making value judgment. Ethics should make value judgments. Economics is a
positive science and not a normative science.
v. Marshall’s definition ignores the fundamental problem of scarcity of any economy. It was Robbins who gave a
scarcity definition of economics. Robbins defined economics in terms of allocation of scarce resources to
satisfy unlimited human wants.

3. Robbins’ Scarcity Definition:

The most accepted definition of economics was given by Lord Robbins in 1932 in his book ‘An Essay on the Nature and
Significance of Economic Science. According to Robbins, neither wealth nor human welfare should be considered as
the subject-matter of economics. His definition runs in terms of scarcity: “Economics is the science which studies human
behaviour as a relationship between ends and scarce means which have alternative uses.”

From this definition, one can build up the following propositions:

i. Human wants are unlimited; wants multiply—luxuries become necessities. There is no end of wants. If food were
plentiful, if there were enough capital in business, if there were abundant money and time—there would not have
been any scope for studying economics. Had there been no wants there would not have been any human activity.
Prehistoric people had wants. Modern people also have wants. Only wants change—and they are limitless.
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TOPIC 1: ECONOMICS

ii. The means or the resources to satisfy wants are scarce in relation to their demands. Had resources been plentiful,
there would not have been any economic problems. Thus, scarcity of resources is the fundamental economic
problem to any society. Even an affluent society experiences resource scarcity. Scarcity of resources gives rise to
many ‘choice’ problems.
iii. Since the prehistoric days one notices constant effort of satisfying human wants through the scarcest resources
which have alternative uses. Land is scarce in relation to demand. However, this land may be put to different
alternative uses.
iv. A particular plot of land can be either used for jute cultivation or steel production. If it is used for steel production,
the country will have to sacrifice the production of jute. So, resources are to be allocated in such a manner that the
immediate wants are fulfilled. Thus, the problem of scarcity of resources gives rise to the problem of choice.
v. Society will have to decide which wants are to be satisfied immediately and which wants are to be postponed for
the time being. This is the choice problem of an economy. Scarcity and choice go hand in hand in each and every
economy: “It exists in one-man community of Robinson Crusoe, in the patriarchal tribe of Central Africa, in
medieval and feudalist Europe, in modern capitalist America and in Communist Russia.”
vi. In view of this, it is said that economics is fundamentally a study of scarcity and of the problems to which scarcity
gives rise. Thus, the central focus of economics is on opportunity cost and optimization. This scarcity definition of
economics has widened the scope of the subject. Putting aside the question of value judgement, Robbins made
economics a positive science. By locating the basic problems of economics — the problems of scarcity and choice
— Robbins brought economics nearer to science. No wonder, this definition has attracted a large number of
people into Robbins’ camp.
vii. The American Nobel Prize winner in Economics in 1970, Paul Samuelson, observes: “Economics is the study of how
men and society choose, with or without the use of money, to employ scarce productive resources which could
have alternative uses, to produce various commodities over time, and distribute them for consumption, now and
in the near future, among various people and groups in society.”

Criticisms:

His definition may be criticized on the following grounds:

i. In his bid to raise economics to the status of a positive science, Robbins deliberately downplayed the importance
of economics as a social science. Being a social science, economics must study social relations. His definition places
too much emphasis on ‘individual’ choice. Scarcity problem, in the ultimate analysis, is the social problem—rather
an individual problem. Social problems give rise to social choice. Robbins could not explain social problems as well
as social choice.
ii. According to Robbins, the root of all economic problems is the scarcity of resources, without having any human
touch. Setting aside the question of human welfare, Robbins committed a grave error.
iii. Robbins made economics neutral between ends. But economists cannot remain neutral between ends. They must
prescribe policies and make value judgments as to what is good for the society and what is bad. So, economics
should pronounce both positive and normative statements.
iv. Economics, at the hands of Robbins, turned to be a mere price theory or microeconomic theory. But other
important aspects of economics like national income and employment, banking system, taxation system, etc., had
been ignored by Robbins.

General definition of Economic

Economics is a social science concerned with the production, distribution and consumption of goods and services. It
studies how individuals, businesses, governments and nations make choices on allocating resources to satisfy their
wants and needs, and tries to determine how these groups should organize and coordinate efforts to achieve
maximum output.

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TOPIC 1: ECONOMICS

THE CONCEPT OF ECONOMIC

There are 5 basic concepts of Economics. Sometimes, Basic Concepts of Economics are referred to as Basic Elements of
Economics.

1. WANTS: Want may be defined as an insatiable desire or need by human beings to own goods or services that
give satisfaction. The basic needs of man include; food, housing and clothing. Human needs are many. They
include tangible goods like houses, cars, chairs, television set, radio, etc. while the others are in form of
services, e.g. tailoring, carpentry, medical; etc. Human wants and needs are many and are usually described as
insatiable because the means of satisfying them are limited or scarce

2. SCARCITY: Scarcity is defined as the limited supply of resources which are used for the satisfaction of unlimited
wants. In other words, scarcity is the inability of human beings to provide themselves with all the things they
desire or want. These resources are scarce relative to their demand. As a student you will need Ksh.150 to buy
school materials but you have only Ksh.100. It can be seen that the money you have, which is your resources,
will not be sufficient to buy all you need. The available resources within the environment can never at any time
be in abundance to satisfy all human wants. Since wants are numerous and insatiable relative to the available
resources, human beings have to choose the most important ones and leave the less important ones. There
would be no economic problem if resources were not scarce.

3. CHOICE: It can be defined as a system of selecting or choosing one out of a number of alternatives. Human
wants are many and we cannot satisfy all of them because of our limited resources. We therefore decide
which of the wants we can satisfy first. Choice arises as a result of the resources used in satisfying these wants.
Choice therefore arises as a result of scarcity of resources. Since it is extremely difficult to produce everything
one wants, choice has to be made by accepting or taking up the most pressing wants for satisfaction based on
the available resources.

4. OPPORTUNITY COST: It is defined as an expression of cost in terms of forgone alternatives. It is the satisfaction
of one’s want at the expense of another want. It refers to the wants that are left unsatisfied in order to satisfy
another more pressing need. Human wants are many, while the means of satisfying them are scarce or limited.
We are therefore faced with the problem where we have to choose one from a whole set of human wants, to
choose one means to forgo the other. A farmer who has only Ksh.380 and wants to buy a spade and a hoe may
discover that he cannot get both materials for Ksh.300. He would therefore choose which one he has to buy
with the money he has. If he decides to buy a spade, it means he has decided to forgo the hoe. The hoe is thus
what he has sacrificed in order to own a spade. The hoe he has sacrificed is the forgone alternative and this is
what is referred to as opportunity cost.

5. SCALE OF PREFERENCE: This is the list of unsatisfied wants arranged in an order of their relative importance, it
is a list showing the order in which we want to satisfy our wants in order of priority

Importance of studying Economic

We study Economics because of the following reasons

1. Rational decision: the study of economics enables individual, group or government to make a rational or wise
choice among their numerous needs with their scarce resources.

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UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

2. Production: the study of economics helps the producer to determine what to produce, where to produce, for
whom to produce and to know the factor f production.
3. Provision of basic tools: Economics helps to provide basic tools that will help to solve and analyze economic
problems in any firm or organization.
4. Allocation of resources: The knowledge of economics helps the government to allocate her scarce resources to
different sector of the economy.
5. Preparation of budget: Economics helps the government to determine her expected income and expenditure
of the country.
6. Participation in government: The knowledge of economics helps individual to participate in government affairs.
7. Satisfaction of wants: It helps us to utilize the principle of choice and other concept of economics in satisfying
our wants.
8. Consumption of commodities: It assists us to determine the pattern of consumption in our environment.
9. It helps government to develop programs that are beneficial to the people
10. It helps business men and women to maximize their profits.
The nature of economics
Economics is the scientific study of the ownership, use, and exchange of scarce resources - often shortened to the
science of scarcity. Economics is regarded as a social science because it uses scientific methods to build theories that
can help explain the behaviour of individuals, groups and organizations. Economics attempts to explain economic
behaviour, which arises when scarce resources are exchanged.

In terms of methodology, economists, like other social scientists, are not able to undertake controlled experiments in
the way that chemists and biologists are. Hence, economists have to employ different methods, based primarily on
observation and deduction and the construction of abstract models.

As the social sciences have evolved over the last 100 years, they have become increasingly specialized. This is true for
economics, as witnessed by the development of many different strands of investigation including micro and macro
economics, pure and applied economics, and industrial and financial economics. What links them all is the attempt to
understand how and why exchange takes place, and how exchange creates benefits and costs for the participants.

THE CONCEPT OF PRODUCTION

What does Product Concept mean?

“Production is the organized activity of transforming resources into finished products in the form of goods and
services; the objective of production is to satisfy the demand for such transformed resources”.

The basic proposition of the production concept is that customers will choose products and services that are widely
available and are of low cost. So business is mainly concerned with making as many units as possible. By concentrating
on producing maximum volumes, such a business aims to maximize profitability by exploiting economies of scale.

Managers try to achieve higher volume with low cost and intensive distribution strategy. This seems a viable strategy
in a developing market where market expansion is the survival strategy for the business. Companies interested to take
the benefit of scale economies pursue this kind of orientation.

In a production-orientated business, the needs of customers are secondary compared with the need to increase
output. Such an approach is probably most effective when a business operates in very high growth markets or where
the potential for economies of scale is significant. It is natural that the companies cannot deliver quality products and
suffer from problems arising out of impersonal behavior with the customers.

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UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

The production concept is a thing of the past and was used when there was very less competition. At such times, the
more you produced, the more will be the consumption of the product. An example in this case is FORD, which
manufactured huge number of automobiles through its manufacturing assembly line which was the first of its kind.

THREE TYPES OF PRODUCTION:

1. Primary Production:
Primary production is carried out by ‘extractive’ industries like agriculture, forestry, fishing, mining and oil extraction.
These industries are engaged in such activities as extracting the gifts of Nature from the earth’s surface, from beneath
the earth’s surface and from the oceans.

2. Secondary Production:
This includes production in manufacturing industry, viz., turning out semi-finished and finished goods from raw
materials and intermediate goods— conversion of flour into bread or iron ore into finished steel. They are generally
described as manufacturing and construction industries, such as the manufacture of cars, furnishing, clothing and
chemicals, as also engineering and building.

3. Tertiary Production:
Industries in the tertiary sector produce all those services which enable the finished goods to be put in the hands of
consumers. In fact, these services are supplied to the firms in all types of industry and directly to consumers. Examples
cover distributive traders, banking, insurance, transport and communications. Government services, such as law,
administration, education, health and defense, are also included.

THE LEVEL OF PRODUCTION

There are 4 different levels of productions which are most commonly used. Which level of production should be used
by the company depends on the type of product being manufactured, the demand of the product as well as the supply
of raw materials. Taking these factors into consideration, below are the 4 levels of Production.

1. Unit or Job type of production

This type of production is most commonly observed when you produce one single unit of a product. A typical example
of the same will be tailored outfits which are made just for you or a cake which is made just like you want it.

Example of Unit type of production

It is one of the most common level of products used because it is generally used by small businesses like restaurants,
individual products providers or individual services providers.

It is also a type of production used by very premium companies like Harley Davidson, or Dell. Harley Davidson actually
has a lot of accessories which can be customized, and which suit the individual. Same ways, you can design your own
DELL laptop on their website with the given specifications.

Features of Unit production or Job Production

• Depends a lot on skill
• Dependency is more on manual work than mechanical work
• Customer service and customer management plays and important role

2. Batch type of Production

It is one of the types of production most commonly used in consumer durables, FMCG or other such industries where
there are large variety of products with variable demands. Batch production takes place in batches. The manufacturer
already knows the number of units he needs to a manufacturer and they are manufactured in one batch.

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UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

So, if a manufacturer has the shortage of Product X and 100 units of this product is consumed in one month, then the
manufacturer can give orders for batch production of 100 units of Product X.

LG has many different types of home appliance products in its portfolio. It has to manufacture all these different
variants of the same type of product. There would be 10-20 types of mixer grinders alone in the product portfolio of LG
home appliances. Thus, a company like LG manufactures these variants via Batch production.

First, one type of mixer will be manufactured completely and then the second type will be manufactured. They are
manufactured on the basis of demand. Depending on demand, the batch production can produce the number of units
required in one batch.

The batches may be as small as 10 units or they may be as large as 1 lakh units of the same products. However, as long
as there is a defined quantity of product which has to be manufactured before moving on to the next item in the list, it
is known as batch production. Examples of batch production include FMCG like Biscuits, confectionaries, packaged
food items etc. It is used in Medicines, Hardware, Consumer durables and many such industries.

Features of Batch production

• Production is done in batches
• The total number of units required is decided before the batch production starts
• Once a batch production starts, stopping it midway may cost a huge amount to the company.
• Demand plays a major role in a batch production. Example – seasonality of products.

3. Mass Production or Flow production

One of the best examples of mass production is the manufacturing process adopted by Ford. Mass production is also
known as flow production or assembly line production. It is one of the most common types/level of products used in
the automobile industry and is also used in industries where continuous production is required.

An Assembly line or mass production plant typically focus on specialization. There are multiple workstations installed
and the assembly line goes through all the workstations turn by turn. The work is done in a specialized manner and
each workstation is responsible for one single type of work. As a result, these workstations are very efficient and
production due to which the whole assembly line becomes productive and efficient.

Products which are manufactured using mass production are very standardized products. High sophistication is used in
the manufacturing of these products. If 1000 products are manufactured using mass production, each one of them
should be exactly the same. There should be no deviation in the product manufactured.

Features of Mass Production

• Mass production is generally used to dole out huge volumes of the product

• It is used only if the product is standardized

• Demand does not play a major role in a Mass production. However, production capacity determines the
success of a mass production.

• Mass production requires huge initial investment and the working capital demand is huge too.

4. Continuous production or Process production

There is a lot of confusion between mass production and continuous production. It can be differentiated by a single
element. The amount of mechanical work involved. In Mass production, both machines and humans work in tandem.

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UNIT: INDUSTRIAL ORGANIZATION & MANAGEMENT (I.O.M)
TOPIC 1: ECONOMICS

However, in continuous production, most of the work is done by machines rather than humans. In continuous
production, the production is continuous,24×7 hours, all days in a year.

A good example of the Continuous production is brewing. In brewing, the production goes on 24 hours a day and 365
days a year. This is because brewing takes a lot of time and production is important. As a result, there is a continuous
input of raw materials such as malt or water, and there is continuous output in the form of beer or other alcoholic
drink. The key factor in this is that the brewing and fermentation process itself is time-consuming, and the maximum
time is spent in the fermentation which is a continuous process.

There are many chemicals which are manufactured in the form of a continuous process due to the huge demand
across the world. Similarly, the Plastic industry is known to adopt the continuous production methodology where
production can go continuously for weeks or months depending on the demand. Once the production starts, you only
need to feed in the raw material, and the machines turn out the finalized products.

Features of Continuous production

• Majority of the work is done by machines rather than humans
• Work is continuous in nature. Once production starts, it cannot be stopped otherwise it will cause huge loss.
• A very controlled environment is required for continuous production.

FACTORS OF PRODUCTION

Production of a commodity or service requires the use of certain resources or factors of production. Since most of the
resources necessary to carry on production are scarce relative to demand for them they are called economic
resources.

Resources, which are called factors of production, are combined in various ways, by firms or enterprises, to produce an
annual flow of goods and services.

Table 5.1: A Classification of Factors of Production:

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Each factor gets a reward on the basis of its contribution to the production process, as shown in the table.

A. LAND AND NATURAL RESOURCES:

Land in economics is taken to mean not simply that part of the earth’s surface not covered by water, but also all the
free gifts of nature’s such as minerals, soil fertility, as also the resources of sea. Land provides both space and specific
resources”.
Land includes farming and building land, forests, and mineral deposits. Fisheries, rivers, lakes, etc. all those natural
resources (or gifts of nature) which help us (the members of the society) to produce useful goods and services. In other
words, land includes not only the land surface, but also the fish in the sea, the heat of the sun that helps to dry grapes
and change them into resins, the rain that helps farmers to grow crops, the mineral wealth below the surface of the
earth and so on.

Characteristics of land

1) Fixed supply:
The total land area of earth (in the sense of the surface area available to men) is fixed. Therefore, the supply of lands is
strictly limited. It is, no doubt, possible to increase the supply of land in a particular region to some extent through
reclamation of land from sea areas or deforestation. But this is often offset by various kinds of soil erosion. The end
result is that changes in the total area are really insignificant. Of course, the effective supply of agricultural (farm) land
can be increased by drainage, irrigation and use of fertilizers.
The prices of land and natural resources tend to be extremely sensitive to changes in consumer demand, rising sharply
if they become more desirable.

2) Alternative uses:
Although the total supply of land is fixed, land has alternative uses. The same plot of land can be used to set up
factories or to grow wheat or sugarcane or even to build a stadium. This means that the supply of land to a particular
use is fairly (if not completely) elastic. For example, the amount of land used for growing tomato can be increased by
growing less of some other crop (e.g., cauliflower). The supply of building land can be increased by reducing the area
under agricultural operation.

3) No cost of production:
Since land is a gift of nature, it has no cost of production. Since land is already in existence, no costs are to be incurred
in creating it. In this sense, land differs from both labour (which has to be reared, educated and trained) and capital
(which has to be created by using labour and other scarce resources or by spending money).

4) Differences in fertility:

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Another important feature of land is that it is not homogeneous. All grades (plots) of land are not equally productive or
fertile. Some grades of land are more productive than others. And Ricardo argued that rent arises not only due to
scarcity of land as a factor but also due to differences in the fertility of the soil.

5) Operation of the law of diminishing return:

The production on land is subject to the operation of the law of diminishing return. As Alfred Marshall has put it “while
the part which nature plays in production shows a tendency to diminishing return, the part which man plays shows a
tendency to increasing return”.
This simply means that as more and more workers are employed on the same plot of land, output per worker will
gradually fall (because each additional worker will make less and less contribution to total product). The law of
diminishing return refers to diminishing marginal product of the variable factor.

6) Mobility:
Land is not geographically mobile. But, it is occupationally mobile, land has many alternative uses. It might be used for
farmland, roads, railways, airlines, public parks, playgrounds, residential housing, office buildings, shopping complex,
and so on.

7) Return:
The income received by the owner of land is known as rent. It may be noted that rent is usually paid for something
more than the use of land or another natural resource, but includes also an element of payment for another factor
which is involved in making the resource available in a usable form.
An example of this is the labour which assists in the process of bringing minerals to the surface. Iron ore is of no use
while it is still under the ground. Productivity and value of land can be increased if it is improved with fertilizers,
irrigation and the erection of fences and buildings. So rent paid for this kind of fertile land is rather a mixed type of
factor income.

B. LABOUR:
Like land, labour is also a primary factor of production. The distinctive feature of the factor of production, called
labour, is that it provides a human service. It refers to human effect of any kind—physical and mental— which is
directed to the production of goods and services. ‘Labour’ is the collective name given to the productive services
embodied in human physical effort, skill, intellectual powers, etc.
As such, there are different types of labour input, varying in effort and skill content, and in particular types of skill
content. Thus, like ‘land’, labour is not homogeneous. The term covers clerical, managerial and administrative
functions as well as skilled and unskilled manual work.

Characteristics of Labour as a Factor:

1) Labour market transactions are particularly significant for:

Labour market transactions are particularly significant for the individual worker. Much of a person’s life style and
relations with other people depend on the job he or she does. Furthermore, the employment of labour involves a
continuing personal relationship between employers and employees, whereas transactions in market for goods are
often brief and impersonal.

2) Labour is an end and means in itself:

A commodity is only a means of production and the object of production is its consumption by labour. Labour,
therefore, becomes a means to its own end.

3) The individual sells his services but not himself:

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The employer, however, must be able to exert some control or authority over the actions of employees. A great deal of
energy has been devoted to planning systems for the direction of employees, and even a brief examination of the state
of industrial relations in most countries shows that still much remains to be done.

4) Labour is inseparable from the labourer:

In other words, labour and the labourer go together. When the seller sells a commodity he does not necessarily go
with the commodity. But the labour can supply his labour only when he goes with it. Moreover, when a seller sells a
commodity he parts with it. But when a labourer sells his labour, he retains the quality with him. He may gain the
satisfaction of his services, but he cannot be separated from the labour.

5) The individual must be present when the labour services are used and thus a fifth feature is that labour services
are not transferable:
For example, a person who has agreed to carry out certain tasks cannot transfer his services to someone else to do the
work, while he does something else. This contrasts with commodities which can be transferred among individuals.
One consequence of having to ‘deliver’ the services personally is that employees have strong views on how their
services should be used. Working conditions are of central importance to workers. It also means that workers must live
near their place of work. The location may significantly affect labour market decisions.

6) labour services cannot be stored:

Labour cannot be ‘saved’ or stored for future use (although rest may enhance performance to some extent).

7) Labour is perishable:
A commodity, if it is not disposed off today, can be disposed off the next day and it may not lose its value. Labour,
however, is perishable in this that if the labourer is not able to sell his services for a day he cannot get the value for
that day. It is lost forever; it is because of this that labour has a weak bargaining power.

8) Labour is affected by surroundings:

A commodity is usually very much affected by its surrounding; a labourer is very much affected by the surroundings
because he is a living being. Therefore, any change in atmosphere has an effect on his health feelings etc.

9) The supply of labour is independent of its demand:

In case of most commodities we see that supply usually varies with demand but in case of labour its supply is in no way
related to demand. Both are determined by different factors.

10) labour services are enhanced by training:

Skill acquisition is often a lengthy and costly process. However, adjustments in the labour market, such as increasing
the supply of a particular skill, often requires a long time. This also means that individuals do not usually train for more
than one occupation as they only have a limited working life over which to justify the investment.

Mobility of Labour:

The mobility of labour has two aspects:

a) The spatial or geographical mobility of labour, which relates to the rate at which workers move between
geographical areas and regions in response to differences in wages and job availability (e.g., a worker from West
Bengal moving to Mumbai) and
b) The occupational mobility of labour which relates to the extent to which workers change occupations or skills in
response to differences in wages or job availability (e.g., a jute mill worker joining a tea garden).

It may apparently seem that labour is the most mobile of all factors—both occupationally and geographically. Workers
can move both freely from one industry to another and from one region to another.

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Reward:
The reward or price that is paid to labour in return for the services it performs is known as a wage or salary. A man’s
wages are associated with his productivity or efficiency and this, in its turn, depends on a variety of factors including
the education and job training he has received, his innate skill and the extent to which he is motivated to put his best
effort in the work he is doing.

In general, the supply of labour varies directly with wages and compensation. Normally, when wages are relatively low,
increases in wages will tend to lead to an increase in the supply of labour. However, as wages continue to rise a stage
ultimately comes when higher wages (incomes) make leisure more attractive.

When incomes are relatively high, therefore, higher wage rates may actually lead to a fall in the number of hours
worked (and, thus, in the amount of labour offered by an individual worker.) This is why the supply curve of labour
bends back to the left and this is often cited as an important exception to the (empirical) law of supply.

C. CAPITAL:

Capital, the third agent or factor is the result of past labour and it is used to produce more goods. Capital has,
therefore, been defined as ‘produced means of production.’ It is a man-made resource. In a board sense, any product
of labour-and-land which is reserved for use in future production is capital.

Capital is that part of wealth which is not used for the purpose of consumption but is utilized in the process of
production. Tools and machinery, bullocks and ploughs, seeds and fertilizers, etc. are examples of capital.

Economists use the term capital to mean goods used for further production. In the business world, however, capital is
always expressed in terms of money. If a businessman is asked, “What is your capital?” he will always mention a sum
of money. But money is not capital because money, by itself, cannot produce anything.

Classification of Capital:
Capital can be classified in two broad categories that which is used up in the course of production and that which is
not.

Fixed and Circulating Capital:

Fixed capital means durable capital like tools, machinery and factory buildings, which can be used for a long time.
Things like raw materials, seeds and fuel, which can be used only once in production are called circulating capital.
Circulating capital refers to funds embodied in stocks and work-in- progress or other current assets as opposed to fixed
assets. It is also called working capital.

Characteristics of Capital:

i. It entails a sacrifice, since resources are devoted to making non-consumable capital goods instead of goods for
immediate consumption. Secondly, it enhances the productivity of the other factors, viz., land and labour.
ii. It is this enhanced productivity which represents the reward for the sacrifice involved in creating capital. Hence we
can predict that new capital is only created so long as its productivity is at least sufficient to compensate those
who make the sacrifices involved in its creation. These two features may now be discussed in detail.

Capital Formation:
People use capital goods like machines, equipment, etc. because capital goods are the creators of other goods. But this
is not the whole truth. People use capital for another important reason to produce goods with less effort and lower
costs than would be the case if labour were not assisted by capital. But in order to use capital goods people must first
produce them. This calls for a sacrifice of current consumption.

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When people use their labour to produce capital goods like textile producing machines, they can use the same labour
for producing consumer goods like textiles. As Stanlake has put it “The opportunity cost of the capital goods is the
potential output of consumer goods which has to be foregone in order to produce that capital, the production of
capital demands abstinence from current consumption.”

Factors Affecting Capital Formation:

(a) Savings and (b) a diversion of resources (from the production of consumption goods to meet current needs to the
production of capital goods to meet future needs). Saving is the difference between current income and current
consumption. In other words, it is the act of foregoing current consumption.

It means that resources otherwise used to produce consumer goods are set aside for producing capital goods. If people
choose not to buy some consumer goods, with some part of their current income, they refrain from buying (utilizing)
the services of the factors required to make those goods.

These factors might, therefore, remain idle. But these savings may be borrowed and utilized by business firms
(entrepreneurs) to finance the construction of capital goods. This is the second step—the diversion of resources for the
production of consumer goods to the production of capital (producers) goods. It may be noted that savings make
possible capital accumulation. It does not cause it.

In short, capital formation depends on savings, which, in its turn, depends on two things:
(1) The capacity to save and
(2) The desire to save.

The capacity to save depends on income and the existence of savings institutions like banks, insurance companies, post
offices, stock exchanges, etc. If income is low, savings will also be low. Even if income is high savings will be low in the
absence of the above-mentioned savings institutions.

The desire to save depends on

(1) the rate of interest and
(2) stability in the value of money (i.e., the rate of inflation).

If the rate of interest is high people will be eager to save more by curtailing their current consumption. People will also
be eager to save more if they expect that there will exist reasonable price stability in the economy in future.

Mobility of Capital:
Capital is both geographically and occupationally mobile. However, a certain portion of a nation’s capital stock which
consists of such things as railway networks, blast furnaces and shipyards are highly specialized equipment and are
virtually immobile in the geographical sense. It is physically possible to dismantle them and move them to different
sites or locations, but the cost of doing so will be so great that it will not be economically feasible to do so.

Such equipment are not even occupationally mobile. Each such equipment can only be used for a specific purpose.
Many buildings however, can be put to better uses. Many of the old buildings used as cinema house or god-owns in
northern area of Calcutta have been dismantled and converted into multi-storeyed buildings.

Some capital equipment is mobile in both the geographical and occupational sense. Examples of such capital
equipment are electric motors, machine tools, hand tools, typewriters, and lorries. Such equipment can be used
effectively in a wide variety of industries and are capable of moving from one location to another at very little cost.
Return:

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The earning of capital, i.e., the price that has to be paid for it, is known as interest. If it stated as percentage of the
principal, representing the sum paid by a borrower who needs finance to purchase a piece of capital equipment.

D. ENTERPRISE (ORGANIZATION):

Organization, as a factor of production, refers to the task of bringing land, labour and capital together. It involves the
establishment of co-ordination and co-operation among these factors. The person in charge of organization is known
as an organizer or an entrepreneur. So, the entrepreneur is the person who takes the charge of supervising the
organization of production and of framing the necessary policy regarding business.

Functions or Role of the Entrepreneur:

1. Decision-making:
The primary task of an entrepreneur is to decide the policy of production. An entrepreneur is to determine what to
produce, how to produce, where to produce, how much to produce, how to sell and so forth. Moreover, he is to
decide the scale of production and the proportion in which he combines the different factors he employs. In brief, he is
to make vital business decisions relating to the purchase of productive factors and to the sales of the finished goods or
services.

2. Management Control:
Earlier writers used to consider management control one of the chief functions of the entrepreneur. Management and
control of the business are conducted by the entrepreneur himself. So the latter must possess a high degree of
management ability to select the right type of persons to work with him. But the importance of this function has
declined, as the business nowadays is managed more and more by paid managers.

3. Division of income:
The next major function of the entrepreneur is to make necessary arrangement for the division of total income among
the different factors of production employed by him. Even if there is a loss in the business, he is to pay rent, interest;
wages and other contractual income out of the realized sale proceed.

4. Risk-taking and uncertainty-bearing:

Risk-taking is perhaps the most important function of an entrepreneur. Modern production is very risky as an
entrepreneur is required to produce goods or services in anticipation of their future demand. Broadly, there are two
kinds of risk which he has to face.

Firstly, there are some risks, such as risks of fire, loss of goods in transit, theft, etc., which can be insured against. These
are known as measurable and insurable risks. Secondly, some risks, however, cannot be insured against because their
probability cannot be calculated accurately. These constitute what is called uncertainty (e.g., competitive risk,
technical risk, etc.). The entrepreneur undertakes both these risks in production.

5. Innovation:
Another distinguishing function of the entrepreneur as emphasized by Schumpeter, is to make frequent inventions-
invention of new products, of new techniques and discovering new markets—to improve his competitive position, and
to increase earnings.

UTILITY AND VALUE

Meaning of Utility:
The simple meaning of ‘utility’ is ‘usefulness’. In economics utility is the capacity of a commodity to satisfy human
wants.

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Utility is the quality in goods to satisfy human wants. Thus, it is said that “Wants satisfying capacity of goods or
services is called Utility.”

In this way utility is measured in terms of money and it is relative. There is difference between utility and usefulness. A
useful commodity may not here utility of goods depend upon the intensity of wants.

A consumer buys or demands a particular commodity he derives some benefit from its use. He feels that his given
want is satisfied by the use or consumption of the commodity purchased. Utility is the basis of consumer demand. A
consumer thinks about his demand for a commodity on the basis of utility derived from the commodity.

Utility depends upon the intensity of want. When a want is unsatisfied or more intense, there is a greater urge to
demand a particular commodity which satisfies a given want. In modern time utility has been called as ‘expected
satisfaction.’ Expected satisfaction may be less or equal to or more than the real satisfaction.

Definition of Utility:
Various economists have defined utility as follows:

1. According to Prof. Waugh:

“Utility is the power of commodity to satisfy human wants.”

2. According to Fraser:
“On the whole in recent years the wider definition is preferred and utility is identified, with desireness rather than with
satisfyingness.”

Characteristics of Utility:
The following are the important characteristic features of utility:

1. Utility has no Ethical or Moral Significance:

A commodity which satisfies any type of want, whether moral or immoral, socially desirable or undesirable, has utility,
i.e., a knife has utility as a household appliance to a housewife, but it has also a utility to a killer for stabbing some
body.

2. Utility is Psychological:
Utility of a commodity depends on a consumer’s mental attitude and assessment regarding its power to satisfy his
particular want. Thus, utility of a commodity may differ from person to person. Psychologically, every consumer has his
likes and dislikes and everyone determines his own level of satisfaction.
A consumer who is fond of apples may find a high utility in apples in comparison to the consumer who has no liking for
apples. Similarly, a strictly vegetarian person has no utility for mutton or chicken.

3. Utility is always Individual and Relative:

Utility of a commodity varies in different situations in relation to time and place. Even the same consumer may derive
a higher or lower utility for the same commodity at different times and different places. For example—a person may
find more utility in woolen clothes during the winter than in summer or at Kashmir than at Mumbai.

4. Utility is not Necessarily Equated with Usefulness:

Utility simply means the ability to satisfy a want. A commodity may have utility but it may not be useful to the
consumer. For instance—A cigarette has utility to the smoker but it is injurious to his health. However, demand for a
commodity depends on its utility rather than its usefulness. Thus many commodities like opium liquor, cigarettes etc.
have demand because of utility, even though, they are harmful to human beings.

5. Utility cannot be Measured Objectively:

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Utility being a subjective phenomenon or feeling of a consumer cannot be expressed in numerical terms. So utility
cannot be measured cardinally or numerically. It cannot be measured directly in a precise manner.

6. Utility Depends on the Intensity of Want:

Utility is the function of intensity of want. A want which is unsatisfied and greatly intense will imply a high utility for
the commodity concerned to a person. But when a wan is satisfied in the process of consumption it tends to
experience a lesser utility of the commodity than before. Such an experience is very common and it is described as a
tendency of diminishing utility experienced with an increase in consumption of a commodity. In other words, the more
of a thing we have, the less we want it.

7. Utility is Different from Pleasure:

A commodity may have utility but its consumption may not give any pleasure to the consumer, e.g., medicine or an
injection. An injection or medicinal tablet gives no pleasure, but it is necessary for the patient.

8. Utility is also Distinct from Satisfaction:

Utility and satisfaction, both are though inter-related but they have not been considered as the same in a strict sense.

Types of Utility:

1. Form Utility:
This utility is created by changing the form or shape of the materials. For example—A cabinet turned out from steel
furniture made of wood and so on. Basically, from utility is created by the manufacturing of goods.

2. Place Utility:
This utility is created by transporting goods from one place to another. Thus, in marketing goods from the factory to
the market place, place utility is created. Similarly, when food-grains are shifted from farms to the city market by the
grain merchants, place utility is created.
Transport services are basically involved in the creation of place utility. In retail trade or distribution services too, place
utility is created. Similarly, fisheries and mining also imply the creation of place utility. Place utility of a commodity is
always more in an area of scarcity than in an area of scarcity than in an area of abundance e.g., Kashmir apples are
more popular and fetch higher prices in Pune than in Srinagar on account of such place utility

3. Time Utility:
Storing, hoarding and preserving certain goods over a period of time may lead to the creation of time utility for such
goods e.g., by hoarding or storing food-grains at the time of a bumper harvest and releasing their stocks for sale at the
time of scarcity, traders derive the advantage of time utility and thereby fetch higher prices for food-grains. Utility of a
commodity is always more at the time of scarcity. Trading essentially involves the creation of time utility.

4. Service Utility:
This utility is created in rendering personal services to the customers by various professionals, such as lawyers,
doctors, teachers, bankers, actors etc.

Can Utility Be Measured?

Utility is a psychological concept. This is different for different people. Therefore, it cannot be measured directly.
Professor Marshall has said that “Utility can be measured and its measuring rod is ‘money. The price which we are
ready to pay for an article is practically its price. Nobody will be prepared to pay more than the utility which we derive
from the article.

For example:

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If I am ready to pay Kshs. 1500 for a watch and Kshs. 2,000 for a Radio. Then I can say that I derive utility from that
watch up to the value of Kshs. 1500; and from Radio up to the value of Kshs. 2,000. “The inference which we can draw
from the above example is that the price which we pay for any article is the utility which we derive from that article.”

Kinds of Utility:
1) Marginal Utility,
2) Total Utility,
3) Average Utility

1) MARGINAL UTILITY:

Marginal utility is the utility derived from the last or marginal unit of consumption. It refers to the additional utility
derived from an extra unit of the given commodity purchased, acquired or consumed by the consumer.
It is the net addition to total utility made by the utility of the additional or extra units of the commodity in its total
stock. It has been said—as the last unit in the given total stock of a commodity.
According to Prof. Boulding—” The marginal utility of any quantity of a commodity is the increase in total utility which
results from a unit increase in its consumption.”

For example:
Suppose Mr. Shanker is consuming bread and he takes five breads. By taking first unit he derives utility up to 20;
second unit 16; third unit 12; fourth unit 8 and from fifth 2. In this example the marginal unit is fifth bread and the
marginal utility derived is 2. If we will consume only four bread, then the marginal unit will be fourth bread and utility
will be 8.

Kinds of Marginal Utility—Marginal utility is of three kinds:

a) Positive Marginal Utility,

b) Zero Marginal Utility,
c) Negative Marginal Utility.

It is a matter of general experience that if a man is consuming a particular goods, then receiving of next unit of goods
reduces the utilities of the goods and ultimately a situation comes when the utility given by the goods become zero
and if the use of the goods still continues, then the next unit will give dis-utility. In other words, it can be said that we
will derive “negative utility”.

This can be studied better by the following table:

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From the table given above it is clear that up to the consumption of the fifth bread we receive positive utility; 6th unit
is the unit of full satisfaction i.e., Utility derive from that unit is zero. From 7th unit the utility received will be negative
utility. The table can be represented in shape of diagram as follows: In diagram No. 1 OX axis (line) shows unit of bread
and OY line shows the Marginal Utility received. From the figure it is clear that from the first unit of bread utility
received are 20 which has been shown on the top of the line.

Similarly, 2, 3, 4, 5 Unit of bread’s utility is 16, 12, 8, 4 respectively All these have been shown on OX line which shows
positive marginal utility. Utility of the sixth bread is zero and that of the seventh bread is negative and negative
rectangle has been shown below OX line.

Zero Utility:
When the consumption of a unit of a commodity makes no addition to the total utility, then it is the point of Zero
Utility. In our table the total utility, after the 6th unit is consumed. This is the point of Zero Utility. It is thus seen that
the total utility is maximum when the Marginal Utility is zero.

Negative Utility:
Negative Utility is that utility where if the consumption of a commodity is carried to excess, then instead of giving any
satisfaction, it may cause dis-satisfaction. The utility is such cases is negative. In the table given above the marginal
utility of the 7th unit is negative.

2) TOTAL UTILITY:

Total Utility is the utility from all units of consumption. According to Mayers” Total Utility is the sum of the marginal
utilities associated with the consumption of the successive units.”

For example:
Suppose, a man consumes five breads at a time. He derives from first bread 20 units of satisfaction from 16, from third
12, from fourth 8 and from fifth 4 i.e., total 60 units.

This can be shown by the following table:

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3) AVERAGE UTILITY:
Average Utility is that utility in which the total unit of consumption of goods is divided by number of Total Units. The
Quotient is known as Average Utility. For example—If the Total Utility of 4 bread is 40, then the average utility of 3
bread will be 12 if the Total Utility of 3 bread is 36 i.e., (36 ÷ 3 = 12).

The following table will explain the point clearly:

It is clear from the above table that by the increasing use of any article Marginal and Average Utility reduces gradually
and Total Utility increases only up to that point where the Marginal Utility comes to zero.

Relation between Total Utility and Marginal Utility:

There is a close relationship between Total Utility and Marginal Utility. As there is increase in the unit of a particular
commodity, the Marginal Utility goes on diminishing and Total Utility goes on increasing. Total Utility goes on
increasing up to that extent till the Marginal Utility becomes Zero. When Marginal Utility is zero Total Utility is
maximum.

After Zero Marginal Utility comes to negative and the result is that Total Utility starts reducing relationship between
Total Utility and Marginal Utility can be started as follows:

(i) When Marginal Utility is reducing, the Total Utility will increase so long Marginal Utility does not become zero.
(ii) When Marginal Utility becomes zero; Total Utility will be maximum.
(iii) After zero when Marginal Utility is negative then there is reduction in Total Utility.

Relationship between Marginal Utility and Total Utility can be studied from the following:

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From the above table it is clear that up to fourth bread Marginal Utility is positive and there is no regular increase in
the Total Utility. And on fifth bread the Marginal Utility is zero and on this point the increase in Total Utility stops. This
is point of safety. As Prof. Bounding has said that “Point of full satisfaction and point of full safety is that point where
consumption increases but there is no increase in Total Utility.” If after fifth bread, extra bread is consumed then there
will be dis-utility and Marginal Utility will be negative. Sixth and seventh bread shows dis-utility.

The relationship between Marginal Utility and Total Utility will be shown by diagram as follows:

In both the diagrams OX line shows bread. In diagram No. 1 OY line shows Marginal Utility and is diagram No. 2 OY line
shows Total Utility. As the number of bread increases Marginal Utility goes on diminishing and Total Utility goes on
increasing—To remember:

(1) Marginal Utility goes on diminishing with the consumption of every additional unit of bread.
(2) Total Utility goes on increasing with the consumption of every additional unit but at a diminishing rate.
(3) Marginal Utility is equal to the increase in the Total Utility. Total Utility is the sum total of the Marginal Utilities
derived from all the units consumed.
(4) When Marginal Utility becomes 0, total utility does not increase.
(5) When Marginal Utility becomes negative, Total Utility decreases.
(6) Increase in Total Utility depends on Marginal Utility.
(7) Since Marginal Utility diminishes, Total Utility increases at a diminishing rate.
(8) When Marginal Utility is Zero, Total Utility is maximum.
(9) When Marginal Utility is negative, Total Utility declines.

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GROUP ASSIGNMENT CAT 1 – 40 MARKS

1. Discuss and explain the origins and need for division of labour
2. Define and discuss specialization
3. Discuss the merits and demerits of division of labour and specialization
4. Discuss mechanization and automation of production as consequences of specialization
5. Explain trends in the automation of production and their effects

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