Nature of Economics:

 Economics is a science of wealth (Classical School of Thought, Adam Smith)

 Economics is a science of material welfare (Non-Classical of School of Thought, Dr. Alfred
Marshall)
 Economics is the sign of scarcity and choice (Modern Scientist, Prof. Robbins)

Definitions of Economics:

1. According to Adam Smith: “Economics is a science which discusses the production of wealth,
consumption of wealth, distribution of wealth.”

There are 4 aspects to explain Adam Smith’s definition of Economics:

 Production of Wealth: this means how wealth is produced. There are 4 factors which
produces wealth. Land, Labor, Capital and Organization. The combination of these four
factors produces goods and services which are called wealth.
 Consumption of Wealth: means how wealth is spent or consumed. The part of wealth which
we spend the necessities of life, is called consumption of wealth.
 Distribution of Wealth: Wealth is produced by the combination of 4 factors of production
and it is distributed among them. The factors are given rewards as rent to land, wages to
labour, interest to capital and profit to entrepreneur.
 Exchange of Wealth: It means how wealth is exchanged. In other words, how wealth passes
from one person to another person or how it shifts from one country to another country
through international trade. To know about this is called exchange of wealth.

2. According to Dr. Alfred Marshall: “Economics is a science of wealth which studies human
behavior in the ordinary business of life; it examines the part of individual and social action which
is most closely connected with the attainment and win the use of material requisites of wellbeing.
Thus economics is on one side of a study of wealth and on the other and more important side, a
part of study of man.

Important Points of the Definition:

 Useful Science: Economics is related with the daily life of a man, therefore, it is an important
and useful science.
 The Study of People Living in Society: In economics, the efforts of the people who take part
in economic activities living in the society are studied. Therefore, economics is not
concerned with the activities of saints, hermits and mads.
 The Study of Efforts Concerned with Material Requisites: In economics, the individual and
collective efforts, which are concerned with material welfare, are discussed.
 Not the Study of Wealth for the Sake of Wealth: Economics does not study wealth for the
sale of wealth rather it studies wealth so that the basic necessities which increase human
welfare, may be purchased.

3. According to Mr. Robbins: “Economics is a science which studies human behavior as a

relationship between ends and scarce means which have alternative uses”.
Basis of Robbins definition:

 Human wants are unlimited: Man is always after his wants to satisfy and wants to keep on
rising again and again without having to end. Had the human wants be limited, they would
have been satisfied easily.
 Wants are not equally important: Man’s wants do not have the same importance for him.
Some wants are more important than the others. For example: you cant live your life
without food, clothing and shelter, so these wants are important. On the contrary, television
and sofa-set are less important than the wants mentioned above because man can sustain
himself without them. Owing to the difference in the importance of wants, man always faces
the problem of choice.
 Means are limited: it means that man’s resources or means (income and wealth) are less as
compared to his wants. In this way, the aggregate resources of production are less than the
needs or wants of the people. Therefore, man has to use his resources sparingly to satisfy his
wants.
 Resources have alternative uses: Man can make an alternative use of his resources. For
example, a student having ten rupees can either buy a pen or a watch a film. He examines
the importance of his wants keeping in view the alternative use of the resources and satisfy
the most important of them and he postpones the rest of them for the future. In this way, a
man keeps on using his resources sparingly keeping in view the importance of wants and it is
possible because the resources can be used alternatively.

Methods of Economic Analysis:

 Deductive Method:
(1) A method of economic analysis in which we move from general to particular to derive
some conclusions is called deductive method.
(2) To draw a certain conclusion from known fact or general principle.
The following steps are taken to draw a certain conclusion from a general fact:
1. Selection of general fact
2. To draw certain conclusion from general fact
3. Testing the validity of the conclusion
4. To explain interrelationship between the general fact and the conclusion
 Inductive Method:
(1) A method of economic analysis in which we move from particular to general to derive
some conclusions is called inductive method.
(2) We approach from particular fact to general fact.
The following points are kept in mind:
1. To collect the facts and figures of a particular nature.
2. To analyze the facts
3. To draw a general inference/conclusion from these facts

Micro-Economics: studies the economic behaviour of individual decision making unit such as the
consumer, business firm, the prices of factory of production
Macro-Economics: deals not with the individual quantities, but with the aggregate of these
quantities, not with the individual income but rather the national income, not with the individual
output but rather the national output.
 Consumer Behaviour
Utility: Power of satisfaction which anything possess is called utility. i.e: writing power in the pen.
Initial Utility: Utility obtained by very first unit of any product is called initial utility.
Positive Utility: Utility before the point of satisfaction is called is positive utility.
Point of Satisfaction/Zero Utility: The point at which consumer maximizes his utility is called point
of satisfaction. (It appears when MU=0 and TU=max)
What is consumer’s equilibrium? The consumer will be in equilibrium when he consumes on
different commodities to get maximum satisfaction until… MUa/Pa=MUb/Pb=MUc/Pc=MUn/MUn
Negative Utility: Utility after the point of satisfaction is called disutility or negative utility.
Marginal Utility: It is the utility obtained by additional unit of any commodity or the utility obtained
by the very last unit is called MU. (MU= △ TU/ △ Q where Q=1)
Relationship between MU and TU:
1. When MU is positive, TU increases by decreasing ration
2. When MU is zero, TU will be maximum
3. When MU is negative, TU decreases
Table: Graph:
Q MU TU
1 20 20
2 15 35
3 10 45
4 5 50
5 0 50
6 -5 45

Difference between utility and usefulness:

Anything which has utility is bought and if any commodity has zero utility for someone it will not be
bought. For example: cigarettes has a positive utility for smokers and it is bought by them and zero
utility for non-smokers so non-smokers do not buy cigarettes. So anything will be bought if it has
utility but it is not necessary that, that thing has usefulness. For example: cigarettes has utility but its
not useful for smokers.
Utility Measurement:
 Cardinal Approach: Classical/Neo Classical economist believe that utility is measureable in
digits, which is called ‘utils’. That term was firstly used by Alfred Marshall whose approach is
cardinal.
 Ordinal Approach: Modern economist believe that utility is not measureable in digits it can
be compared with other units. For example: 1 st utility of any commodity gives more utility
than the 2nd unit if used continuously. This approach is Ordinal.
Law of Diminishing Marginal Utility (LDMU)
‘Cetris Peribus. The MU of any commodity decreases by its continuous use.’
(or) According to this theory the MU of any commodity decreases by its continuous use.
Q MU TU
1 20 20
2 15 35
3 10 45
4 5 50
5 0 50
6 -5 45
Cetris Peribus: It is the other name of assumptions
What are assumptions/Cetris Peribus: For full application some factors are assumed constant.
Assumptions of LDMU:
 Suitable units are to be consumed
 Continuous use of the product
 Taste/Fashion/Habit will not change
 Income of Consumer will not change
 Nature of product will remain the same
 Consumer is rational
What are Limitations: it means exceptions on which the theory is not applicable
Limitations of LDMU:
 Knowledge
 Wealth/Money
 Distinction
 Antique Articles
 Drugs
Practical Importance of LDMU:
 Guidance for Consumer: It provides guidance for consumer, if consumer knows this law he
will be very conscious about MU and TU and he will try to maximize his utility.
 Provide base for taxation: It will provide good base for taxation. As we know, there is less
MU of money in rich people and more in poor, so poor will be taxed less than the rich.

Demand and Supply

Individual Demand: It is the quantity of any product which is demanded by any consumer
(individual) at different prices at specific time.
Aggregate Demand/Market Demand: It is the aggregate quantity of any product which is demanded
at different prices at specific time by all people of the society.
Price Qd1 (rich) Qd2 (middle) Qd3 (poor) AD=qd1+qd2+qd3
100 10 5 0 10+5+0=15
75 15 10 5 15+10+5=30
50 20 15 10 20+15+10=45
25 25 20 15 25+20+15=60

Wish: to only have the desire to purchase a product but not have the purchasing power is called a
wish.
Demand: it is the ability (purchasing power) and willingness (wish) to purchase a product at any
price.
Derived Demand: It is the demand of labor because labor is not demanded directly. i.e If the
demand for construction increases them the demand for labor increases. So if the demand increases
or decreases indirectly it is called derived demand.
Law of Demand
“Cetris Peribus. If price of any product increases its demand decreases and vice versa”
Law of Demand: when other things (income of consumer, taste of consumer, price of substitute,
season) remains unchanged when the price of a commodity increases then the demand in the
market of that commodity will decrease and vice-versa.
Price of Pen Qd of Pen According to the table, when the price of the pen is rupees 10/unit
10 1000 its demand is 1000 units and when the price increases so the
15 900 purchasing power of a consumer decreases so he purchases less
20 800 amount of pens.
25 700

In the above mentioned diagram we have presented quantity demanded for pens on x-axis and price
of pen on y-axis and with the help of price and quantity demand we get a negatively sloped (Left to
Right) demand curve, which shows that if P increases Qd decreases.
Limitations of Law of Demand:
 Giffen Goods – these are the goods which have superior substitute and poor people
consume more of their income on them. For example, beef and mutton.
 High price assumes high quality
 In wars or other disasters
Why the Demand Curve is negatively sloped:
 Free Entry/Exit of buyers. P↓ buyer enters D↑
 Purchasing Power - P↑PP↓R.Y↓D↓
 Price of Substitute - P↑Ps↓Qd↑

Change in Demand
There are 2 types of change in demand:
 Extension/Contraction in Demand (Related to price)
 Rise/Fall in Demand

(i). Extension in Demand: this kind of change happens due to the change in price. If the price of
any product decreases and its demand increases then its known as extension in demand
Price of Pen Qd of Pen
25 700
20 800
15 900
10 1000
 Contraction in Demand: this kind of change happens due to the change in price. If the price
of any product increases and its demand decreases then its known as contraction in demand
Price of Pen Qd of Pen
10 1000
15 900
20 800
25 700

(ii). Rise in Demand: if demand of any commodity increases due to the change in the other
factors like: income, taste or season and not due to the change in price then it is known as
rise in demand
Price of Pen Qd of Pen
25 700
25 800
25 900
25 1000
When demand changes due to the other factors it totally shifts upward from left to right.
Fall in Demand: if demand of any commodity decreases due to the change in the other
factors like: income, taste or season and not due to the change in price then it is known as
fall in demand.
Price of Pen Qd of Pen
25 1000
25 900
25 800
25 700
When demand changes due to the other factors it totally shifts downward from right to left.
Elasticity of Demand
Price Elasticity of Demand: It is the rate of change in quantity demanded of any product by
the change in the price of that product. Ed = △Qd/△P x P/Qd
Income Elasticity of Demand: It is the rate of change in quantity demanded of any product
by the rate of change in the income of any consumer. Ey= △Qd/△Y x Y/Qd (Y=income)
It will be positive for normal goods and negative for inferior/giffen goods.
Inferior goods = Giffen goods
Cross Elasticity of Demand: It is the rate of change in quantity demanded of product A by
the change in price of that product B. EDAB = △QdB/△PA x PA/QdB
It will be positive for substitutes and negative for compliments.

Measurement of Elasticity of Demand

Total Outlay/Expenditure Method:
In this method of measuring Ed, we will take the change in total expenditures done by the
consumer on such commodity by the change in price.
(a) Ed < 1 (P↑Qd↓TE↑): If price of any commodity increases and demand of that
commodity decreases in such way that the total expenditure done on that
commodity increases, the elasticity of demand will be less elastic
P Qd TE= In the table, we have calculated TE when price was 10 rupees and Qd=500
PxQd then TE=5000 and when price increases to 20 and Qd=300 and TE=6000, so
10 500 5000 by the increase in price, TE also increases so it is the example of less elastic
20 300 6000 demand.
 (b) Ed = 1 (P↑Qd↓TE→): If price of any commodity increases and demand of that
commodity decreases in such way that the total expenditure done on that
commodity remains constant, the elasticity of demand will be perfect elastic
TE= In the table, we have calculated TE when price was 10 rupees and Qd=500
P Qd then TE=5000 and when price increases to 20 and Qd=250 and TE=5000, so
PxQd
10 500 5000 by the increase in price, TE remains the same so it is the example of perfect
20 250 5000 elastic demand.

(c) Ed > 1 (P↑Qd↓TE↓): If price of any commodity increases and demand of that
commodity decreases in such way that the total expenditure done on that
commodity decreases, the elasticity of demand will be more elastic
TE= In the table, we have calculated TE when price was 10 rupees and Qd=500
P Qd
PxQd then TE=5000 and when price increases to 20 and Qd=200 and TE=4000, so
10 500 5000 by the increase in price, TE decrease so it is the example of more elastic
20 200 4000 demand.
 Effects of Rise and Fall on equilibrium price
1) When Supply is perfectly inelastic and Demand Rises or Falls:
When supply is perfectly inelastic, the prices rises with a rise in demand and
the price falls with the fall in demand but the quantity remains constant.

2) When Supply Remains Constant but Demand Rises of Falls:

When supply remains constant but demand falls then price decreases and
quantity decreases. Conversely, price rises with a rise in demand and quantity
expands.

3) Demand remains Constant but Supply Rises or Falls:

If demand remains constant then price rises with the fall in supply while
quantity decreases. On the contrary, price decreases with the rise in supply
while quantity increases.
4) More Rise in Demand than that of Supply:
If both demand and supply rise but the rise in demand is greater then, the
price increases and quantity also increases.

5) More Rise in Supply than that of Supply:

If both demand and supply rise but the rise in supply is greater then, the price
decreases and quantity increases.

6) Rise in Demand and Supply in Equal Proportion:

When the ration of increases in demand and supply is equal, price remains
constant but quality increases.
7) Demand Falls More than that of Supply:
If both demand and supply falls but the fall in demand is greater then, the
price decreases and quantity also decreases.

8) Supply Falls More than that of Demand:

If both demand and supply falls but the fall in supply is greater then, the price
increases and quantity decreases.

9) If Fall in Demand and Supply is Equal:

If fall in demand and supply is equal, then price remains constant or price does
not change but quantity decreases.
 Costs and Revenue
Definitions:
Total Cost: Total expenditures which any firm bears for producing specific amount of
any commodity. TC= FC + VC.
Fixed Cost: It is the cost which does not depend upon the level of output. It does not
vary with the change in production. If Q=0, then FC will not be zero, but in the long
run there will be no FC, all cost will be variable cost. TC=VC
Variable Cost: It is the kind of cost which varies with the change in output, if Q↑ it
also increases and vice-versa, if Q=0 then VC will be zero. So in short-run when the
firm is not producing any output TC = FC + 0 => TC=FC.
Implicit Cost: it is the reward of self-owned resource included in the total cost i.e if
producer has his own land he will have to include the rent in to the cost of
production so it will be an implicit cost.
Explicit Cost: it is the reward of hired resource included in the total cost. I.e if the
producer hired some factor of production from the market he will have to include
the reward of the hired resource in the total cost so it will be an explicit cost.
Opportunity Cost: it is the best alternative use of any resource which we have to
forgo for using that resource into other work. For example, if we can get Rs
10000/month as rent and do not give that land on rent then its opportunity cost us
Rs 10000/month.
Marginal Cost: it is the rate of change in TC by producing one extra unit of any
product. MC = TCn – TC n-1.
Average Total Cost (AC/ATC): It is also known as per unit cost and can be obtained
by dividing TC by the output produced. ATC=TC/Q.
Average Fixed Cost (AFC): it can be obtained by dividing Fixed Cost by the output
produced, AFC = FC/Q. it decreases by the increase in output
Average Variable Cost (AVC): it can be obtained by dividing VC by the output
produced, AVC= VC/Q.
Total Revenue (TR): It is the revenue which a firm can get by selling the specific
amount of any commodity at the specific price and can be obtained by, TC= PXQ
Average Revenue (AR): it is the per unit of revenue and can be obtained by dividing
TR by the output sold. AR = TR/Q
It always equal to P because AR=PxQ/Q =>AR = P
Marginal Revenue: it is the revenue obtained by selling very last unit of any product.
MR= △TR/△Q
Perfect Competition: It is the kind of market in which multiple firms are selling
homogenous products at the same price. Any market can be called perfect
competitive market if it matches the following 5 conditions:
 Multiple Buyers/Multiple Sellers
 Firms are producing homogenous products
 Free entrance/exit of firms from the industry
 Perfect mobility of factor of production
 Firms/Consumers have perfect knowledge of the market.
 Price and Output Determination Under Perfect Competition
It is natural to chose the level of output which maximizes profit. When a firm achieves this
goal (maximization of profit) it is said to be in equilibrium position.
There are two method to explain the equilibrium of a firm.
1. TR/TC method. π = TR – TC

In the above mentioned diagram, the profit will be maximum where the slopes of TR & TC
are equal and the firm produces 0Q level of output. The points a&b are called break-even
points, these are the points at which TR=TC and the firm earns normal where Economic
profit=0.
2. MR/MC method. MR = MC approach

In this method of finding out the equilibrium of any firm there are two conditions which
have to be fulfilled. (i) MC=MR (Necessary Condition). (ii) MC intersects MR when it is
rising (Sufficient Condition).
 Factors of Production
Definition: The factors which a man requires to produce the commodities of his need are
called factors of production. They are: Capital, Organization, Land and Labour.

Land: It is the first basic factor of production. It does not mean the surface of land which we
walk on rather it includes everything which is gifted to us free by nature such as mountains,
forests, rivers and minerals.
Characteristics:
 Limited in Supply – The supply of land is totally fixed, it cant increase or decrease.
 Durable in Nature – Land is more durable and long-lasting compared to other factors
of production. Its productive capacity does not end
 Free Gift of Nature – Land is a gift of nature, which man got free of cost. He can
neither produce an inch of land nor destroy it. Thus, some countries have large areas
of land while some have it small.
 Lack of Geographical Mobility – land cannot be shifted from one place to another
one. For example, its not possible to shift a fertile land in the place of a barren land.
Labour: Second factor of production, it means mental or physical work undertaken for
reward. “Labour is any physical or mental work undertaken for wages not for pleasure.”
Characteristics:
 Limited Mobility – it has limited mobility usually because labours don’t like to shift
from one place to another due to many reasons such as their loved ones.
 Labour cannot be stored – it is not possible that a labourer does not work for three
days and he does labour of four days on the fourth day. The labour of the day on
which the labourer did not work will be wasted forever.
 Inelastic Supply – Supply of labour cannot be increased or decreased urgently. If the
demand for labour increases, new labourers cannot be prepared urgently and if the
demand falls, their number cannot be decreased.
Capital: it is the third factor of production. It means that part of income or wealth which is
spent to produce more wealth or increase income such as machines and equipment,
Importance of Capital:
 Attainment of Minerals – discovery of various minerals and their attainment
depends on machines. Metals, natural gas and oil are attained with the help of
machines.
 Decrease in the Cost of Production – The use of modern and latest machines
increases the production of goods to great extent. High-quality goods are produced
in no time. In this way, per unit cost of production decreases.
 Increase in the productivity of labour: When the labours produce goods with the
help of latest machines and tools, their productivity rises many times. Thus, use of
capital increases the productivity of the labourers.
Organization: Entrepreneur is the person who combines land, labour and capital and
decides how many units of every factor of production be employed and what to be
produced.
Forms:
 sole proprietorship
 partnership,
 corporation
 Limited Liability Company
 MACRO-ECONOMICS
National Income
Measurement of National Income:
1. National Income at Factor Price:
If annual monetary rewards of all the factors of production are added up then the total
will be equal to the national income
National Income = Rent of Land + Wages of Labour + Interest of Capital +
Profit of Entrepreneurs.
The following rewards are included in national income:
 All wages, salaries and other monetary rewards received by employees of
governments.
 Income of farmers, traders, lawyers and the labour working on daily wages
 All kinds of interest on bonds, securities and loans.
 Rent of lands, rent of buildings and royalty
 Corporate profit distributed among share-holders.
 Undistributed corporate profit and corporate profit tax paid to the government.
Precautions:
 Earnings from Unfair Means are not counted in National Income:
To measure national income by this method, incomes received by gambling, black
market and other unfair means are not included in national income.
 Transfer Payments are not included:
The incomes received without any labour, transfer payments are not included in
national income. They are Zakat, donations and pensions etc.
2. National Income at Market Price:
In a country, agricultural, industrial, mineral and commercial goods and services are
produced during a year. For example:
 Agriculture goods: wheat, cotton, rice, sugar cane, tobacco
 Industrial products: cloth, sugar, fertilizers and fans
 Handcrafts: carpets, sports goods
 Mineral goods: iron, coal, petrol and natural gas
 Services of doctors, lawyers, engineers.
The total value of all these goods and services calculated at market price, will be national
income.
 Precautions:
 Avoid Double Counting:
It must be kept in mind that the market value of a product must not be counted twice
in national income.
 To Subtract Depreciation Allowance:
For accurate measurement of national income, depreciation allowances must be
subtracted from the market value of goods and services
 To Subtract Indirect Taxes:
Indirect taxes such as sales tax and excise duty should be subtracted from total market
value
 Free Services:
The market value of commodities that are produced as a hobby should not be counted
in national income. For example: vegetables grown in the backyard of a house.
 Subsidies should be Counted:
Subsidies should be counted while measuring national income.
3. Expenditure method:
If we add the expenditure mad on the purchase of goods and services in a country
during one year, we can get national income.
The following expenditures are added to get national income:
 Private consumption expenditure
 Public consumption expenditure
 Private investment expenditures
 Public investment expenditures
 Exports minus imports
Precautions:
 Depreciation cost should be subtracted from the expenditures
 Indirect taxes added in prices should be subtracted
 Subsidies should be included
 Single expenditure on the purchase of a good should be included

If a person first purchases a good but later on the govt. purchases the very good from
him. These will be the double expenditures on a good and the calculations of national
 income will be wrong. That is why, the expenditure on a good should be counted only
once.

Money
Definition: Anything which is generally accepted as a medium of exchange and also
performs the functions of a standard of value and a store of value is money.
Functions of Money:
 Medium of exchange
The first and foremost function of money is that it should serve as a medium of
exchange for buying and selling goods and services. As a medium of exchange,
money has made process of production of wealth, distribution of wealth and exchange
of wealth easy and convenient.

 Common Measure of Value

One of the most important functions of money is that it measures value. As there are
scales for measuring length, weight and size, in the same way, value of goods and
services are measured by the scale of money. With the help of money, we cannot only
determine the value of goods and services but we can also compare their value.
 Store of Value
Money serves for storing value. It means we can preserve our goods for a long time in
the form of money. The reason is that money is not perishable thing rather its
components are paper notes and coins.
 Standard of Future Payments
Money serves as the standard of future payments. It means that people easily accept it
for borrowing and lending. For example, if a customer buys goods worth Rs.2000
from a supplier and promises to pay after a month. After a month, the customer settles
his account by paying Rs.2000 and no person will have any complaints. This function
of money is very important and it has brought a rapid expansion and development in
trade and industry.
 Transfer of Value
Money serves as a mean of transfer of value. It is easy for the people to transfer their
property from one place to another by the help of money.
 A Base for Govt. Payments and Revenue
Government payments and revenue have become easy by money. Govt. receives
taxes/rent in form of money and pays salaries/pensions in the form of money.
 Unit of Account
It means that value of goods and services is calculated in terms of money. For
example, we say apples are Rs.60 per kg and income of a person is Rs.2000 per
month.
Inflation:
Definition: Inflation means a situation in which there is a continuous increase in the general
price level. According to Coulbron, it means “too much money chasing too few goods”.
Inflation is an undesirable condition of the economy. It starts when it becomes impossible to
satisfy the whole demand for goods at existing prices.
Effects:
 Living Standard
 When the prices of goods rise, wages of labourers do not increase with the same rate.
Their purchasing power falls down and they buy less quantity of goods with their
salaries and wages. Their cost of living increases and their living standards falls.
 Discouragement of Savings
As the purchasing power of consumers decreases in case of inflation and they can
hardly make their both ends meet with their incomes, so they cannot think of saving.
Thus, there is a negative effect on savings in case of inflation.
 Reduction in Exports
In case of inflation, prices of goods increase in the country. Demand for its products
in foreign countries falls and exports of the country reduces. This leads to the balance
of trade becoming unfavorable. The country has to devalue its currency. If inflation
continues for several years, then continuous deficit in its balance of trade will lead to
increase in foreign loans and the payments becomes difficult,
 Investment and Production
In the period of inflation, the profits of entrepreneurs increase rapidly and they expand
their investments to a great extent to avail this opportunity. It also increases the
quality of production and opportunities of employment. But, if an economy has
already obtained full employment, then there is no real possibility of increase in real
output. So, price of goods and services increases which leads to hyper-inflation.
 Inequality in Distribution of Income
In a capitalist economy there is already an unequal distribution of wealth. It is divided
in two classes, rich and poor. If inflation emerges in the country, profits of big
entrepreneurs increase to a great extent. In this way, the rich get richer. On the other
hand, the real incomes of the labour fall and they get poorer and poorer. Thus,
inflation makes distribution of wealth more unequal

Business Cycle
Phases of Business Cycle:
There are four phases of a business cycle:
 Depression or Slump
In this phase of a trade cycle, economic activities become very slow. Production of
goods and services are very slow. Level of income and employment is at the lowest.
The demand of goods and services fall to the lowest level, as a result the general
prices also falls. The profits of the entrepreneurs are minimized. Rather firms have to
bear the loss and ultimately, they shut down their businesses. Purchasing power of the
people also decreases. In short, during depression, level of prices, consumption,
income, employment, wages and interest rate reach at the lowest ebb.
 Recovery or Expansion
Phase of depression does not last forever. After sometime, the phase of revival sets in
under the influence of different factors. Demand for goods start rising up and
production units start production to meet this rising demand. Firms replace their
existing machines. The level of employment, national income and consumption starts
rising up. Entrepreneurs become hopeful about the future and increase their
investment. In this way, employment and production and profits regularly increase.
The people start to become hopeful and optimistic. In this way recovery emerges.
Accordingly, prices, wages, interest rates, profits, employment and production start
rising.
 Boom or Prosperity
Phase of recovery leads to phase of boom. Level of incomes rises owning to which
demand for goods and services increases swiftly in the market. This leads to increase
in level of employment and living standard. Production, income and investment
increase with great speed. Rate of interest increases. Demand for labour increases.
That is why, their wages increase. Prices of goods and cost of production increase. As
the profits of firms are highest during the period of boom, so they increase investment
too much. In the phase of boom economy crosses full employment level and
employment reaches at its highest level. Thus, national income, incomes, profits,
prices and living standard reach their peak in the phase of prosperity.
 Recession
In the phase of prosperity, the producers work day and night to produce more goods to
maximize their profit. Even the production of goods becomes higher compared to the
demand. Thus, they start closing down the production units to sell their over
production and the labours become jobless. This further decreases the demand of
goods because the purchasing power of people decreases owing to unemployment. As
a result, profits start to fall, rather there are chances of loss. Investment falls down and
the producers do not set up new factories rather working factories also decrease
production. The period in which an economy comes back from prosperity to slump is
called recession.

International Trade
Definition: It is the act of export and import or transaction of goods and services
between different countries of the world. International trade takes place as a result of
three factors regarding the endowment of productive resources in different parts of the
world i.e. climate conditions, availability of natural resources and technical know-
how.
 Internal and External Trade: Internal trade takes place as a result of transaction of
goods and services within a country while external trade involves two or more
countries. The difference between them exists based on the following points:
o Mobility of factors of production
o Conversion of currency
o Trade restrictions
o Import and export policies
Term of Trade: it is the rate at which two countries exchange commodities with each
other. It is measured by:
Term of Trade=export price index of current year/import price index x 100
Term of trade is said to be unfavorable if value of BOT is less than 100, it shows that
export prices have raised less than import prices.
Free Trade: A policy of no restrictions on the movement of goods between countries
is known as the policy of free trade. These are the following arguments to free trade:
o Countries specialize in the production of commodities, therefore, goods are
produced at lower cost and in large quantities.
o Free trade prevents monopolies at home
o Sectoral development takes place
o Optimum use of resources is accomplished
Balance of Payments: according to kindle Berger: “it is the systematic record of all
economic transactions of a country with the rest of the world”. The balance of
payment is prepared in such a way that a complete and meaningful picture is obtained
about the value, quantity and directions of trade of goods, services and capital. It acts
as a helpful guide for the government to formulate its internal and external economic
policies.
Balance of Trade: It is the systematic record of receipts for visible exports and
payments on visible imports of a country. Visible items are the physical goods traded
which are recorded at ports or custom ports. Eg, cotton and rice. If the value of goods
exported by a country exceed the value of goods imported, then the balance of trade
of the country is called favorable or surplus while in the opposite case it is known as
adverse or deficit.

Public Finance
Tax: is the major source of revenue of public revenue. It is a compulsory by the
people to government treasury to meet the expenditure of the government for the
common benefit of the people.
Canon of Taxation: a government should take into account the following cannons
when levying taxes. The first four are made by Adam Smith.
 Canon of Equality
It means that all individuals should pay taxes in accordance with their incomes. Thus,
canon of equality does not mean that every person should pay equal tax rather it
means that everybody should equally sacrifice for public finance. This is only
possible when the rich pay tax at a higher rate compared to the poor.
 Canon of Certainty
 According to this canon both the tax payer should clearly know the amount of tax, the
time of payment, the method of payment and the place of payment so there is no
difficulty in payment of tax.
 Canon of Convenience
Adam Smith is of the opinion that taxes should be levied on the time when the
taxpayers can easily pay it. Therefore it is necessary that tax should be collected in
installments and at the time when the tax payers get their incomes.
 Canon of Economy
According to this canon, the cost of collecting taxes should be kept as low as possible.
All amount of taxes should not be spent on the salaries of tax-collection.
 Canon of Productivity
According to this, the amount collected from taxes should be enough to meet all
government expenditures. If a government does not have enough, it will borrow loans,
which leads to inflation

 Canon of Diversity
According to this, system of taxation should be multidimensional. A variety of taxes
should be introduced so that taxes should neither become a burden on one class.
 Canon of Simplicity
According to this, the system of taxation should be simple and easy to understand for
a common man. The tax payers may easily understand how to pay taxes. If the
procedure is simple than the tax payers will not face any difficulty in paying it
 Cannon of Elasticity
According to this, system of taxation should be elastic. If the income of the people
increase, the government tax revenues should also increase and vice versa. In the
same way, it should be possible to increase or decrease the rate of taxes with the
increase or decrease in government expenditures.

Zakat and Usher

Zakat: it means purification and growth. Zakat purifies the wealth from which the
fixed amount of zakat is paid. In religious terms, it can be defined as a compulsory
payment on a Sahib-e-Nisab Muslim. He pays it as a religious duty at a given rate.4
Difference between Zakat and Usher:
 Difference in Objectives:
Zakat is a religious obligation and the Holy Prophet clearly says that whoever does
not pay zakat is out of the circle of Islam. The Muslims pay zakat to have favor and
blessings of Allah. While, a government imposes tax on the people and receives
money. The money received is then spent on the social and public welfare
 Difference in Rate
The nisab and rate of zakat is fixed there can be no change in it. While, the
government keeps on changing exemption limit and the rate of tax according to the
circumstances.
 Willingness and Coercion
The people pay zakat according to their own will while they are forced to pay ta. The
people consider tax a burden and they do not pay willingly.
 Tax on Present Income
 Tax is imposed on the income of present year. While, zakat is levied on savings or
that wealth that remain in the possession of a person for one year.
 No Exemption in Zakat
The payment of zakat is compulsory for every Sahib-e-Nisab Muslim and he can get
no exemption in it. While, the government can either increase or decrease tax
 Personally or Through States
Taxes are deposited in state treasury, while if the state does not make any
arrangement for the collection and distribution of Zakat then Sahib-e-Nisab Muslims
have to distribute zakat individually amongst deserving people
 Difference in the Heads of Expenditure
Amount of Zakat can be spent on only certain heads while there are no specific
objectives to spend the amount of tax. A government can spend it according to its own
will.