UNIT – I : INTRODUCTION TO ECONOMICS

Meaning
The term ECONOMICS is derived from a Greek term ‘OIKONOMIA’
which means household management. Aristotle, the Greek Philosopher termed Economics
as a science of ‘household management’.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 about how
to allocate resources. Economics focuses on the actions of human beings, based
on assumptions that humans act with rational behaviour, seeking the most
optimal level of benefit or utility. The building blocks of economics are the studies
of labour and trade. Since there are many possible applications of human labour
and many different ways to acquire resources, it is the task of economics to
determine which methods yield the best results.
Economics can generally be broken down into macroeconomics, which
concentrates on the behaviour of the economy as a whole, and microeconomics,
which focuses on individual people and businesses.
NATURE AND SCOPE OF ECONOMICS

1. Economics as a Science:
Economics is a systematised body of knowledge in which economic facts are studied and
analysed in a systematic manner. For instance, economics is divided into consumption,
production, exchange, distribution and public finance which have their laws and theories on
whose basis these departments are studied and analysed in a systematic manner.

2. Economics Positive Science :

Robbins regards economics as a pure science of what is, which is not concerned with moral or
ethical questions. Economics is neutral between ends. The economist has no right to pass
judgment on the wisdom or folly of the ends itself. He is simply concerned with the problem of
scarce resources in relation to the ends desired.
economics is a positive science. It seeks to explain what actually happens and not what ought to
happen.

3. Economics as a Normative Science:

Economics is a normative science of “what ought to be.” As a normative science,
economics is concerned with the evaluation of economic events from the ethical
viewpoint. Marshall, Pigou, Hawtrey, Frazer and other economists do not agree that
economics is only a positive science. They argue that economics is a social science which
involves value judgements and value judgements cannot be verified to be true or false. It
is not an objective science like natural sciences.

4. Economics as an Art:
Art is the practical application of scientific principles. Science lays down certain principles while
art puts these principles into practical use. To analyse the causes and effects of poverty falls
within the purview of science and to lay down principles for the removal of poverty is art.
Economics is thus both a science and an art in this sense.

5. Economics as a Social Science:

Economics is a social science because it deals with one aspect of human
behaviour, viz., how men deal with problems of scarcity. Samuelson says that
Economics is “the queen of the social sciences”.

6. Problem solving Nature:

The primary function of economists is to formulate policies and to suggest
solutions to economic problems. Acknowledge of economics is essential for
policymaking.

DEFINITION OF ECONOMICS ( Wealth Oriented )

Modern economics started with a Scottish pioneer of political economy, who was also a
moral philosopher, Adam Smith (1723-1790), with the publication of his book ‘An Inquiry
into the Nature and Causes of the Wealth of Nations’.

His publication was the first comprehensive defence of the free market. Even today, it still
has considerable influence on current economic thinking globally.

Central to Mr. Smith’s work was the idea that the market, while seemingly chaotic, is in fact
guided to produce the right quantities and variety of goods and service – what he called
the ‘invisible hand’.

When a certain product is scarce and in demand, there will be great incentives within the
economy to produce more of it. If there is a surplus, the incentives will subsequently
influence people to produce less of it.

Most economist today see Adam Smith as the ‘father of modern economics’.
Criticism on Adam Smith Definition of Economics
As Adam Smith declared economics as a Science of Wealth. Some economists of
19th Century criticized this definition. Firstly Carlyle and Ruskin declared it a “dismal and
a pig science” which teaches selfishness. The main criticisms on the definition of Adam
Smith are given in brief as under.
1. Too Much Importance to Wealth
Definition of Economics by Adam Smith gives primary importance to wealth and
secondary to human being.

This emphasis has now shifted from wealth to human being. Man occupies primary
place and wealth a secondary one. The real fact is that man is more important than
study of wealth.

2. Narrow Meaning of Wealth

In the definition the word “Wealth” means only material goods such as vehicles,
industries, raw material, Banks etc. it does not include immaterial goods like services of
doctor, lawyer and teachers. In modern economics definition the word “Wealth” includes
both material and immaterial goods.

3. Concept of Economic Man

According to this main objective of human activities is only to earn more and more
wealth. in others words he earns only for his self interest and social interest is
completely ignored. But Alfred Marshall and his followers pointed out that economics
does not study a man who works only for his own interest, but a common man.

4. Human Welfare is Missing

The other objection by Marshall is that mans welfare has not been mentioned in Adam’s
definition of economics. He has stressed much on wealth. Wealth is a means to an
end, the end being the human welfare.

5. It Does Not Study Means

The definition lays emphasis on the earning of wealth as an end in itself. It ignores the
means for the earning of wealth.

6. Narrow and Controversial View

Since the word “wealth” did not have a clear meaning of economics by Adam Smith,
therefore, the definition became controversial. Alfred Marshall neoclassical economist
gave his own definition of economics and therein he laid emphasis on man and his
welfare.
Economics is a Science of Material Welfare
(Marshall’s Definition)
Marshall is one of the economists who contributed a good deal to economic theory. Even his
definition of economics occupies an important place in the literature of economics. Marshall was
the first economist who lifted the science of economics from the disrepute it had fallen into due
to its being associated with the study of

Marshall gave the following definition of economics; “Political Economy or economics is the
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.

Three things are worth noting in the above definition provided by Marshall. First, it is a study of
man as such and not of wealth. No doubt, according to this definition, economics is concerned
with wealth but it is concerned with wealth in the sense that it studies man’s action regarding
how he earns wealth and how he spends it. It is thus clear that it is the study of man which
occupies the prominent place in the economic study.

Thus Marshall writes “Economics on the one side is study of wealth and, on the other and more
important side, a part of the study of man.”

2.Secondly, Marshall’s definition implies that economics is concerned with a particular aspect of
man’s life. There are many aspects of man’s life—social, religious, political, etc.

3. Economics studies man’s life in the ordinary business of life. The ordinary business of life
means how a man gets his living and how he spends it. Thus Marshall says “Economics is a
study of mankind in the ordinary business of life.”

4. At another place he says, “Economics is study of man’s action in the ordinary business of life.
It enquires how He gets his income and how he uses it.”

5. Marshall incorporated in his definition that economics “examines that part of individual and
social action which is most closely connected with attainment and with the use of the material
requisites of well-being.” It is the phrase material requisites of well- being that stands for
material welfare. It is thus clear that Marshall laid emphasis on material welfare as the primary
concern of the science of economics.
Marshall’s definition has been criticised by Robbins on the following grounds:

1. Firstly, Robbins is of the view that economics should not have any connection with mate-
rial welfare. Robbins points out that in economics we study not only material things but
also immaterial things. Therefore, according to him, it is incorrect to say that economics
is concerned with material things alone.

2. He points out that in economics we also enquire how the prices of immaterial services
such as professional singers, actors, and actresses, dancers, etc., are determined and they
are important topics of price theory.

3. He thus says: “A theory of wages which ignored all those sums which were paid for
immaterial services or were spent on immaterial ends would be intolerable. Moreover it is
very difficult to separate the material welfare from the other types of welfare.

4. The welfare is entity as such and we cannot divide it into various parts. Even with the
measuring rod of money we cannot precisely and exactly segregate the material welfare
from the total welfare.

5. Robbins has also objected to the word ‘welfare’ in the above welfare definitions.
According to Robbins, the concept of welfare is not fixed and definite one; it differs in
different countries and at different times. Welfare is a subjective thing and it varies from
person to person.

CONCLUSION

Therefore, according to Robbins, it cannot be said in objective terms which things would
promote welfare and which will not. Moreover, according to Robbins, economics is
concerned with many goods and activities which are generally thought to be harmful to
human welfare but they are studied in economics Goods like liquor, cigarettes, opium are
hardly conducive to human welfare but their pacing problem is studied in economics.

Economics is a science which studies human behaviour as a relationship between ends and scarce means
which have alternative uses.” – Prof. Lionel Robbins.
Scarcity Definition of Robbins:
It was Lord Robbins who with the publication of his Nature and Significance of
Economic Science in 1932 not only revealed the logical inconsistencies and inadequacies
of the earlier definitions but also formulated his own definition of economics. According
to Robbins: “Economics is the science which studies human behaviour as a relationship
between ends and scarce means which have alternative uses.” This definition is based on
the following related postulates.

Important Characteristics of Robbins’ Definition:

(i) Unlimited Wants:

Human wants are unlimited in number. Whenever one want is satisfied, then
automatically several wants grow up.

Hence it is endless. With the progress in civilization and development science

and technology numerous wants are developed. Again several human wants are
reoccurring too. Hence, wants are ‘ever growing and never ending’.

(ii) Limited Means:

Human wants are unlimited but resources or means to satisfy them are limited.
The means refer to goods and services which we use to satisfy our wants. They are
material and non- material goods like time, money, services, resources etc. These
resources are scarce.

Here the term scarcity is used not in the absolute sense but in the relative sense
i.e., in relation to demand. A commodity may be available in small quantity but if
nobody demands, it then it is not scarce. Hence, the scarce means are the basis of
all economic problems. Because, if all these means or resources are not scarce,
then there will be no problem in economics.

(iii) Alternative Use of Resource:

All the scarce means can be used in more than one purpose. In other words, they
can be used in several purposes. For instance, land is very scarce, but land can be
used for construction of buildings, cultivation, playground etc. Likewise, all these
economic resources are used for various purposes. Thus, in reality goods can be
put to alternative uses of varying importance.
(iv) Economising Resources:
The main problem of economics is how to satisfy the unlimited wants with
limited means which have alternative uses. Robbins describes this problem as the
problem of economising scarce means. In other words, it is the choice of making
of an economic activity. According to Cassel, “Economics is the science of
Scarcity.” Economics is thus a study of certain kind of economics that is
economising the resources.

(v) Problem of Choice:

The problem of economising resources leads to the problem of choice. Since
wants are numerous and means are scarce, we have to choose the most urgent
wants from these unlimited wants. Hence, the consumer will select few wants
from the numerous wants according to his preference pattern. Thus, scarcity of
resources makes the choice necessary. Hence, Economics is termed as a science
of choice.

Lionel Robbins definition has following drawbacks:

(i) Static: Prof Samuelson pointed correctly that Robbins’ definition is not dynamic in nature, because it
has only discussed about the problems of present generation, not anything about future generation.
Hence the definition suffers with the problem of economic growth.
(ii) Too vast: It discussed the scope of economics to all the activities of mankind that are related to the
problem of choice. The problem of choice is found in both social and unsocial beings. Thus, it has no social
significance in real world.
(iii) Economic problems also arise from more supply: Some economists claim that economic problem
also arises from the plenty of goods as well. The Great Depression of 1930s in USA was due to abundance
of goods, but not due to scarcity of resources.
(iv) Not fit for socialistic economy: Prof. Maurice has criticized Robbins’ definition that his definition is
not applicable for a socialistic economy, because in this type of economy, the Government takes all the
initiatives for supplying all the basic necessities of life among the citizens. For the betterment of whole
society the Government usually launches several beneficiary activities.

(v) Not fit for rich country: The economic problem for a rich and sound economy is different from the
underdeveloped or poor economy. Here the resources are not limited. In fact, resources are plenty in this
type of economy.

(vi) Relation with welfare: Robbins criticised Marshall’s definition on the ground of welfare. However,
limited means are used to fulfil unlimited wants. Thus, it means that maximising satisfaction will lead to
more welfare. Hence, Robbins’ definition is related with welfare also.
CONCLUSION
The science of political economy is growing and its area can never be rigid. In
other words, the definition must not be inflexible. Because of modern research,
many new areas of economics are being explored.

That is why the controversy relating to the definition of economics remains and
will remain so in the future. It is very difficult to spell out a logically concise
definition. In this connection, Mrs. Barbara Wotton’s remarks may be noted –
‘Whenever there are six economists, there are seven opinions!’

Despite these, Cairncross’ definition of economics may serve our

purpose:
“Economics is a social science studying how people attempt to accommodate
scarcity to their wants and how these attempts interact through exchange.” By
linking ‘exchange’ with ‘scarcity’, Prof. A. C. Cairncross has added another cap to
economics.

However, this definition does not claim any originality since scarcity—the root of
all economic problems—had been dealt with elegantly by Robbins.

That is why, Robbins definition is more popular:

Economics is the science of making choices. Modern economics is a science of
rational choice or decision-making under conditions of scarcity.

NEO CLASSICAL ECONOMICS

Neoclassical economics is an approach to economics focusing on the determination of

goods, outputs, and income distributions in markets through supply and demand. This
determination is often mediated through a hypothesized maximization of utility by
income-constrained individuals and of profits by firms facing production costs and
employing available information and factors of production, in accordance with rational
choice theory a theory that has come under considerable question in recent years.
Neoclassical economics dominated microeconomics and, together with Keynesian
economics, formed the neoclassical synthesis which dominated mainstream
economics as Neo-Keynesian economics from the 1950s to the 1970s. It competed
with New Keynesian economics as New classical macroeconomics in explaining
macroeconomic phenomenon from the 1970s till the 1990s, when it was identified as
having became a part of the new neoclassical synthesis along with New Keynesianism.
There have been many critiques of neoclassical economics, often incorporated into
newer versions of neoclassical theory, but some remaining distinct fields.
Three central assumptions :
It was expressed by E. Roy Weintraub that neoclassical economics rests on three
assumptions, although certain branches of neoclassical theory may have different
approaches
1. People have rational preferences between outcomes that can be identified and associated
with values.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of full and relevant information.

• From these three assumptions, neoclassical economists have built a structure to

understand the allocation of scarce resources among alternative ends—in fact
understanding such allocation is often considered the definition of economics to
neoclassical theorists. Here's how William Stanley Jevons presented "the problem
of Economics.”
• From the basic assumptions of neoclassical economics comes a wide range of
theories about various areas of economic activity. For example, profit
maximization lies behind the neoclassical theory of the firm, while the derivation
of demand curves leads to an understanding of consumer goods, and
the supply curve allows an analysis of the factors of production. Utility
maximization is the source for the neoclassical theory of consumption, the
derivation of demand curves for consumer goods, and the derivation of labour
supply curves and reservation demand.
• Neoclassical economics emphasizes equilibria, which are the solutions
of agent maximization problems. Regularities in economies are explained
by methodological individualism, the position that economic phenomena can be
explained by aggregating over the behaviour of agents. The emphasis is
on microeconomics. Institutions, which might be considered as prior to and
conditioning individual behaviour, are de-emphasized. Economic
subjectivism accompanies these emphases.

CRITICISM

1. Criticism of neoclassical economics was offered by Leijonhufvud in the

contention that "Instead of looking for an alternative to replace it, we
should try to imagine an economic theory to transcend its limitations." In
criticism, neoclassical economics is often conflated with all of mainstream
economics.
 2. Neoclassical economics is sometimes criticized for having
a normative bias. In this view, it does not focus on explaining actual
economies, but instead on describing a theoretical world in which Pareto
optimality applies.

3. Criticisms of neoclassical economics are also directed at the rationality

assumption, in particular on the basis of the view that the rationality
assumption cannot be reconciled with altruistic behaviour.

4. Neoclassical economics, according to this criticism, has extreme difficulty

explaining such things as voting behaviour, or someone running into a
burning building to save a complete stranger.

5. Problems exist with making the neoclassical general equilibrium theory

compatible with an economy that develops over time and includes capital
goods.

6. In general, allegedly overly unrealistic assumptions are one of the most

common criticisms of neoclassical economics.

Samuelson’s Growth-Oriented Definition:

Modern age is the age of economic growth. Its main objective is to increase social
welfare and improve the standard of living of the people by removing poverty,
unemployment, inequality of income and wealth, malnutrition, etc. of the nation.
Hence, economic growth is the central point of all economic policies. Prof. Samuelson
has given a definition of economics based on growth aspects.

According to Samuelson, “Economics is the study of how people and society end up
choosing, with or without the use of money, to employ scarce productive resources that
could have alternative uses to produce various commodities, over time, and distribute
them for consumption, now or in the future, among various person or groups in society.
Economics analyses the costs and the benefits of improving patterns of resource use.”
Characteristics of Samuelson’s Definition:
The main characteristics of this growth-oriented definition are as follows:

1. Like Robbins, Samuelson has emphasized the problem of scarcity of resources in

relation to unlimited wants. He has also accepted the alternative uses of resources.

2. Prof. Samuelson includes time element in his definition when he refers to “over time”
which makes the scope of economics dynamic. Herein lies the superiority of
Sameulson’s definition over that of Robbins.

3. Samuelson’s definition is applicable even in a barter economy where money

measurement in not possible. A barter economy has also to face the problem of scarcity
or means in relation to ends.

4. He gives importance to the problem of distribution and consumption along with that
of production. He emphasises on the consumption of various commodities produced
overtime and on their distribution and for future economic growth.

5. By studying the problems of growth, Samuleson also highlights the study of macro-
economics.

6. Samuelson lays stress on the use of modern technique of “cost-benefit analysis” to

evaluate the development programme for the use of limited resources.

7. Sameulson has linked the growth aspects with the scarcity of productive resources.

8. Samuelson regards economics as social sciences, unlike Robbins who regards it as a

science of individual behaviour.

CONCLUSION

In this way, this definition has a universal appeal. Despite various similarities with
Robbins’s definition, it is an improvement over his scarcity definition and is also more
comprehensive and realistic than the earlier definitions.
UNIT - 1

2) BASIC CONCEPTS OF ECONOMICS :

CONSUMPTION
Consumption is defined as the use of goods and services by a household. It is a
component in the calculation of the Gross Domestic Product (GDP). Macroeconomists
typically use consumption as a proxy of the overall economy.

When valuing a business, a financial analyst would look at the consumption trends in
the business’ industry. It is an important step, as it helps the analyst with the assumption
section of the financial model.

Consumption in Neoclassical Economics

Neoclassical economists view consumption as the final purpose of an economic activity,

hence, the per person value is an important factor in determining the productive success
in an economy.

Importance of Consumption

Modern economists give a lot of importance to the level of consumption in the

economy because it characterizes the economic system the country currently operates
in.

1. The beginning of all economic activity

Consumption is the start of all human economic activity. If a person desires something,
he will take action to satisfy this desire. The result of such an effort is consumption,
which also means the satisfaction of human wants.

2. End of economic activities

If, for example, a person desires a sandwich, they will take the effort to make the
sandwich. Once it is made, the food is consumed, resulting in the end of an economic
activity.

3. Consumption drives production

According to economist Adam Smith, “Consumption is the sole purpose of all

production.” It means that the production of goods and services is dependent on the
level of consumption.
4. Economic theories

The study of consumption theory has helped economists formulate numerous theories
such as the Law of Demand, the Consumer Surplus concept, and the Law of Diminishing
Marginal Utility. These theories help analysts understand how individual behaviour
affects the input and output in the economy.

5. Government theories

Consumption habits also help the government formulate theories. The minimum wage
rate and tax rate are determined based on the habits of individuals. It also helps the
government make decisions on the production of essential and non-essential
commodities in a country. It also provides the government with insight into the saving
to spending ratio in the economy.

6. Income and employment theory

Consumption plays an important role in the income and employment theory under
Keynesian economics as put forth by John Maynard Keynes. Keynesian theory states that
if consuming goods and services does not increase the demand for such goods and
services, it leads to a fall in production. A decrease in production means businesses will
lay off workers, resulting in unemployment. Consumption thus helps determine the
income and output in an economy.

GooDS

INTRODUCTION

In economics, goods are items that satisfy human wants and provide utility, for
example, to a consumer making a purchase of a satisfying product. A common
distinction is made between goods which are transferable, and services, which are not
transferable. A good is an "economic good" if it is useful to people but scarce in relation
to its demand so that human effort is required to obtain it.

Meaning and Definition

Goods can be defined as anything from merchandise, supplies, raw

materials to already completed products. All items that are movable and
are sold to a particular buyer.
Goods are material things wanted by human beings. They can be seen or touched.
Services are non-material things. These cannot be seen or touched only their
effects are felt. When we are hungry, we take food. When we fall sick, we take
medicines. When we study, we use book, notebook, pen, paper etc. All these are
examples of goods which satisfy some of our wants. All the things which satisfy
human wants are good.

TYPES OF GOODS :

COMPLEMENTARY GOODS

Definition: Two or more goods that satisfy the wants or needs when consumed
jointly or production of one good automatically triggers the production of
other good. Satisfaction is greater when both goods are consumed together.

Features of Complement Goods

•Such goods have negative cross elasticity of demand. They will have a
perfectly inelastic demand.
•Goods cannot function without each other.
•Dependent Nature & non-interchangeable
Examples
•Car & Petrol/Diesel
•Printers and ink cartridges
•DVD players and DVDs

GIFFEN GOODS

A Giffen good is a low income, non-luxury product for which demand increases
as the price increases and vice versa. A Giffen good is an inferior good (a good
that people buy more of when their income goes down) with the unique
characteristic that an increase in price actually increases the quantity of the
good that is demanded. This provides the unusual result of an upward
sloping demand curve. The Giffen goods which fail with Law of Demand.
These are goods that are substitutes for a more expensive good, that people
buy more of when they cannot afford a superior good. example is
China made IPhone.

Substitution effect of Giffen goods

When the price of a good decreases, there is more consumption of this good.
This is always positive.

Income effect of Giffen goods

When the price of a good falls, the total expenditure (or portion of your
income spent on this good) changes. This can be positive or negative.

Negative income effect

A negative income effect will only occur for inferior goods. For a Giffen
good, the item is so inferior that if its price falls you will buy less of it
(extremely negative income effect) and that if its price rises you will buy
more of it (your income falls so you buy more inferior goods).

VEBLEN GOODS

Veblen goods provide the consumer greater satisfaction (or utility) as the
price increases. A Veblen good is a good where demand rises as price rises.
People think more expensive goods are better quality, and so people buy
more. Studies suggest people do get more satisfaction from receiving
expensive goods. It is possible that designer clothes or luxury cars may
sometimes meet the criteria of Veblen goods. This is often termed the snob
effect – people equate price to quantity. They are not inferior goods.

Example

Luxury Cars
•Gucci bag
•Expensive Wines
The utility of such goods is associated with their ability to denote status.
Decreasing their price decreases the quantity demanded because their status
denoting utility becomes compromised.
SUBSTITUTE GOODS
This means a good’s demand is increased when the price of another good is
increased. Conversely, the demand for a good is decreased when the price of
another good is decreased. That is people search for cheaper alternative.
These Goods are in complete Contrast with Complement Goods, Giffen Goods,
Veblen Goods .
Characteristics of Substitute goods:
•Born from concept of Competition.
•They can serve the same purpose/use.
•Provide needs in Many Ways to Consumers.
•They provide freedom to choose and pressure goods to supply at reasonable
price.
•The increased demand for one of the goods will subsequently cause a
decrease in demand for the other. For examples, If X and Y are substitutes if,
when the price of X rises, the demand for Y rise.
•They have positive cross elasticity of demand.
Examples of Substitute Goods in Economy:
•Pepsi & Coca Cola Drinks
•Coffee and Tea

INFERIOR GOODS
An inferior good means an increase in income causes a fall in demanding these
good. It has a negative income elasticity of demand (YED).
NORMAL GOODS
Means an increase in income causes an increase in demand. It has a positive
YED. Note a normal good can be income elastic or income inelastic.
LUXURY GOODS
A luxury good means an increase in income causes a bigger % increase in
demand. It means that the YED is greater than one. For example, high
definition TV’s
WOULD BE LUXURY GOODS
When income rises, people spend a higher % of their income on the luxury
good. A Luxury good is always a normal good but not vice versa.
PUBLIC GOODS
In economics, a public good refers to a commodity or service that is made
available to all members of a society. Typically, these services are administered
by governments and paid for collectively through taxation.

Examples of public goods include law enforcement, national defence, and the
rule of law. Public goods also refer to more basic goods, such as access to clean
air and drinking water.

NATURE OF PUBLIC GOODS

1.NON – EXCLUDABLE

Non-excludability means that the good is available to all citizens. E.g. Defence
service

2.NON – RIVALRY

Non-rivalrous means that the quantity or value of goods does not reduce in
supply as more people consume them. E.g. public parks.

MERIT GOODS

Goods which people may underestimate benefits of. Also often has positive
externalities, e.g. education.
DEMERIT GOODS
Goods where people may underestimate costs of consuming it. Often has
negative externalities, e.g. smoking, drugs. See: Demerit goods
PRIVATE GOODS

Private goods are those whose ownership is restricted to the group or

individual that purchased the good for their own consumption. A private good
is not shared with anybody else, but can be sold along with transferring rights
to use or consume it. Examples of private goods include food, clothes, and flowers.
There are usually limited quantities of these goods, and owners or sellers can prevent
other individuals from enjoying their benefits. Because of their relative scarcity, many
private goods are exchanged for payment.
Features of private goods:

1. EXCLUDABLE : consumers can be excluded from consumption if they

do not pay to the seller of the goods.

2. RIVALRY : when a good is used or purchased by an individual that less

of the good available for others.

3. REJECTABILITY : When a commodity is kept completely of reach to

other consumers.

4. FREE RIDER : Someone who enjoys the benefits of a good without paying
for it.

FREE GOODS

A good with no opportunity cost, e.g. breathing air.

CONCLUSION

Goods, both tangibles and intangibles, may involve the transfer of product ownership to the
consumer. Services do not normally involve transfer of ownership of the service itself, but may
involve transfer of ownership of goods developed or marketed by a service provider in the
course of the service. For example, sale of storage related goods, which could consist of storage
sheds, storage containers, storage buildings as tangibles or storage supplies such as boxes,
bubble wrap, tape, bags and the like which are consumables, or distributing electricity among
consumers is a service provided by an electric utility company.

3. UTILITY

MEANING
Utility is a term in economics that refers to the total satisfaction received from
consuming a good or service. Economic theories based on rational choice
usually assume that consumers will strive to maximize their utility. The economic
utility of a good or service is important to understand, because it directly
influences the demand, and therefore price, of that good or service. In practice, a
consumer's utility is impossible to measure and quantify. However, some
economists believe that they can indirectly estimate what is the utility for an
economic good or service by employing various models.

DEFINITION

The utility definition in economics is derived from the concept of usefulness. An

economic good yields utility to the extent to which it's useful for satisfying a
consumer’s want or need. Various schools of thought differ as to how to model
economic utility and measure the usefulness of a good or service. Utility in
economics was first coined by the noted 18th-century Swiss mathematician
Daniel Bernoulli. Since then, economic theory has progressed, leading to various
types of economic utility.

Types of Utility:
Utility may take any of the following forms:
(1) Form Utility:
When utility is created and or added by changing the shape or form of goods, it is
form utility. When a carpenter makes a table out of wood, he adds to the utility of
wood by converting it into a more useful commodity like furniture. He has
created form utility.

(2) Place Utility:

When the furniture is taken from the factory to the shop for sale, it leads to place
utility. This is because it is transported from a place where it has no buyers to a
place where it fetches a price.

(3) Time Utility:

When a farmer stores his wheat after harvesting for a few months and sells it
when its price rises, he has created time utility and added to the value of wheat.

(4) Service Utility:

When doctors, teachers, lawyers, engineers, etc. satisfy human wants through
their services, they create service utility. It is acquired through specialised
knowledge and skills.

(5) Possession Utility:

Utility is also added by changing the possession of a commodity. A book on
economic theory has little utility for a layman. But if it is owned by a student of
economics, possession utility is created.

(6) Knowledge Utility:

When the utility of a commodity increases with the increase in knowledge about
its use, it is the creation of knowledge utility through propaganda, advertisement,
etc.

(7) Natural Utility:

All free goods such as water, air, sunshine, etc., possess natural utility. They have
the capacity to satisfy our wants.

Characteristics of Utility:
The following are the characteristics of utility:
1. Utility and Usefulness:
Anything having utility does not mean that it is also useful. If a good possesses
want satisfying power, it has utility. But the consumption of that good may be
‘useful’ or ‘harmful’. For example, the consumption of wine possesses utility for a
man habitual to drinking because it satisfies his want to drink. But the use of
wine is harmful for health, but it has utility. Thus utility is not usefulness.

2. Utility and Satisfaction:

Utility is the quality or power of a commodity to satisfy human wants, whereas
satisfaction is the result of utility. Apples lying in the shop of a fruit seller have
utility for us, but we get satisfaction only when we purchase and consume them.
It means utility is present even before the actual consumption of a commodity
and satisfaction is obtained only after its consumption. Utility is the cause and
satisfaction is the effect or result.
3. Utility and Pleasure:
It is not necessary that a commodity processing utility also gives pleasure when
we consume it. Utility is free from pain or pleasure. An injection possesses utility
for a patient, because it can relieve him of his illness. But injection gives him no
pleasure; instead it gives him some pain. Quinine is bitter in taste but it has the
utility to treat the patient from malaria. So, there is no relationship between
utility and pleasure.

4. Utility is Subjective:
Utility is a subjective and psychological concept. It means utility of a commodity
differs from person to person. Opium is of great utility for a man accustomed to
opium, but it has no utility for a man who is not accustomed to opium. In the
same manner, utility of different commodities differs from person to person.
Therefore, utility is subjective.

5. Utility is Relative:
Utility is a relative concept. A commodity may possess different utility at different
times or at different places or for different persons. In olden days, a Tonga had
greater utility. But now with the invention of bus, its utility has become less. A
rain coat has greater utility in hilly areas during rainy season than in plain areas.
A fan has greater utility in summer than in winter.

6. Utility is Abstract:
Utility is abstract which cannot be seen with eyes, or touched or felt with hands.
For example, the argumentative power of an advocate is abstract. Similarly,
utility is abstract. Utility of a commodity can neither be seen not touched or felt
with hands.

Measurement of Utility:
According to Marshall, the utility of a commodity can be measured in terms of
money. If a consumer is willing to pay Rs.2 for an orange and Re 1 for a banana,
then the utility of an orange is equal to Rs.2 and that of a banana is Re. 1 to him.

It means that the utility of one orange is equal to 2 bananas. In other words, the
utility of an orange to the consumer is twice that of the banana. But this analysis
does not hold when there are two different consumers offering two different
prices for the same commodity.
Suppose Bhanu offers Rs.2 for a banana for which Gautam is prepared to pay Re.
1.The higher price paid by Bhanu does not mean that he gets more utility and
Gautam less utility. Thus money does not measure the utility from a commodity.
It simply measures the intensity of our desire for a commodity. Despite this
weakness, money is used as a measure of utility.

Cardinal and Ordinal Utility:

The terms ‘cardinal’ and ‘ordinal’ have been borrowed from mathematics. The
numbers 1, 2, 3, 4, etc. are cardinal numbers. According to the cardinal system,
the utility of a commodity is measured in units and that utility can be added,
subtracted and compared. For example, if the utility of one apple is 10 units, of
banana 20 units and of orange 40 units, the utility of banana are double that of
apple and of orange four times the apple and twice the banana.

The ordinal numbers are 1st, 2nd, 3rd, 4th, etc. which may stand for 1, 2, 4, 6 or
30, 40, 60, 80, etc. They tell us that the consumer prefers the first to the second
and the third to the second and first, and so on. But they cannot tell by how much
he prefers one to the other.

The entire Marshallian utility analysis is based on the cardinal measurement of

utility. According to Hicks, utility cannot be measured cardinally because utility
which a commodity possesses is subjective and psychological. He, therefore,
rejects the quantitative measurement of utility and measures utility ordinally in
terms of the indifference curve technique.

Total Utility:
Total Utility (TU) implies overall level of satisfaction derived from a good by a
consumer. In other words, TU can be defined as an aggregate sum of satisfaction that a
consumer receives from consuming a specified amount of good or service in an
economy. The amount of a consumer’s TU corresponds to the consumer’s level of
consumption. Suppose a consumer three units of a chocolate A and derives utility from
them as U1, U2 and U3. In such a case, TU from chocolate A would be:
UA = U1 + U2 + U3
If a consumer consumes n number of chocolates (a, b, c…), then
Marginal Utility:
In economics terms, Marginal Utility (MU) can be defined as additional utility gained
from the consumption of an additional unit of a good. In other words, MU implies the
utility derived from additional unit consumed.

Economists use the idea of marginal utility to gauge how satisfaction levels affect
consumer decisions. Economists have also identified a concept known as the law
of diminishing marginal utility. It describes how the first unit of consumption of a
good or service carries more utility than later units.

Types of Marginal Utility

There are multiple kinds of marginal utility. Three of the most common ones are
as follows:

Positive Marginal Utility

Positive marginal utility occurs when having more of an item brings additional
happiness. Suppose you like eating a slice of cake, but a second slice would
bring you some extra joy. Then, your marginal utility from consuming cake is
positive.

Zero Marginal Utility

Zero marginal utility is what happens when consuming more of an item brings no
extra measure of satisfaction. For example, you might feel fairly full after two
slices of cake and wouldn't really feel any better after having a third slice. In this
case, your marginal utility from eating cake is zero.

Negative Marginal Utility

Negative marginal utility is where you have too much of an item, so consuming
more is actually harmful. For instance, the fourth slice of cake might even make
you sick after eating three pieces of cake.

Law Of Diminishing Marginal Utility

According to the Law of Diminishing Marginal Utility, marginal utility of a good

diminishes as an individual consumes more units of a good. In other words, as a
consumer takes more units of a good, the extra utility or satisfaction that he derives
from an extra unit of the good goes on falling.
It should be carefully noted that is the marginal utility and not the total utility than
declines with the increase in the consumption of a good. The law of diminishing
marginal utility means that the total utility increases but at a decreasing rate.

Marshall who was the famous exponent of the marginal utility

analysis has stated the law of diminishing marginal utility as follows:
The additional benefit which a person derives from a given increase of his stock of a
thing diminishes with every increase in the stock that he already has.”

This law is based upon two important facts. Firstly, while the total wants of a man are
virtually unlimited, each single want is satiable. Therefore, as an individual consumes
more and more units of goods, intensity of his want for the goods goes on falling and a
point is reached where the individual no longer wants any more units of the goods. That
is, when saturation point is reached, marginal utility of goods becomes zero. Zero
marginal utility of goods implies that the individual has all that he wants of the goods in
question.

The second fact on which the law of diminishing marginal utility is based is that the
different goods are not perfect substitutes for each other in the satisfaction of various
particular wants. When an individual consumes more and more units of a goods, the
intensity of particular want for the goods diminishes but if the units of that goods could
be devoted to the satisfaction of other wants and yield as much satisfaction as they did
initially in the satisfaction of the first want, marginal utility of the good would not have
diminished.

It is obvious from the above that the law of diminishing marginal utility describes a
familiar and fundamental tendency of human nature. This law has been arrived at by
introspection and by observing how people behave.

Diminishing Marginal Utility Schedule :

Cups of Total Marginal

Tea Utility utility

Consumed (units) (units)

per day
 1 12 12

2 22 10

3 30 8

4 36 6

5 40 4

6 41 1

7 39 –2

8 34 –5

Consider the schedule in which we have presented the total and marginal utilities
derived by a person from cups of tea consumed per day. When one cup of tea is taken
per day, the total utility derived by the person is 12 units. And because this is the first
cup its marginal utility is also 12.

With the consumption of 2nd cup per day, the total utility rises to 22 but marginal utility
falls to 10. It will be seen from the table that as the consumption of tea increases to six
cups per day, marginal utility from the additional cups goes on diminishing (i.e., the
total utility goes on increasing at a diminishing rate).

However, when the cups of tea consumed per day increase to seven, then instead of
giving positive marginal utility, the seventh cup gives negative marginal utility equal to -
2. This is because too many cups of tea consumed per day (say more than six for a
particular individual) may cause him acidity and gas trouble. Thus, the extra cups of tea
beyond six to the individual in question give him disutility rather than positive
satisfaction.

We have graphically represented the data of the above table in Figure 3. We have
constructed rectangles representing the total utility obtained from various numbers of
cups of tea consumed per day. As will be seen in the Figure, the length of the rectangle
goes on increasing up to the sixth cup of tea and beyond that length of the rectangle
declines, indicating thereby that up to the sixth cup of tea total utility obtained from the
increasing cups of tea goes on increasing whereas beyond the 6th cup, total utility
declines. In other words, marginal utility of the additional cups up to the 6th cup is
positive, whereas beyond the sixth cup marginal utility is negative.
The marginal utility obtained by the consumer from additional cups of tea as he
increases the consumption of tea has been shaded. A glance at the Figure 3 will show
that this shaded area goes on declining which shows that marginal utility from the
additional cups of tea is diminishing. We have joined the various rectangles by a smooth
curve which is the curve of total utility which rises Up to a point and then declines due
to negative marginal utility.

Moreover, the shaded areas of the rectangles representing marginal utility of the various
cups of tea have also been shown separately in the figure given below. We have joined
the shaded rectangles by a smooth curve which is the curve of marginal utility. As will be
seen, this marginal utility curve goes on declining throughout and even falls below the x-
axis. Portion below the x-axis indicates the negative marginal utility.

This downward-sloping marginal utility curve has an important implication for

consumer’s behaviour regarding demand for goods. We shall explain how the demand
curve is derived from marginal utility curve. The main reason why the demand curves
for good slope downward is the fact of diminishing marginal utility.

The significance of the diminishing marginal utility of a good for the theory of demand
is that the quantity demanded of a good rises as the price falls and vice versa. Thus, it is
because of the diminishing marginal utility that the demand curve slopes downward.

WANTS

Definition:
It is very difficult to define human wants within few words. All of us want to live.
For this reason, we need food, clothing and shelter.

Human desire for better and ever better living, the desire for change, increasing
knowledge, human progress etc. have led to emergence and growth of more and
newer wants.

Thus wants have been increasing because of the addition of more and more wants
as also because of rise in population and new inventions and discoveries.
Therefore, human wants are ‘ever growing and never ending’.
Human wants have grown for two basic reasons:
(i) Desire for better living due to introduction of new things;

(ii) Rise in population growth.

These are two main factors responsible for the growth of human wants.

Characteristics of Human Wants:

There are several characteristics of human wants.

These are listed below:

(i) Wants are repeated:
Several human wants occur again and again during the same day. We want food
during breakfast, lunch, dinner etc. However, we want medicine at the time we
feel sick. Therefore, some of our wants are reoccurred many times during a day,
while some human wants only repeated after a long time. In some cases, human
wants are only occasional.

(ii) Wants may differ with age:

Human wants are changing according to the age. A child wants toys, whereas an
adult wants a motorbike. A student wants to go to school. A grown-up wants a job
and a secured life.

(iii) Wants may differ with gender:

Wants of a boy and a girl are different. A girl wants to dance, whereas a boy wants
to play. A gentleman wants shirts, pants, ties etc. However, a lady wants sarees
and salwar suits. Thus, both men and women want different goods according to
their needs.

(iv) Wants may differ with preferences:

Human wants are also changing according to tastes and preferences A twin
sisters may wants different types of foods and dresses. Some persons want spicy
foods while some others want very simple non-spicy foods. Wants may also
change according to the habits of the people.

(v) Wants may differ with climate:

A same person wants woollen clothes during winter, cotton clothes in summer
and raincoats at the time of rainy season. People from mountain or hilly areas
want room-heater, but plain- land people demand for AC machine.

(vi) Wants may differ with culture:

A Bengali wants rice and fish, a Punjabi wants roti and dal, a Tamil wants iddli
and dosa etc. in their food. An European wants ‘coat, pant & tie’, whereas an
Indian wants ‘kurta and pyjama’. Thus, human wants are varying with culture.

(vii) Wants may differ with health:

A healthy person wants sufficient good food. However, a sick or ill person wants
proper medicines.

(vii) Wants Are Unlimited: Crisis is the mother of civilization. With the
passage of time, human wants are increasing. We may satisfy some of our wants
for time being, but they may also reoccur. Moreover, there are so many wants
which will never be satisfied during our lifetime.

Classification of Wants:
Wants can be classified in following ways:
(i) Economic and Non-Economic Wants:
The wants which cannot be satisfied by such goods and services that can be
bought are known as economic wants. For example, want for food, want for book,
want for dress etc. To satisfy these wants, a consumer has to spend money.

The wants which cannot be satisfied by making monetary payment for them, are
known as non- economic want. We want love and affection of our parents,
relatives, neighbours etc. We want stable government. We also wants
international peace and amity. We want universal brotherhood.

(ii) Individual Wants and Collective Wants:

Personal or individual wants refer to those wants which are only demanded by a
single person or an individual. For example, Sachin wants a cricket bat, Baichug
Bhutia wants a football, Leander Paes wants tennis-racket etc. These are the
personal wants. ‘On the other hand’ all the things are wanted by us collectively.
For example, good government, roads, hospitals, schools etc. are collective wants
or social wants. Again, we all want India’s win either in a football match or in a
cricket match.

(iii) Necessity, Comfort and Luxury:

Human wants are varying in nature. Want for food, clothing, shelter are the basic
necessities of human beings. We want books, pens, pencils, medicines, fuel and
cooking gas etc. Ail these are basic necessities of human life.

On several occasions, we want to make our life comfortable. We want washing

machine, AC- machine, pressure cooker, mixer, geyser, motor cycle, mobile
phone etc. for our little comfort. These wants are classified as comforts.

There are other wants which are meant for pleasure. Wants for Plasma-TV, AC-
car, well furnished house, computers to play games, travel by air etc. All these
wants are called luxuries. However, what are considered as comforts today may
become necessities in near future.

DEMAND
INTRODUCTION
In economics, demand is the quantity of a good that consumers are willing and able to
purchase at various prices during a given period of time. The relationship between price
and quantity demanded is also called the demand curve. Demand for a specific item is a
function of an item's perceived necessity, price, perceived quality, convenience, available
alternatives, purchasers' disposable income and tastes, and many other factors.

Meaning

Demand is an economic principle referring to a consumer's desire to purchase

goods and services and willingness to pay a price for a specific good or service.
Holding all other factors constant, an increase in the price of a good or
service will decrease the quantity demanded, and vice versa. Market demand is
the total quantity demanded across all consumers in a market for a given good.
Aggregate demand is the total demand for all goods and services in an economy.
Multiple stocking strategies are often required to handle demand.

DEFINITION

Demand refers to the willingness and ability of consumers to purchase a given quantity
of a good or service at a given point in time or over a period in time.

In economics, demand is formally defined as ‘effective’ demand meaning that it is a

consumer want or a need supported by an ability to pay – namely a budget derived from
disposable income. Income provides individuals with a purchasing power which they
exercise in a market through effective demand.

Factors That Influence the Demand of Goods

1. Tastes and Preferences of the Consumers:
The changes in demand for various goods occur due to the changes in fashion and
also due to the pressure of advertisements by the manufacturers and sellers of
different products. On the contrary, when certain goods go out of fashion or
people’s tastes and preferences no longer remain favourable to them, the demand
for them decreases.

2. Income of the People:

The demand for goods also depends upon the incomes of the people. The greater
the incomes of the people, the greater will be their demand for goods. In drawing
the demand schedule or the demand curve for a good we take income of the
people as given and constant. When as a result of the rise in the income of the
people, the demand increases, the whole of the demand curve shifts upward and
vice versa.

3. Changes in Prices of the Related Goods:

The demand for a good is also affected by the prices of other goods, especially
those which are related to it as substitutes or complements. When we draw the
demand schedule or the demand curve for a good we take the prices of the related
goods as remaining constant.

4. Advertisement Expenditure:
Advertisement expenditure made by a firm to promote the sales of its product is
an important factor determining demand for a product, especially of the product
of the firm which gives advertisements. The purpose of advertisement is to
influence the consumers in favour of a product. Advertisements are given in
various media such as newspapers, radio, and television. Advertisements for
goods are repeated several times so that consumers are convinced about their
superior quality. When advertisements prove successful they cause an increase in
the demand for the product.

5. The Number of Consumers in the Market:

The market demand for a good is obtained by adding up the individual demands
of the present as well as prospective consumers of a good at various possible
prices. The greater the number of consumers of a good, the greater the market
demand for it.

6. Consumers’ Expectations with Regard to Future Prices:

Another factor which influences the demand for goods is consumers’ expectations
with regard to future prices of the goods. If due to some reason, consumers
expect that in the near future prices of the goods would rise, then in the present
they would demand greater quantities of the goods so that in the future they
should not have to pay higher prices. Similarly, when the consumers expect that
in the future the prices of goods will fall, then in the present they will postpone a
part of the consumption of goods with the result that their present demand for
goods will decrease.

LAW OF DEMAND
It is one of the important laws of economics which was firstly propounded by neo-classical
economist, Alfred Marshall.

Other things remaining the same, the amount demanded increases with
a fall in price and diminishes with a rise in price.
– Alfred Marshall
Thus, according to the law of demand, there is an inverse relationship between price and
quantity demanded, other things remaining the same.

Law of demand expresses the functional relationship

D = f (p)

where,
P is price and
D is quantity demanded of a commodity
Other things being equal, if a price of a commodity falls, the quantity demanded of it will rise,
and if the price of the commodity rises, its quantity demanded will decline.

Assumptions under which law of demand is valid

This law will be applicable only if the below mentioned points are fulfilled.

(1)No change in consumer's income: Consumer's income must remain unchanged because if
income increases consumer may buy more even at a higher price invalidating the law of
demand.
(2) No change in the size and composition of population: The size of population, gender
ratio and age composition are assumed to remain constant. As such changes are sure to affect
demand.
(3) No change in consumer's taste, preference, habits and fashions: If the taste changes
then the consumer's preference also will change which will affect demand. When commodities
go out of fashion then demand will be low even at a low price.
(4) No expectation of future price change: The consumers do not expect any significant rise
or fall in the future prices.
(5) No change in prices of related goods: The law assumes that prices of substitutes and
complementary goods remain constant.
(6) No change in tax policy of the Government: The level of direct and indirect tax imposed
by the government on the income and goods should remain constant.

DEMAND SCHEDULE
schedule and demand curve as presented below:
Demand Schedule is a tabular representation of various combinations of price and quantity
demanded by a consumer during a particular period of time. An imaginary demand
schedule is given below:

The above demand schedule shows negative relationship between price and quantity
demanded for a commodity.

Initially, when a price of a good is Rs.10 per kg, quantity demanded by the consumer is 10
kg.
As the price decrease from Rs.10 per kg to Rs.8 per kg and then to Rs.6 per kg, quantity
demanded by the consumer increases from 10 kg to 20 kg and then to 30 kg respectively.

Further, fall in price from Rs.6 per kg to Rs.4 per kg and then to Rs.2 per kg, results in
increase in quantity demanded by the consumer from 30 kg to 40 kg and then to 50 kg,
respectively.

Thus, from the above schedule we can conclude that there is opposite inverse relationship
in between price and quantity demanded for a commodity.

Graphical representation of demand curve

It is the graphical representation of demand schedule. In other words, it is a graphical
representation of the quantities of a commodity which will be demanded by the consumer at
various particular prices in a particular period of time, other things remaining the same. We
can show, the above demand schedule through the following demand curve:
In the figure above, price and quantity demanded are measured along the y-axis and x-axis
respectively. By plotting various combinations of price and quantity demanded, we get a
demand curve DD1 derived from points A, B, C, D and E.
This is a downward sloping demand curve showing inverse relationship between price and
quantity demanded.
Limitations/Exceptions of law of demand

Inferior goods/ Giffen goods

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of
goods like low priced rice, low priced bread, etc. are some examples of Giffen goods.

This exception was pointed out by Robert Giffen who observed that when the price of bread
increased, the low paid British workers purchased lesser quantity of bread, which is against
the law of demand. Thus, in case of Giffen goods, there is indirect relationship between
price and quantity demanded.

Goods having prestige value

This exception is associated with the name of the economist, T.Velben and his doctrine of
conspicuous conception. Few goods like diamond can be purchased only by rich people.
The prices of these goods are so high that they are beyond the capacity of common people.
The higher the price of the diamond the higher the prestige value of it.

In this case, a consumer will buy less of the diamonds at a low price because with the fall in
price, its prestige value goes down. On the other hand, when price of diamonds increase,
the prestige value goes up and therefore, the quantity demanded of it will increase.

Price expectation
When the consumer expects that the price of the commodity is going to fall in the near
future, they do not buy more even if the price is lower.

On the other hand, when they expect further rise in price of the commodity, they will buy
more even if the price is higher. Both of these conditions are against the law of demand.

Fear of shortage
When people feel that a commodity is going to be scarce in the near future, they buy more
of it even if there is a current rise in price.

For example: If the people feel that there will be shortage of L.P.G. gas in the near future,
they will buy more of it, even if the price is high.

Change in income
The demand for goods and services is also affected by change in income of the consumers.
If the consumers’ income increases, they will demand more goods or services even at a
higher price. On the other hand, they will demand less quantity of goods or services even at
lower price if there is decrease in their income. It is against the law of demand.
Change in fashion
The law of demand is not applicable when the goods are considered to be out of fashion.

If the commodity goes out of fashion, people do not buy more even if the price falls. For
example: People do not purchase old fashioned shirts and pants nowadays even though
they’ve become cheap. Similarly, people buy fashionable goods in spite of price rise.

Basic necessities of life

In case of basic necessities of life such as salt, rice, medicine, etc. the law of demand is not
applicable as the demand for such necessary goods does not change with the rise or fall in
price.

CONCLUSION

The law of demand describes an inverse relationship between price and quantity
demanded of a good. Alternatively, other things being constant, quantity demanded of
a commodity is inversely related to the price of the commodity.

Economic Laws:

INTRODUCTION
Economic laws are nothing more than careful conclusions and inferences are
drawn with the help of reasoning or by the aid of observation of human and
physical nature. In everyday life, we see the man is always busy in satisfying
his unlimited wants with limited means. In doing so, it acts upon certain
principles.
DEFINITION
According to Robbins,

Economic laws are statements of uniformities about human

behaviour concerning the disposal of scarce means with
alternative uses for the achievement of ends that are unlimited.”
Meaning of Economic Laws:
A law (or generalisation) is the establishment of a general truth on the basis of
particular observations or experiments which traces out a causal relationship
between two or more phenomena. But economic laws are statements of general
tendencies or uniformities in the relationships between two or more economic
phenomena.
Marshall defined economic laws in these words,

Economic laws, or statements of economic tendencies, are

those social laws, which relate to those branches of conduct in
which the strength of the motives chiefly concerned can be
measured by money price.”

It can be inferred from this definition that economic laws are:

(a) Statements of economic tendencies,

(b) Social laws,

(c) Concerned with human behaviour, and

(d) Human behaviour can be measured in money.

On the other hand, according to Robbins, “Economic laws are statements

of uniformities about human behaviour concerning the disposal of
scarce means with alternative uses for the achievement of ends that
are unlimited.” These two definitions are common in that they consider
economic laws as statements of tendencies or uniformities relating to human
behaviour.
Features of Economic Laws:
The following six points highlight the features of economic laws.
• Are not Commands: Economic laws are not orders of the state
(government) and do not command. They are formulated on the basis of
people’s behaviour in the real world.
• Are not Exact: Since economic laws deal with actions of human beings
having free will, they are not as exact as the laws of the natural
sciences. They are statements which are true only in general. For
example, the statement that men will buy goods at the cheapest
available market is true generally but not universally. A man intentionally
pays a higher price to help a relative or a friend, but such cases form a
small fraction of the total transactions of human beings. Economists
tacitly ignore these exceptional cases and frame their laws on the
 expectation that men’s action will, in the great majority of cases, follow a
uniform pattern. This makes economic laws generally true, but less
exact than physical laws. “Economic laws are probability laws, not exact
relationships.” “Abnormal as well as normal patterns of probabilities
occur in economics”, as Samuelson has commented.
• Statements of Cause and Effect: Economic laws, like scientific laws,
are statements of cause and effect. They attempt to state the effects
that will follow from particular causes. Unfortunately, in economic affairs,
many factors operate simultaneously and it is impossible to isolate each
factor to find out its effects separately. The qualifying clause “other
things remaining the same” (ceteris paribus), is used to get over this
difficulty. But in economic life, other things generally do not remain the
same. Hence, economic laws are never exact enough to enable
accurate predictions or prophecies being made.
• Hypothetical: Economic laws are hypothetical Economic laws are also
hypothetical, i.e., they are conclusions drawn from certain assumptions
or hypotheses. But in this, economic laws do not differ from other
scientific laws. The laws of science also start from certain hypotheses
and deduce certain consequences.
• Predictions are Difficult: As regards making predictions the following
example may be noted. The simple and exact laws of gravitation enable
astronomers to make accurate forecasts. But in the case of tides, the
level of water depends on so many factors (e.g., the strength of the
attracting force, geographical features of the country etc.) that it is
impossible to forecast the level accurately. Marshall, therefore, says,
“The laws of economics are to be compared with the laws of tides rather
than with the simple and exact laws of gravitation”.

Nature of Economic Laws:

1. Scientific or like Natural or Physical Laws:
Economic laws are like scientific laws which trace out a causal relationship
between two or more phenomena. As in natural sciences, a definite result is
expected to follow from a particular cause in economics.

Since economic laws are like scientific laws, they are universally valid. According
to Robbins, “Economic laws describe inevitable implications. If the
data they postulate are given, then the consequences they predict
necessarily follow. In this sense, they are on the same footing as
other scientific laws.”
 2. Non-Precise like the Laws of Natural Sciences:
Despite these similarities, economic laws are not as precise and positive as the
laws of natural sciences. This is because economic laws do not operate with as
much certainty as the scientific laws. For instance, the law of gravitation must
operate whatever the conditions may be.

3. Non-predictable like the Law of Tide:

Accurate predictions are not possible in economics alone. Even sciences like
biology and meteorology cannot predict or forecast events correctly. The law of
tide explains why the tide is strong at full moon and weak at the moon’s first
quarter. On this basis, it is possible to predict the exact hour when the tide will
rise.
4. Behaviourist:
Most economic laws are behaviourist, such as the law of diminishing marginal
utility, the law of equi-marginal utility, the law of demand, etc., which depend
upon human behaviour. But the behaviourist laws of economics are not as exact
as the laws of natural sciences because they are based on human tendencies
which are not uniform.

5. Indicative:

Unlike scientific laws, economic laws are not assertive. Rather, they are
indicative. For instance, the Law of Demand simply indicates that other things
being equal, quantity demanded varies inversely with price. But it does not
assert that demand must fall when price increases.

6. Hypothetical:
Prof. Seligman characterised economic laws as “essentially hypothetical”, because
they assume ‘other things being equal’ and draw conclusions from certain
hypotheses. In this sense, all scientific laws are also hypothetical as they too
assume the ceteris paribus clause (i.e. other things being equal). For instance,
other things being equal, a combination of hydrogen and oxygen in the
proportion of 2:1 will form water.

7. Truisms or Axioms:
There are certain generalisations in economics which may be stated as truism.
They are like axioms and do not have any empirical content, such as ‘saving is a
function of income,’ ‘human wants are numerous’, etc. Such statements are
universally valid and need no proof. So they are superior to scientific laws. But all
economic laws are not like axioms and hence not universally true and valid.

8. Historic -Relative:
Economists of the Historical School regarded economic laws as abstractions
which are historic-relative, that is economic laws have only a limited application
to a given time, place and environment.

If the assumptions are consistent with one another and if the process of
reasoning is logical, economic laws would be universally valid. But these are big
“ifs”. We, therefore, agree with Prof. Peterson that economic laws “are not
detailed and photographically faithful reproductions of a portrait of
the real world, but are rather simplified portraits whose purpose is to
make the real world intelligible.”

Limitation of Economic Laws:

a) One major drawback of economic laws is they lack generality.
For example, the laws developed to explain the nature and functioning of
capitalist economies do not have any relevance for socialist countries. For
example, Alfred Marshall developed the laws of demand and supply which
apply in a free market in the absence of government intervention.

b) Such laws do not apply in the erstwhile countries like the former
Soviet Union where the price (market) system yielded place to the planning
system. In a planned economy, market mechanism is replaced by
government allocation or rationing. So, the question of applying the laws of
demand and supply does not arise. Thus, economic laws lack generality
and are not universally applicable.

c) Not all economic laws are applicable to all countries some laws of
economics which have been developed in the context of advanced
industrial countries may not find application in developing countries like
India. As V. K. R. V. Rao has pointed out, the multiplier principle, as
 enunciated by Keynes in the context of the advanced countries of the
world, does not work in developing countries like India. This is attributable
to the structure of such economies.

Similarly, the Quantity Theory of Money has been developed in the context of
industrially advanced countries. It seeks to establish an exact, proportional
relationship between money and prices. But, it cannot explain’ the present price
situation in India.

Here, inflation is not purely monetary phenomenon as predicted by the Quantity

Theory. These two examples make one thing clear at least — the laws and theories
of economics developed in the context of advanced countries cannot be applied in
developing countries like India.

In fact, there is a feeling among some group of economists that, people in

developing countries like India behave and respond differently from those of
advanced countries. For example, greater self-consumption of farmers in India
explain why the supply response of agricultural commodities is not always
favourable in the event of a rise in the price of agricultural products.

It is often observed that, if the price of a particular commodity rises, farmers

produce less of it so as to maintain the same level of income. Thus,’ they not only
produce less at higher price but generate less marketable surplus when price
rises.

Thus, the marketable surplus of, say, wheat varies inversely with its price. But, in
developed countries it is observed that, as usual, the supply curve of agricultural
output slopes upward from left to right and marketable surplus increases when
price rises.

All these examples make it abundantly clear that, most of the laws and principles
of economics which have been developed in the context of advanced countries
cannot be applied in developing countries like India.

MICRO ECONOMICS
INTRODUCTION

Microeconomics is the social science that studies the implications of incentives

and decisions, specifically about how those affect the utilization and distribution
of resources. Microeconomics shows how and why different goods have different
values, how individuals and businesses conduct and benefit from efficient
production and exchange, and how individuals best coordinate and cooperate
with one another. Generally speaking, microeconomics provides a more
complete and detailed understanding than macroeconomics.

Microeconomics is the study of what is likely to happen (tendencies) when

individuals make choices in response to changes in incentives, prices, resources,
and/or methods of production. Individual actors are often grouped into
microeconomic subgroups, such as buyers, sellers, and business owners. These
groups create the supply and demand for resources, using money and interest
rates as a pricing mechanism for coordination.

Meaning: -

The term Micro Economics is derived from the Greek work “Mikros” which
means “Small”. Microeconomics gives a detailed analysis of one part of the
economy or society. It studies the behaviour of individual units of the
economy, such as households, firms, industries and markets. Micro
economics is concerned with the study of behaviour if individual element(s)
of an economy, whereas, macroeconomics concerned with the study of
behaviours of an economy as whole.

Definition: - Micro-economics gives a microscopic picture of the economy.

The activities of numerous economic units and their inter-relationship are
studied and analysed minutely through this method. Defined by (Maurice
Dobb)

Features of Micro economics

1.Study of Individual Unit: - Micro economics is concerned with the study
of economic behaviour of individual units like households, firms, industries
and markets. In other words, it makes microscopic or in-depth study of
individual economic units and no the whole economic units.

2.Microscopic approach: - Micro Economics takes a microscopic view of

the economy to study how it works, i.e. it studies the function of the economy
in terms of behaviour of the individual consumers, producers, firms, markets
and industries. This approach is also known as slicing method, since it splits
the whole economy into smaller units for the purpose of intensive study.
3.Price Theory: - Micro economics analyses how the prices of individual
commodities and services are determined. It also explains how millions of
producers and consumers take decision regarding allocation of resources.

4.Partial equilibrium analysis: - Micro Economics makes partial equilibrium

analysis. Micro economics is based on the assumption ‘Ceteris paribus’
(which means ‘other things being constant).

5.Uses Slicing method: - Micro economics uses slicing method for in-depth
study of economic units. It divides or slices the economy into smaller units,
(such as individual households, individual firms, etc) for the purpose of in-
depth study.

6.Vision: - Micro Economics studies in detail about the behaviour of

individual economic units it examine the trees and not the entire forest.

7.Not a study of Aggregates: - Micro Economics is distinct from Macro

Economics. In Macro Economics we are concerned with the economy as a
whole. In micro economics we are concerned with the study of Individual
units.

Scope of Microeconomics
The scope or the subject matter of microeconomics is concerned with:

Commodity pricing
The price of an individual commodity is determined by the market forces of demand and
supply. Microeconomics is concerned with demand analysis i.e. individual consumer
behaviour, and supply analysis i.e. individual producer behaviour.
Factor pricing theory
Microeconomics helps in determining the factor prices for land, labour, capital, and
entrepreneurship in the form of rent, wage, interest, and profit respectively. Land, labour,
capital, and entrepreneurship are the factors that contribute to the production process.

Theory of economic welfare

Welfare economics in microeconomics is concerned with solving the problems in
improvement and attaining economic efficiency to maximize public welfare. It attempts to
gain efficiency in production, consumption/distribution to attain overall efficiency and
provides answers for ‘What to produce?’, ‘When to produce?’, ‘How to produce?’, and ‘For
whom it is to be produced?’

Significance of Microeconomics
1. In Business Decision Making :
Microeconomics plays a vital role in assisting the business firms and business
decision makers. Some of the major functions of microeconomics in business
decision making are listed below:
2. Optimum utilization of resources
The study of microeconomics helps the decision makers to analyse and determine
how the productive resources are allocated for various goods and services. It also
helps in solving the producers’ dilemma of what to produce, how much to produce
and for whom to produce.

3. Demand analysis
With the help of microeconomic analysis, business firms can forecast their level of
demand within the certain time interval. The demand for a commodity fluctuates
depending upon various factors affecting it. Thus, business firms and decision
makers can determine the level of demand for the commodity.

4. Cost analysis
Microeconomic theories explain various conditions of cost like fixed cost, variable
cost, average cost, and marginal cost. Along with this, it also provides an analysis of
the short run and long run costs that help the business decision makers determine
the cost of production and other related costs, so they can implement policies to cut
down cost and increase their level of profit.

5. Free Market Economy

Microeconomics explains the operating of a free market economy where, an
individual producer has the freedom to take economic decisions like what to
 produce, how to produce, or for whom to produce. Allocation of resources is
determined by price or market mechanism i.e. interaction between demand and
supply

6. Production decision optimization

Microeconomics deals with different production techniques that help to find out the
optimal production decision which helps the decision makers to determine the
factors needed in order to produce a certain product or a range of products.

7. Pricing policy
Microeconomic analysis provides business managers with a thorough knowledge of
theories of production and pricing in order to ensure optimum profit for the firm in the
long run.

8. Determination of Relative Prices of Products &

Factors of production
Microeconomics helps in analysing market mechanisms i.e. determinants of demand and
supply which are responsible for the determining prices of commodities in the market. Along
with this, it provides an insight on theories relating to prices of a factor of rent, wage,
interest, and profit.

9. Basis of Managerial Economics

Microeconomics used for the study of a business unit, but not the economy as a whole is
known as managerial economics. The various tools used in microeconomics like cost and
price determination, at an individual level becomes the foundation of managerial economics.

10. Basis of Welfare Economics

Microeconomics is not only concerned with analysing economic condition but also with the
maximization of social welfare. It studies how given resources are utilized to gain maximum
benefit under various market conditions like monopoly, oligopoly, etc. Analysis of production
efficiency, consumption efficiency, and overall economic efficiency are conducted on the
basis of microeconomics.

11. Formulation of Public Economic Policies

Microeconomics tools are useful for introducing policies relating to tax, tariff, debt, subsidy,
etc. it helps the governmental bodies to fixate on the tax rate, types of tax, and the amount
of tax to be charged to buyers and sellers.
 12. Helpful in Foreign Trade
Microeconomics is useful in explaining and determining the rate of foreign exchange
between currencies, fixing international trade and tariff rules, defining the cause of
disequilibrium in the balance of payment (BOP), and formulating policies to minimize it.

Macro ECONOMICS
INTRODUCTION
Macroeconomics is a branch of economics dealing with the performance, structure, behaviour, and
decision-making of an economy as a whole. For example, using interest rates, taxes and
government spending to regulate an economy’s growth and stability. This includes regional, national,
and global economies.

Meaning :
It is that part of economic theory which studies the economy in its totality or as a
whole.

It studies not individual economic units like a household, a firm or an industry

but the whole economic system. Macroeconomics is the study of aggregates and
averages of the entire economy. Such aggregates are national income, total
employment, aggregate savings and investment, aggregate demand, aggregate
supply general price level, etc.

Here, we study how these aggregates and averages of the economy as a whole are
determined and what causes fluctuations in them. Having understood the
determinants, the aim is how to ensure the maximum level of income and
employment in a country.

In short, macroeconomics is the study of national aggregates or economy-wide

aggregates. In a way it is like study of economic forest as distinguished from trees
that comprise the forest. Main tools of its analysis are aggregate demand and
aggregate supply.

Since the subject matter of macroeconomics revolves around determination of

the level of income and employment, therefore, it is also known as ‘Theory of
Income and employment.
FEATURES OF MACRO ECONOMICS

Macroeconomics is that branch of economics which deals with the study of national aggregates.
The features of macroeconomics are:
(1) Study of Aggregates: Macro Economics deals with the study of entire economy. It studies
the overall conditions in the economy, such as National Income, National Output, Total
Employment, General Price Level etc.
(2) Lumping Method: Macro Economics uses the 'lumping' method for the purpose of
Economic study. The approach of Macro Economics is aggregative in nature. It considers
aggregates like National Income, total consumption, General aggregative price level etc., instead
of personal income, per capital consumption, individual prices of commodities etc.
(3) A General Equilibrium Analysis: Macro Economics analysis is based on general
equilibrium. This is because it deal with the economic system as a whole and studies the inter
relationships and interdependence between the various macro variables in an economy. e.g.
When aggregate demand and aggregate supply are equal. It will determine the level of income
and employment.
(4) Income Analysis: Macro Economics is also known as income theory. It studies the factors
determining National Income and employment and the causes of fluctuations in income and
employment.
(5) Policy Oriented: The study of Macro Economics is useful in formulating economic policies
to promote economic growth, to control inflation, to generate employment, to pull the economy
out of depression etc. Macro Economics is a policy oriented science.
(6) Based on Interdependence: Interdependence is the core subject of Marco Economics.
Everything depends on everything else. So the is an element of interdependence among the
Macro - Economic variables. For examples. changes in the level of investment will finally result
in changes in level of income, output, employment and economic growth.
(7) Dynamic Science: Macro economics studies the change in aggregate economic variables
and analyses the dynamic nature of the economy. It helps us to study the progress of an
economy in investment, total production, total employment, growth etc.

The scope of macroeconomics includes the following parts:

1. Theory of National Income :

The theory of determination of national income is concerned with

finding out the equilibrium level of national income, i.e., the level
of national income at which the purchasing and production plans of the
economy are synchronised.

2. Theory of Employment :

As per Keynes theory of employment, effective demand signifies the money spent on the
consumption of goods and services and on investment. The total expenditure is equal to the
national income, which is equivalent to the national output.

3. Theory of Money :

Theory of Money refers to the idea that the quantity of money available (money
supply) grows at the same rate as price levels do in the long run. When interest
rates fall or taxes decrease and the access to money becomes less restricted,
consumers become less sensitive to price changes and, thus, will have a
higher propensity to consume. As a result, the aggregate demand curve will shift
right, thus shifting up the equilibrium price level.

4. Theory of General price level :

The general price level is a hypothetical measure of overall prices for some set of goods and
services (the consumer basket), in an economy or monetary union during a given interval
(generally one day), normalized relative to some base set.

5. Theory of Economic Growth :

Economic growth refers to an increase in the goods and services produced by an

economy over a particular period of time. It is measured as a percentage increase in
real gross domestic product which is GDP adjusted to inflation. GDP is the market
value for all the final goods and services produced in an economy.
Importance of Macroeconomics:
1. It helps to understand the functioning of a complicated modern economic
system. It describes how the economy as a whole functions and how the level of
national income and employment is determined on the basis of aggregate
demand and aggregate supply.

2. It helps to achieve the goal of economic growth, higher level of GDP and higher
level of employment. It analyses the forces which determine economic growth of
a country and explains how to reach the highest state of economic growth and
sustain it.

3. It helps to bring stability in price level and analyses fluctuations in business

activities. It suggests policy measures to control Inflation and deflation.

4. It explains factors which determine balance of payment. At the same time, it

identifies causes of deficit in balance of payment and suggests remedial
measures.

5. It helps to solve economic problems like poverty, unemployment, business

cycles, etc., whose solution is possible at macro level only, i.e., at the level of
whole economy.

6. With detailed knowledge of functioning of an economy at macro level, it has

been possible to formulate correct economic policies and also coordinate
international economic policies.

7. Last but not the least, is that macroeconomic theory has saved us from the
dangers of application of microeconomic theory to the problems of the economy
as a whole.

CONCLUSION

Macroeconomics is a branch of economics that depicts a substantial picture. It

scrutinises itself with the economy at a massive scale, several issues of an economy
are considered. The issues confronted by an economy and the headway that it makes
are measured and apprehended as a part and parcel of Macroeconomics. When one
speaks of the issues that an economy confronts – inflation, unemployment, increasing
tax burden, etc., are all contemplated. This makes it apparent that macroeconomics
focuses on large numbers.
It studies the association between various countries regarding how the policies of one
nation have an upshot on the other. It circumscribes within its scope, analysing the
success and failure of government strategies.

UNIT - 1

3) PRODUCTION –

SUPPLY
INTRODUCTION
Supply is the willingness and ability of producers to create goods and services to take
them to market. Supply is positively related to price given that at higher prices there is
an incentive to supply more as higher prices may generate increased revenue and
profits.

Meaning of Supply
Supply refers to the amount of a good or service that the producers/providers are
willing and able to offer to the market at various prices during a period of time. There
are two important aspects of supply:

• Supply refers to what is offered for sale and not what is finally sold.
 • Supply is a flow. Hence, it is a certain quantity per day or week or month,
etc.

Determinants of Supply
While the price is an important aspect for determining the willingness and desire to
part with goods/services, many other factors determine the supply of a product or
service as discussed below:
Price of the Good/ Service

The most obvious one of the determinants of supply is the price of the product/service.
With all other parameters being equal, the supply of a product increases if its relative
price is higher. The reason is simple. A firm provides goods or services to earn profits
and if the prices rise, the profit rises too.

1.Price of Related Goods

Let’s say that the price of wheat rises. Hence, it becomes more profitable for firms to
supply wheat as compared to corn or soya bean. Hence, the supply of wheat will rise,
whereas the supply of corn and soya bean will experience a fall.

Hence, we can say that if the price of related goods rises, then the firm increases the
supply of the goods having a higher price. This leads to a drop in the supply of the
goods having a lower price.

2.Price of the Factors of Production

Production of a good involves many costs. If there is a rise in the price of a particular
factor of production, then the cost of making goods that use a great deal of
that factors experiences a huge increase. The cost of production of goods that use
relatively smaller amounts of the said factor increases marginally.

For example, a rise in the cost of land will have a large effect on the cost of producing
wheat and a small effect on the cost of producing automobiles.

Therefore, the change in the price of one factor of production causes changes in the
relative profitability of different lines of production. This causes producers to shift
from one line to another, leading to a change in the supply of goods.
3.State of Technology

Technological innovations and inventions tend to make it possible to produce better

quality and/or quantity of goods using the same resources. Therefore, the state of
technology can increase or decrease the supply of certain goods.

4.Government Policy

Commodity taxes like excise duty, import duties, GST, etc. have a huge impact on the
cost of production. These taxes can raise overall costs. Hence, the supply of goods that
are impacted by these taxes increases only when the price increases. On the other hand,
subsidies reduce the cost of production and usually lead to an increase in supply.

5.Other Factors

There are many other factors affecting the supply of goods or services like
the government’s industrial and foreign policies, the goals of the firm, infrastructural
facilities, market structure, natural factors etc.

LAW OF SUPPLY

The statement given for the law of supply is as follows:

“Other things remaining unchanged, the supply of a commodity expands with a
rise in its price and contracts with a fall in its price.”

The law of supply can be better understood with the help of supply schedule,
supply curve, and supply function. Let us discuss these concepts in detail in the
next sections.

Supply Schedule:
A supply schedule can be of two types, which are as follows:
i. Individual Supply Schedule:
Refers to a supply schedule that represents the different quantities of a product
supplied by an individual seller at different price

The supply schedule for the different quantities of milk supplied in

the market at different prices

The individual supply curve for the individual supply schedule.

EXPLANATION
Supply Curve:
The graphical representation of supply schedule is called supply curve. In a
graph, price of a product is represented on Y-axis and quantity supplied is
represented on X-axis. Supply curve can be of two types, individual supply curve
and market supply curve. Individual supply curve is the graphical representation
of individual supply schedule, whereas market supply curve is the representation
of market supply schedule.
In Figure-14, the supply curve is showing a straight line and an upward slope.
This implies that the supply of a product increases with increase in the price of a
product.

ii. Market Supply Schedule:

Refers to a supply schedule that represents the different quantities of a product
that all the suppliers in the market are willing to supply at different prices. The
supply schedule for the different quantities of milk supplied in the
market at different prices: Market supply schedule can be drawn by

aggregating the individual supply schedules of all individual suppliers in the

market.

The market supply curve of market supply schedule.

The slope of market supply curve can be obtained by calculating the supply of the
slopes of individual supply curves. Market supply curve also represents the direct
relationship between the quantity supplied and price of a product.

Assumptions in Law of Supply:

. Assumes that the price of a product changes, but the change in the cost of
production is constant. This is because if the cost of production rises with
increase in price, then sellers would not supply more due to the reduction in their
profit margin. Therefore, law of supply would be applicable only when the cost of
production remains constant.

ii. Assumes that there is no change in the technique of production. This is

because the advanced technique would reduce the cost of production and make
the seller supply more at a lower price.

iii. Assumes that there is no change in the scale of production. This is because if
the scale of production changes with a period of time, then it would affect the
supply. In such a case, the law of supply would not be applicable.
iv. Assumes that the policies of the government remain constant. If there is an
increase in tax rates, then the supply of product would decrease even at the
higher price. Therefore, for the application of law of supply, it is necessary that
government policies should remain constant.

v. Assumes that the transportation cost remain the same. In case the
transportation cost reduces, then the supply would increase, which is invalid
according to the law of supply.

vi. Assumes that there is no speculation about prices in future, which otherwise
can affect the supply of a product. If there is no speculation about products, then
the economy is assumed to be at balance and people are satisfied with the
available products and do not require any change.

Some of the exceptions of law of supply are as follows:

i. Speculation:
Refers to the fact that the supply of a product decreases instead of increasing in
present when there is an expected increase in the price of the product. In such a
case, sellers would not supply the whole quantity of the product and would wait
for the increase in price in future to earn high profits. This case is an exception to
law of demand.

ii. Agricultural Products:

Imply that law of supply is not valid in case of agricultural products as the supply
of these products depends on particular seasons or climatic conditions. Thus, the
supply of these products cannot be increased after a certain limit in spite of rise
in their prices.

iii. Changes in Other Situations:

Refers to the fact that law of supply ignores other factors (except price) that can
influence the supply of a product. These factors can be natural factors,
transportation conditions, and government policies.
PRODUCTION

Meaning of Production:
Since the primary purpose of economic activity is to produce utility for
individuals, we count as production during a time period all activity which either
creates utility during the period or which increases ability of the society to create
utility in the future.

Business firms are important components (units) of the economic system. They
are artificial entities created by individuals for the purpose of organising and
facilitating production. The essential characteristics of the business firm is that it
purchases factors of production such as land, labour, capital, intermediate goods,
and raw material from households and other business firms and transforms those
resources into different goods or services which it sells to its customers, other
business firms and various units of the government as

Definition of Production:
According to Bates and Parkinson:
“Production is the organised 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”.

According to J. R. Hicks:
“Production is any activity directed to the satisfaction of other peoples’ wants
through exchange”. This definition makes it clear that, in economics, we do not
treat the mere making of things as production. What is made must be designed to
satisfy wants.
From our above definition it is clear that many valuable activities such as the
work done by people in their own houses and gardens (the so-called do it yourself
exercise) and all voluntary work (such as free coaching, free-nursing, collection of
subscription for a social cause such as flood-relief or earthquake- relief)
immensely add to the quality of life but there is no practical way of measuring
their economic worth (value).
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 defence,
are also included.

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 we shall call factors of production, are combined in various

ways, by firms or enterprises, to produce an annual flow of goods and services. If
we keep in mind that the production of goods and services is the result of people
working with natural resources and with equipment such as tools, machinery and
buildings, a generally acceptable classification can readily be derived. The
traditional division of factors of production distinguishes labour, land and
capital, with a fourth factor, enterprise, some-times separated from the rest.
The people involved in production use their skills and efforts to make things and
do things that are wanted. This human effort is known as labour. In other words,
labour represents all human resources. The natural resources people use are
called land. And the equipment they use is called capital, which refers to all man-
made resources.

(1) Land and Natural Resources:

In economics the term land is used in a broad sense to refer to all natural
resources or gifts of nature. As the Penguin Dictionary of Economics has put
it: “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”.
From the above definition, it is quite clear that 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:
Land has certain important characteristics:
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 fertilisers.

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:
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:

Finally, we may refer to a special feature of land, not shared by other factors. In
fact, 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.

Mobility:
Land is not geographically mobile. But, it is occupationally mobile. In most parts
of India, for example, 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. Some of the land, for
example, in hill area, of say, Shillong, or Darjeeling, has an extremely limited
degree of occupational mobility, being useful perhaps for sheep grazing, golf
course or as a centre of tourism.

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.

(2) 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.

Land and Labour:

Labour differs from land in an important way. While land is a stock, labour is a
flow. The term ‘labour’ is used to refer to the flow of labour service per unit of
time. So labour is perishable. If we do not make use of today’s labour power, a
correspondingly large amount is not made available tomorrow (and in future).

A related, but important point should be noted in this context. The worker sells
his services in the market, but retains his capital (working ability). In other
words, what is bought and sold is the service of labour, not labour itself. A firm
cannot buy and sell labour in the same way that it can buy land and capital.

Dual Role:
Another important point to note is that labour is not only a factor of production.
The supplier of labour—the worker—is also a consumer. Thus, labour plays a dual
role in a modern economy. Labour is both the subject and the object of
production.
This means two things:
(1) That the production of anything requires the use of labour as a factor, and

(2) That almost everything is produced to satisfy the needs of the workers, who
are the main consumers. In fact, any economic activity takes place to satisfy the
consumers. And, consumption demand provides the business people with the
incentive to undertake production.

Peculiarities of Labour as a Factor:

In examining labour markets, it is important to recognise that labour has a
number of special characteristics which distinguish it from ordinary
commodities.

1. First, labour market transactions are particularly significant for:

First, 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. Thirdly, the individual sells his services but not himself:

The employer, however, must be able to exert some control or authority over the
actions of employees. This is not a very simple matter, which can be covered
unambiguously by a contract of employment. 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. Fifthly, 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. Sixthly, 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. Finally, 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.

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.

(3) 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.

To put it more clearly, capital is that part of wealth which is not used for the
purpose of consumption but is utilised in the process of production. Tools and
machinery, bullocks and ploughs, seeds and fertilizers, etc. are examples of
capital. We have already identified certain things described as capital in our
discussion on producers’ goods.

Even in ancient times, capital was created for producing food, hunting animals
and for the transportation of goods. At that stage capital goods consisted of
simple tools and implements. Even in the least developed countries some capital
is used. In such countries people make use of simple ploughs, axes, bows and
arrows, and leather bags to carry water.

It may be pointed out in this context that the same article may, at one time, be a
consumption good and, at another time, capital, depending on the use to which it
is put. Thus, if a doctor goes out in his motor car to examine a patient he is using
his car as capital. But if he goes out for a joy ride in his motor car, he is using it as
a consumption good. Similarly, when coal is used in a factory, it is capital, but
when coal is used as domestic fuel, it is a consumption good.

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.

Two Features of Capital:

Two important features of capital are:
Firstly, 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.

In fact, 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.

Factors Affecting Capital Formation:

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).

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 specialised 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.

Return:
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.

(4) Enterprise (Organisation):

Meaning:
Organisation, 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 organisation is known as
an organiser or an entrepreneur. So, the entrepreneur is the person who takes the
charge of supervising the organisation of production and of framing the
necessary policy regarding business.

Functions or Role of the Entrepreneur:

The entrepreneur in modern business performs the following
useful functions:
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 realised 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 under-
takes both these risks in production.

5. Innovation:
Another distinguishing function of the entrepreneur as emphasised 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.

Importance of Enterprise:
The above description indicates the supreme position of the entrepreneur in
production. This is particularly true in the capitalistic or even mixed economy
which is based on the price-profit system. In the socialistic economy, the state
becomes the entrepreneur; the scope of private entrepreneur is extremely limited
in such an economy.

A Separate Factor:
Some economists feel that the above entrepreneurial functions are no different
from those of a particular and specialised form of labour. They point out that
risk- bearing is not something peculiar to the entrepreneur.

Mobility:
Enterprise seems to be the most mobile of all the four factors. There is need to
train labour for some specific task to be performed in a particular industry (say,
road transport service, hotel business or computer operation). Once labour is
trained for some specific task appropriate to some particular industry, it cannot
be easily and quickly transferred to some other industry to do a completely
different job. But the basic functions of the entrepreneur-organisation,
management and risk-taking are the same in all industries.

Return:
The return to the entrepreneur is profit. Profit is the reward for successful
conduct of business.
4) ECONOMIC SYSTEM - CAPITALISM, SOCIALISM , MIXED ECONOMY

INTRODUCTION
An economic system is a mechanism with the help of which the government plans and
allocates accessible services, resources and commodities across the country.
Economic systems manage elements of production, combining wealth, labour, physical
resources and business people. An economic system incorporates many companies,
agencies, objects, models, as well as for deciding procedures.

Types of Economic Systems

• Capitalist Economy
• Socialist Economy
• Mixed Economy

Capitalism:

Definitions of Capitalism:
The concept of capitalism is explained as presented below:
According to Gary M. Pickersgill and Joyce E. Pickersgill, “The capitalist system is
one characterised by the private ownership of the means of production, individual
decision making, and the use of the market mechanism to carry out the decisions of
individual participants and facilitate the flow of goods and services in markets.”
According to Loucks and Hoots, “Capitalism is a system of economic organisation
featured by the private ownership and the use for private profile of man-made and
nature-made capital.”
In the words of D.M. Wright, “Capitalism is a system in which, on average, much of
the greater portion of economic life and particularly of net new investment is carried
on by private (i.e., non-government) units under conditions of active and
substantially free competition, and avowedly at the least, under the incentive of hope
for profit.”
From the above definitions it may be concluded that capitalist system is known as
free enterprise economy and market economy.
Two types of capitalism may be found in the economic system:
(1) The old laissez faire capitalism and
(2) The modern, regulated and mixed capitalism.
The capitalist system is also known as free enterprise economy and market economy.
Two types of capitalism may be distinguished,
1. The old, laissez faire capitalism, where government intervention in the economy is
absent or negligible; and
2. The modern, regulated or mixed capitalism, where there is a substantial amount
of government intervention in the economic and industrial development.
Characteristics of Capitalism:
The following are the basic characteristics of a ‘pure’ capitalism system:
1. Private Property:
Every individual has a right to hold property. This means that every individual is free
to consume his private property and every individual has a right to transfer his
property to his successors after death. Individuals have their property rights
protected and are usually free to use their property as they like as long as they do not
infringe on the legal property rights of others.
Private property, however, is protected, controlled and enforced by law. Private
property is necessary because it supplies the motive underlying economic activity. In
a capitalist economy, the factors of production—land, labour and capital—are
privately owned, and production occurs at private initiative.
2. Free Enterprise:
Free enterprise, an essential feature of the capitalist system, is merely an extension
of the concept of property rights. The term free enterprise implies that private firms
are allowed to obtain resources, to organise production and to sell the resultant
product in any way they choose. In other words, there will not be any government or
other artificial restrictions on the freedom and ability of the private individuals to
carry out any business.
3. Price Mechanism:
The price mechanism plays an important role in the production of goods and
services. Under capitalism, the price is determined by the demand and supply.
4. The Market System:
The market mechanism is the key factor that regulates the capitalist economy. A
market economy is one in which buyers and sellers express their opinions about how
much they are willing to pay for or how much they demand of goods and services.
Prices guide the purchase decisions of the consumers.
At the same time, while they decide to buy or not to buy a product, consumers vote
for or against the product by using their money. Thus, market prices, which reflect
the desires of millions of consumers, provide guidance to investors and other
business persons. The market system, also called the price system, may, therefore, be
regarded as the organising force in a capitalist economy.
5. Economic Freedom:
Another feature of capitalism is economic freedom.
This freedom implies three things:
(1) Freedom of enterprise,
(2) Freedom of contrast,
(3) Freedom to use one’s property.
Under the capitalism, everybody is free to take up any occupation that he likes, and
to enter into agreements with fellow citizens in a manner most profitable to him.
In a capitalist economy, the individual is free to choose any occupation he is
qualified for. This freedom of choice enables the worker to make the best possible
bargain for his labour. This implies that the employers have to competitively bid for
labour. Freedom of occupational choice, however, does not mean guarantee of the
job a worker opts for; the choice is practically limited by the extent of availability of
the jobs.
6. Consumers’ Sovereignty:
Consumers’ sovereignty is at its best in the capitalist system where consumers have
complete freedom of choice of consumption. Under capitalism, the consumer is the
king. Consumers’ sovereignty means freedom of choice on the part of every
consumer. The consumer buys whatever he likes and as much as he likes.
The money price which the consumer offers expresses his wish. The production
decisions in the free market economy are based on the consumer desires which are
reflected in the demand pattern. Frederic Benham remarks- “Under capitalism, the
consumer is the king.”
7. Unplanned Economy:
As is clear from the features mentioned above, the capitalist system is essentially
characterised by the absence of a central plan. No central economic planning is done
in a capitalist economy.
There are no rules and regulations framed by the central agency. The productive
function is the result of decision taken by a large number of entrepreneurs. Freedom
of enterprise, occupation and property rights rule out the possibility of a central
plan. Resource allocation and investment decisions in a free market economy are
influenced by market forces rather than by the State.
8. Freedom to Save and Invest:
The freedom to save is implied in the freedom of consumption, for savings depend
on income and consumption. The term saving implies the sacrifice of consumption.
As George Halm observes- “The right to save is supported by the right to transmit
wealth, so that the choice between present and future consumption is not limited to
the adult life of one person. The freedom to save, inherit, and accumulate wealth is,
therefore, a right which is perhaps more typical for the private enterprise system
than is free choice of consumption and occupation.”
9. Economic Inequalities:
Another feature of capitalism is the existence of glaring inequalities in income,
wealth and economic power. The existence of big monopolies results in the
concentration of not only income and wealth but also of economic power in the
hands of a few people.
10. Motive of Profit:
Profit is an important element of capitalism Investment tends to take the direction in
which there is more possibility of profit. If the producers feel that they can obtain
greater profit by the production of comfortable goods they will be inclined to do so
without caring what people actually need.
11. Competition:
Competition among sellers and buyers is an essential feature of an ideal capitalist
system. Competition reduces market imperfections and associated problems.
Therefore, in a free market economy, a sufficient amount of competition is
considered necessary if the whole production and distribution process is to be
regulated by market forces.
Competition is necessary in a private enterprise economy to keep initiative
constantly on alert, to protect the consumer, and to maintain a sufficiently flexible
price system.
12. Limited Role of Government:
The absence of a central plan does not mean that the government does not play any
role in a private enterprise economy. Indeed, government intervention is necessary
to ensure some of the essential features and smooth functioning of the capitalist
system. For example- government interference is necessary to define and protect
property rights, ensure freedom of entry and exit, enforce contractual agreements
among private entrepreneurs, ensure the satisfaction of certain community wants,
etc. However, government interference in the system is comparatively very limited.
The pure capitalist system described above is highly idealised system. There is hardly
any pure capitalist or free enterprise system in the real world today. The capitalist
economies of today are characterised by state regulation in varying degrees. As a
matter of fact, the modern capitalist economies are mixed or regulated systems.
Merits of Capitalism:
The merits of capitalism are as follows:
1. Automatic Working- Capitalism is controlled by the profit motive and price
mechanism. Thus, there is coordination under capitalism. The whole activity is
automatic in capitalism.
2. Capital Formation- Capitalist economy encourages formations of capital in the
society. New industrial and commercial institutions are set up with the objective of
profits and also encourage income and savings.
3. Maximum Satisfaction- In capitalism, production is carried on, keeping in view
the needs and tastes of the consumer. This provides maximum satisfaction to the
consumer who is a king in a capitalist economy.
4. Reward according to Capacity- In capitalism people are rewarded according to
their capacity, to work and labour. The more people have the spirit of daring
adventure, the more they are rewarded.
5. Efficiency- Under capitalism there is wide competition among the producers. In
the competitive race it is the able producer who wins the race. An efficient producer
produces the best goods at cost of production. Thus, capitalism encourages
efficiency.
Demerits of Capitalism:
The demerits of capitalism may be discussed as below:
1. Economic Inequality- Capitalism gives complete freedom of private property,
occupation and profession and is controlled by price mechanism. This leads to
economic inequalities. The rich become richer and the poor become poorer.
2. Inefficiency in Working- The efficiency of the capitalistic system depends on the
existence of free competition and the mobility of factors of production. But the
existence of social, economic and legal issues hampers free competition with the
result that the factors of production often lie idle.
3. Neglect of National Interest- The capitalists are mainly oriented towards self-
interest of maximisation of profits and for this purpose they complete each of the
formalities. They neglect the social interest. They do not complete their activities,
keeping in view the national interest.
4. Lack of Coordination- Under capitalism the central government has no control
over the activities of the businessmen and producers. The decisions pertaining to
production mostly depend on the producers. The leads to irregularities, excess
production and trade cycles. Thus there is a lack of coordination under capitalism.
5. Unemployment- Some of the economists are of the view that under a capitalist system full
employment situation cannot be brought due to the lack of central economic planning. As a
result, optimum use of resources cannot be possible. This brings up the situation of
unemployment.

Socialism:

Definitions of Socialism:
According to Webbs, “A socialised industry is one in which the national instruments
of production are owned by public authority or voluntary association and operated
not with a view to profit by sale to other people, but for the direct service of those
whom the authority or association represents.”
In the words of H.D. Dickinson, “Socialism is an economic organisation of society, in
which the material means of production are owned by the whole community
according to a general economic plan, all members being entitled to benefit from the
results of such socialist plant production on the basis of equal rights.”
From the above definition it is clear that in a socialist economy, the society has the
ownership over the sources of production. The Planning Commission or Authority
formulates the national plan keeping in view the social and economic development
of the country.
Characteristics of Socialism:
The important characteristics of socialism are as follows:
1. Government Ownership:
In socialist economy the means of production are either owned by the government or
their use is controlled by the government. The state holds the ownership on the
means of production and they are utilised for the welfare of the society. There is no
private property in respect of the means of production.
In communist countries like the USSR and China, the means of production are
mostly owned by the state. In some socialist economies, the private sector also plays
a very important role. In such cases, the government directs and regulates
investment allocation and production pattern in accordance with national priorities.
In some countries, such as India, some of the basic sectors, including a major part of
institutional finance, are in the public sector so that the resource allocation and
investment pattern of the private sector may be regulated by regulating the flow of
the basic inputs to the private sector.
2. Central Planning:
Under socialism, the central planning authority or a Planning Commission
formulates an overall plan for the entire economy according to certain objectives and
priorities. The socialist economies generally have a central authority like the central
planning agency to formulate the national plan for development and to direct
resource mobilisation, allocation and investment to achieve the plan targets.
In the word of Dickinson, “Economic planning is the making of measured economic
decisions, what and how much is to be produced, and to whom this is to be allocated
by the conscious decision of determinate authority, on the basis of comprehensive
survey of the economic systems as a whole.”
3. Social Welfare:
Another feature of socialism is that the means of production are operated with the
object of promoting and serving the good of the community rather than for the
benefit of few persons. Under socialism, the productive resources of the community
are diverted to the production of goods and services which maximise social welfare
rather than earn the largest profits.
4. Lack of Competition:
Since there is governmental control over means of production, government has a
hand in the matter of the kind of product to be produced, the quantity to be
produced and determination of its price. There is no scope for competition.
5. Restriction on Consumption:
In communist countries, there is no consumer sovereignty because the state decides
what may be made available to consumers, unlike in the market economies where
the consumers have the freedom to choose from a wide variety. The consumers in a
communist system, thus, have to content themselves with what the state thinks is
sufficient for them.
6. Restriction on Occupation:
The freedom of occupation is absent or restricted in socialist countries. An individual
may not have the freedom to choose any occupation he is qualified for. Similarly,
individual freedom of enterprise is absent or restricted.
7. Fixation of Wages and Prices by the Government:
The wage rates and prices in a communist economy are fixed by the government and
not by market forces. Non-communist socialist countries may also fix wages and
prices or regulate them by certain means.
8. Equitable Distribution of Income:
An equitable distribution of income is an important feature of the socialist system.
This does not mean, however, that socialist systems aim at perfect equality in income
distribution. Wage differentials, depending on the nature and requirements of the
job, are recognised in socialist countries.
The traditional socialism emphasised government ownership of factors of
production. But a number of today’s socialist systems are based on government
control of the means of production rather than pure state capitalism. Even the Euro-
communism shows a more liberal view than the Russian and Chinese systems. The
recent changes in USSR and India are its best example.

Merits of Socialism:
The merits of socialism are as follows:
1. Economic Equality- Under socialism, there is control of government over
production, there is no scope for centralisation of wealth. Wealth is distributed
among all the people. This avoids economic inequalities.
2. Production Planning- Under the socialist economy, the object is to serve the real
demands and to fulfil the real needs of the people. For this purpose it arranges plant
productions.
3. Economic Stability- Under socialism the government establishes coordination
between the demand for production and supply of various goods. Thus there is a
little likelihood of over-production and under-production. As a result, there is
economic stability in a socialist economy.
4. Proper use of National Resources- Under capitalism, the central planning
authority is better equipped than a capitalist market in locating price output
fluctuations. The state uses the means of production for optimum welfare of the
society.
Demerits of Socialism:
The demerits of socialism are as below:
1. Difficulties of Management- In a socialist system all production setup is based on
government planning, wherein the government officials have to shoulder all
responsibilities. As a result, the government officials are heavily burdened with the
work and it makes proper management difficult.
2. Lack of Freedom- In a socialist economy, it is a government which controls the
economy. The workers are not free to choose occupation according to their choice.
The government controls on all the activities of human life hinder developments.
3. Lack of Consumer’s Sovereignty- In a socialist setup proper attention is not paid
towards the likes and dislikes of the consumer. The government machinery
determines the nature and quantity of production. Thus, the consumer is not a king
in a socialist economy.
4. Lack of Rational Calculation of Cost- The economists are of the view that in
socialist system, there is lack of rational calculation of cost in production process.
Efficient production becomes impossible in the absence of rational calculation of
cost. The reason is the state ownership of the sources of production.

Mixed Economy:
Definitions of Mixed Economy:

According to J.D. Khatri, “A mixed economic system is that in which the public
sector and private sector are allotted their respective roles in promoting the
economic welfare of all sections of the community.”
According to J.W. Grove, “One of the pre-suppositions of a mixed economy is that
private firms are less free to control measure decisions about production and
consumption than they would be under capitalist free enterprise, and that public
industry is free from government restraints than it would be under centrally directed
socialist enterprise.”
On the basis of the above definitions it may be said that mixed economy is
considered as a suitable economic system of country like India. Under this system
the state allocates the different economic activities according to their importance.
Characteristics of Mixed Economy:
The important characteristics of mixed economy are as follows:
1. Division of Public and Private Sector- In mixed economy, public and private
sectors are divided into two parts. In one part are the industries, the responsibility
for the development of which is entrusted to the state and they are owned and
managed by the state. In the second part, the consumer goods industries, small and
cottage industries, agriculture, etc., are given to the private sector. It may be noted
that the government does not work against the private sector.
2. Government Control- Mixed economy cannot function without exercising control
over the private enterprises in the public interest. This control is necessary for the
government to introduce and implement its policies.
3. Protection of Labour- Under mixed economy, government protects the weaker
sections of society, especially labour, that is, it saves labour from exploitation by the
capitalist. Minimum wages and the working hours have been fixed. The government
takes a number of steps to prevent industrial disputes.
4. Reduction of Economic Inequalities- In mixed economy the government takes
necessary steps for the reduction of inequalities of income and wealth. In the
democratic system, the governments try to reduce economic inequalities for
promoting social justice, social welfare and increasing production for all.
Merits of Mixed Economy:
The merits of mixed economy are as follows:
1. Economic Freedom- Under mixed economy the consumers are free to act
according to their choice. There is complete freedom for people to choose their
profession. Economic liberty is available to people.
2. Control on Monopolistic Activities- In a mixed economy, both public and private
sector co-exist and the private sector gets the opportunity to develop. There is a
restriction on monopolistic activities for which the government enacts various rules
and regulations.
3. Social Welfare- Under this system, the capitalist organisations are controlled by
government. The industrial, economic and financial policies of government are
based on the concept of social welfare.
4. Planning and Proper Use of Resource-Under mixed economy the attention is
given to planning. After proper survey all the resources are distributed into different
sectors of the economy. This leads to proper and efficient utilisation of resources.
Demerits of Mixed Economy:
The following are the demerits of mixed economy:
1. Temporary Economic System- Mixed economy cannot be maintained as
permanent economic system. At the very early stage of development this system was
found suitable but later on, its principles went on diminishing.
2. Danger to Democracy- It is possible that with the passage of time socialism may
become powerful. In such condition the whole economic system would go under the
control of government. Thus, there might be danger to democracy.
3. Imbalance in the Economy- The mixed economy cannot provide proper
development as the government wants to maintain a balance between the private
and public sector. The policies of the government are not clear; with the result there
exists presence of imbalance in the economy.
India is regarded as the best example of a mixed economy. The evaluation of such an
economy in India is based on values as embodied in the Directive Principles of State
Policy in the Indian Constitution. According to these Directive Principles it is
obligatory on the part of the state to have a democratic form of government and
within the framework of democracy to bring about a rapid economic development of
the Indian economy in order to raise the national income and the standard of living
of the masses.
The Directive Principles of the Indian Constitution lay down that the Slate strives “to
promote the welfare of the people by securing and protecting as effectively as it may,
social order in which justice—social, economic, and political—shall inform all the
institutions of national life.” In the economic sphere, the state is to direct its policy to
secure a better distribution of ownership and control of the material resources of the
community and to prevent concentration of wealth in the hands of a few and the
exploitation of labour.
The first important characteristic of a mixed economy is the existence of both private
and public sectors. In a sense, both capitalist and socialist economies may be
regarded as mixed economies, because as has been mentioned before, public sector
will definitely exist in a capitalist economy and a small private sector will exist in a
socialist economy.
The existence of a small public or private sector in a capitalist or socialist economy
will not convert them into mixed economies. The important thing is that the
government should follow a definite policy and should declare through the
legislature its determination to allow the coexistence of the two sectors. Through
law, the scope of each is clearly marked out.
Secondly, a mixed economy is necessarily a planned economy. The mixed economy
does not mean simply a controlled economy in which the government interferes in
economic matters through fiscal and monetary policies, but it is an economy in
which the government has a clear and definite economic plan.
Thirdly, the mixed economy has the salient features of capitalism and also of
socialism very clearly and cleverly incorporated together. For instance, the private
sector enterprises are based on self-interest and profit motive. Individual initiative is
given full scope and the system of private property is respected. Individual freedom
and competition are allowed to exist.
At the same time, it is not free or laissez faire capitalism but it is controlled
capitalism since the scope of free enterprise and initiative, the driving forces of self-
interest of society. Either they are restricted to certain industries or they are
controlled through legislative and other measures. On the other hand, the public
sector industries are managed and operated on the basis of welfare of the
community.
CONCLUSION
The mixed economic system, no doubt, is best suited for a vast developing country
like India. Our development experience since independence bears testimony to this.
Had not the public, private and other sectors played their respective roles, it would
not have been possible for India to achieve whatever growth and diversification it
has attained.
The regulation of the private sector and the dominance of the public sector in certain
areas are necessary for the attainment of the objective of the prevention of
concentration of economic power in a few hands to the common detriment, to check
the economic dominance and power of the private sector against social interest, and
to promote social justice.

UNIT – I
5). COST
INTRODUCTION
In economics, cost can be defined as a monetary valuation of efforts, material,
resources, time and utilities consumed, risks incurred, and opportunity forgone
in the production of a good or service.

An organization incurs a number of costs, such as opportunity costs, fixed costs,

implicit costs, explicit costs, social costs, and replacement costs. On the other
hand, revenue is the income earned by an organization from the sales of goods or
services. It excludes deductions of tax, interest, and dividend paid by an
organization. The level of profitability of an organization can be determined by
analysing its costs and revenue.

Cost analysis involves the study of total costs incurred by an organization to

acquire various resources, such as labour, raw materials, machines, land, and
technology. It helps an organization to make various managerial decisions,
including determination of price and level of current production.

Apart from this, it enables an organization to decide whether to opt for the
available alternative or not. On the other hand, revenue analysis is a process of
estimating the total income earned by an organization from different’ sources. An
organization is said to be profitable if its total revenue is more than costs incurred
by it.

DEFINITION

According to the common usage, Cost is the fiscal value of commodities and
facilities that manufacturers and customers buy.
Cost denotes the amount of money that a company spends on the creation or
production of goods or services. It does not include the mark-up for profit.

TYPES OF COST

1. Private Cost:
Social Cost:
Private cost refers to the cost of Production to an individual producer. Social Cost
refers to the cost of producing commodity to society in the form of resources that
are used to produce it.

From the social point of view, the economy has a certain volume of resources in
the form of capital, land etc., which it would be like to put to the best uses.

This depends upon the efficient and full utilisation of resources and also the
specific list of commodities to be produced. It would be ideal if the social cost
coincided with the private costs of producing commodity.

2. Actual Cost and Opportunity Cost:

Actual Costs or Outlay Costs or Absolute Costs mean the actual amount of
expenses incurred for producing or acquiring a good or service. These are the
costs which are generally recorded in the books of accounts for cost or financial
purposes such as payment for wages, raw-materials purchased, other expenses
paid etc.

Opportunity Cost or Alternative Costs:

The Cost of production of any unit of a commodity A’ is the value of the factors of
production used in producing the unit.

The value of these factors of production is measured by the best alternative use to
which they might have been put had a unit of ‘A’ not been produced.

This concept of cost has been popularized by the American writers.

3.Past Costs and Future Costs:

Past Costs:
Actual costs or historical costs are records of past costs.

Future costs are based on forecasts. The costs relevant for most managerial
decisions are forecasts of future costs or comparative conjunctions concerning
future situations.

Forecasting of future costs is required for expense control, projection of future

income statements; appraisal of capital expenditures, decision on new projects
and on an expansion programme and pricing.

4. Explicit Cost and Implicit Cost:

“The total cost of production of any particular goods can be said to
include expenditure or explicit costs and non-expenditure or
implicit costs.” Expenditure or Outlay or Explicit Costs are those costs which
are paid by the employer to the owners of the factor units which do not belong to
the employer itself.
These costs are in the nature of contractual payments and they consist of wages
and salaries paid; payments for raw materials, interest on borrowed capital
funds, rent on hired land and the taxes paid to the Government.

Non-expenditure or Implicit Costs arise when factor units are owned by the
employer himself. The employer is not obligated to anyone in order to obtain
these factors. Expenditure costs are explicit; since they are paid to factors outside
the firm while non-expenditure or implicit costs are imputed costs.

But the latter are costs in the real sense of the term, since the factor units owned
by the organizer himself can be supplied to other producers for a contractual
sum if they are not used in the business of the organizer.

5. Incremental Costs or (Differential Costs) and Sunk Costs:

Incremental Cost:
Is the additional cost due to change in the level or nature of business activity.

The change may take several forms e.g.,:

(i) Addition of new product line,

(ii) Changing the channel of distribution,

(iii) Adding a new machine,

(iv) Replacing a machine by a better one, and

(v) The expansion into additional markets etc.

The question of this type of cost, would not arise when a business has to be set up
a fresh. It arises only when a change is contemplated in the existing business.

Sunk Cost:
Is one which is not affected or altered by a change in the level or nature of
business activity. It will remain the same whatever the level of activity may be.

For Example:
The amortization of past expenses e.g., depreciation.

6. Short-Run and Long-Run Costs:

Short-run Costs are costs that vary with output or sales when fixed plant and
capital equipment remain the same.

Long-run Costs are those which vary with output when all output factors
including plant and equipment vary.

Short-run costs become relevant when a firm has to decide whether to produce
more or not in the immediate future and when setting up of a new plant in ruled
out and the firm has to manage with the existing plant.

7. Fixed and Variable Costs:

Fixed Costs remain constant in total regardless of changes in volume of
production and sales, up to certain level of output. There is an inverse
relationship between volume and fixed costs per unit. If volume of production
increases, the fixed costs per unit decreases. Thus, total fixed costs do not change
with a change in volume but vary per unit of volume inversely.

Variable Costs vary in total in direct proportion to changes in volume. An

increase in the volume means a proportionate increase in the total variable costs
and a decrease in volume results in a proportionate decline in the total variable
costs.

There is a linear relationship between volume and variable costs. They are
constant per unit. Many costs fall between these two extremes. They are called as
semi-variable costs. They are neither perfectly variable nor absolutely fixed in
relation to changes in volume.

They change in the same direction as volume but not in direct proportion there
to. For Example— Electricity bills often include both fixed charge and a charge
based on consumption.

8. Direct and Indirect Costs or Traceable and Common Costs:

A Direct or Traceable Cost is one which can be identified easily and indisputably
with a unit of operation, i.e., costing unit/cost centre. Indirect or Common Costs
are not traceable to any plant, department or operation as well as those that are
not traceable to indirect final products.

For example:
The salary of a Divisional Manager, when a Division is a costing unit, will be a
direct cost. The monthly salary of the General Manger when one of the divisions
is a costing unit would be an indirect cost.

9. Sunk, Shut-Down and Abandonment Costs:

(i) Sunk Cost:
A Past Cost resulting from a decision which can no more be revised is called a
Sank Cost. It is usually associated with the commitment of funds to specialised
equipment or other facilities not readily adaptable to present or future e.g.,
brewing plant in times of prohibition.

(ii) Shut-down Costs:

Are these costs which would be incurred in the event of suspension of the plant
operation and which would have been saved if the operations had continued, e.g.,
for storing exposed property. Further additional expenses may have to be
incurred when operations are re-started.

(iii) Abandonment Costs:

Are the costs of retiring altogether a plant from service. Abandonment arises
when there is complete cessation of activities. These costs become important
when management is faced with the alternatives of either continuing the existing
plant or suspending its operation or abandoning it altogether.

10. Out of Pocket and Book Cost:

Out of Pocket Costs:
Refer to costs that involve current cash payments to outsiders. On the other hand
book costs such as depreciation, do not require current cash payments. Book
costs can be converted into out of pocket costs by selling the assets and having
them on hire. Rent would then replace depreciation and interest, while
understanding expansion; book costs do not come into the picture until the assets
are purchased.

11. Historical Costs and Replacement Costs:

Historical Costs:
Mean the cost of an asset or the price originally paid for it. Replacement cost
means the price that would have to be paid currently for acquiring the same
plant. The assets are usually shown in the conventional financial accounts at their
historical costs.

But during the period of changing price levels historical costs may not be correct
basis for projecting future costs. Historical costs must be adjusted to reflect
current or future price levels.

12. Controllable and Non-Controllable Costs:

A Controllable Cost is one which is reasonably subject to regulation by the
executive with whose responsibility that cost is being identified.

Un-controllable Cost:
Un-controllable cost is that cost which is uncontrollable at one level of
responsibility may be regarded as controllable at some other higher level. The
controllability of certain costs may be shared by two or more executives. The
distinction is important for controlling the expenses and efficiency.

13. Average Cost, Marginal Cost and Total Cost:

(i) Average Cost is the total cost divided by the total quantity produced.

(ii) Marginal Cost is the extra cost of producing one additional unit. It may at
times be impossible to measure marginal cost. For example, if a firm produces
10,000 metres of cloth, it can become impossible to determine the change in cost
involved in producing 10,001 metres of cloth. The difficulty can be solved by
taking units of significant size. In general, economist’s marginal cost is cost
account cost.

(iii) The Total Costs of a firm are the sum of total fixed costs and total variable
costs.

Symbolically:
Total Cost or TC = TFC + TVC

Average Cost or AC = TC + TQ

Marginal Cost or MC = TCn -TCn-1

UINT – I

6) REVENUE

The term revenue refers to the income obtained by a firm through the sale of
goods at different prices. In the words of Dooley, ‘the revenue of a firm is its sales,
receipts or income’.

The revenue concepts are concerned with Total Revenue, Average Revenue and
Marginal Revenue.

1. Total Revenue:
The income earned by a seller or producer after selling the output is called the
total revenue. In fact, total revenue is the multiple of price and output. The
behaviour of total revenue depends on the market where the firm produces or
sells.

“Total revenue is the sum of all sales, receipts or income of a firm.” Dooley

Total revenue may be defined as the “product of planned sales (output) and
expected selling price.” Clower and Due

“Total revenue at any output is equal to price per unit multiplied by quantity
sold.” Stonier and Hague

2. Average Revenue:
Average revenue refers to the revenue obtained by the seller by selling the per
unit commodity. It is obtained by dividing the total revenue by total output.

“The average revenue curve shows that the price of the firm’s product is the same
at each level of output.” Stonier and Hague
3. Marginal Revenue:
Marginal revenue is the net revenue obtained by selling an additional unit of the
commodity. “Marginal revenue is the change in total revenue which results from
the sale of one more or one less unit of output.” Ferguson. Thus, marginal
revenue is the addition made to the total revenue by selling one more unit of the
good. In algebraic terms, marginal revenue is the net addition to the total revenue
by selling n units of a commodity instead of n – 1.

Therefore,

A. Koutsoyiannis, “The marginal revenue is the change in total revenue resulting

from selling an additional unit of the commodity.”

If total revenue from (n) units is 110 and from (n – 1) units is 100.

in that case

MRnth = TRn – TRn _ 1 = 100 – 100

MRnth = 10
MR in mathematical terms is the ratio of change in total revenue to change in
output

MR = ∆TR/∆q or dR/dq = MR

Total Revenue, Average Revenue and Marginal Revenue:

The relation of total revenue, average revenue and marginal revenue can be
explained with the help of table and fig.

Table Representation:
The relationship between TR, AR and MR can be expressed with the help of a

table 1.
From the table 1 we can draw the idea that as the price falls from Rs. 10 to Re. 1,
the output sold increases from 1 to 10. Total revenue increases from 10 to 30, at 5
units. However, at 6th unit it becomes constant and ultimately starts falling at
next unit i.e. 7th. In the same way, when AR falls, MR falls more and becomes
zero at 6th unit and then negative. Therefore, it is clear that when AR falls, MR
also falls more than that of AR: TR increases initially at a diminishing rate, it
reaches maximum and then starts falling.

The formula to calculate TR, AR and MR is as under:

TR = P x q
Or TR = MR1 + MR2 + MR3 + MR3 +….. MR„
TR

In fig. 1 three concepts of revenue have been explained. The units of output have
been shown on horizontal axis while revenue on vertical axis. Here TR, AR, MR
are total revenue, average revenue and marginal revenue curves respectively.

In figure 1 (A), a total revenue curve is sloping upward from the origin to point K.
From point K to K’ total revenue is constant. But at point K’ total revenue is
maximum and begins to fall. It means even by selling more units total revenue is
falling. In such a situation, marginal revenue becomes negative.

Similarly, in the figure 1 (B) average revenue curves are sloping downward. It
means average revenue falls as more and more units are sold.
In fig. 1 (B) MR is the marginal revenue curve which slopes downward. It signifies
the fact that MR with the sale of every additional unit tends to diminish.
Moreover, it is also clear from the fig. that when both AR and MR are falling, MR
is less than AR. MR can be zero, positive or negative but AR is always positive.

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