Chapter 1

THE NATURE, SCOPE AND METHODS OF ECONOMICS

THE INDIVIDUAL AND SOCIETY:-

Most introductory textbooks of Economics begin by asking the question ‘What is

Economics about?’ Although Economics is a vast subject and precise definitions are
usually complex and controversial, it is not a difficult matter to give a simple and sensible
answer to this basic question. Economics is essentially a study of the ways in which
people provide for their well-being. Economists are concerned with the study of human
behavior as a relationship between ends and scarce means which have alternative uses’
(Lionel Robbins).

MICRO AND MACROECONOMICS:-

Economics can be divided into microeconomics and macroeconomics. Microeconomics

is the study of individual markets. (A market is an arrangement which links buyers and
sellers.) For instance, an economist may study the market for compact discs. This will
involve looking at the decisions and behavior of people who buy compact discs, the firms
that sell the compact discs and any other groups which influence the price and availability
of compact discs, such as the government While macroeconomics is the study of the
whole economy. It includes, for example, the study of the nature, causes, consequences of
unemployment, inflation, economic growth and international trade and government
policy.

WANTS AND NEEDS:-

Economics, both macro- and microeconomics, is about the satisfaction of wants. It is
necessary to be quite clear about this; it is people’s wants rather than their needs which
provide the motive for economic activity. People go to work in order to obtain an income
which will buy them the things they want rather than the things they need. It is not
possible to define ‘need’ in terms of any particular quantity of a product, because this
would imply that a certain level of consumption is right’ for an individual. Economists
tend to avoid this kind of value judgment which tries to specify how much people ought
to consume. It is assumed that individuals wish to enjoy as much well-being as possible,
and if their consumption of food, clothing, entertainment and other goods and services is
less than the amount required to give them complete satisfaction they will want more of
them.

SCARCITY:-

Resources are scarce when they are insufficient to satisfy people’s wants. Scarcity is a
relative concept. It relates the extent of people’s wants to their ability to satisfy those
wants. Neither people’s wants nor their ability to produce goods and services are
constant. Most countries’ productive potential is increasing but so is the appetite of their
citizens for goods and services. When a certain living standard is reached, people strive
for even better living conditions. A good example of this is health care. As medical
science and technology advances, people expect more ailments to be treated. So scarcity
is a feature of all societies from the poorest to the most affluent.

CHOICE:-

The resources available to satisfy people’s wants are, at anytime, limited in supply. As
most people cannot have all the goods and services they want, they have to make choices.
With no rise in income, if someone wants to buy, for instance, a new coat they may have
to spend less on eating out for a while. Similarly with limited resources, if a country
wishes to devote more resources to health care it will have to reduce the resources it
devotes to, for example, education.

OPPORTUNITY COST:-

In considering scarcity and choice economists make use of opportunity cost. This is a
very important concept in economics. It makes clear the true resource cost of any
economic decision. For instance, building a new hospital may mean that the construction
of a stretch of motorway has to be postponed. So opportunity cost is the cost in terms of
the best alternative forgone. For example, if a person buys a watch it may cost £50 but
what is more significant is what has to be given up to make the purchase. This may be the
opportunity to purchase a pair of shoes or the opportunity to have extra leisure instead of
working to earn the £50.

ECONOMIC AND FREE GOODS:-

In the case of the vast majority of goods and services, resources have to be used in order
to produce them. For example, to provide health care requires the use of labor in the form
of doctors and nurses, land on which the hospital is built and capital in the form of beds,
operating tables, dialysis machines and other equipment. So the production of most goods
and services involves an opportunity cost — the resources employed could be put to other
uses. These products are called economic goods. However there are a few goods which
do not involve an opportunity cost, for example sea water and sunshine. This is because
they do not require resources to produce them — they are in existence naturally. These
products are known as free goods.
ECONOMICS AS A SOCIAL SCIENCE
NORMATIVE AND POSITIVE STATEMENTS:-

In studying economics and a range of other subjects it is useful to distinguish between

positive and normative statements. An understanding of the difference between the two
types of statement helps people to appreciate the scope and limitations of economics.
Positive statements are those that deal only with facts. ‘Hong Kong is now part of China’,
‘General Motors employs x number of workers’, and ‘Jane Smith obtained a grade A in
Economics’, are all positive statements. If a disagreement arises over a positive statement
it can be settled by looking at the facts and seeing whether or not they support the
statement. Positive statements must be either true or false, where the word true’ is taken
to mean ‘consistent with facts’.

Normative statements usually include or imply the words ‘ought’ or ‘should’. They
reflect people’s moral attitudes and are expressions of what some individual or group
thinks ought to be done. ‘Britain should join the single currency’, ‘more aid should be
given to developing countries’ and ‘income should be distributed more equally’, are all
normative statements. These statements are based on value judgments and express views
of what is ‘good’ or ‘bad’, ‘right’ or ‘wrong’. Unlike positive statements, normative
statements cannot be verified by looking at the facts. Disagreements about such
statements are usually settled by voting on them.

SCIENTIFIC ENQUIRY:-

Scientific enquiry, as the term is generally understood, is confined to positive questions.

It deals with those questions which can be verified or falsified by actual observations of
the real world (i.e. by checking the facts).
One major objective of science is to develop theories These are general statements or
principles which describe and explain the relationships between things observed in the
world. Theories are developed in an attempt to answer the question Why?’. Tides rise and
fall at regular intervals of time, a city is afflicted by smog at certain times of the year, the
price of strawberries falls sharply during the summer months. When some definite
regular pattern is observed in the relationships between two or more things, and someone
asks why this should be so, the search for a theory has begun.

SCIENTIFIC METHOD:-
In trying to produce an explanation of observed phenomena, scientific enquiry makes use
of procedures which are common to all sciences. These procedures are called the
scientific method.

The first step is to define the concepts to be used in such a way that they can be
measured. This is necessary if a theory is to be tested against the facts. If the task is to
discover a relationship between ‘income’ and ‘consumption’, these terms must be defined
in a clearly understood manner
The next step is to formulate a hypothesis. This is an untested statement which attempts
to explain how one thing is related to another For example, an economist asked to say
why prices vary over time might offer the hypothesis that changes in prices are caused by
changes in the quantity of money. Hypotheses will be based on observation and upon
certain assumptions about the way the world behaves. These assumptions may
themselves be based upon existing theories which have proved to have a high degree of
reliability. In economics, for example, many theories are based upon the assumptions that
people will behave in such a manner as to maximize their material welfare. Using
observed facts and making use of certain assumptions, a process of logical reasoning
leads to the formation of a hypothesis. This must be framed in a manner which enables
scientists to test its validity.

It is now necessary to think about what would happen if the hypothesis is correct. In other
words, the hypothesis is used to make predictions (or the hypothesis itself may be framed
as a prediction). If the hypothesis is correct, then if certain things are done, certain other
things will happen. If the general level of prices is causally related to the supply of
money, it may be deduced that an expansion of bank deposits would be followed by an
increase in prices.

The hypothesis must now be tested are the predictions of the hypothesis supported by the
facts? In the natural sciences the testing of hypotheses can be carried out by controlled
experiments in the laboratory, but this, as explained below, is not possible for the social
scientist If the hypothesis is supported by the factual evidence it becomes a theory which
can be used to explain and predict behavior and relationships. It must be noted, however
that, since the number of tests which can be carried out is limited, it is never possible to
say that a theory is true for all times and in all places. A successful theory is one which
up to now has not been proved false. If, at some future time facts emerge which prove the
theory and its predictions unreliable, it will be discarded and a search for a better theory
will begin. A successful theory is extremely useful because it helps economists predict
with a high degree of probability the outcome of certain events.

THE NATURE OF ECONOMICS:-

Economics is defined as a social science. A social science is a subject which is concerned

with human behavior Social sciences, which include, for instance, politics and sociology
as well as economics, differ from the natural sciences in a number of ways.
The most obvious limitation experienced by the social scientist is that she or he cannot
test her or and from the inadequacy of statistical data. For example there are debates
about who should be classified as unemployed and although statistical information on
economic affairs is now available to a far greater extent than ever before, there are still
many deficiencies. Such information often takes a long time to become available in
processed form, and often it is too late to be used in current analysis. It may often be
presented in a form which is not very convenient for analysis. These deficiencies
therefore leave room for disagreement among economists.
Economics is a relatively young science, and although economic analysis has made great
strides in recent years there is still a great deal about the workings of the economic
system that is imperfectly understood. There are many aspects of existing theories which
have not yet been tested, either because insufficient time has elapsed to provide adequate
data, or because no one has found a satisfactory way of testing them. Technical, cultural
and economic changes also bring about changes in economic behavior so that
assumptions about human behavior which served as useful bases for predictions at one
period of time may become increasingly unreliable as the social and economic
environment changes. Economists, then, will be in dispute over the adequacy of certain
existing theories — but it is these very disputes which lead to improvements in existing
theories and the development of new ones.

The main area of disagreement among economists is on matters of economic policy. This
is exactly what one would expect because policy recommendations are influenced by
both economic and political analysis and are affected by value judgments.