Chapter 1: Basic Concepts in Economics PDF

CHAPTER- 1 : BASIC CONCEPTS IN ECONOMICS Introduction : Types of Economic Systems -Capitalism, Today's world is marked by scientific Socialism and Mixed Economy. inventions and discoveries. This...

CHAPTER- 1 : BASIC CONCEPTS IN ECONOMICS Introduction : Types of Economic Systems -Capitalism, Today's world is marked by scientific Socialism and Mixed Economy. inventions and discoveries. This remarkable scientific progress enables to probe into the Kautilya's Views on Economics : question, What is a science? Science the Artha means "Wealth' and systematic body of knowledge. There are two Shastra meansS 'Science'. main types of sciences. Arthashastra implies the " Natural sciences " Social sciences science of acquiring and " Natural science is one whose laws are managing wealth. Essentially, universally acceptable and their validity can be Arthashastra is a treatise tested in a laboratory under controlled conditions. Fig 1.1 on Political Economy in its Natural sciences are also called exact sciences Kautilya broadest sense. because of their empirical approach to the study. e.g. Mathematics, Physics, Chemistry. Key-points based on Kautilya's views : " Social Science is called abstract 1) Crucial role of the state or government. behavioural science because it is related to 2) Focus on creation of wealth as the means to the study of some or the other aspect of human ensure welfare of the state. behaviour. e.g. Psychology is related to 'mental' 3) Need for efficient administrative machinery aspect of human behaviour. Sociology is related for good governance. to the study of 'social' aspect of man as a member of society. Human behaviour can neither 4) Compilation of political ideas into be empirically tested nor can be studied in the Arthashastra. laboratory. Hence, the laws of social sciences Do you know? are not universal but they are only statements of general human tendencies. Kautilya was great statesman, philosopher, economist and royal advisor Meaning of Economics : during the Mourya period. He is also known Economics is a social science. The origin by the name Chanakya or Vishnugupta. of the term Economics' lies in the Greek word, 'Oikonomia' which means management of the Kautilya authored the ancient Indian household. political treatise, the 'Arthashastra'. Economics is referred to as 'Queen of Definitions of Economics : Social Sciences' by Paul Samuelson. Economics deals with the economic aspect of human 1)Adam Smith's Wealth-Oriented Definition behaviour. It deals with how human beings of Economics: satisfy unlimited wants with limited means. Classical economist Adam Let us understand the nature of Economics Smith, also regarded as the with respect to some popular definitions. "Father of Economics", has given the wealth-oriented Refresh your memory : definition of Economics. Have you studied the following concepts Out of his many literary in the previous textbooks? Fig 1.2 contributions to Economics, he Adam Smith 1 is most famous for his 1776 piece of work, "An 3) Lionel Robbins' Scarcity-Oriented Definition of Economics : Inquiry into the Nature and Causes of Wealth of Nations". Adam Smith defines Economics as "a This is the most popular science of wealth". definition of Economics. Robbins, in his book Key-points of AdamSmith's definition: entitled, "An Essay on the 1) Laissez faire i.e. non-intervention of the Nature and Significance governnment. of Economic Science" 2) Capital and wealth accumulation Fig 1.4 Lionel Robbins published in 1932 mentions 3) Nature's law in economic affairs. about the scarcity-oriented definition of Division of labour as an aspect of growth Economics. theory. "Economics is a science which studies human behaviour as a relationship between ends Do you know? and scarce means which have alternative uses". Paul Romer and William Nordhaus have won Nobel Memorial Prize in Economics Key-points of Robbins' definition: for 2018. Paul Romer tends to be described 1) Wants (ends) are unlimited. as a growth theorist whereas Mr. Nordhaus 2) Means are comparatively limited. has remarkably contributed to the field of 3) Wants are gradable on the basis of priority. Environmental Economics. 4) Means have alternative uses. Find out: Do you know? Other Nobel Prize winners in Economics. Names of the Thought Economists 2) Prof. Alfred Marshall's Welfare-Oriented Classical School Adam Smith, Definition of Economics: of Thought of 18| David Ricardo, Neo-classical economist century J. S. Mill, Prof. Alfred Marshall has T.R. Malthus etc. given the welfare-oriented Neo-classical Alfred Marshall, definition of Economics, in School of ThoughtA. C. Pigou, of 19h and 1" half Irving Fisher etc. the book entitled "Principles of 20h century of Economics" which was Modern School of J. M. Keynes, Fig 1.3 published in 1890. His Alfred Marshall Thought from 20h Lionel Robbins, definition states century till date. Paul Samuelson etc. "Economics is a study of mankind in the ordinary business of life. It examines that part Branches of Economics : of individual and social action, which is closely In 1933, Sir Ragnar Frisch coined the terms connected with the attainment and use of Micro Economics and Macro Economics. These material requisites of well-being". terms are derived from the Greek words 'Mikros' Key-points of Marshall's definition : and 'Makros' respectively. 1) Study of an ordinary man. A) Micro Economics : 2) Economics is a behavioural science. Micro means small. Micro Economics deals 3) Study of material welfare. with the behaviour of the individual variables 4) Economics is not simply a study of wealth. such as a household, worker, firm, industry etc. 2 Kenneth Boulding's Definition of Micro a Economics : b) "Micro Economics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities". Basic Concepts of Micro Economics 1)) Want:It is difficult to define 'want' in few C) words. In common language, want can be referred to as a need. In economics, want denotes a feeling of lack of satisfaction'. This feeling enables the individual to satisfy his want. Human wants have grown in number for two basic reasons: " Desire for better living due to inventions and Fig. 1.5 : Age and Wants - a, b, c innovations. " Rise population. ii) Wants differ with age : Wants and their Characteristics of wants: satisfaction differ as per the chronological age. (Fig. 1.5 a, b, c). i) Wants are unlimited : Wants not only arise iv) Wants differ with gender : Men and again and again but they are also unending. If one want gets satisfied, another arises. women want different goods according to their needs. Wants go on multiplying in number. i) Wants are recurring in nature : Several v) Wants differ due to preferences: Individual human wants occur again and again, while habits, tastes and preferences matter a lot some might be only occasional. while deciding wants of the people. Fig. 1.6 : Seasons and Wants 3 vi) Wants differ with seasons : Wants keep on human wants or want satisfying power of a 1 changing with seasons (Fig.1.6). commodity is called utility. vii) Wants differ due to culture : Differences 4) Value Value has two approaches in in culture influence wants that are related to economics, i.e. 'value-in-use' and 'value in food, dressing styles etc. exchange'. Classification of Wants : Value-in-use : It refers to the worth of a Wants can be classified in the following ways. commodity. In simple words, it is usefulness i) Economic and Non-economic wants : of a commodity, e.g. no one has to pay " Economic wants are those where monetary price for sunshine but its immense worth transaction is involved. An individual has for life can never be doubted. In economic to pay the price for them, e.g. food, language, sunshine has a high value-in-use. medicines etc. It is an example of 'free good'. " Non-economic wants are those which can Value-in-exchange : It refers to the worth be satisfied without making monetary of a commodity or a service expressed in payment for them, e.g. air, sun shine etc. terms of another commodity. When this ii) Individual Wants and Collective wants : value is expressed in terms of money, it is " Personal or individual wants refer to those called price of a commodity. A good which wants which are satisfied at the individual commands a price is termed as an 'economic level, e.g. a doctor using a stethoscope, a good', e.g. TV, car etc. judge wearing his coat. Water-Diamond Paradox of values:Some " Collective wants are social wants where commodities have a high value-in-use there is collective satisfaction of wants, e.g. but low exchange value, e.g. water, whereas, travelling by train. some commodities have low value-in-use i) Necessities, Comforts and Luxuries : but high exchange value due to its scarcity. " Necessities are the very basic needs of e.g. diamond (Fig 1.7). life, e.g. food, clothing, shelter, health and education. " Comforts are those wants which make our life comfortable, e.g. washing machine, mixer, pressure cooker etc. Luxuries are those wants which are meant for pleasure and enjoyment, e.g. AC-car, well-furnished house etc. Fig. 1.7 :Water-Diamond Paradox 2) Goods and Services : These are popular terms of economics. Find out : Anything that satisfies human wants is Which of the following is 'free good' or termed as a 'good'. It has material existence, 'economic good'? e.g. chalk used by a teacher. " Water in river Services also satisfy human wants but do not "Oxygen cylinder have any material existence, e.g. Teaching' " Sunshine offered by the teacher. " Water processed for drinking 3) Utility:Capacity of a commodity to satisfy " Air 4  14 5) Wealth: Wealth refers to "anything which has 6) Personal Income : Earnings received by a market value and can be exchanged for money. person from all sources is called his personal To be regarded as 'wealth, a commodity income. must possess the following characteristics : 7) Personal Disposable Income (PDI) It is i) Uility that part of personal income which is left over i) Scarcity after payment of direct taxes such as income iii) Transferability tax, wealth tax etc. iv) Externality You should know : ) Uility:Acommodity must have thecapacity to satisfy human wants, e.g. furniture, Following are the various types of income. refrigerator etc. A) Fixed income : Income which remains i) Scarcity : A commodity must be scarce in stable over a period of time, e.g. rent, supply in relation to its demand if it is to wages. be included in the term 'Wealth', e.g. all B) Fluctuating income : Income which economic goods for which price is paid. is not fixed but keeps on changing, e.g. ii) Transferability:A commodity should be profit. It can be positive, negative or zero. transferable from person to person as well C) Money income : It is the income received as place to place. If the good is material or in actual currency of the country. In other tangible then only it is possible to transfer words, it is the income in cash, e.g. 5,000 it from place to place, e.g. vehicle, jewellery etc. D) Real income : It is the purchasing power of money income, e.g. commodities iv) Externality : A good can be transferred purchased out of money income. only if it is external to human body, e.g. bag. chair etc. E) Contractual income : This income is paid as per the terms and conditions of Do you know? contract, e.g. rent, wages. Physical ransferability This is actual F) Residual income : Income which is left transfer of goods from one person to another over after making payments to all factors and from one place to another, e.g. vehicle. of production is called residual income, Notional Transferability -It is not possible e.g. profit to transfer the good physically but there can be only transfer of ownership rights, e.g. land G) Earned income: Income obtained after participating in the productive activity, Try this : e.g. rent, wages, interest, profit. Prepare a listof commodities which satisfy H) Unearned income : Income received the condition of physical transferability and from all sources without indulging in any notional transferability. productive activity, e.g. windfall gains, lottery prizes. Do you know? Inborn qualities like beauty, melodious 8) Economic activity: Economic activities voice, efficiency etc. are not 'wealth' in the can be classified into four types which strict sense of economics. They are neither include production, distribution, exchange and external nor transferable. consumption. 5  of production which earns the reward in the form of 'interest', e.g. machinery. BscuT technology, factory building etc. iv) Entrepreneur: Entrepreneur is the organizer who is a real captain of the industry. He is a special kind of labour who gets the work done to earn the reward of 'profit' in the process of production. b) Distribution : It is division of factor rewards among different segments of the society. Factors of production claim their Fig. 1.8 : Economic Activities rewards of rent, wages, interest and profit a) Production: Production is creation of utility. through the process of distribution. There are four factors of production such as c) Exchange : It is give and take between land, labour, capital and entrepreneur. various units in the economy. 'Exchange refers to sale and purchase of goods Always remember: and services. In economics, exchange is The activities which are carried out just necessarily a monetary transaction. for the sake of charity, hobby or in general, where there is no monetary exchange are d) Consumption : It is making use of goods and services to satisfy human wants. considered 'unproductive' in the sense of Economics, though they may be adding B) Macro-Economics : immense value to life. Macro means large or aggregate or total. Macro-Economics is therefore the study of Factors of production : aggregates covering the entire economy such i) Land : 'Land' in Economics is a wide as total employment, national income, national term. It is a natural factor of production. output, total investment, total savings, total Any natural resource that is available on, consumption, aggregate supply. aggregate above and below the surface of the earth is demand, general price level etc. called 'land' in Economics, e.g. minerals which are found below the surface of the Kenneth Boulding's definition of Macro earth: soil, water on the surface of the earth; Economics: air, sunshine, wind are above the surface of "Macro Economics deals not with the earth. Land earns 'rent' in productive individual quantities as such, but with the aggregates of these quantities, not with the activity. individual incomes but with the national income., i) Labour : Labour a human factor of production. Any physical or mental effort not with individual prices but with the general price level, not with individual output but with undergone during the process of production the national output". to earn the reward of 'wages' is called 'labour' e.g. carpenter, accountant, Basic Concepts of Macro Economics : engineer etc. 1) National Income : This reveals the total ii) Capital : Capital is a produced means for economic performance of a nation. It is further production. It is a man-made factor referred to as the total income of a country. 6  16 In the economic sense, national income is the Find out: aggregate monetary value of all final goods and Which of the following terms is a part of services produced in an economy during a year. micro economics or macro economics? Definition by National Income Committee : " Global poverty "A national estimate measures the volume Price of a commodity of commodities and services turned out during a Balance of payments given period counted without duplication". Profits ofa firm "National income 2) Saving:It is that part of theincome which is set aside to satisfy the future needs by foregoing current consumption. In other words, saving is Always Remember that part of income which is not spent currently Economic Economic on consumption. Growth Development 3) Investment : It refers to creation of capital 1) Economic 1) Economic assets through mobilisation of savings, e.g. growth means development indicates an increase in economic growth plus machinery, equipment etc. the real national progressive changes 4) Trade Cycles: Trade cycles are fluctuations income of the in certain important in business. They are ups and downs in the country. variables which overall economic activities. Ups and downs determine well-being means fluctuations caused by inflation and of the people. depression respectively. 2) This concept 2) This concept Inflation is a continuous rise in general is narrow and is broader and price level. quantitative. qualitative. Depression is a continuous fall in overall 3) Economic 3) Economic growth is development is not prices and lowering down of economic possible without activity in general. possible without economic economic growth. Do you know ? development. 4) Economic 4) Economic Unemployment created due to impact growth is a of cyclical fluctuations is called 'Cyclical development is a unidimensional multi-dimensional Unemployment'. concept. concept. 5) Economic Growth : The term economic 5) Economic 5) Economic growth is development is growth has a 'quantitative' dimension. In simple Spontaneous and deliberate and words, economic growth means an increase in reversible. irreversible. the real national income of the country, over a 6) Economic 6) Economic long period of time. growth is development is 6) Economic Development: This is a wider measured measured in terms concept which has a 'qualitative' dimension. in terms of of agricultural Economic development implies economic national income productivity, industrial growth plus progressive changes in certain and per capita productivity quality of important variables which determine well-being income. human life etc. of the people, e.g. education, health etc. Table: 1.1 7  CHAPTER - 2 : MONEY Introduction : Barter system : It refers to exchange of goods Man is an intellectual animal. The for goods. invention of money is one of the important Difficulties in Barter System: 1 and fundamental inventions out of various 1) Problem of double coincidence of wants: inventions in the world. According to Crowther. Lack of double co-incidence of wants there is a basic invention in each branch of was one of the major limitations of barter knowledge, e.g. invention of fire in science, system. For instance, person 'A' has cloth invention of wheels in mechanical science. and he wants rice in exchange and person The concept of money is an important concept 'B' has rice but he does not want cloth in which has brought about a revolutionary change exchange. In this case exchange between in the economic life of human beings. Various 'A' and 'B' would not take place as their goods and services are bought and sold with the wants do not coincide with each other. help of money, to satisfy human wants. Modern 2) Lack of commonmeasure of value:While economy is dependent on money. Money which exchanging goods for goods, there was no is in circulation today was created to reduce the standard unit of account to determine the difficulties in Barter System. value ofa commodity. e.g.. it was difficult to compare two litres of milk with two kilograms of rice. 3) Difficulties in storage of goods : is necessary to store goods for future consumption. Sometimes due to perishable nature of certain goods it was difficult to store them for future. Perishable commodities like milk, eggs, fish, vegetable etc. were difficult to store. Difficulties were also experienced due to lack of space required to store heavy and bulky goods. 4) Indivisibility of certain goods : In barter system it was inconvenient to divide Fig. 2.1 : Barter system animals, house etc. into small parts, so it was Problem of double difficult to fix proportion of one commodity coincidence of wants in exchange for another commodity. e.g. Individual 'A' has a sack of wheat and he Lack of common wants a goat in exchange. Individual B'hasa measure of value goat and he wants only half a sack of wheat. Difficulties in Dificulties in In this situation exchange between the two Barter System storage of goods commodities is impossible due to indivisible nature of goat, for it being a live stock. Indivisibility of 5) Problem of making deferred payments certain goods Deferred payment means payments be Problem of making made in future. Repayment of loan was deferred payments difficult due to exchange of commodities,  e.g. it was difficult to repay the perishable goods in the same condition in future. 2 Definitions of Money : 1) Prof Crowther : "Money is anything that is gernerally acceptable asa means of exchange and at the same time acts as a measure and a store of value" BHIM Till Date 2) Prof Walker : "Money is what money does". Evolution of money : Money has come into existence by evolution and 8) Electronic Money not by revolution. With passage of time, the commodities which 7) Plastic Money were used as money have changed 6) Credit Money depending upon the need of time and development of civilization. 5) Paper Money Money used in modern times is 4) Metallic coins a result of many evolutionary changes that took place over a 3) Metallic Money long period of time. 2) Commodity Money Following are the types of 1) Animal Money money which very well explain the LAO Z40401 evolution of money (Fig. 2.2). Types of Money : O50 IAG 240401 1) Animal money : In protohistoric period, 'animal money' was used as a means of exchange, e.g. cow, sheep, goat etc. However, due to their indivisible nature, commodity money came into existence. 2) Commodity money : In olden days, the commodities to be used as money were dependent upon climatic conditions and culture, e.g. animal skin, grains, shells, feathers, tusk, salt, rare articles and stones were used as a medium of exchange. Due to the problem of storage of such commodities, metallic money came into existence. 3) Metallic money : Metallic money used durable metals such as gold, silver, copper, aluminum, nickel etc. However, scarcity of precious metals and lack of uniformity in metallic pieces gave rise to the use of metallic coins. 4) Metallic coins: In ancient times, rulers of various kingdoms used small pieces of metals and affixed their seals on them. With the passage of time, the monetary system was taken over by the government authorities with a view to give uniformity and legal status to metallic coins. Coins can be classified as under: a) Standard or full bodied coins : Full bodied coins are those whose face value is equal to their intrinsic value. Face value indicates the otohistoric exchange value fixed by issuing authority. These coins are made out of iod precious metals like gold, silver etc. Standard coins were used for some days during the British period. Fig. 2.2 : Evolution b) Token coins: Token coins are those whose face value is higher of Money 10  than their intrinsic value. These coins are smart cards, computer etc. It is backed by made of cheaper metals like aluminum, the Central Bank. Electronic money is used nickel etc. These coins are of lower for purchases and transactions globally. denominations and are generally used for Digital wallets are also a form of stored 2 settling smaller transactions. In India, all electronic money. coins in circulation today are token coins. Find out : Difficulties in transportation of token coins gave rise to paper money. List of various modes of digital transactions. 5) Paper Money :PaperMoneywasa substitute for metallic money. In course of time, issue of currency notes was monopolized by the You should know : Central Bank. Paper money consists of a) Legal Tender Money : It is the money paper currency issued by Government and which is backed by law and cannot be Central Bank of the country. refused in transaction by anybody on any In India, one rupee note and all coins are ground. In India, all coins and currency issued by the Government of India. Currency notes are legal tender money. notes of higher denominations are issued by the Central Bank (Reserve Bank of India). b) Non-Legal tender Money: It is the money Inconvenience in handling and risk of storing which is generally used by people in final paper money gave rise to bank money. payments but there is no legal compulsion of acceptance. It can be refused. Cheques, bills 6) Bank Money or Credit Money: Bank exchange are examples of this money. It money refers to deposits which are in the is also known as optional money. form of cash saved by the people. It is used to create credit money. This can be withdrawable and transferable on demand, Qualities of Money : by means of cheque, demand draft etc. The qualities of money are as follows : Cheque, demand draft are not actual money 1) General Acceptability : Anything which is but credit instruments through which deposits used as money must be easily accepted by are transferable. Credit money plays an all for exchange purpose. important role in economic development. On the background of global economy, cashless 2) Divisibility: Money should be easily divisible into smaller denominations to transaction gained importance thereby giving rise to plastic money. facilitate small transactions. 7) Plastic Money: Plastic Money is easy 3) Durability :Money should also possess the to use in transaction due to advanced characteristic of durability. Currency notes technology. Debit cards and credit cards are and coins are being used repeatedly and used as plastic money. Further innovation shall continue to do so for years together on in smart transactions led to the introduction account of durability. of electronic money. 4) Cognizability : Money must be easily Find out : Recent changes introduced by recognised. It should have certain distinct banks for safe use of plastic money. marks so as to avoid confusion by the receiving person. 8) Electronic Money : E-money or Electronic 5) Portability : It should be easy to carry from money is a monetary value that is stored one place to another without any difficulty. and transferred electronically through a expense and inconvenience, e.g. currency variety of means i.e. a mobile phone, tablet, notes are easily portable. 11  6) Homogeneity : Money of a particular building. plot, shop, agricultural land etc. can denomination must be homogeneous or be sold at one place and can be purchased at identical in its features. another place with the help of money. 7) Stability Money should have a stable C) Contingent Functions : monetary value. It serves as a measure According to Prof. Kinley. in the modern of value to exchange goods and services. period money plays an important role almost in These goods can be sold and purchased in all economic transactions. 22 future as per requirements. 1) Measurement of National Income Functions of Money National Income is expressed in money A) Primary Functions : terms. Distribution of national income 1) Medium of Exchange : The most important among the four factors of production is function of money is to serve as a medium in terms of monetary rewards. e.g. rent, of exchange. Any commodity can be wages, interest, profits etc. purchased or sold for money. 2) Basis of Credit Commercial Banks 2) Measure ofValue or Unit ofaccount : Price create credit money on the basis of primary is the value of a commodity or a service deposits. Money provides a liquid base for expressed in terms of money. Money enables creation of credit money. to compare the prices of commodities. Different currencies are used to express the 3) Imparts liquidity to wealth : Money is value of commodity in different countries, called the most liquid asset. Money can e.g. Rupee in India. Dollar in U.S.A., be easily converted into any asset and any Pound in U.K., Yen in Japan etc. Income asset can be converted into money. e.g. a person can purchase gold and if he wants and expenditures of all kinds, assets and liabilities are stated in terms of money as a he can sell it and purchase government unit of account. bonds, securities etc. 4) Estimation of macro economic variables : B) Secondary Functions : Macro Economic variables like Gross 1) Standard of deferred payments : Under National Product (GNP), total savings, barter system taking loans was easy, but total investment etc. can be easily estimated its repayment was difficult because loan in monetary terms. It also facilitates was in the form of grains, cattle etc. Money has overcome this difficultyy. Payments to government tax collection, preparation of be made at a future date is called deferred budget etc. payments. By serving as a standard measure Concept of Black Money: of payment over a time, money makes Black Money is any money which is received borrowing and lending easy. cash but not accounted for and on which tax 2) Store of value: Money acts as a store not paid to the government. Black Money is of value. Money not only satisfies wants tax evaded income. It can be earned through in the present but also makes provision both legal and illegal means. Black money for satisfaction of wants in future. This is encourages illegal activities such as corruption, possible due to savings. According to Lord bribery, black marketing, hoarding etc. This J. M. Keynes, 'money is a link between the creates obstacles in economic development. present and future'. Economic, political and social instability are 3) Transfer of Value : Money enables transfer created in the economy due to black money. To of value from one person to another and control black money. demonetization is one of from one place to another. Real assets like the tools, which many countries have adopted. 12