Chapter 1: Economics - Basic Concepts of Economics and Allocation of Resources PDF

# Chapter 1: Economics - Basic Concepts of Economics and Allocation of Resources ## Types of Economy - The purpose of every economy is to satisfy human wants by using limited or scarce resources. - This is achieved through production and consumption of goods and services. - For production, factors...

# Chapter 1: Economics - Basic Concepts of Economics and Allocation of Resources ## Types of Economy - The purpose of every economy is to satisfy human wants by using limited or scarce resources. - This is achieved through production and consumption of goods and services. - For production, factors of production are engaged in economic activities. - These economic activities bring income to the economic agents, which can either be consumed or saved and invested. - Some countries grow fast while others don't attain such high growth rates. - As a result, some economies are developed while others remain underdeveloped or developing (also known as rich and poor). - Economies are of different types, for example: - Rural and urban economy - Traditional and modern economy - Developed and developing economy - We can also classify economies on the basis of ownership of resources. - The resources available may be in private ownership or collective ownership. - Based on this, economies are of three types: - **Capitalist Economy:** Also called a free market economy or laissez-faire economy. Economic institutions engaged in production and distribution are owned and controlled by private businesses. The absence of government interference in the economic activities of individuals is an important feature. Everyone is free to produce goods and services, choose their production methods, and use resources in the manner they prefer. The economy rotates around the consumer because producers only produce goods which are demanded by consumers. Consumers are sovereign. Important features of this economy are inequality of income, class struggle, and basic economic problems are solved by market interaction between demand and supply. - **Socialist Economy:** The state owns and controls economic institutions involved in production and distribution of goods and services. Central planning authority makes decisions about the central problem of the economy. This includes collective ownership of the means of production, central planning of the economy, and a focus on equality and economic acarity with the goal of reducing class distinctions. - **Mixed Economy:** Economic institutions are owned and controlled either by the state or by individuals. It combines elements of capitalism and socialism. The public and private sectors exist in mixed economies. ## Features of Capitalist Economy 1. **Private Property:** The right of private property is a major feature. It means that productive resources such as factories, mines, etc. are under private ownership, and the owners have the right to own, control, and dispose of them. 2. **Economic Freedom:** Economic freedom is the basis of capitalism. There is freedom of consumption, production, and enterprise. Everyone is free to produce any commodity and invest as he likes. 3. **Competition:** In the capitalist economy, competition exists among producers to attract customers and innovation. 4. **Consumers' Sovereignty:** Consumers are sovereign. Goods and services will be produced according to their demand. Those that can produce in the interest of consumers earn more profit, while those that produce against consumer desire can incur a loss. 5. **Self-Interest:** The capitalist economy is based on the principle of self-interest. Producers, workers, and consumers are guided by their own interests. 6. **Price Mechanism:** The capitalist economy works through a price mechanism. Demand and supply forces determine the equilibrium prices in the market. Buyers and sellers make decisions according to the price of the product on the market. 7. **Limited Role of Government:** In a capitalist economy, the private sector plays a key role, while the government plays a limited role. The private sector is free to conduct economic activities. The government is involved in economic activities to maintain law and order and develop infrastructure to encourage the private sector. 8. **Profit Motive:** The profit motive induces people to work and produce under a capitalist economy. Producers produce goods that give them higher profits. Decisions regarding what to produce, how to produce, and for whom to produce are taken on the basis of profit and not on the basis of social welfare. ## Features of Socialist Economy 1. **State Ownership of Resources:** The basic characteristic of socialism is that the means of production are owned and controlled by the state. Individual ownership of property is permitted to the extent which is sufficient for survival. This means state control over the entire economy and resources are used for the benefit of the whole society. 2. **Social Welfare Objective:** Decisions are made by governments at the macro level to maximize social welfare, not to maximize individual profits. The forces of demand and supply do not play an important role. Careful decisions are taken with the welfare objectives in mind. 3. **Central Planning:** Economic planning is an essential feature of a socialist economy. The Central Planning Authority allocates resources taking into account national priorities and resource availability. The government takes all economic decisions regarding production, consumption, and investment keeping in mind the present and future needs. The planning authorities fix targets for various sectors and ensure that resources are used efficiently. 4. **Economic Equality:** Economic equality is the basis of socialism. In a socialist economy, all members are equal in terms of income and wealth. However, it does not mean that all members have the same income. There may be some reasonable inequalities in income. The quantity and quality of the work done are also taken into consideration. Socialists do not believe in perfect equality, but in social justice. 5. **No Class Conflicts:** In a capitalist economy, the interests of workers and management differ. Both want to increase their own individual profit or earnings. This causes class conflict in the capitalist economy. In socialism, there is no competition between classes. Every person is a worker, so there is no class conflict. All are co-workers. ## Features of Mixed Economy 1. **Co-existence of Public and Private Sectors:** The private sector consists of production units that are owned privately and work on the profit motive. The public sector consists of production units owned by the government and works on the basis of social welfare. Economic activities of each sector are generally controlled by the government using its various policies, e.g., licensing policy, taxation policy, monetary policy, and fiscal policy, to control and regulate the private sector. 2. **Individual Freedom:** In a mixed economy, there is individual freedom to choose any profession and occupation. Consumers are free to purchase any commodity they like. Producers are free to produce and sell goods and services they like. However, the government may put restrictions keeping in mind the welfare of the society. For instance, the government may put restrictions on the production and consumption of harmful goods. 3. **Economic Planning:** Another important feature of the mixed economy is the existence of economic planning. The government tries to promote economic development and social welfare through economic plans. The government exercises full control over the economic activities of the private sector. Both public and private sectors are accorded equal importance in a comprehensive economic plan. 4. **Price Mechanism:** Prices play a significant role in the allocation of resources. For some sectors, the policy of administered prices is adopted. The government also provides price subsidies to help the target group. The aim of the government is to maximize the welfare of the masses. For those who cannot afford to purchase the goods at market prices, the government makes the goods available either free of cost or at subsidized prices. 5. **Regulation of Private Sector:** Another important feature of a mixed economy is that the private sector is regulated and controlled by the government through direct and indirect measures. Private enterprises are directed to achieve national objectives. The government provides support to protect the interests of the weaker sections of society. For instance, the government may define certain specific areas for the functioning of public and private sectors. ## Summary - **Scarcity:** In economics, scarcity always refers to relative scarcity. Anything is said to be scarce if its supply is less than its corresponding demand. Thus, scarcity is the situation in which wants and needs are more than the resources available. - **Choice:** Human wants are unlimited, but resources to satisfy these wants are limited or scarce. Therefore, it is impossible for an economy to produce everything for every individual. This compels us to make a choice about the efficient use of the available resources. Thus, scarcity necessitates choice and maximum satisfaction is the outcome of choice. Hence, scarcity and choice constitute the fundamental basis of economic science. - **Opportunity Cost:** If several opportunities are given up for producing a particular commodity, then opportunity cost is the value of the next best opportunity forgone. Thus, opportunity cost may be defined as the next best alternative foregone. - **Production Possibility Curve:** Production possibility curve is the locus of various combinations of two goods or services that an economy can produce with the full use of its given resources and state of technology. - **Shift in PPC:** PPC shifts up or downward due to the following reasons: - Change in supply of resources - Change in state of technology - **Allocation of Resources:** Every economy faces some common problems called central problems of an economy. They are: 1. **Allocation of Resources:** - What to Produce - How to Produce - For Whom to Produce 2. **Full Employment of Resources** 3. **How to Achieve Growth of Resources?** ## Division of Labor - Division of labor means splitting up a work into many parts and entrusting each part to an individual worker or group of workers according to their ability, knowledge, qualification, experience, training, etc. - **Types of Division of Labor:** - Simple division of labor - Occupational division of labor - Complex division of labor - Territorial division of labor - **Advantages of Division of Labor:** - Right man in the right place - Improvement in skill - Less training required - Large scale production - Diversity of occupation - Inventions - Saving in time, tools, and implements - **Disadvantages of Division of Labor:** - Monotony - Absence of responsibility - Loss of skill - Evils of factory system - Dependency - Over-production - Great risk of unemployment ## Specialization - Specialization means doing the same thing over and over until one becomes an expert in doing that particular task. - It is the outcome of the division of labor. - In the process of specialization, an individual or firm concentrates on what they are good at. - **Advantages of Specialization:** - Increases efficiency - Reduces the risk of errors and mistakes - Time-saving - Reduces costs - Less supervision and control - **Disadvantages of Specialization:** - Monotony - Increase in cost