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This document discusses the nature and scope of economic theory, focusing on the difference between positive and normative economics, and the production possibility curve as a tool to understand economic problems. It explains how limited resources affect production choices, illustrating the trade-offs between different goods. The concept of unemployment and underutilization of resources is also briefly addressed.
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The Nature and Scope of tconomic Theory 23 between positive and normative or welfare economics when judged from the individual's point of view. Aithough there is no difference between positive and welfare econonics when judqed fim the individual point of view. yet it is possible...
The Nature and Scope of tconomic Theory 23 between positive and normative or welfare economics when judged from the individual's point of view. Aithough there is no difference between positive and welfare econonics when judqed fim the individual point of view. yet it is possible to make out a difference between the two by adopting a social point of view. Any course of action which may be best for an individual may u bost for the society. Thus, there is a difference between what a man thinks best for hirn and what is best for the society. When a man does what he thinks best for him, he does not necessarilydo what is best for the society. Ifthe word 'should' is given asocial connotation, the diference between 'what is done and 'what should be done' becomes clear. Thus only by adopting the social point of view, the positive and welfare economics can be differentiated from each other. PRODUCTION POSSIBILITY CURVE : A BASIC TOOL OF ECONOMICS The nature of basic economic problems explained above can be better understood and distinguished from each other with the aid of an important tool of modern economics known as production possibility curve. Production possibility ofcurve is also called the production the production possibility curve and possibility frontier. We shall explain below the concept stated above. problems bringout its relationwith the basic economic alternative production Production possibility curve (frontier) is a graphic representation of resources of the economy are limited. possibilities facing an economy. As the total productive The productive resources can be used the economy has to choose between different goods. production of various alternative goods. It has, therefore, to be decided which goods for the deciding what amounts of different goods are are to be produced more and which ones less. In about the allocation of resources among to be produced, the society would in fact be deciding raising wheat on the farms and how different possible goods. How much labour should go into How many factories would produce much should be employed in manufacturing cloth.produce consumer goods for the civilians. In armaments for the army and how manyshould types of goods--wheat and cloth-are order to simplify our analysis we shall assume that two possibilities with these two goods but the to be produced. We shall explain the production other two goods. analysis made will equaly apply to the choice between any productive resources and they remain Let us assune that there is a given amount of shifted from the production of can be fixed. Although resources are fixed in quantity, yet theyresources are being used fuily and with one good to another. Further, we assume that the given are neither unemployed utmost technical efficiency. in other words, we assume that resources economy is working at the and under-employed. nor inefficiently utilized. That means that presume that level of ful' employment and achieving maximum possible production. We also technology. technology does not undergo any change. In other words, we rule out any progress in efficiency and a In short, we assume fixed resources, full-employment, complete technical given technology. All these assumptions imply that we are looking at our economy at some particular point in time or over a very short period of time. This is because it will be very Uhrealistic to rule out progress in technology and growth in the supply of resources Over a long period of time. With the given amount of resources and a given technology, we have constructed the folowing table showing various production possibilities between wheat and cloth. If allthe given resources are employed for the production of wheat, it is supposed that 15 thousand quintals of wheat are produced. On the other hand, if all the resources are devoted to the Production of cloth, 5 thousand metres of cloth are made. But these are the two extreme Production possibilities. In between these two, there willbe manyother production possibilities 24 Advanced tconomic Theory such as B. CDand E. With production possibility B, the economy can produce, with given resources, 14 thousand quintals of wheat, and one thousand metres of cloth and with production possibility Cth economy can have 12 thousand quintals of wheat and 2 thousand rnetres of cloth and so on As we move from possibility Atowards F, we draw away some resources from the production of wheat and devote them to the production of cloth. In other words, we give up some units of wheat in order to have some more units of cloth. As we move from alternative A to BW sacrifice one thousand quintals of wheat for one thousand metres of cloth. Again, our movement from alternative Bto C. involves the sacrifice of two thousand quintals of wheat for the salke of one thousand more metres of cloth. Alook at the Table 1.l shows that our sacrifice of wheat Table 1.1. Alternative Production Possibilities B 14 13} Production Cloth (in Wheat (in 12 possibilities thousand thousand 11 10 (metres quintals) 9 A 15 B 1 14 E C 2 12 D 9 F 2 4 5 X E 4 5 5 Fig. 1.1. Production Possibility Curve goes on increasing as we move further from Ctowards F. lt is, therefore, clear that in a fuly employed economy more of one good can be obtained only by cutting down the production of another good. Thus, we conclude that a fully employed and technically efficient economy must always give up something of one good to obtain some more of another. The basic fact that resources are limited prevents an economy from having more of both the goods. The alternative production possibilities can be illustrated graphically by plotting the data of the Table 1.1. The curve AFin Figure 1.1 is obtained when the data of the table are plotted. This curve AF is called the production possibility curve which shows the various combinations of two goods or two classes of goods which the economy can produce with a given amount of resources. This production possibility curve AF like the Table 1.1 illustrates that, in a fully employed economy, an increase in the amount of cloth necessitates a decrease in the amount of wheat. As we move from A towards F on the curve we sacrifice some units of wheat ror having more of cloth. On theother hand, if we move up from F towards A, we will be giving up somne amount of cloth for the sake of more wheat. The production possibility curve is also called transformation curve because in moving from orne point to another on it, one good is "transformed" into another, not physically but oy transferring resources fromn one use to the other. With the given resources being fully employe and utilized, the combination of two goods produced can lie anywhere on the productio possibility curve AF but not inside or outside it. For example, the combined output of two goods produced can neither lie at U, nor at H (see Fig. 1.2). This is so because at point U the economy would not be utilizing its resources fuly, and the output of two goods represented by point H, given the productive resources, would lie beyond the capacity of the economy to produce The Nature and Scope of Economic Theory 25 The Problem of Unemployment and Under-utilisa tion of Resources. However, during h wrinis when the ecoNomy is not fully utilizing its resources, or not using them most inth., that is, wthen there is either unemployment or inefficiency in the useof of resources, two products output combination will lie below the economy's production possibility frontier, such 1.2., as at a point like Uin Fig. where the economy can produce more of both the goods or more of either of the two goods (as indicated "H Wheat by arrows) by putting the unemployed resources to work. As the shown by arrows in Fig. 1.2, if then by economy is working at U. most using its idle resources fuly ard Uto efficienth. it can move from production Q or to R. or to Son the P X possibility curve. Cloth in Economic Growth and Shift of Resources Production Possibility Curve Fio. 1.2. The Problem of Under-utilisation production to the question of economic growth and see what happens to the already Let us turn capacity increases over time. Asresources the economy's productive possibiity curve when curve of productive is drawn with a given amountincrease, pointed out, the protuction possibility the production equpment. Now, if the productive resources be ie land. abour and capital showing that more of both goods can outward and to the right possibiity cuve will shift economy makes progress in technology, that is, prodced than before. Further, when the things, the production scientists and engineers discover new and better ways of doingproducing more of both when the will indicate the possibility of possbilty curve will shift to the right andimproving productive efficiency allows the society to by the goods. Technological progress with a given and fixed amount of resources. produce more of both the goods when the From above it follows that increases or an supply of resources the improvement in technology occurs, outwards production possibility curve shifts 1.3. On such as from PPto PP, in Fig.PP, the production possibility curve on than etonomy can produce more goods amount of Wheat Curve PP The increase in the and capital. natural and human resources determinants of progress in technology are of economic growth. Thus, with the growth the economy, the production possibility curve shifts outward. understand the t is very important to Cistinction between ) the movement of the Cloth X economy from a point inside the production Possibility Curve due possibility curve to a point on it. such as rom Fir. 1.3. Shift into Production Economic Growth pOnt Uto point Q in Fiqure 1.2 and () the Advanced lonoic Theory 26 movement of the economy from one production pOssibility curve to another. In both cases national productor output of goods and services increases. But the former involves full employnment of given resources whilethe latter involves the increase in resources or productive capacity. While the first type of movement is dealt with by the short-run Keynes' income and employment or nacro economic theory, the latter is dealt with by the theon of theory economic growth. The fact that, in both these movements of the economy, the national product orincome increases they are likely to be confused with each other. But the ti moements are of quite ditferent nature and ditferent types of measures are required to brina them about. When the economy is working at a utilization point below its curve due to the lack of aggregate demand as it happens at times of depression production possibility in countries, then those policy measures have be adopted which raise the level ofthe capitalist demand. The increase in aggregate demand under such circumstances will bring aggregate of the economy from apoint below the production about a shift possibility curve mean full utilisation of available labour and capital resources and, as a to a point on it. This will result, the levels of national income, output and employment will rise and the existing utilisation of productive capacity will be removed. unemployment and under On the other hand, when the economy is fully utilising its given working at apoint on the production possibility curve, the increase resources and is, therefore, in national output and employment cannot be achieved by simply raising aggregate demand. Under such circumstances, national income and employment can be increased by adopting measures which economic growth. The measures aimed at generating economic growth will involve generate stepping up of the rate of capital accumulation and making progress in technology. Production Possibility Frontier and the Law of Increasing Opportunity Cost The production possibility frontier AF in Figure 1.1 shows an important economics. That principle is the law of increasing opportunity cost. The opportunity principle of acomnodity means the amount of a next best commodity foregone for cost of extra unit of the commodity. The reduction in output of a commodity producing an foregone productive resources which can be used for the production of additional units of thereleases other commodity. From looking at the Table 1.1 it will be clear that, as we move from possibility A to possibility B, we have to give up one thousand quintals of wheat in order to have one thousand metres of cloth. It means, in other words, that a first thousand metres of cloth have the opportunity cost of one thousand quintals of wheat to the society. But as we step up the production of cloth and move further from B to C, extra two thousand quintals of wheat have to be forgone for producingextra one thousand metres of cloth. Thus, in one thousand metres of cloth involve the opportunity cost of two thousand moving from Bto C. As we move further from Cto D, D to E and E to F. the quintals of wheat. have to make for having extra one thousand metres of cloth sacrifice in terms of wheat which we goes on words, opportunity cost goes on increasing as we have more of cloth andincreasing. less of In otne Cost of extra one thousand metres of cloth as we move from C to D. wheat. The D to E and E to Fis thousand. 4 thousand and 5 thousand quintals of wheat respectively. It is increasing opportunity cost that makes the production this principle o possibility curve concave to the org But the question now arises: Why does the cioth increases as we produce more of cloth. Asacrifice of wheat or the opportunity cost simple answer to this question is that economic resources are not equally suited or adaptable specificity of resources: a given resource is more suitedtotoalternative the uses. This is knovwn another. Thus, land is more suited to the production of wheat production of one good thot wheat requires relatively larger use of land than cloth. As we than cloth. The production resources which are less and less adaptable or productive inincrease the production the production of Clou" of cloth would have to be pushed in that line of production. As we move fron A towards F. we will Advancd Economic Theory 20 function of investment in capital alone but also depends on technological pprogress, expansion health care, and institutional changes such as land reforms in agriculture education inMoreover, and the real problem of developing countries is not merely to generate and prornote in GNP but also to eradicate mass poverty and chronic unemployment T high growth rate hiaher rat scarce resources efficiently to generate raising the rate of saving and allocating sufficient condition of eliminating mass poverty ar ronomic growth is necessary but not a large-scale chronic unemployment. believed that benefits of growth wo Of course, in the fifties and sixties it was widely place, the problers trickle down to the poor and unemployed and therfore once growth takes poverty and unemployment faced by the developing countries would automatically be solved of of poverty and unemployrnent This has been belied by the actual experience. For removal also of what is being produced and hou: what is required is not only the growth of output butwrites, "Buta growth in wealth is not at the output is being distributed. Thus, Joan Robinson paean was raised in praise of growth. all the same thing as reducing poverty. A universal bother about poverty. Growth wil Growth was going to solve all problems. No need to need to pay attention to it. The any lift up the bottom and poverty will disappear without with the same cry. "18 economists who should have known better, fell in To sum up, Robbins' definition which lays stress on allocation of scarce resources to meet growth, poverty andunemployment variousends does not fully bring in itsambit the problems of Robbins' definition was accepted faced by the developing countries like India. For a long time does not indicate adequately the Rabbins' definition as aproper one but nowadays it is felt that As we have pointed out above, Robbins content, scope and the subject-matter of economics.employment determination as well as the definition does not cover the theory of incomne and Schultze of the University of Maryland. theory of economic growth. According to Charles does not fuly reflect two "Robbins'definition of economics is misleading, in particular it and instability. "9 growth of the major concerns of modern economics, namely, Economic is What Economists Do. of giving proper However in recent years economists have stopped discussing the problem definition has definition of economics and the controversy regarding its proper and adequate economics is about. almost stopped. Many modern economist think that for explaining what understo0d by about can he better there is no necessity for defining it. What economics is which they are knowing subjects with which economists have been concerned and with is wihat concerned to day. Therefore, Professor Jacob Viner has remarked." Economics knowng economists do." Thismeans what economists is about can be better understood from a the questions which economists have raised and discussed. What economnics is about therefore be better understood from the studyof its subject-matter. We have discussed a the various questions and issueswith which economists are concerned. POSITIVE ECONOMICS, NORMATIVE ECONOMICS AND WELFARE ECONOMICS normative It is important to know the difference between positive economics and economics. Positive economics is concerned with explaining what is, that is, it describesthheories concerned and laws to explain observed economic phenomena, whereas normative economics isS Oxford 18. Joan Robinsorn, The Second Crisis of Econonic Theory. printed in her Selected Economic Writings. University Press, 1974. p. 245. 19. Charles L. Schulze, National Income Analysis (Foundatioons of Modern Economics), 1965, p2. The Nature and Scope of Economic Theory 21 with what shoud be or what ought to be the things. J. N. Keynes draws the distinction between the two types of economics in the following manner: "A positive science may be defined as a body of systematized krnowledge concerning what is, normative science or aregulative science is a today of systematized knowledgerelating to criteria of what ought to be, and is concerned with the ideal as distinguished from the actual....The objective of a positive science is the establishment of unitormities, of a normative science, the determination of the ideals." 0 Thus, in positive economics we derive propositions, theories and laws following certain rules of logic. These theories, laws and propositions explain the cause and effect relationship between economic variables. In positive microeconomics, we are broadly Concerned with explaining the determination commodities. In positive of relative prices and the allocation of resources between different national income and macroeconomics we are broadly concerned with ho the level of level of prices are employment, aggregate consumption and investment and the general prices, what should be determined. In these parts of positive economics, what should be theshould be the distribution the savingrate, what should be the allocation of resources, and what what should be and what ought to be fall of income are not discussed. These questions of given the profit maximization assumption, within the purview of normative economics. Thus, which willequate marginal cost with positive economics states that monopolist will fix a price be or ought to be fixed so that maxinum marginal revenue. The question what price should positive economics. Similarly, given the social welfare is achieved lies outside the purviewof what actual wage rate is determined. monopoBy in the labour market, positive economics explains that they does not go into the question how much wage rate should be paid to the workers sodistributed It income between different individuals is should not be exploited. Likewise, how national positive economics is not concerned with economics. But falls within the domain of positive economics is question of how income should be distributed. On the other hand, normative the concerned with describing what should be the things. It is, therefore, also called prescriptive What price for a product should be fixed, what wage rate should be paid, how economics. within the purview of normative economics. income should be distributed, etc., fall should be noted that normative economics involves value judgements or what are It people simply known as values. By value judgements or values is meant the conceptions of the or bad. These conceptions regarding values of the people are based on the about what is good ethical, political, philosophical and religious beliets of the people and are not based upon any logic or law. Because normative economics involves value judgements, eminent scientific should not become normative in character.21 economist L. Robbins contended that economics judgements in the economic analysis. To that it was unscientific to include the value He opined mnore and more conceived of as that of the expert. quote him, "the role of the economist is follow certain actions, but who cannot judge as who can say what consequences are likely to drawing difference between economics and an economist the desirability of ends".22 While ascertainable tacts, ethics with valuations and ethics he further writes, "economics deals with plane of discourse. Between the obligations, The two fields of inquiry are not on the same logical qulf fixed which no generalisations of positive and normative economics, there is a space or time bridge over. Propositions involving ingenuity can disquise and no juxtaposition inpropositions involving the verb 'is23 the verb ought' are different in kind from cannot be Value judaements of various individuals differ and their rightness or wrongness decided on the basis of scientific logic or laws. Therefore, in our view, positive economics London, 1930. p. 46. 20. JN. Kevnes Scone and Method of Political Economy, Macmillan, 21. L Rcbbins. "Nature and Siqnificance of Economic Science". Macrnillan, London, 2nd Edition. 1938. 22. bid. 23. lbid 22 Advanced Economic Theory shouid be kept separate and distinct from normative economics. However, from the fact tha normative economics involves value judgements, it does not mean that it should be considere as useless or not meaningful and should not be the concerrn of economics. As a matter of fat manyvital issues concerning economic welfare of the society necessarily involve some valo judgements. If economics is to become an 'engine for social betterment, it has to adopt certain norms, ideals or criteria with which to evaluate economic policies and pass judgements on what is good and what is bad from the viewpoint of social welfare. We agree with A. C. Piqou "our impulse is not the philosopher's impulse, knowledge for the sake of knowledge but rather the physiologist's knowledge for the healing that knowledge may help to bring. "24 As is clear from above, normative economics is concerned with welfare propositions. since what is good or what is bad ultimately depends upon its effect on the welfare of the individualand the society. In recent years, a branch of economics known as welfare economics has been developed. This welfare economics seeks to evaluate the social desirability of alternative social states or economic organisations. Thus, Sotitovsky writes, "welfare economics that branch of economic analysis which is concerned primarily with establishment of criteria that can provide a positive basis for adopting policies which are likely to maximise social welfare" 25 In short,welfare economics is to prescribe criteria or norms with which to judge the desirability of certain economic re-organisatiom and prescribe policies on that basis. However, an imnportant difference between positive economics and welfare economics may be noted. The propositions or lawS of positive economics are derived from a set of axioms. Whereas the propositions or laws so derived are capable of being tested and verified by observations of the facts in the real world, the propositions of welfare economics cannot be So tested and verified because we cannot know whether welfare has actually increased or not. This is because welfare is not an observable quantity like price or quantities of goods, "it is a subjective., bird of an other sort".o We cannot measure welfare in cardinal terms. Being of welfare or satisfaction resides in the mind of an individual and, therefore, it is not capable in testing a being measured in quantitative terms. Further, there are still more difficulties welfare generally proposition regarding social welfare because propositions regarding socialstates, "the normal involve value judgements of some sort. Thus Graff is very right when he normal way of 'the way of testing a theory in positive economics is to test its conclusions, judge the validity of testing a welfare proposition is to test its assumptions. "27 Therefore, to invariably involve the weltare propositions we must test its assumptions or premises which value judgements. To quote Graff again, "in positive economics, the proof of the pudding 5 indeed in the eating. The welfare cake, on the other hand, is so hard to taste, that we must test its ingredients before baking" 28 From the above it seems that difference between positive and welfare economics is qulie clear; in one case what man does without considering the favourable or unfavourable eiecis on others while in the other it is what he should do and must consider the favourable o economicsis unfavourable effects on others. But the distinction between positive and welfare not as clear as it is supposed to be. Everyman does what he thinks is the best for him. It ney be that he does often what others do not consider to be best for him. But in such Cases probability of a faulty judgement by others is equal to is own faulty judgement. Thus. does man being a common factor in both the cases it is reasonable to conclude that "what a difference and'what he should do' are one andthe same thing in every case and that there is no 24. A.C. Pigou, Economics of Weifare, 4th Edition, Macmillan, London, 1932, p.5. 25. Tibor Scitovsky, Papers on Welfare and Growth. 1962, p. 1974. 26. J. De V. Graff, Theoretical Welfare Economics, Cambridge University Press, 1957. p.2, 27. bid. p. 2. 28. bid, p.2. The Nature and Scope of Economic Theory 23 hofveen positive and normative or welfare economics when judged from the individual's point of view. Athough there is no difference between positive and welfare economics when judged fim between the two by the individual point of view, yet it is poSsible to make out a difference best for an individual may adoptinga social point of view. Any course of action which may be a man thinks best for him what ot be best for the society. Thus, there is a difference betweenthinks best for him. he does not what he and what is best for the society. When aman does 'should' is given a sociai connotation, the nocessarily do what is best tor the society. If the word be done' beComes clear. Thus only by should difference between 'what is done and what and welfare economics can be differentiated positive adopting the social point of view, the from each other. BASICTOOL OF ECONOMICS 21 D1. Introduction to Scope of Economics Eminent economist J.N. Keynes in his book The Scope and Method of Economics" had incuded the study of the following three things under the scope of economics: (i) Subject matter of Economics (ii) Nature of Economics and (iii) Relation of Economics with other sciences. Many modern economists study the 'limitations of economics' in place of its relation with other sciences under the scope of economics. As such, following topics are included under scope of econormics: (1) Subject Matter of Economics (2)Nature of Economics (3) Limitations of Economics. O1.1 Subject Matter of Economics () Different view8: According to Samuelson, to describe the subject matter of economics in a few lines and to delimit it from other subjects and to explain to a new student what economics is about, is a dificult task. In this context Mrs. Wootton says, "Wherever six economists gather, there are seven opinions." This statement is fuly applicable to the subject matter of economics. Economists have different views with regard to the subject matter of economics. () According to the great thinker Aristotle, the subject matter of economics is the economic management of state and household. (ii)According to Adm Smith, it is an enquiry into the nature and causes of wealth." (iii) Marshall and other neo-classical economists have widened the subject-matter of economics by including in it the study of those activities of social. beings which are connected with the material requisites of welfare. (iu) Lord Robbins has further WANTS widened the subject-matter of economics. According to him subject matter of economics is related to (i) ECONOMIC those efforts of human beings which they undertake (i) to acquire scarce resources in order to (iii) satisfy their unlimited wants. As a result of these EFFORTS SATISFACTION efforts they get economic goods or wealth. When with the help of these goods they satisfy one want, at CIRCLE once, another want crops up. In this way, economic circde as shown in figure moves on. It is this economic circle which is the beginning and end of the WEALTH subject-matter of economics. According to modern economists, like Samuelson, Boulding, Leftwitch Figure 1 etc. the subject-matter of economic relates to (A) economic activities (B) economic systems and (C) economic policies. (A) Economic Activities: Subject-matter of economics is concerned with the study of economic activities. Its study is divided into two parts: (a) Kinds of Economic Activities (b) Objectives of Economic Activities 22 Bouldinghas divided economic activities into the (O) Kinds of Economic Activities: Prof. following parts: concerned with the use of )onsumption: Consumption is that economic activity which is For example, wearing of a shirt, eating onomiCgoods and services for the satisfaction of human wants. of bread, drinking of milk etc. are consumption activities. concerned with increasing the utility or value (1)Production: Production is that activity which is OT thegoods and services. Manufacturing biscuits with the help of Maida, sugar and labour is an actof where it is needed, is also an act of Proaucton. Iransporting of sand from the river bank to a town, (iu) enterprise and (v) production. There are five factors of production: () land (i) labour (iii) capital organisation. a factor of production is (iii) Exchange: Activity relating to the buying and selling of a product oractivity is also called price This called exchange. This buying and selling is mostly done in terms of money. determination and it is divided into two parts: product under different (ii) (a) Product Pricing: It relates to the determination of the price of the conditions of the market, viz. perfect competition, monopoly and imperfect competition. factors of (iii) (b) Factor Pricing: It relates to the determination of the price of different production. Price of land is rent, that of labour is wage, that of capital is interest and price for the services of 'distribution'. the entrepreneur is profit. This activity is also called Chapmnan has rightly said, "Economics is that branch of knowledge that studies consumption, production, exchange and distribution of wealth.'" (b) Obiectives of Economic Activities: According to modern economist Ragnar Frisch, econonic activities have two main objectives. (i)proper allocation of the resources and (i) efficient use of resources. Proper allocation of resources is asubject of study of Micro-economics and efficient use of resources is a subject of study of Macro-economics. Thusstudy of economic activities is split up into two parts: (a) Micro Economics: Onder it the economic activities of an economic unit, or a group of ononomic units,are studied. For instance,demand of a commodity by a consumer or demand of that commodity by the market. This part of economics covers the study of: (1) Theory of Demand (2) Theory ofProduction, (3) Prodúction Function, (4)rice determination, (5) Factor pricing or distribution, and (6) Economic Welfare. isa Meero Economics: Macro-economicsS Is the study of aggregates or average covering the anine economy. It therefore studies (1)Natonal income (2) Fulemployment (3) Price level ncsion (5) International Trade (6)Public Finance (7) Money and Banking Institutions I81 Fconomic growth (9) Trade Cyeies and (0) Macro Iheories of Distribution of National Income etc. D Eeonomic Systems: On the bass or tne organisation and institutions are divided into three parts: (i) relatina to economic the economic systems Capitalism: people are free to consume, produce and exchange the goods. There is no interference In activities, this system of the government in the economic activities of the citizens. People can accumulate private property. (li) Socialismn: Under this economic system, activitieslike consumption, production, exchange etc. are fully under the control of the 23 govemment. People cannot kep private property. (1) Mixed Economy: Under this system some economic activities are controlled by the government while others are left to be managed by the people as they wish. (C) Economic Policies: As a result of the operation of economic systems there arise several economle problems, like unemployment, price-rise, poverty, depression etc. In order to tackle these problems, study of economics examines such policies as (1) Monetary policy (2) Fiscal policy (3) Price policy (4) Economic planning and (5) International Liquidity. In short, Anatol Murad says, "The subject-matter of Economics is the description of nature and behauiour of an economy or of an economic system and investigation of economic problems with the object of offering solutions. 2. Nature of Economics By nature of a subject it is meant whether it is science or an art or both science and an art. The objective of the study of the nature of economics is to know whether economics is ascience or an art or it is both a science and an art. If it is a science, whether it is apositive or a normative science or both? In the words of Samuelson, "Economics is the oldest of the arts, the newest of sciences, - indeed the queen of all the social sciences." Nature of Economics Science Art Positive Normative 02.1 ls Economics a Science ? To find an answer to this question, it is essential to have knowledge of two things: () What is a Science ? (i) What are the characteristics of a science? (1)What is a Science ?: The term 'science' is derived from Latin word 'Scire' meaning to know'"'. Knowing a subject means understanding it andbeing able to explain its causes and effects. Science is defined in these words, "Sclence is a systematic body of knowledge concerning the relationship between causes and effects of a particular phenomenon." For instance, an economist observes that when prices rise ordinarily demand contracts. Or, when a consumer buys more and more units of a commodity the utlity of each successive unit goes on diminishing In this way, an economist compiles facts concerning economic activities. But mere compilation of facts is not science. In the words of Poincare "Science is built up of facts as ahouse is built of stones ; but an accumulation of facts is no more a science than a heap of stones is a house." In other words to build science, wehave to collect, claify and analyse the facts systematically. In Economics also we have to accumulate, classify and analyse economic facts systematically. (2) Characteristics of Science: Renowned philosopher Bacon has pointed out four main characteristics of science: 24 (a) Observation of facts (b) Measuremernt (c) Explanation and (d)Verification. Detailed study of these facts can prove that economics is a science. (a) Observation of facts: To begin with, facts relatingto a subject are observed. In economics, facts relating to economic activities are observed. For example, an economist observes that when prices rise, ordinarily demand contracts. When a consumer buys large quantity of a commodity then its utility by the economists. diminsnes. In this way, facts pertaining to economic activities are observed Measurement: Facts are subiected to measurement in science. ForAnthis purpose, facts ara properly(0)classified and presented. In economics also, facts are measured. economist will try to measure how much demand has contracted as a result of a aiven rise in price. If there is unemployment in the country what is the number of unemploued ? At which rate the national income of the çountry is growing? With a view to measuring these facts theeconomist seeks the help of mathematics, statistics and econometrics. The facts so compiled are called data or statistics. (c) Explanation: After observing, compiling and measuring the facts the sarne are sOught to be explained in science; in other words, the same are put to a systernatic study. Economic laws are frarned by establishing a relationship between the cause and efect of a fact. For example, Law of demand is formulated in economics on the basis of the study of the relationship between change in price (cause) and the change in demand (effect). () Verification or Validity of laws: The final feature of science is that by applying the scientitie laws to real life it is verified whether the same are valid or not. In other words, whether the same are in conformity ith the facts or not. Every science seeks to verify the validity of its laws. The validity of the laws can be verified in twoways: (a) lf a law is based on real assumptions, it is regarded valid (b) If the prediction based on a law comes true then also the law is considered valid. For this purpose experiments are also conducted. Validity of economic laws is also subjected to verification. For instance, many economic laws,such as, lawof diminishing returns, law of diminishing marginal utility etc. are treated as valid because they apply to the real happenings in life. It is evident from the above that economics is a science. But some scholars do not agree with this view. They maintain that economic laws are not as exact and universal as the laws of physics and chemistry etc. In reality their disagreement is not justified. According to Seligman, science has two branches: (1)Natural science and (2) Social science. Economics is a social science because it deals with men ; whereas physics, chemistry etc. are natural sciences as they deal with lifeless matter. (3) Arguments in Favour of Economics beling a Social Sclence Following arguments are given in favour of economics being a social science: ()Systematic Study: Economics is concerned with the study of one subject alone, that is, the studyof inter-related activities like consunmption, production, exchange etc. of wealth. Facts concerning uwith economic activities are compiled and observed. The same are classified and measured, How Anil M..hlo can màke more runs in a cricket test match or how B.R. Chopra can produce good movies, are not the subjects of study. of economics. These are not interdependent activities. 25 () Scientific Laws: Laws of economics, such as, law of demand, law of supply etc. are scierntific laws. These laws establish causal relationship between economic events. Law of demand states that as the price of a commodity rises its demand is likely to contract. In this way, this law establishes a relation between change in price (cause) and consequent change in demand (effect). (u1)Validity of the Lawe: Every science verifies the validity of its laws. lfa law is based on real assumptions or its predictions come true, then it is regarded valid. Many laws of economics, like law of diminishing returns, law of diminishing marginal utility are based on real experiences of life and so are treated valid. It is therefore evident that economics is a social science. It is a systematic study of the economic activities of the human beings based on scientific laws. (4)Arguments against Economics being a Natural Science Those who hold that economics is not ascience actually mean to say that it is not as exact a science as a natural science is. They advance the following arguments against its being a natural science: () Difference among Economists: Economists differ mostly in respect of economic problems. Onthe contrary, natural scientists have very itle difference among themselves in respect of their subject. (11) Exact Laws: Laws of natural sciences, such as, physics law of Gravitation is an exactly perfect law. According to this law, anything thrown up must come down to the earth because of the gravitational pull of the earth. On the other hand, laws of economics are not exactBy perfect. They are mere statements of tendencies. Law of demand will be valid only iÍ there is no change in the income, fashion etc. of the consumer. (1) Untversal Laws: Laws of natural sciences are of universal applicability. They hold good at all times and at all places. Economics laws are far from being universal. They are not applicable at all times and at every place. They are liable to change as theydeal with human beings. (iv) Verification of Truth: Natural scientists can verify the truth of the laws pertaining to their science in the laboratories through experiments. They can also make correct predictions on the basis of these laws. Economics has no laboratory to verify the correctness of its laws. Measuring-rod of money is the only apparatus available to it to measure economic activities but it is not exact. The value of money iself goes on changing, as such, it cannot sèrve as adependable measure. No wonder, predictions based on economic laws many a time prove wrong. At the best it can be said that as against other social sciences, economics is a more exact science, as it has money as the measuring rod to measure economic activities. In short. it can be maintained that economics is not a natural science. It is a social science. O2.2 Is Economics only a Positive or a Normative Science? With regard to the nature of economics, another question that arises is whether it is only a positive science or a normative science. Economists are not unanimous in this respect. According to Robbins, Friedman etc. economics is only a positive science. On the other hand, Marshall, Pigou, Hawtrey etc. are of the opinion that it is both a positive and a nomative science. O2.3 Economics is a Positive Science Positive science is that science which studies an accurate and true description of events as they happen. In the words of R.T. Bye, "Positive science confines itself to accurate description ofphenomena, 26 itexplains what is, how it works and what t are its effects." According toJ.N. Keynes, 'A Positive Science may be defined asabody of sustematised knowledge concerning, what is ? Positve science confines itself to the study of: what, how and why. Its study does not tell: what ought to be. Positive science has no place for any kind of suggestion. Eminent classical economists like Senior and modern economists like Milton Friedman, Lord Robbins etc. are of the opinion that economics is only a positive science. It studies what is ? What was? and what will be ? Study of economics explains what is the rate of wage, How is it determined? It does not explain what ought to be the rate of wage. In the words of Boulding, "The economist studies the choices, he does notjudgethem." According to Lord Robbins, "The function of economist is to explore and explan and not to aduocate or condemn." Statements relating to positive science are subject to verification. UArguments in Favour of Economics being a Positive Science Lord Robbins is of the opinion that if economics is restricted to apositive science, it will have the fol lowing advantages: () More Logical: Basis of positive science is logic while that of a normative science is emotion. Being based on logic, positive science is more exact. It is by logic that the relationship between cause and eftect of an act can be established. If economics confines itself to be a positive science, it can make excessive use of logic. More use of logic will render economics more exact. (2) More Efficiency: Thepositive and normative aspect of every problem is studied separately to take advantage of the division of labour. In case of division of labour a workisdivided into many parts and each part is entrusted to a separate worker. As a result, each worker becomes efficient in his work. Likewise, it is suggested that if the economists concentrate on the positive aspect of and leave the normative aspect to be looked after by the politicians and social economic activities their job in a more efficient manner. scientists, then theywill do (3)More Uniformity: If economics concerns itself with the study of it will evoke less disagreement and more agreement among the realities of economic activities economists. This will be conducive to the progress of this science. If, on the other hand, itwill be studied both as a then the possibility of its evoking disagreemernt among them will increase.positive and normative science (4) More Neutrality: The economist will not what ought to be' simultaneously. Whatever stay neutral if he seeks to know both what is' and facts in that very context. Thus hewOuld fail tosuggestions he would like to give, he would try to present the is therefore essential to study economics as a present the economic activities in their true perspective. It positive science only to know the tue facts (B) Formulation of Theories: A theory example, law of.demand states the relationship expresses the mutual relationship between facts. For ALin function of economics is to tormulate economic between 'price' and 'demand'. As a positive science, micsrestricts itself to the study ot facts as they theories. This function can be best discharged if are and does not indulge in passing the facts (or ends) are desirable or not. iudoment whether D2.4 Economics is also a Normative Science Many eminent economists, like, Marshall, Pigou, normative science. Anormative scienceeis one that aims at Hawtrey, Wolf etc. regard economics as a determining norms' or 'values' or ideals'. Itis 27 asciencewhose object is also to assist in the solution of concrete problems. J.N. Keynes has apty said, A normative science or aregulatory science is a body of systematised knowledge relating to criteriaof "uwhat ought to be' and concermed with the ideal as distinguished from the actual. The object of normative science is the determination of ideals." Asa nomative science, economics offers several suggestions. For example, it counsels that there should be economic development of the country, prices should be stabilized, full ernployment should be achieved, income should be equitably distributed etc. Economics /s not concermed with examining the facts only but it has to set economic noms as well. In the words of Pigou,Economics is chiefiy valuable neither as an intellectual gymnastic nor even as a means of winning truth for its own sake, but as a handmaid of Ethicsand a servant of practice." Economics is therefore not concemed with mere collection of facts. It is nat enough for the economist to explain and analyse the problem. He has to offer suggestions for the solution of concrete problems. He has to pronounce judgments and tender advice on economic issues. According to Mahatma Gandhi, "Such an economics as assauts moral values of individualsand nature, is immoral and repugnant." Normative statements are not verifiable. O2.5 Arguments in Favour of Economics being a Normative Science Folowing arguments are offered in favour of economics being a normative science: (1) More Practical: Economics studies the economic activities of man. Economic activities are based not only on logic but also on emotions. If economics is to be made more useful and practical, then alongwith logic, care must also be taken of man's emotions. In that event, economics must decide, what ought to be' and what ought not to be'. As anormative science, it will prove more practical. (2) More Useful: Economics is a social science. It should suggest ways and means to promote economic welfare of man. It can become more useful if it is not only "light-bearing'", but also "fruit-bearing'". Economics should not merely analyse and examine economic activities but also offer sugqestions to render them more useful. Economics can be of great service to mankind as a normative science. (3) More Economical: If the economist synchronizes the analysis of economic problems with concrete economic policies he would save time. It willbe a huge waste of time, if economic facts are to be analysed by the economist as an armchair academician and economicdecisions are to be made and implemented by another person. Propriety demands that the person who explores and explains the economic phenomenon should also take concrete decisions regarding the economic objectives and suggest measures to achieve themn. (4) More Realistic Approach: From the very beginning economic growth has been the subject of study of economics. In the modern era, study of problems concerning economic planning and eco nomicgrOwth has become the main subject matter of economics. In reality, economics studies subjects like economic welfare, economic development and proper allocation of resources etc. Study of these sub jects has made economics a normative science. In short,Prof. Wagner has rightly said, Economics is bothapositive and a normative science.' 02.6 Is Economics an Art ? There isa controversyamong the economists as to whether economics is an art or not. According to Walras, Cournot, Robbins, etc., economics is not an art. But Marshall, Pigou, etc. are of the view 28 that economics is nottonly ascience, it isalso an art. Before entemningintofurther discussion itt is to know what is an art? According to Cossa, sclence is concerned with 'knowing' and art is pertinernt with 'doing'. "Art isthe practical application of knowledge for achieving definite ends." In the Wagner, "Art is the examination of ways and means for attaining a definite aim." Inthis words of concemed Keynes says, "An art is a:system of rules for the attainment of given ends." Eminent Italiancontext J.N. Cossa also says, "Art directs, Art imposes, predicts or proposes rules. It solves general problems." economist J.N. Keynes has used the term 'Applled Economics' in place of the term 'Art'. Modern economists substitute the term 'Economic Policv for 'Art'. As an art, economics helps us in the soluti ofour practical problems. Its study engbles us to know the best methods of achieving economic objectives OArguments in Favour of Economics being an Art Economics is regarded as an art on the following counts: (1) Solution of the Problems:Economics can be a more useful subject for the help in the solution of their economic problems, Economics tells us how an people if it can economy can make most efficient and optimum use of its scarce resources. In this connection Pigou says, "Economics is not onlu light-giving but also fruit-bearing." (2) Realistic Situation: The realistic situation with regard to the study of economist spends most of his time in solving the real economic problems of life, economics is that an such as, inflation. unemployment, depression, economic development, etc. According to Stigler, more than ninety percent of economists spend more than half of their time in solving practical It is as an art that economics chalks out problems through economics. policies relating to the promotion of economic welfare of the people. (3) Practical basis of Assumptions: We can remove the doubts that arise with regard to the real nature of economic laws by dividing economics into science and art. For instance, many laws of economics are based on the assumption of perfect competition. It can therefore be concluded that formation of Trade Unions will violate economic laws. But organisation of Trade Unions to ameliorate the conditions of thewhen economics as an art suggests the opposed in priniciple. labourers, then such unions will not be (4) Verification of of economic theories. It is Economic Theories: Study of economics as an art facilitates the verification through art that their principle that devaluation promotes exports. The validity can be verified. For example, it is an of this principle can be verified by economic practice. If in practice it proves otherwise, then avalidity new puttingit into OArgumnents against Economics being an Art principle will have to be explored. Following arguments are advanced against economics (1) Different Nature of being an art: Science and economics is a science then it cannot be an art. OnArt: Science and art differ in their the contrary, if it is respective nature. I no claim on scientific base. recognised as an art then itwill have (2)Nature of uog much influenced by Economic Problems: Economic problems are not situation of political, social and religious nature. It purely economic. They are for the economists to tackle the problems from economic point of will therefore not be possible view alone. 29 (3) Uncertainty: If economics is treated as an art then different economists will frame different policies and suggest diferent measures to solve divese economic problems. These suggestions may be contradictory. This will impart an element of uncertainty to economics. (4) Lack of Immediate Solution:Economics cannot be made use of to seek immediate solution of economic problems. In the words of J.M. Keynes, The theory of economics does not funish abody ofsettled conclusions immediately applicable to policy, It is a method rather than adoctrine, an apparatus of the mind technique of thinking, which helps its possessor to draw correct conclusions. " OConclusion In short economics is both a science and an art. In the words of Cossa, "Science requires art, art requires science, each being complementary to the other." Prof. Mehta has given a suggestion to remove any doubt on the subject. He suggests that as a science it should be called 'economics" and as an art it should be called "economy." Regarding the nature of economics,Chapman, has aptly said, Economics is a positive science dealing with economic facts as they are, a normative science inquiring facts as they ought to be and an art finding out the ways and means by which the desired ends can be reached.'" D3. Limitations of Economics Study of scope of economics willbe incomplete without the mention of its limitations. The same are given below: (1) Study of Human Activities Only: Economics deals with the activities of human beings. Study of birds, animals and lifeless- matter is beyond its scope. (2) Study of RealMan: It deals with the economic activities of real man and not economic man as suggested by classical economists. An economic man is one who works for self-interest. (3) Study of Average Man: Economics is concerned with the study of an average man. It does not deal with extra-ordinary persons like, criminals, misers, lunatics etc. These days anti-social and illegal economic activities like, black marketing, black money and smuggling etc, operate to the detriment of the economy. So the analysis of these activities also form a part of the study of economics. hes (4) Study of Social Man: There has been a difference of opinion among the economists regarding the type of men to be studied under economics. Some are of the opinion that we should study the activities of such men who form apartof the society. Others hold that it should include the activitiesof allhuman beings irrespective of the fact whether they are a part of the social- frame or have an existence outside it. Dr. Marshall supports the view point of the former and Lord Robbins that of the latter. (5) Study of Economic Activities: Economics should concern itself with those activities of the men which are related to scarce means or wealth. Robbins holds that study of economics should embrace all sorts of activities concerning scarce means whether material or non-material. (6) Science and Art: Economics is a social science and an art. As a social science, it is botha positive and a normative science. But the norns are not set by the economists. Theseare set by the politicians or the social reformers. (7)Economics Laws: Economics' laws though scientific, are not as exact as the laws of natural sciences. 01. ECONOMICS – DEFINITION AND NATURE & SCOPE OF ECONOMICS – DIVISIONS OF ECONOMICS Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The central focus of economics is on scarcity of resources and choices among their alternative uses. The resources or inputs available to produce goods are limited or scarce. This scarcity induces people to make choices among alternatives, and the knowledge of economics is used to compare the alternatives for choosing the best among them. For example, a farmer can grow paddy, sugarcane, banana, cotton etc. in his garden land. But he has to choose a crop depending upon the availability of irrigation water. Two major factors are responsible for the emergence of economic problems. They are: i) the existence of unlimited human wants and ii) the scarcity of available resources. The numerous human wants are to be satisfied through the scarce resources available in nature. Economics deals with how the numerous human wants are to be satisfied with limited resources. Thus, the science of economics centres on want - effort - satisfaction. WANT SATISFACTION EFFORT Economics not only covers the decision making behaviour of individuals but also the macro variables of economies like national income, public finance, international trade and so on. A. DEFINITIONS OF ECONOMICS Several economists have defined economics taking different aspects into account. The word ‘Economics’ was derived from two Greek words, oikos (a house) and nemein (to manage) which would mean ‘managing an household’ using the limited funds available, in the most satisfactory manner possible. i) Wealth Definition Adam smith (1723 - 1790), in his book “An Inquiry into Nature and Causes of Wealth of Nations” (1776) defined economics as the science of wealth. He explained how a nation’s wealth is created. He considered that the individual in the society wants to promote only his own gain and in this, he is led by an “invisible hand” to promote the interests of the society though he has no real intention to promote the society’s interests. Criticism: Smith defined economics only in terms of wealth and not in terms of human welfare. Ruskin and Carlyle condemned economics as a ‘dismal science’, as it taught selfishness which was against ethics. However, now, wealth is considered only to be a mean to end, the end being the human welfare. Hence, wealth definition was rejected and the emphasis was shifted from ‘wealth’ to ‘welfare’. ii) Welfare Definition Alfred Marshall (1842 - 1924) wrote a book “Principles of Economics” (1890) in which he defined “Political Economy” or Economics is a 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”. The important features of Marshall’s definition are as follows: a) According to Marshall, economics is a study of mankind in the ordinary business of life, i.e., economic aspect of human life. b) Economics studies both individual and social actions aimed at promoting economic welfare of people. c) Marshall makes a distinction between two types of things, viz. material things and immaterial things. Material things are those that can be seen, felt and touched, (E.g.) book, rice etc. Immaterial things are those that cannot be seen, felt and touched. (E.g.) skill in the operation of a thrasher, a tractor etc., cultivation of hybrid cotton variety and so on. In his definition, Marshall considered only the material things that are capable of promoting welfare of people. Criticism: a) Marshall considered only material things. But immaterial things, such as the services of a doctor, a teacher and so on, also promote welfare of the people. b) Marshall makes a distinction between (i) those things that are capable of promoting welfare of people and (ii) those things that are not capable of promoting welfare of people. But anything, (E.g.) liquor, that is not capable of promoting welfare but commands a price, comes under the purview of economics. c) Marshall’s definition is based on the concept of welfare. But there is no clear-cut definition of welfare. The meaning of welfare varies from person to person, country to country and one period to another. However, generally, welfare means happiness or comfortable living conditions of an individual or group of people. The welfare of an individual or nation is dependent not only on the stock of wealth possessed but also on political, social and cultural activities of the nation. iii) Welfare Definition Lionel Robbins published a book “An Essay on the Nature and Significance of Economic Science” in 1932. According to him, “economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. The major features of Robbins’ definition are as follows: a) Ends refer to human wants. Human beings have unlimited number of wants. b) Resources or means, on the other hand, are limited or scarce in supply. There is scarcity of a commodity, if its demand is greater than its supply. In other words, the scarcity of a commodity is to be considered only in relation to its demand. c) The scarce means are capable of having alternative uses. Hence, anyone will choose the resource that will satisfy his particular want. Thus, economics, according to Robbins, is a science of choice. Criticism: a) Robbins does not make any distinction between goods conducive to human welfare and goods that are not conducive to human welfare. In the production of rice and alcoholic drink, scarce resources are used. But the production of rice promotes human welfare while production of alcoholic drinks is not conducive to human welfare. However, Robbins concludes that economics is neutral between ends. b) In economics, we not only study the micro economic aspects like how resources are allocated and how price is determined, but we also study the macro economic aspect like how national income is generated. But, Robbins has reduced economics merely to theory of resource allocation. c) Robbins definition does not cover the theory of economic growth and development. iv) Growth Definition Prof. Paul Samuelson defined economics as “the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time, and distribute them for consumption, now and in the future among various people and groups of society”. The major implications of this definition are as follows: a) Samuelson has made his definition dynamic by including the element of time in it. Therefore, it covers the theory of economic growth. b) Samuelson stressed the problem of scarcity of means in relation to unlimited ends. Not only the means are scarce, but they could also be put to alternative uses. c) The definition covers various aspects like production, distribution and consumption. Of all the definitions discussed above, the ‘growth’ definition stated by Samuelson appears to be the most satisfactory. However, in modern economics, the subject matter of economics is divided into main parts, viz., i) Micro Economics and ii) Macro Economics. Economics is, therefore, rightly considered as the study of allocation of scarce resources (in relation to unlimited ends) and of determinants of income, output, employment and economic growth. B. SCOPE OF ECONOMICS Scope means province or field of study. In discussing the scope of economics, we have to indicate whether it is a science or an art and a positive science or a normative science. It also covers the subject matter of economics. i) Economics - A Science and an Art a) Economics is a science: Science is a systematized body of knowledge that traces the relationship between cause and effect. Another attribute of science is that its phenomena should be amenable to measurement. Applying these characteristics, we find that economics is a branch of knowledge where the various facts relevant to it have been systematically collected, classified and analyzed. Economics investigates the possibility of deducing generalizations as regards the economic motives of human beings. The motives of individuals and business firms can be very easily measured in terms of money. Thus, economics is a science. Economics - A Social Science: In order to understand the social aspect of economics, we should bear in mind that labourers are working on materials drawn from all over the world and producing commodities to be sold all over the world in order to exchange goods from all parts of the world to satisfy their wants. There is, thus, a close inter-dependence of millions of people living in distant lands unknown to one another. In this way, the process of satisfying wants is not only an individual process, but also a social process. In economics, one has, thus, to study social behaviour i.e., behaviour of men in-groups. b) Economics is also an art. An art is a system of rules for the attainment of a given end. A science teaches us to know; an art teaches us to do. Applying this definition, we find that economics offers us practical guidance in the solution of economic problems. Science and art are complementary to each other and economics is both a science and an art. ii) Positive and Normative Economics Economics is both positive and normative science. a) Positive science: It only describes what it is and normative science prescribes what it ought to be. Positive science does not indicate what is good or what is bad to the society. It will simply provide results of economic analysis of a problem. b) Normative science: It makes distinction between good and bad. It prescribes what should be done to promote human welfare. A positive statement is based on facts. A normative statement involves ethical values. For example, “12 per cent of the labour force in India was unemployed last year” is a positive statement, which could is verified by scientific measurement. “Twelve per cent unemployment is too high” is normative statement comparing the fact of 12 per cent unemployment with a standard of what is unreasonable. It also suggests how it can be rectified. Therefore, economics is a positive as well as normative science. iii) Methodology of Economics Economics as a science adopts two methods for the discovery of its laws and principles, viz., (a) deductive method and (b) inductive method. a) Deductive method: Here, we descend from the general to particular, i.e., we start from certain principles that are self-evident or based on strict observations. Then, we carry them down as a process of pure reasoning to the consequences that they implicitly contain. For instance, traders earn profit in their businesses is a general statement which is accepted even without verifying it with the traders. The deductive method is useful in analyzing complex economic phenomenon where cause and effect are inextricably mixed up. However, the deductive method is useful only if certain assumptions are valid. (Traders earn profit, if the demand for the commodity is more). b) Inductive method: This method mounts up from particular to general, i.e., we begin with the observation of particular facts and then proceed with the help of reasoning founded on experience so as to formulate laws and theorems on the basis of observed facts. E.g. Data on consumption of poor, middle and rich income groups of people are collected, classified, analyzed and important conclusions are drawn out from the results. In deductive method, we start from certain principles that are either indisputable or based on strict observations and draw inferences about individual cases. In inductive method, a particular case is examined to establish a general or universal fact. Both deductive and inductive methods are useful in economic analysis. iv) Subject Matter of Economics Economics can be studied through a) traditional approach and (b) modern approach. a) Traditional Approach: Economics is studied under five major divisions namely consumption, production, exchange, distribution and public finance. 1.Consumption: The satisfaction of human wants through the use of goods and services is called consumption. 2.Production: Goods that satisfy human wants are viewed as “bundles of utility”. Hence production would mean creation of utility or producing (or creating) things for satisfying human wants. For production, the resources like land, labour, capital and organization are needed. 3. Exchange: Goods are produced not only for self-consumption, but also for sales. They are sold to buyers in markets. The process of buying and selling constitutes exchange. 4. Distribution: The production of any agricultural commodity requires four factors, viz., land, labour, capital and organization. These four factors of production are to be rewarded for their services rendered in the process of production. The land owner gets rent, the labourer earns wage, the capitalist is given with interest and the entrepreneur is rewarded with profit. The process of determining rent, wage, interest and profit is called distribution. 5. Public finance: It studies how the government gets money and how it spends it. Thus, in public finance, we study about public revenue and public expenditure. b) Modern Approach The study of economics is divided into: i) Microeconomics and ii) Macroeconomics. 1. Microeconomics analyses the economic behaviour of any particular decision making unit such as a household or a firm. Microeconomics studies the flow of economic resources or factors of production from the households or resource owners to business firms and flow of goods and services from business firms to households. It studies the behaviour of individual decision making unit with regard to fixation of price and output and its reactions to the changes in demand and supply conditions. Hence, microeconomics is also called price theory. 2. Macroeconomics studies the behaviour of the economic system as a whole or all the decision-making units put together. Macroeconomics deals with the behaviour of aggregates like total employment, gross national product (GNP), national income, general price level, etc. So, macroeconomics is also known as income theory. Microeconomics cannot give an idea of the functioning of the economy as a whole. Similarly, macroeconomics ignores the individual’s preference and welfare. What is true of a part or individual may not be true of the whole and what is true of the whole may not apply to the parts or individual decision- making units. By studying about a single small-farmer, generalization cannot be made about all small farmers, say in Tamil Nadu state. Similarly, the general nature of all small farmers in the state need not be true in case of a particular small farmer. Hence, the study of both micro and macroeconomics is essential to understand the whole system of economic activities. 2 Micro and Macro-economics The sutbject matter of economies has been divided into two parts : MicroeconomicS and NiatoecOnOmis, These terms were first coined and used by Ragnar Frisch and have now then adopted by the cconomists all the world over. Nowadays one can (ext book on inodern economic analusis which does not divide its hardly come across a deang with micOccOnOnmics and the other with analysis into two parts, one IS deived trom the Greek word mikros, meaning macroeconomics. The term microeconomiCs "smal and the term macroeconomics is derived trom the Greek word makros. meaning "large." Thus microeconomics deals witrn the alaiysis of snall individual units of the economy such as individual consumers, individual firms a Small aggregates or qroups of individual units such as the other hand, macroeconomics concerns itsclf with the various industries and markets. On and its large aggregates such as total national output andanalysis the econorny as a whole of cONsmption, aggregate investment. Thus, according to K. E.income, total employment, total Boulding, "Microecononics is the study of particular firms,particular households, individual industries, perticular commodities."l About macroeconomics he prices, wages, incomes, individual deals not with individual quantities as such but with remarks, "Macroeconomics aggregates of these quantities; not with individual incones but with the national income; not with individual prices but level: not with individual outputs but with the national with the price output."2 MICROECONOMICS Asstated above, microeconomics studies the economic actions and behaviour of individual units and small groupsof individual units. In microeconomic theory we discuss cells of economic organism, that is, the various units of the how the various economy such as consumers, thousands of producers or firms, thousands of workers and resourcethousands of suppliers in the economy do their economic activities and reach their equilibrium states. In other words, in microeconomics we make a microscopic study of the economy. But it should be remembered that microeconomics does not study the economy in its totality. Instead, in we discuSS equilibrium of innumerable units of the economy piecemeal and their microeconomics to each other. Professor Lerner rightly says, "Microeconomics consists of lookinginter-relationship at the economy through a microscope, as it were, to see how the milions of cells in the body economic-the individuals or households as consumers, and the individuals or firms as producers--play their part in the working of the whole economic organism.."3 For instance, in microeconomic analysis we study the demand of an individual consumer for a good and from there go on to derive the market demand for the good (that is, demand of a group of individuals consuming à 1. K.E.Boulding, A Reconstruction of Economics, (1950). p.3. 2. K.E. Boulding, Economic Analysis, p. 25 3. Abba P. Lerner, Microeconomic Theory, printed in Perspectives in Economics, edited by Brown, Neuberger and Palmatier (Preliminary edition, 1968), p.29. Advanced Economic Theony lehaviour of fthe indivichual 33 theony studies the Micro and Macro-fconomics 32 mKroeconomic particular good). Lkewise, prir and output and their reactns to the changesin the output fixation by an firmnds demar the gven amount of proxhuked goocts and servdces armong millons of the people for consumpticon of r e in regard to the fixaton conditions to estabish From there we gO on same protuwt) industry in suxh a way as to maximize the total satisfaction of the society. When such efficiency is achieved it is no longer possible by any redstritutiorn of goods among the people to make and supply of firms produg the by which the (Lndustry means a group determinethe mechanismn some peopie better off without making some other ones worse off.s Allocative economic Thus. microeconomic theon seeks to equbbrim, different proceedng from the individual units to a efficiency or optimum direction of production consists of prohucing th¡se goods which are positn of Since econonic units attain the or a sige market. most desired by the people, that is, when the direction of production is guch that maximizes as 3sgieiustn narrout defined grOp sUhnarrow defined groups such as an ixustry or market microeCOnomic SOcial weitare analsis concerns itsolt with benir of all wits in the economy for any However particular In other words, allocative economic efflciency implles that pattern of production (.e, not stud the oalit of sUstem or economy as a whob t amounts of varlous goods and services produced) should correspond to the desired pattern it does the stuv of economic economc actity n othe worts. of consumption of the people. Even if eficiencies in consurnption and production of goods moeconoic anahSis outside the domatn o Product and Factor Pricn are present, it may be that the goods which are prochiced and dstributed for consunption may Allocation, Microeconomic Theory Studies Resourceresources as given and seeks to explain bo not be those preferred by the people There may be some goods which are more preferred by Microeconomac theory takes the total quantity of qoods It is the allocation of resources th the people but which have not been produced and vtce versa. To sum up. allocative efficiency particular (optimum direction of production) is achieved when the resources are so allocated to the they are aiocated to the production of they shal be produced. The allocation ot determines what gods shal be protuced and how free market economy depends unon production of various goods that the maximum possible satistaction of the people is obtained goods in a Once this is achieved, then by producing some goods more and others less by any rearrangermert resources to the prottion of vanous various factors of production. Therefore to of the resources will mean loss of satistaction or efficiency The question of economic efficiency prices of the varnous gOods and the prnces of the microeconomics proceeds to analuse xplan how the alocabon ot resources is determined. is the subject-matter of theoretical welfare economics which is an inportant branch of how the relatue pnces of goods and factors are determined. Thus the theory of product microeconomic theory. factor pricing (or the theory of distribution) fall within the domain of That microeconomic theory is intinately concerned with the question of efficiency and pncing andthe theary of