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 remarka...

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 is the Artha means 'Wealth' and systematic body of knowledge. There are two Shastra means '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 or 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 4) Compilation of political ideas into member of society. Human behaviour can neither 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 a 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, Kautilya authored the ancient Indian 'Oikonomia' which means management of the political treatise, the 'Arthashastra'. household. Economics is referred to as 'Queen of Definitions of Economics : Social Sciences' by Paul Samuelson. Economics 1) Adam Smith's Wealth-Oriented Definition deals with the economic aspect of human 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 Inquiry into the Nature and Causes of Wealth of Definition of Economics : Nations". Adam Smith defines Economics as "a This is the most popular science of wealth". definition of Economics. Key-points of Adam Smith's definition : Robbins, in his book 1) Laissez faire i.e. non-intervention of the entitled, "An Essay on the government. Nature and Significance Fig 1.4 of Economic Science" 2) Capital and wealth accumulation Lionel Robbins published in 1932 mentions 3) Nature's law in economic affairs. about the scarcity-oriented definition of 4) Division of labour as an aspect of growth Economics. theory. "Economics is a science which studies Do you know? human behaviour as a relationship between ends 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 18th 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 Thought A. C. Pigou, the book entitled "Principles of 19th and 1st half Irving Fisher etc. of 20th century of Economics" which was Fig 1.3 published in 1890. His Modern School of J. M. Keynes, Alfred Marshall Thought from 20th 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 in population. iii) Wants differ with age : Wants and their satisfaction differ as per the chronological Characteristics of wants : age. (Fig. 1.5 a, b, c). i) Wants are unlimited : Wants not only arise again and again but they are also unending. iv) Wants differ with gender : Men and If one want gets satisfied, another arises. women want different goods according to Wants go on multiplying in number. their needs. ii) 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 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 iii) 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 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) Utility that part of personal income which is left over ii) Scarcity after payment of direct taxes such as income iii) Transferability tax, wealth tax etc. iv) Externality You should know : i) Utility : A commodity must have the capacity to satisfy human wants, e.g. furniture, Following are the various types of income. refrigerator etc. A) Fixed income : Income which remains ii) 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. iii) 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 transferability - 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 list of 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, 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 considered ‘unproductive’ in the sense of and services to satisfy human wants. 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 activity. aggregates of these quantities, not with the individual incomes but with the national income, ii) Labour : Labour is a human factor of not with individual prices but with the general production. Any physical or mental effort 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 iii) 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  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 of a firm National income 2) Saving : It is that part of the income 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 machinery, equipment etc. an increase in economic growth plus 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. 3) Economic 3) Economic Depression is a continuous fall in overall growth is development is not prices and lowering down of economic possible without possible without activity in general. economic economic growth. development. Do you know ? 4) Economic 4) Economic Unemployment created due to impact growth is a development is a of cyclical fluctuations is called ‘Cyclical unidimensional multi-dimensional Unemployment’. concept. concept. 5) Economic 5) Economic 5) Economic Growth : The term 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 national income productivity, industrial Economic development implies economic and per capita productivity quality of growth plus progressive changes in certain income. human life etc. important variables which determine well-being of the people, e.g. education, health etc. Table : 1.1 7  EXERCISE Q. 1. Choose the correct option : Q. 2. Complete the correlation : 1) Statements related to Economics : 1) Natural sciences : Exact sciences : : Social a) Economics is a social science. sciences : b) Concept of economics is derived from Greek 2) Physics : : : Psychology : Social science word ‘Oikonomia’. 3) Arthshastra : Kautilya : : Wealth of Nations : c) Economics is related to the study of human economic behavior. d) Economics is related to management of the 4) Necessity : : : Comforts : Washing household. machine Options : 1) a, b and c 2) a and b 5) Free goods : Value-in-use : : Economic goods : 3) b and c 4) a, b, c and d 2) Statements incorrect with reference to Adam Q. 3. Identify and explain the concepts from the given Smith's definition : illustrations : a) Adam Smith is a classical economist. 1) My father purchased a two wheeler vehicle. This b) Wealth of Nations is authored by Adam Smith. helps to fulfil my travel needs. c) Economics is the science of wealth. 2) A study of the annual income of the family of d) Economics studies common man. Ramesh Options : 1) d 2) a, b and c 3) As per the data for financial year 2018-19, 3) a and d 4) c and d the country's production of goods and services 3) Key points in Lionel Robbins' definition : increased by 20%. a) Wants are unlimited 4) Karuna's mother saves ` 1000/- every month out of b) Means are limited her given salary. c) Wants are not gradable 5) Ram's father utilized his provident fund amount to d) Means have alternative uses. set up grocery store. Options : 1) a and b 2) b and c 3) a, b and d 4) a, b, c and d Q. 4. Answer the following : 1) Explain the features of wealth. 4) Statements related to wealth : a) Wealth means anything which has market value 2) Explain the characteristics of human wants. and can be exchanged for money. Q. 5. State with reasons whether you agree or disagree b) It is external to human being. with the following statements : c) Wealth has no utility. 1) All wants can be satisfied at a time. d) Wealth is scarce and exchangeable. 2) Human wants change as per the seasons and Options : 1) a, b and d 2) a, c and d preferences. 3) b, c and d 4) None of the above 3) Value-in-use and Value-in-exchange are the 5) Aspects considered in National Income : same. a) Final goods and services are included in national income. Q. 6. Answer in detail : b) Produced goods and services in a financial year 1) Explain the basic concepts of macro economics. are included in national income.  c) Double counting is avoided. d) Value is considered as per market price. Options : 1) a and c 2) b and c 3) a, b and d 4) a, b, c and d 8