Section 1 : Introduction to Economics Revision
Introduction
The term "economy," from which we get “Economics," comes most directly from the Old French word "economie," meaning "management of a household."
Definition —Lionel Robbins
‘Economics is a social science, which studies human behaviour as a relationship between ends and scarce means, which have alternative uses’.
Four basic issues
1 Multiplicity of wants
2 Gradability of wants
3 Scarcity of resources
4 Alternative use of resources
Modern Definition
The scientific study of the choices made by individuals and societies in regard to the alternative uses of scarce resources which are employed to satisfy wants.
Meaning
Economics is the study of the way people organize themselves to sustain life and enhance its quality. Individuals engage in four essential economic activities: resource maintenance, production of goods and services, distribution of goods and services, and consumption of goods and services. It is a social science that studies the allocation of scarce resources used to produce goods and services that satisfy consumers' unlimited wants and needs.
Social Science
Social Science can be defined as a systematised body of knowledge pertaining to human relationship and groups living in society .Different aspects of human behaviour or social life of human beings is dealt with as parts of group or society and not as independent individuals.
e.g. History, psychology, sociology, economics, political science.
Scientific Methodology
¨ Organise reality in a rational manner by observation and gathering of data.
¨ Spotlighting aspects of data to see for emerging patterns.
¨ Formulate hypothesis.
Reliability and validity of the data must be checked along with the value of sources.
Economics as Social Science
Economics is a social science because it is a systematised body of knowledge regarding economic behaviour of man in society . it seeks to explain how society deals with the scarcity problem It adapts a scientific framework & it is particularly concerned with studying human behaviour and about economy as a whole
Steps in scientific method
1 Recognising the problem or issue.
2 Cutting away unnecessary details by making assumption.
3 Developing a model or story of the problem or issue.
4 Making predictions.
5 Testing the model i.e. how well it predicts events.
Scarcity
¨ The Excess of wants resulting from having limited resources ( land labour capital and entrepreneurs) in satisfying the endless wants of people
¨ Economics concerns itself with only those things which are scarce.
¨ It is a Universal Problem
¨ If something is scarce , it will have value
Micro Economics
Micro means small
Microeconomics is the branch of economics that studies individual units: e.g. households, firms and industries. It studies the interrelations between these units in determining the pattern of production and distribution of goods and services.
Macro Economics
Macro means large.
Macroeconomics is the branch of economics that studies the entire economy, aggregate consumption, aggregate production , aggregate investment, unemployment, inflation, business cycles and so on(grand totals):e.g. the overall level of prices, output and employment in the economy. It is concerned with the economy as a whole.
E.g. If we use analogy of a car , the study of engine axle and brakes separately are micro issues ,how all parts work together is a macro issue.
Growth
¨ Growth is the process of increasing the economy's ability to produce goods
¨ The main sources of growth are increases in the quantity and quality of the economy's resources (land, labour ,capital and entrepreneurship).
¨ It is the increase in national output within an economy during a time period usually 12 months
Economic Growth
¨ Economic growth is a term usually associated with a region, country or area
¨ Economic growth means that the actual output of that area increases. that means, the amount of goods and services produced in that area increased.
¨ It is measured by measuring total national output in an economy in two different time periods
Development
Development means goals such as access to basic necessities such as food water shelter, availability of employment, education & culture , having social choices and basic freedom such as freedom of speech and democratic elections.
Economic Development
¨ It is a measure of welfare ,a measure of well being.
¨ It is measured not just in monetary terms but also in terms of other indicators such as education indicators health indicators and social indicators.
Sustainable development
Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs
If a country’s capital and land assets remain constant or increase over time then it is sustainable development ,
It means not using up resources faster than the Earth can replenish them.
Positive statements
Ø They are objective statements
Ø Deal with matters of fact, evidence or they question about how things actually are.
Ø Involves no value-judgements, opinions, emotions
Ø Can be proved disproved using a scientific approach
Ø Can be described as “what is, what was, and what probably will be” economics
Ø Unbiased or Detached
Ø Depends on Logic, reason & Empiricism.
Ø Explains the way the economy actually operates
E.g.Women are paid less than men.
Inflation rate in 1999 was 2.5 %
Normative statements
Ø Subjective Statements
Ø Value judgments based on opinion only.
Ø Cannot be proved or disproved as right or wrong.
Ø Biased and Attached.
Ø Depends on values ,beliefs, preferences ,self interest.
Ø Contain words such as: should, ought, or prefer.
Ø Seeks to recommend the way the economy should operate. It is the policy side of economics
E.g. Women should be paid the same as men.
Defence spending ought to be cut.
Ceteris Paribus
A very basic (essential) assumption which allows economic models to predict outcomes and relationships with a degree of certainty and conviction simply by assuming that variables not addressed in the model are kept constant.
Ceteris paribus is an old Latin phrase that translates as ‘other things being equal’ or ‘other factors remain unchanged .A quick method of showing that we have made the assumptions is to write ceteris paribus alongside
Example
· What would happen to the quantity demanded of Coca-Cola in Germany if prices increased by 10%, ceteris paribus
· ‘ An increase in the amount of hours spent studying economics will lead ,ceteris paribus , to an increase in average marks received on economics test’.
Factors of Production
Anything which contributes to production is called a factor of production.
Land, Labour, capital, and entrepreneurship used by society to produce consumer satisfying goods and services are termed as factors of production, they are also known as resources or scarce resources.
· Land
In economics land refers to all kinds of natural resources that are freely found
in nature ,which are limited in supply ,which can be controlled by man and
used in the production of goods. Reward for land is rent.
· Labour can be defined as any mental or physical effort (excluding entrepreneurial organization) which contributes to the production of goods and services for which it receives income. Reward for labour is wages / salaries
· Capital refers to that part of wealth which is used along with labour for producing additional wealth .Reward for capital is interest.
· Entrepreneurship is the special sort of human effort that takes on the risk of bringing labour, capital, and land together to produce goods. or services in the expectation of a future reward. That reward is called profit in economics.
Functions of an entrepreneur
¨ Management and control
¨ Risk and uncertainty bearing
¨ Innovation
Factor Income
Rent
It is the factor payments to the owners of land for using the various resources of land in the production of goods and services
Wages
A factor payment to the owner of labour for using labour services in the production of goods and services
Interest
It is the payments for the use of borrowed funds or the price paid for the use of loanable funds’
Profit
Profit refers to a reward enjoyed by an entrepreneur for his entrepreneurship or for his contribution to the process of production. It is a reward for bearing of risks and uncertainties and introducing innovations
Utility
Utility is defined as want satisfying power of a commodity so all the commodities having capacity to satisfy a want possess utility.
Total utility of a commodity refers to the sum total of the utility derived by a consumer from all the units of that commodity taken together at a point of time or during a period of time .
Marginal utility refers to an addition made to the total utility by consuming one more unit of a commodity
Features of utility
It is a subjective term
It cannot be measured objectively
It is a relative term
It has no ethical significance
It is different from pleasure
It depends upon the intensity of the want
Utility of the good can be multipurpose
Utility does not mean satisfaction
Utility is distinct from usefulness.
Opportunity cost
The cost of any activity measured in terms of the benefit from the best alternative forgone.
Opportunity cost is the option foregone in making a choice of alternative A over alternative B . When the best alternative is chosen from a range of alternatives the second best choice is known as opportunity cost.
Opportunity cost for different people will not be the same.
An opportunity cost can be either explicitt, usually involving a monetary payment, or implicit, which does not involve a transaction
E.g .The opportunity cost of deciding not to work is the lost wages foregone
The opportunity cost of spending money on a foreign holiday is the lost opportunity to buy a new dishwasher or the chance to enjoy two short breaks inside the United Kingdom
Free Goods
¨ It refer to those goods which are provided freely by nature ,their supply is abundant that no price is paid for securing them .e.g. air, water, sunlight etc .All free gifts of nature are free goods
¨ Does not incur any opportunity costs in its production I.e. resources involved have no alternative uses.
¨ No cost so no choice .No market , zero price & no relevance for surplus.
¨ Production using free goods undertaken with free resources.
¨ Does not appeal to the economist
Economic Goods
¨ Economic goods are those goods which have utility and which are relatively scarce .
¨ Cost is incurred for producing them and price is paid for purchasing them.
¨ It uses scarce resources in being provided,
¨ They have an opportunity cost of the alternative goods foregone and are the things which economists are interested in.
¨ Limited availability in relation to desired use.
¨ Exchanged through markets
Basic Economic Decisions
1. What should be produced in the economy and in what quantities ?
It deals with the allocation of resources to make the goods and services in right quantities that society wants with society's limited resources
2. How should production be organised?
It deals with production, methodology, organization and technology for best outcome.
It determines the way society's limited resources are combined in the production of goods and services
3. For whom should production take place?
It is the problem of distributing Economic goods and services.
Production possibility frontier
Production possibility frontier shows the boundary of what is possible to produce and is used as an illustration in economics to show the choices facing all countries in producing goods which use limited factors of production. Thus it draws the boundary between what can and cannot be achieved . PPC is also known as production transformation curve.
· Show the different combinations of goods and services that can be produced with a given amount of resources
· There is no ‘ideal’ point on the curve
· Any point inside the curve – suggests resources are not being utilised efficiently
· Any point outside the curve – not attainable with the current level of resources
· Useful to demonstrate economic growth and opportunity cost
When the PPF shifts outwards, there is growth in an economy
If Economic growth leads to higher level of consumption ,increase in goods and services reduces poverty, leads to an improvement in nutrition, health care and literacy then development has taken place along with economic growth.
Growth and development are not the same.
The Market Economy
A free market economy is one where economic decisions are made through the free market mechanism. The forces of market demand and supply, without any government intervention, determine how resources are allocated.
Features of market mechanism
¨ Consumer sovereignty (freedom of consumption)
¨ Freedom of enterprise, occupation, savings and investment.
¨ Profit oriented production
¨ Free price mechanism (prices of products & factor units are determined by the forces of demand and supply)
¨ Price acts as a signal & an incentive for producers
¨ Firms consumers and owners of factors of production act in their own self interest, firms will maximise profits, consumers their utility and factor owners their return.
¨ Free market produces the best possible outcome in terms of resource allocation.
¨ Factors of production are privately owned.
¨ Motive of profit maximisation
¨ Circular flow of money and goods.
¨ Minimum role of the government.
¨ Economic activities are guided by the market forces.
¨ Existence of free competition
Command Economy
A command economy is an economy, or economic system, that relies heavily on central planning by government to allocate resources and answer the three basic questions of allocation. It is an economy where all key economic decisions are made by the government (or state).
Features of command Economy
¨ All economic decisions are taken by central planning authority according to the plan that contains details about production, consumption, distribution, savings, investment etc.
¨ All means of production are owned and controlled by the state so no private ownership.
¨ Prices of most of the goods are fixed by the state and these prices are used by the state as tools of planning.
¨ All investments are made by the state ,individuals cannot establish private business to earn profit.
¨ Money credits and profits are used for controlling the enterprises and they are not the basis of transactions
¨ Central planning authority lays down the objectives of planning such as rapid increase in national income, achievement of self-sufficiency, removal of poverty and unemployment & attempts to achieve them in a specific period.
¨ There is comprehensive planning as the plans for all interdependent sectors are minutely detailed in physical terms and implemented.