UNIT-1

Introduction

Meaning, Kinds of Economics

Economics was originally introduced as a science of statecraft. It was concerned with the collection of
revenue for the state i.e., government. Advisors to the government were also required to point out the
best possible way of spending the revenue. Over a period of time economists have emphasized
different aspects of economic activities, and have arrived at different definitions of economics hand in
hand with the stages of development of economics.
Stages as Economics developed as a subject:
1. Wealth Definition
2. Material Welfare Definition
3. Scarcity and Choice Definition
4. Development and Growth Definition

Wealth Definition (Adam Smith): Adam Smith, known as the "Father of Economics," defined
economics as the study of wealth. In his book An Inquiry into the Nature and Causes of the Wealth of
Nations (1776), he emphasized that economics is concerned with the production, distribution, and
accumulation of wealth.
Focus: Wealth creation and the means by which a nation increases its wealth.
Criticism: Overemphasis on wealth neglects social and human aspects.
Ignores issues like inequality, well-being, and resource allocation.
Example: Studying how industries contribute to a country's GDP.

Material Welfare Definition (Alfred Marshall): Explanation: Alfred Marshall, in his book
Principles of Economics (1890), shifted the focus from wealth to human welfare. He defined
economics as a study of mankind in the ordinary business of life, emphasizing how resources are used
to promote material well-being.
Focus: The study of how people achieve material welfare and improve their standard of living.
Criticism: Limited to "material" welfare, ignoring non-material aspects like education, health, and
happiness.
Overlooks broader societal concerns and environmental sustainability.
Example: Analyzing how access to essential goods like food and clothing affects quality of life.

Scarcity and Choice Definition (Lionel Robbins): Lionel Robbins, in his book An Essay on the
Nature and Significance of Economic Science (1932), defined economics as the study of human
behavior as a relationship between ends (unlimited wants) and scarce means (limited resources),
which have alternative uses.
Focus: Decision-making under conditions of scarcity.
Key Concepts:
Scarcity: Resources are finite, but human desires are unlimited.
Choice: The need to prioritize among competing alternatives.
Opportunity Cost: The cost of choosing one option over another.
Criticism:
Ignores welfare and human emotions.
Does not address growth, development, or societal progress.
Example: A government deciding between investing in education or healthcare due to limited funds.

Development and Growth Definition (Modern View) Modern economists view economics as a
study of how nations achieve sustainable development and growth, focusing on improving living
standards and overall societal well-being.
Focus:
Economic development: Improving the quality of life and reducing poverty.
Economic growth: Increasing a nation's output of goods and services (GDP).
Key Aspects:
Human development indicators like health, education, and equality.
Balancing economic progress with environmental sustainability.
Criticism:
Can neglect short-term issues like unemployment and inflation while focusing on long-term goals.
Example: A country implementing policies to boost renewable energy, create jobs, and reduce income
inequality.
Comparison of Definitions

Wealth Material Welfare Scarcity and Choice Development and Growth

Aspect
Definition Definition Definition Definition

Scarcity and decision- Growth and societal

Focus Wealth creation Human welfare
making progress

Ignores human Limited to material Neglects development Can overlook short-term

Criticism
factors well-being and welfare issues

Basic needs Allocating healthcare Sustainable development

Example GDP analysis
provision funds policies

Nature And Scope Of Economics

Nature of economics:
1. ECONOMICS – AS A SCIENCE AND AS AN ART: Economics is both a science and an
art: as a science, it studies economic phenomena systematically, using data and models to
analyze cause-and-effect relationships, while as an art, it applies this knowledge to solve real-
world problems like unemployment and inflation through policies and strategies.
2. Economics as POSITIVE AND NORMATIVE SCIENCE: positive economics focuses on
describing "what is" with factual and objective analysis, while normative economics
prescribes "what ought to be," incorporating value judgments to recommend policies for
societal welfare.

SCOPE OF ECONOMICS
(i) Micro Economics: This is considered to be the basic economics. Microeconomics may be
defined as that branch of economic analysis which studies the economic behaviour of the
individual unit, may be a person, a particular household, or a particular firm. It is a study
of one particular unit rather than all the units combined together. The microeconomics is
also described as price and value theory, the theory of the household, the firm and the
industry. Most production and welfare theories are of the microeconomics variety.

(ii) Macro Economics: Macroeconomics may be defined as that branch of economic analysis
which studies behaviour of not one particular unit, but of all the units combined together.
Macroeconomics is a study in aggregates. Hence, it is often called Aggregative
 Economics. It is, indeed, a realistic method of economic analysis, though it is complicated
and involves the use of higher mathematics. In this method, we study how the equilibrium
in the economy is reached consequent upon changes in the macro-variables and
aggregates. The publication of Keynes’ General Theory, in 1936, gave a strong impetus to
the growth and development of modern macroeconomics.

The economic problem: Scarcity and choice;

Scarcity
(i) Resources (like land, labor, and capital) are limited, but human wants are unlimited.
(ii) Scarcity forces prioritization of needs, leading to the concept of choice.
Choice
(i) Involves deciding how to allocate resources to satisfy the most pressing needs.
(ii) Example: A country must decide whether to allocate its budget to healthcare or defense.
Key Questions Arising from Scarcity (Three central problems of economy)
What to produce?
Governments and businesses must prioritize goods based on demand.
Example: Should resources be used to produce luxury cars or affordable housing?
How to produce?
Choosing production techniques:
Labor-intensive (using more human labor).
Capital-intensive (using more machinery).
For whom to produce?
Deciding the target market:
Should resources cater to the affluent or address basic needs for all?

Opportunity Cost:
Definition: The value of the next best alternative forgone when a choice is made.
Example: If a company invests in product A instead of product B, the profit from product B is the
opportunity cost.
Importance in Decision-Making:
Helps prioritize resources for maximum benefit.
Example: A farmer choosing between growing wheat or rice based on profitability.

Three major Economic systems;

Capitalist Economy (Market Economy):
 Resources are owned and controlled by private individuals or firms.
 Prices are determined by market forces of demand and supply.
Advantages: Efficient resource allocation, innovation driven by competition.
Disadvantages: Can lead to inequality and neglect of social welfare.

Socialist Economy (Planned Economy):

Resources are owned by the state, and central planning governs production and distribution.
Advantages: Focuses on social welfare and reduces inequality.
Disadvantages: Can result in inefficiencies and lack of innovation.

Mixed Economy:
Combines features of both capitalism and socialism.
Example: India has private enterprises alongside state-run industries.
Advantages: Balances efficiency with social welfare.
Disadvantages: Can face conflicts between private and public interests.

Allocation of Resources and Distribution

The allocation of resources refers to how resources (labor, capital, land) are distributed among
competing uses. This process helps in deciding what goods and services are produced, in what
quantity, and for whom. Distribution deals with how the output is divided among the members of
society.

In a market economy, prices act as signals to allocate resources. In planned economies, governments
decide the allocation and distribution to ensure equity and fulfill societal goals. In mixed economies,
both market forces and government policies influence resource allocation and distribution.

Incremental Profit Approach

The Incremental Profit Approach is a decision-making tool used to assess the impact of small changes
in production or business strategies on profitability. It involves comparing the incremental revenue
(additional revenue generated by a change) to incremental costs (additional costs incurred by that
change) to determine the impact on profit.

If the incremental revenue exceeds the incremental costs, the decision is considered beneficial, and
the firm can proceed with the change.
If incremental costs are higher than incremental revenue, the firm should reconsider the change.
This approach helps businesses make informed decisions about adjustments in pricing, production
levels, and operational efficiency by focusing on the marginal effect rather than aggregate profit.

Types of markets
Perfect Competition:

Definition: A market structure where a large number of buyers and sellers trade homogeneous
products, with no single participant influencing the price.
Characteristics:
Many buyers and sellers.
No barriers to entry or exit.
Perfect information availability.
Products are identical, so no brand loyalty exists.
Example: Agricultural markets like wheat or rice.
Outcome: Prices are determined by market forces of demand and supply, ensuring efficiency and
consumer welfare.

Monopolistic Competition:

Definition: A market structure where many sellers offer similar but not identical products, allowing
differentiation.
Characteristics:
Many sellers and buyers.
Product differentiation through branding, quality, or features.
Some control over pricing due to brand loyalty.
Moderate barriers to entry and exit.
Example: Clothing brands, restaurants.
Outcome: Firms compete through non-price factors like advertising, leading to diversity in choices
but not complete efficiency.

Monopoly:

Definition: A market structure where a single seller dominates the market, offering a unique product
with no close substitutes.
Characteristics:
One seller, many buyers.
High barriers to entry (legal, financial, or technological).
Full control over prices (price maker).
Lack of competition.
Example: Utility companies (electricity, water).
Outcome: Higher prices and reduced output compared to competitive markets, often leading to
inefficiencies and potential exploitation.

Oligopoly Market:
. An oligopoly is a market dominated by a few large firms that are interdependent. Examples include
the automobile, telecommunications, and energy industries.
Key Features
1. Few Sellers: A small number of firms control the market.
2. Interdependence: Firms’ decisions affect and are influenced by competitors.
3. Barriers to Entry: High costs or legal hurdles limit new competitors.
4. Price Rigidity: Prices are stable to avoid price wars.
5. Non-Price Competition: Firms compete via branding and quality, not just price.
6. Collusion: Firms may cooperate to fix prices or market shares.