Grade 11 Economics Note

NATURE OF ECONOMICS

Introduction

Economics is a social science. Man performs different activities to fulfill his desires. Desires can be different. Voting ones favorite political party, visiting temples, dining with relatives are different activities which satisfy  different kinds of desires like political, religious and social activities. However, economics is concerned with economic activities only. Economic activities are those activities which are concerned with the efficient use of scarce resources, which can satisfy human wants. Production, consumption, distribution and exchange are the common examples of economic activities.

 

History of Economics

The term 'Economics' is derived from the two Greek word 'Okios' and 'Nomikos'. The Greek philosopher Xenophon (440-355 BC) in his treatise 'Oeconomics' regarded economics as the science concerned with the problems of household management. Aristotle (384-322 BC) regarded economics as an important pillar of politics of the state. Economics was regarded as a part of other disciplines like logics, politics, ethics etc. until Adam Smith made the first systematic analysis of economics in his book 'An enquiry into the Nature and causes of Wealth of Nations' published in 1776.

 

Definition of Economics

Different Economics at different periods of time have defined economics in their own ways. However, we are concerned with three different definitions given by three different economists which are as follows.

Wealth Definition/Classical Definition

Welfare Definition/ Neo-Classical Definition

Scarcity Definition/Modern Definition

Wealth Definition/ Classical approach

Adam Smith also known as the 'Father of Economics' made the first attempt to present a systematic analysis of economics in his book 'An Enquiry into the Nature and causes of Wealth of Nations' published in 1776. Adam Smith defined economics as an enquiry into the nature and causes of wealth of nations or science of wealth. He asserted that economics is concerned with the production, consumption, exchange and distribution of wealth. Other classical economists like J.S. Mill, F.A. Walker, J.B. Say, David Ricardo fully supported the classical approach to Economics put forward by Adam Smith.

 

Characteristics/Features of the wealth Definition

Study of wealth: This definition regards economics as the study of wealth, its production, consumption, exchange and distribution.

Study of economic man: This definition considers the study of economics activities like production, distribution, consumption etc. all other activities of a person are outside the orbit of this definition. This man is always guided by self interest.

Inclusion of material goods: The definition of wealth given by Adam Smith includes only material goods and ignores the non-material goods. Material goods are those goods which can be seen, touched and transferred like pen, pencil, book, car etc. whereas non- material goods cannot be seen, touched or transferred but felt only like the ability to cure, sing etc.

Investigation of the source of wealth: This definition considers increment in production of material goods through specialization and division of labor as the source of wealth.

Criticisms of the wealth definition

Excess emphasis of wealth: This definition regards man as means and wealth as ends. However, wealth is for the sake of man, man is not for the sake of wealth. Hence, this definition has been criticized on the ground for giving excess importance to wealth.

Narrow meaning of wealth: The classical definition includes only material goods under wealth and excludes all non-material goods.

Unrealistic concept of economic man: This definition considers economics as the study of economic man whose all activities are guided by self interest only. However, this is not always the case in real life scenarios where love, friendship also carry a lot of value.

Neglects economic welfare: This definition considers economics as the study of wealth only and totally neglects the economic welfare of the society.

 

Welfare Definition/Neo-Classical Definition

The welfare definition of economics was given by Alfred Marshall, an eminent English economist. The wealth definition given by Adam Smith received many bitter criticisms on various grounds. Marshall enlarged the scope of economics by shifting the focus of economics from material wealth to material welfare. In his book, 'Principles of Economics' (1890), he defined economics as 'Economics is the study mankind in ordinary business of life. It examines that part of individual and social action, which is closely connected with the attainment, and the use of material requisites of well being. It is on the one side a study of wealth, and on the other and more important side , a part of the study of man'. A.C. Pigou, Cannan and Beveridge have strongly supported the view of Marshall.

 

Characteristics of Welfare Definition

Primary concern on mankind: Unlike the classical definition, this definition gives more emphasis on human welfare rather than wealth. It states that wealth is not for its own sake but for the sake of human welfare.

Study of material welfare: Welfare definition gives emphasis on material welfare. As such, it studies only material requisites of well being or causes of material welfare and ignores non-material aspects.

Study of economic activities: People engage in various kinds of activities like political, social and religious activities. However, the welfare definition encompasses only economic activities related with the earning of income and expense and excludes other activities.

Social science: Economics is a social science and it is concerned with the study of economic activities of those people only who live in an organized society. People living in isolation like saints are excluded in the study of economics.

 

Criticisms of Welfare Definition

Connection between economics and welfare: Marshall identifies economics as the science which deals with human welfare. However, certain economic activities which are disastrous for human health like production and consumption of wine and cigarettes also fall within the purview of economics.

Material and non material welfare: Marshall defined economics as a science concerned with material welfare. However, sometimes the same activity could be material and non-material at other times. For example, A doctor's services in exchange for fees would be a material activity whereas a doctor's service for philanthropic reasons would be non-material because nothing is received in exchange of such services.

Use of money as a measurement of welfare: Marshall used money as a measuring rod of welfare. However, money itself is not an accurate measurement of satisfaction. Different people like rich and poor may derive different level of satisfaction even from the same amount of money.

Social science: Marshall stated economics as a social science. He considered economics as a study of people living in organized societies only. But, the laws of economics are universally applicable, be it a person living in an organized society or be it a person living in isolation.

 

Scarcity Definition/ Modern Definition

Professor Lionel Robbins, London School of Economics took a new approach to present a new dimension in the definition of economics in his book 'An Essay on the Nature and Significance of Economic Science' published in 1932. In his words 'Economics is the science which studies human behavior as a relationship between ends and scarce means which have alternative uses'. This definition of economics has gained a worldwide popularity and consensus among the economists. Economists like Karl Manger, Peter, Stigler, Scitovosky, etc. supported Robbins notion of Economics.

 

Characteristics of Scarcity Definition

Unlimited Wants: Human wants are unlimited. No one can satisfy all of his/her wants. After a want is satisfied, other wants come up and hence a person cannot be fully satisfied.

Scarce/Limited means: Wants are unlimited but the means through which wants can be satisfied are limited at a person's disposal. Here, scarcity is not in absolute terms but in relative terms to the unlimited desires of people.

Alternative uses of scarce means: According to Professor Robbins the limited resources can be put to alternative uses. For example, a sum of 300 rupees can be used to watch a movie or eat at a restaurant.

Urgency of wants: Professor Robbins states that wants are different in urgency or intensity. The wants which are more urgent are satisfied first than the wants that are less urgent.

Problem of choice: Since the wants of people are unlimited in relation to the limited means to fulfill those desires, people have to choose which want to satisfy and which to postpone for a later date. Hence, it is the problem of choice that haunts each and every person. If resources were abundant to fulfill every want, then there would be no problem of choice. This problem of choice is the economic problem which forms the subject matter of economics.

 

Criticisms of the Scarcity Definition/Modern Definition

Implicit concept of welfare: Marshall's definition of welfare has been criticized by Robbins. However, the idea of welfare is implicit in the scarcity definition. Whenever one makes choices to use scarce means into a use for maximum satisfaction, it gives the same notion of choices to maximize welfare.

Abundance can create Problems: Robbins attributed scarcity of means in relation to its demand as the source of the economic problem. However, abundance may also result in problems too. The excessive number of working population might result in unemployment, excessive money supply in the economy results in inflation etc.

Inseparability between means and ends: Something can be both means and ends in life which creates a lot of confusion. A person studying M.B.B.S. wants to get a medical officer degree. It is an end for him. But the same degree also acts as a means to get an M.D. degree.

Self-contradictory: This definition states that economics is a positive science which is neutral between ends. But, the idea of choice between alternative uses to maximize satisfaction makes it a normative science. Hence, the definition is self contradictory.

Comparison and Contrast between the three Definitions

Basis of comparison

Classical Definition

Neo-Classical Definition

Modern Definition

Nature of study

Economics is a science of wealth.

Economics is a science of material welfare.

Economics is a science of human behavior.

Aim of human beings

To maximize wealth

To maximize material welfare

To maximize pleasure or satisfaction

Role of wealth

Wealth is an end in itself.

Wealth is a means for material welfare.

Wealth is a scarce resource to maximize satisfaction.

Scope of the study

It considers the concept of economic man only

It considers the concept of people living in organized society only.

It is pervasive and is applicable to all people, living in a society or in isolation.

  

Subject Matter of Economics/Scope of Economics

The subject matter of economics or its scope refers to the areas of study that falls under the purview of economics. The scope of economics can be divided on the basis of two criterions.

On the basis of economic activities

Human wants are unlimited. In order to satisfy those want people have to put efforts. The fulfillment of wants gives satisfaction. This process consists of various economic activities namely production, consumption, exchange and distribution. Hence, all of these activities come under the scope of economics.

 

On the basis of Modern Analysis

The Modern analysis of economics divides the area of study of economics into two parts namely Micro and Macro economics. Microeconomics deals with the economic behavior of individual units like households, firms and industries. Macroeconomics deals with aggregates of the economy or the economy as a whole. As such it deals with total output, national income, general price level, inflation, economic growth, consumption, investment etc.

 

Positive and Normative Economics

Positive Economics deals with factual statements of a phenomena.  It answers questions like what is, what was and what will be about economic phenomena. It describes the relationship between various economic variables in the light of theory or empirical evidence. For example, when price of a commodity goes up, the quantity demanded of the commodity decreases.

Normative economics deals with value judgments. It answers the question of what ought to be rather than what is. Hence, it is also called prescriptive economics. It deals with moral and ethical concerns in economics. It analyses economic events to draw conclusion what must be done to increase welfare of the society as a whole. For example, Tax rates should be reduced in export oriented industries to boost exports for reducing BOP Deficit.

 

Microeconomics VS. Macroeconomics

 

Microeconomics

Micro is derived from the word 'Mikros' meaning small. Thus, Microeconomics deals with the behavior of individual units of the economy like individual consumer, individual producer, individual market , individual industry etc. Microeconomics is the microscopic study of the economy. According to K.E. Boulding, 'Microeconomics is the study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities'.

 

Importance of Microeconomics

Helps to know the functioning of the economy: Microeconomics studies the behavior of the individual units of the economy. It tells us how the individual units of the economy take decisions regarding allocation of scarce resources to various productive uses. It aids in knowing the working of the economy.

Aids in devising appropriate policies: The knowledge and understanding of working and interactions, relationships between individual units of the economy helps in the formulation of various policies and enhances their effectiveness.

Helps in business decision making: Microeconomics includes the process of price determination, factors affecting demand, elasticity of demand, demand forecasting tools and techniques which are extremely useful in the decision making process of firms.

 

Macroeconomics

The word Macro is derived from the term 'Makros' meaning large. Hence, macroeconomics is concerned with the study of the economy as a whole. It gives the big picture of the large macroeconomic variables like production, consumption, investment, savings, interest rate etc. In the words of K.E. Boulding, 'Macroeconomics deals not with individual quantities but with aggregate of these quantities, not with individual incomes but with national income, not with individual prices but with price level, not with individual output but with national output'.

 

Importance of Macroeconomics

To understand the working of the economy: Macroeconomics studies the economy in its aggregate form. It studies on how macroeconomic variables are determined, how they are interrelated and how the change in one macroeconomic variable influences other variables and aspects of the whole economy. Hence, it helps in knowing the functioning of the economy.

Helps in devising suitable policies: The problem of inflation, unemployment and economic growth are the major reasons of headaches of both developed and underdeveloped countries. These problems carry so much weight that keeping them under a certain level can keep a government stable and failure to address such problems can collapse the whole government. The knowledge of working of the economy and the interrelationship between economic variables helps the government to devise appropriate policies to solve these serious problems.

Helps in comparison: The macroeconomic indicators like GDP, Inflation, Unemployment percentage act as the standard against which relative developments of countries over time can be compared. A country's relative development in the present can be known compared to the past.

To know the effectiveness of policies: Macroeconomics gives various tools and techniques to know the effectiveness of using various policies under given situations. Basically, the IS-LM model helps to know the policy effectiveness of using various policies. It also sheds light on the fact that sometimes a single policy cannot help to achieve the stated objectives and hence the judicious mix of both the policies is necessary. Moreover, it helps to throw light on the fact that microeconomic laws do not apply under macro situations.

 

 

Distinction between Microeconomics and Macroeconomics

Basis of Difference

Microeconomics

Macroeconomics

Economic unit

Microeconomics is concerned with the study of individual units of an economy.

Macroeconomics is concerned with the study of aggregate units of an economy.

objective

Microeconomics is concerned with the use of scarce means to achieve maximum satisfaction.

Macroeconomics is concerned with the objectives of full employment, price stability, economic growth and favorable BOP.

Methodology

Microeconomic theories are based on the 'ceteris paribus' or all other things being equal assumption. Hence, it is known as partial analysis.

Macroeconomic theories are not based on such assumptions. Hence it is known as general equilibrium analysis.

Components of equilibrium

The demand and supply forces interact to create an equilibrium price.

The Aggregate demand and Aggregate supply interact to reach the general equilibrium.

Theories

Price theory, Theory of value

Theory of output, income and employment

Examples of variables

Price, demand, supply etc.

National income, National output, General Price Level, Full Employment etc.

 

Interdependence between Microeconomics and Macroeconomics

Though microeconomics and macroeconomics are different on many grounds, they are interdependent, interlinked and exert influence on each other.

 

Dependence of microeconomics on macroeconomics

Although microeconomics is a small part of the economy, the changes in macroeconomic variables shape and exert an influence on the microeconomic variables. The change in the general wage level also helps shaping the wage of labor in an individual firm. Here, general wage level is a macroeconomic variable whereas wage of labor in an individual firm is micro variable.

 

Dependence of macroeconomics on microeconomics

microeconomics studies the behavior of individual units of an economy. But, macroeconomic units are the sum of individual microeconomic units and hence the changes in microeconomic units eventually give shape to the macroeconomic units. For example, changes in the individual outputs of firms results in changes in national output, saving of individual units determine the national saving. This is because, macroeconomic variables are the collective result of microeconomic variable. Hence, they are dependent on small microeconomic units.            


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