Module 1: Understanding Economics - What is Economics

Overview of Economics

  • Economics is a vital subject in social science that enters into daily life through numerous economic concepts:
    • Goods
    • Market
    • Demand
    • Supply
    • Price
    • Inflation
    • Banking
    • Tax
    • Lending
    • Borrowing
    • Rate of interest
  • Everyday economic decisions made by individuals include:
    • Distributing income to purchase various goods
    • Formulating budgets for specific tasks
    • Taking up employment to earn income
    • Withdrawing money from banking institutions
  • Economic situations are observed at multiple levels:
    • Local society
    • Domestic country
    • Foreign nations
    • Global economy

Meaning and Evolution of Definitions of Economics

  • Economics covers a vast scope and large area of study, making a single precise definition difficult.
  • The definition and scope of economics have evolved over time across distinct historic phases:

Economics as a Science of Wealth

  • Time Period: Late eighteenth and early nineteenth century.
  • Advocates: Classical thinkers and scholars.
  • Definition: Economics is viewed as the science of wealth, dealing with:
    • The nature and causes of wealth.
    • The creation of wealth by individuals and nations.
  • Limitations:
    • Ignored individuals who possessed no wealth.
    • Created a societal divide between the rich and the "not rich" (poor).

Economics as a Science of Welfare

  • Time Period: Early nineteenth century.
  • Main Idea: Shifted focus from wealth alone to the "welfare of the society".
  • Categorization of Welfare:
    • Quantitative Welfare: Measurable in terms of money, including consumption of goods and services, and increases in per capita income.
    • Qualitative Welfare: Non-measurable aspects such as living in peace, enjoying leisure, and acquiring knowledge.
  • Scope in Economics: As a science of welfare, economics is strictly concerned with quantitative welfare because it can be measured monetarily.
  • Limitations: Addressed only material aspects of welfare, whereas human beings require both material goods and non-material services.

Economics as a Science of Scarcity and Choice

  • Core Premise: Resources available to individuals and society are limited (scarce), whereas human wants (ends) are unlimited.
  • Definition: Economics studies human behavior as a relationship between ends and scarce means which have alternative uses.
    • Ends: Refers to human wants.
    • Scarce Means: Refers to limited resources that have alternative uses.
  • Process of Choice: Individuals and societies must make appropriate choices to allocate limited resources among competing uses to achieve their goals.
  • Comprehensive Example (Cloth vs. Wheat Production):
    • An economy cannot produce unlimited amounts of both cloth and wheat due to limited resources.
    • Resources must be divided between the production of both goods.
    • Scenario: If the demand for wheat increases, the economy requires more resources to produce larger quantities of wheat.
    • Action: Given that total resources are fixed, resources must be withdrawn from cloth production and reallocated to wheat production.
    • Outcome: Production of cloth falls while production of wheat increases.
    • Economy's Alternatives:
    1. Maintain the exact same production levels of cloth and wheat.
    2. Increase wheat production to satisfy higher demand, thereby reducing cloth production.
    • Function of Economics: Explains how an economy solves allocation problems using limited resources.

Economics as a Science of Growth and Development

  • Time Period: Twentieth century.
  • Main Focus: Achieving overall growth and development across the whole economy, highlighting the role of government.
  • Scope Expansion: Expanded beyond individual decision-making and resource use to analyze the production and consumption of commodities over time.
  • Key Principles:
    • Individual satisfaction of wants requires the growth of the overall economy.
    • Mechanisms must be established to distribute the benefits of economic growth among all citizens.
    • Measures economic performance through resource allocation, production efficiency, and long-term capability growth.
  • Classification of Economies:
    • Developed Economies: Countries such as the USA, European nations, and Japan that have achieved high levels of income for their citizens through efficient resource management.
    • Developing Economies: Countries like India where many citizens remain poor; economics provides analysis and guidance to attain higher growth and development.

Economics as a Science of Sustainable Development

  • Time Period: Late twentieth century to present.
  • Main Focus: Welfare of future generations and environmental protection.
  • Issues Addressed:
    • Unchecked economic growth leads to environmental pollution, resource depletion, and excessive waste.
    • Rapid depletion of finite resources such as minerals, mineral oil, and forests due to excessive consumption by current generations.
  • Moral Imperative: Scarce resources must be used judiciously and efficiently to preserve resources and guarantee welfare for future generations.

Branches of Economics

  • The study of economics is divided into two main branches: Micro Economics and Macro Economics.

Micro Economics

  • Etymology: Derived from "micro", meaning very small.
  • Definition: The study of economic behavior and decision-making at an individual level or small scale.
  • Key Areas of Study:
    1. Buyer Decisions: How an individual consumer allocates limited income among various goods and services at given prices to maximize personal satisfaction.
    2. Seller Decisions: How an individual seller determines the quantity of goods to supply at a given price to maximize profit.
    3. Price Determination: Analyzing how individual market prices of goods and services are determined through market forces.
    4. Producer Decisions: How an individual producer combines various factors of production to yield maximum output at minimum cost.

Macro Economics

  • Etymology: Derived from "macro", meaning very large.
  • Definition: The study of economic decisions and phenomena at the aggregate level of the whole society, country, or national economy.
  • Key Subject Areas:
    • Government Policies: Analysis of nationwide policies such as taxation, public expenditure, and welfare programs meant to solve broader societal problems.
    • Economic Aggregates:
    • Aggregate Consumption Expenditure: Sum of consumption expenditures across all individuals in society.
    • National Income: Aggregation of all individual incomes across the country.
    • Inflation: Causes, consequences, and mechanisms for controlling nationwide price rises.
    • Unemployment: Issues and solutions surrounding national labor employment levels.
    • Economic Growth and Development: Analysis of overall national output expansion and long-term living standard improvements.

Positive vs Normative Economics

  • Economic analysis and decision-making by individuals, businesses, and governments involve both positive and normative dimensions.

Positive Economics

  • Focus: Statements describing "What is" or what actually happens/might happen in the economic world.
  • Nature: Objective, factual statements based on observable facts, figures, and verifiable data.
  • Examples:
    • "India's population has crossed 100 crore100\text{ crore} mark. India is the second largest populated country in the world."
    • "Workers will work hard if they are given more wages."
    • "India has a large number of poor people."
    • "Poor people are suffering due to price rise of essential commodities."
    • "Bank has increased its interest rate."

Normative Economics

  • Focus: Statements describing "What ought to be" or "What should be".
  • Nature: Subjective value judgments, ethics, and prescriptions regarding what policies or actions ought to take place for the good of society.
  • Examples:
    • "India should not allow its population to grow so fast. It must control its population."
    • "Factories should increase the wage rate of workers to provide justice for hard work."
    • "The government should spend more on education."
    • "People should be encouraged to save in post offices and commercial banks."

Interplay in Policy Formulation

  • Governments and institutions combine positive analysis with normative values to execute public policy:
    • Population Control: Positive facts showing rapid population growth leading to economic issues drive normative judgments that result in national family planning initiatives.
    • Minimum Wage Laws: Positive facts showing worker efforts in relation to compensation, paired with normative considerations of fairness, drive the implementation of statutory minimum wage laws.

Summary of Core Learning

  • Economics as a social science discipline is categorized across five evolutionary definitions:
    1. Science of Wealth
    2. Science of Welfare
    3. Science of Scarcity and Choice
    4. Science of Growth and Development
    5. Science of Sustainable Development
  • Main Branches:
    • Micro Economics deals with individual decision-making entities (buyers, sellers, individual markets).
    • Macro Economics deals with national economic aggregates (national income, overall consumption, inflation, unemployment, national growth).
  • Analytical Approaches:
    • Positive Economics handles factual, objective descriptions ("What is").
    • Normative Economics handles value-based policy prescriptions ("What ought to be").

Questions and Exercises

Intext Questions 1.1

  • Question 1: "Economics is a science of wealth". What does this imply?
    • Answer: As a science of wealth, economics explains the nature and causes of wealth, as well as the creation of wealth by individuals and nations.
  • Question 2: Which aspect of welfare does economics deal with as the science of welfare?
    • Answer: Economics deals specifically with the quantitative aspect of welfare, which can be measured in terms of money.

Intext Questions 1.2

  • Statement (i): Inflation is studied under micro economics.
    • Answer: False (Inflation is a macroeconomic issue affecting the whole economy).
  • Statement (ii): Determination of price of a good is a problem under macro economics.
    • Answer: False (Price determination of an individual good is studied under micro economics).
  • Statement (iii): Macro economics deals with the issue of employment and unemployment.
    • Answer: True.
  • Statement (iv): Micro economics deals with individual decision making with respect to buying a good.
    • Answer: True.

Intext Questions 1.3

  • Identify whether the following statements are Positive or Normative:
    1. "India has a large number of poor people."
    • Answer: Positive
    1. "The government should spend more on education."
    • Answer: Normative
    1. "Poor people are suffering due to price rise of essential commodities."
    • Answer: Positive
    1. "Bank has increased its interest rate."
    • Answer: Positive
    1. "People should be encouraged to save in post offices and commercial banks."
    • Answer: Normative

Terminal Exercises

  • Question 1: Economics is science of scarcity and choice. Explain.
  • Question 2: How does wealth definition of economics differ from welfare definition of economics?
  • Question 3: Differentiate between micro and macro economics?
  • Question 4: Distinguish between Positive and Normative economics by giving examples?