Introduction

Economics

Greek Words

Oikos + Nomos

Oikonomia

Meaning - “ Household Management ” or “ Management of State”

Definition of Economics Economics has been variously defined by different economists

from time to time.

This is partly because “ economics is an unfinished science” (F. Zuethen, Economic Theory & Method,1953)

J.N.Keynes says – “Political Economy is said to have strangled itself with definitions” (Scope & Method of Political Economy)

Classical definitions of Economics are grouped together under 3 heads:-1. Wealth Definition (Adam Smith)2. Welfare Definition (Dr. Alfred Marshal)3. Scarcity Definition (Lionel Robbins)

Adam Smith(Economics is a Science of wealth)

Book :- “An Enquiry into the Nature and Causes of the Wealth of Nations” (1776)

Definition :- “Economics enquires into the factors that determine wealth of the country and its growth”.

“The great object of Political Economy of every country is to increase

the riches and power of that country”.

Subject matter of the book :- Wealth and Riches of a country cannot grow without the proper utilization of

its resources. Production and Expansion of Wealth.

Wealth Definition (Continues…..) David Ricardo (Principles of Political Economy) shifted the emphasis from the production

of wealth to the distribution of wealth.

Definition - “The produce of the Earth (all that is derived from its surface) by the united application of Labour, Machinery & Capital is divided among three classes of the community, namely- The proprietor of the Land The owner of the stock of Capital necessary for its cultivation The Labourers by whose industry it is cultivated.”

He further writes – “To determine the laws which regulate this distribution, is the principle problem in Political Economy”.

John Stuart Mill – “ The Political Economy is science of the production and distribution of wealth.”

J. B. Say (French Economist) – “Economics is the Science which treats of wealth.” F. A. Walker (Political Economy,1883) – “Economics is the name of that part of

knowledge which relates to wealth.”

Critical Evaluation of “Wealth Definition”

Critics

Carlyle & Ruskin – Gospel of Mammon / Pig Science / Dismal Science.

Study material wealth & ignores immaterial services(services of teachers, doctors, musicians, dancers etc)

Describes only productive factors like-land, labour & regard immaterial services as unproductive.

Emphasis on wealth & put man on secondary place.

Don’t stress on man’s behaviour & neglects promotion of human & social welfare.

Classical economists emphasis on institution of private property as legally, morally & naturally just. i.e.- right of wealth or natural rights of the factors of production on their several shares.

Natural & moral basis of property rights is not accepted by modern economists. Property are conferred by society and vested in the name of society.

In defense

a) Production, exchange & distribution of wealth gives physical substance to men & their standard of living.

b) Determine income, employment & economic growth.

Welfare Definition Dr. Alfred Marshal (Principles of Economics, end of 19th century) – “Political

Economy or Economics is the study of mankind in the ordinary business of life; it examines that part of individual & social action which is most closely connected with the attainment & with the use of the material requisites of well-being.”

So according to him- “Economics is on the one side a study of wealth; and on the other, and more important side, a part of the study of man.”

So there are 3 things worth of noting:- 1 Social Science- It is study of man as such and not only wealth. 2 Economic Aspect – It is concerned with a particular aspects of man’s life

(study of man’s action in the ordinary business of life; i.e.:- How he gets income and how he uses it.)

3 Welfare – The primary object and end of Economics is the promotion of material welfare; not totally welfare or spiritual well-being but part of material well being. So goal is described there.

Other Economists who supported the welfare definitions are- E. Cannan A. C. Pigou

Critical Evaluation of Welfare definition1. Restricted only to the material welfare or material things.2. Concept of welfare is not fixed and definite- i.e.- why welfare / Economics is

not all about welfare.

Scarcity Definition (Lionel Robbins’ Definition)

Book – “An Essay on the nature & Significance of Economic Science.” (Published in 1931)

Definition- “Economics is the science which studied human behavior as a relationship between ends and scarce means which have alternative uses.”

So Economics is a science of choice.There are 3 things in the definition-1. Unlimited wants / Multiplicity of wants2. Scarce means / Scarcity of means3. Alternative uses of means.

Critical Evaluation of Robbins Definition1. Robbins opposes the concept of social welfare2. Robbins criticized on that Economics neutral

between ends.3. Robbins criticized making Economics human science

instead of social science. My personal definition -“Economics is social science which deals with mankind

in economic way and better utilization of resources to meet human wants so that social welfare and nation’s growth are achieved.”

Subject Matter of Economics:-Types of Economics :-1. Micro Economics2. Macro EconomicsMicro Economics – It studies the economic action

and behavior of individual units and small groups of individual units.

Product Pricing

• Theory of Demand• Theory of

Production & Cost

Factor Pricing

(Theory of Distribution)

• Theory of Wages• Theory of Rent• Theory of Interest• Theory of Profit

Theory of welfare

Micro Economic Theory

MacroeconomicsMakros (meaning = Large) + Nomos (science)Definitions- “Macroeconomics analysis the

behavior of the whole economic system in the totality or entirety”.

“Macroeconomics studies the behavior of the large aggregates such as total employment, the national product or Income, the general price level of the economy”.

Macroeconomics is also known as aggregate economics.

Subject Matter of Macroeconomics• Macroeconomic Theory

Theory of Income & Employment

Theory of general price level & Inflation

Theory of Economic Growth

Macro Theory of Distribution( Relative shares of wages

& Profits)

Theory of consumption function

Theory of Investment

Theory of Fluctuations(Business cycle)

Demand & Law of DemandUtility – “Utility means want satisfying power of a

commodity”. It is also defined as – The amount of satisfaction which a

person derives from consuming a commodity.”

There are 2 dimensions to it:Total utility: Total amount of satisfaction Marginal Utility: Additional satisfaction derived from

consuming an additional unit of the product.

Demand – “The demand for a commodity is the amount of it that a consumer will purchase or will be ready to take off from the market at various given price in a period of time.”

Law of Demand• “ Other things being equal / constant, if price

of a commodity falls ,the quantity demanded of that product will rise and Vice-versa.

• So According to law of Demand – There is inverse relationship between price and quantity demanded

• .Demand shedule & Demand CurvePrice in Rs. Quantity Demanded in

unit

12 10

10 20

8 30

6 40 Quantity

Price

Factors influencing Demand (Determinants of Demand)

Taste and preferences of the consumersIncomes of the peopleChanges in the price of the related goods-Substitutes goods- example- Tea & Coffee Computer & LaptopsComplementary goods – example- Milk & Milk products Car & Petrol

Number of consumers in the markets (Population of state)Changes in propensity to consumesConsumer’s expectations with regard to future prices of

that goodsIncome distribution

Law of Demand (continued…..)

So according to law of demand- Quantity demanded is functions of following-

Qd = f (Px , I, Pr, T, A, ………..)Where • Qd= quantity demanded of a goods• Px = price of that goods• I = Income of people• Pr = Price of related goods• T = Tastes and preferences• A= Advertisement

Exceptions to Law of Demand• Veblin Effects / Veblin Goods- Theory given by

Thorstein Veblin for prestige goods.• Giffen Goods – Theory given by Sir Robert

Giffin , for inferior goods.• Demand of necessity- example- Salt• Scarcity or Inflection• Natural calamities

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Movement of Demand curve1.Extension and contraction in demand(movement is along the same curve in both the directions: upward and

downward, only price is changing other things remaining the same)2.Increase and decrease in demand(there is a shift in the demand curve due to change in the determinants of

demand other than price)

• Market Demand:

• Market demand is the amount demanded of a commodity at different price levels. In brief we can say the market demand is the sum of individual demands for a product at a price per unit of time. Therefore quantity demanded of a commodity by an individual per unit of time, at a given price, is known as ‘Individual Demand’ for that commodity. The aggregate of individual demands for a product is called market demand for the product.

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PRICE & QUANTITY DEMANDED ---- Demand curve of A, B, C & Market

Price of X

Quantity of X demanded by

various Individuals

Market Demand

A B C

10 5 1 0 6

8 7 2 0 9

6 10 4 1 15

4 14 6 2 22

2 20 10 4 34

1 27 15 8 50

Example is given below for market demand: Below table explains the demand for commodity X by different consumers at different price level. How we will calculate the market demand for commodity X

A demand BC

Total market demand

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• Types of Demand• 1. Price Demand• 2. Income Demand• 3. Cross Demand• Elasticity of Demand(Quantum of changes / Degree of responsiveness / Sensitivity)

• Dr. Alfred Marshall has put the concept of Elasticity. He defined Elasticity of demand as the extent to which the quantity demanded of a commodity changes in response to a given change in price. Dr. Marshall first limited this concept only to effect of price and demand, but later he has expanded the area to Income and Cross-relationship of demand with these factors.

• According to Marshall there are 3 types of elasticity they are:

• Price Elasticity of Demand: It measures the effect of a change in the price of Y on the demand of Y

• Income Elasticity of Demand: Effect of a change in consumer’s income on the demand for product X or Y or any other product.

• Cross Elasticity of Demand: Effect of a change in the price of Y product on the demand of X

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PRICE ELASTICITY OF DEMAND Price elasticity of demand indicates the degree of responsiveness of quantity

demanded of a goods to the change in its price Price elasticity of demand is defined as the ratio of the percentage change in

the quantity demanded of a commodity to a percentage change in the price of that goods.

Dr. Marshall defined the concept of price elasticity as “ The elasticity of demand in market is great or small according as the amount demanded increases much or little for a given fall in the price, and diminishes much or little for a given rise in the price”

• Ep = % Change in quantity Demand ed

% Change in Price

• The price and demand is having inverse relationship between them, therefore the numerator or denominator will be negative. As such Ep will always be a negative quantity. As it is always negative minus sign generally omitted. Example if price falls by 1% and the demand increases by 3%. The Ep = 3% = - 3. so Ep is 3 and (-)ve sign omitted.

-1%

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• So when • Ep > 1 Elastic Demand • Ep < 1 Inelastic Demand • Ep = 1 Unitary elastic demand

• (A) Types of Price Elasticity: • Perfectly Elastic Demand: • Perfect elasticity of demand refers to that situation where slightest rise in price

causes the quantity demanded of the commodity to fall to zero and contrary slightest fall in price increase in the quantity demanded of the commodity. The demand is hypersensitive and the elasticity is infinity.

• Example: 5% increase in demand for no change in price

Y Ep = 5 = ~. 0 Price D D1 O X Q Q1 Demand

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2. Perfectly Inelastic Demand: Y Ep = 0 = 0. D 5 Price P1 P O X D1 Demand Perfect inelastic demand refers to that situation where any rise in price does not cause any change in the quantity demanded of the commodity. The demand is insensitive and the elasticity is zero

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3. Highly Elastic Demand: Y D Ep = 40 = 2. 20 Price P Demand Curve P1 D1 O X Q Q1 Quantity

Highly elastic demand refers to that situation where small fall in price causes more than proportionate change in the quantity demanded of the commodity. The demand is highly sensitive and the elasticity is high.

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4. Inelastic Demand:

D Y Ep = 5 = 0.5 10 Price P Demand Curve P1 D1 O X Q Q1 Quantity Inelastic demand refers to that situation where high fall in price causes slight change in the quantity demanded of the commodity. The demand is insensitive and the elasticity is low.

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5. Unit Elasticity of Demand:

Y Ep = 20 = 1 D 20 Price P Demand Curve P1 D1 O X Q Q1 Quantity Unit elastic demand refers to that situation where any fall in price causes equally proportionate change in the quantity demanded of the commodity. The elasticity is stable.

Factors / Determinants of Elasticity of Demand• Nature of the commodity• Availability of substitutes• Number of uses of a commodity• Proportion of consumers' income spent• Time period• Price level• Postponement of purchases

Importance of Price elasticity• Pricing decisions by the business• Uses in economic policy• Explanation of the paradox of plenty• Importance in Fiscal policy• Use in international trade

Income Elasticity of Demand

• Income elasticity of demand may be defined as-• “The ratio of percentage change in quantity demanded of a goods to a percentage change in income”.

• So Ei = % change in quantity demanded

% change in income• Zero income elasticity • Positive income elasticity , when Ei > 0 for normal goods• Negative income elasticity, when Ei < 0 inferior goods• When Ei > 1 for luxury goods• When Ei < 1 for necessity goods

Cross Elasticity of DemandDegree of responsiveness of demand for one goods in response to change in price of another goods

represents the cross elasticity of demand of one goods for the other“ Cross elasticity of demand of x for y is – The ratio of % change in the quantity demanded of goods x to %

change in the price of goods y. Ec = % change in qty. demanded of x % change in price of goods y

Example of cross elasticity- 1. Maruti suzuki8000, Vans, Swift, Esteem 2. Gillete razor & Blade3 Automobile industry- Maruti (A Star) General Motor(Spark) Ford(i10)

Importance of Elasticity of Demand

• In production• For price determining• In Fiscal policy• In market competition• In international trade & Foreign exchange• In public finance.• In trade unions

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Law of Supply

• Meaning of Supply: As demand is defined as a schedule of the qualities of good that will be purchased at

various prices, similarly the supply refers to -the quantities of a good that will be offered for sale at

various prices by the firm.“ Amount of a product which a producer is willing to or able to produce and make

available for sale in the market at specific price for a given period of time.”

Law of Supply“ Other things being constant, when the price of a commodity rises the quantity supplied

of it in the market increases and when the price of the commodity falls its quantity supplied decreases.”

So quantity supplied of a commodity has direct or positive relation with its price.

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LAW OF SUPPLY:- Price perQuantity (Rs.)

Quantity Supplied (In Quintals)

500 100

510 150

520 200

530 225

540 250

550 275

Diagrammatic Representation:

Y S’ 540 530 520 510 500 S 0 100 150 200 225 250 X

Factors determining supply

• Number of producers or sellers in the market• State of Production technology• Cost of production (Factor price)• Prices of other products or related products• Objectives of the firm• Future price expectation• Taxes and Subsidies

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• ELASTICITY OF SUPPLY

• Elasticity of supply of a commodity is defined as the responsiveness of quantity of a supplied goods to change in price of that commodity.

• “ The ratio of proportionate change in quantity supplied of a commodity to proportionate change in the price of that goods.”

• Es = % change in qty. supplied• % change in the price of that goods

• (A) Types of Elasticity:

• 1. Perfectly Elastic Supply:

• Perfect elasticity of supply refers to that situation where slightest rise in price causes the quantity supplied of the commodity to infinity and contrary slightest fall in price decrease in the quantity supplied of the commodity. The supply is hypersensitive and the elasticity is infinity.

• Example: 5% increase in supply for no change in price

Y Es = 5 = ~. 0 Price S S1 O X Q Q1 Supply

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2. Perfectly Inelastic Supply: Y Es = 0 = 0. S 5 Price P1 P O X S1 Supply Perfect inelastic demand refers to that situation where any rise in price does not cause any change in the quantity demanded of the commodity. The demand is insensitive and the elasticity is zero

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3. Highly Elastic Supply: Y Es= 40 = 2. 20 Price S1 P1 Supply Curve P S O X Q Q1 Quantity

Highly elastic demand refers to that situation where small fall in price causes more than proportionate change in the quantity demanded of the commodity. The demand is highly sensitive and the elasticity is high.

4. Inelastic Supply:

Y S1 Es = 5 = 0.5 10 Price

Supply Curve P1 P S O X Q Q1 Quantity

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Inelastic demand refers to that situation where high fall in price causes slight change in the quantity demanded of the commodity. The demand is insensitive and the elasticity is low.

5. Unit Elasticity of Supply:

Y ES = 20 = 1 S1 20 Price P1 Supply Curve P S O X Q Q1 Quantity Unit elastic demand refers to that situation where any fall in price causes equally proportionate change in the quantity demanded of the commodity. The elasticity is stable.

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DETERMINANTS OF ELASTICITY OF SUPPLY: Elasticity of supply is determined by following factors:

1. Time: While considering the elasticity of supply time plays a very vital role in its determination. Normally the time period is divided into 3 categories:

Market Period: It is very short term period and it is difficult to change any factor of

production. (Period duration max 1-3 Months) Short Period: In this period it is possible to adjust the quantity supplied by

variation in the variable factor. (Period duration max 6-18 Months)

Long Period: This period is the long period and supplier getting sufficient time to alter and expand the quantity to be supplied. (Period duration max 2 years & More) 2. Change in marginal cost of production 3. Response of the producers 4. Availability of infrastructure facility and other inputs for expanding output. 5. Possibility of substitution of one product for others.