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    Economics Notes

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    Anubhav Das

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    Definition of Economics Adam Smith the classical economist defines economics as an 8 Wealth of nations. He says that political ©conomy is considered as a branch of science man or legislator, Proposes two distinct objects. St, to provide a plentiful Tevenue or subsistence for the people OR more Properly enable them to provide such a revenue or Subsistence for themselves Secondly, to supply the state or common wealth with the revenue sufficient for the public services J-B Say, (1803) defines economics as the aim of political economy is to show the way in which wealth is produced, distributed and consumed JS Mill (1805-1873) in his Principles of Political Economy s Political economy professes to teach or inv Wealth and laws of its production and its ¢ ys, igate the nature of stribution, Riccardo (1772-1823) in his Principles of Political Economy and Taxation says that, Economist studies how the produce of the earth is distributed. Thus economics deals with distribution of income and wealth MAIN FEATURES OF WEALTHE DEFINITION * Economics is the study of wealth only. It deals with the Consumption, production, exchange and distribution of Wealth > ‘Only such material commos Scarce and useful. Non-ma’ es constitute wealth which are s like services and free trial good Goods are not wealth of wealth changes which » Economics studies the causc To ase wealth Means economic development will have to be production of material goods will have t CRITICISM * Too much importance to wealth: wealth has primary pl. eases. « Restricted meaning of wealth: Material goods |, considered as wealth. Non material services are not tak. swealth. But modern economist use the word wealth for |). goods and services. Thus by restricting the wealth to materia! goods only, this definition narrowed the scope of economics. * No mention of man’s welfare: This definition gives no importance to the economic welfare of the society. It emphasises only the accumulation of wealth. It pays no attention to equitable distribution. * Concept of economic man: The wealth definition is based on the assumption that every man works more to self-interest. It does not deal with the selfish economic man. satisfy his common man but the As the wealth definition is nz the scope of economics by givin row, the later economist expanded are definition WELFARE DEFINITION OF ECONOMICS Alfred Marshall in his Principles of Economics says thus: Economics is the study of mankind in the ordinary business of life It examines that part of individual and social action which is most closely connected with the attainment and with the uses of Material requisites of well-being. Alfred marshall explains that political economy or economics is the study of man’s action in the ordinary business of life. It inquires how he gets his income and how he uses i side study of wealth and the other and more important side a part of the study of man, Thus it is on the one 3 (1877-1959) s Economies Welfare According to A.C. Pigou Ue f economic welfa Econom says, Economics is the 1 an n be brought direct! fare which can welfare is that part of er ti ith the measu indirectly into relation w th th Edwin Cannan in his Elementar F fr cal econor aim of pont economics as tht en: co-oper nie vhich i Ns general causes on ¥ needs. Beveridge in his Economics as a Liberal Education, says E nomics is the study of the general methods by which men co Operate to meet their material needs Thus economics was a science of wealth. Now it is a science of welfare. Main features of Welfare definition v A study of mankind: Econom studies the economic activities of man which are concerned with the material welfare of man Y Ordinary business of life: An ordinary man works mostly ©arm wealth and spends his earning to get maxin Satisfaction out of it. Economics studies economic activities of an ordinary man. ¥ Study of individual and social action: Economics stuc Man not in isolation but as a member of a social group. It Studies the personal and social activities of man which are i, concerned with his material welfar ’ Y Study of material welfare: Economics is a subject which studies the welfare of man which is of the material type. The He acdpel of study of non-material welfare is out economics. ‘RITS OF WELFARE DEFINITION & Avoid criticism made against Adam Smith: This definition Ifa Mar ull ve r emphasises man and his w« to man and wealth % Classifies economic activities M i classifies the economic activities of man stechinl w and non-material welfar ial and social of economics: | f classified as indi % Clear on the scope according to welfare den man only, it is te as they are re oa / CRITICISM OF WELFARE DEFINITION / Lionel Robbins (Leon Robbins) Critic Marshall’s definition 4 Limited the scope of economics: Marshall's definition has limited the scope of economics to the st udy of material goods only. But there are non-material services of a singer, doctor, teacher, lawyer which has economic value. Hence the scope of economics should include all goods and services which are economic in nature, 4 Restriction of activities of economics to ordinary man Marshall's definition restricts economics to the study of man in the ordinary business of life. All men are faced with the problem of choice. Therefore economics is the study of all men whether ordinary or otherwise. + Lack of clear concept of welfare: Whatever economics is concerned with, it is not concerned with caus welfare as such. The idea of welfare is vague of material uncertain and unstable, The concept of welfare changes according to place and circumstances. Welfare depends on the individual. Welfare cannot be quantitatively measured: Welfare Cannot be measured as it depends on the feeling of a persor Though Pigou regards money as an instrument for the measurement of economic welfare, but it is not time, feeling of satisfact ‘one. No two persons get the same satisfaction with the same ‘quantity purchased by him spending equal amount of money J Classificatory rather than analytical: The division of "economic activities into economic and non-economic is ‘completely unscientific and illogical. Even an economic activity has a non-economic activity. ROBBIN’S SCARCITY DEFINITION Lionel Robbins, An Essay on the Nature and Significance of Economic Science (1931) criticised Marshall’ definition. He defines ‘economics thus: Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses. \i i | ng the definition we can find that it lays down the wing three fundamental propositions which constitutes the sis of the structure of economic science. analy (a). Ends refers to wants. Human wants which unlimited in number. Of one want is satisfied anot her crops up. If wants k been limited, they would have been adequately satisfied and there would have been mo economic problem. Also, since human wants compelled to choose between the more urgent ants. That is why economics is called a nad are unlimited, one want and | urgent w: science of choice. unlimited yet the means or resources to There are certain free good which also Like nomic (b). although wants are satisfy them are limited satisfy human wants. Most @ur wants, if the resources are also unlimited, no ¢ problem would have arisen. Here the term scarcity is used in a r ve sense. It is scarcity in relation to requirements. t of the things we want are scarce. is tha third proposition underlying Robbin’s definitior heans are capable of alternative uses. If a commodity [pat to only one use, few economic problems would arise in its stion. On the other hand, ifa commodity can be put to more m@ use, no economic problem would have arisen. As soon as jee had been made of it, the commodity would have become d. Since our means can be put to so many uses, we must between these uses. We must decide what to buy and what uy. This will show our scale of preferences ‘definition is defined as the study of th sian terms, Economics inistration of scarce resources and of the determinants of Economics is a study of the factors affecting national income. n’s words, ‘stribution and stability of a country ‘it as a science of wealth is too narrow. To define 1 ‘mankind in the ordinary business of life is too broad and ‘ of material welfare is too narrow, To define it as scarcity or choice is too wide and to define it as that part {individual and social action is too narrow. Prof Viner has right ut that Economies is what economists do. E Onomics may defined as a social science concernec proper uses and allocation of resources for tt and maintenance of growth with stability Paul Samuelson defines economics on tt oasis of modern concep wth criteria is a study of how men and societ ise of money ould have alterr over time and distribute them Demand analysis Two techniques are used in th or demand analysis Utility analysis or Marshellian an Indifference Curve ai Uiility analysis of demand is ince Utility of a « By changing , Bg wansformati' ce utility: utility can be increased by transporting a good from When timber is brought to the market, it one place to another. st comes to have much gre: By storing 4 commodity and selling it at a time of ater utility than it had in the fore Time utility: scarcity we can g sumptions of marginal utility analysis ive it greater utility. Basic a: Cardinal measurement of utility that utility can be measured and the exact it can be given by assigning definite numbers such as it means that a person can express the satisfaction the consumption of commodity in quantitative terms. ft assumes ived from Utilities are independent It assumes that utilities of different commodities are independent of one another. Utility of one commodity does not in any wa: y affect that of another. In other words, the satisfaction derived from the consumption of one goods is the function of that good alone and is not affected by the consumption of another. On this assumption otal utility of all goods consumed by a consumer is simply the m total of the separate utilities of all the goods consumed by nstant marginal utility of money arginal utility of money remains constant even though the ‘quantity of Money with the consumer diminishes by the successive purchase made by him. It is assumed that while marginal utility commodity varies with the quantity of the commodity the marginal utility of money remains constant. This is necessary because of marginal utility of a of a purchased, t assumption commodity is measured in terms of money Introspection ned that from one’s own experience (judging what It is assum ‘ ible to draw another person's happens in one’s own mind it is pe mind. This is self-observation applied to assumed that mind of men work identically Law of Diminishing Marginal Utility another person. It is in similar situations, « The additional benefit whic Marshall states the law thus: ‘ of his stock of a thin person derives from a given increase diminishes with every increase In stock that he already has. * Explanation The law refers to common experience of every consumer. The law can be explained with the help of an example, The table below shows our hypothetical consumer ¢ onsumes goes on consuming a commodity Units tal Utility Marginal Utility 1 20 20 : 2: 38, 18 1 64 11 5 70 6 70 7 62 Zs 8 46 7 Suppose a consumer starts eating a piece of apples one after er. The first piece of apples gives him great satisfaction, By the second one meeting The satisfaction of at the fourth less anoth: the time he starts taking the second piece, him a less urgent want yields less atisfactic the third will be less than that of second one « than that of the third and so on ‘The additional satisfaction goes , fn decreasing with every successive pieces till it drop down to zero If the consumer is forc atisfaction turns to dis satisfaction. The total utility however, goes on inci until the consumption 0) 1 noting that it increases at a dimii In word a thing the from the atisfactio! in other people’s stock: law says that: when there is an increase in our stock. But e utility change, not because of a change in Rete RES cause of a change in other people’s stock. For e.g Value of Jand increases without any change in its dimensions when a. vay station has been built nearby, her possessions: Utility also depends on our other possessions. The law ignores the relation of complementarity. For e.g. a carriage emer 10 may be lying useless with us, but as soon as we are able to bur; horse, its utility goes Up- Fashion: Utility depends on fashion too. The utility of my dress will goes up when that dress.comes in fashion. Practical Importance of the Law of diminishing marginal Utility Taxation The law of diminishing marginal utility has great practical importance. This law forms the basis of the theory and practice of taxation. Progressive system of taxation, imposing a heavier burden on the rich people is the practical application of this principle in the field of public finance, Richer a person the higher is the rate of the tax he has to pay since to him the marginal utility of money isiless. Price Determination The law explains why with increase in its supply, the value of a commodity must fall. It forms thus the basis of the theory of value: Household expenditure his law governs fatger purchase v Purchase of a ily expenditure san Since we know that a lower marginal utility, we restrict our particular commodity, because we cannot afford to fe our limited resources. We Marginal utility equals price Ww p purchases at @ point where Downward sloping demand curve Tis the law h tell lich tel us 3 r irves slope downwards Socialism THE Socialist talc Gstribution of MS Fich of the wealth , that they n lose MBG the wealth which is transfer Basis of some economic laws EeMevery important laws of eco \ : GiMinishin. marginal 11 lus, concept of elasticity of demand. These laws § are ultimately been derived from the law of ag marginal utility. ' Law of Equi-Marginal Utility The idea of equi-marginal principle was first mentioned by H.H. Gossen (1810-18580 of Germany. Hence it is called Gossen's second law. Alfred Marshall made significant refinements of this jaw in his ‘Principles of Economics’, The law of equi-marginal utility explains the behaviour of a consumer when isumes more than one commodity. Wants ed bu some which is available to the consumers are bu incoi ¢ tos its is limited. This law explains how the sumer d limited income on various commodities to maximum satisfaction. In the words of Prof. Marshall, “If a person has a thing which can be put to several uses, he will distribute it among these uses in such a way that it has the same marginal utility in all”. | | Statement of the law Owing to multiplicity of wants and scarcity of means, wants are competitive. We have; therefore, more urgent and less urgent wants. When we are weighing in out mind whether to buy a little more or little less of a commodity, it seems we are trying to balance © marginal utility of the commodity and that of money. But what are really balancing is the marginal utility of that particular odity and marginal utility of other commodities, which we id purchase with that amount of money. Here substitution s place. It is not merely a substitution of one thins for another sfying the same want, but substitution even of entirely different odities, Every consumer aims at getting the maximum sible satisfaction. For this purpose, he will substitute the more for the less useful thing, The law of equi-marginal utility is own as the law of substitution or the law of maximum tion or the principle of proportionality between prices and utility. It is called law of substitution because we € more useful thing for the less useful thing It is known as law of maximum satt of substitution, we are able called law of equi-marginal marginal utilities have been substitution, that we get maximum satisfaction. Assumptions it is only when h the process of The consumer is rational so he wants to get maximum satisfaction. The utility of each commodity if measurable. The marginal utility of money remains constant. The income of the consumer is given. ‘The prices of the commodities are given The law is based on the law of diminishing marginal utility, Take two goods A and B. So long as the marginal utility of money spend on good A is not equal to marginal utility of money spend on good B, the consumer will increase his satisfaction by substituting one good for the other until marginal utility of money is the Same in both cases. The consumer will attain maximum satisfaction and will be in equilibrium, Symbolically the consumer will be in equilibrium when MUA MUB MUm PA PB Where MUA is the marginal utility of con amodity A MUB is the marginal utility of commodity B PAs the Price of commodity A PB is the Price of commodity B Mum is the marginal utility of mone © Mw i Ni mI in the two figures given above, on X axis, the unit of money is taken and on the ¥ axis; m inal utilities. Suppose a person has Rs. 7/- to spend on two commodities say apples and oranges whose diminis! ginal utilities are shown by the two curves AP and atisfaction if y. The consumer will gain maximum s money (Rs.3/- ) on apples and QM’ money (Rs.4/-) catise in this situation the marginal utilities of the (PM = PM). Any other combination will give less chaser spend MN money (Rs.1/-) more on apples and me amount of money N’M’ (*MN) less on oranges. The n shows loss of utility represented by the shaded area and a gain of PMNE utility. As MN=N’M’ and PM= PM’) it oved that the area LN’M’P” (loss of utility from reduced ) is bigger that PMNE (gain of utility from consumption of oranges) of apples). Hence the total ‘utility of this 1c eased consumption combination is less. no other combination of apples and oranges gives as the consumer as when PM=P’M’. ie where { apples and oranges purchased are equal, ney at our d isposal conclude, a satisfaction to ‘marginal utilities © given amount of mon ifference Curve Technique eks to maximize his satisfaction from the ach an equilibnum position. But in * must build up a seale of re find their place. ie, Te a consumer ta do so, der to be able Hi all objects of desi erences on whic! 4% t of the pric preferences from this scale of ods yields him The consumer's scale of preferen ruling in the market. He builds | the commodities he constim preferences he knows that one: the same Satisfaction as nother A Basic assumptions of consun 1. Completeness: We assu: the consumer’s scale of preference is so complete th able to choose any one of the two combinations of ies presented to him. 2. Non-satiation: A consumer prefers more to less. 3. Consistency or Transitivity: If a consumer regards Q better than R and R better obviously he will prefer Q to S, if his choice is open. Consumer’s choice has to be consistent. 4. Substitutability: Unless one combination can be substituted for ai consumer's preferences will not be possible. 7. indifference curve is convex to the origin and ‘diminishing rate of marginal rate of substitution. Curves SIS Of Consumer's scale of preferences, we can draw eurves. An indifferent curve represents satisfaction of from two commodities. It is drawn on the assumption all points (combinations of two commodities) on an srence curve, the total satisfaction remains same, ence Map it of indifference curves is called an indifference map Rate of Substitution cept of marginal rate of substitution is a tool of indifference parallel to the concept of marginal utility in Mmarshallian analysis of demand. marginal rate of substitution shows how much of on lodity is substituted for how much of another or at what rate consumer is willing to substitute one commodity for another in consumption pattern. 15 abination| Good |Good )MRS “of X| Cor x 1% 15 X and | forgo 4 X for 1 Y and yet remain at the . Here marginal rate of substitution of X rate of substitution may thus be defined at is sacrificed for obtaining one Y or it may $ the amount of X that may be given to the loss of one Y so that he may remain at the same that when the consumer has we may define marginal rate of substitution of X quantity of Y which would just compensate the the loss of the marginal unit of X. of Indifference Curves yard Sloping to the right: an indifference curve slopes wards from left to the right, It is because when the amer decides to have more units of the two goods, he will to reduce the number of the units of the other good, if is to remain on the same indifference curve. i.e. level of his atisfaction is to remain the same. a \ ~ —_ oT 16 oat that instead of sloping downward to the right, an indifference curve is a horizontal straight line, as is indicated in the figure given above. This shows that when the consumer is at point A, he has 7 X and 1 Y and he is at a certain level of satisfaction. When he moves from Ato Bon the same indifference curve, he remains at the same level) satisfaction despite the fact that he has more of Y (i.¢ 2) and the same number of X. This is obviously absurd. After all, the addition of Y without losing any of X he had in the previous position, must take him on to a higher indifference curve rather than keeping him on the old indifference Suppose curve. 2, Non-intersecting: The second property is that no two such curves will ever cut each other. At point B our hypothetical consumer is on the indifference 4 mirve IC1, while at point A, he is on the higher indifference curve 9) 1,6. the combination represented by Point A gives hima evel when he is Git means that point C lies on both indifferen om tim means that C is at once equal to A and E iSisay that one level is equal to two different levels Bi Convexity: The third property of indiff they are normally convex to the origin The Convexity rule is that and 1 and legs and less of Y for ¥ goes on falling ce Line or Budget Line 3. It is absurc eren urve is that as we have mor the marginal rate of s jose our consumer has Rs.15/- to spend on two commodities and B. Further suppose that the price of commodity A in the market is Rs.1 5/-per unit and price of commodity B is Rs.1/- per unit. With Rs 15/- he can buy 10 units of commodity A and zero sunits of commodity B or 15 units of commodity B and zero units of commodity A. By joining points A and M, we get what is called price line or budget line. This line shows all possible combinations of two goods (here ¢ commodity A and B) that the consumer can buy if he spends the entire sum of money on his purchases at the given prices. CONSUMER’S EQUILIBRIUM The consumer is said to be in equilibrium when he obtains the maximum possible satisfaction from his purchases, given the prices in the market and the amount of money he has for making purchases. In order to explain how a consumer reaches an equilibrium position with the help of indifference curves following assumptions are made the > Our consumer has an indifference map showing his scale of preferences for various combinations of the twe goods- A and B. This scale of preferences will remain the same throughout the analysis. > He has given and constant among of money to spend on the goods and if he does not spend on one good, he must spend on the other. > Prices of goods in the market are given and constant > Each of the goods is homogeneous and divisible > The consumer acts rationally, that is, he tries to maximize his satisfaction t \ ¥ Kw i \v 18 y Suppose our consumer has an indifference map shown in | above diagram, Further suppose that the price line facing consumer is AM. Given a certain amount of money he has to spend on A and B and the prices of A and B prevailing in the market Since his income and the relative prices of the two goods to be purchased are shown by the price-income line AM., his equilibrium must be on some point on this line. This line that contains all the possible opportunities of combining the two goods that is open to our hypothetical consumer. Actually the consumer will be in equilibrium at the point P. i.e. he will be buying OR of B and OH of A. The consumer will maximize his satisfaction and be in equilibrium at a point where the price line touches (or is tangent to) an indifference curve. In the diagram such point is P, which lies on indifference curve IC3. There can only be one point such as P with a given price line. Any combination other than P will give less satisfaction to the consumer. four consumer chooses a combination S, he will be on a lower ifference curve [C1 and will get less satisfaction than P. The mbination of N will also give him less satisfaction because it lies 2, Similarly all other combinations i.e. A, M, K, L, will give ‘satisfaction to the consumer compared to the combination P. librium point P, the marginal rate of substitution MRS of A is equal to the price ratio between these two goods, since h the indifference curve 1C3 and the price line AM have the slope at the point P F DIMINISHING RETURNS nt of the law: Every farmer knows by experience t lar piece of land is cultivated over ae over as Be ly yields less that proportionate returns If eve ae ae il more, units of labour and capital are Ee ae See rerun per unit does not increas {1 sta ie and n the capit 1 es the Jaw thus: “An inerea plied causes pplied in the cultivation of land a Agr tralized by adverse natural influences, >» There is very limited Scope for ithe use of machinery ir agriculture. Thus economies which result from the use of Specialized machinery, cannot be se: ured in agriculty » The Scope of division of labour is also limited, He nee advantages of division of labour are lost and dimir returns set in * Agricultural operations are Spread over a very lar iMficult. This reduces the yield » Soil get: exhausted after some time and yields less and less » All lands are hot equally fertile. If Cultivation is extended to inferior lands, the feturns per acre must diminish the shing Be area and DEMAND The demand for anything at a 81Ven price is the will be bought per unit of Ome at that price “By demand we mean the y. amount of it which 1g to BOBER, arious quantities Of a given « commodity oF Service which consumers would buy in one Period of time at various price PrICes OF related commodities Market in a given anous incomes Or at various the i demand for all the consumers combit demand Income demand: Ii refers to the various quantities of goods «1. vices which would be purchased by the consurt els of incomes, Here we assume that the price of r service as well as the prices of related goo preferences remains unchanged. Cross demand: The cross demand means the quantities o and services which will be purchased with reference to change price not of this good but of other inter related goods. Demand schedule and demand curve: The tabular representation of vyariows quantities purchased at various price level is demand schedule. Graphical representation of demand schedule is called demand curve. Generally demand curve slopes downwards. Exceptional demand curves Generally demand curves slopes downward to the left. But sometimes the demand curve, instead of sloping downward, will rise upward. In other words, people will buy more when the price rises. This can be represented only by a rising demand curve. This was first investigated by Sir Robert Giffen. The Giffen Paradox hold that the demand curve strengthened with a rise in price and weakened with a fall in price, Benham has mentioned four situations where demand curve rises upward, instead of sloping downward, (a). When a serious shortage is feared, people get panicky and buy more even though the price is rising, (b). In case the use of commodity confers distinction, the wealthy people will buy more when the price rises, to be included among the few distinguished personage. (c) Sometimes ometimes People buy more at higher (d). If the price of ity of life goes up, t S whole expenditure, He may cut Tucles and in order to make Up mG his particular food. Thus more of this” lased in spite of its high price, LAW OF DEMAND. oe of a S law simply expresses the relation Between @uamuty | : a nece readjust spent or + commodity demanded and its price, The law states tat on. varies inversely with price, not necessarily: a a, in also be stated thus: A rise in the priée @f @ commodity or 8 is followed by a reduction in demand, and @ fall in price is ed by an increase in demand, if conditions of demand remains constant. The conditions of demand remaining constant S very Important because demand is subject fo several influences. | Marshall stated the law thus: Other things remaining constant (Ceteries Paribus) the quantity demanded of a commodity extends with a fallin price and contracts with a rise im price. Here other things implies that income of the consumer, Prices of related commodities, taste and preferences etc should remain constant. Glen siseemeh commusnen steamed a le a a Pr‘te Re seag Pu A abydd cmle ach | 3 i a & : @ =) Pacer hath | = Ui, alo tc Lin oft In the words of Alfred Marsh of demand in market is ox demanded increases much 61 diminishes much or little fo Three types of elasticity of d tionate the change Price elasticity of demand ai ii in quantity demanded with} ‘ Bipate chenae a price level eP mount - Price Elasticity of demand (Ped) = ----7" ~~ -&% Change in Pri Income elasticity of demand.” fined as Proportionate the change Income elasticity of demand is de! t to proportionate change in the in quantity demanded with respect income of the consumer. % change in quantity demanded , Income Elasticity of demand = = Ba fs % Change in income Cross elasticity of demand is defined as Proportionate the change 7 in quantity demanded of commodity X with respect to { proportionate change in the price of the commodity Y j % change in quantity demanded of X > (Gross Elasticity of demand sen enn gente ra 4 % Change in price of ¥ Five cases of elasticity (or five cases of price elasticity of demand) Perfectly Elastic or Infinite Elasticity It means that even an infinitesimally small reduction in price leads. to an unlimited extension of demand. In this case the demand arve is a horizontal straight line parallel to x axis: Pet: ws P po Perfectly inelastic or Zero elastic It shows that howsoever amount demanded remain. curve is a Vertical str, much the price may Ss the same ‘aight line perp. fall or rise, the In this case the endicular to x demand axis. aks add ‘ pointed out that both perfectly inelastic and perfectly ‘clastic demand are the two extreme limits which are seldom met with in real life and can be explained only theore ly On the other hand, in actual life the elasticity demand lies between these two limits i.e more th n infinity However, it may be an zero and less Less Elastic In this case percentage change in price is more thar change in demand. In this case the demand cu Age is steeper More Elastic In this case percentage change in price is less change in demand, In this ca ase the demand curve an percentage is flatter, Unit elasticity In this case percentage change in price quantity are equal. The demand cul rectangular hyperbola, ae SUPPLY Supply means the amount offered fe Meyers define supply as a schedule ¢ would be offered for sale at all possib time or during any one period of time, supply remain the same.

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