1

What is Economics All About 1

Chapter OutlLne
1.1 Defin ition ofEc onom ics
1.2 Meth odolo gy of Eono mics
1.2. 1 Meth odolo gy of Economic Laws
12.2 Meth odolo gy of Economic Theory
1.3 Scop e of Econ omic s
1.3.1 Micr o Econ omics (Elementary Theory of Price)
1.3 .2 Macr o Econ omic s (Th eory of Incom e an d Empl
oyme nt)

If we look aroun d, we find peop le engaged in various activities, viz.

agriculture, trade , business,
indus try, etc. We find teachers teaching at schools and colleges, lawye
rs practising in courts, doctors
treati ng their patie nts at clinics and hospitals, workers worki ng
in factories, busin essm en engaged
in business activities, artists enter tainin g audience and so on. 'fhe
motive behin d these activities is
to earn mone y for the satisfaction of the wants . The activities perfo
rmed for mone y sake are called
economic activi ties. Econ omic activities form the subject matte
r of economics. Thes e are different
from non-e conom ic activities, unde rtake n out oflove, affection
or social responsibility.
Ther e is no conse nsus betw een two econo mists as to the corre
ct defin ition and subje ct matte r of
Economics. An appro priate defin ition will be one which defines
the boun dary of the subject clearly
and correctly. This raises issues whic h can best be appreciated
by a perso n who has gone throu gh
the subject. Thus , a forma l defin ition of Economics is not likely
to be of much intere st to perso ns
not famil iar with the kinds of probl ems that Econ omic s deals
with. In view of above, it becom es
necessary to indic ate, at the outse t, the natur e of Economics.

1.1 DEF INIT ION OF ECONOMICS

In every econ omy or coun try whet her it is rich or poor, capita
list or socialist, peop le are engaged
in the task of maki ng best use of the available resources, for satisf
ying as many wan ts as possible.
 1.2 Economics - /
'
l These wants may be individual or collective and may or may not be satisfied through the market.
11 The task of allocation of resources may be organised by private individuals or by the State.
! The concept ofscarcity (the root of all economic problems) is crucial to understand the problem of
allocation of resources. Almost all resources such as materials, men, money, machines, methods,
etc. are scarce under most circumstance s. Even air, the classic example of an unlimited resource,
can become scarce. While clean air is almost becoming a rare commodity in crowded urban areas,
air pollution can be prevented only at substantial costs. Water is free at many places but scarce and
costly in arid or densely populated areas. Goods such as sand or dirt that may be free in their
original locations tome at a price, when they are transported to places where they are needed.
The counterpart of pervasive scarcity is the unlimited wants. Human wants know no bounds and
are not limited by the level of income or wealth . Every one desires to acquire a little more. No
sooner a want is satisfied, that a new one emerges. Multiplicity of wants is an essential and
fundamental characteristic of human existence. However, all wants are not of equal intensity and
people are able to allocate resources to satisfy some of their wan ts.
The conflict between unlimited wants and scarce resources constitutes the basis of all economic
problems in society. It is this conflict that forces people, to make a choice as to which want to
satisfy and which to forgo. Had resources been unlimited like wants, no economic problem would
have arisen. In that case, all wants could have been satisfied.
The term scarcity of resources is used here in a relative sense, i.e., relative to the uses to which the
resources can be put. Mere absolute scarcity has no economic significance. Further, if a particular
resource is limited but can be used only for one purpose, there is no problem. However, the resources
have alternative uses. A plot ofland can be put under cotton c;:ultivation or for the production of
wheat. A worker can be employed in textile factory or in sugar-mills. While coal can be used as fuel
for domestic cooking purposes, it can also be used for running trains. This leads to an economic
problem.
People have to make choice between ends (wants) and scarce means (resources). This requires that
the alternative uses to which a given quantity of resource may be put should themselves be capable
of being ranked in order of preference by the owner of the resources. Otherwise, the question of
choice becomes meaningless. If a manufacture r gets same net income in the production of two
products, the question of choice as to which product to produce has no significance for him.
Each one of us faces such economic problems both in the individual capacity and as member of a
group, such as a co-operative society or a joint stock company or economy as a whole. An individual
faces economic problem in the capacity of both an income earner and an income spender. As an
income earner, he has to choose an occupation. As an income spender, he has to decide the goods
and services to spend upon. Similarly, a producer or manufacture r has to decide-what to produce,
how to produce and for whom to produce? The three basic or central problems, i.e. what, how and
for whom to produce are studied under the theory of demand and supply and the theory of
. distribution respectively under micro -economics.
Beside these central or fundamental problems, every economy faces the problem ofgrowth with
stability, i.e., a choice between current consumption and growth. The theory of economic growth
deals with this problem. Initiating the process of economic development is a problem of
underdevelo ped countries, while maintaining high rates of growth is important for advanced
 1.3
What is Economics All About?
pti on and ·
uir es sav ing a por tio n of its nat ion al pro duc t fro m cur ren t con sum
co~nt~ies. Thi~ ~eq cks of pro duc tiv e
itio n to _sto ck of pro duc tiv e res ources or for capital formation. Sto
usm g It for add ital
oug h use . To ach iev e a net add ition to capital stock, saving and cap
resour~es kee p dec rea sm g thr
iati on of pro duc tiv e resources.
for ma tio n mu st exc eed the dep rec ~ee n con sum er
is ess ent iall y a cho ice bet we en pre sen t and fut ure or a cho ice bet
Th is pro ble m on by the con sum ers , the
cap ital goo ds. Wh ile the for me r are used for final con sum pti be
goo ds and
ers in pro duc ing goo ds. Th e ava ilable recources of an eco nom y can
latt er are use d by the pro duc goods or capital goo ds (pr odu cer
goo ds) . Th e
duc tio n of eit her con sum er
em plo yed in the pro sen t wa nts of the
con sum er goo ds lik e wh eat , cloth, fur nit ure , etc. satisfy the pre
pro duc tio n of y, chemicals, aircrafts,
e pro duc tio n of cap ital goo ds like raw materials, plant, machiner y, by
peo ple. Th hen ing the pro duc tio n bas e of an econom
han d, hel ps in stre ngt
missiles, etc., on the oth er resources are used for pro duc ing
con sum er
pro duc tiv e cap aci ty. If all the
hel pin g it to exp and its nt in ter ms of pro duc tio n of cap ital
goo ds, the
pro vis ion is ma de for inv est me
goo ds onl y and no people-will rem ain
in fut ure wo uld no t inc rea se. Th us, increase in sta nda rd ofl ivi ng of l have
pro duc tio n , "H e wh o can not see bey ond the daw n wil
an old Ch ine se say ing
sta gna nt in future. To quo te e to cur e his hea dac he at dus k and
onl y rai n
nk at noo n, mu ch gre en win
mu ch go od win e to dri t of resources of an eco nom y mu
st be dev ote d to
the res t of the day s." Th us, par
wa ter to dri nk for elo pm ent activities.
of bot h cap ital goo ds and to the pro mo tio n of research and dev
the pro duc tio n nom y
tec hno log ica l pro gre ss ach iev ed in this way would enable the eco
Th e capital acc um ula tio n and ens ure ~ig her sta nda rds of liv ing of
peo ple ,
er goo ds in the fut ure and
to hav e mo re of con sum economy. Therefore, eco nom y sho
uld dec ide the
for sur viv al and gro wth of an
wh ich is nec ess ary gro wth also req uir es
nt and typ es of cap ital and con sum er goods. Further, eco nom ic
relative am ou
full uti lisa tio n of res our ces . def ine d
tio n of Eco nom ics wil l be use ful for the students. Eco nom ics can be
At thi s stage, the def ini ins titu tio ns which
nce con cer ned wit h tho se asp ects of social behaviour an d those
as a social scie uses, to pro duc e an d
all oca tio n of sca rce res our ces am ong unl imi ted and competing an d
involve the of hum an wants, which are inn um era ble
in the sat isfa ctio n
distribute goods an d services s and organisations engaged in the pro
duc tio n,
nom ics stu die s ind ivid ual
unsatiable. Th ere for e, Eco and services and fur the r deals wit
h the ways in
ge and con sum pti on of goo ds
dis trib uti on, exc han the me ans at the ir
soc ieti es see k to sat isfy the ir ma ter ial nee ds and desires, sin ce
wh ich me n and ·
pletely.
dis pos al ham per the m to do so com , bu t
we en alte rna tive s is fac ed not onl y by a per son living in a society
Pro ble m involving choice bet e Ro bin son Cru soe ), cut off fro m
the society.
ing on an iso late d isla nd (lik
also by an ind ivi dua l liv rna tiv e uses.
e at his dis pos al, wh ich is lim ited and is cap abl e of bei ng pu t alte
He has lab our or tim ice as to how
f has to arr ang e for all the goo ds required by him, he can ma ke a cho
Th oug h he him sel e to dev ote to oth er
sho uld dev ote to pro cur e foo d for him sel f and how mu ch tim
mu ch tim e he
ref ore , eco nom ise tim e and tha t is an eco nom ic pro ble m. He
activities or leisure. He mu st, the lik e to
ties in the ma tte r of foo d, clo thi ng and she lte r tha t he wo uld
sho uld fix an ord er of pri ori
d tim e at his disposal.
pro vid e for him sel f wit hin lim ite ividuals. It dea ls
cs is, how eve r, no t con cer ned with suc h pro ble ms of isolated ind
Mo der n Ec ono mi mi cs ena ble s us to
ms of peo ple liv ing in the soc iety at large. Th e stu dy of Ec ono
wit h the pro ble we en con sum ers and
un der sta nd soc ial pro ble ms ari sin g from the int era cti ons bet
ana lys e and bed as a social science.
em plo yer s and lab our ers . Th at is why, Eco nom ics is oft en des cri
pro duc ers ,
r
I
I
I
1.4 I
Economics : /
1.2 ME THO LOD OG V OF ECONOMICS
·-
\

For mul atio n of eco nom ic laws or principl

es and eco nom ic theo ry requ ires ado ptio \
method. In the words of Peterson. "The term n of a certain
met hod refers to the techniques and procedu
by economists in both the con stru ctio n and res used
verification of eco nom ic principles".
1.2 .1 · Me tho dol ogy of Economic
Laws
Economic laws can be derived on the basis
of deductive or inductive reasoning. Both
are decribed as follows: the methods

1. Deductive Me tho d
The deductive met hod or deductive logic
consists of arriving at a cert ain outc ome or
from some fun dam enta l trut hs, axioms, sup conclusion
pos ition s or basic assu mpt ions thro ugh a
logical reas onin g. Hen ce, we star t with the process of
general assu mpt ions and mak e pred icti ons
process oflogical ded ucti ons . If real facts thro ugh a
con firm the predictions, it is acce pted as eco
If not, it is either' amm end ed in view of acquired nom ic law.
facts or rejected altogether.
Given the assumptions, different economic
units are assumed to behave in a rati ona l man
this i;nethod. For instance, activities of the ner under
man are guided by the mot ive of self inte
this as absolute trut h, it is possible to predict rest . Taking
hum an behaviour, that the peo ple buy in the
mar ket and sell in the dearest market. Oth cheapest
er typical examples are the Ricardian theo
law of demand, the law of supply, the law of ry of rent, the
diminishing marginal utility, the law of dim
returns and so on. The deductive met hod is inishing
also called hypothetical, abstract, positive
met hod . It is 'hyp othe tica l' in the sense or a priori
that the assu mpt ions or axio ms (als o call
conditions) may not corr espo nd to actual ed causes or
facts, but so nea r to actual facts that they may
premises for reas ons ing and deriving con be used as
clusions. It is also 'abs trac t' as the pro blem
by removing all irrelevant facts. The process is simplified
of deductive met hod is kno wn as a priori reas
process involves ded ucti on of principles or oning.This
laws or doctrines by a prio r assu mpt ion of
beh avio ur on the part of the eco nom ic man an axiomatic
. Deductive met hod was exte nsiv ely use
and neo-classical eco nom ists such as Rica d by classical
rdo, Malthus, Senior, J.S.Mill, Cairness, Mar
and Pigou. It is pop ular even with the mod x, Marshal!
em economists, as it has several adv anta ges:
(i) Economics being a social science deals
with such hum an beh avio ur on whi ch ther
scope for actual experiments, as data are inad e is limited
equate or not available. Her e, ded ucti ve met
is useful, whi ch is simple and doe s not invo hod
lve muc h of coll ecti on of data . Fur ther , it
expensive and less tim e con sum ing. is less
(ii) Hhelps in laying dow n basic prin cipl
es of hum an beh avio ur.
(iii) S_everal forces act simultaneously on
the eco nom ic phe nom ena , mak ing it com
tive met hod analyses com plex eco nom ic plex . Ded uc-
. . phe nom ena and bri· ngs ex t
general1sat1ons. ac nes s t o eco nom ic ·
(iv) Forecasts and con clus ions based on
b d "bl this met hod are exa ct clea rc t d ·
een ma e poss1 e by the applica . .
tion of sop hist
, u an 1mpart1· a1. Th"1s has
duc tive met hod . icat ed mat he f l h
ma ica tee niqu es in t h e de-
(v) It is universally applicable as it is bas
ed on hum a11 b h ·
e av1our.
 1.5
What is Economics All About?

ant age s <led uct'ive me th od 1s . me tho d is

Des pite several .adv . ' not free from shortcomings. Thi s
b ased on unr eal1stic ass um ptio n s, especia . 11 . sophisticated theoretical models wit
h little
Ifth Y m case of
. . al t
em pm c con ent.. ese assumptions are removed, economic hypothesis based on them is refuted. .
d h . . . . eco nom ic
Furth er, con e us1l 0ns eriv ed thr o h th· y a hm 1ted app hca t10 n as
k h ug is me t od have onl on
· d't· Fin all b. preconceived notions of economists
. . · . Y, per son a I iases and
con 1 10n s eep c ang ing
. .
in economic policy.
several issues ren der 1t ma pph cab le · .
· s h.1gh 1eve1of competence m · logI·C and abstraction
s, the use of the ded uct ive me th o d reqmre
Thu . .. me tho d. A
pos itiv e app roa ch are pre req uisi te for successful applicability of this
Unbiased and result in establish-
l ~f car e and obj ecti vity wo uld avoid faulty economic reasoning and I :~
goo d dea ,, \ . • :.\ 1., ~ \ -,: \J I ' , · )
ld and sou nd eco nom ic law . ~~ I
• I '

me nt of vai '1 \

(
2. Inductive Me tho d t 't , I l \ ...

of
ls wit h the nor ma tive asp ect of the science, i.e., what ought to be as well as
Ind uct ive me tho d dea . Contrary to
tec hni que of a pra ctic al app roa ch to the problems of economic science
what is. It is a general. Un der this
lves reasoning from the particular to the
the deductive logic, inductive logic invo units und er
arding the behaviour of eco nom ic
collected reg
me tho d, em piri cal inf orm atio n is and
. The n gen era lisa tion s are arri ved at on the basis of extensive experience
diff ere nt con diti ons nd eco nom ic
The num ber of obs erv atio ns has to be large to establish valid and sou
obs erv atio n. ween eco nom ic vari-
this me tho d, we sta rt wit h fact and try to establish relationship bet
laws. In orical, concrete, ethical or
. Inductive method is also called hist
ables thr oug h a process ofin duc tion is the result
d. The adv oca tes of this me tho d believe that economy of every cou ntry
:\_; :'..:J e_aljstic me tho orical evolution and .
g evo luti on and the col lect ed facts can be varified thro ugh hist
',' ·.: ·of a' lon are ma de by separating tile
erim ent atio n. The y are the n clas sified, analysed and generalisations
, , exp ed at
lev ant fact s from the rest . For exa mple, suppose an experiment is perform
unnecessary and irre s are taken. If,
by diff ere nt per son s in whi ch larg e num ber of hard and green ban ana
various places e, a law can be-formu-
eati ng, the y are said to be unr ipe and the result is the same everywher
after ting a law is called induc-
s are unripe. This method of formula
lated, tha t al! har d and gre en ban ana
tive me tho d. tha t as the inc om e of a
Law is a fam ous exa mp le of ind uctive method. This law describes
Engel's es, while tha t on com -
inc rea ses , the pro por tion of its exp end itur e on necessities decreas
fam ily
s up. Par eta's law of inco me ineq ualities, Malthusian theory ofpopulation are
forts and lux urie s goe they realy are.
les. Ind uct ive me tho d is clai med to be realistic as it describes things as
oth er examp
It has ma ny advantages: in economic investiga-
es clear and substantical advantage
(i) Exp erim ent al ind uct ion possess tio11 lead to
rese arc h. The eco nom ic law s whi ch are arrived at by a process ofinduc
tion and the applica;tion of
, exa ct and me asu rab le con clus ions. The results obtained thro ugh
pre cise validity onl y und er
ity. It tells tha t generalisation have
ind uct ive me tho d are closer to real ible to
ons , in a cer tain plac e and at a par ticu lar time. It is alm ost imposs
cer tain con diti uctive me tho d.
con clu sio ns wh ich hav e uni ver sal application, as don e und er ded
der ive of economic
d of sati stic al ind uct ion , thu s, give s pro per atte ntio n to the complexity
Me tho
phe nom ena . avi our pat tern of the
ict reality, as it is based on actual beh
(ii) Thi s me tho d is exp ect ed to dep irical
ts. Tha t is why , ma ny bus ines s firm s use this me tho d and und erta ke emp
economic uni
 1.6 Economics_ I
investigation to determine expected resp
onse of consumers to cha nge s in quality
of thei r pro duc ts or to the way the goods and price
are advertised. Kno wle dge of responses
ous sections of society like consumers, prod of vari-
ucers, investors, farmers, etc., helps the
men t in formulating suitable policies to gov ern-
achieve thei r goals.
(iii) It gives due exphasis to'the historical evolution
of various eco nom ic c~~cepts and ideas.
economics, som e imp orta nt laws have been In
discovered from an emp mca l stud y of facts
,
(iv) Inductive met hod can be used to check and vari
fy the con clus ions of ded ucti on to bring
light deficiencies in their trea tme nt and to
to amplify their conclusions.
(v) This met hod involves less chances
of mistakes.
In spite of the above stat ed advantages,
inductive met hod is no free from limitatio
laws based upo n inductive met hod may ~s. Economic
not remain valid in future, as thes e exp
flowing from changes in economic caus lain the effects
es only. But, economic activities are also
economic causes whi ch also keep changing affe cted by non-
. Further, data one relies upo n may be
the prim ary data for nati ona l income com inaccurate,e.g.
putation in India. Complexity in collecti
of data also causes pers ona l prejudice. on and ~nalysis
Finally, this met hod is expensive and tim
can only be used by those who possess e-co nsu min g. It
skill and com pete nce to han dle com plex
data .
The deductive and indu ctiv e met hod s,
are not com plem enta ry to eac h other.
whe n ado pted in isolation will not give Any one of them,
reliable or satisfactory results. Tha t is
eco nom ists use bot h of these methods. why, modern
Economic hypothesis or laws are deri
process of logical ded ucti on. The se are ved thro ugh the
empirically tested and veri fied thro ugh
eco nom etri c' met hod s i.e., induction. Mar statistical or
shall rightly points out ," "Ind ucti on and ded
bot h nee ded for scientific thou ght as the ucti on are
righ t and left foot are bot h nee ded for
deductive met hod gives analytical or theo wal king :' While
retical explanation to eco nom ic facts of
inductive met hod tests or verifies the sam phe nom eno n,
e empirically. Inductive met hod helps in
assumptions for deductive method, the sele cting relevant
latter helps in inte rpre ting com plex real
way. While former involves reasoning from ity in a meaningful
the particular to the general, the latter imp
from general to the particular. In the fina lies movement
l analysis, bot h tend to con verg e toge
met hod s sho uld be judiciously com bine ther . Thu s, both
d to get correct, useful and full results.
Samuelsson are wor th noth ing, who nicely Her e, the words of
con clud es the who le mat ter by say ing
t1.
reason~n_g is th~ key success in the mas
t~ry of basic eco nom ic prin cipl es and shre
that "Logical
wd weighting
of emp mcal evidence 1s the key to succ
ess m mas tery of eco nom ic application
s."
1.2 .2 Me tho dol ogy of Economic The ory
Wh ene ve: we mak e an att~ mpt to exlain
a gro up of facts, we have a hypothesis2
can explam new facts and 1s not refuted . If this hypothesis
. . or con trad icte d by new di·scove · ·t
An eco nom ic theo ry 1s used to explain nes , 1 b eco mes a theor y.
'E · D •, obs erve d phe nom ena thro
conomIC ynam1c an d 'Postit.1ve . , ugh 'E
con om1 c a f1c' or
, · St
F,orm oifE · A z • A or Nor mat ive as disc usse d in Sec tion 3 3 3 4 · Ch t 3 on
. conom1c na ys1s. successful theo ry enables us to the p ed· t · d . , . hm ap er
of vari ous occ urre nce s. Eco nom ic theo r IC m a van ce t e consequenc
es
ry trie s to find out the ·
phe nom eno n and pos tula tes the rela tion imp orta nt cau ses of the eco nom ic ·
ship betw een the eco · h
nom1c p eno men a, but also give ·
I. In.recent years, statistics or econometrics
s
.• . or
mathematics is bein · .
2. A hypothes1S' 1s a statement about how two g mcreasmgly used as a tool of economic analy .
or more variabl sis.
es are re 1ate d to each other.
What is Economics All About?
l.7
explanations for them. It is a hypothesis that has been succe
ssfully tested.Economic theory is different
from an economic law in the sense that the latter simply descr
ibes the relationship betweeen variables
and does not provide any explanation for such relationsh
ip. Economic theory, on the other hand,
provides logical basis of the law. It derives the law through
a process oflogical reasoning and explains
the conditions under which the stated generalisation will
hold true. For example, theory of demand
tests then hypothesis that if the price of a good falls, then
the quantity demanded of the goods rises.
Economics, being a science of human behavior, uses the
same method as used in other sciences in
formulating a theory. It is systematic and logical enquiry abou
t an economic phenomenon. Following
Chart 1.1 explains the principle steps in the formulation
of an economic theory.
Chart 1.1
Defining the Problem and Various Tenns

Assumptions

A Process of Logical
Deductions and Predictions ·

A Process of Empirical Theory is Discarded in

Observations (Testing of · Theory is Favour of a Better
Modified Alternative Theo ry
Hypothesis)

Eithe r Or

Predi ctions are not

Consistent with Real Facts
Conclusion 1---►
►·IL~~==~:...=-=-:.:.:.... :..------

Predictions are Consistent with

the Real Facts

\ Theory is Accepted J

. f om1·c theory requires us to proceeed steps by step.

This chart shows t h at const.r uction ol an
.
econ
The various steps involved m formu atmg an economic theory are described be1ow.
. . Problem and Various Terms
1. Def, n,ng . h . to have clear perception of the problem
The first step in the formu1afion of an economic
t
t eory is .
d terms to be used are also defined. For insta
to be enquired into. Further, var ious conc ep s an nce,
d't the terms like demand, consumers, supply, pro ducers
while studying the price of a commo l y, ,
market have to defined.
 1.8 Economics - J

2. Assumptions
After defining the prob lem and various con
cepts, a set of assu mpt ions are mad e. The se
may be behavioural, i.e., relating to the rele assumptions
vant eco nom ic units. For ex~m_p~e, the ~on
to maximise thei r satisfactions, while prod Sumers want
uce rs are inte rest ed in max1m1smg thei r
way, the beh avio r of bot h con sum ers and profits. In the
prod uce rs in ratio nal. Rat iona lity of con
producers is a crucial assumption in economi sum ers and
cs. Further, the assu mpt ions can also be tech
i.e., relating to the pro duc tion technology and nological,
factor end owm ents . Finally, som e assu mpt
mad e to simplify the analysis as the real eco ions are
nom ic phe nom eno n is very com plex .
3. Log ica l Ded uct ion
A process of logical ded ucti on is the nex
t step in the form ulat ion of an eco nom ic
discovers the imp lica tion of the assumptions theo ry whic;h
. These imp lica tion s are also call ed pred icti
theo ry. For example, if we assu me that man ons of the
is selfish, it can be logically ded ucte d and
that a seller will sell mor e if it brin gs mor pred icte d
e prof it to him .
4. Em piri cal Obs erv atio ns
A process of empirical observations involves
testing the predictions 'hyp othesis' aga inst
evidence or the actual facts. The aim is to judg the empirical
e whether the pred ictio ns are con sist ent with
facts _o f the world. For example, response of the real
con sum ers to rising pric es ove r a peri od can
to check the vali dity of the pred ictio n. be studied

S. Conclusion
If the predicti~ns are con siste nt with the facts,
the theory is esta blis hed and it gain s acce
the contrary, 1f the facts refute the pred ictio ptan ce. On
n, the theo ry is eith er mod ifie d or it is disc
favour of a bett er and mor e satisfactory alte arde d in
rnative theory.
1.3 SCOPE OF ECO NO MIC S

Trad
. 'bition•ally, the subj ect mat ter of eco nom ics
has bee n divi ded · t • n pro duc •
d 1stn ut1on, exchange and public finance. m o con sum ptio tion
· •f . . . The natu re ofh uma t d
th eir sat1s acti on are stud ied m con n wan s an t h e prm · c1p
• 'les
aov ernm• g'
sum ptio n. The pro duc tion of the
help of the various factors of prod ucti on is
considered und er rod u . goo ds an~ s~rv . t> •
the dist ribu tive shar e of these factors are 1ces with ~he
stud ied d d ~ . ctlo n. The pnn c1p
exchange of goods and thei r prices In pub t les governmg
. t· fi un er lS nbu tion . Exc han ge dea ls with
1.e., how gov ernm ent gets mon ey and · 1c man ce, we stud y the ec the
how ·t d h . f .
. .. . ono m1c unc tion s of a state,
t h ese activ1tJes are mcluded in price theo ry I spen s t e sam e In th d .
of supply covers prod ucti on. Similarly dist ·
WI11. th
1e eory of den • d. · e mo ern eco nom ics, all o f
ribtiti·o d h
an d pro d uct pricing resp ectively. , n an exc anglan e1
cov ers con sum ptio n, theo ry
t d"
<re s u 1ed und er fact or pric ing
The mod ern eco nom ic theo ry is however
' ·, d.1v1'd ecl .
t h eory) and mac ro-econ omi cs (inc mto two b h .
b h · ome theo ry) M' ~anc es-m icro -eco nom ics (price
M
e av1our. aero eco nomics, on the othe r hai ·d icro -eco nom1cs 15
M' . 1 ,
.
is 1 . · · the ana lysi·s of the indi vidu al
1cro -eco nom1cs an~ mac ro-e con omi cs are ti t 1e analysis of .
. . h . . mas s or agg rega te beh avio ur.
aggrega t 10n, 1.e., t e exte nt to which the eco 1us use d 111 co .
. . . . nne
economic analysis. . nom1c u111ts . d h ctio n wit h the leve l of the
an t e vari able s are cov ered in the
What is Economics All About? 1.9

1.3.1 Micro Economics (Elem entar y Theo ry of Price}

Thus, micro-economics
!he term micro is derived from the Greek word 'mikros' which means small.
IS the theory of small. For tw? centuries, price theory or.
value theory (as it was called at that time)
al economist Adam
has been the centre of attention of economists. It owes its origin to the classic
Smith and culmination to Alfred Marshall.
or decision mal<ing
Micro-economics is that branch of Economics, which studies an economic
with the analysis of the
unit a?d considers in detail the behaviour of that particular unit. It deals
y, such as particular
behaviour and e~onomic actions of small individual units of the econom
various industries and
consum-ers, particular firms or small groups of individual units, including
lar firms, particular
markets. In the words ofK.E. Boulding3, "Micro-economics is the study of particu
lar commodities':
house-holds, individual prices, wages, incomes, individual industries, particu
s equilibrium of
Micro-economics is the microscopic study of the economy. Here, we discus
We also study role
innumerable units of the economy piecemeal and study their inter-relationships.
ers in the·working of
played by individual households as consumers and individual firms as produc
a good from demand
the whole economic organization. For instance, we derive market demand for
the behaviour of the
of individual consumers. Likewise, in micro-economic analysis, we also study
ns to the changes in
individual firms in the fixation of price, output, employment and their reactio 4
fixation by an industry.
the demand and supply conditions. From this, one can determine price-output
nt economic units
Therefore, micro-economic theory seeks to determine mechanism by which differe
d group. The study of
attain the state of equilibrium from the individual units to a narrowly define
s.
economy as whole, however, lies outside the scope of micro-economic analysi
studied under micro-
Micro-economics may assume full employment. The principle problems
n the production of
economics relate to the allocation of scarce resources of the economy betwee
factors ofproduction.
different goods and services and the determination ofprices ofgoods as well as of
of different goods and
Allocation of resources is, in fact, explained in terms of the relative price
ics. Price, in tum,
services. The theory of price, thus, constitutes the central theme of micro-econom
the theory ofpricing.
depends on the forces of demand and supply, which are the two subdivisions of
deals with the
Gardner Ackley in his book 'Macro Economic Theory' says, "Micro-economics
ion of resources
division of total outpu t among industries, products and firms, and the allocat
interest is in relative
among competing uses. It considers problems of income distribution. Its
prices of particular goods and services."
which the economist
In the words of Quirk, "Micro economic theory provides the framework within
elementary economic
describes and analyses the behaviour patterns and inter relationships of the
objective of micro
units like consumers, firms industries, commodities and markets. The main
distribution of goods
economic theory is to explain and predict how production, exchange and
."
and services responds to the incentive structure operating in a given society
(maximisation of the
Micro-economics explains the conditions of efficiency in consumption
isation of production
satisfaction of consumers, given income), efficiency in production (maxim
ction of the society).
or profits, given resources) and overall efficiency (maximisation of the satisfa

3. Boulding, K.E.. : A Reconstruction ofEconom ics, 1950, P.3

4. Industry is a group offirms producing identical product.
5. Ackley, Gardner: Macro Economic Theory, P.4
 Economics - I
1.10

When such situation of efficiency is reached, it is not possible to make any one better off without
making some other one worse off by any redistribution ofgoods, services or factors. The question
ofeconomic efficiency is the subject matter of welfare economics, which is an imp_o rtant branc~ of
micro-economic theory. The whole content of micro-economics is presented 10 the followmg
Chart 1.2:
Chart 1.2
Micro-Economic Theory

Theory of Economic Theory of

Product Pricing Factor Pricing
Welfare lnternnlional Trade
I (Theory of Distribution)
I I
Theory of Theory of Wages Ren t Interest Profits
Demand Production
&Cost

Importance ofMicro Economics

Micro economic analysis is extremely useful and it has both theoretical and practical importance.
It is highly helpful in the formulation of economic policies that will promote economic welfare
of the masses. Before Keyn esian Revolution, economics mainly consisted of micro-economic s.
In spite of the popularity of macro-economic s these days, micro-economic s has not lost its
importance.
Micro-economics solves the three central problems of the economics, i.e., what goods and services
are produced (and in what quantity), how goods and services are prod uced and distributed (for
whom to produce). In the words of Watson6, "Micro-economic theory explains the composition
or allocation of total production, why more of some things are produced than of others". He further
remarks that "It has many uses. The greatest of these is depth in understanding of how a free private
enterprises economy operates''.
Micro-economics seeks to explain, whether the allocation of resources is efficien t and explain the
causes for deviations from the efficiency or economic optimum. It also suggests suitable policies
to promote economic efficiency.
Micro-economic s has application in various diversified fields of Economics and commerce such
as agricultural economics, labour economics, international economics, consumer economics,
comparative economics, welfare economics, regional economics and public finance. M icro-
economics is used to explain the factors, which determin e the distribution of the incidence or
burden of a commodity tax between producers and sellers on one hand and the consumers on
the other. It also tells us the amount of damage caused to the social welfare and economic efficiency
as a result. Further, gains from international trade and the distribution of this gain among the
participant countries is also explained by micro-economics. Success of devaluation in correcting
the disequilibrium in the balance of payments depends upon the elasticities of demand and
supply of exports and imports, which is the subject matter of micro-economic s. Further, the
determination of floating foreign exchange rate depends upon the demand and supply of that
currency.
6. Watson, D.S.: Price Theory and its Uses, 1963, P.5
What is Economics All About? I. 11

ed decision making in
A new branch of micro economics namely Business economics has improv
mming has provided
business through ~emand and cash analysis. Further, the theory oflinear progra
a powerful analytical tool to analyse business problems.

·1.3 ..2 Macr o Economics (Theo ry of Income and Empl oyme nt)
Most of the modern
The term macro is derived from the Greek word makros, which means large.
tion of Keynes 'General
economics is now macro-economics. It has become popular only after publica
ed, "the modern
Theory ofEmployment, Interest and Money' in 1936. K.Boulding has rightly remark
work ofJ.M.Keynes".
developments in macro economics ...... are most closely associated with the
forerunner of macro
Besides Keynes, Robert Malthus (a classical economist and an important
among the prominent
economics), Karl Marx, Leon Walras, Kunt Wicksell and Irving Fisher were
is. The theory of
economists who contributed to the development of the macro-economic analys
economic growth has further made its use indispensable.
s of the economy as a
Macro-economics, also called income theory is concerned with the analysi
e and output, total
whole and its large aggregates or averages such as total national incom
aggregates result from
employment, aggregate demand and supply, and general price level. These
such as consumers,
activities in different markets and from the behaviour of different decision makers
system or its major
governments and firms. Macro-economics studies the entire economic
private consumption
components such as households, business and government. It deals with total
diture, total imports
expenditure, total private investment expenditure, total government expen
loyment, inflation
and exports of goods as well as services. It seeks the causes and cures for unemp
and balance of payments deficits.
unit, but, with all such
Thus, macro-economics is not concerned with a particular decision making
. That is why, the
units combined together. It presents a complete picture of the economic system
E. Boulding7 "Macro-
macro-economics is termed as aggregative economics. In the words of Kenneth
quantities, not with
economics deals not with individual quantities but with aggregate of these
with price levels, not
individual incomes but with national income, not with individual prices but
with individual outputs but with the national output:'
It concerns the overall
Gardner Ackley8 says: "Macro-economics deals with economic affairs in large.
of trees which compose
. dimensions ofeconomic life .... It studies the character offorest, independently
it:'
oflevel, composition,
In a nutshell, macro-economics examines and explains the determination
i.e., national income,
fluctuations (cycles) and trends (growth) in the overall economic activity,
We merely study the
output and employment. Further, here, full employment is not assumed.
can be achieved.
determinants of the full employment and see how the fullest possible employment
1.3:
Various aspects of the macro-economic can be shown in the following Chart

7. Boulding, K.E. : Reconstruction ofEconomics, 1950, P.3

8. Ackley, Gardner: Macro Economic Theory, P.4
 1.12 Economics - I

Chart 1.3
Macro-Economk Theo~'

I
Theory of Theory of
I
Theory of Macro Theory
Income and General Price Economic of Distribution
Employment Level and Growth (Relative Shares of
Inflation Wages and Profits)

I
TheOI)' of Theory of
Consumption Investment

I
Theory of Fluctuations
(or Business Cycles)

Importance ofMacro Economics

The analysis of macro-economics has acquired great significance in recent years. The movements
in economic aggregates influence the health of the macro economy and economic fortunes of
individuals. Macro-economics explains as to why some economies grow with increases in their
living standards, while others do not. It also shows cyclical variations and government's measures
to reduce such fluctuations. The study of macro-economics is useful in many ways:
(I) Formulation and Execution of Economic Policies: The government intervention in the
economic activities has been increasing day by day. The government, however, can not deal
with a particular individual or with small groups. Hence, the study of the macro-economics
becomes very important at the time of formulation and execution of economic policies.
The economic policies for the removal of poverty, unemployment and price instability are
based upon aggregative requirements.
(2) Functioning of Economy: Macro-economics helps us to get ,m idea of how a complex
economic system functions. It is very difficult to interpret the functioning of an economy
in terms of micro-economics, as there are numerous decision making units in the economy.
We can understand the complex economic S)'Stem through ..,
the stud)'. of national aaareaates
00 0
like income, output, expenditure, saving and investment.
(2) Helps to Understand Micro Economics Better: The study of the macro-economics makes
the understanding of micro-economics better. Almost every micro-economic law is based
on macro-economic study. For instance, the law of diminishing marginal utility (a
fundamental law of consumption) has been framed by observing the behaviour of many
consumers in the society.
(4) Study of Economic Development: The macro-economic developments have led to the
study of the economic growt~. This has en~bled us to study and understand the problems
of the underdeveloped countnes. By analysmg such problems, it has become possible for us
 r/'. -, - - ·
iI • • • • • ~ ~• •• C

'hat is Economics All About? f.::~

. ; : .. , , . ·•A{:,_9)?,• , J.J J

to pro t th d r:-: ~:~cu, ~ \ ~~~ t

cro eco nom ic analysis helps us to
mo e e seve lop me nt of· these cou• ntries. Th e ma . .
stu dy the pro ces of the inc · the factors accelerating the
om e generat10n and to det erm ine
eco nom ic eff icie ncy.
t is not pos sib le to me asu re the size o[ material welfare in terms of the
[5) S ud y of Welfare: It
lth of the sectors
eco no mi cs. Mo vem ent s in ma cro economic aggregates reflect the hea
~c ro- The importance
ich the ind ivid ual s wo rk and the prices of the goods that they purchase.
m wh economics is the
cro -ec ono mi cs is enh anc ed, as the main objective of the stu dy of
of ma
we lfa re of society.
has assumed
of Inf lat ion and De fla tio n: In these days, the problem of inflation
:6). Th eor y It is the result
ens ion s in bot h the dev elo ped and the underdeveloped countries.
ser iou s dim important
agg reg ate dem and , as exp lain ed by Keynes. The theory ofinflation is an
ofexcessive sustained
cro -ec ono mic s. In con tras t, def lation is associated with a steady and
sub jec t of ma ative
lev el. Inf lati on as wel l as def lati on are explained in terms of aggreg
fall in the pri ce the
les like agg reg ate dem and , out put and mo ney supply, which explain
eco nom ic var iab e
Th e ste ps for rem edy ing these ma ladies are also based on the aggregativ
gen era l pri ce level.
app roa ch. ,
by
ari son s: Ma cro eco nom ics fac ilitates int ern atio nal com par iso ns
7) Int ern ati on al Comp pti on and saving
vid ing inf orm ati on abo ut agg reg ate demand, national income, con sum
pro
for dif fer ent cou ntr ies .

POINTS TO REMEMBER

De fin itio n of Ec on om ics

ns which
con cer ned wit h tho se asp ect s of social behaviour and institutio
1. Economies is duce
cat ion of sca rce res our ces am ong unlimited and competiting use~, to pro
involve the allo e human
goo ds and ser vices in the satisfa ction of innumerable and unsat1abl
and distribute
wants .

! Me tho do log y of Ec on om ics n of a

mic Jaw s or pri n cipl es am ! eco nomic theory requires adoptio
I. Fo rm u l at1· 0n o f econo ,
certain me tho d. ing.
b d · •d the b·1
' sis of deductive or inductive reason
Economic · laws can e enve 011
2.
h d f "fo ctiv c log ic consists of arr ivin . g. at a certain. out com e. or
•
Th e ded uct ive me t o or ( e,
3 tal tru ths , axioms, suppos . 1t1ons or basic assum . ptionsd
•
con clu sio n fro m som e {
uno 1
am en l ass u mp tion s an
•
. J reasoni ng. Hence , we start
with the genera I . t·· h
t· 1og1· ca
thr oug h a proces s o
J . pro ces s of logical ded uct ion s. If rea • •
tac ts con
f 1rm • de
t
• • ·l 111 view o acquire
ma ke pred1ct1ons t uo ug d
1 <1
eco nom ic law. If not, it is eit her ammen<led
. . • • as
pred1ct10ns, 1t 1s accepte . .
.
facts or rejected altogether. ect ol the science .e., what ought to be as
, 1
I ·th the nor ma tive asp .
. me th o d d ea s wi
Inductive 1.
4
f h · It · vol ves rea son ing from the particular to the genera
· well as o w at is. m economic phenomenon and
/"' imoortanl causes of the