INDIAN ECONOMY

UNIT-1

INTRODUCTION

Knowledge has many branches. Economics is an important and useful branch of knowledge.
The word "economics" is derived from a Greek word "okionomia", which means "household
management" or "management of house affairs" -i.e., how people earn income and resources and
how they spend them on their necessities, comforts and luxuries. With the passage of time, the word
"okionomia" was used for an economy as whole in the sense that how a nation takes steps to
fulfill its desires and preferences with the help of scarce means.

DEFINITION

According to Robbins -" Economics is the science which studies human behavior as a
relationship between ends and scarce means which have alternative uses".

FUNDAMENTAL ECONOMIC TOOLS

Economics is both conceptual and practical. Economic theory provides a number of concepts
and analytical tools which are of immense help to a manager in taking many decisions and
business planning.

1 The Opportunity Cost Concept

Since resources are scarce, we cannot produce all the commodities. For the production of one
commodity, we have to forego the production of another commodity. We cannot have everything
we want. We are, therefore, forced to make a choice. In economics, the opportunity cost of
anything is the next best alternative that could be produced by the same factors, costing the same
amount of money. In managerial economics the opportunity cost of a decision is the sacrifice of
alternatives required by that decision. Sacrifice of alternatives is involved when carrying out a
decision requires using a resource that is limited in supply with the firm. Opportunity cost,
therefore, represents the benefits or revenue forgone by producing one thing rather than another.
The opportunity cost of a manager is what he could have earned as manager in some other
company.

The concept of opportunity cost implies three things:

1 The calculation of opportunity cost involves the measurement of sacrifices.

2. Sacrifices may be monetary or real.

3. The opportunity cost is termed as the cost of opportunity missed or alternative foregone.

Opportunity cost is just a notional idea which does not appear in the books of account of the
company. If a resource has no alternative use, then its opportunity cost is nil. Its Importance
in managerial decision making, the concept of opportunity cost occupies an important place. The
economic significance of opportunity cost is as follows:

1 It helps in determining relative prices of different goods.

2. It helps in determining normal remuneration to a factor of production.

3. It helps in the proper allocation of factor resources.

2. The Incremental Concept

The incremental concept is the most important concept in economics which is used in managerial
economics. The two major concepts in this analysis are incremental cost and incremental
revenue. Incremental cost is defined as the change in total cost resulting from a decision of the
firm. It measures the difference between the old and the new total cost.

Similarly incremental revenue is defined as the change in total revenue resulting from a decision
of the firm. It measures the difference between the old and the new total revenue,

The incremental principle may be stated as follows: A decision is clearly a profitable one if

(i) It increases revenue more than costs.

(ii) It decreases some cost to a greater extent than it increases others.

(iii) It increases some revenues more than it decreases others.

(iv) It reduces costs more than revenues.

Illustration
Some businessmen hold the view that to make an overall profit, they must make a profit on every
job. So they refuse orders that do not cover full costs plus some provision of profit. This will lead
to rejection of an order which prevents short run profit. This problem is illustrated below.
Suppose a new order is estimated to bring in additional revenue of Rs. 10,000 to a firm. The
costs are estimated as under:

Labour Rs. 3,000

Materials Rs.4,000

Overhead charges Rs. 3,600

Selling and administrative expenses Rs. 1,400

Full Cost Rs. 12,000

The order appears to be unprofitable because cost (Rs. 12,000) is more than revenue (Rs.
10,000). It results in a loss of Rs. 2,000. However, suppose there is idle capacity which can be
utilised to execute this order. If order adds only Rs. 1,000 to overhead charges, and Rs. 2000 by
way of labour cost because some of the idle workers already on the pay roll will be deployed
without additional pay and no extra selling and administrative expenses, then the actual
incremental cost is as follows:
Labour Rs. 2,000

Materials Rs. 4,000

Overhead charges Rs. 1,000

Total Incremental Cost Rs. 7,000

Thus there is a profit of Rs. 3,000 because incremental revenue (Re. 10,000) is more than
incremental cost (Rs. 7,000). The order can be accepted on the basis of incremental reasoning.
Incremental reasoning does not mean that the firm should accept all orders at prices which cover
merely their incremental costs.

Its Limitations
This concept has certain limitations:

(a) The concept cannot be generalised because observed behaviour of the firm is always variable.

(b) The concept can be applied only when there is excess capacity in the firm,

(c) The concept is applicable only during the short period.

3. The Principle of Time Perspective

The time perspective principle states that t consideration both to the short run and long run
effects of perspective principle states that the decision maker must give due who introduced time
element in economic theory. Managerial economics short run and long run effects of his
decisions. It was Marshall the short run and long run effects of decisions on revenues as well as
cost theory. Managerial economics is concerned with problem in decision making is to establish
the right balance between sessions on revenues as well as costs. In the short period, the firm can
change its sort period, the firm can change its output without changing its size. The Mon Period
relates to a few months in which supply can be changed in accordance with demand. This is
possible by changing the variable factors. For instance, if the company uses the supply of its
product, it can do so by working the fixed factors like plants, machines, etc. more fully. This can
be done by starting two or three shirts and by employing more labour, raw materials, etc. In the
short period, it is not possible to change the fixed factors, the scale of production and
organisation. Therefore, supply can be increased or decreased to match the increase or decrease
in demand by changing the variable factors.

In the long period, the firm can change its output by changing its size.

The long period is of many years in which supply can be fully adjusted to demand. This is done
by changing the fixed factors. During this period the old machines, equipments and plants can be
replaced by the new. New firms can enter the industry and old firms can leave it. The scale of
production, organisation and management can also be changed. Thus supply can be adjusted to
demand in every possible way in the long-run.

In the short period, the average cost of a firm may be either more or less than its average
revenue. In the long period, the average cost of the firm will be equal to its average revenue.
4. The Discounting Principle
Everyone knows that a rupee today is worth more than a rupee tomorrow. This is famous saying
that “a bird in hand is worth two in the bush.” Therefore, anybody will prefer Rs. 100 today to
Rs. 100 next year. There are two reasons for this:

(a) There is risk and uncertainty in the future. So Rs. 100 today is preferable to get than after a
year.

(b) Ever if a person is sure to receive Rs. 100 next year, it would be better to receive Rs. 100
now and invest it for a year and earn a rate of interest on Rs. 100 for one year.

For making a decision in regard to an investment which will yield a return over a period of time,
its present worth or value is calculated by the discounting principle. This is used in managerial
economics in making decisions relating to investment planning and capital budgeting.

The formula of computing the present value is given below:

5. Equi-Marginal Concept
One of the famous principles of economics is the equi marginal concept. The principle states that
an input should be so allocated that value added by the last unit is the same in all cases. Let us
assume a case in which the firm has 100 unit of labour at its disposal, and the firm is involved in
three activities viz., A, B, C. The firm should allocate these workers in such a work that the
marginal productivity (value) of the last worker employed in each activity is the same.

An optimum allocation cannot be achieved if the value of the marginal product is greater in one
activity than in another. It would be, therefore, profitable to shift labour from low marginal value
activity to high marginal value activity, thus increasing the total value of all products taken
together. If, for example, the value of the marginal product of labour in activity A is Rs. 50 while
that in activity B is Rs. 70 then it is possible and profitable to shift labour from activity A to
activity B. The optimum is reached when the values of the marginal product is equal to all
activities. This can be expressed symbolically as follows:
The Equi marginal principle is an extremely practical concept.

(1) It is used as a rational budgetary procedure.

(2) It is also applied in investment decisions.

(3) It is used allocation of research expenditures.

(4) For a consumer, this concept implies that money may be allocated over various commodities
such that marginal utility derived from the use of each commodity is the same.

(5) For a producer this concept implies that resources be allocated in such a manner that the
marginal product of the inputs is the same in all uses.

NATURE OF ECONOMICS

1. Economics is a Science :

The term science is defined as a body of knowledge which describe the relationship
between set of giving causes and their effect in that science.

(a) Economics is a science because it is body of generalization principles and theories

which trace out a casual relationship between causes and effect.
(b) Economics is a science because it gives a systematic knowledge about economic
activities of human beings.

2. Economics is an Art

A discipline of study is term as an art if it tells us how to do a thing, i.e., to achieve

objectives in the best possible manner. Prof. Keyner says that, “An Art is a system of
rules for achievement of a given objective.”

Economics is used for achieving a variety of goals. Everyone has some specific goals. It
decides its course of action by keeping in mind the end to be achieved and the situation
face by it. Economics laws are widely use and delight upon at all level of all economic
activities so that it makes Economics an Art.

3. Economics is a Positive Science

Positive science is that science which studies accurate and true description of events as they
happen. Positive science confines itself to to study of: what, how and why?
Argument In Favour of Economics being a Positive Science

a. More logical: Basis of positive science is logic while that of a normative

science emotion. It is by logic that the relationship between causes and effect of
one can established.

b. More efficient: The positive and normative aspect of every problem is

studied separately to take advantage of the division of labour. In case of division
of work divided into many parts and each part is entrusted to a separate worker.
As a result, each worker become efficient in his work..

c. More neutral: The economist will not neutral if he seeks to know both
what is an what ought to be simultaneously. It is therefore, essential to study
economics as a positive science only to know the facts.

Positive issues/Examples of Positive Statements in Economics

(i) India is an over-populated country.

(ii) Prices in Indian economy are constantly rising.
(iii) We have adopted mixed economy.
(iv) Indian economy is developing economy.
(v) There is inequality of income in our economy

4. Economics is a Normative Science :

Many economists like Marshall, Pigou, regard as a normative science. A normative science is
one that aims at determining norms values or ideals. Normative science means “What
ought to be?”

Arguments in Favour of Economics being a Normative Science

(a) More practical Economics studies the economic activities of man. Economic activities
are based not only logic but also on emotion if economics is to be made mo useful and
practical, then along with logic care must also be taken of man‟s emotion.

(b) More useful: Economics is a social science. It should suggest way and means promote
economic welfare of man.

(c) More economical: If the economist synchronizes the analysis of economic problem
with concrete economic policies he would save time.

Normative issues/Examples of Normative Statements in Economics

(i) The fundamental principle of economic development should be the

developments of our rural India.
(ii) Agricultural income should also be taxed.
(iii) There should not be multi-national companies in consumer goods industries in our
country.
(iv) Private sector should be encouraged for accelerating the pace of our industrialization.
 5. Economics is a Social Science :

Economics is a social science because it deals with one aspect of human behaviour, viz., how
men deal with problems of scarcity. Samuelson says that Economics is “the queen of the social
sciences”.

Economics deals with human beings living in a society, i.e., in a large group of persons with
touching interests and problems. It does not deal with problems of solitary individuals like
Robinson Crusoe. In a community of people everybody is influenced by the actions of the others.

Economics deals with the activities of people, living in an organised community or society, in so
far as such activities are related to the earning and use of wealth or with the problems of scarcity,
choice and exchange. Economics is, therefore, considered to be a branch of sociology which is a
study of the history and nature of society. As a consequence of this we find that economics is
closely related to the other social sciences like Ethics, Political Science, and History etc.

SCOPES OF ECONOMICS

1. Micro Economics

The English word micro is derived from Greek word „MIKROS‟ meaning “small”.
Micro economics deals with the analysis of small individual units of the economy such as
individual consumers, firms and small aggregates or groups of individual units
(industries)

According to K.E. Boulding “Micro economics is the study of particular firms, particular
households, individual prices, wages, incomes, individual industries and particular
commodities”

2. Macro Economics

The English word micro is derived from Greek word „MAKROS‟ meaning “large.

Macro economics is the study of the behaviour of the economy as a whole. In other words,
macro economics deals with total or big aggregates such as national income, output and
employment, total consumption, aggregate saving and aggregate investment and the
general level of prices.
 In the words of Boulding, “Macro economics deals not with individual quantities as
such but with aggregates of these quantities, not with individual incomes but with the
national Income, not with individual prices but with the price level, not with Individual
outputs but with the national output.

MEANING OF ECONOMIC SYSTEM

An economic system is a mechanism with the help of which the government plans and allocates
accessible services, resources, and commodities across the country. Economic systems manage
elements of production, combining wealth, labour, physical resources, and business people. An
economic system incorporates many companies, agencies, objects, models, and deciding
procedures.

TYPES OF ECONOMIC SYSTEMS

Capitalist economy: In a capitalist system, the products manufactured are divided among
people, not according to what they want but on the basis of purchasing power, which is the
ability to buy products and services. This means an individual needs to have the money with him
to buy the goods and services. The low-cost housing for the underprivileged is much required but
will not include demand in the market because the needy do not have the buying power to back
the demand. Therefore, the commodities will not be manufactured and provided as per market
forces.
Socialist economy: This economy system acknowledges the three inquiries in a different way. In
a socialist society, the government determines what products are to be manufactured in
accordance with the requirements of the society. It is believed that the government understands
what is appropriate for the citizens of the country. Therefore, the passions of individual buyers
are not given much attention. The government concludes how products are to be created and how
the product should be disposed of. In principle, sharing under socialism is assumed to be based
on what an individual needs and not what they can buy. A socialist system does not have a
separate estate because everything is controlled by the government.
Mixed economy: Mixed systems have characteristics of both the command and the market
economic system. For this purpose, the mixed economic systems are also known as dual
economic systems. However, there is no sincere method to determine a mixed system.
Sometimes, the word represents a market system beneath the strict administrative control in
certain sections of the economy.

ECONOMIC SECTOR
The economic sector is divided into three economic sectors. They are as follows:
Primary sector: It is that sector which relies on the environment for any production or
manufacturing. A few examples of the primary sector are mining, farming, agriculture, fishing,
etc.
Secondary sector: In this sector, the raw material is transferred to a valuable product. A few
examples are construction industries and manufacturing of steel, etc.
Tertiary sector: It is also known as service sector, and it includes production and exchange of
services. A few examples are banking, insurance, transportation, communication, etc.

Characteristic Features of Indian Economy

A developing economy is one in which the process of development has begun, but it has not
affected the whole economy in a full-fledged manner as of yet. The following are some of the
characteristic features of developing economies:
1. Low Per Capita Real Income: The real income of a country refers to the purchasing
power of the country as a whole in a given financial year, while the per capita real income
refers to the average purchasing power of the country or the purchasing power of an
individual in a country in that year. Developing countries share the characteristic of a low
per capita real income.
2. High Rate of Population Growth: Where there is a high population, there also has to be
an infrastructure in place to support that population. This means there need to be enough
educational and medical facilities, enough employment opportunities with good salaries,
etc. With a high population, especially an increasingly high population, providing these
facilities to each citizen becomes a huge task and most often, governments are unable to
follow through, thus leaving the economy in the developing stage.
3. High Rate of Unemployment: As mentioned before, the appropriate opportunities and
facilities are unavailable for the high population in developing countries. Unemployment
is a problem that deserves an explanation of its own because a lack of employment leads
to a lack of funds for an individual and his or her family to even beget the basic necessities
of life.
4. Dominance of Agriculture: When institutions have not yet been developed in a country,
and there are not enough jobs available for people, they have to turn to what they have
been doing for centuries before - primitive primary sector jobs. While these jobs, such as
agriculture, are incredibly important in the larger perspective, they do not fetch workers a
whole lot of income, nor do they add to the development of an economy to a very large
extent.

5. Disparities in Income Distribution: High degree of disparity in income/wealth

distribution is found in India. Though the objective of establishing a socialistic society
was adopted in Second Five Year Plan but it has not been yet achieved. According to the
data shown by National Sample Survey Office (NSSO), 39% of rural population possesses
only 5% of all the rural assets while, on the other hand, 8% top households possess 46% of
total rural assets. Income disparities are more intensive in urban areas as compared with
those of rural areas.

6. Lack of Capital: Savings are low in India due to low national income and high
consumption expenditure. Gross domestic savings which were 23.1% of GDP in 1990-91,
increased upto a level of 37.7% in 2007-08. Similarly gross domestic capital formation,
which was 23.3% in 1993-94, increased upto the level of 35.5% in 2005-06, but slightly
increased to 39.1% in 2007-08. It shows the low savings capacity in the country which
results in shortage of capital formation.
 7. Lack of Industrialization: India lacks in large industrialization based on modern and
advanced technology, which fails to accelerate the pace of development in the economy.
Average annual growth rate of industrial sector (including mining, manufacturing, and
power generation) was 8.5% in the Seventh Plan against the target of 8.7% p.a.

8. Market Imperfections: Indian economy faces a number of market imperfections like lack
of mobility among production factors from one to the other and lack of specializations
which hinder the optimum utilization of available resources. All these market
imperfections and their results are important reasons for undeveloped state of Indian
economy.

Challenges to Indian Economy

India is an underdeveloped though a developing economy. Bulks of the population are living in
conditions of misery. Poverty is not only acute but al chronic. At the same time, there exist
unutilized natural resources. The co existence of the vicious circle of poverty with the vicious
circle of affluence perpetuates misery and foils all attempts at removal of poverty. It is in this
context that an understanding of the major issues of development should be made

1. Population Explosion: This monster is eating-up into the success of India According to
2011 census of India, population of India in 2011 was 1,210,193,422, growing at a rate of
1.58% approx. Such a vast population puts lots of stress on economic infrastructure of the
nation. Thus India has control its burgeoning population.

2. Poverty: As per records of NSSO, 20.4% of the Indian population was living below
poverty line in 2005-06. Though this figure has decreased in recent times but some major
steps are needed to be taken to eliminate poverty from India.

3. Unemployment: The increasing population is pressing hard on economic resources as

well as job opportunities. Indian Government has started various schemes such as
Jawahar Rozgar Yojna and self-employment scheme for Educated Unemployed Youth
(SEEUY). But these are proving to be a drop in an ocean.

4. Low Level of Human Development: Human development is usually measured in terms

of Human Development Index (HDI) constructed by the United Nations Development
Program (UNDP). The HDI is a composite of three basic indicators of human
development - longevity, knowledge and standard of living. India with a HDI value of
0.619 ranks a lowly 128 in terms of HDI.

5. Inequitable Distribution of Income: The distribution of income and wealth in India is

inequitable. Income inequalities result from the concentration of wealth and capital.

6. Predominance of Agriculture: Occupational distribution of population in India is not at

all satisfactory and clearly reflects the economic backwardness of the economy.A second
indicator of the predominance of agriculture in the Indian economy is the proportion of
national income originating in this sector.

7. Technological Backwardness: While technological progress is at the heart of

development process, over a wide range of productive activity, techniques of production
 are backward in India. Agriculture which provides subsistence to more than half of the
population is even now characterised by highly backward techniques.

ECONOMIC GROWTH & DEVELOPMENT

Economic growth is an increase in a country's real level of national output which can be caused
by an increase in the quality of resources (by education, etc.), increase in the quantity of
resources and improvements in technology or in another way an increase in the value of goods
and services produced by every sector of the economy. Economic growth can be measured by an
increase in a country's GDP (Gross Domestic Product).

According to Douglass North and Robert P. Thomas, "Economic growth occurs if output
grows faster than population".

According to Simon Kuznets, "Economic growth is a sustained increase in per capita or

per worker product".

Economic growth can be referred to as the increase that is witnessed in the monetary
value of all the goods and services produced in the economy during a time period. It is a
type of quantitative measure that reflects the potential increase in the number of business
transactions taking place in the economy.

ECONOMIC DEVELOPMENT

Economic development is defined as a sustained improvement in material well being of society.

Economic development is a wider concept than economic growth. Apart from growth of national
income, it includes changes – social, cultural, political as well as economic which contribute to
material progress. It contains changes in resource supplies, in the rate of capital formation, in
size and composition of population, in technology, skills and efficiency, in institutional and
organizational set-up. These changes fulfill the wider objectives of ensuring more equitable
income distribution, greater employment and poverty alleviation. In short, economic
development is a process consisting of a long chain of interrelated changes in fundamental
factors of supply and in the structure of demand, leading to a rise in the net national product of a
country in the long run.

FACTORS AFFECTING ECONOMIC GROWTH & DEVELOPMENT

The process of economic growth is a highly complex phenomenon and is influenced by
numerous and varied factors such as political, social and cultural factors. These factors are as
follows:
A. Economic Factors
1. Natural Resources: The principal factor affecting the development of an economy is the
natural resources. The natural resources include the land area and the quality of the soil, forest
wealth, good river system, minerals and oil resources, good climate, etc. For economic growth,
the existence of natural resources in abundance is essential. A country deficient in natural
resources may not be in a position to develop rapidly. However, the availability of rich natural
resources are a necessary condition for economic growth but not a sufficient one. In less
developed countries, natural resources are unutilized, underutilized or misutilised. This is one of
the reasons of their backwardness.
On the other hand countries such as Japan, Singapore etc. are not endowed with abundant natural
resources but they are among the developed nations of the world. These countries have shown
committment towards preserving the available resources, putting best efforts to manage the
resources, minimizing waste of resources etc.

2. Capital Formation: Capital formation is another important factor for development of an

economy. Capital formation is the process by which a community’s savings are channelised into
investments in capital goods such as plant, equipment and machinery that increases nation’s
productive capacity and worker’s efficiency thus ensuring a larger flow of goods and services in
a country. The process of capital formation implies that a community does not spend whole of its
income on goods for current consumption, but saves a part of it and uses it to produce or acquire
capital goods that greatly add to productive capacity of the nation.

3. Technological Progress: Technological progress is a very important factor in determining the

rate of economic growth. Technological progress mainly implies the research into the use of new
and better methods of production or the improvement of the old methods. Sometimes technical
progress results in the availability of natural resources. But generally technological progress
results in increase in productivity. In other words, technological progress increases the ability to
make a more effective and fruitful use of natural and other resources for increasing production.
By the use of improved technology it is possible to have greater output from the use of given
resources or a given output can be obtained by the use of a smaller quantity of resources. The
technological progress improves an ability to make a fuller use of the natural resources e.g. with
the aid of power - driven farm equipment a marked increase has been brought about in
agricultural production. The USA, UK, France, Japan and other advanced industrial nations have
all acquired the industrial strength from use of advanced technology. In fact economic
development is facilitated with the adoption of new techniques of production.

4.Human Resources Development: A good quality of population is very important in

determining the level of economic growth. So the investment in human capital in the form of
educational and medical and such other social schemes is very much desirable. Human resource
development increases the knowledge, the skills and the capabilities of the people that increase
their productivity.

5. Population Growth: Labor supply comes from population growth and it provides expanding
market for goods and services. Thus, more labor produces larger output which a wider market
absorbs. In this process, output, income and employment keep on rising and economic growth
improves. But the population growth should be normal. A galloping rise in population retards
economic progress. Population growth is desirable only in a under-populated country. It is,
however, unwarranted in an overpopulated country like India.

6. Social Overheads: Another important determinant of economic growth is the provision of

social overheads like schools, colleges, technical institutions, medical colleges, hospitals and
public health facilities. Such facilities make the working population healthy, efficient and
responsible. Such people can well take their country economically forward.

B. Non-Economic Factors
Non-Economic factors that include socio-economic, cultural, psychological and political factors
are also equally significant as are economic factors in economic development. We discuss here
some of the essential non economic factors which determine the economic growth of an
economy.
1. Political Factors: Political stability and strong administration are essential and helpful in
modern economic growth. The stable, strong and efficient government, honest administration,
transparent policies and their efficient implementation develop confidence of investors and
attracts domestic as well as foreign capital that leads to faster economic development.

2. Social and Psychological Factors: Social factors include social attitudes, social values and
social institutions which change with the expansion of education and transformation of culture
from one society to the other. The modern ideology, values, and attitudes bring new discoveries
and innovations and consequently to the rise of the new entrepreneurs. The outdated social
customs restricts occupational and geographical mobility and thus pose an obstacle to the
economic development.

3. Education: It is now fairly recognized that education is the main vehicle of development.
Greater progress has been achieved in those countries, where education is wide spread.
Education plays an important role in human resource development, improves labor efficiency
and removes mental block to new ideas and knowledge thus contributes to economic
development.

4. Desire for Material Betterment: The desire for material progress is a necessary precondition
for economic development. The societies that focus on self-satisfaction, self-denial, faith in fate
etc. limit risk and enterprise and thus keep the economy backward.

Economic Growth Economic Development

Definition

It refers to the increase in the monetary growth of It refers to the overall development of the quality of life
a nation in a particular period. in a nation, which includes economic growth.

Span of Concept

It is a narrower concept than that of economic It is a broader concept than that of economic growth.
development.

Scope

It is a uni-dimensional approach that deals with It is a multi-dimensional approach that looks into the
the economic growth of a nation. income as well as the quality of life of a nation.

Term

Short-term process Long-term process

Measurement

Quantitative Both quantitative and qualitative

 Applicable to

Developed economies Developing economies

Government Support

It is an automatic process that may or may not It requires intervention from the government as all the
require intervention from the government developmental policies are formed by the government

Kind of changes expected

Quantitative changes Quantitative as well as qualitative changes

Examples

GDP, GNP HDI, per capita Income, industrial development