Chapter 1 Basic Concept of Economics and Distribution of Resources Complete Notes

Syllabus: Content to study

1. Definition of economics: Adam Smith, Alfred Marshall, Robbins
2. Concepts of positive and normative economics
3. Concepts and differences of micro and macro economics
4. Types of goods and services: Normal, Giffen, Inferior, Substitutes, Complement, Private , Public, economic and free
5. Introduction and characteristics of factors of production: Land, Labour, Capital and Organization

Complete Notes

Adam Smith Definition of Economics/ Wealth Definition

This definition was introduced by Scottish economist Adam Smith (1723-1790).

1. According to Adam Smith “Economics is concerned with an enquiry into the nature and causes of wealth of nations, and it is related to the laws of production, exchange, distribution and consumption of wealth.”
2. This definition is mentioned in his famous book titled ‘An Inquiry into the Nature and Causes of Wealth of Nations.
3. According to Adam Smith, Economics is related to the laws of production, exchange, distribution and consumption of wealth.
4. The central point of his definition is ‘wealth' and therefore, it is called ‘wealth definition.’
5. Smith has mainly been focused in defining ‘economics’ in terms of wealth and describes ‘economics’ as the ‘science of wealth.’
6. This definition further explored that the wealth of a nation included only material goods. Non-material goods were not included.
7. Adam Smith in his definition gave too much importance to the creation of wealth in an economy. Many economists believed that economic success of any nation depended only on the accumulation of wealth.

Features and Characterstics:

1. Study of Wealth

Economics deals with the study of wealth only. Therefore, it is concerned with the activities of man related to production, consumption, exchange and distribution of wealth.

2. Secondary Place to Mankind

Smith has given ‘wealth’ as the first priority in Economics and has placed ‘Mankind’ in the second place.

3. Only Material Commodities

This definition is basically based on the man who is always aware of his ‘self-interest’ that leads him to material gains.

Criticisms:

1. Narrow Defination

The wealth-centric definition of economics limited its scope as a subject and was seen as narrow and inaccurate. Smith’s definition forced the subject to ignore all non-wealth aspects of human existence.

2. Over Emphasis on wealth:

The Wealth Definition has given excessive emphasis to wealth rather than human being and welfare. This definition laid too much emphasis on wealth and did not consider human welfare.

3. Unrealistic Concept of Economic Man

Stressed on the concept of Economic Man: This definition is based on the concept of Economic man that emphasised the main motive of a man is to acquire wealth. However, other motivations of a man like feeling affection, emotions etc. are neglected.

4. Ambiguous:

The definition of wealth is not very clear. In earlier days, wealth included only material goods such as money, gold, silver, land, sugar, tea and ghee which are visible. Non-material goods were not included. Hence, non-material goods such as services of teachers, doctors and engineers are not considered „wealth‟ under this definition.

Alfred Marshall Definition of Economics/ Welfare Definition

1. This definition was introduced by English economics Alfred Marshall (1842 –1924).
2. Alfred Marshall, one of the greatest leaders of neo-classical economists, gave a new concept about economics by publishing his book,” Principles of economics” in 1890 A.D
3. He extended the scope of economics by shifting the emphasis from wealth to man.
4. According to him, “Economics is a study of mankind in the ordinary business of life.”
5. Marshall explained that the objective of economics is to increase human welfare. Wealth is not the end but it is only the means.
6. His definition has been supported by various popular economists like economists like A.C. Pigou, Cannon, and Beverage.

Features:

1. Primary Concern to mankind

Adam Smith placed ‘wealth’ whereas Marshall has placed ‘mankind’ in the primary concern of economics. Economics is mainly concerned with the study of mankind in relation to wealth. Wealth is for the benefit of mankind and secondary importance should be given to mankind and secondary importance to wealth.

2. Study to an ordinary man

As mentioned in his definition, economics is related to the study of behavior of an ordinary man. Ordinary men are those who are involved not only in accumulating more wealth but also try to experience love, sympathy, goodwill, etc. to make their social life more meaningful.

3. Study of material welfare

Economics does not study the hole of human welfare but only part of it called material welfare. Material welfare means satisfaction derived from the consumption of physical goods. Any forms of goods of economic value that provide satisfaction are regarded as the subject matter of economics. Non-material welfare is outside the scope of economics

4. Study of social science

Marshall explains that economics studies those people who live in society. It does not study about isolated people, not belonging to a society such as a sadhu, priests, beggar, monks, etc.

Criticisms

Welfare definition has been criticized by more recent economists, including Lionel Robbins. The definition of Marshall has been strongly criticized by Robbins in his authored book titled, ‘An essay on the nature and significance of economic science’, published in 1932 A.D.The major criticisms of this definition are:

1. Narrow concept of the subject

Marshall in his definition of Economics concentrated chiefly on material welfare and ignored non-material welfare and neglected non-material welfare. Resultantly, the use of the word “Material” in his definition of Economics considerably narrows down its scope. This is because human welfare is not affected only by the measure of material goods produced and consumed but also by the amount of non-material goods produced and consumed. For example, the services of lawyers, dancers, teachers, doctors, engineers and professors satisfy wants and are scarce in supply. Therefore, this appears to be a major drawback of this definition.

2. Economics is human science not only social science

According to Marshall, economics studies the economic activities of social man only. But in Robbins’s view, this idea is wrong. The man who lives outside society may be engaged in economic activities. Either the person lives in society or not, he has to face various economic problems. Hence, economics is not only social science but it is a human science also.

3. All material goods may not provide welfare

According to Marshall, material goods provide welfare for the person, but some of the goods like a cigarette, alcoholic drinks, etc. are not able to promote welfare for the user. When harmful goods are used, welfare can’t be achieved.

4. Not Practical

This definition of welfare is theoretical in nature. It is not practically possible to divide man’s activities into material and non-material activities.

Lionel Robbins Definition of Economics/ Scarcity Definition

This definition was introduced by British economist Lionel Robbins (1898-1984).

1. This definition is found in his book titled, ‘An essay on the nature and significance of economic science’, published in 1932 A.D.
2. According to him, "Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses."
3. He has highly criticized Alfred Marshall’s definition of economics (welfare definition). His argument is that economics is concerned with the problems arising from scarcity.
4. People solve the problem of scarcity by allocating scarce resources to the best possible use.
5. Most of the man’s economic activities are moving around the problem of scarcity and choice. This is the central idea in Robbins’s definition.

Features/ Characteristics

1. Unlimited human wants or use

According to Robbins’s, human wants are unlimited. These unlimited wants are not possible to satisfy at a time. If one want is satisfied, another arises in our mind immediately. Thus there is a chain of wants, one want chasing another. There are no ends of human needs.

2. Limited resources

Human wants are unlimited but the means to satisfy them are limited relatively. The wants are more times than means. We called such a resource as a limited whose supply is less than demand. Limited resources mean time, money, wealth, etc.

3. Scarce resources have an alternative use

Human wants are unlimited but the means to satisfy this wants are scare but the scare means have alternative uses. For example, money can be used to buy food, a book or to go to the cinema.

4. All wants are not equally urgent.

According to Robbins’s, all wants are not equally urgent. They differ in urgency. Some wants are more urgent than the other ones. So, more urgent wants need more immediate satisfaction and others can wait. Current wants are more important than future wants. For example – Medicine is more important than cosmetics for a sick girl.

5. Problems of choice

Although human wants are unlimited, all the wants are not equally important or urgent. More important wants have to be fulfilled immediately and less important wants have to be fulfilled immediately and less important can be postponed. So, human beings make a choice of wants to derive maximum satisfaction. So, according to Robbins’s, choice making is really an economic problem.

6. Unrealistic Assumption

Robbins believes that each individual does only those activities from which he derives maximum satisfaction. But in practical life, an individual does not always compare the satisfaction he derives from different activities but usually he acts without thinking so much. Thus, this assumption of Robbins is unrealistic.

Similarities between Welfare and Scarcity Definition

These are the similarities between Welfare and Scarcity definition:

1. Both the definition has given importance to man than to wealth.
2. Both regarded economics as science.
3. Both the definition is based on the assumption of the rational behavior of man.
4. The concept of welfare forms the subject matter in both definitions.

Difference between Microeconomics and Macroeconomics

Economics is divided into two categories: microeconomics and macroeconomics.

Microeconomics	Macroeconomics
Concerned with the behavior of individual economic agents such as households, firms, and industries.	Deals with the performance, structure, and behavior of the entire economy.
Focuses on the study of how individuals and firms make decisions regarding the allocation of limited resources.	Focuses on the study of aggregate economic variables such as inflation, unemployment, and economic growth.
Analyzes the demand and supply of goods and services in specific markets.	Analyzes the economy-wide demand and supply of goods and services.
Studies the production and costs of individual firms.	Studies the overall level of production and costs in the economy.
Analyzes how prices are determined in specific markets.	Analyzes how overall prices are determined in the economy.
Studies the behavior of consumers and producers in response to changes in market conditions.	Studies the overall behavior of the economy in response to changes in fiscal and monetary policy.
Aims to provide a basis for understanding the efficiency of resource allocation and market outcomes.	Aims to provide a basis for understanding the overall health and stability of the economy.

Difference between goods and Services

Topic	Goods	Services
Meaning	Goods are the material items that can be seen, touched or felt and are ready for sale to the customers.	Services are amenities, facilities, benefits or help provided by other people.
Nature	Tangible	Intangible
Transfer of ownership	Yes	No
Evaluation	Very simple and easy.	Complicated
Return	Goods can be returned.	Services cannot be returned back once they are provided.
Separable	Yes, goods can be separated from seller to seller.	No, services cannot be separated from service provider.
Variability	Identical	Diversified
Storage	Goods can be stored for the use in future or multiple use.	Services cannot be stored.
Production and Consumption	There is a time lag between production and consumption of goods.	Production and consumption of services occurs simulation.

Types of Goods

1. Normal Goods:

A normal good is a good that experiences an increase in its demand due to a rise in consumers' income. Normal goods have a positive correlation between income and demand. Examples of normal goods include food staples, clothing, and household appliances.

2. Inferior Goods:

Inferior goods are the opposite of normal goods. Inferior goods are goods that see their demand fall as consumers' incomes rise. In other words, as an economy improves and wages rise, consumers would rather have a more costly alternative than inferior goods. However, the term "inferior" doesn't refer to quality, but rather, affordability.

3. Giffen Goods:

Giffen goods are rare forms of inferior goods that have no ready substitute or alternative such as bread, rice, and potatoes. The only difference from traditional inferior goods is that demand increases even when their price rises, regardless of a consumer's income.

4. Substitute Goods:

Those goods which are used in place of each other are called substitute goods. In absence of one, another good can be used. They are also called competitive goods. For example, Coca-Cola and Pepsi are substitute goods.

5. Complementary Goods:

Those goods which jointly satisfied want are called complementary goods. They are either purchased together or used together. For example, Fountain Pen and Ink are complementary goods.

6. Public Goods:

Those goods which are common to all and owned by society collectively are called public goods. Public goods are the ones which are provided by the nature or the government for free use by the public. For example, roads, bridges, national defense, etc.

7. Private Goods:

Private good, a product or service produced by a privately owned business and purchased to increase the utility, or satisfaction, of the buyer. The majority of the goods and services consumed in a market economy are private goods, and their prices are determined to some degree by the market forces of supply and demand. For example, land, building, vehicles, etc. are private goods.

8. Free Goods:

A free good is a good that is not scarce, and therefore is available without limit. A free good is available in as great a quantity as desired with zero opportunity cost to society. free goods, such as air, are naturally in abundant supply and need no conscious effort to obtain them.

9. Economic Goods:

A good is an "economic good" if it is useful to people but scarce in relation to its demand so that human effort is required to obtain it. Economic goods are those which have a price and their supply is less in relation to their demand or is scarce.

Factors of Production

Factors of production are the inputs needed for the creation of a good or service. The factors of production include land, labor, capital and organization. These include any resource needed for the creation of a good or service.

1. Land:

Land refers to all kind of natural resources which are free gift of nature. It includes all the gift of nature on the surface and under the surface. For example, soil, rivers, forests, mines, air, sunlight, etc.

Features:
1. Land is free gift of nature.
2. Land is fixed in supply.
3. Land differs in fertility.
4. Land has no geographical mobility.
5. Land is a passive factor of production
6. Labour:

Labour refers to all those human efforts done physically or mentally for earning money. Labour refers all those physical and mental efforts placed during production.

Features
1. Labour is an active factor of production.
2. Labour is mobile.
3. Labour is perishable.
4. Labour cannot be separated from labourers.
5. Labourers doesn’t sell himself but only labour.
6. Capital

In economics, capital refers to the assets–physical tools, plants, and equipment–that allow for increased work productivity. It is unlike land or labor in that it is artificial; it must be created by human hands and designed for human purposes. Not all wealth is capital. Capital is the part of wealth used for further production.

Features
1. Capital is a man-made factor.
2. It is mobile.
3. It is a passive factor.
4. It is a temporary factor.
5. It depends upon technology of production.