Definitions Economics
• Adam Smith’s definition:
• Economics is an academic discipline which is more than two centuries old.
• In 1776, Adam Smith regarded as the father of economics and published his famous book
“ An Inquiry into the nature and causes of Wealth of Nations”
Definitions Economics
• In this book ‘ Economics is described as the science of Wealth’
• Ever since after publication of Smith’s book several other definition of economics have been provided by several economists.
• We shall consider some of these definition:
Adam Smith, Marshall and Robbins
Definitions Economics
• Adam Smith’s definition: Father of modern Economics
• “An Inquiry into the Nature and Causes of the Wealth of Nations”- Published 1776
• In this book he provided a frame work for the study of Economics
Definitions Economics
• According Smith: “Economics is the science of Wealth”.
• This implies that the task of Economics is to give specialized knowledge about how the wealth of a nation can be increased.
• In other words, Economics gives special knowledge about the factors on which the wealth of a country depends.
Definitions Economics
• In this connection one thing should be noted.
• Before Adam Smith, there was a group of thinkers who thought that like an individual any country can also become rich by accumulating gold and precious metals from foreign countries.
• This means that the country having more precious metal or gold would be more prosperous.
Definitions Economics
• That group of thinkers was known as mercantilists.
• Adam Smith Strongly opposed this view.
• The country can not be prosperous only by accumulating precious metals or gold.
• The wealth of a nation depends on the volume of productions.
Definitions Economics
• A country become more wealth through more production as wealth is generated through production.
• According Smith, the main theme of Economics is to discuss the determinants or factors of production and the way to increase these factors of production.
Definitions Economics
• Criticism:
• The definition gives more importance on the creation of wealth. Nothing is said about the use of wealth.
• The welfare of the people is increased through the use of wealth. Therefore, wealth is not main objectives. The main objectives is to increase the welfare of human beings.
Definitions Economics
• The welfare increases through removal of wants. This aspect has been neglected in this definition.
• Secondly: in this definition, wealth is regarded as the main theme of Economics. But those men for whom wealth is created and also their behaviour are not considered in this definition.
Definitions Economics
• How men create wealth and how this wealth removes the wants of people and increases their welfare should actually be the main theme of Economics.
• But Smith’s definition there is no mention about the role of human beings.
Definitions Economics
• Thirdly: More emphasis is given on wealth
• Some people think that the main purpose of Economics is to accumulate wealth honestly or dishonestly.
• That’s way Economics has been described as the Gospel Mammon by earlier philosophers.
• Due to the belief in this definition, Economics was neglected as a branch of knowledge by earlier thinkers.
Definitions Economics
• In fact, Adam Smith’s definition is the origin of this wrong notion about the subject-matter of Economics.
Definition of Economics
• Marshall’s definition of Economics
• To remove the wrong notion about of
Economics Prof. Alfred Marshall gave
another definition of Economics in his
famous book “Principles of
Economics’.
Definition of Economics
• This book was published in the year 1890.
• According to Marshall, “Economics is a
study of mankind in the ordinary
business of life and examines that part
of individual and social action which
is connected with material requisites
of well being”.
Definition of Economics
• No doubt the Marshall definition is superior to that of Adam Smith Definition.
• Why?
• In this definition instead of giving
emphasis on wealth, importance is
given on the activities of mankind.
Definition of Economics
• There are innumerable (countless)
activities connected with our daily life
and the task of Economics is to discuss
those activities which are connected
with the personal welfare of human
beings.
Definition of Economics
• As a result, “ Economics is, on the one side, a study of wealth and on the other and more important side, a part of study of man”.
• There are two important defects in
Marshall’s definition.
Definition of Economics
• First: in one sense this definition is very broad and another sense it is also narrow.
• The Subject matters of Economics becomes very broad if it deals with all the activities connected with daily life.
This is so because men perform various
types of activities in daily life.
Definition of Economics
• If Economics deals with the
activities connected with material
welfare, then also the subject-matter
of Economics becomes very
narrow because the non-material
welfare or welfare obtained from
services is excluded from the scope
of Economics.
Definition of Economics
• Secondly: why people perform different activities in daily life is not mentioned in this definition.
• Every man performs many activities to earn income. This income is used to purchase commodities to be consumed.
• The income of the individual is limited but his want is unlimited.
• When one want is satisfied, a new wants
arises.
Definition of Economics
• Men are engaged in various economic activities due to the existence of unlimited wants and limited resources.
• This problem of scarcity of resources is absent in Marshall’s definition.
• According to Robbins, the main subject-
matter of Economics is how to meet
unlimited wants with the limited resources of
the economy.
Definition of Economics
• Robbins' definition of Economics:
• Another improved and sophisticated definition as compared to Marshall’s definition is given by Prof. Robbins in his famous book ‘ Nature and Significance of Economic Science’.
• The book was published in the year 1931.
Definition of Economics
• According to Robbins “Economics
is the science which studies human
behaviour as a relationship between
ends and scare means which have
alternative uses”.
Definition of Economics
• This definition rests on three facts.
• First: man has unlimited wants. When one want is satisfied a new want arises. It is not possible to satisfy all the wants at a time.
But the intensities of different wants are
different. Some are more urgent and are to
be satisfied initially.
Definition of Economics
• Secondly: man has limited amount of
resources. By resources here it is meant
natural resources, man-made capital goods
and consumption goods, etc. It is not
possible to satisfy all wants with limited
resources. Hence a man has to decide which
want is to be satisfied first or which wants is
more important than other.
Definition of Economics
• Thirdly: limited resources have alternative uses. If resources are utilized to satisfy some wants, some other wants remains unsatisfied. Hence it has to be decided how to make the efficient use of resources.
According to Robbins, Economics studies
the ways in which man can strike a balance
between unlimited wants on the one hand
and limited resources on the other.
Definition of Economics
• Economics is a science because this subject provides specialized knowledge about this.
• When resources are scarce, a choice problem arises.
• Economics provides specialized knowledge
about how optimum choice can be made.
Definition of Economics
• Limitations: According Robbins, Economics is a human science and not a social science. The subject matter of Economics is how man utilizes limited resources to satisfy wants. This man may live within the society or outside the society.
Therefore, in Robbins’ definition, this social aspect is neglected.
• Social beings are dependent on one another. The goods and services are exchanged among different to remove wants. The exchange is an important economic activity. But the problem of exchange has been totally neglected in Robbins’ definition.
Definition of Economics
• Secondly: if the task of Economics is only
to decide how the limited resources can be
utilized efficiently in different ways, then
only the value theory should be included in
the subject-matter of Economics.
Definition of Economics
• How prices of goods and services are
determined, how factors prices are
determined, what will be the amount
of an input needed for the production
of a particular commodity, etc.,
become the subject of discussion in
Economics.
Definition of Economics
• The national income of a country, different components of national income, the upward and downward movement of national income, economic growth and development, etc., cannot become the subject-matters of Economics. According to Robbins’ definition, Macroeconomics is not included in Economics.
But at present this Macroeconomics has become very important in Economics.
Value
• Classical economist use the term value in two senses
• Value-in-use or use value
• Value-in-exchange or exchange value
• Use value- refers to the utility or satisfaction which can be obtained from the commodity. Use value at present is known as utility and it is subjective matter. It cannot be measured in terms of any material units.
Value
• Use value is important because unless a commodity has use value it will not be demanded in the market.
• Nobody will be willing to pay any price
for a commodity which has no use value.
Value
• Exchange value-The exchange value of a commodity refers to the amount of other commodity which can be obtained in exchange for this commodity.
• X and Y two commodities
• Exchange value of X is equal to the amount of Y which can be obtained in exchange for one unit of X.
• Exchange value is regarded as the value of commodity.
Economic Theory
• Microeconomic theory
• Macroeconomic Theory
• Microeconomic theory is also known as Microeconomics
• Macroeconomic theory is also known as Macroeconomics
Economic theory
• These terms were first used by Ragnar Frisch
• The term ‘Micro’ comes from the Greek word ‘Mikros’ means small.
• The term ‘Macro’ comes from the Greek
word ‘Makros’ means large.
Microeconomics
• Microeconomics deals with the analysis of individual economic units such as consumers, firms and small aggregates or group of individual unit such as industries and markets.
Microeconomics
• Macroeconomics deals with the analysis
of the economy as a whole and its large
aggregates such as total national output,
national income, total consumption,
aggregate investments etc.
Microeconomics
• In the words of Lerner, “Microeconomics consist of looking at the economy through a microscope, as it were, to see how the millions of cells in the body economic- the individuals or households as consumer and individual or firms as producers play their part in the working of the whole economic organism”.
Microeconomics
• Thus the Microeconomic theory tries to determine the mechanism by which the different economic units attain equilibrium, proceeding from the individual units to a narrowly defined group.
• It does not consider the totality of behaviour of all units in the economy. Microeconomics does not consider the economic system or the economy as whole.
Microeconomics
• It takes the total quantity of resources as
given and seeks to explain how they are
allocated to the production of different
commodities. It also explain whether the
allocation of resources is efficient or not.
Microeconomics
• Sometimes it is stated that whereas Macroeconomics examines the economy as whole, Microeconomics is not concerned with it. But this is not correct.
• Both Microeconomics and Macroeconomics analyse the economy as a whole. But their approaches are different.
Microeconomics
• Microeconomics examines the economy as a whole microscopically.
• It analyses the behaviour of individual economic units and their inter-relationship.
• This is known as general equilibrium analysis.
Microeconomics
• Microeconomics deals with some aggregates but the aggregate with which Macroeconomics is concerned are somewhat different.
• In Macroeconomics the aggregates are related to the economy as a whole.
•
Microeconomics
• In Microeconomics market demand for a product is analyzed and the market demand is the aggregate of individual demands of all consumers of the commodity.
• But in Macroeconomics when we talk to aggregate demand it refers to the aggregate demand of all commodities by all economic units in a given period of time.
Microeconomics
• Apart from economy-wide aggregates macroeconomics also deals with sub- aggregates relating to the whole economy.
• Microeconomics also use aggregates but these aggregates are not related to economy-wide totals.
Economic theory
• Microeconomics and Macroeconomics are interdependent.
• The theories regarding the behaviour of some macroeconomic aggregates are derived from the theories of individual behaviour.
• For example-the aggregate investment function can be derived from the individual investment decisions of firms.
Economic theory
• Even if Macroeconomic aggregates are derived from Micro behaviour patterns, a separate study of Macroeconomics is necessary because whatever is true for individual economic units considered in isolation, may not be true for the economic units considered as a whole.
• What is true of individual component is not necessarily true of their collective whole.
Economic theory
• Not only does Macroeconomics depend upon Microeconomics, Microeconomics also depends upon Macroeconomics.
• For example-the determination of factor prices like rent, wage, interest and profit is included in the subject matter of Microeconomics.
• But profit cannot be determined without considering the Macroeconomic environment in which the firms operates.
Economic theory
• From the above analysis we can conclude that there is considerable amount of interdependence between Microeconomics and Macroeconomics.
• Microeconomics provides the building blocks of Macroeconomic theories.
• Macroeconomics may also contribute to microeconomic understanding.
Economic theory
• As a matter of fact, Microeconomics and Macroeconomics are complementary to each other, rather than being competitive.
• Prof. Samuelson states that, “there is really no opposition between Microeconomics and Macroeconomics. Both are absolutely vital and you are only half educated if your understand the one while being ignorant of the other”.
Importance of Microeconomics
• It has both theoretical and practical Importance.
• It is highly useful for the formulation of economic policies which will promote the welfare of the common people.
• The theoretical approach to microeconomics utilise abstract models in an attempt to see how prices are determine and how resources are allocated to various uses.
Importance of Microeconomics
• It can also be used as the basis for prediction.
• These predictions are of the form: if this occurs then this will follow.
• A shot-put and a feather: A vacuum
Importance of Microeconomics
• It can also be applied to economic policy.
• This means we can use microeconomics to analyse the action of govt. when it functions to influence the economy.
• We should able to study govt. policies afecting prices of commodities and wages.
• We can also see how these policies affect the allocation resources.
•
Importance of Microeconomics
• Microeconomics theory can also be used by business enterprises.
• The analytical methods developed from the study of microeconomics can be used in managerial decision making.
Importance of Microeconomics
• It can also be used to examine the conditions of economic welfare i.e. to examine the subjective satisfactions that individual derive from consuming goods and services. This is an aspect of normative economics.
Importance of Microeconomics
• Microeconomic theory has also applications in International Economics.
For example: Microeconomics analysis is applied to show how the gains from international trade can be distributed among the participants.
In determining the equilibrium rate of exchange or in determining the conditions for the success of devaluation the tools of demand and supply are used.
Interdependence
• Microeconomic theory and Macroeconomic theory complements of each other.
• For economic analysis the discussion of both is needed.
• For Macroeconomic discussion, microeconomic discussion is necessary because the behaviour of totals is determined from the behaviour individuals.
Interdependence
• Hence we can know macro behaviour from the analysis of the behaviours of small and tiny units.
• Again, sometimes it is seen that something which is true for individuals seperately can’t be true for totals.
• Hence, we should not only discuss microeconomics; we should discuss macroeconomics separately.
Static and Dynamic Economics
• Static analysis: If the analysis is such that all the variables involved refer to the same point of time or period of time then this analysis is known as static analysis.
• Example: quantity demanded during a period of time depends on price at that period of time.
• The total savings of the economy during a period of time depends on the level of income of that period.
Static and Dynamic Economics
• Dynamic analysis: if the variables involved refer to different points of time or, different periods of time then this analysis is called dynamic analysis.
• Planned supply in any period depends on the actual price prevailing in the previous period then it represents a dynamic relationship.
Static and Dynamic Economics
• Static analysis is always considered with the determination of an equilibrium position.
• But it does not concern itself with the time required for an equilibrium position to be achieved.
• It does not considered the path by which variables approach their equilibrium position.
This is considered in dynamic analysis.
Static and Dynamic Economics
• The most useful variety of statics is the so called comparative statics.
• In comparative static analysis one static equilibrium position is compared with another static equilibrium position.
• In a static equilibrium analysis there may be several parameters which are assumed to remain constant at a certain level.
Static and Dynamic Economics
• When we compare one equilibrium position with another corresponding to two different values of one parameter, we adopt comparative static analysis.
• Such a process analysis is not necessary if the speed of adjustment is very high.
• But if the speed of adjustment is slow we require dynamic analysis to get a complete picture of the movement from one equilibrium to another.
Static and Dynamic Economics
• Dynamic analysis is necessary for three reasons:
• First: since adjustment of one variable to change in other takes time, there are lag in many functions. The presence of these lags necessities the use of dynamic analysis.
Static and Dynamic Economics
• Second: there are certain variables which depend, among other things, on the rate of change of certain other variables.
• Third: dynamic analysis is also necessary for considering the stability of equilibrium.
Stability of Equilibrium
• An equilibrium is said to be stable if any disturbance from the equilibrium again restores the equilibrium position.
Equilibrium
• The concept of equilibrium has been borrowed from mechanics where we get the idea of equilibrium system of forces.
• In mechanics a system of forces is said to be in equilibrium if the forces making for movement in one direction are exactly counterbalanced by the forces making for movement in the opposite direction.
Equilibrium
• Thus an equilibrium situation is a state of rest characterized by the absence of change over time.
• The equilibrium value of a variable is simply that value which, if reached, will remain constant.
• Since economics is a social science which is concerned with human behaviour.
• Let us consider what equilibrium means in terms of human behaviour.
Equilibrium
• For this let us take the concept of equilibrium price.
• In microeconomics theory we know that any price is said to an equilibrium price if the quantity demanded by all buyers at this price is equal to the quantity supplied by all sellers at this price.
Equilibrium
• If the equilibrium price prevails the purchase plans of the buyers are satisfied and the sales plans of the sellers are also satisfied.
• The purchase and sales plans of the buyers and sellers are mutually consistent.
• Thus when equilibrium price prevails people are satisfied with the actual price ruling in the market and the actual quantities sold in the market.
Equilibrium
• When people are not satisfied, disequilibrium exists and some persons will modify their behaviour.
• For example if the ruling price is not the equilibrium then at this price purchase and sales plans will not be consistent with each other.
• Planned demand will not be equal to planned supply.
Equilibrium
• In such a situation the price will change and as price changes purchase and sales plans also change.
• This process continues until the equilibrium price is reached.
Equilibrium
• In the same way the output level for the economy as a whole is in equilibrium when the planned demand for output is equal to planned supply of output.
• Total value of planned supply of output is known as aggregate supply and
• Total value of planned demand is known as aggregate demand.
Equilibrium
• The output level for the economy as a whole will be in equilibrium when aggregate demand equals aggregate supply.
• Equilibrium analysis may be of two types:
• 1) Partial equilibrium analysis
• 2) General equilibrium analysis
Equilibrium
• Partial equilibrium: In partial equilibrium analysis equilibrium in one market is reached on the assumption that all other things remain unaffected.
• In general equilibrium analysis everything is supposed to change.
• General equilibrium analysis traces interdependence among different markets of the economy.
Equilibrium
• In microeconomic theory partial equilibrium analysis is usually used.
• However, the partial equilibrium analysis is also supplemented by a general equilibrium analysis to show how the decisions taken by different economic units in an economy are mutually consistent.
Equilibrium
• The study of general equilibrium is important for several reasons.
• Firstly: the general equilibrium theory provides a complete model of economic behaviour. It shows how different parts of the economic system are mutually interdependent. It also shows the complexity of the real world.
Equilibrium
• Secondly: general equilibrium theory yields a set of prices and quantities which lead to optimal allocation of resources. This solution and its optimality property can be used as a norm to judge the significance and implications of deviations of the various markets from this ideal situation.
• Thirdly: general equilibrium analysis also used as micro foundations of macroeconomics. There is also close connection between the general equilibrium theory and the theory of welfare economics.
