Study Note - 1

BASIC CONCEPTS OF ECONOMICS

This Study Note includes
1.1 Definition and Scope of Economics
1.2 Few Fundamental Concepts
1.1 DEFINITION & SCOPE OF ECONOMICS
What is Economics?
Economics is one of the social sciences. It explains about the economic activities of a man. Any
activity
which is related to earning of the money and spending of the money is called economic activity.
Almost all people are engaged in economic activities, because they want to earn the money.
The main economic problem is to transform society’s resources into consumable commodities
by using
productive technology. It is a problem because human wants are unlimited and society’s
resources
are limited. So the central task of economics is to decide how much of which commodities are to
be
produced for the optimum satisfaction of human wants.
Subject Matter of Economics:
In economics, a want is something that is desired.
Want is the starting point of economic activity. Wants leads to efforts. An effort leads to
satisfaction.
Wants Efforts Satisfaction.
This is the subject matter of economics. This subject matter of economics is divided into four
parts.
(i) Production
(ii) Exchange
(iii) Distribution
(iv) Consumption
(i) Production: In economics, Production involves the creation of goods and services by using
resources. It is a process to change the raw materials into final/finished goods. It is nothing but
creation of utility. To produce anything so many factors are essential. All these factors are
classified
into four categories. They are:
(a) Land
(b) Labour
(c) Capital
(d) Organization
Technique and Technology:
Technique is defined as the ratio in which the inputs are combined together to produce one unit
of the
product. For example, if capital (K) and labour (L) are used in the production process and if 1
unit of K
is combined with 2 units of L to produce 1 unit of the product, then, K:L=1:2 will be called the
technique
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of production. Suppose, we know two more techniques of production eg., K:L=2:3 and K:L=3:4,
then
we know the technology which is nothing but the spectrum of all available techniques. Here, the
knowledge of the three available techniques ie., K:L=1:2, K:L=2:3, K:L=3:4 will form the
technology.
(ii) Exchange: It means change of the goods from one person to another person. Once upon a
time
goods were exchanged for goods. It is called “Barter system” To overcome the Inconveniences
in the barter system money was invented. Now the goods are exchanged for money. Price is
essential for the exchange of goods for money.
(iii) Distribution: Distribution means sharing of the income among the factors of production. The
total
income which is generated by selling of these goods and services in the market must be
distributed
among the factors of production in the form of rent, wages, interest and profits.
There are two types of distribution
1. Micro distribution
2. Macro distribution
1. Micro Distribution
Micro distribution is nothing but pricing of factors of production. It means it explains how the
price
(rent) per unit of land is determined. In the same way how the price per unit of labour and
capital,
etc. is determined are discussed.
Ricardian theory of rent, modern theory of rent, different wage theories, Interest theories, profit
theories, etc are discussed.
2. Macro Distribution
Macro distribution means sharing of the total national income among the total factors of
production. It means we came to know whether the income is distributed properly or not
properly
among the people in the society.
Modern economists extended the subject matter of economics. They added some other
concepts
to the economics. They are:
(a) Employment (b) Income (c) Planning and Economic development (d) International trade
(iv) Consumption: It is an act to use the goods or service to satisfy the wants. In economics,
Consumption
is typically defined as final purchase by an individual that are not investments of some sort. In
other
words when you buy food, clothes, airplane tickets, a car, etc., that’s consumption.
Through consumption the consumer destroys the utility of the commodity. This utility was
created
by the producer through production.
If someone buys a house to live in, that should be defined as consumption. If they buy a house
to
rent out it to someone else, that should be defined as an investment. Similarly, if they buy a car
to
drive, that’s consumption. If you buy a car to use as a taxi for a business, that could be
construed
as an investment. In short the reason for the purchase determines whether something is viewed
as
on investment or as consumption.
1.1.2 DEFINITIONS OF ECONOMICS:
The definitions of economics can be classified into four categories.
(a) Wealth definitions
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Basic Concepts of Economics
(b) Welfare definitions
(c) Scarcity definitions
(d) Growth definitions
Wealth definitions:
Almost classical economists followed wealth definition. It is mostly associated with J.B. Say and
Adam
smith. Adam smith was called “Father of economics”. The name of book written by Adam smith
is “An
enquiry into the nature and causes of Wealth of nations”, (1776). Adam Smith delinked the
economics
from political economy and he explained It in a scientific manner.
Definitions:
According to J. B. Say, “economics is the study of science of wealth.
According to Adam Smith, “economics is the science which deals with the wealth”.
According to the above definitions:-
•
Economics explains how the wealth is produced, consumed, exchanged and distributed.
•
According to Adam smith man is an economic man.
•
Economics is a science of study of wealth only.
•
This definition deals with the causes behind the creation of wealth.
•
It only considers material wealth.
Criticism:
This definition was criticized by so many philosophers. They are Carlyle, Ruskin, Walrus, and
Dickens and
others.
According to critics, economics is a decimal science, Gospel of Mammon, bread and butter
science,
uncompleted science etc.
Wealth is of no use unless it satisfies human wants.
This definition is not of much importance to man and his welfare.
Welfare definition:
This definition was given by Alfred Marshall. He was the follower of Adam smith. He wrote a
famous
book “Principles of economics” (or) “Principles of political economy” in 1870.
Definition:
“Economics is the study of mankind in ordinary business of life. It examines that part of
Individual
and social action which is most closely connected with the attainment and with the use of
material
requisites of well being”.
According to Alfred Marshall’s definition, economics is one side study of wealth, on other and
more
important side is the study of part of man (or) welfare of the man.
Main Points:
1. According to this definition, economics is a social science.
2. According to definition, goods are classified into two types (or) categories
- Material goods
- Immaterial goods
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3. According to Alfred Marshall, economics is a normal science.
4. The top priority is given to man (or) welfare of man, secondary priority is given to wealth.
5. Marshall enhanced the status of man from economic man to social man. Economics related
only
some material goods which promote the human welfare.
Criticism:
This definition was criticized by Lionel Robbins on the following grounds:
1. According to Robbins, welfare definition is incomplete definition.
2. According to Robbins, economics must be neutral between ends.
3. According to Robbins, economist must be as a describer not a describer.
4. Marshall neglected some materials goods which do not promote human welfare, but these
goods
are also produced; exchanged & consumed. So, they also come under the subject matter of
economic
Example: Cigarette and alcoholic products.
Scarcity Definition/Robbins definitions
This definition was given by Lionel Robbins. He wrote a famous book “an essay on the nature
and
significance of economic science” (1932).
Definitions:
“Economics is a science which studies human behavior as a relationship between ends and
scarce
means which have alternative uses”. - Robbins
Main Points:
In the above definition
1. Wants are unlimited
2. Limited resources
3. Alternative uses of limited resources
4. Problem of choice
Merits:
1. According to this definition economics is an analytical science.
2. Economic turn into universal science.
3. According to Robbins, it is a positive science.
4. Neutral between ends.
Criticism:
These definitions was also criticized by so many economists on the following terms:
1. It is not a universal science.
2. Not applicable to developed countries.
3. Not applicable to communist (or) dictatorship countries.
4. It is not applicable to developing countries like India.
5. It is an old wine in a new bottle.
6. It also neglected the dynamic concepts.
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Basic Concepts of Economics
Growth Definition
This Definition was given by J.M. Keynes and P.A. Samuelson in the book written by Samuelson
was
“Economics - An Introductory Analysis”, (1948). In this book he gave a new definition to
economics.
Definitions
“Economic is the study of how men and society choose with ‘or’ without use of money to employ
the
scarce productive resources that would have alternative uses to produce various commodities
over
time for distributing them for consumption now or in future among the various persons and
groups in
the society. It Analyse the costs and benefits of improving pattern or resource [use allocation]. -
P.A.
Samuelson
Main points:
1. Like the scarcity definition, it also accepts the unlimited wants and limited resource which
have
alternative uses.
2. According to Samuelson, the problem of scarcity of resources not only confined to present
but also
to the future. It means he introduced the concept of time element.
3. He also adopted a dynamic approach to the study of economics considering Economic
Growth
as an integral part of economics.
4. This definition includes Marshall’s welfare definition and Robbin’s scarcity definition.
Scope of Economics
Traditional
Approach
•
Economics is a social science.
•
It studies man’s behaviour as a rational social being.
•
It is considered as a science of wealth in relation to human welfare.
•
Earning and spending of income was considered to be end of all economic
activities.
•
Wealth was considered as a means to an end – the end being human welfare.
Modern
Approach
•
An individual, either as a consumer or as a producer, can optimize his goal is an
economic decision.
•
The scope of Economics lies in analyzing economic problems and suggesting policy
measures.
•
Social problems can thus be explained by abstract theoretical tools or by empirical
methods.
•
In classical discussion, Economics is a positive science.
•
It seeks to explain what the problem is and how it tends to be solved.
•
In modern time it is both a positive and a normative science.
•
Economists of today deal economic issues not merely as they are but also as they
should be.
•
Welfare economics and growth economics are more normative than positive.
1.1.3 MICRO AND MACRO ECONOMICS
The term ‘Micro’ and ‘Macro’ were introduced by Ragnar Frisch in economics. He is the Prof. of
Oslo
University in Britain. According to him, economics is studied in two ways i.e., Micro level and
Macro
level.
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Meaning of Micro economics:
The word Micro is derived from Greek work ‘Mikros’, means ‘very small or Millionth part’. It
studies about
the behavior of Individual units. Individual units are a consumer, a producer, a firm or industry.
Marshall
developed the Micro economics very well. According to Marshall the Micro economics divide the
economy into small units or small parts, each part is studied. It explains how a consumer gets
maximum
satisfaction, how the producer gets maximum output and how the firm gets maximum profit.
Definition:
Micro economics is study of “particular firm particular household, individual prices, wages,
incomes,
individual Industries, particular commodities”. - K. E. Boulding
Scope of Micro Economics:
The Micro economics explains how the price of a good is determined and how the price per unit
of
factors of production is determined and it is also deals with theories of economics welfare. So
Micro
economics is called “Price theory”.
Scope of Economics
Theory of
trade cycles
Theory of
Inflation
Theory of output
and employment
Micro theory of
distribution Demand
Theory of
Economics growth
Consumption Investment
Users or significance of Micro economics:
1. Understanding the operations of economy
2. Economic welfare of people
3. Managerial economics
Macro Economics:
The word “Macro” is derived from Greek word “Makros”, means “large or very big”. The Macro
economics studies the economy as a single unit. It does not deal with Individual units. It deals
with the
aggregates ‘or’ totals and averages.
For example: national income, full employment, total output, total investment, total consumption
etc.
Definition:
According to Gardner Ackaly, “Macro economics is concerned with such variables as a
aggregate
volume of output of a economy with the extend to this resources are employed with the size of
the
national Income and with the general price level”.
Scope of macro economics:
Macro economics studies about the National Income i.e. calculation of the national income,
trends
in the national income etc., It also deals with total employment (full employment), total output
etc.,
It also studies about trade cycles, Inflation etc., It also deals with theories of economic growth
and
macro theory of distribution. It is also called Income and Employment theory.
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Basic Concepts of Economics
Both Micro and macro economics are interdependent. From 1930 onwards there is an
importance to
the Macro economics.
Scope of Macro economics can be explained by the following chart.
Scope of Macro
Theory of
trade cycles
Theory of
Inflation
Theory of output
and employment
Micro theory of
distribution Demand
Theory of
Economics growth
Consumption Investment
The Macro economics analysis some problems of the economy
1. Level of output and employment
2. Fluctuate in level of output, employment and National Income
3. Changes in the general price level
4. Economic growth and economic development
5. Theories of distribution
Significance of Macro economics:
1. Understanding the working of an economy
2. Formulating policies
3. Prepare the economics plans
4. Take the remedial measures of trade cycles & Inflation
WHETHER THE ECONOMICS IS SCIENCE OR ART
Meaning of Science:
The term science implies:-
1. A systematic body of knowledge which traces the relationship between cause and effect.
2. Observation of certain facts, systematic collection and classification and analysis of facts
3. Making generalization on the basis of relevant facts and formulating laws or theories there by.
4. Subjecting in the theories to the test of real world observations.
5. Like the physics chemistry and botany economics also satisfy the above four characteristics.
Economics is regard as science.
Economics as an Art:
Keynes defines Art as ‘a system of rules for the attainment of a given end”. The object of Art is
to
formulate rules to be used for the formulation of policies.
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Difference between science and Art:
1. Science is theoretical but art is practical.
2. A science teaches us “to know”, an Art teacher us “to do”.
3. Economics as a science in methodology and Art in its application.
4. Economics is both science and Art.
WHETHER THE ECONOMICS IS POSITIVE SCIENCE ‘OR’ NORMATIVE SCIENCE?
Economics as a positive science:
1. The positive science explains “what it is” but not “what ought to be”
2. It explains about the things as they are
3. It does not deal with value judgments.
4. According to Lionel Robbins economics is a Positive science.
Economics as a Normative Science:
1. A normative science explains what ought to be and what not ought to be.
2. It does relates to value judgments
3. It deals with good & bad (or) right and wrong.
4. According to Alfred Marshall economics is a normative science.
5. Economics is both positive and normative science
DEDUCTIVE METHOD AND INDUCTIVE METHOD
Whereas Deductive method is a static analysis, Inductive method is dynamic.
Deductive Method:
1. It is also called prior method, abstract method and analytical method.
2. In this method the laws or theories are prepared on the basis of fundamental assumptions.
3. In this method the logic proceeds from general to particulars.
For example: law of D.M.U, law of equi-marginal utility, law of consumer surplus etc.
4. Classical economists followed deductive method.
Inductive Method:
1. This method is also known as historical method ‘or’ statistical method.
2. In this method the laws ‘or’ theories are prepared on the basis of facts ‘or’ statistical data.
3. In this method the logic proceeds from particular to general.
For example: law of variable proportions, law of returns to scale, population theories etc.
4. Modern economist followed Inductive method.
Central Problems of All economies
Due to the scarcity of resources every economy should faces some problems. The central
problems of
all economics are explained as follows:
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Basic Concepts of Economics
What to produce
If the present is given importance the resources are diverted for the production of consumer
goods. If
future is given importance resources are diverted for the production of capital goods.
How to produce
This problem is arising because of unavailability of some resources. A country may produce by
labour
Intensive technique ‘or’ capital Intensive technique, depending upon its man power and stock of
capital.
For whom to produce
Government policy determines what are the commodities to be produced and for whom. One
can
make a conjecture from the pattern of production of the country. If the government decides to
produce more ordinary buses than luxury cars then one can understand that the country is
producing
for the poor and not for the rich.
1.2 FEW FUNDAMENTAL CONCEPTS
1. Wealth:
The stock of goods under the ownership of a person ‘or’ a nation is called wealth.
(a) Personal wealth:
The stock of goods under the ownership of a person is called personal wealth.
For example: houses, buildings, furniture, land, money in cash, company shares, stocks of other
commodities etc., health, goodwill etc. can also be considered to be the parts of Individual
wealth. But in economics only transferable goods are considered as wealth.
(b) National Wealth:
The stock of goods under the ownership of a nation is called national wealth. It includes the
wealth (common property) of all the citizens in the country. For example: Natural resources,
roads, parks, bridges, hospitals, public education institutions etc., If the citizen of the country
holds a government bond It is personal wealth. But form the government point of view it is a
liability. So, it should not be considered the part of wealth of nation.
Wealth and welfare:
Welfare means well-being ‘or’ happiness. In generally, If the wealth increases welfare also
increase
but.
1. If a nation goes on creating wealth without paying any consideration to the health and mental
peace of citizens. It is doubtful whether the welfare increases.
2. If the wealth is not distributed properly. It is also doubtful whether welfare increases.
2. Money:
Anything which is widely accepted in exchange of goods or in settling debts is regarded as
money.
Once upon a time Barter system was prevailed.
Under barter system goods are exchanged for goods. For example, 1 kg of rice is exchanged
for 2 kg
of wheat. But if 2 goats are exchanged for 1 cow, the problem of indivisibility crops up. 1 goat
cannot
be exchanged for ½ a cow. So, barter system was replaced by the monetary system.
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10 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA
1. When some commodities used as a medium of exchange by customs. It is called customary
money.
For example: The use of cowries in ancient India as a medium of exchange.
Constituents of Money Supply:
1. Rupee notes and coins
2. Credit cards
3. Traveler cheques
3. Market:
In ordinary language the term market refers to a place where the goods are bought and sold.
But in
economics it refers to a system by which the buyers and sellers established contact with each
other
directly ‘or’ indirectly with a view to purchasing and selling the commodity.
Function of the Market:
1. To determine the price of the goods.
2. To determine the quantity of goods [supply]
Market Mechanism:
Market Mechanism means the totality of all markets i.e. the markets. The market mechanism
determines
the prices and quantities brought and sold of all the goods and services.
4. Capital Stock and Investment:
Investment is the increment in capital stock. Suppose, we have a reservoir filled with water and
there
is a tap over the reservoir. If the tap is turned on, water will flow in the reservoir and the water
level in
the reservoir will increase. If we are permitted to draw analogy, then, water in the reservoir can
be
compared to the capital stock and the water-flow from the tap can be compared with the
investment.
Capital stock indicates the productive capacity of the economy. Suppose, with 100 machines the
economy can produce at the maximum 1,00,000 units of output. Here, 100 machines represent
the
capital stock and 1,00,000 units of output represent productive capacity. If the economy decides
to increase the level of output, it has to produce new machines. Producing new machines is
called
capital formation or investment. If through out the year 50 machines have been produced, then
these
50 machines will be the investment for the economy. The economy can start production with 150
(100
+ 50 ) machines as the new capital stock in the next year.
Types of Investment:
(a) Real Investment:
An increase in the real capital stock is called real investment. For example machines, raw
material,
buildings and other types of capital goods.
(b) Portfolio Investment:
The purchasing of new shares of a company is called portfolio investment.
Note: Purchasing of an existing share from another share holder is not an investment. Because
it cannot
increase the capital stock of the company.
It is the savings that are invested:
In the product market, equilibrium will be established when the following equation holds.
Y=C+I
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Basic Concepts of Economics
Where, Y is the National Income (or, output), C is Consumption demand and I is Investment
demand.
The right hand side of the equation is aggregate demand and the left hand side of the equation
is aggregate supply. In equilibrium, aggregate demand is exactly equal to aggregate supply.
Aggregate supply or, national income can be sub-divided into two parts consumption and
savings
(C + S). Therefore, equilibrium equation will now be
C+S=C+I
Or, S = I
So, only in equilibrium, savings is equal to investment. But there is no guaranty that these two
should
always be equal. This is because savings are made by the households while investments are
undertaken
by the businessmen. Their motives are completely different.
• Note: if there is foreign investment then S ≠ I.
Gross Investment and Net Investment:
The Aggregate Investment made by an economy during a year is called gross investment. The
gross
investment includes
(a) Inventory Investment:
Investment in raw materials, semi finished goods and finished goods are called inventory
investment.
(b) Fixed Investment:
Investment made in fixed assets kike machines, building, factories shares etc. is called fixed
investment.
Net Investment:
By deducting the depreciation cost of capital from gross investment the net investment can be
obtained.
Net Investment = Gross Investment – Depreciation
5. Production:
It refers to creation of goods for the purpose of selling them into the market. In one word
production
means ‘Creation of utility”. When a child make a doll for playing for her enjoyment of this activity.
It is
not called production but the doll maker who sells these dolls in the market is engaged in
production.
Factors of production:
The goods and services with the help of which the process of production is carried out are
called
factors of production. Total factor of production.
1. Land
2. Labour
3. Capital
4. Organization
The factors of production are also called Inputs. The goods and services produced with the help
of
Inputs are called output.
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6. Consumption:
Consumption is defined as the satisfaction of human wants through the use of goods and
services.
Determinants of consumption:
1. Present Income
2. Future income
3. Wealth income
7. Saving:
Saving is defined as income minus consumption. Whatever is left in the hands of an individual
after
meeting the consumption expenditure is called saving. Saving is generated out of current
income and
also out of past income.
8. Income:
The net inflow of money (purchasing power) of a person over a certain period of time is called
income
For example: Daily income, weekly income, monthly income and yearly income.
Wealth and Income:
A person (‘or’ a nation) consumes a part of income and saves the rest. These savings are
accumulated
in the form of wealth. Wealth is a stock owned at a point of time. Income is a flow, over a period
of
time.
9. The concept of consumer surplus:
This concept was introduced by Alfred Marshall. This concept is derived from law of diminishing
marginal
utility. Consumer surplus is the difference between willing price and actual price.
C.S. = Willing Price – Actual Price
or
C.S = Demand Price – Market Price
Definition:
The excess of price which a consumer would be willing to pay for a thing rather than go without
the
thing and over what he actually does pay.
10. LAW OF DIMINISHING MARGINAL UTILITY:
The law of D.M.U explains the common experience of every consumer. It is based upon one of
the
characteristics of wants i.e. “A particular want is suitable”. According to this law when a person
goes
on increasing the consumption of any one commodity the additional utility derived from the
additional
unit goes on diminishing. So, it is called law of diminishing marginal utility. The law of D.M.U was
firstly
profounded by H.H. Gossan in 1854. So, it is called Gossans’ first law of consumption. The law
of D.M.U
was developed by Alfred Marshall.
Definition:
“The additional benefit which a person derives from a given increase his stock of anything,
diminishes
with every increase in the stock that he already has”. - Marshall
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Basic Concepts of Economics
Concepts in this law:
1. Total utility:
It is the total amount of satisfaction obtained by the consumer by the consumption of total units
of a
thing. The sum of marginal utilities is also called total utility.
TUx = f[Qx]
Or
TUx = ΣMUx
2. Marginal Utility:
It is the additional utility obtained by the consumer by the consumption of additional unit of a
thing ‘or’
one more unit of a thing. The change in the total utility is also called marginal utility.
MU
x
= TU
P
∆
∆
Or
MUn = TUn - TUn - 1
Table explanation:
Units Total utility Marginal utility
1 40 40
2 70 30
3 90 20
4 100 10
5 100 0
6 90 -10
Diagrammatic Explanation:
Fig: 1.1 Marginal Utility & Total Utility Curve
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Main Points:
1. When total utility Increases, then the Marginal utility diminishes. So, T.U. Curve moves
upward from
left to right and M.U curve slope downwards from left to right.
However, this is only true when the law of diminishing marginal utility operates. Initially, it may so
happen that the marginal utility might be rising along with the total utility curve for a particular
commodity.
2. When the total utility reached the maximum, then the marginal utility is zero. At this point T.U
curve
reached the peak stage and M.U curve intercepts ‘X’ axis.
3. When the total utility goes on diminishing then the M.U becomes negative. So, the T.U curves
slopes
downwards and M.U curve crossed the x-axis.
Assumptions:
1. The units are Homogeneous.
2. The units must be of reasonable size.
3. There is a onetime gap between one unit of consumption and the next unit of consumption.
4. There is no changes in the taste, preferences of consumer.
Exceptions:
1. Collection of the rare goods.
2. Hobbies
3. Misers
4. Money and gold
5. Reading ‘or’ books
Importance:
1. Value paradox
2. Basis for economic laws
3. Finance Minister
4. Re-distribution of wealth
12. DEMAND FORECASTING:
The success of the business firm depends upon the successful demand foresting. Estimation of
future
demand for product at present is called demand forecasting.
Methods of Demand forecasting:
1. Expert opinion method
2. Survey of buyers intensions
3. Collective opinion method
4. Controlled experiments
5. Statistical method.
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Basic Concepts of Economics
13. PRODUCTION POSSIBILITY CURVE (PPC):
The PPC is also called production possibility frontier, production possibility boundary and
production
transformation curve. The PPC curve shows the various combinations of two commodities that
can be
produced by an economy with the given resources and given technology.
A
Opportunity cost
B
C
D
Quantity of butter produced
Quantity of guns produced
+10
+10
+10
50
Fig: 1.2 Production Possibility Curve
Main points:
1. The PPC curve always slopes downwards form left to right. Because when the production of
one
commodity is increased the production of another commodity will be foregone.
2. It is concave to the origin because MRT goes on increasing.
3. The slope of the PPC at any given point is called Marginal rate of transformation (MRT). The
slope
defines the rate at which production of one good can be redirected into production of other. It is
also called opportunity cost.
Suppose, we are on the point D of the left hand diagram of fig.1.2. If we now try to move to the
right,
we are in fact throwing away guns and taking butter instead. There are some specialised input
which
are meant for gun factory will be useless in the butter factory. So, gradually more and more
inputs will
become unemployed. Hence, the sacrifice of the same number of guns will yield less and less
amount
of butter as we move to the right and this will result in a concave curve. In other words, the
Marginal
Rate of Transformation will be falling.
Note:
•
If the PPC curve is straight line, the opportunity cost is constant.
•
All the combinations which lie on the PPC curve are possible combinations.
•
The points beyond the PPC curve are impossible combinations.
•
Shift of the PPC curve is nothing but economic growth.
•
Any point which lies below the PPC curve is possible combination. But if the economy is
working
below the PPC curve that indicates the unused resources ‘or’ unemployment.
FUNDAMENTALS OF ECONOMICS AND MANAGEMENT
16 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA
PPC curve solves the economic problems
If we can choose a point a point on the PPC curve, then we will be able to solve the first of the
economic problems ie., what to produce. Since the chosen point is on the PPC curve, we are
utilising
all the resources fully and efficiently. Now the question is how to land up on a point on the PPC
curve.
Adam Smith identified an “invisible” hand which will guide the economy to reach that coveted
point.
The “invisible” hand is nothing but the “price system”. If too little has been produced, demand for
that good would exceed supply. This would push up the price of that good. This will induce
producer
to produce more of that good than others. Once we have solved the first question what to
produce,
next question comes up: how to produce. A labour intensive technique would employ relatively
more
labour and little capital. A capital intensive technique would do the opposite. Which technique is
to be
chosen depends on the prices of the factors of production. If labour is cheap and capital is
expensive,
a labour intensive technique would be chosen. Third question is : for whom to produce. A
commodity is
consumed only by people who have the purchasing power. When the price system decides the
price
of labour ie., the wage rate and the amount of labour to be employed, it also determines the
income
of the workers ie., their purchasing power. Thus, when the prices of every commodity and every
factor
of production are determined, we know which commodity will go to which consumer and in what
quantity.
I. Choose the correct answer
1. Who was the father of Economics
(a) Marshall (b) Adam smith (c) Robbins (d) Keynes
2. Normative Economic theory deals with …..
(a) What to produce (b) How to produce
(c) Whom to produce (d) How the problem should be solved
3. Cetris peribus means
(a) Demand constant (b) supply constant
(c) Other thing being constant (d) none
4. Micro Economics theory deals with.
(a) Economy as a whole (b) Individual units
(c) Economic growth (d) all the above
5. In economics goods includes material things which …
(a) A can be transferred (b) can be visible (c) both A & B (d) None
6. Human wants are
(a) limited (b) unlimited (c) undefined (d) none
7. Nature of PPF curve is ….
(a) convex to the origin (b) concave to the origin (c) both (d) none
8. If PPF is linear it implies …
(a) constant opportunity cost (b) diminishing apart cost
(c) Increasing opportunity cost (d) none
THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 17
Basic Concepts of Economics
9. Any point beyond PPF is ….
(a) attainable (b) unattainable (c) both (d) none
10. If an economy is working at the point left to PPF curve that shows…
(a) Full employment (b) unemployment (c) excess production (d) none
II. Fill in the blanks
1. According to __________ Economics is the study of science of wealth.
2. According to _______ definition economic is a social science.
3. According to ______ top priority is given to man.
4. According to _______ Robbins Economics must be ___ between ends.
5. Alternative uses of limited resources leads to ______
6. According to ____ definition Economics analytical science.
7. Growth definition is mostly associated with _____
8. ____ definition includes welfare definition and scarcity definition.
9. In deductive method the logic proceed from ___ to ____.
10. In inductive method the logic proceed form ____ to ____.
III. State the statements true or False
1. According to Adam Smith man is economic man ( )
2. According to Marshall Economic is normative science ( )
3. Positive science related with J.B. Say ( )
4. The terms micro & macro are introduced by Ragnar Frisch ( )
5. Science is practical, but Art is theoretical ( )
6. Positive science does not related to value judgments ( )
7. Gross investment = net investment + depreciation ( )
8. Consumption depends not only on present income but also future income ( )
9. Value paradox was depicted by law of demand ( )
10. PPC is also called PPF ( )
IV. Matching
1. Principles of economics ( ) A. Analytical method
2. Wealth of nations ( ) B Price theory
3. An essay on the nature and
significance of economic science ( ) C. Historical method
4. Economic an introductory analysis ( ) D. Marshall
5. Micro Economics ( ) E. MRT
6. Macro Economics ( ) F. Production
7. Deductive method ( ) G. Adam smith
FUNDAMENTALS OF ECONOMICS AND MANAGEMENT
18 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA
8. Inductive method ( ) H. P.A. Samuel son
9. Opportunity Cost ( ) I. J.H. Keynes.
10. Creation of utility ( ) J. Robbins
V. Give the answer in one (or) two sentences
1. Define wealth
The stock of goods under the ownership of a person ‘or’ a nation is called wealth.
There are two types of wealth i.e.
1. Personnel wealth: Example: houses, buildings, furniture, cars etc.
2. National wealth: Example: natural resources, roads, parks, bridges etc.
2. What is money
Anything which is wide accepted in exchange of goods or in settling debts is regard as money.
Once
upon a time Barter system was prevailed.
3. Market
In ordinary language the term market refers to a place where the goods are bought and sold.
But in
economics it refers to a system by which the buyers and sellers established contact with each
other
directly ‘or’ indirectly with a view to purchasing and selling the commodity.
4. Real Investment
An increasing the real capital stock is called real investment. For example machines, raw
material,
buildings and other types of capital goods.
5. Portfolio Investment
The purchasing of new shares of a company is called portfolio investment.
6. Income
The income of a person means the net inflow of money (or purchasing power) of this person
over a
certain period. For instance, on industrial worker’s annual income is his salary income over the
year. A
businessman’s annual income is his profit over the year.
Important Question
1. Explain about wealth definition.
2. Explain about welfare definition.
3. Explain about scarcity definition.
4. Explain about Growth definition.
5. Distinguish between micro and macro economics.
6. State whether the economic is science of Art.
7. State whether the economics is positive or normative science.
8. Explain about the control problem of all economics.
9. Define the wealth and its types.
10. Explain the relationship between wealth and welfare?
11. What is money and state its constitutes?
THE INSTITUTE OF COST ACCOUNTANTS OF INDIA 19
Basic Concepts of Economics
12. Define the market and explain its functions.
13. What is meant by investment? And its types?
14. What is production and what are the factors of production?
15. What is consumption and its determination?
16. Relationship between income and wealth.
17. Relationship about consumer’s surplus.
18. Explain about the law of Diminishing marginal utility.
19. What is demand forecasting and state its methods?
20. Explain about production possibility curve.
Key:
I.
1. (a)
2. (d)
3. (c)
4. (b)
5. (c)
6. (b)
7. (b)
8. (a)
9. (b)
10. (b)
II.
1. J.B. Say
2. Welfare
3. Marshall
4. Neutral
5. Problem of choice
6. Scarcity
7. P.A.Samuel Son
8. Growth
9. General to particular
10. Particular to general
FUNDAMENTALS OF ECONOMICS AND MANAGEMENT
20 THE INSTITUTE OF COST ACCOUNTANTS OF INDIA
III.
1. True
2. True
3. False
4. True
5. False
6. True
7. True
8. True
9. False
10. True
IV.
1. D
2. G
3. J
4. H
5. B
6. I
7. A
8. C
9. E
10. F