The Ultimate Guide to Economics

What is economics?

Economics as a subject is very important for everyone to study. One must be aware of his surrounding environment in which we are living. We can define it as a framework within which all economic activities that are production, consumption, investment etc. takes place. It is a mechanism which provides a living to its people.

The study of economics is a science because it concerns with human behaviour. Humans wants are unlimited. But we must understand that resources are limited. Hence, we need to use it accordingly. We need to make choices when resources are in a very limited quantity.

 

What do we mean by an economic problem and how does it arise?

It is a problem of scarcity and opportunity.  It occurs because:

  • Human needs are unlimited.
  • Resources to satisfy such wants are scarce.
  • We can put resources to alternate uses.

Now let us discuss what the essential problems of an economy are:-

 

Central Problems of an Economy

The above info-graphic states the central or we can say major problems of an economy. Now let us discuss them:

Central problems of an economy

What to produce and in what quantity

It is an issue of deciding between what type of stocks an economy should develop and in what quantity. It means an economy has to perform a distinction between producer goods and consumer goods.

As the resources are scarce, an increase in the production of one commodity results in a decrease in the production of another. This happens because resources are moved from one commodity to another.

How to produce

Here the problem arises because of making a choice between which type of technology an economy should use for production. Here one has to decide between labour-intensive technology (the practice of more labour and less capital) and capital intensive technology (use of more machines and less labour).

In a developing economy such as India, we widely use labour. This is because labour is cheaply available and they are in huge quantity too. Also, it will solve the problem of unemployment.

For whom to produce/distribution Problem

It is a problem of making a choice between for which section of the society an economy should produce. This means one needs to create a choice between rich class and the poor class. This is because rich demand more luxury while poor demand more necessities.

This problem arises because there is no equal division of income and wealth. So equal importance needs to be there for all four factors of production. These are land, labour, capital and enterprise.

Other related problems

Other problems apart from the above ones are:

  • Fuller and efficient use of resources
  • The problem of growth of resources.

Below infographic shows that which centre problems belong to which branch of economics:-

 

Centre problems and branch of economics

The two main branches of economics are of prime importance are:-

Microeconomics

It is that branch of economics which deals with the study of individual behaviour. For eg: a seller,  a buyer, a private budget, etc.

  • Individual demand and individual supply are the main components.
  • It is concerned with the issue of allocation of resources.
  • It is said as price theory too.
  • The subject is price determination and resource allocation.

Macroeconomics

It is that branch of economics which deals with a study of aggregate behaviour. Aggregative behaviour means an economy in total. For e.g.:- Govt. budget, national income, total population, etc.

  • Over here the primary tools are aggregate demand and aggregate supply.
  • It deals with the problem of fuller utilisation of resources.
  • One knows it as a theory of income and employment.
  • The subject is a determination of income and employment.

Nature of economies

3 types of economies are there in the infographics given below:

Nature of economy

Now let us study each of the above types of economies:

Capitalist/Market economy

It is that economy in which the private sector owns all means of production/individuals. So the aim of the producer is to maximise profits. The role of Govt. is next to negligible here. In such kind of economies, the price mechanism is the force that is the market forces of demand and supply. Examples of such kind of economies are US, UK, Japan, etc.

Socialist/Planned economy

It is that economy in which public sector (Govt.) is the owner of means of production. So the aim of the Govt. is to maximise social welfare. Hence, in such economies planning commission/central planning authority is there for that purpose. Example of such economies is China, Russia, etc.

Mixed economy

It is that economy in which means of production ownership is with a private and a public sector. The private sector produces to maximise profits and the public sector produces to maximise social welfare. Hence, in such economies solution is the combination of price mechanism and planning mechanism. Examples of such economies are India, Pakistan, etc.

In economics there is a concept of positive and normative economics explained below in the form of an infographic:

Postitive and Normative Economics

The point to note here is that positive economics deals with questions such as what is, what are. Normative economics deals with what ought to have been, etc.

To quote another example, we can say:

All human beings are mortal is an example of positive economics. When we say they should control the rate of growth of population, then it is an example of normative economics.

There can be instances where a particular statement is a combination of both positive and normative economics. An example: – Cigarette smoking is injurious to health. Therefore, tobacco production needs to shut.

Now let us discuss the two most important concepts which drive any economy that is demand and supply.

Demand

It is defined as the quantity of a commodity which a consumer is willing to buy at a given price, at a given time backed up by the ability to pay.

Demand Function

It is defined as an equation showing the functional relationship between demand for a commodity and its various determinants/factors.

Factors affecting demand for a commodity

Price (P)

There exists an inverse relationship between the price of a commodity and demand for a commodity. This means when the price of commodity increases, its demand will decrease and vice versa.

Price of related goods (Pr)

There are two kinds of related goods, substitute and complementary goods. Substitute goods are those which are utilised easily in place of each other with equal ease such as tea and coffee. Complementary goods are those whose usage is together to satisfy our wants such as petrol and car.

Income of the consumer (Y)

There is a direct relationship between the income of the consumer and the demand for a commodity. So this means with the rise in income, demand for a commodity increases and vice versa. Though this relationship does not hold true for all commodities such as in the case of inferior goods. This is because inferior goods are low-quality goods whose demand decreases with the rise in income of the consumer.

Tastes and Preferences (T)

When a commodity is in consumers taste and preferences, its demand increases. On the other hand, when it is not in consumers taste and preferences, its demand decreases.

Other factors

There can be several other factors which affect the demand for a commodity. Here we have mentioned three of them:

 Fashion

The commodity in fashion is more attractive for consumers and vice versa.

Composition of population

When a country’s population say comprises mainly of old age, demand for medicines increases.

Future expectation about prices

When prices expectation is to rise in the future, demand for a commodity will increase at the price and vice versa.

Supply

It is as an economic term which tells how much amount of a specific product or service the sellers want to offer to its consumers and at what price and period.

Stock

It is the total quantity of goods lying unsold with a seller.

Supply function

It is an equation which shows a relation among a supply of the commodity and factors which affect it.

Determinants of supply or Factors affecting supply

The factors affecting supply are as follows-

Price of a commodity (Px)

There is a direct relationship between the price of the commodity and supply of the commodity.  This means that when the price of the commodity increases, its supply will decrease and vice versa.

Price of related goods (Pr) 

There is an inverse relationship between the price of other commodity and supply of a commodity. For example, when the price of Coca Cola increases, the supply of Pepsi will decrease and vice versa.

Price of inputs (Pi)

There is an inverse relationship between the Price of inputs and supply of a commodity. This is because when the price of inputs rises, the cost of production increases. So this results in a decrease in profit margins. Because of this, there is a decrease in supply and vice versa.

Technology (T)

Using modernised or improved technology results in higher productivity because of which it causes an increase in supply. Using obsolete technology causes a decrease in supply.

The goal of the firm (G)

A goal can be sales maximisation or profit maximisation. When the goal is sales maximisation, the seller will increase the supply of the commodity at the same price. When the goal is profit maximisation, the seller creates an artificial scarcity in the market. Because of this, a decrease in supply takes place at the given price.

Other factors (O)

There can be several other factors which affect the demand for a commodity. Here we have mentioned 2 of them:

The future expectation of prices

When there is an expectation that prices will rise in the future, supply will decrease. While, when the prices expectation is to fall in the future, supply will increase.

Govt. policy

Imposition of taxes on the seller results in an increase in the cost of production. So, supply decreases as a result. When Govt. provides subsidies to the seller, supply will increase at the price.

Leave a Comment