Economics

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Economics

  1. 1. Introduction Economics Greek Words Oikos + Nomos OikonomiaMeaning - “ Household Management ” or “ Management of State”
  2. 2. Definition of Economics Economics has been variously defined by different economists from time to time. This is partly because “ economics is an unfinished science” (F. Zuethen, Economic Theory & Method,1953) J.N.Keynes says – “Political Economy is said to have strangled itself with definitions” (Scope & Method of Political Economy) Classical definitions of Economics are grouped together under 3 heads:- 1. Wealth Definition (Adam Smith) 2. Welfare Definition (Dr. Alfred Marshal) 3. Scarcity Definition (Lionel Robbins)
  3. 3. Adam Smith (Economics is a Science of wealth) Book :- “An Enquiry into the Nature and Causes of the Wealth of Nations” (1776) Definition :- “Economics enquires into the factors that determine wealth of the country and its growth”. “The great object of Political Economy of every country is to increase the riches and power of that country”. Subject matter of the book :-  Wealth and Riches of a country cannot grow without the proper utilization of its resources.  Production and Expansion of Wealth.
  4. 4. Wealth Definition (Continues…..) David Ricardo (Principles of Political Economy) shifted the emphasis from the production of wealth to the distribution of wealth.Definition - “The produce of the Earth (all that is derived from its surface) by the united application of Labour, Machinery & Capital is divided among three classes of the community, namely-  The proprietor of the Land  The owner of the stock of Capital necessary for its cultivation  The Labourers by whose industry it is cultivated.” He further writes – “To determine the laws which regulate this distribution, is the principle problem in Political Economy”. John Stuart Mill – “ The Political Economy is science of the production and distribution of wealth.” J. B. Say (French Economist) – “Economics is the Science which treats of wealth.” F. A. Walker (Political Economy,1883) – “Economics is the name of that part of knowledge which relates to wealth.”
  5. 5. Critical Evaluation of “Wealth Definition” In defense a) Production, exchange & distribution of wealth Critics gives physical substance to men & their standard of living.Carlyle & Ruskin – Gospel of Mammon / Pig b) Determine income, employmentScience / Dismal Science. & economic growth.Study material wealth & ignores immaterial services(services of teachers, doctors, musicians, dancersetc)Describes only productive factors like-land, labour & regard immaterial services as unproductive.Emphasis on wealth & put man on secondary Don’t stress on man’s behaviour & neglectsplace. promotion of human & social welfare.Classical economists emphasis on institution of private property as legally, morally & naturallyjust. i.e.- right of wealth or natural rights of the factors of production on their several shares.Natural & moral basis of property rights is not accepted by modern economists. Property areconferred by society and vested in the name of society.
  6. 6. Welfare Definition Dr. Alfred Marshal (Principles of Economics, end of 19th century) – “Political Economy or Economics is the study of mankind in the ordinary business of life; it examines that part of individual & social action which is most closely connected with the attainment & with the use of the material requisites of well-being.” So according to him- “Economics is on the one side a study of wealth; and on the other, and more important side, a part of the study of man.”So there are 3 things worth of noting:- 1 Social Science- It is study of man as such and not only wealth. 2 Economic Aspect – It is concerned with a particular aspects of man’s life (study of man’s action in the ordinary business of life; i.e.:- How he gets income and how he uses it.) 3 Welfare – The primary object and end of Economics is the promotion of material welfare; not totally welfare or spiritual well-being but part of material well being. So goal is described there.Other Economists who supported the welfare definitions are- E. Cannan A. C. Pigou
  7. 7. Critical Evaluation of Welfare definition1. Restricted only to the material welfare or material things.2. Concept of welfare is not fixed and definite- i.e.- why welfare / Economics is not all about welfare.Scarcity Definition (Lionel Robbins’ Definition) Book – “An Essay on the nature & Significance of Economic Science.” (Published in 1931) Definition- “Economics is the science which studied human behavior as a relationship between ends and scarce means which have alternative uses.” So Economics is a science of choice.There are 3 things in the definition-1. Unlimited wants / Multiplicity of wants2. Scarce means / Scarcity of means3. Alternative uses of means.
  8. 8. Critical Evaluation of Robbins Definition1. Robbins opposes the concept of social welfare2. Robbins criticized on that Economics neutral between ends.3. Robbins criticized making Economics human science instead of social science.My personal definition -“Economics is social science which deals with mankind in economic way and better utilization of resources to meet human wants so that social welfare and nation’s growth are achieved.”
  9. 9. Subject Matter of Economics:-Types of Economics :-1. Micro Economics2. Macro EconomicsMicro Economics – It studies the economic action and behavior of individual units and small groups of individual units.
  10. 10. Product Pricing Factor PricingMicro (Theory ofEconomic Distribution)Theory Theory of welfare
  11. 11. MacroeconomicsMakros (meaning = Large) + Nomos (science)Definitions- “Macroeconomics analysis the behavior of the whole economic system in the totality or entirety”.“Macroeconomics studies the behavior of the large aggregates such as total employment, the national product or Income, the general price level of the economy”.Macroeconomics is also known as aggregate economics.
  12. 12. Subject Matter of Macroeconomics • Macroeconomic TheoryTheory of Income Theory of general Theory of Macro Theory of& Employment price level & Economic Distribution( Inflation Growth Relative shares of wages & Profits) Theory of Theory ofconsumptio Investment n function Theory of Fluctuations(Business cycle)
  13. 13. Demand & Law of Demand Utility – “Utility means want satisfying power of a commodity”. It is also defined as – The amount of satisfaction which a person derives from consuming a commodity.”There are 2 dimensions to it: Total utility: Total amount of satisfaction Marginal Utility: Additional satisfaction derived from consuming an additional unit of the product. Demand – “The demand for a commodity is the amount of it that a consumer will purchase or will be ready to take off from the market at various given price in a period of time.”
  14. 14. Law of Demand• “ Other things being equal / constant, if price of a commodity falls ,the quantity demanded of that product will rise and Vice-versa.• So According to law of Demand – There is inverse relationship between price and quantity demanded• .Demand shedule & Demand Curve P Price in Rs. Quantity Demanded in r unit i 12 10 c 10 20 e 8 30 6 40 Quantity
  15. 15. Factors influencing Demand (Determinants of Demand)Taste and preferences of the consumersIncomes of the peopleChanges in the price of the related goods-Substitutes goods- example- Tea & Coffee Computer & LaptopsComplementary goods – example- Milk & Milk products Car & PetrolNumber of consumers in the markets (Population of state)Changes in propensity to consumesConsumer’s expectations with regard to future prices of that goodsIncome distribution
  16. 16. Law of Demand (continued…..)So according to law of demand- Quantity demanded is functions of following-Qd = f (Px , I, Pr, T, A, ………..)Where• Qd= quantity demanded of a goods• Px = price of that goods• I = Income of people• Pr = Price of related goods• T = Tastes and preferences• A= Advertisement
  17. 17. Exceptions to Law of Demand• Veblin Effects / Veblin Goods- Theory given by Thorstein Veblin for prestige goods.• Giffen Goods – Theory given by Sir Robert Giffin , for inferior goods.• Demand of necessity- example- Salt• Scarcity or Inflection• Natural calamities
  18. 18. Movement of Demand curve1.Extension and contraction in demand(movement is along the same curve in both the directions: upward and downward, only price is changing other things remaining the same)2.Increase and decrease in demand(there is a shift in the demand curve due to change in the determinants of demand other than price)• Market Demand:• Market demand is the amount demanded of a commodity at different price levels. In brief we can say the market demand is the sum of individual demands for a product at a price per unit of time. Therefore quantity demanded of a commodity by an individual per unit of time, at a given price, is known as ‘Individual Demand’ for that commodity. The aggregate of individual demands for a product is called market demand for the product. 18
  19. 19. Example is given below for market demand: Below table explains thedemand for commodity X by different consumers at different price level. Howwe will calculate the market demand for commodity X PRICE & QUANTITY DEMANDED ---- Demand curve of A, B, C & MarketPrice of Quantity of X Market X demanded by Demand various Individuals A B C 10 5 1 0 6 8 7 2 0 9 A demand Total market 6 10 4 1 15 demand 4 14 6 2 22 2 20 10 4 34 1 27 15 8 50 19
  20. 20. • Types of Demand• 1. Price Demand• 2. Income Demand• 3. Cross Demand• Elasticity of Demand(Quantum of changes / Degree of responsiveness / Sensitivity)• Dr. Alfred Marshall has put the concept of Elasticity. He defined Elasticity of demand as the extent to which the quantity demanded of a commodity changes in response to a given change in price. Dr. Marshall first limited this concept only to effect of price and demand, but later he has expanded the area to Income and Cross-relationship of demand with these factors.• According to Marshall there are 3 types of elasticity they are:• Price Elasticity of Demand: It measures the effect of a change in the price of Y on the demand of Y• Income Elasticity of Demand: Effect of a change in consumer’s income on the demand for product X or Y or any other product.• Cross Elasticity of Demand: Effect of a change in the price of Y product on the demand of X 20
  21. 21. PRICE ELASTICITY OF DEMAND Price elasticity of demand indicates the degree of responsiveness of quantity demanded of a goods to the change in its price Price elasticity of demand is defined as the ratio of the percentage change in the quantity demanded of a commodity to a percentage change in the price of that goods. Dr. Marshall defined the concept of price elasticity as “ The elasticity of demand in market is great or small according as the amount demanded increases much or little for a given fall in the price, and diminishes much or little for a given rise in the price”• Ep = % Change in quantity Demand ed % Change in Price• The price and demand is having inverse relationship between them, therefore the numerator or denominator will be negative. As such Ep will always be a negative quantity. As it is always negative minus sign generally omitted. Example if price falls by 1% and the demand increases by 3%. The Ep = 3% = - 3. so Ep is 3 and (-)ve sign omitted. -1% 21
  22. 22. • So when • Ep >1 Elastic Demand • Ep < 1 Inelastic Demand • Ep = 1 Unitary elastic demand • (A) Types of Price Elasticity: • Perfectly Elastic Demand: • Perfect elasticity of demand refers to that situation where slightest rise in price causes the quantity demanded of the commodity to fall to zero and contrary slightest fall in price increase in the quantity demanded of the commodity. The demand is hypersensitive and the elasticity is infinity. • Example: 5% increase in demand for no change in price YEp = 5 = ~. 0 Price D D1 O X Q Q1 Demand 22
  23. 23. 2. Perfectly Inelastic Demand: YEp = 0 = 0. D 5 Price P1 P O X D1 DemandPerfect inelastic demand refers to that situation where any rise in price does not causeany change in the quantity demanded of the commodity. The demand is insensitive andthe elasticity is zero 23
  24. 24. 3. Highly Elastic Demand: Y DEp = 40 = 2. 20 Price P Demand Curve P1 D1 O X Q Q1 QuantityHighly elastic demand refers to that situation where small fall in price causes more thanproportionate change in the quantity demanded of the commodity. The demand is highlysensitive and the elasticity is high. 24
  25. 25. 4. Inelastic Demand: D YEp = 5 = 0.5 10 Price P Demand Curve P1 D1 O X Q Q1 QuantityInelastic demand refers to that situation where high fall in price causes slight change inthe quantity demanded of the commodity. The demand is insensitive and the elasticity islow. 25
  26. 26. 5. Unit Elasticity of Demand: Y Ep = 20 = 1 D 20 Price P Demand Curve P1 D1 O X Q Q1 QuantityUnit elastic demand refers to that situation where any fall in price causes equallyproportionate change in the quantity demanded of the commodity. The elasticity is stable. 26
  27. 27. Factors / Determinants of Elasticity of Demand• Nature of the commodity• Availability of substitutes• Number of uses of a commodity• Proportion of consumers income spent• Time period• Price level• Postponement of purchases Importance of Price elasticity• Pricing decisions by the business• Uses in economic policy• Explanation of the paradox of plenty• Importance in Fiscal policy• Use in international trade
  28. 28. Income Elasticity of Demand• Income elasticity of demand may be defined as-• “The ratio of percentage change in quantity demanded of a goods to a percentage change in income”.• So Ei = % change in quantity demanded % change in income• Zero income elasticity• Positive income elasticity , when Ei > 0 for normal goods• Negative income elasticity, when Ei < 0 inferior goods• When Ei > 1 for luxury goods• When Ei < 1 for necessity goodsCross Elasticity of DemandDegree of responsiveness of demand for one goods in response to change in price of another goods represents the cross elasticity of demand of one goods for the other“ Cross elasticity of demand of x for y is – The ratio of % change in the quantity demanded of goods x to % change in the price of goods y. Ec = % change in qty. demanded of x % change in price of goods yExample of cross elasticity- 1. Maruti suzuki8000, Vans, Swift, Esteem 2. Gillete razor & Blade 3 Automobile industry- Maruti (A Star) General Motor(Spark) Ford(i10)
  29. 29. Importance of Elasticity of Demand• In production• For price determining• In Fiscal policy• In market competition• In international trade & Foreign exchange• In public finance.• In trade unions
  30. 30. Law of Supply• Meaning of Supply: As demand is defined as a schedule of the qualities of good that will be purchased at various prices,similarly the supply refers to -the quantities of a good that will be offered for sale at various prices by the firm.“ Amount of a product which a producer is willing to or able to produce and make available for sale in the market at specific price for a given period of time.”Law of Supply“ Other things being constant, when the price of a commodity rises the quantity supplied of it in the market increases and when the price of the commodity falls its quantity supplied decreases.”So quantity supplied of a commodity has direct or positive relation with its price. 30
  31. 31. LAW OF SUPPLY:- Price per Quantity Supplied Quantity (Rs.) (In Quintals) 500 100 510 150 520 200 530 225 540 250 550 275Diagrammatic Representation: Y S’ 540 530 520 510 500 S 0 100 150 200 225 250 X 31
  32. 32. Factors determining supply• Number of producers or sellers in the market• State of Production technology• Cost of production (Factor price)• Prices of other products or related products• Objectives of the firm• Future price expectation• Taxes and Subsidies
  33. 33. • ELASTICITY OF SUPPLY• Elasticity of supply of a commodity is defined as the responsiveness of quantity of a supplied goods to change in price of that commodity.• “ The ratio of proportionate change in quantity supplied of a commodity to proportionate change in the price of that goods.”• Es = % change in qty. supplied• % change in the price of that goods• (A) Types of Elasticity:• 1. Perfectly Elastic Supply:• Perfect elasticity of supply refers to that situation where slightest rise in price causes the quantity supplied of the commodity to infinity and contrary slightest fall in price decrease in the quantity supplied of the commodity. The supply is hypersensitive and the elasticity is infinity. Y Es = 5 = ~.• 0 Price Example: 5% increase in supply for no change in price S S1 O X Q Q1 Supply 33
  34. 34. 2. Perfectly Inelastic Supply: YEs = 0 = 0. S 5 Price P1 P O X S1 SupplyPerfect inelastic demand refers to that situation where any rise in price does not causeany change in the quantity demanded of the commodity. The demand is insensitive andthe elasticity is zero 34
  35. 35. 3. Highly Elastic Supply: Y Es= 40 = 2. 20 Price S1 P1 Supply Curve P S O X Q Q1 QuantityHighly elastic demand refers to that situation where small fall in price causes more thanproportionate change in the quantity demanded of the commodity. The demand is highlysensitive and the elasticity is high.4. Inelastic Supply: Y S1Es = 5 = 0.5 10 Price Supply Curve P1 P S O X Q Q1 Quantity 35
  36. 36. Inelastic demand refers to that situation where high fall in price causes slight change in the quantity demanded of the commodity. The demand is insensitive and the elasticity is low. 5. Unit Elasticity of Supply: Y ES = 20 = 1 S1 20 Price P1 Supply Curve P S O X Q Q1 QuantityUnit elastic demand refers to that situation where any fall in price causes equallyproportionate change in the quantity demanded of the commodity. The elasticity is stable. 36
  37. 37. DETERMINANTS OF ELASTICITY OF SUPPLY:Elasticity of supply is determined by following factors: 1. Time: While considering the elasticity of supply time plays a very vital role in its determination. Normally the time period is divided into 3 categories:  Market Period: It is very short term period and it is difficult to change any factor of production. (Period duration max 1-3 Months)  Short Period: In this period it is possible to adjust the quantity supplied by variation in the variable factor. (Period duration max 6-18 Months)  Long Period: This period is the long period and supplier getting sufficient time to alter and expand the quantity to be supplied. (Period duration max 2 years & More) 2. Change in marginal cost of production 3. Response of the producers 4. Availability of infrastructure facility and other inputs for expanding output. 5. Possibility of substitution of one product for others. 37

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