economics notes.docx

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UNIT-1

Definition of 'Economics'

There are a variety of modern definitions of economics. Some of the differences may reflect

evolving views of the subject itself or different views among economists.

A social science that studies how individuals, governments, firms and nations make choices on

allocating scarce resources to satisfy their unlimited wants. Economics can generally be broken

down into: macroeconomics, which concentrates on the behavior of the aggregate economy; and

microeconomics, which focuses on individual consumers.

The title page gave as its subject matter "population, agriculture, trade, industry, money, coin,

interest, circulation, banks, exchange, public credit and taxes".

The philosopherAdam Smith (1776) defines the subject as "an inquiry into the nature and causes

of the wealth of nations," in particular as:a branch of the science of a statesman or legislator

[with the twofold objective of providing] a plentiful revenue or subsistence for the people ...

[and] to supply the state or commonwealth with a revenue for the publick services.

J.-B. Say (1803), distinguishing the subject from itspublic-policy uses, defines it as the science

of production, distribution, and consumption of wealth. On the satirical side, Thomas Carlyle

(1849) coined 'the dismal science' as an epithet for classical economics, in this context,

commonly linked to the pessimistic analysis ofMalthus (1798).John Stuart Mill (1844) defines

the subject in a social context as:

The science which traces the laws of such of the phenomena of society as arise from the

combined operations of mankind for the production of wealth, in so far as those phenomena arenot modified by the pursuit of any other object.

Alfred Marshallprovides a still widely cited definition in his textbookPrinciples of Economics

(1890) that extends analysis beyondwealth and from thesocietal to themicroeconomic level:
http://en.wikipedia.org/wiki/Adam_Smithhttp://en.wikipedia.org/wiki/Jean-Baptiste_Sayhttp://en.wikipedia.org/wiki/Public_policyhttp://en.wikipedia.org/wiki/Wealthhttp://en.wikipedia.org/wiki/Satiricalhttp://en.wikipedia.org/wiki/Thomas_Carlylehttp://en.wikipedia.org/wiki/The_dismal_sciencehttp://en.wikipedia.org/wiki/Epithet#Alternative_contemporary_usagehttp://en.wikipedia.org/wiki/Classical_economicshttp://en.wikipedia.org/wiki/Malthushttp://en.wikipedia.org/wiki/John_Stuart_Millhttp://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/Principles_of_Economics_%28Marshall%29http://en.wikipedia.org/wiki/Principles_of_Economics_%28Marshall%29http://en.wikipedia.org/wiki/Principles_of_Economics_%28Marshall%29http://en.wikipedia.org/wiki/Wealth#Economic_analysishttp://en.wikipedia.org/wiki/Societalhttp://en.wikipedia.org/wiki/Microeconomichttp://en.wikipedia.org/wiki/Microeconomichttp://en.wikipedia.org/wiki/Societalhttp://en.wikipedia.org/wiki/Wealth#Economic_analysishttp://en.wikipedia.org/wiki/Principles_of_Economics_%28Marshall%29http://en.wikipedia.org/wiki/Alfred_Marshallhttp://en.wikipedia.org/wiki/John_Stuart_Millhttp://en.wikipedia.org/wiki/Malthushttp://en.wikipedia.org/wiki/Classical_economicshttp://en.wikipedia.org/wiki/Epithet#Alternative_contemporary_usagehttp://en.wikipedia.org/wiki/The_dismal_sciencehttp://en.wikipedia.org/wiki/Thomas_Carlylehttp://en.wikipedia.org/wiki/Satiricalhttp://en.wikipedia.org/wiki/Wealthhttp://en.wikipedia.org/wiki/Public_policyhttp://en.wikipedia.org/wiki/Jean-Baptiste_Sayhttp://en.wikipedia.org/wiki/Adam_Smith


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Economics is a study of man in the ordinary business of life. It enquires how he gets his income

and how he uses it. Thus, it is on the one side, the study of wealth and on the other and more

important side, a part of the study of man.

Lionel Robbins (1932) developed implications of what has been termed "[p]erhaps the mostcommonly accepted current definition of the subject.

Economics is a science which studies human behaviour as a relationship between ends and

scarce means which have alternative uses.

Robbins describes the definition as not classificatory in "pick[ing] out certain kinds of

behaviour" but rather analyticalin "focus[ing] attention on a particular aspectof behaviour, the

form imposed by the influence ofscarcity."

Some subsequent comments criticized the definition as overly broad in failing to limit its subject

matter to analysis of markets. From the 1960s, however, such comments abated as the economic

theory of maximizing behavior andrational-choice modelingexpanded the domain of the subject

to areas previously treated in other fields. There are other criticisms as well, such as in scarcity

not accounting for themacroeconomics of high unemployment.

Gary Becker,a contributor to the expansion of economics into new areas, describes the approachhe favors as "combin[ing the] assumptions of maximizing behavior, stable preferences, and

market equilibrium, used relentlessly and unflinchingly." One commentary characterizes the

remark as making economics an approach rather than a subject matter but with great specificity

as to the "choice process and the type ofsocial interaction that [such] analysis involves."
http://en.wikipedia.org/wiki/Lionel_Robbinshttp://en.wikipedia.org/wiki/Human_behaviourhttp://en.wikipedia.org/wiki/Scarcityhttp://en.wikipedia.org/wiki/Rational_choicehttp://en.wikipedia.org/wiki/Economic_imperialism_%28economics%29http://en.wikipedia.org/wiki/Macroeconomicshttp://en.wikipedia.org/wiki/Gary_Beckerhttp://en.wikipedia.org/wiki/Preference_%28economics%29http://en.wikipedia.org/wiki/Economic_equilibriumhttp://en.wikipedia.org/wiki/Economic_equilibriumhttp://en.wikipedia.org/wiki/Social_interactionhttp://en.wikipedia.org/wiki/Social_interactionhttp://en.wikipedia.org/wiki/Economic_equilibriumhttp://en.wikipedia.org/wiki/Preference_%28economics%29http://en.wikipedia.org/wiki/Gary_Beckerhttp://en.wikipedia.org/wiki/Macroeconomicshttp://en.wikipedia.org/wiki/Economic_imperialism_%28economics%29http://en.wikipedia.org/wiki/Rational_choicehttp://en.wikipedia.org/wiki/Scarcityhttp://en.wikipedia.org/wiki/Human_behaviourhttp://en.wikipedia.org/wiki/Lionel_Robbins


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BASIC CONCEPT OF ECONOMICS

The basic concept or elements of economics are: wants, scale of preference, choice, and

opportunity cost.

1. Wants

Want may be defined as an insatiable desire or need by human beings to own goods or services

that give satisfaction. The basic needs of man include; food, housing and clothing. Human needs

are many. They include tangible goods like houses, cars, chairs, television set, radio, e.t.c. while

the others are in form of services, e.g. tailoring, carpentary, medical,e.t.c. Human wants and

needs are many and are usually described as insatiable because the means of satisfying them are

limited or scarce.

2. Scarcity

Scarcity is defined as the limited supply of resources which are used for the satisfaction of

unlimited wants. In other words, scarcity is the inability of human beings to provide themselves

with all the things they desire or want. These resources are scarce relative to their demand. As a

student you will need to buy school materials, e.g books worth $100 but you have only $50. It

can be seen that the money you have, which is your resources, will not be sufficient to buy all

you need. The available resources within the environment can never at any time be in abundance

to satisfy all human wants. Since wants are numerous and insatiable relative to the available

resources, human beings have to choose the most important ones and leave the less important

ones. There would be no economic problem if resources were not scarce hence economics is

sometime defined as the study of scarcity.

3. Scale of preference

It is defined as a list of unsatisfied wants arranged in the order of their relative importance. In

other words, it is list showing the order in which we want to satisfy our wants arranged in order

of priority. In the scale of preference, the most pressing wants come first and the least pressing

ones come last. It is after the first in the list has been satisfied that there will be room for the


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satisfaction of the next. Choice therefore arises because human wants are unlimited or numerous,

while the resources for satisfying them are limited or scarce.

4. Choice

Choice can be defined as a system of selecting or choosing one out of a number of alternatives.

Human wants are many and we cannot satisfy all of them because of our limited resources. We

therefore decide which of the wants we can satisfy first. Choice arises as a result of the resources

used in satisfying these wants. Choice therefore arises as a result of scarcity of resources. Since it

is extremely difficult to produce everything one wants, choice has to be made by accepting or

taking up the most pressing wants for satisfaction based on the available resources.

5. Opportunity Cost

Opportunity cost is defined as an expression of cost in terms of forgone alternatives. It is the

satisfaction of ones want at the expense of another want. It refers to the wants that are left

unsatisfied in order to satisfy another more pressing need. Human wants are many, while the

means of satisfying them are scarce or limited. We are therefore faced with the problem where

we have to choose one from a whole set of human wants, to choose one means to forgo the other.

A farmer who has only $20 and wants to buy a cutlass and a hoe may discover that he cannot getboth materials for $20. He would therefore choose which one he has to buy with the money he

has. If he decides to buy a cutlass, it means he has decided to forgo the hoe. The hoe is thus what

he has sacrificed in order to own a cutlass. The hoe he has sacrificed is the forgone alternative

and this is what is referred to as opportunity cost. Opportunity cost should not be confused with

money cost. Money cost refers to the total amount of money that is spent in order to acquire a set

of goods and services. For example, a customer who spent $20 to buy a pair of trousers has

dispensed with cash. The $20 spent is the money cost.

MAIN DIVISION OF ECONOMICS

There are two divisions or branches of economics; these are called as Macroeconomics and

Consumption, the Distribution, the Exchange, and the Public Finance.


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1.Production in terms of economics means as the manufacturing process of goods to provide and

satisfy the different needs of consumers. utilization of products, goods and services by the

consumers in a given amount of time.

2.Distribution means the way the goods products and services are delivered to the consumers, aswell as the way the products, goods and services are allocated to the consumers through the

different economic outlets.

3.Exchange means the way the products, goods or services are transferred to one person to

another.

4.The Public Finance means the way the government implement financial activities such as on

taxation, on expenditures and other else.

There are certain factors that involved in the production in economics; these are the Land, the

Labor, the Capital, the Entrepreneur, and the Foreign Exchange.

(a)The Land is one of the important factors in production. Land refers to the natural resources

that are going to be utilized in order to produce products or goods.

(b)Labor means the people or the workforce or the manpower that will do specific activities inorder to produce goods or services. They are the employee or the workers of a certain company.

(c)Capital means the physical productive capacity such as machines, tools, factories, money and

other attributes that are needed to produced products or goods.

(d)Entrepreneur means an individual who organizes some other factors and brings all these

factors together in order to produce products or goods. This activity may also be performed by

groups of individual as in the form of cooperative of corporation.

(e)Foreign Exchange means the foreign money or currencies that are reserved in order to import

material or raw materials that are needed in the production processes.


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There are two divisions or branches of economics; these are called as Macroeconomics and

Microeconomics.

Macroeconomics is the economics the deals with the behavior of the whole or entire economy.

This branch of economics is concerned about the level of production, the rate of unemploymentas well as in the gross national product and others.

Microeconomics is the economics that deals with the behavior of a specific segment such as the

consumers, different business firms, the prices of products in the market and others. It is

concerned with the individual unit and not as a whole.

THE SUBJECT MATTER OF ECONOMICS

Economics is a social science concerned with the administration of scarce resources.

Resources are objects and services that are capable of satisfying human wants either

directly or indirectly by helping to produce other objects and services whose use

satisfies human wants. The administration of resources does not always create

economic problems. Some resources are so plentiful that they are more than

sufficient to satisfy completely all the human wants which depend on them. Air, for

example, is such a resource. These resources are called free resources; and there is

no need for organizing their use, because any waste or inefficiency in their utilization

can be made good from their excess supply and need not abridge the satisfaction of

human wants.

By contrast, scarce resources are those that are insufficient to fill completely all the

wants they cater to; these wants therefore can only be satisfied partially. This raises

problems of administration which are the subject matter of economics.1 To begin

with, one problem of administration is to insure the full utilization of scarce

resources, because their incomplete utilization would result in a loss of human

satisfaction. Second, when scarce resources are fully utilized, there is the further

administrative problem of properly allocating these resources among their different

uses and to the satisfaction of different wants. For when scarce resources are fully

utilized, the fuller satisfaction of any one want can only be achieved at the cost of


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thelesser satisfaction of some alternative want or wants. Third, yet another problem

of administration is the proper distribution among consumers of these resources or of

the goods and services produced with their aid.

Most of these problems would present themselves even to an isolated and completely

self sufficient person. Such a person, to fill his needs, would have to rely on his

limited capacity to work and would face the problem of how best to husband his

energy and divide his time between leisure and different types of work. This is a

problem of administering the scarce resources of his time and energy; but it is his

private problem, which he may be left to solve as best he can, because its solution

has no repercussions on other people's welfare. Only when several people cooperate

for the purpose of satisfying their wants do one man's actions affect other people's

welfare. Only in this case does the use and allocation of scarce resources and the

distribution of their products raise problems of social organization; and it is only

these problems that are of interest to the economist.

The foregoing makes it obvious how important the distinction between free and

scarce resources is. That distinction however depends on the quantitative relation

between human wants and the supply of resources available to satisfy them; and this

relation is always changing. Free resources can become scarce and scarce ones free

with the passage of time, as wants and resource availabilities change. For example,

the population explosion and our increased affluence are rapidly turning parking

space from a free into a scarce resource; the same is happening, and for much the

same reasons, to fresh air in the cities and to fresh water everywhere. The opposite

change, once scarce resources becoming free, is exemplified by the thousands of

abandoned cars, appliances, plumbing fixtures, empty bottles, etc., that dot the

American countryside, most of which would be considered valuable (i.e., scarce) in

less affluent societies. If these examples also point to some of the more intractable

problems of our tune, the reason is new problems are always harder to resolve than

routine ones. Society finds it especially difficult to recognize and deal with a


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problem where none existed before or to treat as valuable and learn to budget

resources that, within memory, could be considered free and ignored with impunity.

People cooperate in the use of their scarce resources even in the most primitivesocieties, because specialization improves their efficiency and the division of labor

increases their total product. The more specialization and division of labor there is

among the members of a society, the better use they can make of their limited

resources for the satisfaction of human wants. Most economic progress consists in

increasing these potentialities; and, from the economist's point of view, almost every

innovation and technical invention is merely a new and more efficient method of

specializing and dividing up the task of catering to human wants.

The blessings of economic progress however are gained at the cost of the increasing

complexity of economic organization. The more division of labor there is among the

,members of a society, the more they lose their economic self sufficiency and become

dependent on each other. Economic interdependence is not a bad thing; but it turns

the administration of scarce resources into a social problem. Means must be found

whereby different members of society can exchange their respective products,

whereby they can be induced to work and to produce different goods in the

proportions wanted by society; and when a good embodies the contributions of

several people, these must be brought together, their work coordinated, and the fruit

of their joint effort shared among them. The organization that this requires may be

efficient or inefficient, equitable or unjust; it may function smoothly or be subject to

occasional breakdowns. The farther the division of labor is pushed, the more

intricate does economic organization become, and the greater is the likelihood of

something going wrong with it. The task of economics is to study economic

organization, to appraise its efficiency and equity, and to suggest ways and meanswhereby its imperfections can be lessened or eliminated.

To appraise the efficiency of economic organization, a standard of perfection is, if

not always essential, at least very desirable. In the natural sciences such standards

are easily established. A perfect locomotive, for example, would be one that


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transforms all the heat energy of its fuel into traction; and the efficiency of an actual

locomotive can be measured by the percentage of energy so transformed. In the

social sciences the establishment of standards of perfection is usually very difficult

and constitutes one of the main problems. The function of economic institutions is to

organize economic life in conformity with the community's wishes; and to find out

how well they fulfill this function, one must first ascertain the community's wishes.

Sometimes these are expressed through the politically appointed organs of the

community. For example, the community's wish to assure a minimum income to the

old and to the unemployed may be expressed by a legislative body when it enacts

laws providing old age assistance and unemployment relief. It is even conceivable

that all the wishes of the community might be expressed collectively through its

politically appointed organs. This is more or less the case in the communist state. Insuch a state, appraising the efficiency of economic organization is very simple and

consists of little else than ascertaining the extent to which and the speed with which

the central production plan has been fulfilled assuming, of course, that this plan is a

true expression of the community's wishes.

In a democratic society, most of the community's wishes are not expressed

collectively but must be found out by ascertaining the wishes of each member of the

community. In some cases, this is relatively simple. For example, an approximateindication of the community's desire to work is found in the individual actions of its

members who accept employment or register with employment exchanges. A

comparison of the total number of people who have thus expressed their willingness

to work with the number actually employed gives a rough measure of the economic

system's efficiency in providing employment.

As a rule, however; to ascertain the community's wishes in a democratic society is a

difficult problem; and a large part of this book will be taken up with it. We shall

have to ascertain the way in which the market reflects people's preferences between

different consumers' goods, between different types of work, and between leisure and

the income to be earned by work; for the efficiency of economic organization will to

a large extent be judged by its conformity to the community's preferences in these

matters.


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Having stated the subject matter of economics and the problems that economic

organization must solve, we proceed to consider the nature and forms of economic

organization. Economic organization consists partly in bringing together different

resources in farms, workshops, factories, and other centers of production for the

purpose of producing with their aid new, produced resources. These centers of

production may be owned by private persons and managed for their personal profit or

may be owned by the state and managed by public officials according to rules and

directives issued by the state. The two types of production centers exist side by side

in most economies; but, depending on which is the dominant type, we distinguish

between private enterprise and socialism.

In addition, economic organization also consists in coordinating the activities of

different centers of production, allocating resources among them, and distributing

their products. This, too, may assume two forms. One is trade, which we shall

interpret in its broadest possible sense to mean all exchange of goods and services.

The other is direct regulation by a system of duties and rights. Trade is a

coordinating factor because, in the course of trade, prices are established which to a

greater or lesser extent reflect the preferences of the trading parties and which enable

both the trading parties and others to act in conformity with these preferences. Thatthe activities of different production centers can be coordinated also by direct

regulation goes without saying. Trade and direct regulation occur side by side in

most economies; moreover, trade itself may be subject to regulation by the state.

But, according to whether trade or direct regulation predominates, we distinguish

between market and planned economies.

It has long been a tradition to associate private enterprise with the market economy

and socialism with planning, although such a pairing of the two sets of concepts isnot necessary nor invariable; and we are increasingly getting away from it. Nazi

Germany provided an example of planning in a private enterprise economy, so did

the United States and Great Britain during the Second World War, and so does

France today with respect to the very important area of investment planning. As to a

market economy under socialism, its theoretical possibility was proved a long time


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ago,2 and an increasing number of communist countries today are recognizing the

advantage and instituting the practice of market prices and profit incentive. Their

adoption by them is no more a betrayal of socialism than our occasional use of

planning is of capitalism.

Under private enterprise in a market economy, trade determines most of the relations

of firms with each other and with the suppliers of original resources and the

consumers of final products. The firm itself, however, may own and control several

production centers; and the activities of the several plants and workshops of the firm

are coordinated through direct regulation by the management of the firm, which in

such an economy is the authority that makes production decisions.

In a planned economy, most or all relations between the different centers ofproduction are subject to direct regulation and central control by the state; but, for

securing the services of labor and distributing final products among consumers, even

the planned economy often relies on trade and the market mechanism. Not to rely on

the market mechanism at all would necessitate the direct regulation of everybody's

economic relations by a system of duties and rights. The state would have to

determine who had the duty of performing labor, in what occupation, and for how

many hours per day; and it would also have to determine who had the right to

consume how much of each commodity.

Such a direct regulation of all economic relations by a system of duties and rights

may be conceivable within the family circle or in a primitive tribe; but it would be

insupportably rigid and oppressive in a more complex economy. It would require an

excessive amount of regulation; and the connection between duties and rights would

become so remote as to obscure the fact that the performance of duties is the

payment, the quid pro quo, for the enjoyment of rights. In consequence, people

would soon regard their duties as oppressive, unfair, or unreasonably hard.

Moreover, the assignment of duties and the granting of rights can hardly allow for

personal differences and preferences and is bound to be rigid and lead to inefficiency

and injustice.


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Trade is free from many of these shortcomings. It stresses the principle of give and

take and renders the connection between services performed and benefits received

very explicit. As a result, a man who would resent as slavery the state imposed duty

to work may consider himself a free man when working for a wage even if he is

forced to work by economic necessity. The market gives people a freedom of choice

in consumption and in the selection of occupation that direct regulation can hardly

provide. Furthermore, in the course of trade, market prices are established for the

goods and services exchanged; and, provided that certain conditions are fulfilled,

these prices express the preferences of the trading parties and their valuation of the

resources exchanged. This characteristic of prices enables the market mechanism to

register people's preferences and to organize production, allocate resources, and

distribute products according to these preferences. In fact, the pricing systemprovides such a simple means of ascertaining the community's wishes and is so

powerful an aid to economic organization that no economy except the most primitive

can afford to do without it.

But trade is not superior, to direct regulation in every respect. To begin with, the

principles of equity and social justice are easily forgotten and ignored when people

rely exclusively on the automatism of the market. Moreover, trade is not always

efficient as a means of organizing economic life. Its degree of efficiency depends onthe nature of markets the number of people in the market, their sureness of judgment,

the degree of equality in their economic power, and so forth; and to insure the

efficiency of trade often requires legal safeguards. Hence, even in the market

economy, trade is often subject to legal regulation. This may take several forms.

Most commonly, it consists of restrictions and corrective measures imposed on

private trading. Antitrust legislation and the public regulation of railroad fares and

rates are examples of restriction in the interest of the greater efficiency of trade.

Minimum wage legislation, unemployment insurance, and progressive taxation are

correctives aimed at modifying the distribution of income as determined by the

market.

Finally, there are many goods and services in whose provision and distribution trade

and the market cannot play an efficient role, even under the best circumstances.


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These are called collective or public goods and services. Obvious examples are

defense, police protection, communications, all of which are better provided

collectively, through public action, even though they too had their origin (and

occasionally still have their counterpart) in private bodyguards, vigilante groups,

private messengers, and private pigeon posts. The distinguishing feature of

collective goods is partly that they affect several people simultaneously and cannot

therefore be distributed to each according to his different wants, partly that they are

usually easier and cheaper to provide collectively. Police and fire protection

provided for my neighbor benefit me too to some extent; and they can easily and

cheaply be extended to give me full protection.

The dividing line, however, between collective and individual goods is blurred: a

public park benefits the whole neighborhood but even a private garden gives some

pleasure to neighbors and passersby. Moreover, this dividing line is not only blurred

but continuously shifting, just as the dividing line between free and scarce resources

is shifting. For example, the substitution of private for public transportation is one of

the manifestations of our rising standard of living; at the same time however, the rise

in the standard of living, together with the increasing density of population, also

increases our potential to disturb the environment and step on each other's toes,

which turns many hitherto private enjoyments into matters of public concern.We shall try to deal with all these issues; but the main concern of this book is with

private enterprise in a market economy. It is customary to distinguish between two

types of problems in such an economy. One pertains to the degree of employment of

scarce resources, and the other has to do with the efficiency and equity of their

employment and of their allocation and distribution. Throughout this book, we shall

only be concerned with the latter type of problem. In particular, we shall analyze the

behavior of firms and the functioning of markets; and we shall try to appraise the

efficiency and equity of the economic organization which results from the

independent production decisions of private firms whose behavior is coordinated by

the market mechanism. Before doing so, however, we must say a few words on the

problem of employment and on the exact relation that this problem bears to the

problems with which we shall be concerned.


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We mentioned at the beginning of this chapter that free resources, being more than

sufficient to fill all the wants they cater to, exist in excess supply. This means that

they remain underemployed. Scarce resources, however, may on occasion also

remain underemployed, because, though insufficient to fill all the wants they cater to,

they may be more than sufficient to fill the demand for them. For the wants whose

satisfaction depends on scarce resources are filled only to the extent that they are

backed up with purchasing power and become effective as demand in the market.

Demand therefore need not correspond to wants; and the failure of the economic

system to register wants properly and make them effective as demand results in the

underemployment of scarce resources and a consequent loss of human satisfactions.

When demand is insufficient to call for the full employment of a scarce resource, the

only way to increase the satisfaction of wants that depend on this resource is to raise

the demand for it. Hence when a scarce resource becomes underemployed, it no

longer matters whether it is used efficiently or not. The only consideration that

remains relevant is that of equity. It is not worthwhile to eliminate inefficiency in the

utilization of underemployed resources, because, as long as demand is insufficient to

maintain full employment, inefficiency diminishes unemployment and not the

satisfaction of wants.3 Similarly, it does not matter if too large a proportion of

underemployed resources is devoted to the satisfaction of one particular want,because this again results in less unemployment and not in the lesser satisfaction of

other wants.4 Efficiency in the use of underemployed scarce resources is as

irrelevant as it is in the administration of free resources, and for exactly the same

reason. In both cases, there is an unemployed reserve of resources, which is drawn

upon to offset losses due to wasteful or improper use. Here however the parallelism

ends. For the underemployment of free resources is due to the saturation of the

wants they cater to and therefore causes no loss; whereas the underemployment of

scarce resources is due to imperfection in the economic system and does result in

economic loss.

A situation in which there is both underemployment and an inefficient use of scarce

resources may be compared to that of a prisoner who serves two sentences


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concurrently. He would gain by having his longer sentence revoked or revised; but

as long as this sentence stands unchanged, he would derive no benefit from proving

his innocence of the crime that earned him the shorter sentence, because it would not

set him free sooner. Similarly, at a time when the insufficiency of demand causes

unemployment, the only way to increase the satisfaction of human wants is to raise

demand; for the mere existence of unemployment proves that the loss of satisfactions

due to the insufficiency of demand exceeds and absorbs any loss that may be due to

faulty allocation. Hence if insufficient demand and inefficient administration were

equally important, unemployment would disappear. The existence of unemployment

is proof that the effect of inefficiency is less important than the effect of insufficient

demand.

The problem of unemployment has first claim to the economist's attention. Only in a

fully employed economy does allocation become an economic problem. In other

words, only when scarce resources are fully employed does the way in which they

are employed and allocated among alternative uses become relevant from the

economist's point of view. This is why the problems of allocation and distribution

dealt with in this book are described as the economic problems of a fully employed

economy.

Nevertheless, the usefulness of the following analysis is not confined to thosecomparatively short periods of high prosperity when all resources are fully

employed. For if it seldom happens that all resources are fully employed, it is

equally rare that all scarce resources are underemployed. Neither labor nor

productive equipment is homogeneous; and the underemployment of labor as a whole

or of equipment as a whole seldom means that all kinds of labor or all kinds of

equipment are underemployed. As a rule, underemployment in some occupations

and of some types of equipment exists side by side with full employment in other

occupations and of other types of equipment; and the proper use and allocation of the

fully employed resources do create economic problems.

Furthermore, the problems to be discussed in the following chapters are not entirely

irrelevant even at a time of general underemployment. For the efficiency or

inefficiency of economic organization at any one time inevitably bequeaths a legacy


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of efficiency or inefficiency to the future. Accordingly, although the efficiency with

which employed resources are used and allocated during a period of

underemployment is of no immediate relevance, it does become relevant later, when

full employment has been restored. For example, technological improvements

introduced during a depression often fail to raise output while the depression lasts

and only aggravate unemployment. Nevertheless, their introduction at that stage may

still be desirable, because it may be the condition of higher output in the subsequent

prosperity. Similarly, an employment policy adopted in depression must be judged

not only by its immediate effectiveness in raising demand and relieving depression

but also by its effects on efficiency. For as soon as the increase in demand has

eliminated unemployment, problems of allocation will arise; and the seriousness of

these problems may depend on the particular way in which full employment wasachieved. While unemployment exists, all cures seem equally good if they are

equally effective. But equally effective cures of unemployment may affect the

allocation of resources differently; and if they do, they will be differently appraised

once full employment has been restored and the proper use and allocation of

resources have again become the primary aim of economic policy.5 Hence, the

subject matter of this book, although it is confined to the problems of a fully

employed economy, has a bearing even on the choice of employment policies if their

long run effects are taken into consideration.


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Microeconomics Macroeconomics

1. It is the study of individual economic units of

an economy

It is the study of economy as a whole and its

aggregates.

2. It deals with individual income, individual

prices and individual output, etc.

It deals with aggregates like national income,

general price level and national output, etc.

3. Its Central problem is price determination and

allocation of resources.

Its central problem is determination of level of

income and employment.

4. Its main tools are demand and suply of a

particular commodity/factor.

Its main tools are aggregate demand and

aggregate supply of economy as a whole.

5. It helps to solve the central problem of what,

how and for whom to produce in the economy

It helps to solve the central problem of full

employment of resources in the economy.

6. It discusses how equilibrium of a consumer, a

producer or an industry is attained.

It is concerned with the determination of

equilibrium level of incoem and employment of

the economy.

7. Price is the main determinant of

microeconomic problems.

Income is the major determinant of

macroeconomic problems.

8. Examples are: individual income, individual

savings, price determination of a commodity,individual firm's output, consumer's equilibrium.

Examples are: National income, national

savings, general price level, aggregate demand,aggregate supply, poverty, unemployment etc.

Scope of Economics

Scope means the sphere of study. We have to consider what economics studies and what lies

beyond it. The scope of economics will be brought out by discussing the following.

a) Subjectmatter of economics: Economics studies mans life and work, not the whele of it,

but only one aspect of it. It does not study how a person is born, how he grows up and dies, how

human body is made up and functions, all these are concerned with biological sciences, Similarly


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Economics is also not concerned with how a person thinks and the human organizations being

these are a matter of psychology and political science. Economics only tells us how a man

utilizes his limited resources for the satisfaction of his unlimited wants, a man has limited

amount of money and time, but his wants are unlimited. He must so spend the money and time

he has that he derives maximum satisfaction. This is the subject matter of Economics.

Economic Activity: It we look around, we see the farmer tilling his field, a worker is working in

factory, a Doctor attending the patients, a teacher teaching his students and so on. They are all

engaged in what is called Economic Activity. They earn money and purchase goods. Neither

money nor goods is an end in itself. They are needed for the satisfaction of human wants and to

promote human welfare .

To fulfill the wants a man is taking efforts. Efforts lead to satisfaction. Thus wants- Efforts-Satisfaction sums up the subject matter of economics.

b) Economics is a social Science:In primitive society, the connection between wants efforts and

satisfaction is close and direct. But in a modern Society things are not so simple and straight.

Here man produces what he does not consume and consumes what he does not produce. When

he produces more, he has to sell the excess quantity. Similarly he has to buy a product which is

not produced by him. Thus the process of buying and selling which is called as Exchange comes

in between wants efforts and satisfaction.Nowadays, most of the things we need are made in factories. To make them the worker gives his

labour, the land lord his land, the capitalist his capital, while the businessman organizes the work

of all these. They all get reward in money. The labourer earns wages, the landlord gets rent the

capitalist earns interest, while the entrepreneurs (Businessman) reward is profit. Economics

studies how these incomewages, rent interest and profits-are determined. This process in

called Distribution: This also comes in between efforts and satisfaction.

Thus we can say that the subject-matter of Economics is

1. Consumption- the satisfaction of wants.

2. Production- i.e. producing things, making an effort to satisfy our wants

3. Exchange- its mechanism, money, credit, banking etc.


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4. Distribution sharing of all that is produced in the country. In addition,

Economics also studies Public Finance

Macro EconomicsWhen we study how income and employment is generated and how the

level of countrys income and employment is determined, at aggregated level, it is a matter ofmacro-economics. Thus national income, output, employment, general price level economic

growth etc. are the subject matter of macro Economics.

Micro-Economic When economics is studied at individual level i.e. consumers behavior,

producers behavior, and price theory etc it is a matter of micro-economics.

c) Economics, a Science or an Art? Broadly different subjects can be classified as science

subjects and Arts subjects, Science subjects groups includes physics, Chemistry, Biology etc

while Arts group includes History, civics, sociology Languages etc. Whether Economics is a

science or an art? Let us first understand what is terms science and arts really means.

A science is a systematized body of knowledge. A branch of knowledge becomes systematized

when relevant facts hove been collected and analyzed in a manner that we can trace the effects

back to their and project cases forward to their effects. In other words laws have been discovered

explaining facts, it becomes a science, In Economics also many laws and principles have been

discovered and hence it is treated as a science. An art lays down formulae to guide people who

want to achieve a certain aim. In this angle also Economics guides the people to achieve aims,e.g. aim like removal poverty, more production etc. Thus Economics is an art also. In short

Economics is both science as well as art also.

d) Economics whether positive or normative science: A positive science explains ''why" and

"wherefore" of things. i.e. causes and effects and normative science on the other hand rightness

or wrongness of the things. In view of this, Economics is both a positive and. normative science.

It not only tells us why certain things happen, it also says whether it is right or wrong the thing to

happen. For example, in the world few people are very rich while the masses are very poor.

Economics should and can explain not only the causes of this unequal distribution of wealth, but

it should also say whether this is good or bad. It might well say that wealth ought to be fairly

distributed. Further it should suggest the methods of doing it.


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UNIT-2

CONSUMPTION OF HUMAN WANTS

Introduction

Consumption is a branch of economics, which deals with the satisfaction of human wants. The

existence of human wants is the starting point of all economic activity in the world. When a want

is satisfied, the process is known as consumption. In plain language, consumption means usage.

Thus, we speak of the consumption of food. But in economics we can speak of the consumption

of the services of lawyer or a doctor. The point we have to note here is that consumption applies

both to commodities and services.

Consumption is a study about the theory of wants. Under consumption, we study about the

nature of wants, the classification of wants, the laws relating to consumption such as the Law of

diminishing Utility, Engels Law of Family Expenditure and the Law of Demand and so on.

Some goods are consumed in order to produce other goods. Such goods are known as production

goods. Thus, for example, cotton used in making cloth may be considered as a production good.

Some goods satisfy final wants. They are known as consumption goods. Examples of the latter

category are food, clothing and services directly rendered by certain categories of labor such as

doctors and actors.

The early economists emphasized only the production of wealth. They considered economics

mainly as a study of the production of wealth. Now economists pay more attention to

consumption. For wealth is produced only for consumption. Not only that, they have realized

now that production of wealth in a country at any time depends on the level of consumption. For

it determines demand and it is demand that stimulates production.


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Characteristics of Human Wants

1. Wants are unlimited: It means that human wants are without number. Even if some wants

are satisfied now some other wants will appear again. For example, a student may want a

bicycle and he may get one. But soon he wants a scooter or a motor-cycle. Suppose he

gets one. After sometime, he may develop a desire for a motor-car. Again, suppose a poor

man becomes rich suddenly, we may think his sudden riches will solve all his troubles.

But it is not the case. For the rich man will have his own economic problems. His wants

may be unlimited in relation to his limited means. Another thing ehave to note is that no

man is completely satisfied forever. If one want is satisfied, another want will spring up

in its place.

2. Wants are satiable: Though wants are unlimited in number, they are limited in their

capacity for satisfaction. That is, any particular want can be satisfied for a while. For

example, a child cannot get continuous satisfaction from eating some sweets, say

chocolates. It is only because we cannot get continuous satisfaction from a single good,

we go in search of new goods. The fact that wants are satiable is an important

characteristic of wants. It is the basis of the Law of Diminishing Utility.

3. Wants are alternative: Wants are largely alternative. It means a particular want may be

satisfied in a number of ways, that is, by more than one commodity. If a man is hungry,his hunger may be satisfied by taking some bread or rice or fruits. Again if we want some

recreation, we may go to cinema or drama or listen to the radio.

4. Wants are competitive: Our wants are unlimited but means (time, money and other

resources) are limited. So there is competition among wants. Wants compete for our

limited means. For example, take the case of a student. He may get a gift of $50 from his

uncle. He may want to do so many things with it. But his money on hand can buy only

one thing. All the things that he wants compete for those fifty dollars. So he has to choose

among them. This results in the choice of the most urgent or important thing. Thus, the

competition among wants results in choice. That is why we say Economics is the science

of choice.

5. Wants are complementary: Sometimes to satisfy a particular want we need more than one

good. One commodity may be useless without another. Thus, a single shoe is practically


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useless. A pen is of little service without ink. So we require two or more things to satisfy

a want. Examples are (1) carriage and horse and (2) car and petrol. Sometimes a

commodity taken by itself may satisfy a want independently. Thus, bread alone may

satisfy the want of a hungry man. But if it is taken together with butter and jam, one may

get greater satisfaction.

6. Wants are recurring in nature: No one person can be free from wants forever. Even if

some wants are satisfied for a while, they will again appear sometimes at regular

intervals. For example, we feel hungry in the morning. Our hunger is satisfied when we

take some breakfast. But again we feel hungry in the afternoon and at night. The same

thing is repeated the next day and it goes on forever. Thus, wants recur.

7. Wants become habits: Some wants become habits. Suppose you take a cup of coffee in

the morning. Soon you will find it becomes a habit with you. Like that, many wantsbecome habits. Suppose for some days in the summer season you sleep under a fan. Soon

you will feel you cannot sleep without it. It will become a habit with you. A smoke after

lunch is another case in point.

Classification of Human wants

Wants may be classified into necessaries, comforts, luxuries and collective wants.

Necessaries

Necessaries may be further classified into necessaries for existence, necessaries for efficiency

and conventional necessaries.

(a)Necessaries for existence: There are certain things without which man cannot live. They are

absolutely essential for human existence on this earth. They are known as necessaries for

existence or necessaries for life. Examples for this are food, clothing and shelter.

(b) Necessaries for efficiency: There are certain things, which are necessary to promote

efficiency. For example, an educated person will be any times more efficient than an uneducated

person. Thus, education is one of the necessaries for promoting efficiency. By education, we

mean both general education and technical education. The working class in a country where a


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majority of the people are educated will be much more efficient than workers in a country with a

high rate of illiteracy. Efficiency depends also on the standard of health of the working people.

For that, extension of public health measures are necessary. Hospitals, and periodic medical

check-up of the working classes are all necessary to promote efficiency of the people.

(c) Conventional necessaries: Certain wants become necessary by force of habit or custom or

convention. Such things are known as conventional necessaries. There are many examples for

this. For instance, a cup of coffee in the morning becomes a necessity with some people and with

others a smoke after lunch. A dinner during marriage celebration and new clothes for the bride

and the bride-groom on the marriage day may also be given as examples of conventional

necessaries.

Comforts

Comforts are not strictly necessary for life but they give pleasure and add to the efficiency of the

consumer. Thus, a car to a doctor is not merely a comfort to him. It promotes his efficiency. If he

is a busy doctor with a good practice, he can visit a number of patients without waiting for long

hours at bus-stops. Similarly, a fan in a shop may promote the efficiency of a business man. If

there is a fan, he can stay on in the shop and do some business even during the afternoon, which

is usually hot particularly in summer. Otherwise, he has to shut his shop for two or three hours inthe afternoon. Similarly, if some comforts are provided for a student, he may study well.

Luxuries

Luxuries add to the pleasure of a person but they do not add anything to his efficiency. Some

enjoy luxuries to show off their wealth and riches. Luxuries have prestige value. And some

luxuries are pure waste. Diamonds and pearls are all luxuries. They have prestige value. Usually

they sell at very high prices. Sometimes we find a single person owns many cars. It is definitely a

luxury. Kings of the past enjoyed many luxuries. Even today, some merchant-princes enjoy

many luxuries.

However, we have to remember that there is nothing rigid about the classification of wants into

necessaries, comforts and luxuries. We cannot take any good and say this is a necessary good or


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comfort or luxury. For what is a luxury to one person may be a necessity to another person. A car

may be a necessity to a big business man in a city but it is a luxury to a poor teacher working in

an elementary school. Again travel by airplane may be a necessity to the President of a country

but it is definitely a luxury to a clerk or a teacher. Again what is necessity in one country may

not be a necessity in another country. Thus, woolen clothing is a necessity in a rich country like

England with cold climate but it is a luxury in a country with a hot climate.

Again what is luxury at one time may become a necessity at another time. Thus, when electricity

was first introduced in England, it was used only by rich families. It was then a luxury. Now it is

necessity with most of us. Further, whether a particular want is a necessity or comfort or luxury

also depends upon the income of the people and price of the good in question. So the point is

this. In classifying wants into necessaries, comforts and luxuries, we have to take into accountmany things such as the income of the consumers, the status of consumers, the climate of the

country, prices of thecommodities and so on.

Collective Wants

The term collective wants refers to the wants of the people as a whole. If I want a shirt, I can

pay for it. Similarly, if I want the services of a doctor, I can pay for them. But I cannot afford to

pay for a policeman to protect my house at night. The government helps in such cases. Itprovides goods and services, which meet the wants of the people for which individually they

could not afford to pay. Such wants are called collective wants and the goods that are supplied by

the government to satisfy such wants may be called collective goods. To satisfy collective wants,

the government employs soldiers, police, teachers, doctors and so on. We do not pay anything

directly for such services. Of course, we have to pay for them when we pay our taxes.
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Human Wants and their Classification

Man is a bundle of desires. His wants are infinite in variety and number. Some wants are natural,

for example foods, air, clothing and shelter without which existence of mans life is not possible.

Similarly wants vary from individual to individual and they multiply with civilization.

Characteristics of Human Wants:

1. Human wants are unlimited:Mans mind is so made that he never completely satisfied

and hence there is no end to human wants. One want is satisfied another want will crop

up to take its place and thus it is never ending cycle of want.

2. Any particular want is satiable:Though the wants are unlimited, but it is possible to

satisfy a particular want, provided has the means (resource).3. Wants are complementary:It is a common experience that we want things in groups. A

single article out of group can not satisfy human wants by it self. It needs other things to

complete its use e.g. a motor-car needs petrol and mobile oil it starts working. Thus the

relationship between motor-car and petrol is complementary.

4. Wants are competitive:Some wants competes to other. We all have a limited amount of

money at our disposal; therefore we must choose some things and reject the other. E.g.

sugar and jaggery, tea and coffee.5. Some Wants are both complimentary and competitive: When use of machinery is

done the use of labour needs to be reduced. This indicates competitive nature. But to run

the machinery the labour is also required and as such it indicates complimentary

relationship.

6. Wants are alternative:There are several ways of satisfying a particular want. If we feel

thirsty, we can have water, lassi, in summer while coffee, tea in winter. The final choice

depends upon availability of money and the relative prices.

7. Wants vary with time place and person:Wants are not always the same. It varies with

individual to individual. People want different things at different times and in different

places.

8. Wants vary in Urgency and Intensity:All wants are not equally urgent and in tense.

Some wants are urgent while some are less urgent.


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9. Wants multiply with civilization:With the advancement the wants multiply. Therefore

the wants of people living in urban area are more than the villagers. With civilization the

demand for radio, T.V, motor-car etc, are increasing.

10.Wants are recur: Some wants are recurring in nature, e.g. food we require again and

again.

11.Wants change into habits:If a particular want is regularly satisfied a person becomes

used to it and it grows into habit e.g. smoking of cigarate and use of drugs.

12.Wants are influenced by income, salesmanship and advertisement: It income is

higher more wants can be satisfied. Many things we buy of particular brands due to

salesmanship or advertisement.

13.Wants are the result of custom or convention:As a part of custom and convention we

buy many thins. Really they are not required but unlikely we have to purchase it e.g.expenses on social ceremonies.

14.Present wants are more important then future wants:Future is uncertain and hence

man is more concerned with the satisfaction of the present wants rather than future wants.

Classification of wants

The wants can be classified as under.

A.Necessaries: These can be sub divided as

Necessaries of existence: The things without which we can not exist e.g. water, food,

clothing, shelter.

Conventional necessaries: The things which we are forced to use by social custom.

B. Comforts: After satisfying our necessaries we desire to have some comforts. For

example table and chair for a student help to increase the efficiency. But cushioned costlychair is not a comfort.

C. Luxuries:Luxury means superfluous consumption. After getting comforts, man desire

luxury. The luxury articles need not required e.g. gold and silver, costly furniture, etc.


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Diminishing marginal utility

Utility refers to the amount of satisfaction a person gets from consumption of a certain item.and

marginal utility refers to the addition made to total utility, we get after consuming one more unit.

An individual's wants are unlimited in number yet each individual's want is satiable. Because of

this, the more we have a commodity, the less we want to have more of it.

This law state that as the amount consumed of a commodity increases, the utility derived by the

consumer from the additional units, i.e marginal utility goes on decreasing.

The law of diminishing marginal utility explains the downward sloping demand curve

Definition

According to Marshall, The additional benefit a person derives from a given increase of his

stock of a thing diminishes with every increase in the stock that he already has

he concept that marginal utilities diminish across the ranges relevant to decision-making is called

the "law of diminishing marginal utility" (and is also known asGossen'sFirst Law). This refers to

the increase in utility an individual gains from increase in the consumption of a particular good.

"The law of diminishing marginal utility is at the heart of the explanation of numerous economicphenomena, including time preference and the value of goods... The law says, first, that the

marginal utility of each homogenous unit decreases as the supply of units increases (and vice

versa); second, that the marginal utility of a larger-sized unit is greater than the marginal utility

of a smaller-sized unit (and vice versa). The first law denotes the law of diminishing marginal

utility, the second law denotes the law of increasing total utility."[15]

The law of diminishing marginal utility is similar to the law ofdiminishing returnswhich states

that as the amount of onefactor of productionincreases as all other factors of production are held

the same, the marginal return (extra output gained by adding an extra unit) decreases.

As the rate of commodity acquisition increases, marginal utility decreases. If commodity

consumption continues to rise, marginal utility at some point may fall to zero, reaching
http://en.wikipedia.org/wiki/Hermann_Heinrich_Gossenhttp://en.wikipedia.org/wiki/Hermann_Heinrich_Gossenhttp://en.wikipedia.org/wiki/Hermann_Heinrich_Gossenhttp://en.wikipedia.org/wiki/Gossen%27s_lawshttp://en.wikipedia.org/wiki/Gossen%27s_lawshttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Value_%28economics%29http://en.wikipedia.org/wiki/Value_%28economics%29http://en.wikipedia.org/wiki/Marginal_utility#cite_note-Mises-15http://en.wikipedia.org/wiki/Marginal_utility#cite_note-Mises-15http://en.wikipedia.org/wiki/Marginal_utility#cite_note-Mises-15http://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Factors_of_productionhttp://en.wikipedia.org/wiki/Diminishing_returnshttp://en.wikipedia.org/wiki/Marginal_utility#cite_note-Mises-15http://en.wikipedia.org/wiki/Value_%28economics%29http://en.wikipedia.org/wiki/Time_preferencehttp://en.wikipedia.org/wiki/Gossen%27s_lawshttp://en.wikipedia.org/wiki/Hermann_Heinrich_Gossen


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maximumtotal utility. Further increase in consumption of units of commodities causes marginal

utility to become negative; this signifies dissatisfaction. For example,

beyond some point, further doses of antibiotics would kill no pathogens at all, and might

even become harmful to the body.

to satiate thirst a person drinks water but beyond a point consumption of more water

might make the person vomit,hence leading to diminishing marginal utility

it takes a certain amount of food energy to sustain a population, yet beyond a point, more

calories cannot be consumed and are simply discarded (or cause disease).

Diminishing marginal utility is traditionally a microeconomic concept and often holds for an

individual. For an individual, the marginal utility of a good or service might actually be

increasing. For example:

bed sheets, which up to some number may only provide warmth, but after that point may

be useful to allow one to effect an escape by being tied together into a rope;

tickets, for travel or theatre, where a second ticket might allow one to take a date on an

otherwise uninteresting outing;

dosages of antibiotics, where having too few pills would leave bacteria with greater

resistance, but a full supply could effect a cure. the third leg is more useful than the first two when building a chair.

As suggested elsewhere in this article, occasionally one may come across a situation in which

marginal utility increases even at a macroeconomic level. For example the provision of a service

may only be viable if it accessible to most or all of the population, and the marginal utility of a

raw material required to provide such a service will increase at the "tipping point" at which this

occurs. This is similar to the position with very large items such as aircraft carriers: the numbers

of these items involved are so small that marginal utility is no longer a helpful concept, as thereis merely a simple "yes" or "no" decision.

Assumptions:

1.All the units of a commodity must be same in all respects .


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2.The unit of the good must be standard

3.There should be no change in taste during the process of consumption

4.There must be continuity in consumption

5.There should be no change in the price of the substitute goods

Explanation:

As more and more quantity of a commodity is consumed, the intensity if desire decreases and

also the utility derived from the additional unit..

Suppose a person eats Bread. and 1st unit of bread gives him maximum satisfaction. When he

willead 2nd bread his total satisfaction would increase. But the utility added by 2nd bread(MU)

is less then the 1st bread. His Total utility and marginal utility can be put in the form of afollowing schedule.

Plotting the above data on a graph gives
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Here, from the MU curve we can see that MU is declinig as consumer consumes more of

the commodity.

When TU is maximum, MU is Zero.

After that, TU starts declining and MU becomes negative.

Exceptions:

Money

Hobbies and Rare Things

Liquor and Music

Things of Display

Importance:
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Basis of Law of Demand

Basis of Consumption Expenditure

The basis of Progressive Taxation

Law of equi -marginal uti l i ty

INTRODUCTION:

It is a classical theory of consumer behavior, law of substitution in consumption or

maximum satisfaction.

STATEMENT OR DEFINITION OF LAW:

The lawof equi-marginal utility states that A rational person in order to get

maximum satisfaction allocates his expenditures on purchase of different goods in such a

way that marginal utility of the last Rs. Spent in each direction is the same.

This is called the law of satisfaction because we substitute more useful goods to less

useful goods. This is called the law of maximum satisfaction because through it we get

maximum satisfaction and it is called the law of equi-marginal utilitybecause through it

when the marginal utilities are equalized, through the process of substitution, the

maximum satisfaction is attained.

EXPLAINATION WITH THE HELP OF SCHEDULE:

The law can be explained with the help of schedule.

A hypothetical person has to spend Rs. 7. He is going to buy twocommodities A & B.

the price of each commodity is Rs. 1 unit. Our hypothetical consumer is a rational person.
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Rs. MU of commodity A MU of commodity

B 1 40 35

2 35 30

3 30 25

4 25 20

5 20 15

6 15 10

7 10 05

SUM 175 140

SCHEDULE:

It is clear from the above scheduling that when our hypothetical consumer spends Rs. 4

on commodity A and Rs. 3 on commodity B. The marginal utilities are equal at that

point. The total utility is 220, which is maximum in any other case.

Suppose, 6 rupees spend on A and 1 rupee on B [40+35+30+25+20+15+35 = 200]

If he changes his plan i.e. spends more on commodity B and less on commodity A.

The marginal utilities would not be equal and he would not gain maximum satisfaction.

The total utility would also be less in any case other than when the marginal utilities are

equal and satisfaction is maximum.


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EXPLAINATION WITH THE HELP OF DIAGRAM:

Diagram:In this figure on the axis OX is the quantity of commodity A and on the axis OXis the

quantity of good B on the axis OY is the marginal utility of the amount of moneyspend

on goods A and B.

It is clear that when consumer spends Rs. 4 on good A and Rs. 3 on good B. The

marginal utilities are same and satisfaction is maximum. On the right side of OY is the

curve UA that represents the MU of Aand is down ward sloping from left to right.

On the left hand sideof OY is the curve of UB which represents the MU of B and is also

down wardfrom right to left. If the consumer spends more Rs On commodity A and less

on commodity B themarginal utilities are not equal and satisfaction is less e.g. if he

spends 5 on commodity B and 2 on commodity A OR spends 3 on A and 4 on B the

satisfaction is not maximum.

It can be shown with the help of a figure.

Diagram:

In both figures the gain in utility is less than the first and thesatisfaction is also decrease.

ASSUMPTIONS:

Following are the assumptions of the law.Independent Utilities:

The marginal utilities of differentcommodities should be independent of each

other and diminishes with more and more purchase.

Marginal Utility of Money:
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The marginal utility of money should remain constantfor theconsumer as he

spends more and more of it on the purchase of goods.

Rationality:

Every consumer should be rational in the purchase of goods. His aim should be tomaximize the total utility and nothing else.

Substitution of Goods:

It is assumed that goods are naturally substitutes of each other. The result of

substitution will be the MU of one commodity will fall and that of another commodity

will rise.

Awareness of Market:

It is assumed that consumer has much awareness about the market.Divisibility of Goods:

The law is based on the assumption that goods are divisible in small units.

CRITICIZM OR LIMITATIONS:

Following are the limitations of the law.

No Rational Calculation:

The law involves rational calculations. But in the busy and routine life we are notcapable to do so that who is rational and who is irrational.

Consumers Ignorance:

The consumer may not aware of the goods which are more useful than the goods

which they are going to purchase. So, they cannot substitute more useful goods to theless

useful goods and hence the law is not applicable to them.

Indivisibility of Goods:

Sometimes the goods are not divisible to small units. So MU cannot be

calculated and law is not applicable.

Wrong Assumptions:

It assumed that utilities are measurable but in actual utility cannot be calculated

because it is a state of mind. It is assumed that marginal utility of money remains


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constant but the law of DMU applies to money equally.

PRACTICAL IMPORTANCE:

This law is applied to all problems of scarce (limited) resource against unlimitedwants.

This law plays an important role in the theory of distribution and exchange.

It extends over thefield ofthe theory of production.

CONCLUSION:

Thus the law of substation applies in all branches of economic theories.

Law of demand

Ineconomics,thelawstates that,all else being equal,as the price of a product increases,quantity demanded falls; likewise, as the price of a product decreases, quantity demandedincreases.

In other words, the law of demandstates that the quantity demanded and the price of acommodityare inversely related, other things remaining constant. If theincomeof the consumer,prices of the relatedgoods,and preferences of the consumer remain unchanged, then the change

in quantity of good demanded by the consumer will be negatively correlated to the change in theprice of the good. There are, however, some possible exceptions to this rule (seeGiffen goodsandVeblen goods).
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Mathematical expression

Mathematically, theinverse relationshipmay be expressed as a causal relation:

Where, is the quantity demanded of x goods

is the function of independent variables contained within the parenthesis, and

is the price of x goods.

Hence, in the above model, thefunction( ) is a varying one: i.e., the law of demand postulates

as the causal factor (independent variable)and as thedependent variable.

Graphical depiction

A demand curve is a graphical depiction that abides by the law of demand. It shows how the

quantity demanded of some product during a specified period of time will change as the price of

that product changes, holding all other determinants of the quantity demanded constant. Price is

measured on the vertical axis and quantity demanded on the horizontal axis.

There are two important things to note about the demand curve:

It is downward sloping indicating that between the price of a product and the quantity

demanded a negative or inverse relationship exists. In other words, as the price declines

the quantity demanded increases. This is indicated by a downward movement along the

demand curve. An increase in price decreases the quantity demanded, and an upward

movement along the demand curve occurs.

The movement along a given demand curve due to a change in price is referred to as

"change in quantity demanded". As the price changes, the quantity demanded changes.

The term "change in demand" refers to a shift of the demand curve because of factors

other than price.
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Assumptions

Every law will have limitations or exceptions. While expressing the law of demand, the

assumption is that other factors of demand, except the price of a good, are unchanged. If they

don't remain constant, the inverse relation may not hold well. In other words, it is assumed that

the income and tastes of consumers and the prices of related goods are constant. This law

operates when the price of the good changes and all other non-price factors do not change.

The main assumptions are:

The function shows the relationship between Price and Quantity Demanded at a static time (t).

Habits, tastes and fashions remain same.

Income of the consumer does not change.

Prices of related goods remain constant.

Number of buyers remain constant.

The commodity is anormal goodand has no prestige or status value.

People do not expect changes in the price.

Price is independent and quantity demanded is dependent.

income level should remain constant

Exceptions to the law of demand

Generally, the amount demanded of a good increases with a decrease in price of the good and

vice versa. In some cases, however, this may not be true. Such situations are explained as in

below.

Giffen goods

Initially discovered by [vasudeva], economists disagree on the existence of Giffen goods in the

market. A Giffen good describes an inferior good that as the price increases, demand for the

product increases. As an example, during theIrish Potato Famineof the 19th century, potatoes

were considered one of Giffen good's. Potatoes were the largest staple in the Irish diet, so as the

price rose it had a large impact on income. People responded by cutting out onluxury goodssuch
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as meat and vegetables, and instead bought more potatoes. Therefore, as the price of potatoes

increased, so did the demand.[2]However, this change of demand did not mean movement along

the demand curve, but rather a shift of the whole demand curve. What occurred was not an

increase in demanded quantity due to increase in price (which would be a violation of law of

demand), but rather, a change in the relationship between price and demanded quantity. Thus, the

Giffen good confuses the change in demanded quantity with the change in the relationship

between price and quantity. .

Veblen Goods

Some expensive commodities like diamonds, expensive cars, etc., are used as status symbols to

display ones wealth. The more expensive these commodities become, the higher their value as a

status symbol and hence, the greater the demand for them. The amount demanded of these

commodities increase with an increase in their price and decrease with a decrease in their price.

Also known as aVeblen good.

Expectation of change in the price of commodity

If a household expects the price of a commodity to increase, it may start purchasing a greater

amount of the commodity even at the presently increased price. Similarly, if the household

expects the price of the commodity to decrease, it may postpone its purchases. Thus, some argue

that the law of demand is violated in such cases. In this case, the demand curve does not slope

down from left to right; instead it presents a backward slope from the top right to down left. This

curve is known as an exceptional demand curve. Technically, this is not a violation of the law of

demand, as it violates theceteris paribuscondition.

The Law of Demand and Change in Demand

The law of demand states that, other things remaining same, the quantity demanded of a good

increases when its price falls and vice-versa. Note that demand for goods changes as a

consequence of changes in income, tastes etc. Hence, demand may expand or contract and

increase or decrease. In this context, let us make a distinction between two different types of

changes that affect quantity demanded, viz., expansion and contraction; and increase and
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Overview

Economist Paul A. Baran introduced the concept of "economic surplus" to deal with novel

complexities raised by the dominance of monopoly capital. With Paul Sweezy, Baran elaborated

the importance of this innovation, its consistency with Marx's labor concept of value, and

supplementary relation to Marx's category ofsurplus value.[1]

On a standardsupply and demanddiagram, consumer surplus is the area (triangular if the supply

and demand curves are linear) above the equilibrium price of the good and below the demand

curve. This reflects the fact that consumers would have been willing to buy a single unit of the

good at a price higher than the equilibrium price, a second unit at a price below that but still

above the equilibrium price, etc., yet they in fact pay just the equilibrium price for each unit they

buy.

Likewise, in the supply-demand diagram, producer surplus is the area below the equilibrium

price but above the supply curve. This reflects the fact that producers would have been willing tosupply the first unit at a price lower than the equilibrium price, the second unit at a price above

that but still below the equilibrium price, etc., yet they in fact receive the equilibrium price for all

the units they sell.
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Consumer surplus

Consumer surplus is the difference between the maximum price a consumer is willing to pay and

the actual price they do pay. If a consumer would be willing to pay more than the current asking

price, then they are getting more benefit from the purchased product than they initially paid. An

example of a good with generally high consumer surplus is drinking water. People would pay

very high prices for drinking water, as they need it to survive. The difference in the price that

they would pay, if they had to, and the amount that they pay now is their consumer surplus. Note

that the utility of the first few liters of drinking water is very high (as it prevents death), so the

first few lite

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