Economics

Ar Shyne UKmea college of architecture

Semester 4: 2011 AR 408 HUMAN SETTLEMENTS & STUDY OF SOCIOLOGY, ECONOMICS AND CULTURE

Definitions 1776- Adam Smith: “An Enquiry into the nature and

causes of the wealth of nations.”

1890- Dr.Alfred Marshall: “Economics is a study of man’s actions in the ordinary business of life; it enquires how he gets his income and how he uses it. Thus it is on one side a study of wealth and on the other, and more important side, a part of the study of man.

1930- Lionel Robbins: “Whatever economics is concerned with, it is not concerned with the causes of material welfare as such.”

Definitions Lionel Robbins: “Economics studies human behaviour

as a relationship between ends and scarce means which have alternative uses.”

1936, John Maynard Keynes: “the study of the administration of scarce resources and of the determinants of employment and income.”

1950, Frederic Benham: “study of the factors affecting the size, distribution and stability of a country’s national income.”

DefinitionsDefinitions range from ‘wealth’ to ‘study of mankind’ to ‘material welfare’……

“A social science concerned with the proper uses and allocation of resources with a view to achieving and maintaining growth and stability.”

Scope

Subject Matter of

Economics

Micro Economics

ConsumptionProductionExchangeDistribution

Macro EconomicsIncome and

employment theory

Growth theoryGrowth of the

economy

Scope Traditional Approach

Consumption – nature of human wants as well as the principles governing their satisfaction.Production – production of wealth using land, labour, capital and organisationExchange – interaction of forces of demand and supplyDistribution – of shares to the four agents of production.

Modern Approach

Macro economics vs Micro economics-Study of economic system as a whole – total expenditure, total employment and general price level.

Scope Economics as a Social science

Concerned with society and not individuals.Positive as well as a normative science – not

only concerned with the cause-effect but also with the right and wrong. Economics as an Art

explore and explain man’s action in relation to wealth but also advocates and condemns. Economics in relation to other sciences enrich and

enforces the studies – economics & politics, economics & history, economics & ethics etc.

ScopeImportance of Economics Theoretical importance

InformativeMental trainingUnderstanding functioning of the economic

systemTeaches mutual dependenceCivic sense

Practical importanceProfessional valueApplicable to householder, economists,

bureaucrats etc.Solving problem of scarcity

Vital Processes of an EconomyProduction – of goods and services. Performance of an economy is judged by the level of its production.-any economic activity which is directed to the satisfaction of the wants of the people.Eg. making of cloth as well as selling by the retailer, services by Architects, Doctors etc.

Vital Processes of an EconomyConsumption – the act of satisfying one’s wants.Consumption along with investment determines the level of income and employment in the economy.

Investment – the excess of production over consumption in a year is called saving and this saving is invested for further production.

Types – Inventories (goods in process) & Fixed investment

Basic TermsGoodsTo satisfy man’s wants.Goods – commodities – concrete & tangibleServices – work done by a person to satisfy – intangible.

Anything that can satisfy a human want is called a ‘good’ in Economics.

Basic TermsTypes of goods

Free goods – which is in plenty and available without payment.Economic goods – which are scarce, and needs payment.

Distinction between economic goods and free goods is not permanent.

Basic TermsTypes of goodsConsumption goods – satisfying consumers directly. Eg –food, clothing etc – Goods of First Order.

Capital goods – help us to produce other goods. Eg – tools, machines etc. – Goods of Second Order.

Intermediate goods – between consumption and capital goods – raw materials used – for eg. cotton used to make cloth.

Basic TermsTypes of goods

Material & Non Material goods Transferable and Non transferable goods –

physically or non physically Personal -ability and skill- Internal goods and

Impersonal goods – External goods – possessions Private and Public goods Necessaries, Comforts and Luxuries

Basic TermsUtilityQuality in a commodity by which it satisfies the human want. Utility has no ethical or moral significance. Eg. tobacco

is having utility value for its consumer. Utility is not synonymous with pleasure Utility does not mean satisfaction Utility is subjective Utility varies in different situations.

Basic TermsUtility

Forms of Utility Form utility – changing the form of an article. Place utility – by transporting a good from one place to

another. Time utility – by storing a commodity and selling it at a

time of scarcity.

Basic TermsValueValue of a commodity means the commodities or services that we can get in return for it – purchasing power or value in exchange.

Value in use in economics – utility.

Qualifications to have value Must possess utility Must be scarce Must be transferable or marketable.

Basic TermsValue

Value expressed in terms of money – price.

Value is relative – not absolute. No general rise or fall in values, but general price rise can happen.

Basic TermsWealth

Synonymous with economic goods and which are having utility.Representative wealth – documents, titles and promissory notes.All money is wealth but wealth is not money alone.

Wealth & Income – wealth is a fund and income a flow.Wealth & welfare – wealth is the means and welfare the end. But increase in wealth does not necessarily mean increase in welfare.

Basic TermsWealth - classifications

Individual wealth – material (eg – land, cash etc.) and non-material possessions. (eg – goodwill of his business.)

Personal wealth – skill, intelligence etc. Social or communal wealth – owned by state and

municipality. National wealth – aggregate wealth of citizens or

natural wealth like rivers, climate etc. Cosmopolitan wealth – wealth of the whole world. Negative wealth – debts owned by individuals or

states.

Micro Economics or Price theoryDemand Theory

People demand goods and services in an economy to satisfy their wants.

A desire accompanied by ability and willingness to pay makes a real or effective demand.

The most important function of microeconomics is to explain the laws of demand and supply, market mechanism and working of the price system.

Micro Economics or Price theoryClassification of wants Necessaries

Of existence – eg. food and clothingOf efficiency – eg. study tableConventional – eg . By social custom

Comforts Luxuries

Necessaries, comforts and luxuries are relative.

Micro Economics or Price theoryLaw of Demand“At any given time, the demand for a commodity or service at the prevailing price is greater than it would be at a higher price and less than it would be at a lower price.”

- Demand varies inversily with the price.- At a specific time with specific conditions.

Micro Economics or Price theoryExtension or contraction of demand – demand change because of mere price change.

Increase in demand – greater demand at the same price or the same quantity demanded at a higher price.

Decrease in demand – less demand at the same price or the same quantity demanded at a lower price.

Micro Economics or Price theoryIncrease and Decrease of Demand - Diagrammatic

D1 - Same quantity at a higher priceD2 – Same quantity at a lower price

Micro Economics or Price theoryExceptions

Conspicuous consumption – when consumer regards the consumption of a commodity as a mark of distinction.

Giffen paradox – peculiar behaviour resulting in substitution.

Anticipatory behaviour – if prices are expected to go higher, higher demand may persist.

Trade cycles – cycles of economic prosperity.

Micro Economics or Price theoryDemand Analysis – economic laws are formulated after analysing consumer’s behaviour.

1.Utility analysis Law of Diminishing Marginal utility Law of Equimarginal Utility

2.Indifference curve technique

Micro Economics or Price theoryLaw of Diminishing Marginal Utility

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

The additional benefit which a person derives from a given increase of his stock of anything diminishes with the growth of the stock that he has – Dr. Alfred Marshall

Its is the ‘additional’ or ‘marginal’ utility which decreases and not the actual utility.

Micro Economics or Price theoryLaw of Diminishing Marginal Utility

Consumption of free laddus as an eg.No. of Laddus Marginal Utility Total utility

1 15 15

2 13 28

3 10 38

4 8 46

5 4 50

6 2 52

7 0 52

8 -2 50

9 -5 45

Marginal utility goes on decreasing

7th laddu give no additional satisfaction and 8th and 9th have negative effect.

Total utility increases on a diminishing rate.

Micro Economics or Price theoryLaw of Diminishing Marginal Utility - Terms

Initial utility – of the 1st unitTotal utility – at each step including marginal utilityZero utility – when consumption makes no addition to total utility.Negative utility – when consumption goes to excess.

Marginal utility – utility at the point where the consumer stops further consumption of a commodity. Also known as final utility. Also defined as the addition to the total utility of the last unit considered just worthwhile.

Micro Economics or Price theoryDiagrammatic Representation

Micro Economics or Price theoryLimitations to Law of Diminishing Marginal Utility

• Dissimilar units• Very small units• Long intervals• Rare collections• Abnormal consumers

Micro Economics or Price theoryImportance and Applications

• In taxation – based on the concept that utility of money for rich is less than that of poor – principle of progressive taxation.

• In determining prices – to balance between the price and satisfaction of a commodity.

• In support of socialism – supporting the view that excess wealth in the hands of rich should be transferred to the poor who will have greater utility.

• In household expenditures – wiseful spending• Basis of economic laws – law of demand, law of

substitution, elasticity of demand etc.

Micro Economics or Price theoryLaw of Equimarginal Utility

Also known as Law of Substitution

Human wants are unlimited whereas the means to satisfy these wants are strictly limited - hence choice on spending.We substitute some units of the commodity of greater utility tor some units of the commodity of less utility.The result of this substitution will be that the marginal utility of the former will fall and that of the latter will rise, till the two marginal utilities are equalized.

Micro Economics or Price theoryLaw of Equimarginal Utility

Say we have Rs 7And buy Rs 3 on oranges and Rs 4 on apples.Total Marginal utility 10+8+6+8+6+4+2 = 44

To maximise utility, need more oranges than apple.Total marginal utility = 46

Micro Economics or Price theoryLaw of Equimarginal UtilityDiagrammatic representation

108

Loss of utility from reduced consumption of oranges is bigger than gain of utility from increased consumption of apples.

So maximum utility at PM = P’M’

Micro Economics or Price theoryIndifference Curve AnalysisProponent – Prof John R Hicks

Assumptions On commanding choices of combinations of

commodities, consumer has a scale of preferences and the utilities can be compared as being greater, less or equal.

Consumer formulates his preferences independently of market prices.

An indifference curve thus plotted shows all possible points where the total satisfaction remains constant.

Micro Economics or Price theoryIndifference Curve Analysis

Price line/Budget line – connecting all possible combination of two goods, given consumer’s income and relative prices of two goods.

Micro Economics or Price theoryIndifference Curve Analysis

The indifference curves must slope downward from left to right. As the consumer increases the consumption of X commodity,

he has to give up certain units of Y commodity in order to maintain the same level of satisfaction.

Indifference curve that lies above and to the

right of another indifference curve represents

a higher level of satisfaction.

The Slope of the curve is referred as the

Marginal Rate of Substitution. The Marginal Rate of Substitution is the rate at which the consumer

must sacrifice units of one commodity to obtain one

more unit of another commodity.

Micro Economics or Price theoryIndifference Curve AnalysisConsumer’s Equilibrium with IC AnalysisConsumer’s equilibrium – position of max. satisfaction when a certain money is spend on a combination of commodities.At equilibrium, Marginal rate of substitution = price ratio between two goods

Micro Economics or Price theoryProduction Possibility CurveAlso known as Production Possibility Frontier or Transformation curve.Graphical representation of production possibilities open to an economy with the available resources.

Micro Economics or Price theoryProduction Possibility Curve

Opportunity cost is what a personsacrifices when they choose one option over another.

Micro Economics or Price theoryLaw of SupplyIn a given market, at any time, the quantity of any goods which people are ready to offer for sale generally varies directly with the price.Other things remaining the same, as the price of a commodity rises, its supply is extended, and as the price falls, its supply is contracted.

Micro Economics or Price theoryLaw of Supply

Micro Economics or Price theoryFactors of ProductionProduction – creation or addition of value or wealth. Consists of not only goods but services from doctors, teachers etc also.Factors affecting ProductionNatural factors – natural resources and events like calamities.Political factors – form of government.Technical progress Development of Infrastructure - credit, banking, transport, communication etc.Character of the people – hardwork, education, discipline etc.

Micro Economics or Price theoryFactors of Production

Traditional Classification

Land – All natural resourcesLabour – Any type of work earning an income.Capital – cash, tools, machinery etc. used in productionOrganisation – bringing together above 3 factors of production, rewarding them and taking risk.

Micro Economics or Price theoryFactors of Production

Land“By land is meant not merely land in the strict sense of the word, but whole of the materials and forces which nature gives freely for man’s aid in land, water, in air and light and heat”- Dr.Marshall

Economic prosperity is closely linked with LandAgriculture – soil, climate, rainfall etc.Industrial output – proximity of raw materials, mines etc.Efficient transport – topography, means etc.

Micro Economics or Price theoryFactors of Production

Labour“an exertion of mind or body undergone partly or wholly with a view to earning some good other than the pleasure derived directly from the work”

Micro Economics or Price theoryFactors of Production

Capital“that part of a person’s wealth, other than land, which yields an income or which aids in the production of further wealth.”“produced means of production or man made instrument of production”.

Fixed capital and working capital

Micro Economics or Price theoryFactors of Production

Organisation/EnterpriseOrganising and risk taking