Consumer equilibrium

1. Consumer Equilibrium in case of single commodity
“Consumer equilibrium is the state of consumer’s demand which he thinks to be the best and which he does not want to alter” Prof Marshall
Law of consumer equilibrium is applied only when marginal utility and price of goods are same. It is based on two factors
• Each consumer obtains maximum satisfaction by consumption of goods and service.
• Level of income is fixed at the given point of time.

With every successive unit, the consumer gets less satisfaction. At 6 units, the consumer is getting maximum satisfaction where Price=MU and at 7-unit MU of money is exceeding,
Consumer Equilibrium in case of single commodity

Here purchase of a commodity depends on
• Price of the commodity
• Marginal Utility of money
• Marginal Utility of price.
• Equilibrium MUm =MUx/Px
2. Consumer Equilibrium in case of two commodities is represented in two ways
1. Utility approach (cardinal analysis)
In this approach, consumer attain equilibrium in two conditions
a. When the price of the two commodities are the same or equal
The consumer will reach equilibrium only when MUx =MUy,
here consumer will attain equilibrium when MU of both the commodities say Y and X are equal and price of both are same.
b. when the price of two commodities are different
Consumer will reach equilibrium only when  MUx/Px = MUy/Py
 For example, if MUx = 16 andPx = 2 at 6th unit and MUy, = 40 and Py = 5 at 5th unit Equilibrium will be attained at 6th unit of x and 5th unit of y i.e 8
ii. Indifference curve analysis (Ordinal approach)
This approach was propounded by Allen and Hicks. According to them, the utility cannot be measured in monetary terms. Consumer feels no difference between the various combination of commodities as long as consumer satisfaction remains the same.
An indifference curve shows the combination of two commodities for which the consumer is indifferent.
“A single indifference curve shows the different combination of X and Y that yield equal satisfaction to the consumer” Leftwich

As per the table and graph at all the combination of X and Y, Consumer gets the same level of satisfaction. The combination contains different quantity but the consumer gets the same level of satisfaction. The marginal rate of substitution decreasing from left to right.
Properties of Indifference Curve
Indifference Curve slopes downward, consumer prefer more goods to fewer goods.
MRS tends to diminish as IC is convex to the origin.
IC never intersect each other
High IC represents the high level of satisfaction than the lower one.
Assumptions of Indifference Curve
• The consumer is rational. To maximize total satisfaction, he aims to attain the highest level of IC.
• IC is ordinally measurable.
• As per the preference, consumer arranges the various combination of goods. His choice is translative.
• The consumer is able to give rank to indifference combination of two goods.
• To determine the equilibrium combination of two commodities are used.
• It is based on diminishing marginal rate of returns.

Economic problems

Economic problems
Suppose you are in the market. You have seen that there are shops in which there are countless customers. There are also shops without any customers. Does it ever come to your mind the reason behind this? It may be the bad behaviour of the shopkeeper.
Apart from this, what would be the possible reasons? There are so many reasons for this. Some of them are the availability of the items or the products needed, their varieties, ease of availability etc.
These are some of the economic problems. A producer has to go through these. He needs to find solutions for the economic problem. Let us study the economic problem in details.
A consumer will have some needs and wants. Sometimes there is a surplus of the services. Sometimes there is a scarcity of the services or the products. Production, distribution, and nature of goods and services are the basic economic activities.
To avoid the economic problem one has to decide how to allocate the scarce resource. One has to understand how to achieve efficiency with the existing resources Also, one has to understand that some resources are limited. One always has to deal with the scarcity and the choices. Basically one always has to decide
• What goods and services to produce.
• Nature of the goods to produce.
• Preferences and priorities of the goods.
• How to produce the best services.
• For whom to produce these services

Type of Economic Problem
The available finite resources are insufficient to satisfy all human wants. Depending upon the above points there are basically three types of economic problem. They are
• What to produce.
• How to produce.
• For whom to produce.
Before understanding these economic problems, let us first understand what an economic resource is.
Economic Resources
Economic resources are the factors of production that are used to produce goods or services. The various types of economic resources are
Land: All the natural resources for producing goods and services. For example rivers, forests, minerals etc.
Labour: The physical and mental contribution of any human towards production. For example labourers, workers, etc.
Capital: Man-made resources used for producing goods and services. For example, machinery, buildings, computers, etc.
Entrepreneur: Any person who takes the risk by employing other resources to produce goods and services. For example, a businessman, head of the shop, head of the factory etc.
Central Problems of an Economy
What to produce
The first central problem of an economy is to decide what goods and services need to be produced. Also, one has to decide the quantities of production. It involves the allocation of resources.
First one has to decide the nature of the goods to produce it. Once it is done, the quantity is decided. This decision is based on the preference and priorities of society. A higher priority on capital goods implies fewer consumer goods now and more in the future.
How to produce
The second central problem of an economy is to decide how to produce these goods. First one needs to decide the nature and the quantities. After that one has to decide the techniques or the methods of producing these goods.
It depends upon the availability of resources within the economy. Choice of techniques and methods of producing goods must bring an efficient allocation of resources. It must also bring the overall productivity in the economy.
For whom to produce
The third central problem of an economy is to decide for whom to produce these goods. In other words, one can say it is the decision of the allocation of goods among the members of society.
Distribution of income determines who will be getting what. A rich person may have a large share of the luxuries. The poor person will have basic goods. It depends on the principle of efficiency and equity

Production possibilities curve

The production possibility curve represents graphically alternative produc¬tion possibilities open to an economy.
The productive resources of the community can be used for the production of various alternative goods.
But since they are scarce, a choice has to be made between the alternative goods that can be produced. In other words, the economy has to choose which goods to produce and in what quantities. If it is decided to produce more of certain goods, the production of certain other goods has to be curtailed.
Let us suppose that the economy can produce two commodities, cotton and wheat. We suppose that the productive resources are being fully utilized and there is no change in technology. The following table gives the various production possibilities.

It all available resources are employed for the production of wheat, 15,000 quintals of it can be produced. If, on the other hand, all available resources are utilized for the production of cotton, 5000 quintals are produced. These are the two extremes represented by A and F and in between them are the situations represented by B, C, D and E. At B, the economy can produce 14,000 quintals of wheat and 1000 quintals of cotton.
At C the production possibilities are 12,000 quintals of wheat and 200u quintals of cotton, as we move from A to F, we give up some units of wheat for some units of cotton For instance, moving from A to B, we sacrifice 1000 quintals of wheat to produce 1000 quintals of cotton, and so on. As we move from A to F, we sacrifice increasing amounts of cotton.
This means that, in a full-employment economy, more and more of one good can be obtained only by reducing the production of another good. This is due to the basic fact that the economy’s resources are limited.
The following diagram (21.2) illustrates the production possibilities set out in the above table.

In this diagram AF is the production possibility curve, also called or the production possibility frontier, which shows the various combinations of the two goods which the economy can produce with a given amount of resources. The production possibility curve is also called transformation curve, because when we move from one position to another, we are really transforming one good into another by shifting resources from one use to another.

It is to be remembered that all the points representing the various reduction possibilities must lie on the production possibility curve AF and not inside or outside of it. For example, the combined output of the two goods can neither be at U nor H. (See Fig. 21.3) This is so because at U the economy will be under-employing its resources and H is beyond the resources available.

Markets structure

Markets structure


A variety of market structures will characterize an economy. Such market structures essentially refer to the degree of competition in a market.
There are other determinants of market structures such as the nature of the goods and products, the number of sellers, number of consumers, the nature of the product or service, economies of scale etc. We will discuss the four basic types of market structures in any economy.
One thing to remember is that not all these types of market structures actually exist. Some of them are just theoretical concepts. But they help us understand the principles behind the classification of market structures.

1] Perfect Competition
In a perfect competition market structure, there are a large number of buyers and sellers. All the sellers of the market are small sellers in competition with each other. There is no one big seller with any significant influence on the market. So all the firms in such a market are price takers.
There are certain assumptions when discussing the perfect competition. This is the reason a perfect competition market is pretty much a theoretical concept. These assumptions are as follows,
• The products on the market are homogeneous, i.e. they are completely identical
• All firms only have the motive of profit maximization
• There is free entry and exit from the market, i.e. there are no barriers
• And there is no concept of consumer preference
2] Monopolistic Competition
This is a more realistic scenario that actually occurs in the real world. In monopolistic competition, there are still a large number of buyers as well as sellers. But they all do not sell homogeneous products. The products are similar but all sellers sell slightly differentiated products.
Now the consumers have the preference of choosing one product over another. The sellers can also charge a marginally higher price since they may enjoy some market power. So the sellers become the price setters to a certain extent.
For example, the market for cereals is a monopolistic competition. The products are all similar but slightly differentiated in terms of taste and flavours. Another such example is toothpaste.
3] Oligopoly
In an oligopoly, there are only a few firms in the market. While there is no clarity about the number of firms, 3-5 dominant firms are considered the norm. So in the case of an oligopoly, the buyers are far greater than the sellers.
The firms in this case either compete with another to collaborate together, They use their market influence to set the prices and in turn maximize their profits. So the consumers become the price takers. In an oligopoly, there are various barriers to entry in the market, and new firms find it difficult to establish themselves.
4] Monopoly
In a monopoly type of market structure, there is only one seller, so a single firm will control the entire market. It can set any price it wishes since it has all the market power. Consumers do not have any alternative and must pay the price set by the seller.
Monopolies are extremely undesirable. Here the consumer loose all their power and market forces become irrelevant. However, a pure monopoly is very rare in reality.

Branches of economics

Branches of economics


1.Classical economics
Classical economics is often considered the foundation of modern economics. It was developed by Adam Smith, David Ricardo, . Classical economics is based on
Operation of free markets. How the invisible hand and market mechanism can enable an efficient allocation of resources
Classical economics suggests that generally, economies work most efficiently when government intervention is minimal and concerned with the protection of private property, promotion of free trade and limited government spending.
Classical economics does recognise that a government is needed for providing public goods, such as defence, law and order and education.
2. Neo-classical economics
Key people: Leon Walrus, William Jevons, John Hicks, George Stigler and Alfred Marshall
Neo-classical economics built on the foundations of free-market based classical economics. It included new ideas such as
• Utility maximisation.
• Rational choice theory
• Marginal analysis. How individuals will make decisions at the margin – choosing the best option given marginal cost and benefit.
Neo-classical economics is often considered to be orthodox economics. It is the economics taught in most text-books as the starting point for economics teaching. The tools of neo-classical economics (supply and demand, rational choice, utility maximisation) can be used in new fields and also for critiques.
Keynesian economics
Key people: John Maynard Keynes
Keynesian economics was developed in the 1930s against a backdrop of the Great Depression. The existing economic orthodoxy was at a loss to explain the persistent economic depression and mass unemployment. Keynes suggested that markets failed to clear for many reasons (e.g. paradox of thrift, negative multiplier, low confidence). Therefore, Keynes advocated government intervention to kick-start the economy.
Keynesian economics is credited with creating macroeconomics as a distinct study. Keynes argued that the aggregate economy may operate in very different ways to individual markets and different rules and policies were needed.
Keynes didn’t reject all elements of neo-classical economics but felt new ideas were needed for the macro-economy – especially with the economy in recession.
• Keynesian economics
Monetarist economics
Key people: Milton Friedman, Anna Schwartz.
Monetarism was partly a reaction to the dominance of Keynesian economics in the post-war period. Monetarists, led by Milton Friedman argued that Keynesian fiscal policy was much less effective than Keynesians suggested. Monetarists promoted previous classical ideals, such as belief in the efficiency of markets. They also placed emphasis on the control of the money supply as a way to control inflation.
Monetarist economics became influential in the 1970s and 1980s, in a period of high inflation – which appeared to illustrate the breakdown of the post-war consensus
• Monetarism
Austrian economics
Key people: Ludwig Von Mises, Carl Menger
This is another school of economics that was critical of state intervention, price controls. It is broadly free-market. However, it criticised elements of classical school – placing greater emphasis on the individual value and actions of an individual. For example, Austrian economists argue the value of a good reflects the marginal utility of the good – rather than the labour inputs.
d) Austrian economics
Marxist economics
Key people: Karl Marx
Emphasises unequal and unstable nature of capitalism. Seeks a radically different approach to basic economic questions. Rather than relying on free-market advocate state intervention in ownership, planning and distribution of resources.
Neo-liberalism/Neo-classical
A modern interpretation of classical economics. Considerable overlap with monetarism. Essentially concerned with the promotion of free-markets, competition, free trade, privatisation, lower government involvement, but some minimal state intervention in public services like health and education. Few identify as ‘neo-liberal’ – sometimes used as a term of abuse.
d) Neoliberalism | Related terms: Washington Consensus
New Branches of economics
Environmental economics/welfare economics
Key people: Garrett Hardin, E.F. Schumacher, Arthur Pigou
This places greater emphasis on the environment. This can include:
d) Neo-classical analysis of external costs and external benefits. From this perspective, it is rational for man to reduce pollution
e) Market failures – tragedy of the commons, Public goods, external costs, external benefits.
f) Environmental economics can take a more radical approach – questioning whether economic growth is actually desirable.
Behavioural economics
Key people: Gary Becker, Amos Tversky, Daniel Kahneman, Richard Thaler, Robert J. Shiller,
Behavioural economics examines the psychology behind economic decision making and economic activity. Behavioural economics examines the limitation of the assumption individuals are perfectly rational. It includes
d) Bounded rationality – people make choices by rules of thumb
e) Irrational exuberance – People get carried away by asset bubbles.
f) Nudges/Choice architecture – how the framing of decisions affects the outcome
Development economics
Key people: Simon Kuznets and W. Arthur Lewis, Amartya Sen and Muhammad Yunus.
Concerned with issues of poverty and under-development in poorer countries of the world. Development economics is concerned with both micro and macro aspects of economic development. Issues include
d) Trade vs aid
e) Increasing capital investment.
f) Best ways to promote economic development
g) Third World debt
Econometrics
Key people: Jan Tinbergen
Use of data to find simple relationships. Econometrics uses statistical methods, regression models and data to predict the outcome of economic policies. For example, Okun’s law suggests a relationship between economic growth and unemployment.
Labour economics
Key people: Knut Wicksell
Concentration on wages, labour employment and labour markets. Labour economics starts from neo-classical premise of labour supply and marginal revenue product of labour.
Recent developments in labour economics have placed greater emphasis on non-monetary factors, such as motivation, enjoyment and labour market imperfections.

FIVE FUNDAMENTAL PRINCIPLES OF ECONOMICS

FIVE FUNDAMENTAL PRINCIPLES OF ECONOMICS
There are five fundamental principles of economics that every introductory economics begins with at the start of the semester: rationality, costs, benefits, incentives, and marginal analysis.

Below is a list of these five concepts with a brief intuitive discussion and examples.

1. People make rational choices:

If you drove to work/school today, I bet you would disagree with this one (because of all of the irrational drivers out there).  However, it is an assumption that economists make to let the models work. Remember that to economists, rationality means that people act in their own best interest with the information that they have available to them. It doesn't mean they make the best long term decisions, it just means they make the best decisions according to their own desire for happiness (with the information that they have).

 In general, most people are rational. For example people eat food, go to work, play nice with others, etc. If people behaved irrationally, then there would be no chance in the world to predict their behavior.  By assuming that people are rational, and make decisions based on what is best for them, we can break down the decision making process.  This allows us to study the factors that influence decision making.

2. Costs and opportunity costs:
The most common use of the word cost is a monetary cost. Generally we are concerned with the trade offs that are associated with decisions we make. We have to pay for food, movies, or classes.  But there are other types of costs; in economics we call these opportunity costs.  For more info on opportunity costs, look here. To summarize, opportunity costs are the value of the highest foregone activity. An example would be giving up the opportunity to work while you are attending classes. In this case, you have to pay for classes (a monetary cost) AND give up other activities (an opportunity cost).

3. Benefits:

The reason we incur costs is because we also derive benefits from them.  Benefits can take many forms, but the most common are monetary or happiness related.  In economics we try to measure happiness using the word “utility”, which is basically a numerical measure of how satisfied someone is consuming or using a good or service. We are interested in benefits because they are typically the thing that individuals and firms are trying to maximize with their behavior (utility and profit respectively).

4. Incentives:

Incentives are the rewards and punishments we experience every day. This is sometimes called the carrot and the stick. The carrot is a benefit trying to make someone do something (positive reinforcement) while the stick is a cost trying to scare someone into doing something (negative reinforcement).

We like to get rewards, so we will generally make a decision so that we will get rewarded.  At the same time we don’t like punishment so we will avoid decisions that will result in us getting punished.  Economists are interested in how people respond differently to rewards and punishments for similar scenarios.

For example, is it more effective to reward people for driving safe by lowering their car insurance premium every year when they don’t get in an accident, or is it better to punish them by jacking up their rates when they do get in an accident?  Economists would use surveys and data to see which is more effective at getting people to drive safe.  Another example about incentives can be seen here.

5.  Marginal Analysis:

Almost everything analyzed in economics is done so on the margin.  This means that economists are interested in the NEXT decision being made.  Focusing on the margin means only considering the NEXT piece of pizza eaten, or the NEXT video game being made.  If you are familiar with calculus then this concept makes sense.  If not, think about drinking beer with your friends.  Whenever you order your NEXT beer you consider how much you want that NEXT beer, and how much money that NEXT beer will cost you.  While decisions made in the past will affect your happiness from that NEXT beer, and the amount of money you have, the decision to buy that NEXT beer is made then.

Definition and nature and scope of economics

DEFINITION AND NATURE & SCOPE OF ECONOMICS

Economics is the science that deals with production, exchange and consumption of various commodities in economic systems. It shows how scarce resources can be used to increase wealth and human welfare. The central focus of economics is on scarcity of resources and choices among their alternative uses. The resources or inputs available to produce goods are limited or scarce. This scarcity induces people to make choices among alternatives, and the knowledge of economics is used to compare the alternatives for choosing the best among them. For example, a farmer can grow paddy, sugarcane, banana, cotton etc. in his garden land. But he has to choose a crop depending upon the availability of irrigation water.
Two major factors are responsible for the emergence of economic problems. They are: i) the existence of unlimited human wants and ii) the scarcity of available resources. The numerous human wants are to be satisfied through the scarce resources available in nature.  Economics deals with how the numerous human wants are to be satisfied with limited resources. Thus, the science of economics centres on want - effort - satisfaction.

 Economics not only covers the decision making behaviour of individuals but also the macro variables of economies like national income, public finance, international trade and so on.

A. DEFINITIONS OF ECONOMICS
Several economists have defined economics taking different aspects into account. The word ‘Economics’ was derived from two Greek words, oikos (a house) and nemein (to manage) which would mean ‘managing an household’ using the limited funds available, in the most satisfactory manner possible.
i) Wealth Definition
Adam smith (1723 - 1790), in his book “An Inquiry into Nature and Causes of Wealth of Nations” (1776) defined economics as the science of wealth. He explained how a nation’s wealth is created. He considered that the individual in the society wants to promote only his own gain and in this, he is led by an “invisible hand” to promote the interests of the society though he has no real intention to promote the society’s interests.
Criticism: Smith defined economics only in terms of wealth and not in terms of human welfare. Ruskin and Carlyle condemned economics as a ‘dismal science’, as it taught selfishness which was against ethics. However, now, wealth is considered only to be a mean to end, the end being the human welfare. Hence, wealth definition was rejected and the emphasis was shifted from ‘wealth’ to ‘welfare’.
ii) Welfare Definition
Alfred Marshall (1842 - 1924) wrote a book “Principles of Economics” (1890) in which he defined “Political Economy” or Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is most closely connected with the attainment and with the use of the material requisites of well being”. The important features of Marshall’s definition are as follows:
a) According to Marshall, economics is a study of mankind in the ordinary business of life, i.e., economic aspect of human life.
b) Economics studies both individual and social actions aimed at promoting economic welfare of people.
c) Marshall makes a distinction between two types of things, viz. material things and immaterial things. Material things are those that can be seen, felt and touched, (E.g.) book, rice etc. Immaterial things are those that cannot be seen, felt and touched. (E.g.) skill in the operation of a thrasher, a tractor etc., cultivation of hybrid cotton variety and so on. In his definition, Marshall considered only the material things that are capable of promoting welfare of people.
Criticism: a) Marshall considered only material things. But immaterial things, such as the services of a doctor, a teacher and so on, also promote welfare of the people.
b) Marshall makes a distinction between (i) those things that are capable of promoting welfare of people and (ii) those things that are not capable of promoting welfare of people. But anything, (E.g.) liquor, that is not capable of promoting welfare but commands a price, comes under the purview of economics.
c) Marshall’s definition is based on the concept of welfare. But there is no clear-cut definition of welfare. The meaning of welfare varies from person to person, country to country and one period to another. However, generally, welfare means happiness or comfortable living conditions of an individual or group of people. The welfare of an individual or nation is dependent not only on the stock of wealth possessed but also on political, social and cultural activities of the nation.
iii) Welfare Definition
Lionel Robbins published a book “An Essay on the Nature and Significance of Economic Science” in 1932. According to him, “economics is a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. The major features of Robbins’ definition are as follows:
a) Ends refer to human wants. Human beings have unlimited number of
wants.
b) Resources or means, on the other hand, are limited or scarce in supply. There is scarcity of a commodity, if its demand is greater than its supply. In other words, the scarcity of a commodity is to be considered only in relation to its demand.
c) The scarce means are capable of having alternative uses. Hence, anyone will choose the resource that will satisfy his particular want. Thus, economics, according to Robbins, is a science of choice.
Criticism: a) Robbins does not make any distinction between goods conducive to human welfare and goods that are not conducive to human welfare. In the production of rice and alcoholic drink, scarce resources are used. But the production of rice promotes human welfare while production of alcoholic drinks is not conducive to human welfare. However, Robbins concludes that economics is neutral between ends.
b) In economics, we not only study the micro economic aspects like how resources are allocated and how price is determined, but we also study the macro economic aspect like how national income is generated. But, Robbins has  reduced economics merely to theory of resource allocation.
c) Robbins definition does not cover the theory of economic growth and development.
iv) Growth Definition
Prof. Paul Samuelson defined economics as “the study of how men and society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time, and distribute them for consumption, now and in the future among various people and groups of society”.
The major implications of this definition are as follows:
a) Samuelson has made his definition dynamic by including the element of time in it. Therefore, it covers the theory of economic growth.
b) Samuelson stressed the problem of scarcity of means in relation to unlimited ends. Not only the means are scarce, but they could also be put to alternative uses.
c) The definition covers various aspects like production, distribution and consumption.
Of all the definitions discussed above, the ‘growth’ definition stated by Samuelson appears to be the most satisfactory. However, in modern economics, the subject matter of economics is divided into main parts, viz., i) Micro Economics and ii) Macro Economics.
Economics is, therefore, rightly considered as the study of allocation of scarce resources (in relation to unlimited ends) and of determinants of income, output, employment and economic growth.
B. SCOPE OF ECONOMICS
Scope means province or field of study. In discussing the scope of economics, we have to indicate whether it is a science or an art and a positive science or a normative science. It also covers the subject matter of economics.
i) Economics - A Science and an Art
a) Economics is a science: Science is a systematized body of knowledge that traces the relationship between cause and effect. Another attribute of science is that its phenomena should be amenable to measurement. Applying these characteristics, we find that economics is a branch of knowledge where the various facts relevant to it have been systematically collected, classified and analysed. Economics investigates the possibility of deducing generalizations as regards the economic motives of human beings. The motives of individuals and business firms can be very easily measured in terms of money. Thus, economics is a science.
Economics - A Social Science: In order to understand the social aspect of economics, we should bear in mind that labourers are working on materials drawn from all over the world and producing commodities to be sold all over the world in order to exchange goods from all parts of the world to satisfy their wants. There is, thus, a close inter-dependence of millions of people living in distant lands unknown to one another. In this way, the process of satisfying wants is not only an individual process, but also a social process. In economics, one has, thus, to study social behaviour i.e., behaviour of men in-groups.
b) Economics is also an art. An art is a system of rules for the attainment of a given end. A science teaches us to know; an art teaches us to do. Applying this definition, we find that economics offers us practical guidance in the solution of economic problems. Science and art are complementary to each other and economics is both a science and an art.
ii) Positive and Normative Economics
Economics is both positive and normative science.
a) Positive science: It only describes what it is and normative science prescribes what it ought to be. Positive science does not indicate what is good or what is bad to the society. It will simply provide results of economic analysis of a problem.
b) Normative science: It makes distinction between good and bad. It prescribes what should be done to promote human welfare. A positive statement is based on facts. A normative statement involves ethical values. For example, “12 per cent of the labour force in India was unemployed last year” is a positive statement, which could is verified by scientific measurement. “Twelve per cent unemployment is too high” is normative statement comparing the fact of 12 per cent unemployment with a standard of what is unreasonable. It also suggests how it can be rectified. Therefore, economics is a positive as well as normative science.
iii) Methodology of Economics
Economics as a science adopts two methods for the discovery of its laws and principles, viz., (a) deductive method and (b) inductive method.
a) Deductive method: Here, we descend from the general to particular, i.e., we start from certain principles that are self-evident or based on strict observations. Then, we carry them down as a process of pure reasoning to the consequences that they implicitly contain. For instance, traders earn profit in their businesses is a general statement which is accepted even without verifying it with the traders. The deductive method is useful in analyzing complex economic phenomenon where cause and effect are inextricably mixed up. However, the deductive method is useful only if certain assumptions are valid. (Traders earn profit, if the demand for the commodity is more).
b) Inductive method: This method mounts up from particular to general, i.e., we begin with the observation of particular facts and then proceed with the help of reasoning founded on experience so as to formulate laws and theorems on the basis of observed facts. E.g. Data on consumption of poor, middle and rich income groups of people are collected, classified, analysed and important conclusions are drawn out from the results.
In deductive method, we start from certain principles that are either indisputable or based on strict observations and draw inferences about individual cases. In inductive method, a particular case is examined to establish a general or universal fact. Both deductive and inductive methods are useful in economic analysis.
iv) Subject Matter of Economics
Economics can be studied through a) traditional approach and (b) modern approach.
a) Traditional Approach: Economics is studied under five major divisions namely consumption, production, exchange, distribution and public finance.
1.Consumption: The satisfaction of human wants through the use of goods and services is called consumption.
2.Production: Goods that satisfy human wants are viewed as “bundles of utility”. Hence production would mean creation of utility or producing (or creating) things for satisfying human wants. For production, the resources like land, labour, capital and organization are needed.
3. Exchange: Goods are produced not only for self-consumption, but also for sales. They are sold to buyers in markets. The process of buying and selling constitutes exchange.
4. Distribution: The production of any agricultural commodity requires four factors, viz., land, labour, capital and organization. These four factors of production are to be rewarded for their services rendered in the process of production. The land owner gets rent, the labourer earns wage, the capitalist is given with interest and the entrepreneur is rewarded with profit. The process of determining rent, wage, interest and profit is called distribution.
5. Public finance: It studies how the government gets money and how it spends it. Thus, in public finance, we study about public revenue and public expenditure.
b) Modern Approach
The study of economics is divided into:  i) Microeconomics and ii) Macroeconomics.
1. Microeconomics analyses the economic behaviour of any particular decision making unit such as a household or a firm. Microeconomics studies the flow of economic resources or factors of production from the households or resource owners to business firms and flow of goods and services from business firms to households. It studies the behaviour of individual decision making unit with regard to fixation of price and output and its reactions to the changes in demand and supply conditions. Hence, microeconomics is also called price theory.
2. Macroeconomics studies the behaviour of the economic system as a whole or all the decision-making units put together. Macroeconomics deals with the behaviour of aggregates like total employment, gross national product (GNP), national income, general price level, etc. So, macroeconomics is also known as income theory.
Microeconomics cannot give an idea of the functioning of the economy as a whole. Similarly, macroeconomics ignores the individual’s preference and welfare. What is true of a part or individual may not be true of the whole and what is true of the whole may not apply to the parts or individual decision making units. By studying about a single small-farmer, generalization cannot be made about all small farmers, say in Tamil Nadu state. Similarly, the general nature of all small farmers in the state need not be true in case of a particular small farmer. Hence, the study of both micro and macroeconomics is essential to understand the whole system of economic activities.