Introduction of Economics

The word economics was derived from the Greek word ‘Oeconomicus’ which

means household management and agriculture management. Economics is social

science which is dynamic in the sense that economics got changed with the

change in time and human civilization. Economics was used in the early time of

human civilization informally because people used to live outside the society.

When the society has developed, increased numbers of family, production in

large scale, exchange, development of market and invention of money to

facilitate the transaction got the importance place in the area of economics. Now,

in the modern times the scope of economics has become very broad and includes

the each and every sectors of the society and hence economy. The overall

development of economics can be divided into the following three periods.

Classical period (1776-1890)

The period between 1776 and 1890 is known as classical period in the history of

economics. In this period, the classical economist, Adam Smith, the leader of

classical school, defined economics as a science of Wealth in his book “Wealth of

Nation”. Adam smith defined the economics as the science for the first time and

gave definite shape to economics in the history of economics. Since he gave

particular definition of economics for the first time, he is known as father of

economics.

Adam smith defines economics as science of wealth. According to him, it is only

wealth to satisfy human needs in the society. So, people must effort for increasing

the volume of wealth. In this period, other economists like J.B Say, Ricardo, and

Malthus etc. were the followers of Smith and they also defined the economics as

science of Wealth. According to J.B say “Economics is that body of Knowledge

which relates to wealth”.

It shows that in classical period economics was related with the study of wealth

and wealth generating human activities. To Smith, only way to increase wealth in

the society is the increase in the productivity of labor which depends on division

of labor. Further, division of labor depends on the extent of market. It means

labor division becomes more possible when market is free and large. Adam

smith’s definition can be explained in the following points.

i) Study of Wealth

Wealth definition deals with production, exchange, distribution and consumption

of wealth.

ii) Significance of wealth

According to the wealth definition human beings make all his effort only to earn

wealth and he satisfies all his wants only with wealth. So wealth is very important

iii) Primary Place to wealth

Adam smith gave first priority to wealth and second priority to man in his definition. According to him, main goal of every human is to earn wealth and man is only means. So, man is for wealth

iv) Study of Economic man

Smith distinguished between economic and non-economic man. In his view, economics studies only those persons who are directly and indirectly involved in

production and consumption of wealth. Economics does not study non economic man.

v) Source of wealth

According to Smith there is only one source of wealth that is employed labor.

Criticism of Wealth Definition

When the time was near of 1890 the classical ideas were bitterly criticized specially by Ruskin, Morris and Caryel. They abused his economics as bread and butter. It was criticized by Marshall and other economists in the following way.

i) Narrow Definition

According to critics Adam smith made the scope of economics narrow. He only considers wealth and left important aspect mankind and welfare. Similarly it neglected non material wealth and satisfaction from various services. In this sense, Smith narrowed down the scope of economics.

ii) Single source of wealth

To Adam Smith, only employed labor is source of wealth but in reality there are other sources of wealth like capital, natural resources, socio economic institutions and entrepreneurs etc. when labor is combined with these sources the only wealth generation is possible.

iii) Too much emphasized on wealth

Smith emphasized more on wealth. To him, wealth is goal of every people and to satisfy human wants only wealth is sufficient. But, he ignores the welfare from the wealth. Similarly, he neglects satisfaction from various services.

iv) Secondary Place to man

According to Smith wealth is primary thing which is all in all in the society. He gave second place to mankind. But, in reality, man is primary subject and wealth is secondary in the society. Man is centre of every economics activities. So Adam smith is wrong to consider wealth as primary subject.

v) Too much emphasis on economic man

Adam smith gave the idea that economics studies only economic man. His assumption of economic man is wrong. In the sense, it is very difficult to distinguish between economic and non-economic man. Further, non economic aspect is also very important aspect of society.

vi) Overdependence on market

According to smith market economy (free market system) is only way to increase the wealth in the society. But concept of free market (laissez faire) does not deal with the problem of underdeveloped countries like Nepal. Because free market creates gap between rich and poor.

Though classical definition was criticized on some above grounds, it has greater role in the development of economics. Because Adam Smith brought into existence s separate science.

Neo-classical Definition

The period between 1890 and 1932 is regarded as neoclassical definition. When classical definition was criticized bitterly, Alfred Marshall, a leader of neo-classical school gave new dimension to economics with the publication of his book “Principle of Economics” in 1890. He saved economics from disregard and disrepute and brought from wealth to welfare.

Alfred Marshall defined the economics as a science which on the one hand studies wealth and on the other hand and more important side studies man and man’s welfare. Here Alfred Marshall assigned first priority to individual and social welfare where secondary place to wealth. According to Marshall “economics is the study of mankind in ordinary business life. It examines that parts of individuals and social action which is most closely connected with the attainment and use of material requites of well being”.

Marshall highly emphasized on the study of only material welfare and ordinary man where to him economics does not studies not material welfare and extra ordinary man.

Hence, welfare definition defines the economics as the science of material welfare. It establishes linkage between wealth and welfare (man).welfare definition can be explained in the following points.

i) Welfare is Primary Concern

Welfare definition considers that wealth is for material welfare of any individuals. It rejects the idea that man is for wealth and it gives primary concern on material welfare and secondary place to wealth. But it does not consider non-material welfare.

ii) Study of ordinary man

This definition stressed on ordinary man who earns wealth and uses it to get material welfare. But it does not study extra ordinary man like mad person, hermit, sadhu mahatma etc.

iii) Social science

Alfred Marshall advocated economics as a social science which studies human behavior and activities in the society. But it does not study isolated person who lives outside the society.

iv) Normative Science

Neo-classical definition of economics explains economics as normative science because it studies with what should be. It means economics studies the causes after material welfare and talks about what should be done to get material welfare from wealth.

It can be concluded that welfare definition of economics describes how to get maximum material welfare with the use of wealth. So, economics is science of material welfare.

Criticism of Welfare Definition

At the time of early 20th century neo-classical ideas were criticized by modern economist like Leonel Robbins as follow:

i) Welfare definition is classificatory

Welfare definition is criticized as classificatory definition but not analytical because it classified welfare into material and non-material and man into ordinary and extra ordinary. However, it does not give clear explanation of this concept.

ii) Narrow scope

Alfred Marshall has limited the scope of economics to ordinary man and material welfare only. It ignores non- material aspect and extra ordinary man which have also clear economic meaning.

iii) Emphasized only on normative aspect

According to Marshall, economics is normative science which deals with what should be. But he ignores positive aspect of economics that means what is. There is no meaning of normative science without positive aspect.

iv) Surfacial definition

Welfare definition is criticized as surfacial definition because it does not study centre economic problems scarcity and choice.

v) It excludes human science

To Marshall, economics studies people’s activities and behavior only inside the society and it does not study behavior and activities of the people outside the society. But people living outside the society like sadhu, mahatma etc. has also economic problems and they must be studied by economics.

vi) Contradictory

Welfare definition is contradictory because on the one hand it talks about

material welfare which is objective and at the same time it talks about utility

which is subjective. Similarly there is contradiction in the meaning of welfare

also because same physical goods like smoking gives satisfaction to someone

and negative welfare to others.

vii) Welfare cannot be quantitative

According neo-classical economist Pigou, welfare is quantitative and it is

measured by money. But, the welfare from same amount of money differs from

person to person, time to time and place to place. For example, same amount of

money gives higher welfare to poor people and lower to rich people.

Despite several demerits of this definition, it has redefined economic ideas of

classical period and gave the different scope of the economics.

Modern definition of Economics

It has been said that modern period was started in 1932. But, formally it was

started in 1935 with the publication of Robbins’s book “An essay on the Nature

and Significance of Economics”. Modern definition given by Robbins is scientific

and logical in the sense that he explains the basic economic problem scarcity and

choice. Robbins advocates that economics studies the central problem of all

economic agents (producer, Seller, consumers) that is scarcity and choice. So, he

explains economics as science of scarcity and choice. This definition is related

with the problems arising from scarcity like how to make choice. Hence, Robbins

definition can be defined as science of choice. According to Robbins “Economics is

the science which studies human behavior as a relationship between unlimited

ends and scarce means which have alternative uses”. Some other economists like

Stigler also concerned with scarcity and choice.

Robbins definition can be explained in the following main points.

i) Human wants are unlimited

According to Robbins there is multiplicity of wants where fulfillment of one want

creates another want automatically. So we cannot fulfill all our wants at once or

even during our life time.

ii) Limited Resources

Resources are limited or scarce in comparison to human wants because human

wants are always increasing but resources are not.

iii) Wants are of varying importance

According to Robbins unlimited human wants are not equally important. Some

are more urgent and some are less. So, choice between them is possible and we

can fulfill more urgent need now and postpone the less urgent wants.

iv) Alternative uses of resources.

Robbins explains that scarce resources can be used in various uses on the basis of

necessities. It helps to make choice and usefulness of available resources. That

means scarce resources can be best utilized.

v) Choice is the main problem

Unlimited wants with different priority and limited resources with alternative uses

create the problem of scarcity. So, main problem of economics is choice. That

means how to make a choice among various alternatives is the major problem.

vi) Economics is pure or positive science

Robbins explains economics as pure science like Physics and Chemistry which

depends on fact not on value judgment. Similarly, to his economics is positive

science which deals with what is.

vii) Efficient allocation.

Robbins definition stresses on efficiency in the use of scarce resources to satisfy

different human wants. Efficiency in allocation of resources is necessary to

overcome the problem of scarcity and create efficiency in production and

distribution.

Hence Robbins definition is scientific and universally accepted definition because

his definition is not classificatory and is more analytical. It deals with the problem

of almost all economy that is scarcity and choice.

Criticism of Robbins Definition

Though Robbins’s definition is scientific, logical and universally accepted, some

economists like Barbara Wotton and Frasar etc. have made criticism in the

following ways.

i) Still incomplete definition

According to critics scarcity definition is incomplete because it only talks about

scarcity and choice but is not able to address burning and current problem of any

economy like poverty, unemployment, inequality, inflation economic growth and

economic development.

ii) Scarcity is not only problem

Critics say that as Robbins states economic problem does not arise only from

scarcity but also due to the overproduction, inefficient use of resources, and

misuse of resources and mismanagement of economic organizations. These all

create disinvestment and unemployment.

iii) Wrong assumption of pure science

Robbins says economics is a pure science which is tested on the basis of fact and

statistical tools etc. however, some issues like utility, satisfaction, poverty,

inequality cannot be measured in quantity with the help of scientific tools.

Similarly unlike pure science economics studies human behavior which gets

changed with time. So conclusion of economics cannot be applied as that of pure

science everywhere.

iv) It neglects the normative aspect

Robbins considers economics as positive science but ignores the normative

aspects. In reality positive aspect is incomplete in the absence of normative

aspect

v) Similar to Marshall’s definition

Robbins’s definition is similar to Marshall’s definition in the sense of welfare.

Robbins says that scarce resources are used to get maximum satisfaction. Here

scarce resources are similar to the Marshall’s concept of wealth and satisfaction

means welfare.

vi) Limited on allocation of resources.

Scarcity definition explains only how scarce resources are allocated to get the

maximum satisfaction but Robbins does not talk about the further process like

production, exchange, distribution, consumption and re-utilization of resources.

Critics claim that Robbins definition cannot be applied in rich and socialist country

because problem of rich country is plenty of income and over production but not

scarcity. Similarly, socialist economy focuses on providing basic needs to the

people on the basis of collective choice and in such economy there is no proper

choice between ends and means as Robbins says.

In this way, if we leave some short comments, Robbins’s definition is more

scientific, analytical and practical since it deals with main economic ideas scarcity

and choice.

Similarities between Marshall’s and Robbins’ definition.

i) Both deal with Scarce resources

According to Marshall, wealth is the thing that is scarce where as Robbins

mentions scarce resources which is wealth.

ii) Both give importance to man

Marshall was focused on human activities and Robbins is concerned with human

behavior as a relationship between ends and scarce. The centre concern of both is

maximization of human satisfaction.

iii) Both Concern with welfare

Marshall is mainly interested in material welfare where as Robbins is interested in

satisfaction which means welfare

iv) Both Explains Rational man

Both of them explain the rational man who aims to maximize welfare\ satisfaction

with given resources.

Superiority of Robbins definition

Robbins definition is superior in relation to Marshall because of following reasons.

i) Robbins definition is Scientific

Robbins definition is scientific because he does not classify man as ordinary and

extra ordinary and welfare as material and non material. His definition is

analytical in comparison to Marshal.

ii) Robbins definition is universally accepted

Marshall has mainly focused on such problem which is applicable for only some

people where as Robbins talks about scarcity and choice which is applicable to all

type of individual, society and economies.

iii) Wide Scope of Economics

Marshall confined economics into only material welfare, ordinary man and to him

economics only studies man in society. But Robbins includes all of the things and

he clearly mention about the human science.

iv) Economics as Positive Science

Robbins definition explains economics as exact or objective. Whereas, Marshall

studies normative science which is less exact and reliable.

Scope of Economics

Scope of economics means the area it covers. It means it deals with the range of

things that the economics deals with. It includes,

i) Subject matter of Economics

ii) Nature of Economics

Subject Matter of Economic

The issues or things or maters economics covers are known as subject matter of

economics. Subject matter of economics is dynamic in the sense that it changes

with the change in human civilization and thought and ideas. The subject matter

of economics can be defined on the basis of following three bases.

a) On the basis of representative definition

Different economists have given their own definition of economics which specify

the subject matter of economics. According to Adam Smith, the subject matter of

economics is wealth. Whereas, Marshal has defined scope of economics as

material welfare. To Robbins, economics is the science of scarcity and choice

b) On the basis of economic activities

Human being wants to maximize the satisfaction from everything. So, they make

various economic activities in order to obtain it. These economic activities are

subject matter of economics.

i) Production

Production is the creation of utility. It mainly deals with factors of productions

and laws of productions.

ii) Consumption

It deals with consumer behavior and utility. Under consumption it explains theory

of demand and law of diminishing marginal utility.

iii) Distribution

Mainly distribution is related with factor pricing which is share of every factor of

production in national income.

iv) Exchange

Exchange means transfer of goods and services from producer to consumers with

the help of medium of exchange, money. Under exchange, economics studies the

markets like perfect competition and monopoly.

v) Public Finance

It studies the income and expenditure of government. It means public finance is

the study of financial activities of government

vi) International Trade

Mainly it studies the import and export of goods.

C) On the basis of division of economics

In modern times, economics is defined as micro and macro economics.

Microeconomics studies the small economic units such as individual income,

demand, supply, price of particular price and factor, production of firm etc.

Macroeconomic is studies the aggregate economic units such as general price,

total production, aggregate demand, Aggregate supply national savings etc.

Nature of Economics

Is Economics Science or art?

A science is a systematic body of knowledge which makes comprehensive study of

any subject. Science derives the conclusion on the basis of facts and experiments

which establishes cause and effect relationship. Scientific laws are universally

applied. For example we can take law of gravitation law. Similarly Economics is

also a systematic study of knowledge because it studies consumption, production,

exchange and distribution systematically. Like other scientific laws, most of the

economic laws, such as law of demand, establish cause and effect relationship

among the various economic variables and the conclusion is derived from fact and

experiment. As science it arises practical problem. So, economics is science,

however, it is not exact science. It is social science which studies human behavior

which changes from person to person and time and time.

Art is related with the creation of new knowledge and ideas. It is a body of

knowledge that guides an action and teaches how practical problems are solved.

Economics provides solution to problems of economics such as problem of

poverty, unemployment, inequality etc. by making plan, policy and programmes.

So it is also an art.

Hence, we can conclude that economics is both science and art.

Economics as Positive and normative science

Economics as positive science

Positive economics is a systematized body of knowledge that studies what is or

what actually is. It talks about what exists. Positive economics was introduced at

the time of classical period and it is also followed by modern economists.

Positive economics always makes explanation and analyze the economic

variables. It is based on facts and experiment but not on value judgment and

public opinion. Positive economics establishes causes and effects relationship

between economic variables (such as between income and expenditure: when

income increases expenditure also increases).it means positive economics follows

the scientific process. It makes the decisions following scientific processes. The

conclusion is universally applicable, widely accepted and there is no chance of

personal bias. Furthermore it is an objective science which reveals the economic

problems in the economy.

Basically, positive economics develops economic laws and theories assuming

some proposition. Law of demand can be taken as the most important economic

theory of positive economics. The conclusion of positive economics can be

verified with empirical evidences.

Hence, positive economics is a science which makes explanations and prediction

on the basis of facts.

Economics as a Normative Science

Normative economics is the science that studies what should be or what ought to

be. Normative economics studies what is best among the alternatives. It was

introduced in the neoclassical period by Alfred Marshall.

Normative economics is subjective which provides the solution of the existing

problems raised by the positive economics. It derives the conclusion on the basis

of personal opinion, value judgment and ethical consideration. So the conclusion

of normative economics can’t be applied universally and it differs from person to

person. Normative science does not follow scientific process and it does not

establish causes and effect relationship between economic variables. It means

normative economics does not make the explanation and prediction of any

subject. There is the chance of personal bias in the derivation of conclusion.

Normative economics is applied in policy sciences which make plans and policy

such as tax policy, fiscal policy etc. in order to solve the practical problems of

economy. So it is also known as policy science. Its conclusion can’t be verified

tested and proved.

Hence, normative economics is related with the maximization of returns related

to production and consumption.

Microeconomics and Macroeconomics

Microeconomics

The word micro is derived from the Greek word mikros which means a small or

part. So, micro economics is the study of behavior of small or individual economic

units like firm, a person’s income, individual demand and supply, price of

particular product etc. sometimes it studies a small group of individual unit such

as industry, market etc. Microeconomics is the microscopic study of economic

units. Here, micro economics studies tree but not forest.

According to K.E. Buildings ‘ Microeconomics is the study of particular firm,

particular household, individual prices, wages, income, individual industries,

particular commodities.’

The main objective of microeconomics is to study the equilibrium state of

consumer and producer. It deals with the equilibrium of a consumer which means

it is related with how consumer maximizes his satisfaction by given resources. It

deals with the situation of producer’s equilibrium which means it studies how he

allocates his limited resources to get maximum profit. Micro economics tries to

study the market economy where price is very important factor. It means micro

economics explains how price of particular product and factor is determined on

the basis of demand and supply. So, micro economics is known as Price theory.

Microeconomics makes the economic analysis with the help of assumptions like

other things remaining the same (ceteris peribus).

Assumptions of microeconomics

Microeconomics makes the study of individual unit with following points

i) Full employment in the economy

ii) Resources are given

iii) Total output is fix

iv) General price level is given

Microeconomics makes economic analysis with assumptions like ceteris peribus.

It studies the equilibrium of particular sector assuming other all sectors constant.

So, it is known as partial equilibrium analysis. Microeconomics can be understood

with the following ideas.

i) Allocation of resources

Microeconomics explains the use of scarce resources to maximize satisfaction or

profit. It deals with the what, how, how much and to whom to produce.

ii) Theory of price

Microeconomics is related with the determination of price of particular product

and price of particular factor in the respective market on the basis of their

demand and supply.

iii) Theory of economic welfare

Microeconomics is related with efficient utilization of factors of production and

other resources to attain maximum return.

Hence, microeconomics aims to achieve economic efficiency in production,

consumption, distribution and exchange to increase economic efficiency

Macroeconomics

The word macro is derived from the Greek word micros which means big or

aggregate. It means macro economics is the study of aggregate economic units

such as national income, total product, general price level, aggregate demand and

aggregate supply etc. Macro economics is the study of any subject as a whole. It

means it studies forest not the tree.

The main objective of the macroeconomics is to maintain economic stability

through monetary stability and price stability. Basically, it studies aggregate

demand and aggregate supply where aggregate demand is consumption and

investment expenditure.

According to K. E. Building,’ Macroeconomics is that part of economics which

studies overall averages and aggregate of the system rather than particular unit’.

It can be said that macroeconomics studies functioning of economy as a whole. It

is related with the formulation of macroeconomic plans and policies like fiscal and

monetary policies. So, it is known as policy science. Fiscal and monetary policies

are economic tools that help to solve practical problems of economy.

Assumptions

Macroeconomics assumes individual economic units given and studies aggregate

of all individual variables.

i) Individual price and wage are given

ii) Individual income is given

iii) Employment of individual factor is constant

Since, macroeconomics studies equilibrium of all economic variables or sectors at

a time together it is known as general equilibrium analysis. Macroeconomics can

be understood with the following features.

i) Theory of income and employment

It deals with the determination of total income and total employment in the

economy with the help of aggregate demand.

ii) Theory of general price

It studies the average price of the whole economy assuming individual price

constant. Similarly, under the theory of general price level it deals with the

inflation, deflation, money and banking etc.

iii) Theory of economic growth

Economic growth refers to the change in rate of growth of primary, secondary

and tertiary sectors as a whole. It requires increase in the living standard of

people. Macroeconomics formulates fiscal and monetary policies for economic

growth.

iv) Modern theory of distribution

It is related with the determination of aggregate price of factors of production in

the form of rent, wages, interest and profit. It determines the relative share of

factors in national income. So, it is known as distribution theory.

Thus, macroeconomics is related with the economic system as a whole.

Importance of Economics in economic analysis

Importance of microeconomics

Micro economics is the study of individual economic units and has following

importance

i) To understand working of economy

It helps to know how an economy operates by the study of behavior of micro

economic variables like individual income, production of single firm, price of

particular firm etc.

ii) To solve current economic problem

Micro economics helps to solve the current economic problems such as poverty,

pollution, inequality etc.

iii) Efficient allocation of resources

Microeconomics develops economic theories like theory of cost, production,

exchange etc. Which helps to make productive use of resources that brings

efficiency in the economy.

iv) Price determination

Microeconomics helps in the determination of price of particular product and

price of particular factor in the respective market on the basis of their demand

and supply.

v) Policy formulation and implementation

Microeconomics helps to formulate and implement the policies like price policy,

trade policy etc. with the study of individual units.

vi) To understand the macroeconomic variables

To understand some macroeconomic variables like national income, general price

level, aggregate demand, and aggregate supply etc. microeconomic variables are

necessary. For example, to know about NI we must know the individual income.

Importance of Macroeconomics

Macroeconomics which studies aggregate economic variables has the following

importance.

i) To know the functioning of economy

Functioning of the economy is studied with the study of behavior of the aggregate

economic variables like NI, AD, AS, etc.

ii) Formulation of Economic policies

Macroeconomics is known as policy science because it is mainly related with the

policy formulation. In modern period, it helps to formulate policies like

investment policy, trade policy, fiscal policy etc.

iii) Economic growth and economic development

For economic growth and economic development it requires higher rate of

increase in total production and income. Various macroeconomic plans and

policies help to promote investment, production and hence economic welfare. It

makes economic development ultimately.

iv) Economic stability and monetary stability

Macroeconomics analyzes money supply and general price level and helps to

control inflation deflation etc. it leads to economic and monetary stability.

v) To solve various problems

Macroeconomic helps to solve the various socio economic problems of the

society with the formulation of accurate macroeconomic policies.

vi) To understand microeconomic variables

Every individual unit is explained and measured with the help of aggregate of that

unit. For example, price of a particular product explained or determined by

general price level and wages of single labor depends on national wage policy.

Similarly macroeconomics helps to determine the relative share of factors of

production in national income. It means it helps to distribute NI

Distinguish between micro and macro economics

Though Micro economics and macroeconomics seem interdependence to each

other, they have some distinct features. They are

Microeconomics focuses on allocation of resources assuming full

employment in the economy where macroeconomics focuses on

achievement of full employment in the economy.

Under microeconomics market equilibrium is determined by individual

demand and supply where in macroeconomics such equilibrium is

determined by AD and AS

Micro economics is static analysis because it explains equilibrium at

particular time. Where macro economics is dynamic analysis which deals

with rate of change

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