Lecture 1 Nature of Economics Definitions. Difficult to Define Economists like Pareto, Myrdal and Hutchinson think that any search for a precise definition.

Lecture 1

Nature of EconomicsDefinitions

Difficult to Define• Economists like Pareto, Myrdal and

Hutchinson think that any search for a precise definition of Economics is a barren enterprise

• Many economists thought it is needless to waste words in defining Economics

• However, it is essential for a student to have some definition in mind as working basis

Early Definitions• According to Adam Smith – Economics is concerned with an enquiry into nature and causes of

wealth

• Craines in his book said– Economics deal with the phenomenon of wealth

• According to a French economist J.B. Say– Economics is science which treats of wealth

• The American Economist, F.A Walker is of the view that– Economics is that body of knowledge which relates to wealth

• In all these definitions, key position is assigned to WEALTH

Problem with Early Definitions• Too much emphasis on wealth

• This led to development of view that Economics teaches selfishness and came to be called a “dismal science”

• S.Baliey in 1835 discussed the popular view of Economics as:– The unworthiness of political economy in public opinion

stemmed directly from its explicit preoccupation with so degrading a subject-matter as wealth

• Thus, all the vices attributed to wealth became attached to the science of wealth (i.e Economics)

Change in Definition• In the last quarter of the 19th Century

humanistic character of Economics had come to be well recognized

• Schaffle in Germany and Droz in France placed the role of man in Economics higher than that of wealth

• It is now fully recognized that wealth is only a means to an end, the end being human welfare

Marshallian Definition

• Marshal said– 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

Study of Marshall’s Definition• Marshall’s definition puts emphasizes on four

points:– Economics does not regard wealth as the be-all and end-

all of economic activities– Economics is not concerned with ‘economic man’ but is

concerned with an ‘ordinary man’– Economics is a social science and not one which studies

isolated individuals – Economics studies only ‘material requisites of well-

being’ or causes of material welfare

Criticism on Marshallian View• Lionel Robbins criticized Marshall’s definition on following grounds:

– It is not right that an economists confine their attention to the study of material welfare• because in the actual study of economic principles, both the

‘material’ and non-material things

– Marshall’s definition is classificatory• because it makes a distinction between material welfare and non-

material welfare

– It unduly restricted the scope of Economics• All those sums which are paid for ‘immaterial’ services e.g. services

of doctors or lawyers etc. Contd…

Criticism on Marshallian View– Welfare is too vague and indefinite an idea to provide a sound

foundation for building up a respectable science• e.g intoxicants are regarded as wealth but cannot be regarded as

good for human welfare• Idea of welfare vary from age to age, country to country and from

individual to individual

– In assessing welfare, a verdict is needed that what is conductive to human welfare and what is not• This would led us to world of ethics where as Economics is neutral

– According to Marshall, Economics deals with persons living in society. It ignores all others who also may have an economic problem • i.e. of using scarce means for the satisfaction of unlimited ends

Robbins, Definition

• Robbins defined Economics as

– Economics is the science which studies human

behaviour as a relationship between ends and

scarce means which have alternative uses

Study of Robbins’ Definition• Robbins’ definition lays down the following three

fundamental propositions which constitute basis of the structure of economic science– “Ends” refer to wants. Human beings have wants

which are unlimited in number– Wants are unlimited but the means to satisfy them

are strictly limited– Scarce means are capable of alternative uses

• Thus, in Robbins’ sense, economic activity lies in man’s utilization of scarce means having alternative uses, for the satisfaction of multiple ends

Superiority of Robbins’ Definition• Robbins claimed that his definition is superior to

earlier definition because– Independent of classification of material and non-

material wants– Takes into account all kinds of wants– Elevation of economics to a science – No longer function of economics to judge right or

wrong economic activity– It transcends the narrow boundaries within which the

materialist definition confined Economics– Economics to be no longer called “dismal science”

• Thus, the Robbins’ definition is superior both to the early definition (science of wealth) and Marshall’s definition (science of material welfare)

Criticism on Robbins’ Definition • Robbins’ definition attracted following criticism– Robbins reduced economics to only valuation theory.

• Other aspects of the study of economics have been relegated to the background e.g aggregates

– Individual choices having no social implications cannot form the basis of subject-matter of Economics

– Economic growth and economic development has not been covered by Robbins’ definition

– This definition does not explain problem of unemployment

– Human touch is entirely missing– Robbins has made Economics more abstract and

complex and hence difficult and fruitful

Modern Definitions• The credit of bringing about a revolution in

economic thinking goes to Lord J.M. Keynes. According to him– Economics studies how the levels of income and

employment in a community are determined • Thus, in Keynesian terms, Economics is defined as– The study of the administration of scarce resources

and of the determinants of income and employment• In Benham’s words– Economics is a study of factors affecting the size,

distribution and stability of a country’s national income

Conclusion Regarding Definition• There is no short definition of growing science like

Economics would serve the purpose

• One may agree with Prof. Viner that– Economics is what economists do– Economists do resource allocation or resource utilisation. They

study size, distribution and stability of national income and economic growth

• In short, Economics may be defined as – A social science concerned with the proper uses and allocation

of resources for the achievement and maintenance of growth with stability

• Prof. Henry Smith defined Economics as– Study of how in a civilized society one obtains the share of what

other people have produced and of how the total product of society changes and is determined

Major Economic Problems

• What is an economic problem?– In view of the scarcity of means at our disposal

and the multiplicity of ends we seek to achieve – The economic problem lies in making the best

possible use of our resources so as to get maximum satisfaction in case of a consumer and maximum output or profit for a producer

Fundamental Problems • What to produce?

– Quantity and range of goods to produce– Resources are limited, we must choose between different

alternative collection of goods and services that may be produced

• How to produce?– Techniques of production e.g labor intensive, capital intensive

• For whom to produce?– It means that how the national product is distributed i.e. who

should get how much• Are the resources economically used?

– No wastage ro misutilization of resources since they are limited• Problem to full employment?

– Economy must endeavor to achieve full employment not only of labor but of all its resources

• Problem of growth?– Economy must expand or develop to maintain conditions of

stability

Nature of EconomicsScope and Method

Two Main Streams • The study of Economics is divided into two

parts on the basis of looking the system as whole or in terms of its innumerable decision-making units– Micro Economics• It is also called Price Theory

– Macro Economics• It is also called Income Theory

Micro Economics• The word ‘micro’ means a millionth part• In ‘micro economics’ we analyze small part or

component of the whole economy– e.g. individual consumer’s behaviour or firm, price of

particular product or factor of production, employment in firm or industry

• In simple, micro-economic theory studies the behaiour of individual decision making units such as consumers, resource owners and business firms

• The basic assumption in micro economic analysis is full employment in the economy as whole

Importance of Micro-economics• It tells us how millions of consumers and producers take decisions

about the allocation of productive resources among millions of goods and services

• It explains how through market mechanism goods and services produced in the community are distributed

• It also explains the determination of the relative prices of the various products and productive services

• It explains the conditions of efficiency both in consumption and production and departure from the optimum

• Micro-economics helps in the foumulation of economic policies calculated to promote efficiency in production and the welfare of the masses

Limitation of Micro-economics

• It cannot give an idea of functioning of economy as a whole– An individual industry may be flourishing but

economy as a whole may be languishing

• It assumes full employment which is a rare phenomenon in the capitalist world– Therefore an unrealistic assumption

Macro-economics• Macro economics is concerned with aggregates and

averages of the entire economy – E.g national income, aggregate output, total employment,

total consumption, savings and investment, aggregate demand, aggregate supply, general level of prices etc.

• In macro-economics, we study how these aggregates and averages of the economy as a whole are determined and what causes fluctuations in them

• • Macro-economics also analyses the chief determinants

of economic development and the various stages and processes of economic growth

Importance of Macro-economics• It is helpful in understanding and functioning

of a complicated economic system– It gives bird’s eye view of the economic world

• It is useful in framing economic policies for the nation

• Macro-analysis also occupy an important place in economic theory in its pursuit of the solution of urgent economic problems– These problem relate to aggregate output,

employment and national income

Limitations of Macro-economics

• Individual is ignored– It is individual welfare which is the main aim of

Economics

• The macro-analysis overlooks individual differences– e.g. general price level may be stable but the

prices of food grains may have gone spelling ruin to the poor

Integration of Macro and Micro-economics

• Neither the two approaches (micro and macro) can alone adequately help us in analysing the working of the economic system

• It is, therefore, essential to integrate two approaches

• Ignoring one and exclusively concentrating attention on the other may often lead not only inadequate or wrong explanation but also to inappropriate or even disastrous remedial measures

Is Economics Science or Art?• By science we merely understand a systematized body of

knowledge.– It is not merely collection of facts but the facts so arranged

that they speak for themselves.– That is how laws are discovered which explain and elucidate

the facts. – When laws are formulated then a branch of knowledge

become a science• Judged by this standard, Economics is certainly science.– The economist collects the facts, facts have been carefully

analyzed and put under suitable classification, and general principles governing these facts have been discovered and enunciated

• Economics is not only science but also an art– It is a science in its methodology and an art in its application

Positive or Normative Science• Whether Economics is Positive Science or Normative

Science?– Positive science explains WHAT IS– Normative science explains WHAT OUGHT TO BE i.e right

or wrong of a thing– In simple words, positive science ‘describes’ while

normative science ‘evaluates’

• Some early economists, like J S Mill, Robbins, Craines; were of the view that Economics is just a positive science

• However, Cairnes and Macfie talked about normative character of Economics

Can Economics Solve Practical Problems?

• Kenyes said– The theory of Economics does not furnish a body

of settled conclusions immediately applicable to policy.

– It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions

Limitations of Economics• Economics cannot predict the future events

since its laws lack definiteness

• No magic formula by which schemes of social betterment can be tested nor a sovereign remedy to economic ills

• It is not business of the economist as such to decided whether large armaments are necessary or not

Laws of Economics• Like every other science, Economics, too has drawn its own set of

generalizations, which are called laws of Economics

• The nature of economics law is not indicated by the word – “must”, as in the case of statute law, or– by “ought” as in the case moral law;– But their nature is indicated by phrase “other things being equal”

• Economics laws lacks definiteness and exactitude

• Economics laws are said to be hypothetical or conditional since their validity depends on fulfillment of certain conditions

• Economic laws are inevitable and inescapable if some necessary conditions are fulfilled– But these conditions are not always fulfilled– Therefore, economic laws lack predictability

Basic Assumptions in Economics• There are three broad assumptions– Behaviour of individuals • i.e. they behave in a rational manner

– Consumer needs maximum satisfaction, labour purse for higher wages and entrepreneur seeks maximum profits

• It is called maximization principle

– Consumers tastes remain unchanged for fairly long periods of time

– There is a perfect competition in the economy

Methods of Economics

• Like other sciences Economics also uses scientific methods. These methods are:

– Deductive Method

– Inductive Method

– Proper Method

Deductive Method• Economists of Classical School tried to build up the science of Economics

from few simple generalizations– e.g. self-interest alone guides men in their daily life and they try to explain and

predict all human behavior in terms of self interest

• Classical economists by and large supported this method• Merits of Deductive Method

– Useful in analyzing complex economic phenomenon– This method yields exact and true conclusions

• Provided the premises on which they are based are true– It is very simple and easy of application– When data is not available or inadequate then this method is useful for

drawing inferences

• Limitations of Deductive Method– There is a big ‘IF’ in applying deductive method

• i.e. if those assumptions are correct– This method made Economics dogmatic– This method is dangerous when universal validity is claimed for generalizations

based on imperfect or incorrect assumptions

Inductive Method• Historic school represents reaction against the dogmatic attitude of

followers of deductive method

• This method insists on the examination of facts and then laying down general principles– Here we go from “particulars” to “generals”

• Merits– This method can be applied for the verification of conclusions based on

deductive reasoning– Economic phenomenon is too complex for deductive reasoning. It is better

to use inductive method– This method is more suitable and useful in the formulations of economics

policies

• Limitations– This method dangerous when hurried conclusions are drawn on

insufficient number of facts

Proper Method• The modern economist does not rely on one

method. He uses both. It is said– “Induction and Deduction are both needed for

scientific thought as the right and left foot are both needed for walking”

• The deductive method seems to be more suitable in the field of pure theory and inductive method for formulating practical policies

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