What is Economics?
Economics is the study of how humans make decisions in the face of scarcity. These can be individual decisions, family decisions, business decisions or societal decisions.
Resources, such as labour, tools, land, and raw materials are necessary to produce the goods and services we want but they exist in limited supply.
The ultimate scarce resource is time- everyone, rich or poor, has just 24 hours in the day to try to acquire the goods they want. At any point in time, there is only a finite amount of resources available.
Consider a world without scarcity. If infinite quantities of all goods and services were easily produced and all demands were easily met, would there be any economic problems ?
- Business would not worry about cost of labour or availability of raw material; Government would not worry about taxes, subsidies and other economic policies; Consumer would not worry about Prices and Availability of goods. It is because there would not have been any demand and supply problem.
- In every country in the world, there are people who are hungry, homeless , and in need of healthcare, just to focus on a few critical goods and services. Why is this the case? It is because of scarcity.
Three Central Problems that are faced by every Economy in the World
Production, distribution and disposition of goods and services are the basic economic activities of life. In the course of these activities, every society has to face scarcity of resources. Because of this scarcity, every society has to decide how to allocate the scarce resources.
It leads to following Central Problems that are faced by every economy:
1. What to produce?
2. How to produce?
3. For whom to produce?
These problems are called central problems because these are the most basic problems of an economy and all other problems revolve around them.
What to Produce:
This problem involves selection of goods and services to be produced and the quantity to be produced of each selected commodity. Every economy has limited resources and thus, cannot produce all the goods. More of one good or service usually means less of others.
- Immediately after independence, India confronted with the problem of food grain shortage and started importing wheat from USA under 1954 Food Aid Program. But after the war with Pakistan in 1965, the changing geopolitics led to scrappage of food aid by US
How to Produce:
This problem refers to selection of technique to be used for production of goods and services. A good can be produced using different techniques of production. By ‘technique’, we mean which particular combination of inputs to be used. Generally, techniques are classified as: Labour intensive techniques (LIT) and Capital intensive techniques (CIT).
- In Labour intensive technique, more labour and less capital (in the form of machines, etc.) is used.
- In Capital intensive technique, there is more capital and less labour utilization.
In any economy govt determine who will do the production and with techniques. Whether Labour intensive technique or Capital intensive technique should be followed. For example MNREGA was started in 2006 to create rural assets, it's labour intensive technique.
Whom to Produce:
This problem refers to selection of the category of people who will ultimately consume the goods, i.e. whether to produce goods for more poor and less rich or more rich and less poor. Since resources are scarce in every economy, no society can satisfy all the wants of its people. Thus, a problem of choice arises.
- Government needs to take decision regarding who will be the beneficiary of production activities. For example LPG connections to BPL families, Rural electrification etc
Various Types of Economy
There are four types of economic systems –
1. Traditional Economic System
This economic system retains essential characteristics in which there is very less specialization or division of labour.
A traditional economic system is most likely to be found in rural settings, or in such developing nations where farming is predominant. Such settings usually have very few resources to share.
2. Command Economic System
Command or Socialist economic system has a dominant centralized authority in the form of government. The economy in such a country is controlled by the government. It is the sole decision-making authority for determining production and allocation.
Ideally, the command system takes into consideration the best interest of its populace.
3. Market Economic System
Market economic system or capitalist economy involves very less government interference and incorporates the principles of the free market. There is a scant exercise of control over resources. Market forces regulate demand and supply.
However, there does exist some degree of government intervention in the form of regulations against monopoly, and in favor of fair trade.
4. Mixed Economic System
A mixed economic system combines the features of both socialist and free-market economic systems. It is also known as dual systems. Most of the countries today have a mixed economic system with the existence of both public services as well as private industries.
Parameters | Market Economic System | Command Economic System | Mixed Economic System |
Determination of price | Demand and supply in a market determine the price | The central authority, most likely the government, decides prices of goods and services | Price is influenced by market forces of demand and supply as well as government regulations, in certain instances |
Property ownership | Ownership vests with private entities | There is public ownership of property | Property is owned by both public and private entities |
Production | Production is undertaken only with a profit motive | The underlying objective of production is social welfare | Production in a mixed economy includes both profit motive and social welfare |
Competition | There exists competition among entities present in such market | There is no competition in a market owing to State ownership of firms. | Only entities in private sector experience competition |
Government intervention | Government has very less role to play in a market economic system | The government retains full control over firms | Government has a full holding in the public sector but a limited role in its private counterpart |
Various Sectors of Economy
1. Primary Sector
Primary sector in an economy has a direct interface with the environment for purposes of production. Instances of the primary sector are agriculture, farming, mining, and fishing, among others.
Importance of the primary sector relates to the harvesting of products or extraction from the environment for procuring basic food and raw material. The end purpose of the primary sector is to utilize natural resources optimally.
2. Secondary Sector
In the secondary sector of an economy, raw materials are converted into products that are fit for both consumption or sale and helps to move away from a primitive economic system. For example, the secondary sector helps a country to move from agriculture or other similar activities towards a developing market.
In India, the secondary sector holds about 20% of gross domestic product. It helps to provide greater job opportunities to the populace at large.
3. Tertiary Sector
The Tertiary sector primarily covers the service sector, and therefore, focuses on service exchanges and production. Examples of the tertiary sector are – insurance, banking, communication and transportation, among others.
The tertiary sector's significance is on the rise due to rapid technological developments in various basic essential services. These basic services include healthcare, police, banking, etc.
A most significant benefit of the tertiary sector is that it has a lower barrier of entry for businesses.
Quaternary sector and Quinary sector
The Quaternary sector is based on Knowledge, skill and Intellectual Activities. It is sometimes called the knowledge economy.
- Activities associated with this sector include government, culture, libraries, scientific research, education, and information technology. These intellectual services and activities are what drive technological advancement, which can have a huge impact on short- and long-term economic growth.
The Quinary sector represents the highest category of decision makers or policy makers.
- People involved in this sector are called ‘gold collar’ professionals because they are highly skilled and paid senior business executives, research scientists, legal and financial consultants.
The services provided under the quinary sector can’t be completely outsourced whereas services involved in Quaternary type of economy are outsourced in varied forms as the doctor’ services, elementary schools and university classrooms, theaters, and brokerage firms.
Over half of all workers In developed economies are in the ‘Knowledge Sector’ and there has been a very high growth in demand for and consumption of information based services where as quinary services have been limited to a small section of population with large influence.
What are the factors of production? Input and Output
Inputs are the goods and services that can be used to produce goods and services. For example Bricks, cement, sand, labour are inputs required to manufacture building.
Outputs are various goods and services produced with the help of Inputs in the production process, can be consumed or further employed for production
Input is also called as Factors of Production - Land, Labour, Capital and Entrepreneurship. The Payment made for these are called as Factor Income or factor cost - Rent, Wage, Interest and Profit
Land – Land is the term for the natural resources on earth that are used to produce a good or service. For example if a farmer rents or buys a field, he is using land as an input to produce crops.
Labour – This is the human effort that is used in the production of a good or service. If the farmer employs people to work on his land, he is using labour as an input to produce crops.
Capital – Capital is the term used to describe human-made goods like tools and machinery that are used to produce goods or services. If the farmer buys a combine harvester to produce more crops, he is using capital as an input to produce crops.
Entrepreneurship – Entrepreneurship is when an individual takes an idea or innovation and tries to combine all the factors of production in order to make profit. If our farmer thinks of a new and potentially risky idea to increase the profits of the farm, he is using entrepreneurship as an input to produce crops.
Types of Goods in Economics
Final Goods - An item that is meant for final use and will not pass through any more stages of Production or transformations is called Final Good
Consumer Goods - Those final goods which directly satisfy the wants of consumers. Such goods are bread, milk, pen, clothes, furniture, etc.
Consumer goods are further classified into durable and non-durable goods.
- Durable goods are those which can be used in consumption again and again over a considerable period of time, e.g., chair, car, fridge, shoes, TV set.
- Non-durable goods are like single use goods which are used up by consumers in a single act of consumption, e.g., milk, fruits, matches, cigarettes, coal, etc.
Capital goods are fixed assets of producers which are repeatedly used in production of other goods and services.
Intermediate goods - Goods sold by one firm to another for resale or for further production are called intermediate goods.
- Examples are steel sheets used for making automobiles and copper used for making utensils. Cotton from the fields is sold to the spinning mill where it is transformed into yarn
Frequently Used Terms in Economics
Factor Cost : This is the input cost the producer has to incur in the process of producing something. You can also say it as factory cost.
Market Cost : This is derived after adding indirect taxes to the factor cost of the product. This is the cost at which the goods reach to the market.
Nominal Income : The wage one gets in hand per day or month
Real Income : Nominal Income - Inflation Adjustment
Economic Product - Goods and Services that are produced to be sold at market price and goods & services that are produced by the government and public organizations are treated as economic products.
- Economic Products include marketable and non-marketable goods. In estimating national income only economic products are included.
- Non-marketable good are the goods that are not traded in the marketplace (“nonmarket goods” such as clean air, clean water, healthy ecosystems, baby sitting, house cleaning and lawn mowing etc.)
Non-Economic Product - It includes services rendered to self, to family, to relation and neighbors. Non-economic products are not included in national income.
Perishable and Non Perishable - Perishable foods are fresh foods that are likely to spoil if you do not refrigerate or freeze them, and include dairy products, poultry, meat, fish and most cooked leftovers
Non-perishables are foods that have a long shelf life, with examples including honey, dried fruits, dried grains, dried pasta, white rice.
Tangible goods and service is one where there is a physical object that is supplied or procured - for example, in a hotel, when you get a plate of meals, it is a physical thing
Intangible goods and service is one where there is no physical objects is supplied or procured - For example, patents, copyrights, and a company's brand.
- Tangible means anything which we can touch, feel and see
What is Transfer Payment?
Payment made by the people to other people, organizations or to the government without any equal transfer in return are treated as transfer payment. For Example, Gifts paid to relative ad friends, donations given to social organization.
A Transfer payment is a redistribution of income and wealth by means of the government making a payment, without goods or services being received in return.
Governments use such payments as means of income redistribution by giving out money under social welfare programs such as social security, old age or disability pensions, student grants, unemployment compensation
However, Subsidies paid to exporters, farmers, manufacturers are not considered transfer payments. Transfer payments are excluded in computing National Income Accounting.
