Approved by the Government of Nepal, Ministry of Education, Science and Technology,
Curriculum Development Centre, Sanothimi, Bhaktapur as an Additional Learning Material
vedanta
HIGH SCHOOL
ECONOMICS
9Book
Author
Sanjay Karki
vedanta
Vedanta Publication (P) Ltd.
Vanasthali, Kathmandu, Nepal
+977-01-4382404, 01-4362082
[email protected]
www.vedantapublication.com.np
vedanta
HIGH SCHOOL
ECONOMICS
9Book
Author
Sanjay Karki
All rights reserved. No part of this publication may
be reproduced, copied or transmitted in any way,
without the prior written permission of the publisher.
Vedanta Publication (P) Ltd.
First Edition: B.S. 2077 (2020 A. D.)
Layout and Design
Pradeep Kandel
Printed in Nepal
Published by:
Vedanta Publication (P) Ltd.
Vanasthali, Kathmandu, Nepal
+977-01-4382404, 01-4362082
[email protected]
www.vedantapublication.com.np
Preface
I have immense pleasure to bring out the book ‘High School Economics’ which is
designed strictly in accordance with the syllabus of Economics for Class IX prescribed
by the Curriculum Development Centre, Ministry of Education, Government of Nepal.
I have made a careful effort with this edition to incorporate features that will facilitate
the teaching and learning of economics. The book has been written in a very simple
language to suit the students for whom it is their first book about economics. The matters
are dealt with exhaustively within the parameters set for Class IX students. Concepts
and terms have been clearly defined and presented wherever necessary in the form of
‘Keynote, Glossary, Key Idea and Checkpoint.’ The underlying idea is to provide the
reader general understanding of economics as a subject more clearly and analytically.
In addition, Reading Between the Lines, Economist’s Profile, Eye on the Past and Did
You Know? have been incorporated to make the study refreshing and meaningful. Unit
Summary is provided at the end of every unit to enable the reader quick recap of the
matter studied. Each unit contains an exercise with very short answer, short answer,
and long answer questions as per CDC specifications.
I am thankful to Vedanta Publication (P) Ltd. Kathmandu for getting the series published.
I would like to thank Chairperson Mr. Suresh Kumar Regmi, Managing Director
Mr. Jiwan Shrestha, Academic Director Mr. Hukum Prasad Dahal and Marketing Director
Mr. Manoj Kumar Regmi for their invaluable suggestions during the preparation of the
series.
Thanks are due to my wife Deepa Karki for her support in the course of writing this
book. I am thankful to Mr. Pradeep Kandel, the Senior Designer of the publication
house for his skill in designing the series in attractive form.
I would like to mention my two children Sayon and Anu. Their contribution to this
book was putting up with a father spending too many hours in his study while working
on this book.
Finally, I take responsibility for errors and shortcomings. I would always invite critical
views and suggestions for improvement of the book from both students and fellow
teachers.
Sanjay Karki
Maryland, United States
CONTENT 1
33
Unit 1 Introduction 49
Unit 2 Utility Analysis 73
Unit 3 Demand and Supply Equilibrium 109
Unit 4 Factors of Production 121
Unit 5 National Income 145
Unit 6 Economic Resources 179
Unit 7 Agriculture, Cooperatives and Industry 193
Unit 8 Theory of Production 207
Unit 9 Household Economics
Unit 10 Contemporary Economics Issues
1UNIT INTRODUCTION
Learning Objectives Weight: 19 Lecture Hours
On Completion of this unit the student will be
able to:
• Define and understand the meaning of
economics
• Compare wealth, welfare and scarcity
definition of economics
• Explain the subject matter of economics
• Explain the nature of economics
Understand the concept of positive
• you begin
Beforeeconomics and normative economics
• Acquaint with basic economic term and Economics is the study of how society man-
concepts ages its scarce resources. It provides us
• Understand the concept of microeconomics with important insights into addressing not
and macroeconomics only some of the most important questions
• Explain the importance of economics societies face but also much ‘smaller’ ques-
tions: ones that affect all of us.
Very Short Type Short Type Long Answer Type Total Marks
1 2 0 11
5 Vedanta High School Economics - Book 9
1.0 INTRODUCTION
The word “Economics” originates from the Greek word “Oikonomos”, which
means“one who manages a household ” or management of household affairs.
A household must allocate its scarce resources among its various members as per
their abilities, efforts, and desires. As such, Greek philosopher Xenophon considered
economics as the science of household management.
Like a household, a society has to make decisions with respect
Economics stud-
ies how the scarce to allocation of resources. It has to find some way to decide what
resources are al- jobs will be done and who will do them. It must also allocate the
located and choices output of goods and services they produce. The management of
are optimized by society’s resources is important because resources are scarce and
economic agents have alternative uses as well. This requires economizing scarce
resources.
Economics is the study of how society manages its scarce resources. It studies how
people make decisions: how much they work, what they buy, how much they save,
and how they invest their savings. Economics is the study of the way people choose to
use their limited resources. Resources such as land, labor, capital, and entrepreneurship
do not exist in endless supply. Economists also study how people interact with one
another.
Samuelson: Economics is the study of how societies use scarce resources to produce
valuable goods and services and distribute them among different individuals.
L.G Reynolds: Economics is about economizing; that is, about choice among alternative
uses of scarce resources. Choices are made by millions of individuals, businesses, and
government units. Economics examines how these choices add up to an economic system,
and how this system operates.
1.1 DEFINITION OF ECONOMICS
Economics is hard to define, partly because it is so all encompassing. Although the
history of economics is thousands of years old and a full explanation of economics
would be literally impossible to provide in a nutshell.
Economics as a subject came into being with the publication of “An Enquiry into the
Nature and Causes of Wealth of Nations” in 1776 A.D by Adam Smith. Prior to it, it was
called Political Economy. In fact, the ‘Wealth of Nations’ is a landmark in the history of
economic thought that separated economics from other social sciences.
Different philosophers at different times had defined and applied economics differently. Each
definition lays stress on a particular aspect of economic activities. The various definitions of
economics can be classified into three groups.
1. Wealth definition of economics (Classical) The publication of Adam
Smith’s The Wealth of Na-
2. Welfare definition of economics (Neo-Classical)
tions in 1776, has been de-
3. Scarcity definition of economics (Modern) scribed as “the effective birth
of economics as a separate
Scarce: Limited in quantity discipline.”
Glossary Entrepreneur: An individual who creates a new business, bearing most of the risks
and enjoying most of the rewards.
Nutshell: Brief, in short
Vedanta High School Economics - Book 9 6
A WEALTH DEFINITION - The Classical Definition of Economics
In his book, “An Enquiry into the Nature and Causes of the Wealth
of Nation” published in 1776 A.D. Adam Smith, the father of
economics defined economics as a science concerned with the nature
and causes of wealth of nations. According to him acquisition of
wealth is the main aim of human activity. Hence it is necessary and
important to study how wealth is produced and consumed. He view
was supported by other classical economists like J.E. Cairnes, J.B.Say,
F.A.Walker and J.S Mill who all defined economics as a science of wealth.
Smith- “Economics is the science of wealth”
Say- “Economics is the science which deals with wealth”
Walker- “Economics is that body of knowledge which relates to wealth”
Mill - “The practical science of the production and distribution of wealth”
All these definitions centred on wealth as the core of the study of economics. Hence these
definitions are grouped under wealth definition of economics.
Adam Smith is known Adam Smith considered economics as a subject which studies
as the Father of Eco- consumption of wealth, production of wealth, exchange of wealth
nomics because he and distribution of wealth. He was of the view that economics
was the first person is concerned with the problems arising from wealth-getting and
who put all the eco- wealth-using activities of people. It is the study of economic man
nomic ideas in a sys- whose entire activities are wealth centred. He was interested mainly
tematic way.
in studying the ways by which the wealth of all nations could be
increased.
The main features of the Wealth Definition definition can be presented as follows:
1. Wealth as the Core of Study of Economics: As per Adam Smith, wealth is of prime
importance. He assumed that the whole effort of human society is directed towards
earning wealth. According to him, wealth is the pivot of all economic activities.
2. Study of the Wealth of Nation: Economics enquires into the nature and the causes of
wealth of nations. It deals with consumption, production exchange and distribution of
wealth.
3. Role of Economic Man: According to Adam Smith, economics studies the activities and
behaviour of economic man. An economic man is a person whose sole motive is to earn
wealth.
4. Primary Importance to Wealth: The wealth definition accords top priority to wealth
rather than mankind. Mankind in accorded secondary place in economic life. According
to him, mankind lives for the sake of wealth and wealth is a means for the betterment
of mankind.
5. Source of Wealth: According to Adam Smith, the only one and most important source
of wealth of a nation is wages earned by active labour. Active labour can earn high
amount of wages through division of labor in production and distribution of goods and
services in the country.
6. Material Goods constitute Wealth: Only material goods constitute wealth in the society,
economics has no concern for non-material goods as they do not play any role in the
creation of wealth in the society.
7 Vedanta High School Economics - Book 9
CRTIhTeICwISeMaltShOdFefWiniEtAioLnTHof DclEaFssINicaITl IeOcoNnomists prevailed for about a century. Adam
Smith view of Economics as a science of wealth was criticized by Carlyle, Ruskin and
other economists of the 19th Century. The main criticisms on the definition of Adam
Smith are given in brief as under:
1. A Materialistic Definition: Critics criticised this definition as a materialistic definition as
it gives too much emphasis to wealth and neglect other humanitarian and social welfare
aspects of man. The critics were of the view that mankind is not for wealth rather
wealth should be for the betterment of mankind.
2. Economic Man: Adam Smith considered every human being who wants to earn more
wealth in life as economic man. As per the critics, besides earning money, human beings
do share their feelings of love, sympathy and co-operation in their life for maximum
satisfaction in their life.
3. Narrow Meaning of Wealth: In the definition the word “Wealth” means only material
goods such as vehicles, industries, raw material etc. it does not include immaterial goods
like services of doctor, lawyer and teachers. In modern economics definition the word
“Wealth” includes both material and immaterial goods.
4. Neglect Human Welfare: During the later part of the 19th century, the economists started
realizing the humanistic character of economics. It was visualized that wealth is only
a means to an end, the end being human welfare. Therefore, some economist severely
condemned Adam Smith wealth definition which gives too much importance on wealth
and completely ignored human welfare.
5. Labour not the only Source of Wealth: According to Adam Smith, the main source
of wealth is employed labour. In real, labour alone cannot produce anything. In
the production process, there are other factors of production like land, capital, and
organization including labour. Adam Smith has ignored these aspects.
6. Narrow Scope: Smith treated economics as a sudy of wealth related acivities and had
confined economics only to the study of wealth. This has greatly narrowed the scope of
economics. Key Term
7. Dismal Science: Excessive emphasis on wealth has Dismal science: a derogatory
reduced economics as a science of selfishness and alternative name for econom-
meanness. Social reformers like Thomas Carlyle and ics as a gloomy science
John Ruskin reacted sharply to the wealth concept
of Economics. They branded Economics as a Dismal
Science, Gospel of Mammon and science of bread and butter etc.
Despite the weaknesses, the contribution of Adam Smith to economics cannot be ignored.
He wrote his book at a time when England was on the eve of Industrial Revolution. The
large investments of capital enabled England to produce wealth on a large scale. So it is
natural that Adam Smith emphasized on wealth and considered economics as a science of
wealth.
• The wealth definition of economics is also called the classical definitionKeynote
of economics
• Wealth definition focusses on economic man whose entire activities are
wealth oriented
• Classical economists refer to 18th and 19th century economists
Vedanta High School Economics - Book 9 8
B WELFARE DEFINITION- The Neo Classical Definition of Economics
Alfred Marshall, a pioneer of the Neo classical economists shifted the
focus of economics from wealth aspect of Adam Smith to welfare
aspect. In his book entitled “Principles of Economics” published in
the year 1890 AD, he defined economics as a science of material
welfare. According to him, wealth acted only as means to attain the
ends and wealth should not be treated as end in itself. He was
supported by other neo-classical economists like Pigou, Cannan
and Beveridge.
Marshall - “Economics is the 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 material requisites of well being”
The definition implies that economics studies how material welfare can be promoted
with the use of material resources. Likewise, Cannan and Beveridge defined economics
as:
Cannan -“The aim of political economy is the explanation of the general causes on
which the material welfare of human beings depends”
Beveridge – “Economics is the study of general methods by which men cooperate to meet
their material needs”
The neoclassical economists were of the opinion that the aim of economics is to study
human activities which are conducive to human welfare in its material aspect. As per
Marshall, economics studies wealth, on one hand and on the other hand, it is a part of
the study of man, which is more important.
F eatures of Welfare Definition Key Term
On examining Marshall’s definition, we find that he Material welfare: welfare
has put emphasis on the following points: which can be measured quan-
titatively (in terms of money)
1. Greater Emphasis on Human Aspect: Marshall has given a balanced importance to
Means and Ends, through his definition. He has stated in clear words, that it is on one
hand is the study of wealth and on the other hand, more important to this is the study of
human aspect.
2. Primary Importance to Human: Marshall defined economics as the study of mankind
in relation to wealth. It explains how a man in ordinary business of life earns wealth
and how he utilizes his income to achieve maximum satisfaction. Marshall further
claimed that wealth is for mankind but mankind is not for wealth. Marshall has given
top priority to mankind than to wealth.
3. Study of Ordinary Human Beings: Marshall explained that economics studies about
ordinary human beings. It does not aim to study just about economic men whose main
concern is wealth. It also studies about ordinary human beings in a society who need
feelings of love, sympathy, goodwill and co-operation to make life successful.
4. Material Welfare: Marshall in his definition gave more importance to the means of
material gains or material welfare. According to him, it studies those material resources
on which welfare depends. Material welfare is the satisfaction or utility obtained from
the consumption of physical goods.
9 Vedanta High School Economics - Book 9
5. Study of the Ordinary Business Activities of Life: In his definition, Marshall paid
emphasis to the ordinary business activities. These ‘ordinary business activities’ refers to
those economic activities, which are related to the attainment and utilization of wealth.
6. Social Science: As per Marshall, economics studies the economic As an ethical sci-
activities of people who live in the society. It does not study the ence economics
activities of isolated people of the society such as beggars, saints, relates to econom-
hermits, monks etc. Since economics studies the economic ic activities with
behaviour of the people living in the society, it is also called social sound moral values
science.
7. Ethical Science: Economics is an ethical science. It studies those wants and economic
activities which are ethically and morally good. Unethical and immoral activities like
consumption of liquor, act of bar dancer etc. are outside the scope of economics
8. Normative Science: Economics is a normative science. As a normative science, it is
concerned with the ways and means of promoting material welfare.
Glossary Means: Resources to satisfy human wants
Ends: Wants
Ethics: Moral principles
Normative: Prescribing a norm or standard
CRITICISMS OF WELFARE DEFINITION
The Marshallian definition of economics was popular till the beginning of 20t’
century. Prof-Lionel Robbins criticized Marshall’s definition in his book, “Nature and
Significance of Economic Science,” published in the year 1932 AD. Robbins criticized
Marshall’s definition on the following grounds:
1. Narrow Concept of the Subject: Marshall’s definition only includes material goods and
excludes not material goods like service of a teacher, doctor, lawyer and others. However,
human welfare is not affected only by the measure of material goods produced and
consumed but also by the amount of non-material goods produced and consumed. The
use of the word “Material” in his definition considerably narrows down its scope.
2. Cardinal Measurement of Welfare: Welfare is a state of mind and cannot be quantitatively
measured because of its subjective nature. Because the exact amount of welfare cannot
be measured and the satisfaction derived from purchases, performances and activities
cannot be calculated in exact figures, only assumptions can be made. Also, it differs
from person to person, place to place and age to age. Key Term
3. Vagueness of Ordinary Business Activity: The phrase Cardinal: that which can
used by Marshall, “The activities relating to the ordinary be expressed in quantitative
business of life is unclear and vague, because it is terms
not clear what activities of man come under ordinary
business and what activities are outside its area.”
4. Connection between Economics and Welfare: Marshall tried to establish a connection
between economics and welfare. According to Prof Robbins, Economics has no relation
with human welfare, Many activities do not promote welfare but are rightly considered
as economic activities. For example, alcoholic drinks and cigarettes are bad for our
health. They are produced and sold. There is a market for them. So it is not right to say
that economics studies only material welfare.
Vedanta High School Economics - Book 9 10
5. Non-welfare Consumption: Marshall highly stressed on material welfare rather than
human welfare in his definition. Critics of the definition criticized that some harmful
products such as drugs, tobacco and liquor fulfill some sorts of human wants but do not
promote human welfare. However, such goods form the subject matter of economics as
their consumption involves allocation of scarce resources.
6. Classificatory and Unscientific: Robbins criticized the welfare definition of Marshall
as being classificatory rather than analytical. Marshall has classified human activities
as economic and non-economic activities; resources as material and non material.
According to ProfRobbins, a single human activity can be economic as well as non-
economic according to its purpose. Therefore, no rigid classification is possible for
human activities.
7. Difficult to separate Material and Non-material resources: Marshall According to Mar-
includes only material resources within the scope of economics, shall only material
non-material resources are ignored. In reality material and non- resources promote
material activities cannot be separated on the basis of welfare material welfare
promotion. Even non material resources are found to promote
welfare. They are also related to ethical and social values, but are ignored.
8. Unclear Economic Activities: Marshall has divided human activities in two parts, economic
and non-economic, which is unfair because a similar Key Term
activity of man can be economic and non-economic also Janitor: person employed in
an apartment, office building,
at different times. For example, sweeping his own house etc. to clean the public areas.
by a janitor is a non-economic activity, while sweeping
his employer’s house. becomes an economic activity.
9. Emphasis on Social Science than on Human Science:
Welfare definition of Marshall has regarded economics as pure social science. It studies
human beings who live in a society. But the critics argued that economics should study
all human beings whether they are in the society or outside the society. This is because
economics is not only a pure social science but also a human science.
10. Made Economics an Inexact Science: By introducing ethical concepts like welfare,
Marshall made economics an inexact science. It is rather difficult to measure welfare.
Further, some economic policies which promote the welfare of some people may affect
the welfare of others. Marshall initial interest in
economics stemmed from
the fact that economics was
crucial for the improvement of
the working class. His ethical
stance guided him in his work
on economics.
Keynote • Marshall defined economics as a science of material welfare
• Material welfare refers to welfare which can be measured in quantitative
terms i,e in terms of money
• As per Marshall economics studies only those wants which are ethically
and morally correct
11 Vedanta High School Economics - Book 9
C SCARCITY DEFINITION OF ECONOMICS- Robbins Definition
Lionnel Robbins challenged the traditional view of the nature of
economic science. In his book, “Nature and Significance of Economic
Science”, published in 1932 he gave a definition of economics which
he thought is free from defects. He defined economics as a science of
scarcity and choice.
Robbins- “Economics is the science which studies human behaviour as a
relationship between ends and scarce means which have alternative
uses.”
This definition focused its attention on a particular aspect of human behaviour that
concerns with the utilization of scarce resources to satisfy unlimited ends (wants). It
lays emphasis on the following points:
i. Unlimited Wants: Human wants are unlimited. New wants emerge as soon as existing
wants are satisfied. However all wants are not of equal intensity. Some wants are more
urgent while others can be postponed. Therefore, human wants can never be fulfilled
through out the life time.
ii. Scarce Resources: The resources to satisfy human wants are scarce. So all wants cannot
be satisfied.
iii. Alternative Uses of Resources: The resources which are used to satisfy human wants
are not only scarce, they have alternative uses as well. They can be put into a variety
of uses.
Choice has to be As means are limited, all wants cannot be satisfied. The necessities
made among the should be ranked on the basis of urgency and intensity of wants. This
multiple wants on creates the problem of scarcity. People solve the problem of scarcity
he basis of urgency by allocating scarce resources to the best possible use. This involves
of wants
choice- making. As per the choice made, resources are allocated.
Hence economics is called a science of scarcity and choice.
Features of Robbins Definition
The main features of Robbins definition of economics are as follows:
1. Unlimited Wants: Human wants are unlimited. If one want is satisfied another want
emerge in our mind immediately. There is no end of human needs.
2. Limited Resources: Human wants are unlimited but the means to satisfy them are
relatively limited. The supply of resources is less than its demand. As per Robbins, the
root cause of all economic problems is scarcity of resources.
3. Alternative Uses of Scarce Resources: Human wants are unlimited but the means to
satisfy these wants are scarce. But the scarce means have alternative uses.
4. All wants are not Equally Urgent: According to Robbins, all wants are not equally urgent.
They differ in urgency and intensity. Some wants are more urgent than others. So, more
urgent wants need immediate satisfaction while less urgent wants can be postponed.
5. Problem of Choice: Although human wants are unlimited, all of the wants are not of
equal importance. More important wants have to be fulfilled immediately and less
important wants can be postponed. Depending upon the urgency and intensity of
wants, choice is made among competing wants.
6. Neutrality of Wants: Wants may be good or bad, ethical or unethical, economics study
Vedanta High School Economics - Book 9 12
Glossary them all. It doesn’t comment or make a choice. The choice has to be made by man
himself.
7. Study of Resource Allocation: Economics studies resource allocation. Resources should
be allocated in such a way as to secure maximum possible satisfaction of human wants.
8. Economics as a Positive Science: Economics is a positive science. As a positive science,
it is concerned with the explanation of cause-effect relationship between economic
variables. It also studies resource allocation.
CRITICISMS OF SCARCITY DEFINITION
Though Robbins definition of economics is more scientific as compared to other
definition, it is also not free from defects. The definition of economics given by Robbins
is criticized on the following grounds.
i. Static in Nature: Prof Samuelson pointed correctly that Robbins’ definition is not dynamic
in nature, because it has only discussed about the problems of present generation, not
anything about future generation. Hence the definition suffers with the problem of
economic growth.
2. Confusion between Means and Ends: It is difficult to distinguish between means and
ends. For instance, a post graduate student aims at getting the degree. This becomes an
end for him. Once he gets it, he uses it as a means to get employment. Thus, the same
thing may be means in one situation and the end in another.
3. Economics cannot be Neutral between Ends: The question of allocation of resources
cannot arise without welfare being brought under consideration. Resource allocation
implies choice to be made between competing ends. Choice making requires relative
comparison between ends. So economics cannot be neutral between ends.
4. Absense of Normative Element: As per Robbins, economics is neutral between ends.
This statement has made economics quite colourless, impersonal and devoid of any
normative element. If economics is to serve as an engine of economic welfare, normative
aspect cannot be ignored.
5. Economic Problems Arise not only from Scarcity: As per Robbins’ definition, economic
problem arises due to the scarcity of resources. But problems like unemployment, etc.
also arises due to abundance of resources. The problem of unemployment is not only
due to scarcity of capital but also due to abundance of manpower.
6. Hidden Concept of Welfare: Robbins has criticized the concept of welfare definition of
Marshall, but his definition itself includes the concept of welfare. Robbins’ definition
of economics is concerned with choice between wants and allocation of resources for
maximum satisfaction. In fact, maximum satisfaction implies maximum welfare.
7. Wider Scope than Needed: This definition includes the study of all economic activities
related to allocation of resources. Since all of the economic activities of human life
are included, its scope is vast. It makes difficult to draw the line of demarcation of
economics.
8. Fails to Address Contemporary Economic Problems: Robbins definition fails to explain
contemporary issues of modern economy such as poverty, unemployment, inflation,
trade cycles, economic growth and development etc.
Utilization: To make use of something
Variables: an element, feature, or factor that is liable to vary or change
Allocation: Process of distributing something
13 Vedanta High School Economics - Book 9
SUPERIORITY OF ROBBINS DEFINITION OVER MARSHALL DEFINITION
Robbins’ definition of economics is regarded superior to Marshall’s definition on the
following grounds:
1. Scientific Definition: Robbins’ definition of economics is regarded as more scientific and
analytical. It is not classificatory. Marshall’s definition of economics is classificatory.
Robbins definition is independent of such classification and is thus scientific.
2. Universal Application: Robbins’ definition of economics has universal application. It
is applicable to both planned and unplanned economy. Similarly, it is applicable to
all economic system i.e. capitalist, socialist and mixed economy. Marshall’s definition
lacks such universal application.
3. Wider Scope: Robbins’ definition has widened the scope of economics. As per Robbins,
all types of human wants- material and non material come within the sphere of
economics. While, Marshall focused only on material welfare and has greatly narrowed
the scope of economics. Neutrality of wants
implies no value
4. Uniformity: Robbins definition possesses uniformity and can tell judgement or compar-
whether a particular problem is economic or not. The definition ison between wants
given by Marshall lacks such uniformity. Hence Robbins definition
is considered more scientific and satisfactory.
5. Deals with all types of Human Wants: According to Robbins, all types of human wants;
whether material or non material and those of individuals living in the society or out of
society are dealt in economics. But Marshall’s definition covers only the material wants
and wants of individuals living in the society.
6. Status of Positive Science: Robbins regarded economics as a positive science concerned
with resource allocation and is neutral between ends. It doesn’t make value judgment
and only describes the state of economic events as they are. This aspect of economics
is considered superior to the normative aspects on which Marshall definition is based.
7. Clear Concept of Human Behaviour: Robbins definition provides The problem of choice
a clear view on human behaviour. According to him, human is faced by all econo-
behaviour concentrates for choice and revolves around ends mies and individuals
(wants) and means (resources). Such a clear explanation of human as well
behaviour is not found in Marshall’s definition.
8. Neutral between Ends: According to Robbins, economics is neutral between ends.
Economics is not an ethical science and doesn’t give value judgement. On the other
hand, Marshall definition has an ethical meaning. Economics is expected to pass value
judgement and suggest measures to promote human welfare.
9. Science of Choice: Robbins’ regards economics as a science of choice. It is a realistic
situation since means are always limited in relation to wants. An individual has to
make choice to get maximum satisfaction from limited means. Economics as a science
of choice is considered superior to the Marshallian aspect of economics as a normative
science.
CHECKPOINT 1. Explain the wealth definition of Adam Smith. What are its criticisms?
2. Explain the welfare definition of Marshall. What are its main features?
3. What are the main criticisms of Marshall definition of economics?
4. Critically explain Robbins definition of economics.
5. Explain the superiority of Robbins definition over Marshall’s definition
Vedanta High School Economics - Book 9 14
1.2 SCOPE OF ECONOMICS
Scope means total area or coverage of a particular subject of concern. The scope
of economics is the area or boundary of the study of economics. The scope of
economics will be brought out by discussing the following:
a. Subject matter of economics
b. Nature of economics
c. Economics a positive science or normative science
A SUBJECT MATTER OF ECONOMICS
The subject matter of economics does not remain constant over a long period of
time. It changes with the change in human attitude and their activities. Various
economists have different views about the subject matter of economics.
The classical economists argued that economics is concerned with wealth. According
to the neo classical economists, subject matter of economics is material welfare. As per
Robbins, the subject matter of economics is scarcity and choice. Thus, according to
time, needs and situations, the subject matter of economics also changes. The subject
matter of economics can be divided on the following two bases:
1. Traditional Approach
2. Modern Approach
1. Traditional Approach
Human wants are unlimited. Several economic activities are made to meet human
wants. Since human wants are unlimited and regular fulfillment of human needs gives
birth to many wants. The cycle of wants, efforts and satisfaction continues from birth
till death. This continuous cycle of wants – efforts - satisfaction constitutes the subject
matter of economics. This is expressed in the circular diagram.
WWants Definitions
W WSatisfaction Efforts Consumption: It is the acto of us-
ing up of goods and services to satisfy
human wants
Production: The act of transformation
of inputs into output
The cycle of wants-efforts and satisfaction is split into five departments such as:
1. Consumption: Consumption is the act of using up of goods and services for the satisfaction
of wants. In the Theory of Consumption we try to analyze the behaviour of the consumer.
It includes various laws and theories like the law of demand, law of diminishing marginal
utility, law of substitution etc. which are related to the explanation of consumer behavior.
2. Production: Production is the act of transformation of the factors of production in the
form of goods and services. The produced goods can be used in consumption as well as
for further production. It includes law of production, theory of production, division of
labour, capital formation, process of production etc.
15 Vedanta High School Economics - Book 9
3. Exchange: Exchange bridges production and consumption. It is the process through
which buyers and sellers interact and make dealings for their mutual benefit. In barter
system goods are exchanged for goods. But in modern economy money works as a
medium of exchange. Exchange covers the process of price determination in different
market structures.
4. Distribution: Distribution refers to the process of determination of rewards to
factors of production used in the production process. It includes the theories based
on determination of prices of factors of production like land, labour, capital and
organization in the form of rent, wages,interest and profits.
5. Public Finance: Public finance refers to the study of income and expenditure of the
government. The government collects revenue from tax, non tax and other sources to
meet its recurrent and capital expenditure. Public finance includes government revenue,
government expenditure, government borrowings and financial administration.
2. Modern Approach
Modern economists have divided the subject matter of economics into two branches:
a. Micro economics: Micro economics is that branch of economics which studies the small
units of the economy. It is the study of the economic actions and behaviour of individual
economic units and small group of such individual units. It covers resource allocation,
product pricing, factor pricing and theory of economic welfare.It is a microscopic sudy of
the economy.
b. Macro economics: Macro economics is that branch of economics which studies the
economy as a whole. It studies the large aggregates and averages of the economy such as
national income, national output, price level, employment level, trade cycle etc. It covers
theory of national income and output determination, theory of general price level, theory
of economic growth and macro theory of distribution.
Glossary Capital formation: Net addition to the stock of capital asset
Tax: compulsory financial charge imposed upon a taxpayer by a
governmental organization
Trade cycle:: Fluctuations in economic activities
B NATURE OF ECONOMICS
Economists differ in regard to the nature of economics. To know the nature of economics
it is necessary to know whether economics is a science or an art and whether it is
positive or normative.. As a science economics lays
down laws and principles
IS ECONOMICS A SCIENCE OR AN ART? and studies cause effect rela-
Economics as a Science: tionship
Science is a systematic study of knowledge and fact which develops the correlation-
ship between cause and effect. Science is not only the collection of facts, all the facts
must be systematically collected, classified and analyzed. We observe facts, conduct
experiments and make generalizations after testing the results.
Economics, like all other sciences, studies the relationship between cause and effect.
Economics is a science because it is an organized body of knowledge where relevant
facts are collected, observed and analyzed systematically.
Economics is scientific in the sense that it lays down general principles or laws to
guide the economy. Besides economics is also a science because economic laws are
Vedanta High School Economics - Book 9 16
those which state a casual relationship between two sets of facts. One set is the cause
and the other set is the effect. Thus economic laws represent economics tendencies or
principles expressing what are likely to happen, other things remaining unchanged.
Economics as an Art:
Art is the practical application of knowledge for achieving particular goals. It is the
organized application of scientific principles. Art lays down precepts or formulae
to guide people to achieve certain objectives.
Economics is also an art. It delivers solutions for several of the economic complexities.
It prescribes certain rules and principles. It deals with problems and questions that
arise in society and helps to find suitable solutions and suggestions for them. It also
lays down certain rules and directions to achieve specific goals or good results. e.g.: If
poverty is removed from the society, the welfare of the society will be raised. Hence it
is considered an art.
It may be concluded that economics is both a science Pause for Thought
and an art. It is not a mere theory and also has great Why is economics both
practical importance in solving practical problems of light giving and fruit bear-
the day. It is both light giving and fruit bearing. Hence, ing?
Economics is both a science and an art.
C POSITIVE ECONOMICS AND NORMATIVE ECONOMICS
Nature of economics also can be explained as positive and normative.
POSITIVE ECONOMICS
The concept of positive economics was introduced by classical economists such as
Adam Smith, J.B. Say, David Ricardo and modern economist Prof. Lionnel Robbins.
Positive economics is defined as a body of systematized knowledge and seeks to explain
cause and effect relationship between economic variables. It analyses every issues of
economics positively. The laws are derived from scientific analysis.
Positive statements deal with what is or what will be – statements that can be empirically
tested. The objective of positive economics is to establish uniformity in policy of each
sector of an economy. It assumes some propositions, theories and laws to’ explain cause
and effect relationship between economic variables.
Economics is a positive science. It doesn’t comment Key Term
about wrongness or rightness of an economic situation.
Robbins stated that economics is not concerned with Economy: an economic setup
the desirability or otherwise of ‘ends’. Therefore, the which governs and direct eco-
nomic activities
task of an economist is not to condemn or advocate but
to explore and explain.
Keynes: “A positive science may be defined as a body of systematized knowledge
concerning what is.”
Positive economics concerns with the allocation of resources.
Positive statements Its objective is to explain how society makes decisions about
are descriptive.
Normative statements consumption, production and exchange of goods and services.
are prescriptive. It is concerned with issues such as how individuals behave in
trying to maximise their satisfaction from a given income level
or how firms behave in maximising their profits.
17 Vedanta High School Economics - Book 9
Features of Positive Economics
1. It is the explanation of the state of events as they are.
2. It establishes the relation between cause and effect of an event and states the fact of the
event. e,g Law of demand,law of supply.
3. It concerns with the determination of relative prices of goods and services.
4. It concerns with the allocation of resources.
5. Positive economics explains how society makes decisions about consumption,
production, and exchange and deals with “what is” scenario. Key Term
6. It is neutral between ends and doesn’t make value GDP: Gross Domestic
judgement. Product is the total value
7. It is based on fact and cannot be approved or disapproved. of goods and services pro-
NORMATIVE ECONOMICS duced in an economy
Economics is also a normative science because it also analyses economic activities
ethically. Normative economics is defined as a body of systamatized knowledge
related to `what ought to be’. It does not try to make detail study on cause and effect of
any economic issue. It does not analyse economic issues scientifically rather makes hard
and fast decision to establish economic stability in the economy. Normative statments
judges value (goodness and badness). For example over-production of alcoholic
products harms the society, various industries should be established to increase GDP
growth rate of the country.
As a normative science, economics should be allowed to pass moral judgments of an
economic situation and prescribe that a certain action should be taken. According to
Marshall, economics is a normative science because it has a norm or aims viz, welfare.
Keynes: “A normative science is a body of systematized knowledge relating to the
criteria of what ought to be.”
Normative economics deals more with value judgements, statements which include the
words should or ought. For example, ‘income should be distributed more equally’ is a
normative statement. Unlike a positive statement, there is no way of proving it correct
or incorrect.
Features of Normative Economics
1. It is the explanation of the state of events as they ought to be.
2. It is based on subjective value judgement. It concerns with “Which is good and Which
is bad”.
3. It makes prescriptions about what should be done. It is concerned with “What should
be” and “What ought to be”.
4. It seeks to direct the activities, establishes the ideals and determine policies; e,g What
should be done to increase demand, supply etc.
5. It concerns with the promotion of economic welfare.
6. Normative economics focuses on the value of economic fairness. It has an ethical touch
and concerns with the rightness or wrongness of an event.
Propositions: A statement or assertion that expresses a judgement or opinion
Glossary
Positive statements: Statements are descriptive and make a claim about how the world is.
Normative statements: Claims that attempt to prescribe how the world should be
Welfare: A state of well being
Vedanta High School Economics - Book 9 18
Keynote1.3 IMPORTANCE OF ECONOMICS
The importance of economics can be examined from theoretical aspect as well as
practical aspect. Its importance can be studied as follows:
1. THEORETICAL IMPORTANCE
The theoretical importance of economics are as follows:
1. Intellectual Value: The knowledge of Economics is very useful as it broadens our outlook,
sharpens our intellect, and inculcates in us the habit of balanced thinking. The study of
Economics increases mental capacity to understand various economic problems.
2. Enhances Analytical Capacity : Economics helps to increase Deductive method is based
the analytical capacity of people in two ways. Inductive drawing conclusions with-
method makes economic laws on the basis of reality of events valid reasoning
and deductive method increase the power of observation.
3. Development of Scientific System: Economics is a social science. Economics studies
the real economic problems in the society. Economic problems are resolved through
direction of consumption, production, exchange and distribution. The analysis of these
is based on scientific research study.
4. Feeling of Co-operation: Economics helps to increase the cooperative feeling in people.
Each and every economic units play some role in production, consumption, exchange,
distribution. They collectively develop the country.
5. Useful Citizenship: Knowledge of Economics is indispensable for a good citizen. Wooten
has rightly remarked that: “You cannot be a citizen in real sense unless you are at least
in some degree an economist.”
6. Source of Unavoidable Information: In modern days, the understanding of inflation,
exchange rate, shares, balance of payment, deficit financing etc. has become unavoidable
for a successful life. Economics is the major source of all these inevitable information.
7. Understanding Economic System: The study of Economics Balance of payment is the
not only enables to understand different economic systems, difference between receipts
i.e. capitalism, socialism, mixed economic system but also and payments of a country
creates a vision to look into the working of a particular over a period of time
economic system.
8. Sense of Responsibility: Economics teaches us that we have to meet our unlimited
wants with limited resources. It creates a sense of responsibility which in turn makes
a person a better citizen.
9. Rationality: The study of Economics teaches rationality. It makes a person rational. It
teaches to avail the best possible situation within the given conditions.
10. Critical Analysis: An economist critically analyses the situation and then draws
conclusions. This provides a guideline for successful life. It enables the ordinary citizen
to be able to appreciate or criticize the government.
• The study of Economics creates in us intelligent appreciation of our posi-
tion and the spirit of co-operation with others.
• Mixed economic system is an economic system in which there is coexist-
ence of both the private sector and public sector
• Inflation is a situation of persistent rise in the general price level
19 Vedanta High School Economics - Book 9
2. PRACTICAL IMPORTANCE
Practical importance of economics can be explained as follows:
1. Importance to Households: Economics is useful to the householder. With the knowledge
of economics, the householder is able to utilize his little income to get the maximum
satisfaction for his family by proper budgeting and careful spending. This increases the
happiness of the family.
2. Helpful in International Comparison: Study of national income, economic growth and
nature of economy help the comparison of the country with other countries of the
world. In such comparison, macroeconomics is used.
3. Importance to Producers: Economics is helpful to the producer. It suggests him the ways
of bringing about the most economical combinations of the various factors of production
at his disposal. It also helps in solving the various intricacies of exchange. Economics
helps the producers in determining the rewards to factors of production, i.e., wages,
rent, interest and profit. It also helps the producers in the fixation of the price of their
product.
4. Importance to Labourers: Labourers and trade union leaders should have knowledge of
Economics to understand the problems of labour solve them. To solve industrial disputes
and wage problems, labor leaders require knowledge of Economics. They should know
under what circumstances trade unions can secure higher wages.
5. Importance to Politicians: A good politician must have the knowledge of various
economic problems, such as unemployment, rising prices, vicious circle of poverty
and economic development of various sectors and regions.
6. Importance to Academicians: Economics as a science develops scientific outlook.
Economic theories explain the concept of consumption, production, investment and
distribution. It also tell about the various economic problems, their causes, effects and
their possible solutions.
7. Importance to Administrators: Fiscal and monetary policies are formulated by the
administrators, so they must know the theories of taxation and finance. It will enable
them to understand the sources of public revenue and debt.
8. Importance in Framing Laws: The knowledge of economics is very essential for the
legislators and parliamentarians. They will be able to frame laws effectively only by
having knowledge of the subject.
9. Effective Manpower Planning: Developing economies suffer from over population and
under utilization of resources. Unemployment is a chronic problem in these countries.
Economics helps in making effective plans for making the best possible use of all the
active population.
10. Gateway to Economic Development: Economic development is the ultimate objecive of
all nations. It is the knowledge of Economics which serves as a gate-way to economic
development.
CHECKPOINT 1. Explain the subject matter of economics.
2. Is economics a science or an art?
3. What is positive economics? What are its features?
4. What is normative economics? What are its features?
5. Explain the practical importance of economics.
Vedanta High School Economics - Book 9 20
1.4 BASIC TERMS AND CONCEPTS
A. GOODS AND SERVICES
Goods are material and In economics, the term “goods” refer to material and non-
are tangible while ser- material things which satisfies human wants. Just as an apple
vices are intangible
or a chair is a good, music or the services of actors, musicians
and teachers are some of the examples of goods (services).
Distinction between Goods and Services
1. A good is a tangible output of a process that has physical dimensions. Whereas, a
service is an intangible process that cannot be weighed or measured.
2. Goods refer to material objects which satisfy human wants. While services refer to non
material objects which satisfy human wants.
3. Goods can be stored over time. Whereas, services as a process are perishable, time
dependent and can’t be stored.
4. The ownership of goods can be transferred. Whereas, the ownwership of services is
not transferable.
5. There is time lag between production and consumption of goods. Whereas, there can’t
be time lag between production and consumption of services.
Goods can be classified as free goods and economic goods.
a. Free Goods: The goods provided by nature without any cost are called free goods. They
are not scarce. So they do not command a price in the market. They are known as free
goods. For example, air, sunlight, water etc. are free goods.
b. Economic Goods: Economic goods are those which have a price and their supply is less
in relation to their demand. The production of such goods requires scarce resources
having alternative uses. Such goods are found in limited quantity and have value in
exchange.
Economic goods are ob- It may be noted that what is a free good at one place can become
tainable only on pay-
ment while free goods an economic good at another place. It all depends on the supply
are obtained free of cost of a good and the demand for it. For example, water is a free
good in villages and an economic good in cities.
Depending uponthesupplyofagoodandthedemand forit a good may be a free good or an economic good
Economic goods may further be classified as:
1. Material Goods: Material goods are those which are tangible. They can be seen, touched
and transferred from one place to another. For example, cars, shoes, cloth, machines,
buildings, wheat, etc., are all material goods.
2. Non-material Goods: The goods which do not have definite shape, size and weight are
called non-material goods. They are intangible and cannot be seen, touched or transferred.
Services of all types are non-material goods such as those of doctors, engineers, lawyers,
teachers, etc.
21 Vedanta High School Economics - Book 9
3. Transferable Goods: The goods and services whose ownership can be changed from
person to person are called transferable goods. For example, land, house, book,
television etc. are transferable goods.
4. Non-transferable Goods: The goods and services whose ownership cannot be changed
are called the non-transferable goods. For example, ability of teachers, doctors, nurses,
singers, dancers, skill of carpenter etc. are non-transferable goods.
5. Consumer Goods: Consumers’ goods are those final goods which directly satisfy the
wants of consumers. Such goods are bread, milk, pen, clothes, furniture, etc. Food,
clothes, shoes, movies etc. are consumer goods. They are also called goods of first order
as they satisy our want directly.
6. Producer Goods: Producer goods or capital goods are Pause for Thought
those goods which help in the production of other
goods that satisfy the wants of the consumers directly Why are consumer goods
or indirectly. Machineries, tools, etc are producer goods. called goods of first order
They are called goods of second order as they satisy our and capital goods as goods
want indirectly by aiding production of consumables. of second order?
7. Private Goods: If a person has a sole right on the production and distribution of good,
it is called private good. Such goods are used by the owner according to their wish.
House, car, bike, land etc. are private goods.
Private good has rivalry and excludability e.g. If you sell a bottle of Coke to one individual
others cannot consume it..
8. Public Goods: If a person does not have a sole right on the production and distribution
of a goods it is called public good. Such goods are used by the whole society. Road,
public hospital, public schools, colleges etc are public goods.
A public good has two characteristics:
a. Non-rivalry – consuming the good doesn’t reduce the amount available to others.
b. Non-excludable – once provided you can’t stop anyone consuming it.
9. Perishable Goods: If a good can not be reused after using it once, it is called perishable
good. Value of such good, disappears with time. Petroleum products, firewood, food
products are perishable goods.
10. Non-perishable Goods: If a good can be used again and again for some specific purpose,
it is called durable or non perishable good. Value of such goods does not decrease over
time. Land, house, vehicles etc are non-perishable goods.
11. Necessary Goods: The goods which are highly necessary for managing the daily life of
the consumers are called necessary goods. They are further classified into:
a. Necessities of Life: Necessaries of life or necessaries of existence are those goods of
consumption without which a man cannot live or exist. Food, clothing and shelter are
considered as necessities of life.
b. Necessities for Efficiency: Those goods which are essential to maintain or increase our
efficiency and ability to work are called the necessaries for efficiency. Table and chair
are necessities for efficiency for a student.
c. Conventional Necessities: Conventional necessities are those necessaries which we
are forced to use either because of social customs or our society expects us to do so.
For example, sarees and sindoor for hindu women are conventional necessities.
Vedanta High School Economics - Book 9 22
12. Comforts: The goods which make the work easy and simple are comfort goods. Such
goods increase the efficiency of workers. People use things of comfort to maintain
or increase efficiency. Use of a fan in summer and a room heater in winter makes life
comfortable. Luxury goods are
13. Luxury Goods: The goods whose satisfaction doesn’t increase our goods of conspicuous
efficiency, but simply gives us pleasure are called luxury goods. consumption and their
consumption may de-
Costly furniture, luxurious car, jewelleries are a few examples of crease efficiency
luxuries.
The line of demarcation between necessities comforts and luxury is thin. A television
which was a luxury in the past is now a necessity. Likewise, a car is a luxury to a student
and a necessity to a business executive.
14. Substitute Goods: Substitutes are the goods which have the same uses. Tea and coffee
are examples of substitutes.
15. Complementary Goods: Complementary good is a good which is consumed with another
good. They are used jointly. Pen and ink, car and petrol are complementary goods.
16. Normal Goods: Normal goods are those whose quantity demanded increases as the
consumer’s income increases and decreases as the consumer’s income decreases.
17. Inferior Goods: An inferior is a good of low quality consumed by the poor the demand
for whose varies inversely to change in consumer’s money income. An example of
inferior good is millet which is consumed by the poor in place of rice.
18. Giffen Good: A Giffen good is a special case While all giffen goods are inferior, all
of an “inferior good” of which people buy less inferior goods are not necessarily giff-
when their income rises. It does not have easily en. Inferior goods ought to have a costly
available substitutes, as a result of which the substitute. While a Giffen good should
income effect dominates the substitution effect. not only be inferior but also lack close
The term is named after the economist Robert substitute goods and a major share of
Giffen. consumer’s income is spent.
Glossary Tangible: Capable of being perceived especially by the sense of touch
Value in exchange: Which can can be traded in monetary terms
Conventional: Based on or in accordance with what is generally done or believed-
Conspicuous: easily seen or noticed; readily visible or observable
B. WANTS
Wants may be defined as an insatiable desire or need by human beings to own goods
or services that give satisfaction. It refers to something which is good to have, but
not essential for survival.
In economics, wants are defined as something that a person would like to possess, either
immediately or at a later time. Human wants are unlimited while the means to satisfy
those wants are limited. Hence, all the wants of an individual cannot be met and they
must seek for alternatives. Key Difference
For a desire to become a want, the following four elements Wants are goods and ser-
must be present. vices, which an individual
a. The desire for a thing. like to have while Needs
b. Efforts to satisfy the desire. are something that one must
c. The means (i.e. money) to purchase the thing. have, in order to live
d. Readiness to spend the means (i.e. money) to satisfy the desire.
23 Vedanta High School Economics - Book 9
Characteristics of Wants
The following are some common characteristics of wants.
1. Human Wants are Unlimited: There is no end the human wants. When one want is
satisfied, another crops up to take its place. The never-ending cycle of wants goes on
and on.
2. A Particular Want can be Satisfied: An individual want can be completely satisfied at
a particular point of time. For instance, when a hungry person takes food, his want is
satisfied. But the same want will arise again.
3. Wants are Competitive: Wants are competive as well. One commodity competes with
another for our choice. We all have a limited amount of money at our disposal, whereas
we want so many things at the same time. So choice has to be made between wants on
the basis of urgency and intensity. The urgent wants should be fulfilled first.
4. Wants are Complementary: Several wants must be satisfied together in a group. One
want gives rise to another want. For example, if a person wants to write a letter he will
require paper, pen and ink. Similarly, a person who buys a car requires petrol to run it.
5. Some Wants are formed by Habit: Some wants arises due to consumption of habitual
goods such as alcohol, cigarettes and drugs. If a particular want is regularly satisfied, a
person becomes used to it and it grows into a habit.
6. Wants Recur: Most of the human wants are of a recurring nature. This applies to most
of our routine expenditure, especially on food.We take food and our hunger is satisfied.
But after a few hours, we again feel hungry, and we have to satisfy our hunger every time
with food.
7. Wants are Relative: Certain human wants are relative to time and place. We need
woollens during winter and cotton clothes during summer. So wants change from time
Depending upon the
to time, from person to person and from place to place.
urgency and intensity
8. Wants vary in Intensity: All wants are not equally urgent and wants are prioritized
intense. Some wants are more urgent and intense than others. and satisfied
These are generally satisfied first, while others are postponed.
9. Wants are affected by Social Customs: Man is a social animal. Therefore, wants are
also affected by our social customs. Many of our wants are conventional. They are
dictated to us by society. Whether we like it or not, we have to spend a lot of money on
social ceremonies.
10. Present Wants are more Important than Future Wants: Future is uncertain. So, it is
natural among human beings to prefer present wants to future wants, as the satisfaction
of present wants gives more satisfaction than the future wants.
Classification of Wants
Human wants are unlimited and varied. Some wants are very urgent and some are less
urgent. On the basis of degree of necessity human wants are divided in three types.
• Necessities Pause for Thought
• Comforts
• Luxury How is want different
from need? Which of the
1. Necessities: Necessities refer to the basic or primary two is vital for survival?
wants for food, clothing, shelter, medical care, education, etc. The existence of human
life becomes difficult without their satisfaction. They are further classified into:
Vedanta High School Economics - Book 9 24
Keynotea. Necessaries of Life: There are the goods and services without which human life
is impossible. Food, water, air, clothing and accommodation are examples of such
necessaries. These goods are inevitable for human beings to run daily life. For
example food, clothes, shelter, medicine etc. are the necessities of life.
b. Necessaries of Efficiency: These refer to the goods and services which are not
required for survival. Rather they are necessary to make people efficient. For
example, a person can survive without books and stationery. The necessities for
efficiency are essential to maintain or increase our efficiency or energy and ability
to work.
c. Conventional Necessaries: The things which have become necessary due to
customs and traditions are conventional necessities. For example, wearing of new
clothes on marriage, decorating houses on Tihar are conventional necessities.
These have become necessary by force of tradition and social customs.
2. Comforts: Comforts refer to the goods and services which make life easier and comfort
able. They provide freedom from suffering, anxiety, pain, etc. Comforts improve our
health and efficiency. For example, a chair may be necessary for efficiency but a cushion
on it will make us comfortable.
3. Luxuries: Luxuries are those things the satisfaction of which do not increase our efficiency,
but simply gives us pleasure. In other words, luxuries are the goods of conspicious
consumption. Costly furniture, luxurious car are a few examples of luxuries. Luxuries do
not increase our efficiency to work but sometimes their use may decrease efficiency.
• Desire is the root of want
• Human wants are unjlimited but a particular want is satiable
• Wants changes according to time, place and situations
• Luxury goods may sometime decrease our efficiency rather than increase
our efficiency e,g consumption of expensive whisky
C. WEALTH
In the ordinary sense, wealth is understood as money or assets
which have economic value. But in economics, it has a special
meaning. In economics, weath refers to anything which is scarce,
transferable,possesses utility and has value in exchange. Car, land,
motorbike, pencil, copy, television, radio, clothes etc are wealth.
All economic goods have value-in-exchange. So, wealth includes all economic goods.
Wealth has been defined as “stock of goods existing at a given time that have money
value”. We may consider anything that has money value as wealth in economics.
Characteristics of Wealth
The characteristics of wealth are as follows:
a. Utility: Wealth should have utility. It should have the capacity to satisfy a human want.
b. Scarcity : Wealth is scarce. It has value due to scarcity. If any good is abundant, it does
not have value.
c. Transferability : If the ownership of certain goods can be transferred one person to
another, if is called transferability. Wealth should be transferable.
d. Exchange Value: It must have exchange value. Its value can be expressed in terms of
money.
25 Vedanta High School Economics - Book 9
D. PRICE
When value is expressed in money, it is called price. Generally, economists make no
distinction between value and price. All prices are related to one another. They
form the price system. Price mechanism plays a very important role in a capitalistic
economy. Buyers express their desire for goods only through prices. Every price we pay
for a good is a vote in favour of it. It is the price system that regulates the economic
activity of a society. Key Term
Two types of price may be noted: Price mechanism: a system
a. Nominal Price: The nominal price of a good is its value in where the forces of demand
terms of money, such as rupees, dollars, yen etc. It is the and supply determine the
prices of goods and services
price of a commodity expressed in term of money.
b. Relative Price: The relative or real price is its value in terms of some other good, service,
or bundle of goods. The term “relative price” is used to make comparisons of different
goods at the same moment of time. For example 1 pen:2 pencil is the relative price of
pen with respect to pencil.
E. CONSUMPTION
Consumption can be defined in different ways, but is usually best described
as the final purchase of goods and services by individuals. It is the direct
utilization of goods and services by consumers to satisfy their wants. By
consumption we mean the satisfaction of our wants by the use of commodities
and services.
The act of consumption simply involves the destruction of utilities. So it is
also defined as the destruction of utility. The destruction of utility may be immediate in
case of single use goods; while for durable and other services, it is gradual and takes time.
But mere destruction of utility does not mean consumption. A house destroyed by fire or
earthquake, is not consumption because it fails to satisfy human wants. Thus, only the
destruction of utility that leads to satisfaction of human wants is consumption
Consumption is thus the act of using up of goods and Pause for Thought
services to satisfy human wants. To conclude with Prof.
Meyers, “Consumption is the direct and final use of goods Consumption is destruc-
and services in satisfying the wants of human beings.” tion of utility. However, de-
Importance of Consumption struction of a house by fire
is not consumption. Why?
In modern times, consumption is treated as an inducement
on which the economic system of a country rests. The importance of consumption is
explained as under.
1. Beginning of all Economic Activities: A man makes effort to satisfy his want. Consumption
also means the satisfaction of human wants. In fact, the main motto of every productive
activity is that people consume goods and production is done for consumption,
which constitute economic activities. Consumption, therefore, is the beginning of all
economic activities.
2. Index of Standard of Living: The consumption pattern of a person, i.e., what he eats, what
he wears, in which type of house he lives in, etc. give us the knowledge of the standard of
living of the person.
Vedanta High School Economics - Book 9 26
3. Source of Production: According to Adam Smith, “Consumption is the sole purpose of all
production.” Production increases with increase in consumption. It is consumption of
goods that necessitates their production.
4. Importance in Economic Theory: On the basis of the study of individual behaviour as
regards consumption, certain laws of consumption have been formulated in economics
such as the Law of Diminishing Marginal Utility, Law of Demand, Consumer’s Surplus,
etc. In this way, the study of consumption has contributed much in the formulation of
certain economic principles.
5. Importance for the Government: The Government formulates its economic policies on
the basis of the consumption habits of the people. Minimum wages and imposition of
taxes are determined by the government considering the consumption requirements of the
public.
Glossary Comforts: Goods which make our lives comfortable or easy
Utility: Want satisfying power of a commodity
Inevitable: Unavoidable
Formulation: The act of devising or creating something
1.5 CONCEPT OF MICRO AND MACRO ECONOMICS
The term ‘Micro’ and ‘Macro’ economics have been coined by Prof. Ragnar Frisch of
Oslo University in 1933.
MICRO ECONOMICS
The word ‘micro ‘is derived from a Greek word ‘mickros’ which means ‘small’. As
such, microeconomics deals with the study of the individual units of the economy.
Precisely, microeconomics studies the economic actions and behaviour of individual
units of an economy such as consumers, firms, and Key Term
industry etc. Therefore, it is the study of a particular Economy: an economic setup
which governs and direct eco-
unit rather than all units combined together. It studies nomic activities
how the millions of economic units constituting the
economy perform their economic activities and reach
their respective equilibrium position.
K.E. Boulding “ “Micro economic is the study of particular firms, particular household,
individual prices, wages, incomes, individual industries, particular commodities, etc.”
Micro economics seeks to explain how the individual firms determine the price of the
product, how much to produce, what amount of product will maximize its profit, and
how to minimize the cost of production. In other words, micro economics examines
how resources are allocated among various individual firms and industries, how the
prices of various product are determined, and how the output produced is shared
among those. Did you know? Ragnar Frisch was a Norwegian
In short, microeconomics is the study of economist and the co-recipient of
the economic behaviour of individual the first Nobel Prize in Economics in
consumers, firms, and industries and 1969 along with Jan Tinbergen. He is
the distribution of production and known for being one of the founders
income among them. It is primarily of econometrics, and for coining the
concerned with the determination of widely used term macroeconomics/
price of different commodities and microeconomics in 1933.
factors of production. So microeconomics is also called Price Theory.
27 Vedanta High School Economics - Book 9
Features of Microeconomics
The following features may be pointed about microeconomics:
1. It studies the behavior of individual decision-making units such as consumers’ resource
owners, business firms, individual households, wages of workers, etc.
2. It tells how millions of consumers and producers in an economy take decisions about the
allocation of resources among competing ends.
3. It explains the determination of the relative prices of goods and services and how they are
distributed.
4. It covers product pricing, factor pricing and theory of economic welfare.
5. It analyses economic phenomena under the ceteris paribus Key Terms
assumption and hence is a method of partial equilibrium
analysis. Ceteris paribus: other things
remaining unchanged
6. It is also called ‘price theory’ or ‘value theory’ as it concerns Equilibrium: state of balance
with resource allocation, product pricing and factor pricing.
7. It concerns with the question of economic efficiency and economic welfare.
IMPORTANCE OF MICROECONOMICS
The importance of microeconomics may be explained as below:
1. Understanding the Mechanism of Economic System: Microeconomic analysis explains
how free enterprise economy functions in the market without any central regulating body.
It tells us as to how the prices of the products and the factors of production are determined.
2. Efficient Employment of Resources: The main problem faced by the modern governments
is related to the efficient utilization of resources. Economic development of a country
depends to a great extent on the efficient employment of resources. Micro Economics
emphasizes the need for the efficient employment of the scarce but valuable resources.
3. Investigation of the Conditions of Economic Welfare: Microeconomic analysis tells us
that the economic welfare will be optimum when there is perfect competition in product
market and factor market. It also suggests measures to eliminate wastage of resources and
helps in achieving optimality which in turn is helpful in achieving economic welfare.
4. Tools of Decision Making by a Firm: Microeconomic analysis provides analytical tools
and help the management decision making. Micro economic tools like demand elsticity,
consumer surplus, cost-benefit analysis are of immense help to business management. It
helps management in the choice of commodity, choice of scale of production and choice
of technology for the production etc.
5. Determination of Prices: Microeconomics provides the basis for analyzing and solving the
pricing problems.The theory of product pricing and the theory of factor pricing studied
in microeconomic deals with the determination of prices of their products and rewards of
factors of production.
6. Formulation of Public Policies: Microeconomics analysis helps the government to
formulate different economic policies for the welfare of the people. It gives tools and
foundations for analysis of economic policy. A sound economic policy influences the
economy. It causes changes in allocation of resources.
Vedanta High School Economics - Book 9 28
7. International Trade: Matters relating to international trade, balance of payments,
determination of the exchange value of the domestic currency etc. can be easily understood
with the help of micro economic analysis.
8. Taxation : Microeconomics helps us to understand the complex problems of taxation. It
explains the welfare implications of a tax. It also explains which one of the taxes decreases
the welfare of the society.
9. Demand Forecasting: With the help of the study of microeconomics a firm can plan its
production in accordance with the demand forecast made for its products. This enables
the firm in getting maximum return from its resources.
Limitations of Microeconomics Key Term
Inspite of its great merits and usefulness, microeconomics Laissez faire: Non interfer-
has certain limitations which are described below. ence of the government in the
functioning of the economy
1. Study of Individual Economic Variables Only:
Microeconomics studies individual economic variables only and does not deal with
aggregate economic variables: Microeconomics does not concern with the study of the
entire economy. It just studies small economic units and explains the relationship between
them.
2. Assumption of Full Employment: Microeconomics explains the individual economic
phenomena under the ‘full employment’ and ‘ceteris paribus’ assumptions. According
to J.M. Keynes an economy operates at below the full employment rather than at full
employment.
3. Non-existent Economic System: Microeconomics is based on the assumption of laissez
faire. But pure laissez-faire does not exist in the present day world. Even in capitalist
countries like England, United States and France some industries which are strategic, are
nationalized and are put under government control.
4. Partial Analysis: Microeconomics is concerned with the study of the analysis of only two
variables at time by keeping all other related variables unchanged. Microeconomics cannot
be applied to study the complex economic system. It provides only a partial analysis of
economic phenomenon.
5. Excludes Major Economic Variables: Micro economics excludes major economic variables
such as inflation, public finance,fiscal policy, monetary policy etc from its studies. But
these variables play important role in the functioning of the economy.
6. Unrealistic Assumptions: Microeconomics is based on several unrealistic assumptions
like full employment, perfect competition, free mobility of labour etc. Interestingly these
assumptions are not real.
7. Inadequate and Misleading: The conclusions drawn from Microeconomics are inadequate
and misleading. The analysis of various economic phenomena cannot be applicable to the
economy as a whole.
Glossary Monetary policy: Policy of the central bank relating to money supply and credit
Fiscal policy: Income and expenditure policy of the government
Public Finance: Study of the income and expenditure and financial administration of
the government
29 Vedanta High School Economics - Book 9
MACRO ECONOMICS
The word `macro’ has been derived from the Greek word `Makros’ which means
‘large’. Macroeconomics is the study of an economy as a whole. It deals with macro
variables such as aggregate income, expenditure, savings, investments, inflation,
consumption, employment monetary and fiscal policy etc.
K.E. Boulding “ Macroeconomics deals not with individual quantities but with
aggregate of these quantities, not with individual incomes but with national income,
not with individual prices but with price level, not with individual output but with
national output”.
Macroeconomics studies the economic system as a whole. In it, we get a complete
picture of the working of the economy. It is a study of the relations between broad
economic aggregates such as national income, national output, employment level, price
level, inflation, aggregate demand, aggregate supply etc. It concerns with the truly
big issues of economic life such as- full employment or underemployment, capacity
or under capacity production, economic stability or Key Term
economic instability etc. So it is also called ‘aggregative Employment level: the level
economics.’
of employment in an economy
Features of Macroeconomics over time
1. It is the study of the economy in totality.
2. It uses lumping method for the purpose of economic study. The individual units are
lumped together to form large aggregates.
3. It concerns with the behaviour of aggregates and averages of the economy.
4. It is a general equilibrium analysis and explains the general Definition
economic behaviour of the economy.
Macroeconomics is the
5. Macro economics is the obverse of microeconomics. study of economy-wide phe-
nomena, including inflation,
6. It deals with aggregates like national income, output and unemployment, and eco-
employment, total consumption and the general price level. nomic growth - Mankiw
7. It covers national income, general price level, economic growth and macro theory of
distribution.
IMPORTANCE OF MACROECONOMICS
The importance of macroeconomics can be analyzed on the basis of following headings:
1. Understanding the Working of the Economy: The study of macro economics is of great
importance in understanding the functioning of the economy. The major economic
problems with regard to functioning of the economy relates to national income, output,
employment, economic growth, public finance and balance of payments. Macroeconomics
analyzes and provides explanation to these problems.
2. Analysis of Contemporary Economic Issues: The study of macro economics is vital for
understanding the major issues faced by the country. Macro economics problems like
unemployment, inflation, exchange rate fluctuations, low rate of economic growth are
the problems that affect all economies. Macro economics analyzes and deals with these
contemporay issues.
Vedanta High School Economics - Book 9 30
3. Study of National Income: National income is the basic parameter of macro economics.
It is often considered as the best measure to assess the performance of the economy.
Economists use national income statistics to get quantitative measures of the economy’s
performance and the performance of the different sectors of the economy.
4. Useful in Formulating Economic Policies: Macro economics has practical value in the
formulation of government’s policies like monetary and fiscal policies. In every country,
the government has to shoulder the responsibility of solving the complex problems of
Key Term
the economy. The government can use macroeconomic
knowledge in formulating appropriate monetary and fiscal Parameter: A quantity or
number on which some other
policies to solve them.
5. International Comparison: Study of macroeconomics is of quantity or number depends
great help in making comparison of relative performance of
different economies. National incomes, rate of investment, consumption level and rate of
savings are some of the important parameters used in assessing the relative performance
of different countries.
6. Solution to Contemporary Economic Problems: Macro economics helps the policy makers
in identifying the causes of various problems like unemployment, inflation, adverse
balance of payments, low economic growth etc. It provides analytical tools and suggests
remedies to these problems.
7. Formulate Strategy of Economic Growth: The capacity and source of growth of the economy
can be found out from macroeconomics. The strategy to increase production, income,
investment, employment and economic growth can be devised through macroeconomic
tools like fiscal and monetary policies.
8. Understanding General Unemployment: The use of macroeconomics is useful to solve
the complex economic problems of present day. The general unemployment occurs due to
deficiency of effective demand which is determined by aggregate demand and aggregate
supply. The causes, effects and remedies of general unemployment can be understood
from macroeconomics.
• Utility, scarcity and transferability are important attributes of wealthKeynote
• Perfect competition is a market structure in which there is absence of
rivalry
• Microeconomics is a microscopic study of the economy
• Macroeconomics is the study of the economy in totality
LIMITATIONS OF MICROECONOMICS
Inspite of its great merits and usefulness, macroeconomics Key Terms
has certain limitations which are described below. Fallacy: a mistaken belief
1. Fallacy of Composition: Macro economics assumes Presumes: assumes
aggregate economic behaviour as the sum of individual Heterogenous: dissimilar
behaviour. But what is true of individuals is not necessarily
true of the economy as whole. Such generalizations can be invalid and misleading. This
is called fallacies of composition.
2. Excessive Thinking: Macro economics suffers from the limitations that it always thinks
excessively in terms of aggregates and presumes circumstances to be normal and
homogeneous. But aggregates may result into heterogeneous character. Macroeconomic
aggregates are not a reality but a picture or approximation of reality.
31 Vedanta High School Economics - Book 9
3. Difference in Individual Items: Sometimes while aggregating the variables, the basic
characteristics of the data or the variables are left untouched because there are important
differences in the items. Sometimes, the features of individual components may not be
true to the aggregate. So macro suffers from the danger of excessive generalization.
4. Unable to Influence Society Equally: An aggregative tendency may not influence the
entire sectors of the economy in the same way. For example, a general rise in price such
as inflation may not have similar effects on different sectors of the economy. Likewise,
national income is the total of individual incomes. If national income in the country goes
up, it is not necessary that the income of all the individuals in the country will also rise.
5. Macroeconomic Models Inapplicable to Developing Definition
Countries: The macroeconomic models are designed mostly
to suit the developed countries of the world. The developing Why are macroeconomic
countries face different economic realities, so they do not models more applicable to
benefit much from them. developed countries thean
developing countries
6. Indiscriminate use of Macroeconomics is Misleading: An
indiscriminate use of macro economics in analyzing the problems of the real world can
often be misleading. For instance, if the policy measures needed to achieve and maintain
full employment in the economy are applied to structural unemployment in individual
firms and industries, they become irrelevant.
7. Difficulty in the Measurement of Aggregates: There is difficulty in the measurement of
aggregates. It is difficult to measure the big aggregates like national income, price level,
employment level etc. Aggregates itself suffer from certain serious problems due to
inappropriate use of statistical techniques.
8. Heterogeneous Elements: It may, however, be remembered that macroeconomics deals
with such aggregates as aggregate consumption, saving, investment and income, all
composed of heterogeneous quantities. Money is the only measuring rod. But the value
of money itself keeps on changing, rendering economic aggregates immeasurable and
incomparable in real terms. As such, the sum or average of heterogeneous individual
quantities loses their significance for accurate economic analysis and economic policy.
Glossary Aggregate demand: Total demand for goods and services in an economy
Aggregate supply: Total supply of goods and services in an economy
Contemporary: Living or occurring at the same time
National income: Total income of the economy over a period of time
DISTINCTION BETWEEN MICROECONOMICS AND MACROECONOMICS
Microeconomics and macroeconomics may be distinguished on the basis of following
headings:
1. Definition: Microeconomics is a microscopic study of the economy. Whereas
macroeconomics is the study of the economy in totality.
2. Variables under Study: Microeconomics is concerned with the micro variables such
as individual demand, individual supply, price of a particular commodity or factor
etc. Whereas Macro economics is concerned with macro variables; general price level,
national output, employment level, price level etc.
3. Aggregates in Relation to the Economy: The small aggregates such as market demand,
market supply, and industry which are studied in microeconomics are not related to
the economy as a whole. While macroeconomics studies large aggregates like aggregate
Vedanta High School Economics - Book 9 32
demand, aggregate supply, price level etc. that relates to the whole economy.
4. Dimension: Microeconomics deals with the analysis of individual behaviour, whereas
macroeconomics is concerned with the study the economy as a whole.
5. Scope of Study: Micro-economics covers the areas such as resource allocation, product
pricing, factor pricing and theories of economic welfare. Macroeconomics, on the other
hand covers the areas as such as theories of income and employment, theories of money
and price level, economic growth and macro theory of distribution.
6. Methodology: The methodology applied in the study of microeconomics is more
‘individualistic’ in nature; whereas macroeconomics is more ‘aggregative’ in nature.
7. Approach of Analysis: Microeconomics studies the individual equilibrium process by
using partial equilibrium analysis. On the other hand, macroeconomics uses general
equilibrium analysis for the study of the economic behavior of the economy as a whole.
8. Solution to Present day Economic Problems: The study of micro-economics is not of
much help to solve the important present day problems such as inflation, unemployment,
poverty and so on. While macroeconomics, analyzes these problems and seeks to find
solution to these problems.
9. Objective: Microeconomics has the utility maximization objective on the demand side
and profit maximization objective on the supply side. On the other hand, macroeconomics
has the objective of full employment, price stability and higher economic growth rate.
10. Basis: Price mechanism is the basis of microeconomics. The price mechanism is operated
by the forces of demand and supply. On the other hand, effective demand determined
by aggregate demand and aggregate supply form the basis of macroeconomics.
CONCEPTS FOR REVIEW
Economic man Material welfare Scarcity
Positive economics Social science Human science
Normative economics Neutrality of wants Material requisites
Utility Value in use Value in exchange
Substitute goods Complementary goods Necessity
Comforts Luxuries Wealth
KNOW YOU ECONOMIST
ADAM SMITH- The Father of Modern Economics
Many people had written about economics before Adam Smith did,
but he made economics a social science.
Born in 1723 in Kirkcaldy, a small fishing town near Edinburgh, Scot-
land, Smith was the only child of the town’s customs officer. Lured
from his professorship (he was a full professor at 28) by a wealthy
Scottish duke who gave him a pension of £300 a year—ten times the
average income at that time—Smith devoted ten years to writing his
masterpiece, An Inquiry into the Nature and Causes of the Wealth of
Nations, published in 1776.
33 Vedanta High School Economics - Book 9
GLANCING THE UNIT
Wealth definition 7. Neutral between ends
Economics is the science of wealth. It enquires into 8. Science of choice
the causes of wealth of nations.
Subject matter of economics
Main features of wealth definition The subject matter of economics is studied under
1. The central point of economics is wealth two approaches:
2. Study of economic man
3. Main goal of economics is to earn wealth Traditional Approach
4. Primary importance given to wealth a. Consumption
5. Only material goods constitutes wealth b. Production
c. Exchange
Welfare definition d. Distribution
Marshall defined economics as a science of material e. Public finance
welfare.
Modern Approach
Main features of welfare definition a. Microeconomics
1. Science of material welfare b. Macroeconomics
2. Wealth is a means to an end
3. Economics studies ordinary humans Economics as a science
4. Economics is a social science Economics is a science because it is an organized
5. Study of material resources body of knowledge where relevant facts are
6. Economics is a normative science and collected, observed and analyzed systematically.
concerns with welfare propositions
7. It gives primary importance to man Economics as an art
8. Ethical science Economics is also an art because it lays down certain
rules and directions to achieve specific goals or
Scarcity definition good results.
Robbins defined economics as a science of scarcity
and choice. Positive economics
Positive economics concerns with the allocation of
Basis of Robbins definition resources. Its objective is to explain how society
1. Unlimited wants makes decisions about consumption, production
2. Limited resources and exchange of goods and services.
3. Alternative uses of resources
Normative economics
Main features of Robbins definition According to Marshall, economics is a normative
1. Limited resources in relation to unlimited science because it has a norm or aims viz, welfare.
It explains the situation of ‘what ought to be’.
wants
2. All wants are not equally urgent Theoretical importance of economics
3. Economics concerns with the problem of 1. Intellectual importance
2. Spirit of cooperation
choice 3. Critical analysis
4. Neutrality of wants 4. Makes one rational
5. Study of resource allocation 5. Of responsibility
6. Scarcity, the root cause of all economic 6. Vision about economic system
7. Useful citizenship
problems 8. Increase in knowledge
7. Economics is a positive science
Practical importance of economics
Superiority of Robbins definition over Marshall’s 1. Significance to consumers
1. Scientific definition 2. Helpful in international comparisons
2. Universal application 3. Significance to producers
3. Wider scope 4. Significance for workers
4. Uniformity 5. Significance for politicians
5. Status of positive science
6. Clear concept of human behavior
Vedanta High School Economics - Book 9 34
6. Significance for academicians Limitations of microeconomics
7. Significance for administrators 1. Study of individual economic variables only
8. Solution of economic problems 2. Assumption of full employment
3. Non existent economic system
Goods 4. Partial analysis
Anything that satisfies a human want can be 5. Unrealistic assumptions
considered as “good” in economics. 6. Inadequate and misleading
7. Excludes major economic variables
Free goods
A free good is a good needed by society but available Importance of macroeconomics
with no opportunity cost. 1. Understanding the working of the economy
2. Analysis of contemporary economic issues
Economic goods 3. Study of national income
Economic goods are those which are obtainable free 4. Useful in formulating economic policies
of cost without payment. 5. International comparison
6. Solution to contemporary economic problems
Consumer goods 7. Formulate strategy of economic growth
Consumption goods are those which yield, 8. Understanding general unemployment
satisfaction directly. They are called goods of first
order. Limitations of macroeconomics
1. Fallacy of compositipon
Capital goods 2. Excessive thinking
Capital goods are the goods which help in further 3. Difference in individual items
production of goods and services 4. Unable to influence society equally
5. Models inapplicable to developing countries
Wealth 6. Indiscriminate use of macroecomics is
Anything which is scarce, possess utility and is
transferable is called wealth. misleading
7. Difficulty in measurement of aggregates
Consumption 8. Heterogenous elements
The act of using up of goods and services for the Distinction between microeconomics and
satisfction of our wants is called consumption macroeconomics
1. Literal meaning
Price 2. The dimensional difference
When value is expressed in money, it is called price. 3. The Methodological difference
4. Variables under study
Microeconomics 5. Study of aggregates is relation to the economy
It is the study of small individual units of the 6. Partial and general equilibrium analysis
economy. 7. Fields of Enquiry
8. Solution of present day economic problems
Macroeconomics 9. Development of micro and macro-economics
It is the study of the economy in totality and is
aggregative in nature. 10. Static and dynamic analysis
Importance of microeconomics
1. Analyzing the mechanism of economic system
2. Efficient employment of resources
3. Tools of decision making by a firm
4. Investigates the conditions of economic welfare
5. Determination of prices
6. Formulation of public policies
7. International trade
8. Taxation
35 Vedanta High School Economics - Book 9
QUESTIONS FOR REVIEW
Very Short Answer Type Questions
1. Who is considered the father of economics?
2. What is an economic man as per Adam Smith?
3. What is the main focus of economics as per the wealth definition?
4. Why Carlyle and Ruskin called economics a dismal science?
5. What is meant by material welfare?
6. Who defined economics as a science of scarcity and choice?
7. What is the root cause of economic problems as per Robbins?
8. How is economic neutral between ends as per Robbins?
9. What are called economic goods?
10. What is meant by positive economics?
11. What is normative economics concerned with?
12. Why consumer goods are called goods of first order?
13. What do you mean by conventional necessities?
14. Define wealth.
15. What is demand?
16. What is supply?
17. What is the want satisfying power of a commodity called?
18. What is meant by relative price?
19. Define microeconomics.
20. Define macroeconomics.
Short Answer Type Questions
1. Write the main points described in wealth definition.
2. Explain the main criticisms of wealth definition.
3. Explain the subject matter of economics.
4. High light the main features of material welfare definition.
5. Explain the points of superiority of Robbins definition over Marshall’s.
6. “Economics is both light giving as well as fruit bearing”. Explain.
7. Explain the concept of positive economics.
8. Distinguish between free goods and economic goods.
9. Explain the practical importance of economics.
10. What are the characteristics of wealth?
11. Explain the types of demand.
12. Explain the concept of microeconomics.
13. Explain the concept of macroeconomics.
14. Write limitations of economics.
15. Write the characteristics of wealth.
Long Answer Type Questions
1. Critically explain the Marshallian definition of economics.
2. Critically explain Robbins’ definition of economics.
3. Explain the importance of economic analysis.
4. Distinguish between microeconomics and macroeconomics
5. Describe the subject matter of economics.
Vedanta High School Economics - Book 9 36
2UNIT UTILITY ANALYSIS
Learning Objectives Weight: 12 Lecture Hours
On Completion of this unit the student will be
able to:
• Understand the meaning of utility explain
its types
• Explain the law of diminishing marginal
utility and its limitations
• Explain the importance of the law of
diminishing marginal utility
• Explain the law of substitution and its Before you begin
limitations
• Explain the importance of the law of Theory of consumer behavior in Economics
describes how consumers allocate incomes
• substitution surplus among different goods and services to
Explain the concept of consumer maximize their utility.Law of diminishing
and explain its importance marginal utility, law of substitution and
consumer surplus are some theories that
explains consumer behaviour.
Very Short Type Short Type Long Answer Type Total Marks
1 106
37 Vedanta High School Economics - Book 9
2.0 CONCEPT OF UTILITY
The concept of ‘utility’ Utility in economics was first coined by the noted 18th-century
Swiss mathematician Daniel Bernoulli (1700-1782). The term was introduced
initially as a measure of pleasure or satisfaction within the theory of utilitarianism by
Jeremy Bentham in 1780’s. The concept was adopted extensively in economics in early
19th century with the works of Stanley Jevons, Alfred Marshall etc.
The simple meaning of ‘utility’ is ‘usefulness’. In economics Utility is relative. Dif-
utility is the capacity of a commodity to satisfy human wants. ferent person derives
different utility from
It is defined as the power of a commodity or service to satisfy a the same commodity
human want. According to Prof. Hobson, “Utility is the ability of
a good to satisfy a want.”
Utility is a psychological feeling of satisfaction, pleasure, or well-being which a
consumer derives from the consumption, possession or the use of a commodity. It is
subjective concept and therefore varies from person to person. It resides in one’s mind
and therefore cannot be measured in quantitative terms.
Utility is the want satisfying power of the commodity. Every commodity has want
satisfying power. For example when we drink a cup of tea we get satisfaction. Though
utility and satisfaction are used synonymously, we should note that utility is the
expected satisfaction whereas satisfaction implies ‘realized satisfaction’.
Utility is taken as a pleasurable feeling. However, utility is not always a pleasurable
feeling. It can be bitter and painful as well. For example, medicinal drugs are bitter but
have utility of curing illness.
A TOTAL UTILITY AND MARGINAL UTILITY
TOTAL UTILITY
It refers to the total satisfaction obtained from the consumption of given amount of a
commodity. If there are n units of the commodity then the total utility is the sum of the
utilities of all n units of the commodity.
If there are four units of a commodity, then total utility is, TU = Uo1f(tnh1e) c+ommU2o(dni2t)y. +
U3(n3) + U4(n4) where U1…….U4 are the utilities of n1…..n4 units
Total utility is the summation of marginal utility (MU) and is expressed as:
TU=∑MU Jeremy Bentham
Where, Jeremy Bentham (15
MU= marginal utility February 1748 – 6
∑= summation June 1832) was an
English philosopher,
MARGINAL UTILITY jurist, and social
Marginal utility is the utility derived from the reformer regarded as
last or marginal unit of consumption. It refers the founder of modern
the satisfaction obtained from the consumption utilitarianism.The
of additional unit of the commodity. It may be “greatest happiness
expressed as the difference between utility from principle”, or the principle of utility,
current consumption and previous consumption. forms the cornerstone of all Bentham’s
thought. By “happiness”, he understood a
i.e. MU= TUn- TUn-1
predominance of “pleasure” over “pain”.
Vedanta High School Economics - Book 9 38
Where, TUn= TU from nth unit of the commodity consumed
TUn-1 = TU from (n-1)th unit of the commodity consumed.
n= Number of units consumed.
Marginal utility is also defined as the additional utility obtained from the consumption
of an additional unit of the given commodity. It is the ratio of change in total utility to
change in consumption of a commodity.
i,e = Δ
Δ
If a consumer gets 80 utils of satisfaction from seven units of apple and 86 utils from eight units of apple, the
marginal utility is 86-80=6 utils
Where, The term ‘Util” is a hypotheti-
∆TU= Change in total utility cal unit for measurement of
∆Q= Change in quantity consumed a commodity. utility. The Cardinalists be-
lieved that utility is measur-
able in quantitative terms
2.1 LAW OF DIMINISHING MARGINAL UTILITY
The Law of diminishing marginal utility was propounded by German economist
Herman Heinrich Gossen. It is a psychological law which explains the fundamental
and familiar tendency of human nature in regard to consumption of a commodity. So it
is known as Gossen’s First law of Consumption. However, it was Marshall, who refined
and popularized this law
Statement of the Law
The law of diminishing marginal utility states that the utility obtained from additional
unit of the commodity diminishes. It means that as a man gets more and more units of a
commodity, marginal utility from each successive unit will go on falling till it becomes
zero or negative.
Marshall: “The additional benefit which a person derives from a given increases of his
stock of anything diminishes with the growth of the stock that he has”.
Basis of the Law
The law of diminishing marginal utility is based upon two facts:
1. Human wants are unlimited but a particular want is satiable.
2. Goods are not perfect substitutes for each other. Key Terms
Premises of the Law Satiable: satisfiable
The law points out two basic facts about the nature of utility: Marginal: at the edge
a. The marginal utility diminishes with every increase in Rational: sensible,
consumption of a commodity.
b. The total utility initially increases at a decreasing rate and eventually decreases
Assumptions of the Law
The law of diminishing marginal utility is true under certain assumptions. These
assumptions are as under:
a. The consumer is rational and aims at the maximization of utility.
b. The marginal utility of money remains unchanged.
c. Utility is additive and independent.
39 Vedanta High School Economics - Book 9
d. There is no gap in consumption.
e. Habits, fashion, taste and preference of the consumer remain unchanged.
Explanation of the Law
To explain the law of diminishing marginal utility, consider the following schedule
Units of a commodity Marginal utility Total utility
1 10 10
2 8 18
3 6 24
4 4 28
5 2 30
6 0 30
7 -2 28
As shown in the above schedule, the utility obtained from first unit is 10. The marginal
utility diminishes to 8, 6, 4, 2, 0 and -2 from consumption of 2nd unit, 3rd unit, 4th unit,
5th unit, 6th uni and 7th unit respectively. When MU is zero, a consumer is fully satisfied
with the consumption of a commodity. Corresponding to it, total utility is maximum.
This is the point of satiety. From 7th unit onwards marginal utility turns negative and
total utility starts decreasing.
Y Point of maximum TU Hermann Heinrich Gossen
Total Utility A H.H Gossen (1810- 1858)
was a Prussian econo-
mist. He died bitter and
TR unknown. Just before his
death, he ordered the
destruction of all copies
O Fig. A Units of g*Qood X X of his 1854 treatise (but
Y not destroyed).Gossen’s
work was finally uncov-
ered when a single copy
was found at the British Museum in 1878
Marginal Utility by Robert Adamson, a professor of philoso-
phy of Owens College, Manchester. He in-
Point of satiety formed his colleague W. Stanley Jevons,
(Zero MU)
who realized its importance and promptly
O Fig. B Q X informed Léon Walras that they had both
Units of good* X been anticipated by Gossen. Gossen’s book
was reprinted in 1889. It was Marshall who
MU refined and popularized Gossen’s laws.
Figure A shows the nature of total utility. The TU curve is concave downward indicating
that TU initially increases at a decreasing rate up to OQ units where it is maximum.
Thereafter, it decreases. Figure B shows the nature of marginal utility. The MU curve
is downward sloping indicating that MU diminishes throughout with every increase in
consumption of a commodity.
When TU is maximum at point A corresponding to OQ units of
consumption, MU is zero. This point is called, ‘the point of satiety’.
Increase in consumption beyond the Qthunit cause MU to turn negative.
Vedanta High School Economics - Book 9 40
LIMITATIONS OF THE LAW OF DIMINISHING MARGINAL UTILITY
The law of diminishing marginal utility is not applicable under certain circumstances.
The followings are the limitations or the exceptions of the law:
1. Dissimilar Units: The law of diminishing marginal utility is not The limitations of the
applicable if the units of a commodity differ in shape, size and law of diminishing mar-
quality. For example, if the first orange consumed is not ripe ginal utility are also the
while the second orange consumed is ripe, the marginal utility exceptions to the law
of the second orange will not diminish, instead it may increase.
2. Unsuitable Units: The units of consumption should be of suitable size. If the units of
consumption are too small, then every successive unit of consumption may give higher
utility to the consumer. For example: If a person is given water by a spoon when he is
very thirsty, each additional spoonful will give him more satisfaction. In such a case
the law of diminishing marginal utility is inapplicable.
3. Time lag in Consumption: There should be no time lag in the consumption of different
units. If there is time lag between the consumption of different units, then this law may
not hold good. For example, if a consumer consumes successive units of apple at an
interval of one hour, then the utility from successive units may not diminish.
Durable goods are pur-
4. Durable Goods: Durable goods refer those goods which can chased once at a time so
be used for long time. For example, refrigerator, computer, the time gap of purchase
television, radio are durable goods. Law of diminishing of another unit is long
marginal utility is not applicable for such goods.
5. Habitual Goods: The law will not be applicable for habitual goods such as
consumption of cigarettes, consumption of drugs, alcohol, etc. In case of
habitual goods a person gets more and more satisfaction from additional units.
Utility is not diminished from additional units in case of habitual goods.
6. Taste, Fashion, Customs and Income: There should be no change in tastes, customs,
fashion and income of the consumer. If the income of a consumer increases, the
marginal utility of certain goods will increase. If a dress, out of fashion comes to
fashion, a man develops a taste for pizza the marginal utility of the dress and pizza
increases respectively.
7. Abnormal Persons: This law is not applicable in case of abnormal and eccentric persons
like drunkards, gamblers, and misers. These persons develop a fascination and became
slaves to their habits. A drunkard feels that he gets more utilities with the consumption
of more liquor. Similarly, the utility of money to a miser increases with a rise in his
collection of money.
8. Rare Collection and Antiques: This law is not applicable in Key Term
the case of rare goods. Persons who collect rare goods like Point of satiety: point
of satisfaction. At this
postage stamps, coins, antiquities etc., get more utilities when point MU is zero
they collect more rare goods.
Glossary Utility: ` The want satisfying power of a commodity
Eccentric: Unconventional and slightly strange
Miser: A person who hoards wealth and spends as little money as possible
Antiques: An object having special value because of its age,
41 Vedanta High School Economics - Book 9
IMPORTANCE OF THE LAW OF DIMINISHING MARGINAL UTILITY
The importance of the law of diminishing marginal utility is explained below.
1. Basis of the Law of Demand: The law of demand is the outcome of the law of diminishing
marginal utility. The law of demand states that larger quantities are purchased at a lower
price. The reason is that as more units of a commodity are purchased, its marginal utility
to the consumer becomes less and less. So he gives lesser importance to additional units of
a commodity. Therefore, he will buy additional units of a commodity only at a lower price.
2. Basis of Various Economic Laws: The law of diminishing The law of diminishing
marginal utility is the basis of various economic laws. Economic marginal utility explains
laws such as law of demand, law of substitution, concept of consumer behaviour with
elasticity of demand, consumer surplus etc are based on the regard to consumption of
a single commodity
law of diminishing marginal utility.
3. Basis of Price Determination: Law of diminishing marginal utility helps in price
determination. Higher the marginal utility of the commodity, higher price can be
charged. This is because higher marginal utility implies greater willingness to pay.
Likewise, as the stock of a commodity increases, its marginal utility decreases. When
the marginal utility falls, consumers do not prefer to pay high price. Therefore, the
seller has to reduce the price of the commodity, if he or she wants to sell more.
4. Basis for Progressive Taxation: Progressive taxation results when the rate of taxation
increases with an increase in income of the consumer. The law of diminishing marginal
utility is the basis of progressive system of taxation. As the rich have lower marginal
utility of money as compared to the poor people due to greater stock of money, they
should be taxed at a higher rate.
5. Redistribution of Income and Wealth: The public expenditure Key Term
should be planned in such a manner that more is spent for the
benefit of the poor vis-a-vis the rich. The law of diminishing Equitable: fair and
impartial
marginal utility provides justification of the socialist plea for
an equitable distribution of wealth.
6. Guideline to Household Expenditure: This law governs our daily expenditure. Since
larger purchases reduce marginal utility, we restrict the purchase of a particular
commodity, as we cannot afford to waste our limited resources. We stop further
purchases at a point, where marginal utility equals price.
7. Diversification in Production: Besides diversification in consumption, the law also
helps us in bringing about diversification in the production process. Greater and greater
use of the same kind of good makes us feel bored reducing its marginal utility.
Keynote • The law of diminishing marginal utility is based on introspection
• When Total Utility is maximum, Marginal Utility is zero
• Progressive taxation means, tax rate increases with increase in income
• A consumer in equilibrium equates MU with price of the commodity
• Total uility is the total satisfaction obtained from a commodity
Vedanta High School Economics - Book 9 42
2.2 LAW OF SUBSTITUTION - The Law of Equi-marginal Utility
The law of substitution is simply an extension of the law of diminishing marginal
utility to two or more than two commodities. This law was propounded by German
economist Hermann Heinrich Gossen after the law of diminishing marginal utility. So
it is also known as Gossen’s second law of consumption. It was Marshall who made
significant refinement of this law in his ‘Principles of Economics’.
The law of substitution explains how a rational consumer maximizes his satisfaction
with his limited budget. So this law is also known as law of maximum satisfaction.
Every consumer has unlimited wants. However, the income at his disposal at any time
is limited. The consumer is faced with a choice among many commodities and allocates
his income in such a way as to maximize satisfaction. This law explains how the
consumer makes substitution between goods and spends his limited income on various
commodities to get maximum satisfaction. So the law is also known as the Law of
Substitution.
Marshall: “If a person has a thing which he can put to several uses, he will distribute
it between these uses in such a way that it has the same marginal utility in all”.
Lipsey:“The household maximizing the utility will so allocate the expenditure between
commodities that the utility of the last penny spent on each item is equal”
Conditions for Equilibrium
There are two conditions for consumer equilibrium as per the law:
The law of substitution
a. The proportionality rule (Necessary condition) involves substitution by
= =… … … . . = MUM higher utility good for
lower utility good
The above mentioned condition implies that a consumer reaches his equilibrium in his
allocation of outlays when the ratios of marginal utility to price are equalized for all
commodities that he consumes. This maximizes his satisfaction.
b. Sufficient condition
Along with the fulfillment of the proportionality rule the sufficient condition is that a
consumer spends his money outlay fully on different goods.
Assumptions of the Law of Substitution Pause for Thought
The law is based on the following assumptions
a. The consumer is rational and tries to maximize The law of Substitution is
known, by various names. It is
b. satisfaction. named as the Law of Maximum
c. Satisfaction, the Law of Indiffer-
Utility can be measured in cardinal numbers i,e in ence, the Proportionate Rule and
terms of money. the Gossen’s Second Law.
The marginal utilities of different commodities are
independent
d. The marginal utility of money remains constant.
e. The income of the consumer is given.
f. The prices of the commodities are given.
g. Diminishing marginal utility operates in consumption.
43 Vedanta High School Economics - Book 9
Explanation of the Law
Suppose that the consumer has Rs 7 which he has to spend fully on orange and apple. The
price of orange and apple is Rs 1 per unit each. The utility obtained from different units of
orange and apple is presented in table.
Units of Consumption MU of Good X MU of Good Y
1 10 8
28 6
36 4
44 2
52 0
60 -2
7 -2 -4
The tableshows that a consumer is in equilibrium when he
purchases 4 units of Good X and 3 units of Good Y. The marginal Since PthX e annedcePsysabroythcoanre-
Rs. 1,
utilities of both Good X and Good Y are same, i.e. 4. He derives dition for equilibrium be-
comes MUX =MUY
total utility of 46 (28 from Good X +18 from Good Y).
Any other combination or arrangement will not give him as much satisfaction or utility.
As for example, if he purchases 3 units of Good X and 4 units of Good Y, total utility
will be equal to only 44 which is less than 46. In brief, the consumer obtains maximum
satisfaction when weighted marginal utilities from all goods purchased are equal.
The law of substitution can be illustrated by the help of figure below. In the figures below X
axis represents units of commodities and Y axis represents marginal utility
Glossary
The figure shows that a consumer is in equilibrium when the allocation is Rs 4 in
Good X and Rs 3 in Good Y. Because, with these quantities, the marginal utilities are
equal in both commodities, i.e. PM = P’M’. Hence, this is the best allocation of money.
Any other combination will give him less total satisfaction. If Rs 4 is devoted to Good
Y and Rs 3 to Good X, the gain would be the area between 3 and 4 under MU curve
in commodity Y. But, there would be loss of area between 3 and 4 under MU curve in
commodity X. Hence, the total utility of new combination is less.Any other allocation
will make a loss in utility greater than gain in utility.
Cardinal: A quantity or number
Rational: Logical, sensible
Proportional: Having the same or a constant ratio
Equilibrium A state of perfect balance
Vedanta High School Economics - Book 9 44
LIMITATIONS OF THE LAW OF SUBSTITUTION
The followings are the limitations of law of substitution:
1. Consumer’s Ignorance: If the consumer is ignorant or blindly follows custom or fashion,
he will make a wrong use of money. Due to his ignorance, he may not be aware of other
alternatives. In this case no substitution takes place. Furthermore, an ignorant consumer
cannot judge where utility is higher or where utility is lower.
2. Indivisibie Goods: The law of substitution is based on the assumption that commodities
are divisible and substituable. This is an unrealistic assumption. Though commodities
may be divided according to the convenience of the consumer, it is not possible to divide
all commodities in small units. For example, goods like television, and computer are not
divisible. In this case, we cannot substitute one good for others. MU of money is as-
sumed constant as
3. Constant MU of Money: The theory is based on the assumption money is taken as the
that the marginal utility of money is constant. But that is not really measuring rod of utility
so. The marginal utility of money increases as the stock of money
with a person decreases with the increase in his expenditure.
4. Measurement of Utility: Utility can’t be measured in terms of numbers. It can only be
expressed in terms of range i.e. high or low. Marshall states that the price a consumer is
willing to pay for a commodity is equal to its marginal utility. But modern economists
argue that, if two persons are paying an equal price for given commodity, it does not mean
that both are getting the same level of utility.
5. Increase in Marginal Utility: For this law to hold good marginal utility must diminish as
more and more units of a resource are applied to any one of its uses. The law does not
apply if the marginal utility increases instead of diminishing.
6. Customs and Traditions: Sometimes people are slave of customs or fashion and they
are unable to become rational.Without being rational a consumer cannot substitute
one thing for another. He is compelled to buy the goods for festivals or religious purposes.
7. Unlimited Resources: The law of substitution has no place when the resources are
unlimited as in the case of free gift of nature. In such cases, there is no need to re-
arrange expenditure because they can be used without any cost.
8. Change in Price: In market economy, the prices of goods change frequently. In this case a
consumer cannot allocate his expenditure between the goods. So, when there is frequent
change in price the law of equi-marginal utility is not applicable.
9. Shortage of goods: If there is shortage of goods in market there is no question of
equalizing the MU from several commodities.
10. Choice Uncertain: The alternatives open to the consumer also assumed to be certain.
But consumer choices are uncertain and even risky. In fact, it is expected utilities that
determine consumer’s choices of the various combinations he can buy with a given money
income.
Keynote • The law of substitution is the analysis of the consumer behaviour when
there is consumption of more than one commodity
• Like the Law of diminishing marginal utility, the law of substitution as-
sumes cardinal measurability of utility
• A rational consumer makes proper allocation of his limited resources
45 Vedanta High School Economics - Book 9
IMPORTANCE OF THE LAW OF SUBSTITUTION
The various application of the law of substitution is explained under the following
headings:
1. In Consumption: A consumer is assumed to be rational. He always tries to maximize
his utility subject to budget constraint. The law of substitution helps every consumer
to maximize his utility by equalizing the marginal utilities obtained from different
commodities.
Key Term
2. In Production: A rational producer also seeks to maximize Budget constraint: the
his production in the least possible cost. For maximum limit on purchases set
production the producer has to substitute one factor input by consumer’s budget
with another. He substitutes the factor input having greater
marginal productivity with the factors having less marginal productivity.
3. In Exchange: This law of substitution also applies in exchange, because exchange is
nothing but the principle of substitution itself. The process of substitution occurs till
the marginal utility from each goods remain equal.
4. In Distribution: Distribution concerns with the determination of rewards of the various
factors of production, i.e. determination of rent, wages, interest and profit. The use of
each factors is pushed by the firm to a point where marginal productivity of one factor
is equal of other factor’s marginal productivity and are paid rewards according to their
marginal productivity.
5. In Public Finance: The law of substitution is also applicable in public finance. The
principle of ‘Maximum Social Advantage’ as enunciated by Hicks and Dalton states
that, the revenue should be distributed in such a way that the last unit of expenditure
on various programmes brings equal welfare, so that social welfare is maximized.
6. In Government Policy: The government spends its budget for maximum returns and
social welfare. The government diverts its resources from less productive sector to
greater productive sector. To meet this objective, high tax rate is imposed for rich
people and low tax rate for the poor. As a result, the burden of tax falls equally to all
citizens.
7. Price Determination: The principle of substitution Did you Know?
is also applicable in the determination of prices
when a commodity becomes scarce and its price Marshall was a Cardinalist.
becomes high. In order to bring its price down, we As a leader of the Neo classical
start substituting an abundant commodity for it, its school of thought, he considered
scarcity will end. utility as measurable in quantita-
8. Expenditure of Time: Prof. Boulding relates Marshall’s tive terms i,e in terms of money.
law of equi-marginal utility to the expenditures of The amount of money a person
limited time. He states that a person should spend is willing to pay for a thing is the
his limited time among alternative uses such as utility he derives from it.
reading; studying and gardening, in such a way that
the marginal utility from all these uses are equal.
CHECKPOINT 1. Define utility. Distinguish between total utility and marginal utility
2. Explain the law of diminishing marginal utility. What are its exceptions?
3. Explain the law of substitution. What are its exceptions?
4. What are the conditions for equilibrium under the law of substitution?
5. Show the relation between marginal utility and total utility
Vedanta High School Economics - Book 9 46
T2.3 CONSUMER SURPLUS
he concept of consumer’s surplus was originally introduced by a French engineer
Dupuit, a French engineer-economist. It was initially used to measure the social
benefits of public projects like roads, bridges, canals etc. Marshall developed the
concept in his work ‘Principles of Economics’ (1890).Marshall first named this concept
‘consumer’s rent’.
Marshall: “The excess of the price which the consumer would be willing to pay rather
than go without the things over that which he actually does pay is the economic
measure of this surplus satisfaction it may called the consumer’s surplus”.
Statement of the Concept
In our daily life goods and services are consumed. Generally, the satisfaction we get from
the goods consumed is more than the price paid for them. This extra satisfaction obtained
from the consumption of a commodity is called consumer surplus. Consumer surplus is
the difference between what a consumer expects to pay and the actual amount paid by
the consumer for the commodity. It is the excess satisfaction derived by a consumer
from a commodity over what he actually pays for it. It may be defined as the difference
between willingness to pay for a commodity and the actual payment.
Consumer’s surplus = Willingness to pay-Actual payment.
= ∑MU - P×Q
= TU - TE
Where,
P = price, and Q = total quantity purchased.
TU= Total Utility and TE= Total Expenditure
Assumptions Did you Know?
The Marshallian concept of consumer surplus Jules Dupuit (1804–
1866) was an Italian-born
is based on the following assumptions French civil engineer and
1. Consumer is rational. economist. His 1844 arti-
2. The utility of a commodity is measured in cle was concerned with de-
monetary terms. ciding the optimum toll for
a bridge. It was here that
3. Marginal utility of money is constant. he introduced his curve
4. No change in income, tastes, fashion etc. of diminishing marginal
utility. Dupuit went on
5. Independent goods and independent utilities. to define “relative utility” as the area under
the demand/marginal utility curve above the
6. The price remains constant.
price and used it as a measure of the welfare
7. The law of diminishing marginal utility effects of different prices – concluding that
operates in consumption. public welfare is maximized when the price
(or bridge toll) is zero. This was later known
as Marshall’s “consumer surplus”.
Explanation of the Concept
The consumer surplus can be explained with the help of law of diminishing marginal
utility. As we purchase more units of the commodity, lesser the marginal utility.
Consumer surplus is obtained by taking the difference between total utility and total
amount of money spent.
47 Vedanta High School Economics - Book 9
The concept of consumer surplus is explained with the help of the following schedule
Units of Marginal Utility Price (Actual Consumer
good (willingness to pay) price) Surplus
1 12 8
2 20 12 6
3 18 12 4
4 16 12 2
5 14 12 0
Total 12 60 20
80
In the above table, we have assumed that the market price of the commodity is Rs.12.
Marginal utility explains the price which a consumer is willing to pay for the unit of the
commodity. As more and more units of a commodity is purchased, the marginal utility
declines. Therefore the price, which the consumer is willing to pay, also decreases. The
difference between marginal utility (potential price) and the market price (actual price)
gives the consumer’s surplus.
The table shows that a consumer is in equilibrium when he purchases 5 units of a
commodity as the MU of the 5th unit is equal to the price. From the consumption of five
units altogether, the consumer derives total consumer surplus of 20.
Thus, consumer surplus = Total Utility - Total Expenditure
= 80 -60
= 20
The concept of Consumer Surplus also can be explained with the help of the figure as,
Y
D Consumer Surplus
Ptice, MU PB
MU
O Q Quantity X
In the above figure, marginal utility (price) is taken along the Y-axis and units of
commodity ablyonthgetahreeaXO-aDxiBsQ. DaDndl iasctthueal marginal utility curve. Here, total utility is
represented price paid is OPBQ. So consumer surplus is
the area PDB (area of ODBQ - area of OPBQ) which is shown by the shaded area.
Glossary Marginal utility: Additional utility obtained from additional unit of consumption
Cardinal utility: Utility measurable in quantitative terms
Total utility: Total satisfaction obtained from the consumption of a commodity
Public Finance: Study of the income and expenditure of the government
Vedanta High School Economics - Book 9 48
CRITICISMS OF CONSUMER SURPLUS
Marshall’s measure of consumer’s surplus has been subjected to severe criticisms from
economists due to its unrealistic assumptions. The main criticisms are:
1. Utility not Measurable: The Marshallian concept of consumer’s As per Marshall util-
surplus is based on the assumption that utility is quantitatively ity can be measured in
measurable. The moment we recognize that utility is not quantitative terms i,e in
a measurable quantity, the doctrine of consumer’s surplus terms of money
becomes misleading.
2. MU of Money not Constant: The Marshallian consumer’s surplus presupposes the MU
of money to remain constant throughout the process of exchange. This assumption
undermines the very validity of this concept. For, when a consumer spends his given
money income on the purchase of a commodity, the amount of money left with him is
correspondingly reduced and its marginal utility to him increases.
3. Neglects Complementary Goods: Marshall further assumes the utility of a good
as dependent upon the supply of that good alone. He neglects the problem of
complementarity of goods and thus considers one good as independent of the other.
4. Neglects Substitutes: This concept assumes the absence of substitutes of the commodity
from which the consumer derives the surplus, because the presence of substitutes like
tea and coffee would make the measurement of consumer’s surplus difficult.
5. Neglects Tastes and Sensibilities: Marshall assumes that the differences of taste
and sensibilities should be neglected in calculating consumer’s surplus. This is an
unrealistic assumption because every consumer is prepared to pay more or less for the
same commodity according to his tastes and sensibilities. Even if the incomes of all the
consumers were the same, their tastes and sensibilities would differ.
6. Consumer’s Surplus from Necessaries Indefinite: The consumer’s surplus from
necessaries is indefinite and unascertainable. The prices of necessaries are very low
whereas utility derived from them is very high. Therefore, consumer’s surplus from
them is infinite and indefinite. Rather than die of thirst, a thirsty person may be
prepared to pay everything he possesses for a glass of water.
7. Not Measurable for Luxury Goods: Prof. Taussig criticized As per Marshall, the
the doctrine on the ground that consumer’s surplus cannot be amount of money a per-
measured in the case of luxury goods or prestigious articles. A son is willing to pay for a
fall in the price of articles like diamonds reduces their utility commodity is the utility
he derives from it
to their possessors, thereby reducing consumer’s surplus.
8. Hypothetical, Unreal and Imaginary: According to Prof. Nicholson’s the concept of
consumer surplus is hypothetical, unreal and imaginary. It is so undoubtedly due to
its unrealistic assumptions and an ingenious device of calculating it. It is merely a
theoretical toy.
9. Willingneess to Pay Immeasurable: Another difficulty relating to the demand curve is
that it is not possible to know the entire demand schedule on which it is based. It is
impossible to know what prices the consumer is prepared to pay for every unit of the
commodity.
49 Vedanta High School Economics - Book 9
IMPORTANCE OF CONSUMER SURPLUS
The importance of consumer surplus is explained as below:
i. Distinction between Value-in-use and Value–in–exchange: The concept of consumer’s
surplus, clearly brings out the difference between value-in-use and value in exchange.
What a consumer is willing to pay for a product is the value-in-use of the product and what
the consumer actually pays to get the product is the value-in-exchange of the product.
2. To formulating Fiscal Policy: Study of consumer surplus Key Terms
helps to determine tax on goods. Government can impose Value in use: utility of a
high tax rate on goods where consumer’s surplus is high. commodity
Value in exchange: price of
The impact of tax will be low. But low tax rate should be a commodity
imposed on the goods having low consumers surplus.
3. To determine Price Level: The law of consumer surplus is equally important to determine
price. Producer can increase the price of the goods having high consumer surplus. In
this case supply can be increased and producer get more benefit raising the price of the
goods.
4. To measure Economic Development: The concept of consumer surplus is very important
to measure economic development. It is understood that higher the consumer surplus
higher the level of economic development. Low consumer surplus indicates low
development of the country.
5. Comparison between Places: The concept of consumer surplus can be used to make
comparison between places. A place which offers better facilities have high consumer
surplus. Such a place is considered a better place to live in.
6. In International Trade: International trade refers export and imports. These goods
which cost of production is very high with in the country should be imported. Low
cost of production refers to high consumer surplus. If imported goods are of high cost,
the consumer’s surplus will be low and import is to be discouraged and consumption
of domestic production is preferable.
7. Importance to Monopolist: While practising price Key Term
discrimination, a monopolist may charge different prices for Monopolist: sole pro-
the same commodity from different buyers (i.e., higher prices ducer/seller of a com-
from the affluent buyers and lower prices from others) in such modity
a way that none enjoys any consumer’s surplus.
8. Decision-making: Cost-benefit analysis is an important tool in economics in the area
of decision-making. It is carried out while investing on construction of public projects.
Expected consumer’s surplus is calculated before taking decisions on such big constructions
and investments.If benefits to be obtained are greater than the costs, the investment is
undertaken.
CONCEPTS FOR REVIEW
Utility Total utility Marginal utility
SEuqubjiemctaivrgei n al utility HRaotmio ongaelncoounss um er TPaoxinattioofn s atiety
Substitution Ceteris paribus Consumer surplus
Price determination Monopolist Public finance
Vedanta High School Economics - Book 9 50
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