You are on page 1of 11

Answers 2) A capitalist economy is an economic system in which the production and distribution of commodities take place through the

e mechanism of free markets. Hence it is also called as market economy or free trade economy. Each individual be it a producer, consumer or resource owner has considerable economic freedom. An individual has the freedom to buy and sell any number of goods and services and to choose any occupation. Thus a market economy has no central coordinator guiding its operation. But selforganization emerges amidst the functioning of market forces namely supply, demand and price. Main features of a capitalist economy are as follows: (i) It is an economic system in which each individual in his capacity as a consumer, producer and resource owner is engaged in economic activity with a great degree of economic freedom. (ii) The factors of production are privately owned and managed by individuals. (iii) The main motive behind the working of the capitalist system is the profit motive. The entrepreneurs initiate production with a view to maximize profits. (iv) Income is received in monetary form through the sale of services of the factors of production and fro: profits of private enterprise. (v) Capitalist economy is not planned, controlled or regulated by the government. In this system, economic decisions and activities are guided by price mechanism which operates automatically without any direction and control by the central authorities. (vi) Competition is the most important feature of the capitalist economy. It means the existence of large number of buyers and sellers in the market who are motivated by their self-interest but cannot influence market decisions by their individual actions.

Right to Private Property: Individuals have the right to buy and own property. There is no limit and they can own any amount of property. They also have legal rights to use their property in any way they like. Profit-Motive: Profit is the only motive for the functioning of capitalism. Production decisions involving high risks are taken by individual only to earn large profits. Hence, profit-motive is the basic force that drives the capitalist economy. Freedom of Choice: The question what to produce? will be determined by the producers. They have the freedom to decide. The factors of production can also be employed anywhere freely to get due prices for their services. Similarly consumers have the freedom to buy anything they want. Market Forces: Market forces like demand, supply and price are the signals to direct the system. Most of the economic activities are centered on price mechanism.

Production, consumption and distribution questions are expected to be solved by market forces. Minimal role of Government: As most of the basic economic problems are expected to be solved by market forces, the government has minimal role in the economy. Their role will be limited to some important functions. They include regulation of market, defence, foreign policy, currency, etc.

Merits/Benefits of Capitalist Economy

Increase in productivity: In a capitalist economy every farmer, trader or industrialist can hold property and use it in any way he likes. He increases the productivity to meet his own self-interest. This in turn leads to increase in income, saving and investment. Maximizes the Welfare: It is claimed that there is efficiency in production and resource use without any plan. The self-interest of individual also promotes societys welfare. Flexible System: The shortages and surpluses in the economy are generally adjusted by the forces of demand and supply. Thus it operates automatically through the price mechanism. Non-interference of the State: The State has a minimum role to play. There is no conflict between the individual interest and the society. The economic institutions function automatically preventing the interference of the government. Low cost and qualitative products: The consumers and producers have full freedom and therefore it leads to production of quality products at low costs and prices. Technological improvement: The element of competition under capitalism drives the producers to innovate something new to boost the sales and thereby bring about progress.

Disadvantages of Capitalist Economy

Inequalities: Capitalism creates extreme inequalities in income and wealth. The producers, landlords, traders reap huge profits and accumulate wealth. Thus the rich become richer and the poor poorer. The poor with limited means are unable to compete with the rich. Thus capitalism widens the gap between the rich and the poor creating inequality. Leads to Monopoly: Inequality leads to monopoly. Mega corporate units replace smaller units of production. Firms combine to form cartels, trusts and in this process bring about reduction in number of firms engaged in production. They ultimately emerge as multinational corporations (MNCs) or transnational corporations (TNCs). They often hike prices against the welfare of consumer. Depression: There is over-production of goods due to heavy competition. The rich exploit the poor. The poor are not able to take advantage of the production and hence are exploited. At another level, over-production leads to glut in the market and hence depression. This leads to economic instabilities.

Mechanization and Automation: Capitalism encourages mechanization and automation. This will result in unemployment particularly in labor surplus economies. Welfare ignored: Under capitalism, private enterprises produce luxury goods which give higher profits and ignore the basic goods required which gives less profit. Thus the welfare of public is ignored. Exploitation of Labor: Stringent labour laws are enacted for the exclusive profitmotive of capitalists. Fire and hire policy will become the order of the day. Such laws also help to exploit the labour by keeping their wage rate at its lowest minimum. Basic social needs are ignored: There are many basic social sectors like literacy, public health, poverty, drinking water, social welfare, and social security. As the profit margin in these sectors is low, capitalists will not invest. Hence most of these vital human issues will be ignored in a capitalist system.

Answer 3) Elasticity of demand is known as price-elasticity of demand. Because elasticity of demand is the degree of change in amount demanded of a commodity in response to a change in price. Price elasticity of demand can be measured through three popular methods. These methods are: 1. Percentage method or Arithmetic method 2. Total Expenditure method 3. Graphic method or point method. 1. Percentage method:According to this method price elasticity is estimated by dividing the percentage change in amount demanded by the percentage change in price of the commodity. Thus given the percentage change of both amount demanded and price we can derive elasticity of demand. If the percentage charge in amount demanded is greater that the percentage change in price, the coefficient thus derived will be greater than one. If percentage change in amount demanded is less than percentage change in price, the elasticity is said to be less than one. But if percentage change of both amount demanded and price is same, elasticity of demand is said to be unit. 2. Total expenditure method Total expenditure method was formulated by Alfred Marshall. The elasticity of demand can be measured on the basis of change in total expenditure in response to a change in price. It is worth noting that unlike percentage method a precise mathematical coefficient cannot be determined to know the elasticity of demand. By the help of total expenditure method we can know whether the price elasticity is equal to one, greater than one, less than one. In such a method the initial expenditure before the change in price and the expenditure after the fall in price are compared. By such comparison, if it is found that the expenditure remains the same, elasticity of demand is One (ed=I). If the total expenditure increases the elasticity of demand is greater than one (ed>l). If the total expenditure diminished with the change in price elasticity of demand is less than one (ed<I). The total expenditure method is illustrated by the following diagram. 3. Graphic method: Graphic method is otherwise known as point method or Geometric method. This method was popularized by method. According to this method elasticity of demand is measured on

different points on a straight line demand curve. The price elasticity of demand at a point on a straight line is equal to the lower segment of the demand curve divided by upper segment of the demand curve. Thus at mid point on a straight-line demand curve, elasticity will be equal to unity; at higher points on the same demand curve, but to the left of the mid-point, elasticity will be greater than unity, at lower points on the demand curve, but to the right of the midpoint, elasticity will be less than unity. The primary factor is the availability of close substitutes. For example, suppose a Sunoco station raises the price of its gasoline by 10 percent. Most consumers treat rival brands as almost perfect substitutes and will quickly switch to other suppliers. Sunoco is likely to lose far more than 10 percent of its volume -- an elastic response. But, suppose that the Sunoco station is the only one in town; suppose that no other brands are available. In this case, consumers are stuck. Without an alternative, they will continue to patronize the Sunoco station despite the higher price. Consumers might cut back on unnecessary driving to save money, but the drop in quantity demanded is likely to be quite small -- an inelastic response. How much of our income we spend on an item can be a second factor that impacts elasticity. For example, I never comparison shop for shoe laces. The price does not concern me. I spend so little on laces that even a doubling of their price would have no noticeable impact on my annual budget. Shopping for a better deal would cost me more than it realistically could be worth. To me, saving five cents on a pair of laces is insignificant. But not to Nike or New Balance or Adidas. For a firm that is selling millions of pairs of shoes per year, five cents per lace starts to matter. It may not pay an individual to shop around for a better deal on laces, but it certainly will pay Nike to do so. All else equal, the more we spend on item, the more elastic our demand will be. Time is a third factor that affects elasticity. Given more time we can make more substitutions. Suppose the price of gasoline rises. In the short run consumers will continue to feed their voracious SUV's. But, when they next shop for a new car, many will shift to more fuel-efficient options. The more time we have to shift our purchasing patterns, the more elastic our demands will be. Responsiveness of the demand for a goods or service to the increase or decrease in its price. Normally, sales increase with drop in prices and decrease with rise in prices. As a general rule, appliances, cars, confectionary and other non-essentials show elasticity of demand whereas most necessities (food, medicine, basic clothing) show inelasticity of demand (do not sell significantly more or less with changes in price). Elasticity of demand appears in the definitions of the following terms: market penetration pricing, price

elasticity of demand, elasticity of demand appears in these other terms: income elasticity of demand, own price elasticity of demand. Price elasticity of demand (PED) is defined as the measure of responsiveness in the quantity demanded for a commodity as a result of change in price of the same commodity. It is a measure of how consumers react to a change in price. In other words, it is percentage change in quantity demanded as per the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity, which is it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price. In simpler words, demand for a product can be said to be very inelastic if consumers will pay almost any price for the product, and very elastic if consumers will only pay a certain price, or a narrow range of prices, for the product. Calculating the Price Elasticity of Demand You may be asked the question "Given the following data, calculate the price elasticity of demand when the price changes from $9.00 to $10.00" Using the chart on the bottom of the page, I'll walk you through answering this question. (Your course may use the more complicated Arc Price Elasticity of Demand formula. If so you'll need to see the article on Arc Elasticity) First we'll need to find the data we need. We know that the original price is $9 and the new price is $10, so we have Price(OLD)=$9 and Price(NEW)=$10. From the chart we see that the quantity demanded when the price is $9 is 150 and when the price is $10 is 110. Since we're going from $9 to $10, we have QDemand(OLD)=150 and QDemand(NEW)=110, where "QDemand" is short for "Quantity Demanded". So we have: Price(OLD)=9 Price(NEW)=10 QDemand(OLD)=150 QDemand(NEW)=110 To calculate the price elasticity, we need to know what the percentage change in quantity demand is and what the percentage change in price is. It's best to calculate these one at a time.

Answer 4) There are several factors governing the elasticity of demand for a commodity. They are explained below. 1. Availability of substitutes: A commodity will have elastic demand if there are good substitutes for it. A small rise in the price of a commodity will send buyers to the substitutes. A lower price of a commodity will invite the former buyers of the substitute goods. A rise in the price of Brooke Bond tea may encourage buyers to use Lipton tea and vice versa. If no substitutes are available, demand for goods will be inelastic. Demand for salt is perfectly inelastic because it has no substitute. 2. Nature of the commodity: Demand for necessaries is inelastic, because they are indispensable for human existence. On the other hand, the demand for comforts and luxuries is generally elastic because these goods are not very essential for life and are demanded only when their prices are reasonable. 3. Postponement of consumption: The demand for goods the consumption of which can be deferred for some time is elastic as the demand for the V.C.R. it can be postponed for some time if prices are higher. The demand for necessaries like food grains is inelastic because their use cannot be deferred. 4. Proportion of expenditure: The demand for a good on which a small proportion of income is spent is inelastic. Salt, matchbox, and soap etc. are its examples. On the contrary, the demand for such commodities where a major part of income is spent is elastic like the demand for comforts and luxuries. 5. Alternative use: A commodity having several uses has an elastic demand. For example, electricity, coal, and steel etc. have several uses. The uses to which electricity raises demand for electricity for cooking or heating rooms etc. will fall. It will be used only for the most important purpose. Similarly, with a fall in its price it will be used only for other purpose. On the other hand, a commodity having only one use will have inelastic demand. It may be mentioned that the demand for a good may be elastic for one use and inelastic for another.

6. The time period:

Elasticity of demand varies with the length of the time period. Generally, longer the duration of period. Greater will be elasticity of demand and vice versa. This implies that demand is elastic in the long period and inelastic in the short period. This is so because in the short period generally demand does not change immediately due to price changes. 7. Habit: If consumers are habituated with certain goods the demand for such goods will be usually inelastic because they will use them even when their prices go up. A smoker generally does not give up smoking or does not smoke less when the price of cigarette goes up. 8. Joint demand: In the event of a good being jointly demanded such as car and petrol, the elasticity of demand of the second good depends on the elasticity of demand of the main good. For example, if the demand for car is inelastic, the demand for petrol will also be inelastic. 9. Distribution of income: The more equal distribution of income, the more will be the number of middle-class people. Their demand is relatively more elastic. If the distribution of income is not equal, on the one hand, there will be poor people and on the other hand, there will be rich people. The poor people will buy only necessaries and their demand will be inelastic. The rich will not be affected by price changes. Hence, the demand of the rich will also be inelastic. 10. Price Level: The demand for very costly and very cheap goods is inelastic. Very costly goods are demanded by the rich. Their demand is not affected by price changes. Similarly changes in the price of very cheap goods like salt or match box will not affect on their demand. At a very low price, everybody can purchase a good in enough quantity. Usually demand will be elastic at moderate prices.

Answer 5) Economists have long recognized the three distinct factors that people use to create the things they want. Land, labor, and capital are referred to as "factors of

production. Each factor is plays a unique role in the production of goods, and each factor is clearly distinguishable from the other two. Land is defined as everything in the universe that is not created by human beings. It includes more than the mere surface of the earth. Air, sunlight, forests, earth, water and minerals are all classified as land, as are all manner of natural forces or opportunities that are not created by people. Labor uses capital on land to produce wealth. Every tangible good is made up of the raw materials that come from nature -- and because all people (and other living things) have material needs for survival, everyone must have access to some land in order to live. Land is the passive factor in production. As such, land simply exists. To make the gifts of nature satisfy our needs and desires, human beings must do something with the natural resources; they must exert themselves, and this human exertion in production is called labor. Everything that people do, to convert natural opportunities into human satisfactions -- whether it involves the exertion of brawn, or brains, or both -- is labor, to the economist. When the stuff of nature is worked up by labor into tangible goods, which satisfy human desires and have exchange value, we call those goods Wealth. (When labor satisfy desires directly, without providing a material good, we call that "Services"; thus, economists say that labor provides the economy with "goods and services".) When some of the wealth is used to produce more wealth, economists refer to it as Capital. A hammer, a screwdriver, and a saw are used by a carpenter to make a table. The table has exchange value. The truck which delivers the table to a retail store, the hammer and other tools -- and even the cash register -- are all forms of capital. Capital increases labor's ability to produce wealth (and services too). Therefore, there is always a demand for capital goods, and some labor will be devoted to supplying those goods, rather than supplying the consumer goods that directly satisfy desires. How do we figure out how much of society's labor to devote to capital goods vs. consumer goods? In a market economy, we don't! The returns, or payments, to capital and labor move naturally toward an equilibrium, or balance, in which neither factor has an advantage over the other. If a shortage of capital goods develops, people will be willing to pay higher prices for those goods, and more workers will work on making them. In time, this will create a shortage of consumer goods, and workers will be drawn back toward making them. Likewise, when there's more demand for land, the land factories gear up and crank out more land -- or, well, er, they can't do that, can they? That is why land must be defined as a distinct factor of production. Since land is needed for all production, any time overall production is increasing, land will be in greater demand. When capital goods are in greater demand, labor will eagerly produce more of them. But, the supply of land cannot be increased, because land is not produced by human labor.

Definition of the three distinct, interdependent factors of production is another important analytical tool that helps economists make sense of the processes of production and distribution in a complex society. Each is clearly different from the other.. The mutually exclusive nature of these categories is what makes them so useful. In other contexts, these terms are sometimes used differently, or oddly combined, such as "human capital". It is important to remember that different schemes of definitions and terms can be used for different purposes. Land, for example, is often referred to as "capital", in the sense that one can buy land and use it as a "capital investment". The use of a term like "real estate" -- which is a combination of land and capital as we have defined them here -- can further cloud the issue. This shows us that when economic terms are used, it is very helpful to clearly understand how they are being defined!

Factors of Production In Economics - Meaning

Factors of production refers to inputs required for conducting production. Input is the starting point of every production activity.

According to Prof. Benham, "Anything that contributes towards output is a factor of production." Mere existence of anything doesn't make it a factor of production but its contribution in production process is a necessary condition. Dr. Alfred Marshall described factors of production as "Agents of Production". Cooperation among factors is essential to produce anything because production is not a job of single factor.

You might also like