Basic Concepts of Economics

1. Micro and Macro Economics

Economics is the study of economies, the study of how human beings coordinate
their wants, given the institutional structures of the society. In the study of economics,
coordination refers to how the three central problems facing any economy are solved. These
central problems are: what and how much to produce; how to produce; and for whom to
produce.
Economics is divided into two different branches: Micro & Macro economics.
Microeconomics studies how the forces of supply and demand allocate scarce resources in
the economy. It examines the behavior of firms, consumers and the role of government.
Microeconomics studies the behavior of discrete parts of the economythe
individual, the household, the company. It looks at how prices are determined, and how
prices then determine production, distribution, and use of goods and services. It is the study
of decisions that people and businesses make regarding the allocation of resources and
prices of goods and services. For example, consumers decide how much of various goods to
purchase, workers decide what job to take and business people decide how many workers
to hire and how much output to produce.) As prices have important effects on the
individuals decisions, the microeconomics is frequently called "price theory". The major
scope of microeconomics is supply and demand and other forces that determine price.
Macroeconomics is the field of economics that studies the behavior of the economy
as a whole. It examines whole economic systems and how different sectors interact. It looks
at economy-wide phenomena such as changes in unemployment, national income, rate of
growth, and price levels. For example, macroeconomics would look at the factors that
determine your average living costs. National economic policies and complexities of
industrial production are also studied. It deals primarily with aggregates (total amount of
goods & services produced by society) and general level of prices. It addresses issues such
as level of growth of national output (GNP & GDP), interests rates, unemployment, and
inflation.
Micro and macroeconomics are intertwined, so as economists gain understanding of
certain phenomena, they can help nations and individuals make more-informed decisions
when allocating resources. The systems by which nations allocate their resources can be
placed on a spectrum where the command economy is on the one end and market economy
is on the other. The market economy advocates forces within a competitive market, which
constitute the invisible hand, to determine how resources should be allocated. The
command economic system relies on the government to decide how the country's resources
would best be allocated. In both systems, however, scarcity and unlimited wants force
governments and individuals to decide how best to manage resources and allocate them in
the most efficient way possible. However, there are always limits to what the economy and
government can do.

Utility
Utility is defined as the power in an article or service to satisfy a want. The concept of
utility is subjective and depends on the intensity of want to an individual. It hardly indicates the
actual usefulness or worth of goods or service. So utility is not intrinsic in the commodity. It is
also devoid of any moral or ethical significance. The utility declines as we get more units of a
commodity.
Total utility: total amount of pleasure or satisfaction that is derived from having, owning or
consuming a given amount of a good or service at a point of time.
Average Utility: total amount of pleasure or satisfaction divided by total units of a commodity
consumed by a consumer at a point of time.
Marginal Utility: it refers to the additional pleasure or satisfaction that is derived from
consuming the last unit of a good or service.

Equilibrium

Equilibrium is the most fundamental concept in economics. The word equilibrium is

derived from Latin words acquus, which means equal, and libra which means balance. In
economics, equilibrium can be defined as a situation in which economic forces, as they exist at
the time, have no tendency to change. It is the position towards which an economic
phenomenonprice, quantity, income etc.tends to move and once it reaches the point of
equilibrium, the movement stops. It is a state of balance in such a way that the opposite forces
mutually cancel each other so that the object on which these forces exert their pressure is not
subject to any disturbance. There are economic activities present in a state of equilibriumin
equilibrium a firm produces, sells and earns profit and different firms in the industry carry on
their productive activities smoothly.
Static and Dynamic Economics
The meaning of the two terms in economics is different from the meaning given to them
in physical sciences.
The term static in physical sciences is indicative of a position of rest, of absence of any
movement whatsoever. In economics, however, the term static does not indicate a motionless
economy. There is movement in the economy but this movement is constant, regular, smooth and
certain, devoid of certain jerks and shocks. Uncertainty does not creep in. Thus the chief features
of static state in economies are the absence of uncertainty and the existence of constant
movement through time. This is not a state of idleness but one where work proceeds smoothly at
a steady pace, day in and day out, and year after year in the economy. Pigou remarks, just as the
drops of water that form a stream, are always changing but its form remains the same, in a static
state, the factors change but they are not of any consequence. According to Hicks, we should
call economic static those parts of economic theory where we do not trouble about dating. In
static economics, various economic phenomena and their effects are analysed without reference
to time. For instance, when we say that if price is lowered by 5 %, demand rises by 3%, we are in
the field of static analysis.
The word dynamics means causing to move. In economics it refers to the study of
economic change. In economic static, the relations between the relevant variables refer to the
same point or period of time. In economic dynamic, the relations between relevant variables refer
to different point of time. It is, thus, a process of change through time. Since dynamic is that
which changes and static which does not involve change, it is pertinent to ask what is that

change? An economic unit may undergo a change with respect to itself at a different place or a
different time. We can therefore say that the change may occur with respect to matter, space or
time. For instance, in the process of manufacturing goods, the matter may undergo change or in
the process of transportation space undergoes a change. Similarly, in the process of hoarding
time undergoes a change.
While the economy is in the process of change through time, economic variables may
change in two ways: one way is that, though the time element has undergone a change, the
economy may not change its pattern and thus the values of the economic variables remain the
same. The second way is that the economy may evolve through time and change its pattern so
that the economic variables are non-stationary through time. The former way of happening of the
change relates to static state, while the latter type relates to economic dynamics.
Ragnar Frisch has broadened the vistas of economic dynamics by including in it not only
continuing changes but also the process of change. According to him dynamic analysis is one
in which we consider the magnitudes of certain variables on different points of time and we
introduce certain equations which embrace at the same time several of those magnitudes at
different instants Economic dynamic thus should embody functional relationships of variables
with different dates appended to them. For instance:

Where:

Ct = f (Yt-1)
C is consumption, Y is income and T is time.

1. National Income Concepts

i. Gross National Product (GNP)
GNP stands for the monetary value of all goods and services that are (i) currently
produced, (ii) sold through the official market, (iii) not resold or used in further production, (iv)
produced by the nationally owned resources (factors of production), and (v) valued at the market
prices (current or constant).
GNP is a flow concept and includes only those items that are produced during the period
of time for which the GNP stands. GNP accounts for only those goods and services, which are
traded through the official market. Thus, it ignores the do it yourself activities as well as the
un/under reported productions. For instance, housewives activities, social services and other
unpaid works are excluded. Similarly, unreported production, triggered by the desire to avoid
excise duties or for other reasons are not included in GNP. This gives rise to black or parallel
economy, which has two components: legal but un/under reported and illegal like gambling,
prostitution, narcotics, smuggling, etc. However, self-consumption of production by the producer
and rent on owner-living houses are included in GNP.
Intermediate goods are not included in GNP, for avoiding double counting. Therefore,
only the value of final goods or alternatively values added at each stage of production are
included in it.
It excluded non-productive transactions such as purely financial transactions and second
hand sales. The former are of three types: public transfer payments, private transfer payments
and buying and selling of securities (shares or bonds).
GNP belongs to the nation, and thus, it must be produced by its owned factors of
production only. Since some factors like labour, entrepreneur and capital are globally mobile and

MNCs are operating in many countries including India, a part of this GNP is produced abroad
and a part of foreign GNP is produced under a national territory. Thus, if an Indian professor
takes up a four month Visiting Professorship in a US University, his income in USA is the part
of Indias GNP and similarly the profit that a MNC makes in India, is not a part of Indias GNP.
GNP at market price is inclusive of the indirect taxes (Ti), net of subsidies (S) as it values
the goods at the prices paid by the end users. To get GNP at factor cost (GNPF), one must deduct
net indirect taxes from GNPM:
GNPF = GNPM - Ti +S
ii. Gross Domestic Product (GDP)
It refers to the value of the goods and services produced within the nations geographical
territory, irrespective of the ownership of the resources. Therefore, salary of an Indian visiting
professor in USA is the GDP of USA and the dividend earned by a foreign company in India
constitutes GDP of India. In view of this, while GNP consists of income produced by the
nations owned resources irrespective of the place of production, GDP refers to income produced
within the nations territory irrespective of the ownership of the resources that produced it. The
difference between the two concepts is accounted for by the net factor income earned abroad
(NIA). Thus,
GDPF = GNPF -NIA
From the point of view of the employment generation at home, GDP is more relevant than GNP,
and hence, the former often receives a greater attention than the latter.
iii. NNP:
GNP minus Depreciation.
NNP is measured at factor cost and market prices.
NNPFC = NNPMP - indirect taxes + subsidies
NNPFC is globally known as national income.
iv. NDP
GDP minus Depreciation.
v. Personal Income: It is the sum of all incomes actually received by all individuals or
household during a given period.
PI = NI social security contributions corporate income tax undistributed
corporate profits + transfer payments

vi. Disposable income

DI = PI personal taxes
vii. Gross Domestic Capital Formation
This consists of that part of GDP, which is used to create productive assets such as
constriction of building schools, roads, procurement of machine and equipments.

viii. Gross Domestic Savings

Gross domestic savings have three components: household sector savings, government
sector savings and corporate sector savings. Household sector constitutes the largest share,
followed by corporate sector. Government sector savings are negative.
Other Economic Terms
1. Budget
It is the master financial plan of a government. It brings together estimates of anticipated
revenues and proposed expenditure for the budget period. The term is derived from the old
English word Bougette, the sack or pouch from which the Chancellor of the Exchequer
extracted his papers presenting to parliament the government's financial programmes for the
ensuing fiscal year. In India, the budget is divided into (1) Revenue budget and (2) Capital
budget. The former includes revenue receipts and revenue disbursements while the latter
contains capital receipts and capital disbursements.
2. Economic Growth
Growth of the aggregate quantity of goods and services (GNP) produced annually. It is
generally percentage change in output of goods and services over the preceding year.
3. Investment
The purchase of the means of production such as plant equipments over a given period.
4. Wealth
A stock of assets (physical and financial) accumulated from flows of savings.
5. Crowding out effect
Refers to any reduction in private sector spending as a result of a deficit-financed increase in
the government sector's spending.
6. Deficit Financing
Refers to the various methods the government has at its disposal to finance a given level of
deficit spending.
7. Budget deficit
Total receipts (Revenue and capital) minus total expenditure (Revenue and capital).
8. Revenue deficit
Total revenue receipts minus total revenue expenditure.
9. Fiscal deficit
Total Public Revenue receipts minus total Public Expenditure. It is the sum of overall
budgetary deficit and borrowings and others liabilities.
10. Primary deficit
Fiscal deficit minus interest payment.

11. Inflation
Steady and sustained rise in the general level of prices.
12. Recession
A moderate decline in economic activities, which lasts from 6 to 18 months.
13. Monetary Policy
The policy of a Central bank in exercising its limited power of control over the money
supply, the level of interest rates, credit conditions and the stability of financial markets.
14. Fiscal policy
Government tax policy and spending priorities and decisions. It is the type of government
economic activity that affects the level of national income through changes in government
spending on goods and services, transfer payments, and taxes. The role of fiscal policy is
important in stabilising the economy and achieving low levels of unemployment and
inflation.
15. Transfer Payments
Payments such as social security, welfare and unemployment payments that are made by the
government to an individual and that do not arise out of current productive activities.
16. Subsidy
Subsidies are used by the government to promote social objectives. It is a direct or indirect
payment by a government to households or firms and may also includes grants or other aids
from a central government to local governments.
17. Direct and Indirect Tax
Taxes can be on income received or expenditure incurred. Those taxes, which are imposed on
the receipt of income, are called direct, while those, which are imposed on expenditure, are
regarded as indirect taxes. Income tax, profit tax, property tax, capital gain tax etc., are direct
tax while excise duties, custom duties, sale tax, trade tax etc are indirect taxes.
26. Corporate Income Tax
It is a tax levied on the income of corporations.
27.

Excise Duty
A tax imposed on production of goods.

28. Sale Tax

A tax imposed on the sale of consumer goods.
29. Value Added Tax
A tax levied on a firm, based on the difference between the firm's sales and the firm's
purchases from other firms.

30. Capital receipts

The main items of capital receipts are loans raised by the Government from public,
borrowings by the government from RBI and from other parties through sale of treasury bills,
loans receipts from foreign institutions and governments and recoveries of loans granted by
the central government to State and Union Territory governments.
31. Capital Payments
These payments consist of capital expenditure on acquisition of assets like land, buildings,
machinery and equipment, as also investments in shares and loans and advances given to
State and Union Territory governments etc.

32. Non-plan Expenditure

Total budget expenditure is divided into Non-plan and Plan expenditure. Non-plan
expenditure is further divided in to revenue and capital non-plan expenditure.
Non-plan revenue expenditure includes: interest payment, defence revenue expenditure,
subsidies, debt relief to farmers, postal deficit, police pensions, other general services, social
services, economic services, communication, science and technology and grants to states and
UTs and grants to foreign government.
Capital non-plan expenditure includes: defence capital expenditure, loans to public
enterprises, loans to states and Uts and loans to foreign governments.
Plan Expenditure
The plan expenditure includes expenditure on central plans such as agriculture, rural
development, irrigation, flood control, energy, industry, mineral, transport, communication,
science and technology, environment, social services and others.
33. Capital Gain Tax
It refer to a tax on the increased value of an asset or security; it is a tax on the increment in
the value of an assets held by a person.
34. Countervailing Duty
A duty imposed on imported goods to control unfair trade practices by other countries.
35. Financial Bill
The proposals of the Government for levy of new taxes, modification of the existing tax
structure or continuance of existing tax structure beyond the period approved by the
Parliament are submitted to Parliament through this bill.