ECONOMICS—THE DISCIPLINE

1. Economics is the study of how societies use scarce resources to produce valuable commodities and
distribute them among different people
2. Economics studies how individuals, firms, government, and other organisations within our society
make choices and how these choices determine society’s use of its resources.

Economics is the discipline which studies how the individual, a society, a government is making their prioritised
choices in the process of using the scarce resources to gratify the various needs and wants of life.

Economics is an exercise in the space-time continuum and it deals with living human beings it is a very dynamic
subject. (People’s choice changes as per time and location)

A Working Definition

The activities which involve profit, loss, livelihood, occupation, wage, employment, etc. all are economic
activities. Economics studies all these activities. (Humanities-Study of Human activities)

Economics and Economy

Economics is theory and economy is practise (the real picture which emerges after applying the theory).
Economy is economics at play in a certain region (Nation).

Basically, economic theories are expectations of human behaviour about their economic activities and human
behaviour depends greatly on many internal and external factors, the results are likely to show diversities.
Hence same economic theory applied to different economies may obtain different results. Economics has less
diversity than the economies

The evolutionary history of economics is nothing but modifications of the past theories on the basis of
contemporary results and experiences of the economies. Evolution of practise into theory.

Focus of Economics

Improving living conditions of the humanity at large has been the real and the ultimate goal of the discipline.

Challenge of the Economies

The main challenge of any economy is to fulfil the needs (goods and services) of its population. Every
population needs to be supplied some goods and services for its survival and well-being.

As an economy fulfil one set of needs of its population, they start demanding for a need of higher order. And
thus, goes on the struggle of the economy—solving one challenge and focusing on another. Thus, the standard
of living depends on the economy’s ability to fulfil the needs.

There are two aspects of this challenge. First, the availability of the goods and services (capital and infra
requirement) required by the population and second, the presence of the supply network.

Distribution Network Models

State-The state takes the sole responsibility of supplying the goods and services required by the population
with no payments being done by the consumer—ex: The former Soviet Union and Communist China

Market mode-This functions on the basis of price mechanism. Goods and services are made available in the
market and their prices are determined on the basis of their demand and supply and finally they get
distributed to the population. Ex: Capitalistic economies. Euro-America

State-Market mix-Most prevalent. Certain goods and services are made available to the population freely or at
the subsidised prices by the state and some are supplied by the market for which consumers need to pay. The
amount of mix gets redefined based on the change of socio-economic composition of population.
ORGANISING AN ECONOMY

How the production process in an economy should be organised? Whether the production should be the sole
responsibility of the State/Government or should it be left altogether to the private sector?

The 3 models of economic system evolved in the process of the experiments to define the better way of
organizing the economy.

1. Capitalistic Economy
a. Adam Smith’s Wealth of nations (1776) is the origin of capitalistic economy.” The economy
couldn’t tap its full worth due to the heavy regulations of the government. Division of labour,
non-interference by the government, the price mechanism (competition in market) shall bring a
state of equilibrium in the economy”
b. Also known as Private/Free enterprise system or Market economy.
c. The decisions of what to produce, how much to produce and at what price to sell are taken by
the market, by the private enterprises in this system, with the state having no economic role.
2. State Economy
a. Socialistic economy emphasised collective ownership of the means of production (property and
assets). It ascribed large role to state in running the economy. Prevalent in USSR post Bolshevik
revolution. As per Karl Marx, Socialism was a translational stage to communism (never happened)
b. Communist economy advocated state ownership of all properties including labour with absolute
power to state. Prevalent in Peoples republic of China pre-1985.
c. Also known as Centralised Economy, Centrally Planned Economy, Non-market Economy, state
capitalism (state is the only exploiter)
d. The decisions related to production, supply and prices were all taken by the state only
3. Mixed Economy
a. Proposed by John Maynard Keynes post the great depression-1936. “Capitalization of basic
needs has resulted in unidimensional movement of money, pauperization of masses, reduction
of demand and the depression”, Capitalistic order should take up goals of socialist economy.
b. The essential needs (public goods) were provided by the state free of cost (social sector),
thereby creating demand for private goods which are part of market economy (mixed economy)
c. Oscar Lange suggested the market socialism (mixed economy from socialism end)
d. Experimented in China in 1985 which transformed into a giant market economy but failed in
USSR (political fallout of economic mismanagement) and other economies
e. The WB in the world development report -1999 (Entering the 21st Century) suggested that every
country should determine the areas and the extent of the market and state intervention based
on its own stage of economic development, socio-political and other historical factors. (a
judicious mix (which may have to be redefined time to time) of state and market economy).
WTO advocates mixed economy which is more inclined towards free market economy.

ROLE OF STATE IN AN ECONOMY

Three possible roles for the Government in an economy

1. Regulator of economic system: formulation and implementation of economic policies. (cannot be

handed to private firms as it is not in the best interest of the country)
2. Producer and/or supplier of private goods and services: The goods which are a part of market and
are distributed as per market mechanism. State earns profit as a private enterprise. Can be handled
by private sector while government can take care of public goods
3. Producer and/or supplier of public/social goods and services: These are essential for social justice
and well-being of the people. They are rendered free of cost or subsidised. The losses incurred are
paid from public exchequer (the whole economy pays for the need of few). This cannot be left to
private as it is a loss-making exercise
As per Keynes the economic efficiency, social justice and individual liberty can be solved by a properly
balanced mixed economy. Finding the right balance is the process of economic reform.

WASHINTON CONSENSUS

Coined by John Williamson in 1989– Policy reforms suggested for crisis driven Latin-American countries
The ten prepositions of the reforms are: RTI TDP DEF

a. Fiscal Discipline
b. More public expenditure to fields offering High Economic Returns & improved income distribution
c. Tax reform
d. Interest rate liberalization
e. Competitive Exchange rate
f. Trade Liberalization
g. Liberalization of FDI inflows
h. Privatization
i. Deregulation
j. Secure Property rights

Became synonymous to Neo liberalism (new form of free market economy), Globalization and Market
fundamentalism due to its commitment to the belief that markets can handle everything.

Though originally proposed to Latin America, these reforms were recommended by IMF and WB together with
the US treasury to the developing countries leading to Liberalization, globalization and Privatization cutting
down the role of state. The 2012 recession is believed to be born out of this consensus.

SECTORS OF AN ECONOMY

The three sectors of the economy:

1. Primary Sector: This sector includes all those economic activities where there is the direct use of
natural resources. such economies term their agricultural sector as the primary sector (India).
Sometimes mining is categorized into secondary sector
2. Secondary Sector: This sector uses the produce of the primary sector as its raw materials. Also called
manufacturing or industrial sector
3. Tertiary Sector: This sector includes all those economic activities where different ‘services’ are
produced

TYPES OF ECONOMIES

Based on the share of a particular sector in the total production of an economy and the ratio of the dependent
population on them for their livelihood, economies are classified as:

1. Agrarian Economy: Share of its primary sector is 50 per cent or more in the total output (the GDP) of
the economy. In India, as of now 60% people in primary sector produce 14% of GDP.
2. Industrial Economy: Secondary sector contributes 50 per cent or more to the total GDP of an
economy. Ex-Western economies (developed) crossed this phase post-industrial saturation.
3. Service Economy: The economy whose 50 per cent or more produce value comes from the tertiary
sector. Mostly early industrialized economies.

Stages of growth of an economy-Population shift from one sector to another. Almost every country
started industrialization post WW-II. Many among them observed population shift from secondary to
tertiary sector (post-industrial or service societies).

IDEA OF NATIONAL INCOME

Income is believed to be the focal point of human development. There are 4 ways of calculating the income of
a nation:
 1. Gross Domestic Product: The value of the all final (no value addition beyond) goods and services
produced within the boundary of a nation during one year. Obtained by adding national private
consumption, gross investment, government spending and trade balance (export-import).
a. Growth rate of an economy is per-annum percentage change in GDP (+ for growing economy)
b. Quantitative but not a qualitative concept. Indicates internal strength of an economy.
c. Used by WB/IMF for comparative analysis of nations
2. Net Domestic Product: NDP is the net form of GDP which decreases due to the depreciation during
production process of Goods and Services. NDP= GDP-Depreciation. GDP>NDP
Depreciation means wear & tear/currency comparison. Depreciation (wear & tear) can never be zero.
a. Used in depreciation studies of industry and trade
b. Indicates the achievement of R&D to reduce the depreciation
c. Cannot be used for comparative studies as different depreciation rates are set for different
economies. Depreciation rates is also used for economic policy making
3. Gross National Product: The trans-boundary economic activities are also considered. GNP is obtained
by adding to GDP, the income from abroad (-ve for India till date) which includes:
1. Private Remittances: The net outcome of inflow minus outflow from Indians abroad or foreign
national working in India. It shows the standard of a a county’s HR in international Parlance
2. Interest of external loans: The net outcome of interest payments i.e. inflow (on Money lend out
by the economy) minus outflow (on Money borrowed by the economy). Always -ve for India.
3. External Grants: The net outcome of external grants i.e. the balance of such grants which flow to
and from India. As of now India offers more gains than it receives. It indicates the position of a
nation w.r.t the financial support to/ from the world economies
a. Used by IMF to rank a nation according to the purchasing power parity.
b. It indicates qualitative or quantitative aspects of an economy, Indicates internal and external
strength of an economy.
c. It helps in determining production behaviour and pattern of an economy
4. Net National product: Obtained after deducting depreciation from the GNP:
a. This is the national income of an economy. Purest form of income of a nation
b. Per- Capita income is obtained by dividing NNP by the total population. Higher the rates of
depreciation lower is the PCI

Cost and Price of National Income:

Two sets of prices and costs for calculating the national income

Cost: Income of an economy. Value of its total produced goods and services calculated either at the ‘factor
cost’ or ‘market cost.

A. Factor cost or factory price or production cost/ price: Price of the commodity from the producer’s
side.
B. Market cost or ex-factory price or market price: It is obtained by adding product (indirect) taxes to the
factor cost. It is the cost at which goods reach the market

In India income was calculated at factor cost (also in most developing countries), due to lack of uniformity of
taxes. Since 2015, it is calculated as per market cost.

Price: Income can be derived at two prices: constant (inflation is considered stand-still at a base year), current
(present day inflation is added). MRP is the current price. India calculates the national income at constant
price. Base year is changed from 2004-05 to 2011-12. Developed countries choose the current price.

National income at current price is also released to take in the account of the level and stability of inflation and
to measure the real impact of its poverty alleviation programmes (inflation of BPL populous can never be
accurately assessed)

a. Nominal income: the income received in hand

b. Real income: nominal income minus the present day rate of inflation
 c. Disposable income: The net part of wage one is free to use after deducting the direct taxes

Taxes & National Income