Engineering Economics: Definitions & Scope

Dr. A.N. Sah

Session Plan
Introduction Wealth definition Welfare definition Scarcity definition Modern or Growth Definition Brief History of Economics

1. Adam Smiths Wealth Definition

Adam Smith (1723-1781), in his book, An Enquiry into the Nature and Causes of Wealth of Nations, defines economics as science of wealth. He says thus: Political Economy, considered as a branch of science of statesman or legislator, proposes two distinct objects, first, to provide a plentiful revenue or subsistence for the people, or more properly enable them to provide such revenue or subsistence for themselves, and, secondly, to supply the State or Commonwealth with the revenue sufficient for the public services. It proposes to enrich both the people & Sovereign. Political Economy profess to teach or investigate the nature of wealth and the laws of its production and its distribution J.S. Mill (1805-1873).

Main Features of the Wealth Definitions

1. Economics is the study of wealth only. It deals with the consumption, production, exchange and distribution of wealth. 2. Only material commodities constitute wealth which are scarce and useful. Non-material and free goods like air and water are not wealth. 3. Economics studies the causes of wealth changes which means economic growth. To increase wealth, production of material goods will have to be increased.

Marshalls Welfare Definition

Adam Smiths definition of economics as a science of wealth was criticized as dismal science. In order to save economics from severe criticism, Alfred Marshall (1842-1924) in his Elements of economics he gives more emphasis to human welfare than to wealth. Economics is a study of mankind in the ordinary business of life; it examines that part of individual and social action which is mostly connected with the attainment and with the use of material requisites of well -being. Thus, it is on the one side study of wealth and on the other more important side a part of the study of man.

Cont..
A.C. Pigou, Edwin Cannam, Sir William Beveridge supported the welfare definition. Main Features of welfare Definition
A study of mankind-Economics studies the economic activities of man which are concerned with material welfare of man. Ordinary business of life-An ordinary man works mostly to earn wealth and spends his earning to get maximum satisfaction out of it. Economics studies economic activities of an ordinary man. Study of individual and social action- Economics studies man not in isolation but as a member of a social group. It studies the personal and social activities of human being which are concerned with his/her material welfare. Study of material welfare- Economics is a subject which studies the welfare of man which is of the material type. The study of nonmaterial welfare is outside the scope of economics.

Robbins Scarcity Definition

Lionel Robbins in his An Essay on the Nature and Significance of Economic Science (1931) criticised Marshall for his normative view of economics. Economics is the science which studies human behaviour as a relationship between unlimited ends and scarce means which have alternative uses.

Main Features of Robbins Definition

Unlimited Wants or ends Limited or Scarce means Means have alternative uses. Wants are of different intensity- some wants need immediate satisfaction, others can be postponed. A man is forced to choose between wants due to their different intensity. Neutral between ends-Economics is neutral between ends. An economist is expected to be indifferent as to the ends. He cannot pass judgements on the most appropriate uses of the means for reaching the ends themselves. Thus, economics is free from value judgment. His real task is to indicate how the means at ones disposal can be used to attain those ends in the best possible way. Problem of Choice

Modern or Growth Definition

Robbins definition excludes from its purview the problem of economic growth. It takes an entirely static view of an essentially dynamic problem. Prof. P. Samuelson gave modern or growth definition in his book Economics: Economics is the study of how men and productive resources society choose, with or without the use of money, to employ scarce productive resources which could have alternative uses, to produce various commodities over time, and distribute them for consumption now and in the future among various people and groups of society.

Main features of Samuelsons Definition

Like Robbins, Samuelson has stressed the problem of scarcity of means in relation to unlimited ends. Unlike Robbins Samuelson has made his definition dynamic by including the element of time in it. The main thing about Samuelsons definition is that it deals with the problem of choice in its dynamic setting. Economics is considered as the study of allocation of scarce resources and of the determinants of income, output, employment and economic growth. The growth definition of Samuelson has also a universal appeal. It is applicable to all sorts of economics-past, present and future. The growth definition also transcends all ideological differences, being equally applicable to capitalist, socialist and communist, and mixed economies because the problem of choice in its dynamic setting arises in all.

Economics as a Science
Science is defined as a systematic way of finding knowledge derived from either observation or experimentation in order to find out the nature of a matter or a problem or a phenomenon. The scientific enquiry is comprises of the following steps:
Defining theory or problem or phenomenon to be studied in clear-cut manner. Hypothesising the probable relationships between the main factors relating to the phenomenon. From the hypothesis predictions or conclusions about the phenomenon by deductive reasoning. Test the predictions or conclusions of the theory using actual data or observations. If conclusions drawn are not true then go back to step (2) in order to improve the theory by specifying another hypothesis.

Cont
Sciences such as physics, chemistry, etc., follow the above method of enquiry in order to discover new knowledge. The big question is: can we put Economics in this category? In physics, we study the behaviour of matter which is inanimate (non-living thing) and shows stable response when studied with scientific method discussed above. Theories of physical sciences show stable relationship due to homogeneity of the object under study. However, economics as a discipline study the behaviour of human beings which is animate (living thing). However, theories of social sciences such as economics, sociology, political science do not show stable relationships like stable relationships found in theories of pure sciences. This is because of heterogeneity of behaviour of the animate body i.e. human beings.

Economics as an art
An art is a skill of how to do a thing. While science tells us to know a phenomenon, an art tells us how to do a thing. Economics has definitely an aspect of an art. This is reflected in normative economics where a society based on its value system prescribes norms to tackle its economic problems and guide economic policy. There is clearly no mathematical formula for successful management of an economy or a business. No doubt, theories may guide the decision makers but economic decision making is not entirely a science. Rather, we can say, it is both a science and an art.

Positive and Normative Economics

Positive economics can be termed as: what is, what was, or what will be economics. This type of economic analysis is free from value-judgements and emotion has place in positive economics.
A rise in aggregate household demand will cause a rise in the general level of prices if economy is already operating at full employment level. Economic incentive in the form of lower corporate taxes may enhance the performance of the corporate India. Indian economy has grown at the rate of 6 percent in the last 5 years. Inflation in India is basically a supply side phenomenon.

Cont
Normative economics can be termed as: what ought to be economics. This type of economic analysis is value laden and subjective in nature. This type of economics plays an important role in formulating economic policy. It is generally guided by value system of a society and tries to fix economic problems according to their ideologies. Following are some of the examples of normative statements:
Foreign direct investment in retail sector by government is not a wise decision and should be taken back. Reducing subsidies on petroleum products by the government is going to pinch the poor people of India. Prices of petrol and diesel should not be hiked. Government must pay attention to the agriculture sector of India

Methodology of Economics
What is the method of finding new knowledge in economics? All sciences grow through the development of theories. Every science has to adopt certain methodology for deriving principles, laws and theories which help in studying that science. A theory tries to explain the behaviour of phenomenon under investigation. Economic theory also attempts to explain behaviour of economic variables. It deals with why question. Economic science tries to explain, say, for example following things:
Why are some countries more developed than other countries in this world? Why are State Electricity Boards of various States in India making losses year after year? Why is rupee depreciating against major currencies of the world in recent times? What are the causes of high inflation in India during last 4-5 years?

Cont..
Economics uses scientific method to answer the above and similar type of questions. There are basically two methods that are used for theorising in economics: Deductive Method Inductive Method

Deductive Method
Deductive method is that method where generalization is done from general to particular. This method accepts certain universal truths as the basis or as axiom. Using this universal truth or axiom as a base, it tries to arrive at conclusion about a particular event through reasoning. The basic idea behind of this method is that if something is true for everybody then it will be true for an individual also. This method is also called a priori method or analytical or abstract method. For example, man is mortal. Thus, we can do reasoning like this that Shakti is also mortal because Shakti is a man.

Inductive Method
In this method reasoning is done from particular to general. What is true for an individual is true for the whole society. Thus, this method is just opposite of deductive method. In inductive method, on the basis of experiments and observations, economic laws are derived. This involves collection of detailed data on some economic problem; after data collection, the researcher tries to arrive at certain economic laws and principles based on analysis of data. Thus, this method makes reasoning from particular to general. For example, FDI (Foreign Direct Investment) in multi-brand retail is good for Indian economy or not. While the ruling party says that FDI is good for the economy and will help to create employment. However, the opposition party says that FDI in multi-brand retail will result in large scale unemployment. How to settle this question? This requires collection of data and analysis of data and then one can theorize on FDI in India.

Scope of Economics
Before the Great Depression of 1930s, economic analysis was studied under the name Political Economy. Ragner Frisch, first Nobel Prize winner in Economics, was the first to classify economics into microeconomics and macroeconomics. However, with the publication of The General Theory of Employment, Interest and Money (1936) macroeconomics emerged as a separate branch of economics. Since then economic analysis is broadly classified into two namely:
Microeconomics Macroeconomics

Microeconomics
Micro means small. Thus, microeconomics studies the behaviour of individual units such as individual consumer and individual producer. This tries to study the following questions:
How an individual consumer maximises his/her satisfaction? How an individual producer maximises his/her total output or production? How an individual producer minimises its cost of production or how he/she tries to maximize sales turnover or total revenue of his/her firm? How the price of an individual commodity such as cauliflower is determined? How the price of an input or a factor of production such as labour is determined?

Macroeconomics
Macro means large. Thus, macroeconomics studies the behaviour of not individual units but behaviour of all the individual units together either at a point of time or over a period of time. It is thus a study of aggregates. It is not the study of individual demand but the aggregate demands of all individual; not individual supply but aggregate supply. In macroeconomic analysis, we do not study the individual price of a car or a mobile handset but the general level of price prevailing in the whole economy.

Cont..
The subject matter of macroeconomics includes the following macroeconomic variables:
Gross Domestic Product Economic Fluctuations/Business Cycle Employment General Price Level/Inflation Savings Capital Formation Interest Rate Fiscal and Monetary Policies International Trade and Exchange Rate

The objective of macroeconomic analysis is to understand how the economy of a country or how the whole world economy works.

Fundamental Problems of an economy

According to Eric Roll, The economic problem is essentially a problem arising from the necessity of choice; choice of the manner in which limited resources with alternative uses are disposed off. It is the problem of husbandry of resources. F.H. Knight in his book Economic Organization highlighted the basic economic problems of an economy and gave the following five interrelated problems as follows:
What to produce? How to produce? For whom to produce? Efficient use of resources Economic growth and development

What to produce?
An economy having unlimited wants with limited resources has to decide what goods and in what quantities are to be produced. Whether developed or underdeveloped the requirements of every economy are unlimited but the resources to satisfy these requirements are limited and scarce. In this situation, the economy has to make a choice between different goods and services.

Cont
Necessities such as wheat, paddy, pulses, fuels, milk, textiles, housing, roads, electricity, hospitals, schools and universities, medicines, etc.

Or
luxury goods such as cars, luxury apartments, TV, mobile handsets, smart phones, laptops, refrigerators, microwave, jewellery, etc.

or
to produce some combination of both types of goods and services.

How to produce?
Second fundamental problem an economy faces is how to produce goods and services. Thus, this problem is basically a question of selecting technique of production. There are basically two types of techniques of production:
Labour intensive technique Capital intensive technique The decision regarding to selecting a technique of production is largely depends of comparative cost of these two techniques of production.

For whom to produce?

Third fundamental problem an economy faces is for whom to produce. This problem is relating to distribution of goods and services i.e. national income (sum of quantity of goods and services multiplied by their respective prices) among members of that economy or country. Who gets what from total output produced in an economy is an important problem. The economy of a country should adopt such policies that may distribute total output of the economy in a balanced manner; neither in favour of rich nor in favour of poor sections of the country. This may prevent economic concentration in the hands of few people. The economic policies should be oriented towards improving the conditions of low income people of the society.

Efficient Use of Resources

We know that resources of an economy are limited and therefore it becomes even more important for an economy to make use of all of its available resources in most efficient way. Full utilization or exploitation of resources means more employment and more output. So no economy allows its resources to lie idle. However, due to certain reasons, many resources remain either unutilized or underutilized. The costs of unutilized or underutilized resources are enormous. Thus, it is imperative to identify the reasons for underutilization of resources in the economy and must make efforts to use all available resources in a most efficient manner.

Economic Growth
How to achieve rapid and sustained growth in total output of the economy is also considered a basic objective or problem of an economy. Economic growth refers to the rate at which total physical output of an economy grows over a period of time. It has lot of implications for the standard of living for people of a country. For instance, if an economy grows at 3% per annum, it will take roughly 24 years to double the standard of living of that country. If an economy is growing at 5% per annum, it will take 14.4 years time to double the standard of living. However, if an economy is growing at 10% per annum, it will take only 7.2 years time to double the standard of living of people of that country.

Solutions of basic Problems of an economy

Every economy has to solve these problems somehow or other. While capitalist economy a type of economy where private ownership of resources exists solves the fundamental problems of an economy through price mechanism, a socialist economy where public ownership of resources exists solves the basic problems of economy through economic planning.

Brief History of Economics

The history of economic thought has been shaped by economic problems themselves. New questions have forced economists to reach for new answers and techniques. Economics is as old as humanity. The origin of the word Economics is from Greek words Oekos(a house) and nomos (to manage). Thus, it implies household management. In ancient Sumeria, Babylonia, China, Egypt, Greece, Rome and India, people tried to understand and improve economic process. Plato and Aristotle analysed trade production and values at some length. More than 2000 years ago economic problems (production, money, interest rates, monopoly power, etc) were debated by people, though the analysis was primitive and vague. From 1600 to 1750, the dominant economic doctrine was Mercantalism. They believed that economic wealth was embodied mainly in precious metals whose possession by the State helped to enlarge military and national power. To amass wealth, States relied on taxes and trade restrictions

Cont
The Physiocrats argued against the mercantile view. They stressed that wealth is economic capacity rather than gold. Adam Smith and his famous book, The Wealth of Nations (1776) is the first treatise on the science of Economics. He borrowed Issac Newtons self regulating natural order and applied to Economics. Adam Smith believed in the invisible hand that governs the market and propounded his thesis.

Cont
The next significant contribution to economic thought was by David Ricardo (1772-1823). In his book Principles of Economics and Taxation (1817), he popularized the concept of economic rent and developed the theory of relative prices and created basic analysis of international trade. The third important economic thinker and writer is Alfred Marshall . He developed the micro economic theory. His famous book Principles of Economics (1899) analysed cost, productivity, demand and output and competitive markets.

Cont
The fourth important economic thinker and writer who influenced the entire world and was responsible for the birth of a communist State was Karl Marx (1813-1883). His three-volume book, Das Kapital made a permanent imprint in economic thinking. The fifth economic economist who dominated economic thinking in the entire world was J.M. Keynes. His famous book The General Theory of Employment, Interest and Money formed the basis of Macroeconomics today.

Cont
Post-second world war has seen the birth and rapid growth of developmental economics, part of macro economics emphasizing the economic growth and development. As an offshoot of this another school concentrating on the costs and limits of growth has developed. In this aspect the initiative was taken by all International association of industrialist and Scientists known as Club of Rome. At their request pioneering work was done, among others by J.W. Forester and D.L. Meadaos of MIT. Their report, The limits of Growth (1972) marks the beginning of a new intense debate and discussion. The other post-war development is in quantitative thinking.

Demand Analysis
What is Demand? Law of Demand Exceptions to the law of demand Other factors affecting demand Demand Function The supply side Determinants of supply The market equilibrium

What is demand?
According to Prof. Hibbon, Demand means the various quantities of goods that would be purchased per time period at different prices in a given market. The demand for anything at a given price is the amount of it which will be bought per unit of time at that price- Benham. By demand we mean the various quantities of a given commodity or service which consumers would buy in one market in a given period of time at various prices, or at various incomes, or at various prices of related goods Bober.

Features of Demand
When the person, who is in need and desiring is willing and able to pay for what he desires, the desires changes into demand The demand is always at a price The demand is always per unit of time. The demand indicates the quantity or the amount of the commodity the consumers are prepared to buy at that particular price.

Demand Schedule
A Demand Schedule is a table listing quantities demanded of a good at different prices. Demand schedule is the tabular statement of different quantities of a good bought of different prices of a particular moment of time. A demand schedule is a fundamental tool used by economists to describe the relationship between the price of an item in the marketplace and the consumer demand for that item. A demand schedule includes pairs of data points that identify the price for an item and the quantity of bought at that price. Thus, a demand schedule is a table showing quantities demanded of a commodity at different prices during a given period of time.

Demand curve
According to R.G. Lipsey, This curve, which shows the relation between the price of a commodity and the amount of that commodity the consumer wishes to purchase, is called demand curve. The demand curve slopes downward from left to right. Demand curve is graphical representation of a demand schedule which shows listing of quantities demanded at different prices for a given period of time. Demand curve shows relationship between price of the product and its quantity demanded at various prices. The slope or gradient of this curve is negative other factors determining demand held constant.

Individual demand and market demand

Individual demand refers to demand of an individual consumer in the market for a good of a service during a period of time. The individual demand is the demand of one individual or firm. It represents the quantity of a good that a single consumer would buy at a specific price point at a specific point in time. While the term is somewhat vague, individual demand can be represented by the point of view of one person, a single family, or a single household.

Market Demand
Market demand provides the total quantity demanded by all consumers. In other words, it represents the aggregate of all individual demands. Market demand is an important economic marker because it reflects the competitiveness of a marketplace, a consumers willingness to buy certain products and the ability of a company to leverage itself in a competitive landscape. If market demand is low, it signals to a company that they should terminate a product or service, or restructure it so that it is more appealing to consumers.

Types of Demand
Price Demand Income Demand Cross Demand

Law of Demand
The law of demand simply expresses the relation between quantity of a commodity demanded and its price. In Alfred Marshalls words, The amount demanded increases with fall in price and diminishes with a rise in price. According to Bilas, The law of demand states that, other things being equal; the quantity demanded per unit of time will be greater, lower the price and smaller, higher the price. According to Samuelson, Law of demand states that people will buy more at lower prices and buy less at higher prices, other things remaining constant. In Fergusons words, according to the law of demand the quantity demanded varies inversely with price.

Cont..
The law of demand is represented through demand schedules. They summarize the information on prices and quantities demanded. The demand schedule may be the individual demand schedule and market demand schedule. The individual demand schedule refers to the prices and amount demanded of the commodity by an individual. Market demand schedule is defined as the quantities of a given commodity which all consumers will buy at all possible prices at a given moment of time.

Cont..
Price (Rs.) Amount Demanded by X City 1500 2000 2300 2400 2680 3000 3150 3200 3450 3500 3650 3800 4000 4500 Amount Demanded by Y City 1800 2100 2200 2300 2450 2556 2624 2700 2815 2900 3010 3100 3400 3500 Amount Demanded by Z City 600 850 1000 1050 1120 1260 1325 1420 1500 1650 1780 1800 1960 2000 Market Demand (X+Y+Z) 3900 4950 4600 5750 6250 . . . . . . . . 10000

5400 4800 4500 4200 4000 3800 3500 3000 2850 2560 2400 1995 1500 1260

Exception to the Law of Demand

Inferior goods
An inferior good is that good which demand declines when the income of the consumer increases.

Giffen Goods
A consumer good for which demand rises when the price increases, and demand falls when the price decreases.

Veblen goods
Goods that are perceived to be exclusive as long as prices remain high or increase. Veblen goods get their name from economist Thorstein Veblen, who was one of the first to look into and write about conspicuous consumption and the concept of seeking status through consumption.

Veblen goods are often referred to as "status symbols". Expectation of change in price in future

Factors affecting demand

Price of the commodity Income of the consumer Prices of related goods Taste, Preferences, and fashions of the consumer Size and composition of population Money supply Income distribution Savings Conditions of trade Expectation regarding the future Climate & weather Government policy

Different Kinds of changes in Demand

Extension of demand Contraction of demand Increase in demand Decrease in demand

What is Supply?
Supply means the amount of goods offered for sale at a given price during a specified period of time. Meyers says, We may define supply as a schedule of a good that would be offered for sale at all possible prices at anyone instant of time, or during anyone period of time, for example, a day, a week and so on, in which the conditions of supply remain the same.

Factors Affecting Supply

Price of the commodity Change in input prices Technological progress Price of product substitutes Nature and size of industry Government Policy Means of communications Nature Political disturbances Taxation Monopoly control

Different Kinds of Changes in Supply

Extension of Supply Contraction of Supply Increase in Supply Decrease in Supply

Market Equilibrium
In physical term equilibrium means state of rest. In general sense, it means balance in opposite forces. In the context of market analysis, equilibrium refers to a state of market in which quantity demanded of a commodity equals the quantity supplied of the commodity. The equality of demand and supply produces an equilibrium price.

Elasticity
In the words of Marshall, The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price. A.L. Meyers, The elasticity of demand is a measure of the relative change in amount purchased in response to a relative change to price on a given demand curve. Elasticity of demand measures the responsiveness of demand to changes in price K. Boulding The elasticity of demand for a commodity is the rate at which quantity bought changes as the price changes.- A.K. Cairncross Mrs. Joan Robinson says, The elasticity of demand, at any price or at any output, is the proportional change of amount purchased in response to a small change in price, divided by the proportional change of price.

Degrees of Elasticity
Perfectly elastic Relatively elastic demand Unitary elastic demand Relatively inelastic demand Perfectly inelastic demand

Factors Affecting elasticity

Availability of substitutes Nature of commodity Proportion of income spent Time factor Number of uses of a commodity Habitual necessities Possibility of postponing the purchase of a commodity

Importance of Elasticity
Determination of price and output Price discrimination Taxation Joint products Use in international trade Pricing policy for public utilities Determination of sale policy for supermarkets

Types of Elasticity
Income elasticity Cross elasticity Advertising elasticity

Thank You