The word Economics is derived from the Greek words “OKIOS

NEMEIN” meaning household management .

Man is bundle of desires. Goods and services satisfy these
wants. But almost all the goods are scarce. To produce goods
land, labour, capital and organization are needed. Economic
problem arises because of scarcity.
Economics is a study of economic problems. Wants are
motive force for economic activity. Wants leads to efforts.
Efforts secures satisfaction.
Wants Efforts

satisfaction
1. Consumption: Extracting utility from goods and services.
2. Production: Production of goods and services which posses
utility.
3. Exchange: means buying and selling of goods and services. It
is link between consumer and producer.
4. Distribution: Sharing of income by the four factors of
production.
 Evolution in the Definitions of
Economics
• A. Wealth Definition (1776) Adam Smith

• B. Welfare Definition (1890) Alfred Marshall

• C. Scarcity Definition (1932) Lionel Robbins

• D. Growth Definition (1948) P.A. Samuelson

• E. Modern Definition (2011) A.C. Dhas

 Wealth Definition (1776)
• Adam Smith, who is regarded as Father of Economics,
published a book titled ‘An Enquiry into the Nature and
Causes of the Wealth of Nations’ in 1776.
• He defined economics as “a science which inquires into
the nature and cause of wealth of nations”.
• He emphasized the production and growth of wealth as
the subject matter of economics.
 ADAM SMITH

Wealth of Nations (1776)

 Features of Wealth Definition
• Characteristics:
It takes into account only material goods
Magnified the emphasis on wealth
It inquires the caused behind creation of wealth
• Criticisms:
It defined wealth in a very narrow and restricted sense.
It considered only material and tangible goods.
It gave emphasis only to wealth and reduced man to secondary place.
 Welfare Definition (1890):
• In 1890, Alfred Marshall stated that “Economics is a
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 wellbeing”.
• It is on one side a study of wealth; and on the other side,
a study of human welfare based on wealth.
 ALFRED MARSHALL

Principles of Economics (1890)

 Features of Welfare Definition
• Characteristics:
It is primarily the study of mankind.
It is on one side a study of wealth; and on other side the study of man.
It takes into account ordinary business of life – It is not concerned
with social, religious and political aspects of man’s life.
It emphasises on material welfare i.e., human welfare which is related to wealth.
It limits the scope to activities manageable to measurement in terms of money

• Criticisms:
It considers economics as a social science rather than a human science.
It restricts the scope of economics to the study of persons living in organized
communities only.
Welfare in itself has a wide meaning which is not made clear in definition.
 Scarcity Definition (1932
• According to Lionel Robbins: “Economics is the science
which studies human behavior as a relationship
between ends and scarce means which have alternative
uses.”

• He emphasized on ‘choice under scarcity’. In his own

words, “Economics ,,, is concerned with that aspect of
behaviour which arises from the scarcity of means to
achieve given ends.”
 LIONEL ROBBINS

An Essay on the Nature and Significance of Economic

Science (1932)
 Features of Scarcity Definition
• Characteristics:
Economics is a positive science.
New concepts: Unlimited ends, scarce means, and alternate uses of
means.
It emphases on Choice – A study of human behavior
It tried to bring the economic problem which forms the foundation of
economics as a social science.
It takes into account all human activities.

• Criticisms:
It does not focus on many important economic issues of cyclical instability,
unemployment, income determination and economic growth and
development.
It did not take into account the possibility of increase in resources over
time.
It has treated economics as a science of scarcity only.
 Growth Definition (1948)
• According to Prof. Paul A Samuelson “Economics is the
study of how men and society choose with or without the
use of money, to employ the scarce productive resources
which have alternative uses, to produce various
commodities over time and distribute them for
consumption now and in future among various people and
groups of society. It analyses the costs and benefits of
improving pattern of resource allocation”.
• This definition introduced the dimension of growth under
scarce situation.
 PAUL A SAMUELSON

Economics: An Introductory Analysis (1948)

 Features of Growth Definition
• Characteristics:
It is not merely concerned with the allocation of resources but also
with the expansion of resources.
It analysed how the expansion and growth of resources to be used to cope
with increasing human wants.
It is a more dynamic approach.
It considers the problem of resource allocation as a universal problem.
It focused on both production and consumption activities.
It is comprehensive in nature as it is both growth-oriented as well as future-
oriented.
It incorporated the features of all the earlier definitions
• Criticisms:
It assumes that economics is relevant for scarcity situations and it
ignored surplus resource conditions.
 Modern Definition of Economics (2011)
• According to [Link], “Economics is the study of
choice making by individuals, institutions, societies,
nations and globe under conditions of scarcity and
surplus towards maximizing benefits and satisfying their
unlimited needs at present and future”.
• In short, the subject Economics is defined as the “Study of
choices by all in maximizing production and
consumption benefits with the given resources of scarce
and surplus, for present and future needs.”
 In Sum
• A review of all these definitions and their evolution indicate
that the core of the subject economics is ‘choice making’.

• It is a subject concerned about achieving growth by optimizing

the given resources, based on choices.

• The evolution of the definition of economics has taken 235 years,

with the origin of Adam Smith in 1776.
 UTILITY
• Utility does not mean usefulness. The term utility refers
to the want satisfying power of a commodity.
• It means realised satisfaction to a consumer when he is
willing to spend money on a stock of commodity which
has the capacity to satisfy his want.
• Expected satisfaction is different from realised
satisfaction. Realised satisfaction takes place only after
the commodity has been consumed.
• Measurement of Utility
• Measurement of a utility helps in analyzing the demand
behavior of a customer. It is measured in two ways
• Cardinal Approach
• In this approach, one believes that it is measurable. One can
express his or her satisfaction in cardinal numbers i.e., the
quantitative numbers such as 1, 2, 3, and so on. It tells the
preference of a customer in cardinal measurement. It is
measured in utils.
• Ordinal Approach
• In this approach, one believes that it is comparable. One can
express his or her satisfaction in ranking.
 Cardinal Utility Ordinal Utility
Definition
It explains that the satisfaction level after It explains that the satisfaction level after
consuming any goods or services can be consuming any goods or services cannot be
scaled in terms of countable numbers. scaled in numbers. However, these things
can be arranged in the order of preference.

Example
Pizza gives Sam 60 utils of satisfaction, Sam gets more satisfaction from a pizza as
whereas burger gives him only 40 utils. compared to that of a burger.
Measurement
Utility is measured based on utils. Utility is ranked based on satisfaction.
Realistic
It is less practical. It is more practical and sensible.
Used By
This theory was applied by Prof. Marshall This theory was applied by Prof. J R Hicks
• Measures of Utility
• Total
• The sum of the total satisfaction from the consumption of specific
goods or services. It increases as more goods are consumed.
• Total Utility (T.U.) = U1 + U2 + … + Un
• Marginal
• It is the additional satisfaction gained from each extra unit of
consumption. It decreases with each additional increase in the
consumption of a good.
 Assumptions of the Law

1. Cardinal measurement of utility

2. Consumption of reasonable quantity
3. Continuous consumption
4. No change in Quality
5. Independent utilities
6. MU of money remains constant
7. Fixed Income and prices
Circular Flow of Income Model
 Circular Flow of Income Definition
• A circular flow of income is an economic model that describes how the
money exchanged in the production, distribution, and consumption of
goods and services flows in a circular manner from producers to consumers
and back to the producers.
• Circular flow of income refers to an economic model describing the circular
movement of money between firms/producers and households. Such a
model is also called a two-sector economy, as it only considers two sectors,
households and firms.
• Other models are used to understand the flow of money at the macro-level
to overcome such drawbacks of the two-sector economy. These models are
a three-sector model of economy and a four-sector model of the economy.
Diagram of the Two Sector Circular Flow of Income
 However, the basic model of the circular flow of income
considers only two sectors – the firms and the households –
which is why it is called a two-sector economy model.
• Let’s understand the meaning of these terms and the whole
concept in simple steps.
• Firms are the producers of goods and services, and
therefore, they require various production or societal
resources to produce goods and services.
• The factors of production are land, labor, building, stock,
stationery, etc.
• Households provide the resources or factors of production. For
example, a household provides land and labor to carry out business
operations in
exchange for the money paid in rent, wages, etc.
• So, the money flows from the firms to the household in rent, wages,
etc.
• The households utilize wages and rent to purchase certain goods and
services to fulfill their needs and wants.
• When the households pay for these goods and services, the money flows
back to the firms, completing the circular movement of money.
 Example
We can take the example of a Nutella factory to explain the circular
flow of income.
▪ Here, the Nutella factory is the firm that is the producer of jars of
Nutella spread. Some of the factors of production include cocoa
beans, land for housing the factory, the building, and laborers for
carrying out the production process.
▪ The household that has rented out its land to establish the factory
will enjoy monetary compensation or rent in exchange.
Simultaneously, the labor will be compensated with wages in
exchange for their hard work to produce jars of the chocolate
spread.
▪ The logistics team will be paid further for delivering the Nutella
jars to stores and e-commerce warehouses.
▪ The household will purchase the Nutella jar utilizing the money it
earned as wages or rent.
▪ When households pay for the Nutella jars, the money will reach
the factory owners, completing the money’s circular flow.
 Assumptions of 2 sector income model
➢There are no savings by the households. Whatever they earn, they
spend in the form of consumer expenditure.
➢Firms retain no profit, and whatever they earn from selling goods
and services is given back to households in wages, rent, etc.
➢There is no government interference in the money flow, i.e., there is
no tax liability on the households or regulations imposed on the
movement.
➢It is assumed that it is a closed economy without any external
interference from foreign countries, i.e., there is no foreign trade.
Circular Flow of Income in a Three- Sector Economy
• A three-sector economy model rectifies some of the drawbacks of
the two-sector model by introducing the following.

[Link] government plays a important role in consuming a major

portion of the money flow in taxes.
[Link], the flow of money follows from the firms and households to
the government in taxes.
[Link] government utilizes taxes to develop infrastructure and other
services like healthcare, education, etc. So, the government pays
back in terms of incentives and purchases goods from the firms.
[Link] government pays the households interest rates in government
securities, pay revisions, government jobs, etc.
[Link], it all completes the circular movement of money.
6. If the government’s income from the taxes is less than its
expenditure, it is said to have a deficit budget.
 Circular Flow of Income in A Four Sector Economy
The four-sector economy model is an open-ended economy that goes beyond
by considering the foreign sector’s role in the overall economic cycle.
 The main features of the four-sector economy are as follows:

[Link] the introduction of the foreign sector, the scope widens

further. The money flows to households or firms when they buy
goods and services from a foreign country, also known as imports.
[Link] money flows back to households when foreign countries give
them employment. For firms, money flows back when foreign
countries purchase goods and services, also called exports.
[Link] the value of imports is equal to the value of exports, it is called a
balanced trade. If imports are greater than exports, it is a trade
deficit. If exports are greater than imports, it is called a trade
surplus.
• Central Problems of the Economy Any economy faces below mentioned problems:

1. What to produce and in what quantity? Luxury goods, inferior goods, capital goods or
consumer goods

2. How are these goods produced? Problem of choice of technique.

3. For whom to produce?

 PPC
• Production Possibility Curve Production Possibility Curve is a curve, which shows the
various alternative production possibilities of two goods that can be produced with given
resources and techniques of production.

• It is also known as transformation curve or production possibility frontier. It is an important

tool to solve the central economic problems.
• Assumptions of PPC

1) The resources available are fixed.

2) The technology remains unchanged.

3) The resources are fully employed.

4) The resources are not equally efficient in production of all the goods. So, if resources are
transferred from the production of one good to another, the Marginal Opportunity Cost
increases.
• Properties Of PPC It is a downward sloping curve from left to
right. It is so because to increase the production of one good,
we have to decrease the production of the other. Because of
this inverse relation, PPC is negatively sloped.
• The shape of the Production Possibility Curve is concave to the
origin. It is so because the Marginal Opportunity Cost tends to
rise.
• Marginal Opportunity Cost The Marginal Opportunity Cost is
the rate at which the quantity of output of one commodity is
sacrificed to produce one more unit of the other commodity
• Shape Of PPC The shape of PPC depends on Marginal Rate of Transformation, as stated
below:

1)If MRT is rising, then PPC will be concave to the origin which is always the case.

2)If MRT is constant, then PPC will be a straight line.

3) If MRT is falling, then PPC will be convex to the origin which is the best shape
• Shift of PPC

• The Production Possibility Curve will shift under the following two conditions:

• Change in resources.

• Change in technology of production for both the goods.

• Rotation Of PPC The Production Possibility Curve will rotate outward under the following
two conditions:

• Improvement in technology in favor of one commodity.

• Growth of resources for the production of one commodity.