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The word Economics is derived from the Greek word
“OKIOS NEMEIN” meaning household management
Man is a bundle of desires. Goods and services satisfy
these wants. But almost all the goods are scares
To produce goods factors of production are needed and
these are all scarce
ECONIMICS is the branch of knowledge concerned with
the production consumption and transfer of wealth.
Economics – the study of how individuals and societies
make decisions about ways to use scarce resources to
fulfill wants and needs.
The Method of Economics
The study of economics is classified into positive and normative economics.
Marshall studied the economics as normative science and Robbins studied
economics as positive science .
Positive economics studies economic behavior without making judgments.
It describes what exists and how it works.
Normative economics, also called policy economics, analyzes outcomes of
economic behavior, evaluates them as good or bad, and may prescribe
courses of action.
A positive science is concerned with “what is” and a normative science with
“what ought to be”.
Positive economics is objective and fact based, while normative economics
is subjective and value based. Positive economic statements do not have to
be correct, but they must be able to be tested and proved or disproved.
Normative economic statements are opinion based, so they cannot be
proved or disproved
The divisions of Economics
Microeconomics is the branch of economics that
examines the functioning of individual industries and the
behavior of individual decision-making units—that is,
business firms and households. It studies the behavior of
the consumers, producers and resource owners and there
relationship in the market.
Macroeconomics is the branch of economics that
examines the economic behavior of aggregates— income,
output, employment, and so on—on a national scale. It
studies the economic system as a whole .
Examples of microeconomic and macroeconomic concerns
Production Prices Income Employment
How much steel
How many offices
How many cars
Price of Individual
Goods and Services
Price of medical
Price of gasoline
Income and Wealth
Wages in the auto
Jobs in the steel
employees in a firm
Growth of Output
Rate of Inflation
Total wages and
Total number of
RELATION BETWEEN MACRO-MICRO ANALYSIS
There is an obvious relationship between microeconomics and
macroeconomics, in that aggregate production and consumption levels
are the result of choices made by individual households and firms, and
some macroeconomic models explicitly make this connection. Most of
the economic topics covered on television and in newspapers are of the
macroeconomic variety, but it’s important to remember that economics is
about more than just trying to figure out when the economy is going to
improve and what the Fed is doing with interest rates.
The study of forces that determine the distribution of scarce resources.
Economic analysis provides insight into how markets operate, and offers
methods for attempting to predict future market behavior in response to
events, trends, and cycles. Economic analysis is also used by governments to
determine tax rates and evaluate the financial health of the nation or state.
A systematic approach to determining the optimum use of scarce resources,
involving comparison of two or more alternatives in achieving a specific
objective under the given assumptions and constraints.
Economic analysis takes into account the opportunity costs of resources
employed and attempts to measure in monetary terms the private and social
costs and benefits of a project to the community or economy.
Study of economic systems or a study of a production process or an industry to
see if it is operating effectively and how much profit it is making
Typical Managerial decisions
Decisions concerning the operation of the firm, such as the choice of firm
size, firm growth rates, and employee compensation. Types of decision
1. Programmed and non programmed decisions: Programmed decisions
are those which are normally repetitive in nature and are taken as a routine
job and responsibilities. These types of decisions are made by middle level
management in accordance with some policies, rules and procedures. They
have short term impact. For example: – granting a leave to an employee,
purchasing office materials etc. non programmed decisions are non
repetitively taken by top executives. They need to collect data and analyze
then and forecast the strategic plans.
2. Major and minor decisions: among different decisions some decisions
are considerably more important than others and are prioritized. They are
called major decisions. For example, replacement of man by machine,
diversification of product etc. contrary to that, some of the remaining
decisions are considerably less important than others and are not so
prioritized. They are minor decisions. For example, store of raw materials
3. Routine and strategic decisions: Routine decisions are those decisions which are
considered as tactical decisions. They are taken frequently to achieve high degree
of efficiency in the organizational activities. For example, parking facilities, lighting
and canteen etc. strategic decisions are those which are related to lowering the
prices of products, changing the product etc. they take more fund and degree of
4. Organizational and personal decision: Organizational decision is taken by top
executives. For official purpose. They affect the organizational activities directly.
Authority is also delegated. Personal decisions are concerned to an employee. The
executives whenever takes the decisions personally that is known as personal
5. Individual and group decisions: When a single employee is involved in decision
making it is called individual decision. They are taken by ole proprietor when the
problem is of routine nature. On the other hand when the decision is of group taken
in a large organization where important and strategic decisions are taken the it is a
6. Policy and operating decisions: Policy decisions are taken by top level
management to change the rules, procedures, organizational structure etc and they
have a long tern effect. Operational decisions are taken by low level management
which have short term effect and which affect the day to day operation of the
A financial manager is responsible for providing financial advice and support to
clients and colleagues to enable them to make sound business decisions.
Financial and accounting management deals with managerial activities related to
procurement and utilization of fund for business purpose. Its sub areas are as
Some of the functional areas covered in financial management are discussed as
1. Determining Financial Needs:
A finance manager is supposed to meet financial needs of the enterprise. For this
purpose, he should determine financial needs of the concern. Funds are needed to
meet promotional expenses, fixed and working capital needs. The requirement of
fixed assets is related to the type of industry. A manufacturing concern will require
more investments in fixed assets than a trading concern. The working capital needs
depend upon the scale of operations, larger the scale of operations, the higher will
be the needs for working capital. A wrong assessment of financial needs may
jeopardies the survival of a concern.
Selecting the Sources of Funds: A number of sources may be
available for raising funds. A concern may resort to issue of share capital
and debentures. Financial institutions may be requested to provide long-
term funds. The working capital needs may be met by getting cash credit
or overdraft facilities from commercial banks. A finance manager has to
be very careful and cautious in approaching different sources. The terms
and conditions of banks may not be favourable to the concern. A small
concern may find difficulties in raising funds for want of adequate
securities or due to its reputation. The selection of a suitable source of
funds will influence the profitability of the concern. This selection should
be made with great caution.
Financial Analysis and Interpretation: The analysis and interpretation
of financial statements is an important task of a finance manager. He is
expected to know about the profitability, liquidity position, short-term and
long-term financial position of the concern. For this purpose, a number
of ratios have to be calculated. The interpretation of various ratios is also
essential to reach certain conclusions. Financial analysis and
interpretation has become an important area of financial management.
Cost-Volume-Profit Analysis: Cost-volume-profit analysis is an important
tool of profit planning. It answers questions like, what is the behaviour of
cost and volume? At what point of production a firm will be able to
recover its costs? How much a firm should produce to earn a desired
profit? To understand cost-volume-profit relationship, one should know
the behaviour of costs. The costs may be subdivided as: fixed costs,
variable costs and semi-variable costs. Fixed costs remain constant
irrespective of changes in production.
An increase or decrease in volume of production will not influence fixed
costs. Variable costs, on the other hand, vary in direct proportion to
change in production. Semi-variable costs remain constant for a period
and then become variable for a short period. These costs change with
the change in output but not in the same proportion.
The first concern of a finance manager will be to recover all costs. He
will aspire to achieve break-even point at the earliest. It is a point of no-
profit no-loss. Any production beyond break-even point will bring profits
to the concern. The volume of sales, to earn a desired profit, can also be
ascertained. This analysis is very helpful in deciding the volume of
output or sales. The knowledge of cost-volume profit analysis is
essential for taking important decisions about production and profits.
Working Capital Management:
Working capital is the life blood and nerve centre of a business. Just as
circulation of blood is essential in the human body for maintaining life,
working capital is essential to maintain the smooth running of business. No
business can run successfully without an adequate amount of working
capital. Working capital refers to that part of the firm’s capital which is
required for financing short-term or current assets such as cash, receivables
and inventories. It is essential to maintain a proper level of these assets.
Finance manager is required to determine the quantum of such assets. Cash
is required to meet day-to-day needs and purchase inventories etc.
The scarcity of cash may adversely affect the reputation of a concern. The
receivables management is related to the volume of production and sales.
For increasing sales, there may be a need to give more credit facilities.
Though sales may go up but the risk of bad debts and cost involved in it may
have to be weighed against the benefits. Inventory control is also an
important factor in working capital management. The inadequacy of
inventory may cause delays or stoppages of work. Excess inventory, on the
other hand, may result in blocking of money in stocks, more costs in stock
maintaining etc. Proper management of working capital is an important area
of financial management.
Profit Planning and Control: Profit planning and control is an important responsibility
of the financial manager. Profit maximization is, generally, considered to be an
important objective of a business. Profit is also used as a tool for evaluating the
performance of management. Profit is determined by the volume of revenue and
expenditure. Revenue may accrue from sales, investments in outside securities or
income from other sources. The expenditures may include manufacturing costs,
trading expenses, office and administrative expenses, selling and distribution
expenses and financial costs.
The excess of revenue over expenditure determines the amount of profit. Profit
planning and control directly influence the declaration of dividend creation of
surpluses, taxation etc. Break even analysis and cost-volume profit relationship are
some of the tools used in profit planning and control.
Dividend Policy: Dividend is the reward of the shareholders for investments made by
them in the shares of the company. The investors are interested in earning the
maximum return on their investments whereas management wants to retain profits for
further financing. These contradictory aims will have to be reconciled and in the
interests of shareholders and the company. The company should distribute a
reasonable amount as dividends to its members and retain the rest for its growth and
A dividend policy is influenced by number of factors such as magnitude and trend of
earnings, desire and type of shareholders, future requirements of the company,
government’s economic policy, taxation policy, etc. Dividend policy is an important
area of financial management because the interests of the shareholders and the
needs of the company are directly related to it.
Production Possibility curves
A graphical representation of the alternative combinations of the amounts of two goods or services that an
economy can produce by transferring resources from one good or service to the other. This curve helps in
determining what quantity of a nonessential good or a service an economy can afford to produce without
jeopardizing the required production of an essential good or service. Also called transformation curve.
As indicated on the chart above, points A, B and C represent the points at which production of Good A and
Good B is most efficient. Point X demonstrates the point at which resources are not being used efficiently
in the production of both goods; point Y demonstrates an output that is not attainable with the given
Let us take an imaginary example, a society can produce either 15000 butter or 5000 guns with given
resources or technology. In between these two extreme possibilities, there are many possibilities like A,
B,C, D, E & F as shown in the following table.
Possibilities Guns Butter
A 0 15000
B 1000 14000
C 2000 12000
D 3000 9000
E 4000 5000
F 5000 0
As shown in the above table if all the resources and given technology are used for the production of guns there would be no
butter. Similarly, if all resources and given technology are used for the production of butter there is zero production of guns. In
between A and F possibilities, there are B, C, D and E possibilities which represent some butter and some units of gun. These
possibilities are represented by Production Possibility Frontier (PPF). According to Paul A. Samuelson, "The Production
Possibility Frontier shows the maximum amount of production that can be obtained by the economy, given, its technological
knowledge and quantity of inputs available" PPF represents the maximum of goods and services available to the society " The
PPF can be represented in the following diagram
The Production Possibility Frontier Curve
As shown in the above figure, society has to decide which combination of guns and butter has to be produced
with given resources and technology. There is maximum limitation to the amounts of butter and guns that can
be produced with given resources and technology in a country. The increase in the production of guns requires a
reduction in the production of butter. This explains that society has to reduce the production of one commodity
in order to increase the production of other commodity. In this case, we assume that society can produce only
two commodities. In our example, they are butter and guns. It explains that butter can be transformed into guns
or guns into butter. In other words land, labour and machine used for butter can be transformed for the
production of gun. Thus, the production of one commodity can be transformed into production of another
commodity. The production possibility curve is also known as Transformation Curve.
DEVELOPMENT OF MACROECONOMICS SCHOOL OF VIEW
The field of macroeconomics is organized into many
different schools of thought, with differing views on
how the markets and their participants operate.
Classical: Classical economists hold that prices, wages and rates are flexible
and markets always clear. As there is no unemployment, growth depends upon
the supply of production factors. (Other economists built on Smith's work to
solidify classical economic theory.
Keynesian: Keynesian economics was largely founded on the basis of the
works of John Maynard Keynes. Keynesians focus on aggregate demand as the
principal factor in issues like unemployment and the business cycle. Keynesian
economists believe that the business cycle can be managed by active
government intervention through fiscal policy (spending more in recessions to
stimulate demand) and monetary policy (stimulating demand with lower
rates). Keynesian economists also believe that there are certain rigidities in the
system, particularly "sticky" wages and prices that prevent the proper clearing
of supply and demand.
Monetarist: The Monetarist school is largely credited to the works of Milton
Friedman. Monetarist economists believe that the role of government is to
control inflation by controlling the money supply. Monetarists believe that
markets are typically clear and that participants have rational expectations.
Monetarists reject the Keynesian notion that governments can "manage"
demand and that attempts to do so are destabilizing and likely to lead to
New Keynesian: The New Keynesian school attempts to add microeconomic foundations to
traditional Keynesian economic theories. While New Keynesians do accept that households and firms
operate on the basis of rational expectations, they still maintain that there are a variety of market
failures, including sticky prices and wages. Because of this "stickiness", the government can improve
macroeconomic conditions through fiscal and monetary policy.
Neoclassical: Neoclassical economics assumes that people have rational expectations and strive to
maximize their utility. This school presumes that people act independently on the basis of all the
information they can attain. The idea of marginalism and maximizing marginal utility is attributed to
the neoclassical school, as well as the notion that economic agents act on the basis of rational
expectations. Since neoclassical economists believe the market is always in equilibrium,
macroeconomics focuses on the growth of supply factors and the influence of money supply on price
New Classical: The New Classical school is built largely on the Neoclassical school. The New
Classical school emphasizes the importance of microeconomics and models based on that behavior.
New Classical economists assume that all agents try to maximize their utility and have rational
expectations. They also believe that the market clears at all times. New Classical economists believe
that unemployment is largely voluntary and that discretionary fiscal policy is destabilizing, while
inflation can be controlled with monetary policy.
Austrian: The Austrian school is an older school of economics that is seeing some resurgence in
popularity. Austrian school economists believe that human behavior is too idiosyncratic to model
accurately with mathematics and that minimal government intervention is best. The Austrian school
has contributed useful theories and explanations on the business cycle, implications of capital
intensity, and the importance of time and opportunity costs in determining consumption and value.
The goal of macro economic policy
Stable and sustainable economic growth and development: For advanced
economies, stable and sustainable development means the desire to see national
income grow in real terms in a way that can be sustained in the future, without
generating other significant economic problems.
For developing economies, further development is often the primary goal, and can
be summarised as the desire to increase the longevity of the population, increase
access to education, and attain a decent standard of living.
Stable prices: Stable prices mean average prices rising by only a small amount,
such as 2% per year.
Full employment: Full employment occurs when the labour force is fully employed
in productive work.
A balance of payments with the rest of the world: This means that a country is
able to ‘pay its way’ in the world.
Care for the environment: Care for the environment means protecting the
environment from misuse and overuse. The environment is increasingly recognised
as an important asset that needs to be protected.
An equitable (fair) distribution of income: An equitable
distribution of income means that the gap between rich and poor is not
excessive, but still enough to create incentives to work.
Not all economists agree about the order of priority for achieving these
objectives. Nor do they agree about which specific instrument should
be used to achieve a given objective.
A sound structure to public finances: In terms of the role of the
public sector, Keynes argued that more government spending could
adequately compensate for lower private consumer and capital
spending. In short, if an economy was in recession, it did not matter
who injected the money - the public sector was just as productive as the
private sector. However, as public (sovereign) debt has spiraled over the
last decade, the control and reduction of debt levels has become a
major policy objective.
RELATIONSHIP WITH 8 VARIANTS OF NATIONAL PRODUCT AGGREGATES
We have shown the distinction between national product at market
prices and national product at factor cost, based on whether or not net
indirect taxes have been included. And there is also a distinction
between gross or net national product according to whether investment
is inclusive of capital consumption or not. Further, a distinction has
been drawn between domestic and national product, according to
whether we are measuring net factor income from abroad (i.e. the net
return on factors owned by nationals of the country concerned) or
whether we are measuring what is produced within the domestic
economy. This implies that there are eight possible combinations of
national product aggregates, as shown below.
Gross Domestic Product (GDP) at market prices (MP)
at factor cost (FC)
Gross National Product (GNP) at market prices (MP)
at factor cost (FC)
Net Domestic Product (NDP) at market prices (MP)
at factor cost (FC)
Net National Product (NNP) at market prices (MP)
at factor cost (FC)
The way that these national product aggregates are related to each other can be understood
from the figure
We can sum up the differences between gross and net, market
prices and factor cost and national and domestic concepts in the
Gross=Net + Depreciation
Market Prices=Factor Cost + [Indirect Taxes - Subsidies]
National=Domestic + Net Factor Income from Abroad
There are some national product aggregates that are more
frequently met with and we have several ways of ordering them.
One of these is as follows:
i. Gross domestic product at market price + net factor income
from abroad equals
ii. Gross national product at market prices - net indirect taxes
(indirect taxes - subsidies) equals
iii. Gross national product at factor cost - capital consumption
(depreciation) equalsiv. Net national product at factor cost,
which is popularly known as national income.
Percentage number that shows the extent to which a
price (or a 'basket' of prices) has changed over
a period (month, quarter, year) as compared with the
price(s) in a certain year (base year) taken as
Difficulties faced in Estimating National Income
Six major difficulties faced in the measurement of national income are as follows: 1. problems
of definition, 2. lack of adequate data, 3. non-availability of reliable information, 4. choice of
method, 5. lack of differentiation in economic functioning, 6. double counting.
All the countries face some special difficulties in estimating national income. Some of these
difficulties are given below:
(1) Problems of Definition: What should we include in the National Income? Ideally we should
include all goods and services produced in the course of the year, but there are some services which are
not calculated in terms of money, e.g., services of housewives.
(2) Lack of Adequate Data:The lack of adequate statistical data makes the task of estimation of
national income more acute and difficult.
(3) Non-availability of Reliable Information: The reason of illiteracy, most producers has no idea of
the quantity and value of their output and do not follow the practice of keeping regular accounts.
(4) Choice of Method: The selection of method while calculating National Income is also an
important task. The wrong method leads to poor results.
(5) Lack of Differentiation in Economic Functioning: In all the countries the occupational
specialization is still incomplete so that there is a lack of differentiation in economic functioning. An
individual may receive income partly from farm ownership and partly from manual work in industry in
the slack season.
(6) Double Counting: Double counting is also an important problem while calculating national
income. If the value of all goods and services totaled, the total will overtake the national output,
because some goods are currently consumed being used in the making of others. The best way to avoid
this error is to calculate only the value of those goods and services that enter into final consumption.
uses of National Income Statistics
NI statistics may be analyzed and utilized for many reasons.
These include comparing countries, making economic forecasts,
to improve government or business policies and actions or to
understand if an organization has been successful in reaching its
One of the main uses of national income data is to recognize if a
nation (government) has chosen the correct economic policies.
Every single government on earth strives to achieve economic
growth. Economic growth is defined as a country’s national
income over time. Consequently government agencies and
departments examine such data to comprehend if government
aims have been reached. After the statistics have been analyzed
the organization in question may choose to change policies or
create new ones to stimulate economic growth if the objectives
have not been achieved. However if the objectives have been
accomplished, the government would normally also instigate
changes to increase even more economic growth and expansion.
For these changes, organizations utilize national income
statistics for a different reason.
To understand changes that need to be made, a government
economic agencies use national income calculations to make
predictions of the future, through analysis or graphs, data and
diagrams. Economists recognize trends, which may be obvious or
surreptitious. If these trends are positive, economists
recommend that government policies are not modified. If not,
economists often advise drastic changes to improve current
outlooks towards the future.
Another use of national income statistics is as a basis to compare
countries, either directly or by economic growth or living
standards. Rising national incomes is often equated to rising
living standards. This measures people’s general wellbeing and
wealth. If two countries are compared, the nation with a higher
value of national income is stated to be more developed and
advanced, as its people enjoy better living standards.
Thus, one may observe that national income data may be
utilized in many various ways to come to better understanding of
the present or to create forecasts of the economic future and
recognize trend, which may in time become reality.