Chapter 1. Introduction to Economics

Meaning of Economics
• The term ‘economics’ comes from the Greek term Oikonomos, which is composed of

oikos (house) and nomos (custom or law), meaning Rules of the Household. Economics is the social science that studies economic activities to gain an understanding of the processes that govern the production, distribution and consumption of goods and services in an economy.
• Initially, the study of economics concentrated mainly on wealth by concentrating on factors of production and consumption. This emphasis on wealth excluded from its study, those who were not directly connected with the formal economic system. Thus, the needs of poor, senior citizens, children etc. were neglected. It was corrected with the emergence of welfare economics, which focused on welfare needs of the whole society instead of just the production of wealth.

Branches of Economics

Traditionally, economics has been divided into the two main branches :

Micro Economics
• It is concerned with how supply and demand interact in individual market and how these interactions determine the price level of goods and services.
• It examines the economic behaviour of individual actor at the level of the individual economic entity — the individual firm, the individual consumer and the individual worker.

Macro Economics
• It is concerned with how the overall economy works. It studies such things as employment, Gross Domestic Product (GDP) and inflation; the stuff of news stories and government policy debates.
• It studies the economy as a whole and its features like national income, employment, poverty, balance of payments and inflation.

Some Other Branches of Economics

Development Economics
• It is a branch of economics, which deals with the economic aspects of the development process in low income countries.
• The goal of development economics is to determine how poor countries can be transformed into prosperous ones.

Behavioral Economics
• This branch studies the effects of social, cognitive and emotional factors on the economic decisions of individuals and their consequences for market prices, returns and resource allocation.
• It is mainly exploring why people sometimes make irrational decisions and why and how their behaviour does not follow the predictions of economic models.

Environmental Economics
• This branch studies the economic impact of environmental policies. Its goal is to balance the economic activity and the environmental impacts, by taking into account all the costs and benefits.

International Economics
• It is a branch of economics, which studies economic interactions among different countries, including foreign trade, foreign exchange, balance of payments and balance of trade.
• The guiding principle in the study of international economics is comparative advantage, which indicates that every country, no matter what their level of development, can find something that it can produce cheaper than others.

Information Economics
• It is a branch, which studies how information and information technology influence the economy.

Information economics has certain characteristics, like:
(i) It is easy to create, but hard to trust. (ii) It is easy to spread, but hard to control.

Demographic Economics
• Demographic economics or Population economics is the application of economics to demography; the study of human population, including size, growth, density, distribution and vital statistics.

Types of Economies
• Typically, economies are divided into different types based on the extent of government involvement in economic decision-making.

Based on the above criteria, the following are the major types of economies:

Traditional Economy
• In this type of economy, there is very little government involvement. Allocation of resources here is based on rituals, habits or customs.
• Economic roles are defined by the family and people work together for the common good. There is also very little individual choice in this system. Examples of this type exist in tribes in Amazon, Aborigines in Australia etc.

Free Market Economy
• This type of economy also has very little governmental interference or control. Economic decisions here are made based on market principles. There is a lot of competition between firms, which provides many choices to consumers.
• Resources for production are under private ownership and they make their decisions with the desire to maximise profits. Although, there are no pure free market economies. United States and Australia come close to this type.

Command Economy
• Here, the resources of production are completely under government control. The functioning of these economies is based on control planning. Due to lack of competition, resource allocation is inefficient and consumers have very little choices. Examples of this type are the former Soviet Union, Cuba, North Korea etc.

Mixed Economy
• This type of economy consists of a combination of public sector and private sector units. Here, the government is the decision-maker for the public sector and individuals, and businessmen make decisions for the private sector.
• It basically incorporates governmental involvement in a market based economy. Examples of this type are India, Russia and UK etc.

Open Economy
• An economy is said to be open, if it has trade with other economies. In this economy, market is mostly free from trade barriers and where exports and imports form a large percentage of the GDP.
• The degrees of the openness of an economy determines government’s freedom to pursue economic policies of its choice and the susceptibility of the country to international economic cycles.

Closed Economy
• An economy is said to be closed, if it has no trade or trade area with other economies. In this economy, the consumer get everything within the economic borders and government act as the arbitrator, articulator and facilitator.

Capitalist Economy
• Capitalism is the economic system based on private or corporate ownership, production and distribution of goods. Capitalists favour a system of free enterprise which means the government does not interfere in the economy that the laws of supply and demand will make sure that the economy runs most efficiently in meeting people’s needs. Capitalism is characterised by competition in which there is rivalry in supplying or getting an economic service or goods.

Socialist Economy
• Socialism is an economic system in which the means of production are socially owned and used to meet human needs instead of to create profits.
• Socialism tends to favour cooperation whereas capitalism is characterised by competitions. A form of socialism called communism sprang up based on the writings of Karl Marx and Friedrich Engels.
• Communism advocates class struggle and revolution to establish a society of cooperation with strong government control. Communism predominated in the former Soviet Union and much of Eastern Europe at one time. Today, it predominates in China and Cuba, but its influence has lessened.

Sectors of an Economy
• A nation’s economy can be broadly divided into various sectors to define the proportion of people engaged in a particular sector. This categorisation is generally seen as a continuum of the distance from the natural environment.
Traditionally, economies are divided into the following three sectors :
(i) Primary Sector
• This sector is involved in the extraction or harvesting of products from the Earth. It includes the production of raw materials and basic foods. Some of the activities included in this sector are agriculture, mining, forestry, fishing, quarrying etc.
• The packaging and processing of raw materials is also considered as a part of this sector. As an economy develops the share of primary sector in total production and employment goes down.
(ii) Secondary Sector
• The secondary sector of the economy is involved in the production of finished goods. All manufacturing, processing and construction activities lie in this sector (in India, construction sometimes considered as part of the services or tertiary sector).
• Some of the activities in this sector are metal working, automobile manufacturing, textile, production, shipbuilding etc. Most economies in their process of development go through the middle phase, where the secondary sector becomes the largest sector of the economy in terms of production and employment with the reduction in importance of the primary sector.
• India is an exception, where we have directly moved to services sector development, without first improving the manufacturing capabilities.
(iii) Tertiary Sector
• The tertiary sector of the economy is also called as the services sector. This sector provides services to the general population and to business. Some of the activities which are part of this sector are retail, transportation, entertainment, tourism and banking etc. In the advanced developed economies, the tertiary sector is the largest in terms of production and employment.
• Sometimes, two more sectors, i.e. quaternary and quinary are defined separately, even though these can also be considered as part of the services sector itself.

Other Sectors of Economy

Quaternary Sector
• This sector consists of the intellectual and knowledge based activities. Examples of activities associated with this sector are research and development, culture, information technology, consulting, financial planning, education etc.

Quinary Sector
• This sector consists of the highest levels of decision-making in a country. This includes the top officials of government, media, universities etc.

Classification of Countries by theWorld Bank
TheWorld Bank prepares theWorld Development Report (WDR). TheWDR as of July, 2018, classified the different countries on the basis of their per capita income.

Categories Based on Per Capita Income
• High income countries—$ 12,055 and above
• Upper middle income countries—Above $ 3895 to $ 12,055
• Lower middle income countries—Above $ 996 to $ 3895
• Low income countries—$ 995 and less.

Source World Bank Report, 2018

Classification of Countries Based on Economical Activities

Developed Country
• It refers to a country with a relatively high level of economic growth and security. A country’s degree of development is evaluated on the basis of per capita income or GDP, level of industrialisation, general standard of living and the amount of widespread infrastructure.

Developing Country
• It is also called a less developed country with lower living standard, underdeveloped industrial base and low Human Development Index (HDI).

Least Developed Country
• According to the United Nations, countries having lowest indicator of socio-economic development with the lowest HDI ratings are called as least developed countries.

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