Topic: Basic Concepts of Economy

Q. What are the definitions of economics?

Answer. Economics as a word comes from the Greek: oikos means ‘family, household, or estate’, and nomos stands for ‘custom, law’ etc. Thus, “household management” or manage-ment of scarce resources is the essential meaning of economics. Economics encom-passes production, distribution, trade and consumption of goods and services. Economic logic is applied to any problem that involves choice under scarcity.

Q. Evolution of the subject.

Answer : Initially, economics focused on “wealth” and later “welfare”. Still later, in recent years, it has given sufficient attention to the study of trade offs- giving up one to gain another. The focus on tradeoffs arises from the traditional assumption that resources are scarce and that it is necessary to choose between competing alternatives. Choosing one benefit implies forgoing another alternative the opportunity cost (cost of foregoing an Opportunity).

Q. Who is known as the father of Economics?

Answer :Adam Smith, generally regarded as the Father of Economics, author of An Inquiry into the Nature and Causes of the Wealth of Nations (generally known as The Wealth of Nations) defines economics as “The science of wealth.” Smith offered another definition, “The Science relating to the laws of production, distribution and exchange.”
Definitions in terms of wealth emphasize production and consumption, and do not deal with the economic activities of those not significantly involved in these two processes, for example, children and old people. The belief is that non-productive activity is a cost on society. It meant that man was relegated to the secondary position and wealth was placed above life.
Thus arose the shift in the focus to welfare economics study of man and of human welfare, not of money alone. Economics involves social action connected with the attainment of human well being.

Q. Discuss the different branches of economics.

Answer : Economics is usually divided into two main branches:
Microeconomics which examines the economic behavior of individual actors such as consumers, businesses households etc to understand how decisions are made in the face of scarcity and what effects they have.
Macroeconomics, which studies the economy as a whole and its features like national income, employment ,poverty, balance of payments and inflation.
The two are linked closely as the behavoir or a firm or consumer or household depends upon the state of the national and global economy.

Q. What is Keynesian theory of macro economics?

Answer :

• Keynesian macroeconomics based on the theories of twentieth-century British economist John Maynard Keynes. It says that the state can stimulate economic growth and restore stability in the economy through expansionary policies. For example through massive programme of spending on infrastructure when the demand is low and growth is negative.

• In the recessionary phase that the economies of the western world in particular and rest of the world in general, went through (some are still undergoing the recession) due to 2008 financial crisis, the relevance of Keynes is growing.

• The intervention by State is only when the economic cycle turns down and growth slows down or is negative. In normal times, it is the market the drives growth through the force of supply and demand.

• Indian government stepped up expenditure with three fiscal stimuli in since December 2008 to revive growth. With growth spurting, the gradual and calibrated exit from the stimulus was begun in the 2010-11 Union Budget.

• The theories of Keynesian economics were first presented in The General Theory of Employment, Interest and Money (1936).

Q. Define Neoliberalism.

Answer. Neoliberalism refers to advocacy of policies such as individual liberty, free markets, and free trade. Neoliberalism “proposes that human well being can best be advanced by liberating individual entrepreneurial freedoms and skills within an institutional framework characterized by strong private property rights, free markets and free trade”.

Q. What is socialist theory of economics?

Answer. In distinction to the above, there is the school of socialist economics based on public (State) ownership of means of production to achieve greater equality and give the workers greater control of the means of production. It establishes fully centrally planned economy which is also called command economy - economy is at the command of the State. Private ownership of assets is not allowed. For example, erstwhile USSR, Cuba etc.

Q. What is development economics?

Answer:  Development economics is a branch of economics which deals with economic aspects of the development process, mainly in low-income countries. Its focus is not only promoting economic growth and structural change but also improving the well being of the population as a whole through health and education and workplace Conditions, whether through public or private channels. The most prominent contemporary development economists are Nobel laureates Amartya Sen and Joseph Stiglitz.

Q. What is structural change? Give an example.

Answer : Structural change of an economy refers to a long-term widespread change of a fundamental structure, rather than microscale or short-term change. For example a subsistence economy is transformed into a manufacturing economy, or a regulated mixed economy is liberalized. An nsulated and protectionist economy becomes open and globalized. A current structural change in the world economy is globalization.

Q. Define green economics.

Answer: Green economics focuses on and supports the harmonious interaction between humans and nature and attempts to reconcile the two.

Q. What is Economic Growth? and how can we measure it, Discuss about its various methods.

Answer : Economic growth is the change- increase or decrease, in the value of goods and services produced by an economy. If it is positive, it means an increase in the output and the income of a country. It is generally shown as the increase in percentage terms of real gross domestic product (GDP adjusted to inflation) or real GDP.
Measuring Growth

Measures of national income and output are used in economics to estimate the value of goods and services produced in an economy. They use a system of national accounts or national accounting. Some of the common measures are Gross National Product (GNP) and Gross Domestic Product (GDP).

National income accounting

National income accounting refers to a set of rules and techniques that are used to measure the national income of a country.
GDP is defined as the total market value of all final goods and services produced within the country in a given period of time- usually a calendar year or financial year.
GDP can be real or nominal. Nominal GDP refers to the current year production of final goods and services valued at current year prices. Real GDP refers to the current year production of goods and service valued al base year prices. Base year prices are Constant prices.
In estimating GDP, only final marketable goods and services are considered. Only their values are added up and they pertain to a given period. When it is compared to the base year figure, the growth levels are Seen.
To explain further, gains from resale are excluded but the services provided by the agents are counted. Similarly, transfer payments (pensions, scholarships etc) are excluded as there is income received but no good or service produced in return. However, not all goods and services from productive activities enter into market transactions. Hence, imputations are made for these non-marketed but productive activities: for example, imputed rental for owner-occupied housing.

Market Price and Factor Cost

Market price refers to the actual transacted price and it includes indirect taxes- custom duty, excise duty, sales tax, service tax etc.
Factor cost refers to the actual cost of the Various factors of production includes government grants and subsidies but it excludes indirect taxes.

Relationship between market price and factor cost.

GNP at factor cost = GNP at market price - indirect taxes + subsidies
GDP at factor cost = GDP at market price - indirect taxes + subsidies

Factor costs

Factor costs are the actual production costs at which goods and services are produced by the firms and industries in an economy. They are really the costs of all the factors of production such as land, labour, capital, energy, raw materials like steel etc that are used to produce & given quantity of output in an economy. They are also called factor gate costs (farm gate, firm gate and factory gate) since all the costs that are incurred to produce a given quantity of goods and services take place behind the factory gate i.e. within the walls of the firms, plants etc in an economy.

Transfer Payments

Transfer payment refers to payments made by government to individuals for which there no economic activity is produced in return by these individuals. Examples of transfer are scholarship, pension.

Q. How can we estimate GDP/GNP?

Answer: There are three different ways of calculating GDP. The expenditure approach adds consumption, investment, government expenditure and net exports (exports minus imports).
On the other hand, the income approach adds what factors earn: wages, profits, rents etc.
Output approach adds the market value of final goods and services .
The three methods must yield the same results because the total expenditures on goods and services (ONE) must by definition be equal to the value of the goods and services produced (GNP) which must be equal to the total income paid to the factors that produced these goods and services.
In reality, there will be minor differences in the results obtained from the various methods due to changes in inventory levels. This is because goods in inventory have been produced (and therefore included in GDP), but not yet sold. Similar timing issues can also cause a slight discrepancy between the value of goods produced (GDP) and the payments to the factors that produced the goods, particularly if inputs are purchased on credit.

Q. Define final goods.

Answer : Final goods are goods that are ultimately consumed rather than used in the production of another good. For example, a car sold to a Consumer is a final good; the components such as tyres sold to the car manufacturer are not; they are intermediate goods used to make the final goods. The same tyres, if sold to a consumer, would be a final goods. Only final goods are included when measuring national income. If intermediate goods were included too, this would lead to double counting; for example, the value of tyres would be counted once when they are sold to the car manufacturer, and again when the car is sold to the consumer.
Only newly produced goods are counted. Transactions in existing goods, such as second-hand cars, are not included, as these do not involve the production of new goods.

Q. What is GDP?

Answer : GDP considers only marketed goods. If a cleaner is hired, their pay is included in GDP. If one does the work himself, it does not add to the GDP. Thus much of the work done by women at home taking care of the children, aged; chores etc which is called ‘care economy’ is outside the GDP. Gross means depreciation (wear and tear of machinery in their use) of capital stock is not subtracted. If depreciation is subtracted, it becomes net domestic product. Calculating the real GDP growth -inflation adjusted GDP growth allows us to determine if production increased or decreased, regardless of changes in the inflation and purchasing power of the currency.

Q. Is GDP & GNP are related or they are different from each other?

Answer : The two are related. The difference is that GNP includes net foreign income. GNP adds net foreign investment income compared to GDP. GDP shows how much is produced within the boundaries of the country by both the citizens and the foreigners. It is the market value of all the output produced in the territory of a nation in one year. GDP focuses on where the output is produced rather than who produced it. GDP measures all domestic production, disregarding the producing entities nationalities.
In contrast, GNP is a measure of the value of the output produced by the “nationals” of a country- both with in the geographical boundaries and outside. That is, all the output that the Indian citizens produce in a given year - both within India and all other countries.
For example, there are Indian and foreign firms operating in India. Together what they produce within the Indian geography is the GDP of India. The profits of foreign firms earned within India are included in India’s GDP, but not in India’s GNP.
In other words, income is counted as part of GNP according to who owns the factors of production rather than where the production takes place. For example, in the case of a German-owned car factory operating in the US, the profits from the factory would be counted as part of German GNP rather than US GNP because the capital used in production (the factory, machinery, etc.) is German owned. The wages of the American workers would be part of US GDP, while the wages of any German workers on the site would be part of German GNP.
GDP is essentially about where production takes place. GNP is about who produces. If it is an open economy with great levels of foreign investment (FD1) and lesser levels of outbound FDI, its GDP is likely to be larger than GNP.
If it is an open economy but more of its nationals tend to move economic activity abroad or earn more from investing abroad compared with non-nationals doing business and earning incomes within its borders, its GNP will be larger than GDP.
If it is a closed economy where nobody leaves its shores, nobody invests abroad, nobody comes in and nobody invests in the country, its GDP will be equal to GNP
Japan used to belong in the last category. Until the mid-1990s, the difference between Japan’s GDP and GNP amounted to less than one percentage point of GDP. With only limited numbers of people doing business abroad, the GDP and GNP were essentially the same thing.

Q. Define Net National Product.

Ans. In the production process a country uses machines and equipment. When there is depreciation, we have to repair or replace the machinery. The expenses incurred for this are called the depreciation expenditure. Net National Product is calculated by deducting depreciation expense from gross national product.
NNP = GNP - Depreciation
National Income is calculated by deducting indirect taxes from Net National Product and adding subsidies. National Income (NI) is the NNP at factor cost.
NI = NNP - Indirect Taxes + Subsidies

Q. What is Per Capita Income?

Answer : Per Capita Income is per capita GDP: GDP divided by mid year population of the corresponding year.
The growth of GDP at constant price shows an annual real growth.
The real GDP per capita of an economy is often used as an indicator of the average standard of living of individuals in that country, and economic growth is therefore often seen as indicating an increase in the average standard of living.

Q. Why we need to measure economic growth?

Answer : The following aims can be attributed to the study of economic growth.

• when growth is quantified , we can understand whether it is adequate or not for the given goals of the economy.

• we can understand its potential and accordingly set targets.

• we can adjust growth rates for their sustainability.

• we can prevent inflation or deflation to some extent if we see the performance of the economy in quantitative terms.

• we can balance the contributions of the three sectors of the economy and steer the direction of growth towards national goals- away from agriculture to manufacturing as in the case of India in recent years.

• target appropriate levels of employment creation and poverty alleviation.

• forecast tax revenues for governmental objectives.

• corporates can plan their business investments.

Q. Discuss the problems for calculating National Income.

Answer : The measurement of national income encounters many problems. The problem of double-counting. Though there are some corrective measures, it is difficult to eliminate double-counting altogether. And there are many such problems and the following are some of them.

(i) Black Money

Illegal activities like smuggling and unreported incomes due to tax evasion and corruption are outside the GDP estimates. Thus, parallel economy poses a serious hurdle to accurate GDP estimates. GDP does not take into account the ‘parallel economy’ as the transactions of black money are not registered.

(ii) Non-Monetization

In most of the rural economy, considerable portion of transactions Occurs informally and they are called as non-monetized economy- the barter economy. The presence of such non-monetary economy in developing countries keeps the GDP estimates at lower level than the actual.

(iii) Growing Service Sector

In recent years, the service sector is growing faster than that of the agricultural and industrial sectors. Many new services like business process outsourcing (BPO) have come up. However, value addition in legal consultancy, health services, financial and business services and the service sector as a whole is not based on accurate reporting and hence underestimated in national income measures.

(iv) Household Services

The national income accounts do not include the ‘care economy’- domestic work and housekeeping. Most of such valuable work rendered by our women at home does not enter our national accounting.

(v) Social Services

It ignores voluntary and charitable work as it is unpaid.

(vi) Environmental Cost

National income estimation does not account for the environmental costs incurred in the production of goods. For example, the land and water degradation accompanying the Green revolution in India. Similarly, the climate change that is caused by the use of fossil fuels. However, in recent years, green GDP is being calculated where the environmental costs are deducted from the GDP value and the Green GDP is arrived at.

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