Chapter 1

Basic Concepts

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Economics has a very significant position in all social sciences. To understand eco-
nomics properly, we need to analyse the nature and scope of the subject.Economics

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is a social science that studies the production, distribution and consumption of

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goods and services and it spans from mathematics to psychology. It studies how

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individuals, businesses, governments, and nations make choices about how to allo-

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cate resources. Economics focuses on the actions of human beings, based on the
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assumption that humans act with rational behavior, seeking the most optimal level
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of benefit or utility.
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Meaning and definition of Economics

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The word economics is derived from two Greek words ’oikos’ and ’nemein’ meaning
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’house’ and ’manage.’ Economics is concerned with the management of of household

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through the economic use of scarce resources available to the individuals or the whole
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society.
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The definitions put forward by economists can be categorised into four: wealth
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based definition, welfare based definition, scarcity based definition, and growth based
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definition.
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Wealth Definition
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The classical economists define economics as the “Science of Wealth” which deals
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with the consumption, production, exchange and distribution of wealth. Adam

Smith in his famous work “Wealth of Nations” published in 1776, defined economics
as “an enquiry into the nature and causes of wealth of nations.” It is about wealth
generating and wealth spending activities of man.

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 Welfare Definition
According to Alfred Marshall, wealth is only a means to an end and the end is
welfare. Marshall in his famous book “Principles of Economics” published in 1890
defines economics as follows: “Political economy or 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 the material
requisites of well being.”

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Scarcity Definition

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Prof. Lionel Robbins of the London School of Economics in his challenging book

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“An Essay on the Nature and Significance of Economic Science” published in 1932

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introduces his scarcity definition of economics. According to him, “Economics is the

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science which studies human behaviour as a relationship between ends and scarce

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means which have alternative uses.”

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Growth Definition
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Economics is a fast growing and unfinished science. To define such a developing
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subject is not an easy job. The definition which is acceptable today may become
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obsolete tomorrow. The present day economists have however, evolved a fairly
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satisfactory and generally acceptable definition of economics. According to them,

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“Economics is a study of the allocation and development of scarce resources and the
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determinants of employment, output, income and economic growth.”

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Recently Prof. Samuelson has given a definition based on growth aspects which
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is known as the Growth definition. “Economics is the study of how people and
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society end up choosing, with or without the use of money, to employ scarce pro-
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ductive resources that could have alternative uses to produce various commodities
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and distribute them for consumption, now or in the future, among various persons
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or groups in society. Economics analyses the costs and the benefits of improving
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patterns of resource use.”

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Micro and Macroeconomics

The subject matter of economics has been divided into two parts: microeconomics
and macroeconomics. These terms were first coined and used by Ragnar Frisch
and have now been adopted by economists the entire world over. The term mi-
croeconomics is derived from the Greek word mikros, meaning, small and the term
macroeconomics is derived from the Greek work makros, meaning large.

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 Microeconomics studies individuals and business decisions, while macroeconomics
analyzes the decisions made by countries and governments. Microeconomics focuses
on supply and demand, and other forces that determine price levels, making it a
bottom-up approach. Macroeconomics takes a top –down approach and looks at the
economy as a whole, trying to determine its course and nature. Investors can use
microeconomics in their investment decisions, while macroeconomics is an analytical
tool mainly used to craft economic and fiscal policy.
Microeconomics is a branch of economics that studies the behavior of individuals
and firms in making decisions regarding the allocation of scarce resources and the

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interactions among these individuals and firms. Macroeconomics is a part of eco-

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nomic study which analyzes the economy as a whole. It is the average of the entire

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economy and does not study any individual unit or a firm. It studies the national

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income, total employment, aggregate demand and supply etc.

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Nature and Scope of Economics

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In order to understand the nature of economic laws, we have to clearly state whether
economics is a science or an art and moreover, if it is a science, whether it is positive
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or normative. The scope of economics’ is a broad subject and encompasses not only
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its subject matter but also various other things, such as its scientific nature, its
ability to pass value judgments, and to suggest solutions to practical problems.
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Economics as social science

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Science is a systematized body of knowledge regarding a subject. A science is not

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a mere collection of facts. It indicates a relationship between cause and effect. It

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studies uniformities pervading a subject and tries to find out generalizations which
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we call laws. Economics also can be regarded as a full- fledged science because it
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studies the uniformities of human conduct in the ordinary business relations. It

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investigates the possibility of deducing generalizations as regards the behavior of

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human beings and their economic motives. Hence, economics is a science, because
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it tries to discover the universal out of the chaotic facts.

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The phenomena of science must be easily amenable to measurement. Here the

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claim that economics is a science is based upon the fact that it deals with that part
of man’s actions which can be measured by the measuring rod of money. Of all the
social sciences, economics is the most exact; because none of the social sciences has
got any external measure to make possible a definite quantitative measurement.
It has to be admitted that human motives cannot be accurately measured and
that the moving forces of economic action can only be measured roughly and im-
perfectly. Therefore, economics which is most perfect of all social sciences, is not

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 exact as the physical science, because it deals with human motives which are very
complex. There could be also persons who behave in an irrational manner. But,
they form only a minority.
The existence of free will in men prevents economics from being a science.
Economists cannot claim precision for their laws. Economic prophecies are often
found to be false by subsequent event. The reason for this must be sought not in
the unscientific nature of economic causes but in our ignorance of the causes at work.

Positive economics and normative economics

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Positive economics is concerned with explaining what it is, that is, it describes

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theories and laws to explain observed economic phenomena, whereas normative eco-
nomics is concerned with what should be or what ought to be the things. In positive

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economics we derive propositions, theories and laws following certain rules of logic.

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These theories, laws and propositions explain the cause and effect relationship be-

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tween economic variables. In positive microeconomics, we are broadly concerned

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about explaining the determination of relative prices and the allocation of resources
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between different commodities. In positive macroeconomics, we are broadly con-
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cerned with how the level of national income and employment, aggregate consump-
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tion and investment and the general level of prices are determined.
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Normative economics is concerned with describing what should be the things. It

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is, therefore, called prescriptive economics. What price for a product is to be fixed,
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what wage rate should be paid, how income should be distributed, etc., fall within
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the purview of normative economics. It involves value judgments or what are simply
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known as values.
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Short run and long run analysis

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A short run is a time period during which consumers and producers have not had
enough time to make all the adjustments to the new situation. A long run is a time
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period during which consumers and producers have enough time to make all the
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adjustments to the new situation. We cannot exactly say, how short a short run is,
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and how long a long run is.

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Consider, for instance, a sudden increase in the oil price by the OPEC. The
immediate impact would be an increase in the prices of oil and other products
requiring oil. After some time, consumers would adjust to this situation by using
more energy-efficient cars and appliances, building energy efficient homes and so on.
These adjustments would eventually reduce demand and bring the price of oil back,
down.

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 Equilibrium and disequilibrium analysis
The word equilibrium is derived from the Latin word libra, meaning “weight” or
“balance.” In economics, equilibrium implies a position of rest characterized by
absence of change. It is a state where there is complete agreement of the economic
plans of the various market participants so that no one has a tendency to revise or
alter this decision.
Suppose a continuous and constant supply of a commodity comes to market with
a prospective demand for it from the buyers, for this the market price must be such

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as to equate the demand and supply of the commodity. When demand and supply

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are equal to a particular price, it is the state of equilibrium. The price at which

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the commodity is bought and sold is the equilibrium price and the quantity of the
commodity bought and sold at the price is the equilibrium quantity.

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Disequilibrium is a situation where there is no complete agreement of the eco-

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nomic plans of the various market participants.

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In the figure, price is given in the Y axis and the quantity supplied is given in

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the X axis. The curve DD shows demand and SS, supply in the market. At price 2
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the corresponding points in the demand and supply curves are d and c respectively.
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The quantity supplied is only 2 the quantity demanded is 4 here we can say that
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there exists an excess demand or deficiency in supply dc in the economy. In the same
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manner, at price 4 the corresponding points in the demand and supply curves are a
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and b respectively. Here the quantity supplied is b, while the quantity demanded is
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a. Here we could see an excess supply or deficiency of demand ab. However, at Price
3 the corresponding points in the demand and supply curves are e. We could also
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note that at this point both the curves intersect each other. The quantity supplied
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at this point is 3.
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Price
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Supply Curve
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Excess Supply
4
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3 e
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2
Excess Demand
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1 Demand Curve

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1 2 3 4 5 Quantity

Figure 1.1: Market Equilibrium

Here we can say that the point of equilibrium in the economy is at point e. The
market forces of supply and demand reach a point of balance or agreement at this

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 point. Any other point in the figure shows a point of disequilibrium or disagreement
between the forces of demand and supply.

Partial and general equilibrium analysis

Partial equilibrium analysis uses the ceteris paribus assumption. The smaller the
sector being considered better the possibility of that particular equilibrium analy-
sis can predict its behavior. It was popularized by the English economist Alfred
Marshall.

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Partial equilibrium analysis is used in two cases: 1) the first case is when we

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are concerned with an event or occurrence that affects only a given industry and its

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effect on others is negligible; 2) the second case is when we are concerned with first
order effects alone.

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General equilibrium analysis is concerned with the study of the effects of certain

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changes and policies after all the interactions in the economy have taken place.

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General equilibrium is achieved only when all these industries are in equilibrium

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simultaneously. In economics everything depends on everything else. Thus one
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would think that every problem in economics would be approached from the point
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of view of general equilibrium. It is often the case that macroeconomic theories
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tend to be general equilibrium in character and microeconomic theories tend to be

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partial equilibrium in character. General equilibrium theory was first systematically

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studied by the French mathematical economist, Leon Walras.

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Deductive and Inductive reasoning

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There are two method of reasoning in theoretical economics. They are the deductive
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and inductive methods.

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Deductive Method
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Deduction Means reasoning or inference from the general to the particular or from
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the universal to the individual. The deductive method derives new conclusions from
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fundamental assumptions or from truth established by other methods. It involves

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the process of reasoning from certain laws or principles, which are assumed to be
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true, to the analysis of facts.

Deduction involves four steps: (1) Selecting the problem. (2) The formulation of
assumptions on the basis of which the problem is to be explored. (3) The formulation
of hypothesis through the process of logical reasoning whereby inferences are drawn.
(4) Verifying the hypothesis.

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 Inductive Method

Induction “is the process of reasoning from a part to the whole, from particulars to
generals or from the individual to the universal.” Bacon described it as “an ascending
process” in which facts are collected, arranged and then general conclusions are
drawn.
The inductive method involves the following steps: 1) The Problem; In order to
arrive at a generalisation concerning an economic phenomenon, the problem should
be properly selected and clearly stated. 2) Data; The second step is the collection,

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enumeration, classification and analysis of data by using appropriate statistical tech-

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niques. 3) Observation; Data are used to make observation about particular facts

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concerning the problem. 4) Generalisation; On the basis of observation, generali-
sation is logically derived which establishes a general truth from particular facts.

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Thus induction is the process in which we arrive at a generalisation on the basis of

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particular observed facts.

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Functions of an economic system
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Faced with the pervasiveness of scarcity, all societies from the most primitive to the
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most advanced must somehow determine, 1) what to produce, 2) how to produce,

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and 3) for whom to produce.

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What to produce refers to which goods and services a society chooses to produce
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and in what quantities to produce them. No society can produce all the goods and
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services it wants. So it must choose which to produce and which to forgo.

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How to produce refers to the way in which resources or inputs are organized to
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produce the goods and services that consumers want.

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For whom to produce deals with the way that the output is distributed among
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the members of the society. Those individuals who possess the most valued skills
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or own a greater amount of other resources will receive higher incomes and will be
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able to pay and coax firms to produce more of the commodities they want.
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The economic system should also provide for the growth of the nation. Although
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governments can affect the rate of economic growth with tax incentives and with
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incentives for research, education and training, the price system is also important.
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In addition an economic system must allocate a given quantity of a commodity over

time. Rationing is also accomplished by the price system.

Production possibilities frontier

Production possibility curve is an analytical tool which is used to illustrate and
explain the problem of choice or economizing process in a hypothetical economy or

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 society. In every economic society, the economizing problem arises on account of the
limited resources in relation to unlimited wants. Prof. Samuelson has production
possibility curve to clear the problem of scarcity and choice.
Production possibility frontier or the transformation curve shows the alternative
combinations of commodities that a nation can produce by fully utilizing all of its
resources with the best technology available to it. Let us take a situation where the
economy is producing just two products- steel and wheat. Steel symbolizes a capital
good and wheat consumer good. Since the resources available in the economy are
limited the output is also limited. Here more steel can be produced only at the cost

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of less wheat and vice versa. Thus the economy cannot increase the supply of both

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from its scarce resources. This is the economic problem that the society has to face.

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Wheat

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P E F

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B C

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A He
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D
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0 P’ Steel
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Figure 1.2: Production Possibility Frontier

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The figure above shows the production possibilities curve, which is marked by
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P P 0 . Points P, C, D, E, and P 0 show the combinations of the two products that

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the society may produce from its limited resources. When we join these various
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points, we obtain a curve which is known as the production possibility curve. This
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curve is also known as transformation curve because when we move from one point
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to another say from C to D, we will be transforming wheat into steel by shifting

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resources from the production of wheat to the production of steel. Any point inside
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this curve, say point A or B indicate that resources are not being fully utilized. The
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society cannot go outside this curve for example point F as its resources do not
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permit it to do so. This is the reason that the curve is also known as the frontier.

Utility
The analysis of consumer behavior is greatly facilitated by the use of a utility func-
tion that assigns a value or utility level to commodity bundles. The concept of
utility is used to introduce the consumer tastes. The analysis of consumer tastes

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 is a crucial step in determining how a consumer maximizes satisfaction in spending
income.
The property of a good that enables it to satisfy human wants is called utility.
As individuals consume more and more of a good per time period their total utility
(TU) or satisfaction increases, but their marginal utility diminishes. The aggregate
amount of satisfaction received from consuming various amounts of a good or basket
of goods is called Total Utility. Marginal Utility (MU) is the extra utility received
from consuming one additional unit of the good per time while holding constant the
quantity consumed of all other commodities.

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Quantity Marginal Utility Average Utility Total Utility

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1 10 10 10

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2 8 9 18

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3 5 7 21

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4 3 6 24

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5 1 5 25

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6 -1 4 24
7 -3 3 21

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Total Utility
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Utility

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0 Quantity
Marginal Utility
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The figure shows the Total and marginal utility of a good. Marginal utility is
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positive but declines until the Total Utility is maximised. When TU declines MU is
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negative. The negative slope or downward to the tight inclination of the MU curve
reflects the law of diminishing marginal utility.

Cardinal utility and Ordinal utility

Cardinal utility means that an individual can attach specific values or numbers of
‘utils’ from consuming each quantity of a good or baskets of goods. Ordinal utility is
much weaker notion than cardinal utility because it only requires that the consumer

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 be able to rank goods in order of his preference. In short ordinal utility only ranks
various consumption bundles, whereas cardinal utility provides an actual index or
measure of satisfaction.

Demand
Demand indicates the quantities of a good or service which the household is willing
and financially able to purchase at various prices, holding other things constant.

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Individual Demand

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We may define the demand for a commodity of the individual household as a list or
schedule of the quantities that will be bought at various prices. The demand for a

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commodity of an individual depends upon a number of factors such as price of the

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commodity, income of the individual, tastes and preferences of the individual, prices

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of other goods etc.

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Demand schedule and demand curve He
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The individual demand schedule is a table which explains the relation between the
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price of a commodity and the demand for it. Below we have a hypothetical individual
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demand schedule for oranges. In the first column are given alternate prices per dozen
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oranges and in the second column against each price is shown the quantity demanded
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of oranges. When we show the household demand schedule graphically, we have a

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demand curve for oranges of the household. On the Y axis is shown the price of
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oranges and on the X axis the quantity of oranges demanded at each price.
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Price Quantity demanded

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30 10
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25 15
20 20
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15 25
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10 30
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Table 1.1: Individual demand schedule

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From the diagram we could understand that at lower prices more of the com-
modity is demanded. This is true for most commodities. This inverse price quantity
relationship is called the law of demand. The law of demand states that other
things remaining unchanged, the quantity demanded of a commodity
varies inversely with its price.

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 Price
30

20

10

Quantity

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5 10 15 20 25 30 35

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Figure 1.3: Individual Demand

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Market Demand

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A market demand schedule is a table showing the quantity of a commodity that

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consumers are willing and able to purchase over a given period of time at each price
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of the commodity, while holding constant all other relevant economic variables on
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which demand depends. Among the variables held constant are consumers income,
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their tastes, the prices of related commodities and the number of consumers in the
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market.
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Price Qty Ddd by A Qty Ddd by B Qty Ddd by C Market Demand

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10 20 17 13 20+17+13 = 50
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20 16 13 11 16+13+11 = 40
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30 13 10 7 13+10+7 = 30
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40 9 6 5 9+6+5 = 20
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50 5 3 2 5+3+2 = 10
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Table 1.2: Market demand schedule

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The market demand is the sum total of demands of all consumers in the market
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for a commodity at various prices. We can derive the market demand for a com-
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modity by adding up the quantities demanded of the commodity at various prices

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by all the consumers that buy the commodity in a period of time. Table below gives
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the market demand schedule. If the market has only three buyers for a commodity,
their willingness to purchase the particular quantities of the commodity at various
prices is shown here.
By plotting on graph various price-quantity combinations given by the market
demand schedule, we obtain the market demand curve for the commodity. The price
per unit is usually measured along the vertical axis, while the quantity demanded is
measured along the horizontal axis. The graphical expression of the above market

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 60
Price

40

20

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Quantity

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10 20 30 40 50 60

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Figure 1.4: Market Demand

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demand schedule is shown in the figure below. Here market demand curve is given

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by the curve DD.

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Reasons for the law of demand He
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Demand curve has a negative slope; i.e., it slopes downward to the right. This nega-
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tive slope is the reflection of the law of demand or inverse price-quantity relationship.
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The two major reasons are income effect and the substitution effect.
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Income effect: when price of a commodity falls, the consumer can buy more
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quantity of the commodity with his given income. In other words, as a result of fall
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in price of the commodity, consumers real income or purchasing power increases.

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This increase in real income induces the consumer to buy more of that commodity.
This is called income effect of the change in price of the commodity.
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Substitution effect: When the price of a commodity falls, it becomes relatively

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cheaper than other commodities. This induces the consumer to substitute the com-
modity whose price has fallen for other commodities which have now become rela-
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tively dearer. As a result of this substitution effect, the quantity demanded of the
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commodity, whose price has fallen, rises.

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Exceptions to the law of demand

Law of demand is generally believed to be valid in most of the situations. However,

some exceptions to the law of demand are there.
Goods having prestige value: Veblen effect: Thorstein Veblen has propounded
the doctrine of conspicuous consumption. According to him some consumers mea-
sure the utility of a commodity entirely by its price, i.e., for them, the greater the
price of the commodity greater the utility. This is called Veblen effect.

12
 Goods with uncertain product quality: In markets where prices act as signals of
quality, people tend to assume that quality has gone up when prices are raised and
hence may demand more of the commodity at a higher price.
Giffen goods: This was pointed out by Robert Giffen. Goods in whose case there
is a direct price-demand relationship is called Giffen goods. When there is a rise
in price of a Giffen good, its quantity demand increases and with a fall in its price
its quantity demanded decreases. The demand curve will slope upward to the right
and not downward.

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Factors determining demand

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The factors which determine demand for goods are:

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1. tastes and preferences of the consumers,

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2. Income of the people,

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3. Changes in the prices of related goods,

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4. Number of consumers in the market, He
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5. Consumers expectations, and
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6. Income distribution.
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Price elasticity of demand

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Price elasticity of demand relates to the degree of responsiveness of quantity de-

manded of a good to the change in price. Precisely, price elasticity of demand is
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defined as the ratio of the percentage change in quantity demanded of a commodity

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to a percentage change in price. Thus;

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percentage change in the quantity demanded

ep =
percentage change in the price
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The demand for some goods is more responsive to the changes in price than those
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for others. In economics terminology, we would say that demand for some goods is
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more elastic than those for the others. Demand for a good is said to be elastic if
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price elasticity of demand for it is greater than one. Similarly, demand for a good is
called inelastic if price elasticity of demand for it is less than one. When the demand
for a good is equal to one it is called unitary elastic demand. Thus; Elastic demand:
ep > 1, Inelastic demand: ep < 1, Unitary elastic demand:ep = 1.

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 Pice Pice
4 4

3 3

2 2
Elastic Demand
1 1
Inelastic Demand
0 0
0 1 2 3 4 Quantity 0 1 2 3 4 Quantity

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Pice Pice

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4 4

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3 3

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2 2

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1 1

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ep = 1 Unitary Elastic ep = 0 Perfectly Inelastic
0 0

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0 1 2 3 4 Quantity 0 1 2 3 4 Quantity
Pice
4
He
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cr

3
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2
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1
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ep = ∞ Perfectly Elastic
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0
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0 1 2 3 4 Quantity
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Figure 1.5: Types of Elasticity of Demand

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Perfectly elastic and perfectly inelastic demand

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There are two extreme cases of price elasticity of demand. First extreme is perfectly
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inelastic demand. In this case, changes in price of a commodity does not affect the
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quantity demanded of the commodity at all. Here the demand curve is a vertical
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straight line as shown in the figure. Whatever be the price, quantity demanded of
the commodity remains unchanged.
The second extreme situation is of perfectly elastic demand in which case demand
curve is a horizontal straight line. This is to show that a small reduction in price
would cause the buyers to increase the quantity demanded from zero to all they
could obtain. On the other hand, a small rise in priced of a product would cause the
buyers to switch completely away from the product so that the quantity demanded
falls to zero.

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 Measurement of price elasticity

Price elasticity of demand is given by the percentage change in the quantity de-
manded of a commodity divided by the percentage change in its price.
∆Q/Q ∆Q P
ep = ∆P/P
= .
∆P Q

Since quantity and price move in opposite directions, the value of is negative.
To compare price elasticities, we use their absolute value (i.e., the value without
negative sign. Formula (1) measures point elasticity of demand or the elasticity at

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a particular point on the demand curve. More frequently we are interested in the

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price elasticity between two points on the demand curve. We then calculate the arc

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elasticity of demand. If we used formula (1) to measure arc elasticity, we would get
different results depending on whether price rises or falls. To avoid this, we use the

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average of the two prices and the average of the two quantities in the calculation.

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Letting P1 refer to the higher of the Quantity two prices and P2 refer to the lower

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of the two prices , we have the formula for arc elasticity of demand:

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∆Q (P1 +P2 )/2 ∆Q P1 +P2
ep = .
∆P (Q1 +Q2 )/2
= .
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∆P Q1 +Q2
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Determinants of Price elasticity
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The following are the main factors which determine price elasticity of demand for
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a commodity: 1. the availability of substitutes, 2. the proportion of consumers

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income spent, 3. the number of uses of a commodity, 4. complementarity between

goods, and 5. time.
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Other elasticity concepts

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Elasticities can be defined with respect to any two variables. Going beyond price
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elasticity of demand income elasticity of demand and cross-price elasticity of demand

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are also important to be understood.

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Income elasticity of demand

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Income elasticity of demand is the degree of responsiveness in the quantity demanded

of a good due to a change in the income of the consumer. Income elasticity of
demand, u, is defined as:
∆Q Y
u = ∆Y .Q
where Y stands for income and Q denotes quantity demanded. Here we asssume
that everything except consumer income remains the same.

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 Cross-price elastcities
The elasticity of demand for good Y with respect to the price of good X measures
responsiveness of demand for Y to a change in the price of X and is defined by:
∆Qy PX
µY , PX = ∆P .
X QY

Again, the assumption of ceteris paribus applies, and this time we assume that
everything remains except the price of X.

Supply

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ar
ev
Supply is one of the two forces that determine the price of a commodity in the

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market. In simple words supply means the quantity of a commodity offered for sale
at a particular price during a given period of time in the market. It refers to the

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schedule of quantities of a good that the firms are able and willing to offer for sale

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at various prices.

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Factors or determinants influencing supply
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1. Price of the commodity: as the price increases, sellers would be willing to sell
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more and more of their commodities and vice versa as this would help them
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increase their profit.

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2. Price of the related goods: Supply depends also on the price of the related
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goods in the market. If the price of a substitute good goes up, producers will
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increase the production of the substitute commodity.

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3. Cost of Production: The changes in the cost of production would also result
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in the increase or decrease in the supply of the commodity.

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4. New inventions: the development of technology help in raising the productivity

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and supply.
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5. Natural factors: favourable natural factors help in boosting the production

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and supply.
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6. Use of inputs: the use of inputs also affect the supply.

7. Development of transport and communication: the supply of the commodity

depends on the availability of transportation and communication facilities.

8. Future expectations: the expectations of the producers with regard to the

changes in prices also affect the supply of commodities.

16
 Supply schedule and supply curve
A supply schedule is a tabular statement showing the different quantities of a com-
modity supplied by an individual firm within a given period of time at different
prices. It assumes that technology, resource prices and for agricultural commodi-
ties, weather conditions are held constant. The various price-quantity combinations
of a supply schedule can be plotted on a graph to obtain the market supply curve
for the commodity.
Price of X Quantity Supplied

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20 10

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15 8

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10 6

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5 4

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Table 1.3: Supply Schedule

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Price of X

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10
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8
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6
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2
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Quantity
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5 10 15 20 25
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Figure 1.6: Supply Curve

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Hypothetical market supply schedule and market supply curve are given. Here
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price of the commodity X is given on the Y Axis and the quantity supplied on the
K

X axis. SS shows the market supply curve. A market supply schedule is a table
L
NI

showing the quantity supplied of a commodity at each price for a given period of
VI

time. It shows the total quantities of a product which all of its producers jointly
offer for sale at different prices. By adding up the individual supply curves of various
firms horizontally one arrives at the market supply curve of the commodity. The
positive slope of the supply curve, i.e., its upward to right inclination reflects the
fact that higher prices must be paid to producers to cover rising marginal, or extra
costs and thus induce them to supply greater quantities of the commodity. As
with the demand curve, various points on the supply curve represent alternative
price-quantity combinations.

17
 Law of supply: other things remaining the same, as the price of a commodity
rises, its supply is extended and as the price falls supply is contracted. Supply varies
directly with the price. Higher the price, the larger the supply; the lower the price,
the smaller the supply. Hence the law indicates the direction in which the supply
will move as a result of change in price.

Exceptions to the law of supply

1. The law of supply does not apply to rare articles like ancient coins etc.

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ar
2. The law of supply does not hold good to speculators in the stock market as

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they buy and sell on the basis of future expectations.

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3. Sellers will be ready to sell in case of perishable goods.

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4. In case the seller is in dire need for cash, he will like to sell his stock at the

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lower price.

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National Income He
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National income of a country means the sum total of incomes earned by the citizens
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of that country during a given period, say a year.National Income of any country
can be defined as the complete value of the goods and services produced by any
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country during its financial year.

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There are various concepts of National Income including GDP, GNP, NNP, NI,
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PI, DI, and PCI which explain the facts of economic activities.
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GDP at market price

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It is money value of all goods and services produced within the domestic domain
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with the available resources during a year. GDP = P Q Where, GDP = gross
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domestic product, P = Price of goods and services, and Q= Quantity of goods and
K

services.
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GDP is made up of 4 Components: 1, Consumption 2, Investment 3, Government

NI

expenditure 4, Net foreign exports of a country

VI

GDP = C + I + G + (X − M )
Where, C=Consumption, I=Investment, G=Government expenditure, and (X-
M) =Export minus import.

Gross National Product (GNP)

It is market value of final goods and services produced in a year by the residents of
the country within the domestic territory as well as abroad. GNP is the value of

18
 goods and services that the country’s citizens produce regardless of their location.
(NFIA = Net factor income from abroad.)
GN P = GDP + N F IA
or,
GN P = C + I + G + (X − M ) + N F IA

Net National Product (NNP)

It is market value of net output of final goods and services produced by an economy

a
during a year and net factor income from abroad.

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N N P = GN P − Depreciation

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or,
N N P = C + I + G + (X − M ) + N F IA − IT − Depreciation

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Where, IT= Indirect Taxes

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National Income at factor cost

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NI is also known as National Income at factor cost which means total income earned
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by resources for their contribution of land, labour, capital and organisational ability.
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Hence, the sum of the income received by factors of production in the form of rent,
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wages, interest and profit is called National Income.

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N I = N N P + Subsidies − IndirectT axes

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or,
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N I = C+G+I+(X-M) +NFIA-Depreciation-Indirect Taxes +Subsidies

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Personal Income
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PI is the total money income received by individuals and households of a country

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from all possible sources before direct taxes.

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P I = N I−Corporate Income Taxes−Undistributed Corporate Profits−Social Security

Contribution + Transfer Payments.
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Disposable Income
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NI

DI is the income left with the individuals after the payment of direct taxes from
VI

personal income. It is the actual income left for disposal or that can be spent for
consumption by individuals.
DI = P I − Direct Taxes

Per Capita Income

PCI is calculated by dividing the national income of the country by the total pop-
ulation of a country.

19
 P CI = Total National Income
Total National Population

Measurement of National Income

There are three methods to calculate National Income:

1. Income Method

2. Product/ Value Added Method

a
3. Expenditure Method

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Income Method

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Under this method, we add all the incomes from employment and ownership of

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assets before taxation received from all the production activities in an economy. In

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this National Income is measured as flow of income.

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We can calculate NI as:

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Net National Income = Compensation of Employees+ Operating surplus mixed
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(w +R +P +I) + Net income + Net factor income from abroad.
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Where, W = Wages and salaries, R = Rental Income, P = Profit, and I = Mixed
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Income
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Product/ Value Added Method

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Under this method, we add the values of output produced or services rendered
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by the different sectors of the economy during the year in order to calculate the
fE

National Income. In this method, we include only the value added by each firm in
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the production process in the output figure.Here National Income is measured as

flow of goods and services.
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We can calculate NI as:

National Income = G.N.P – Cost of capital – Depreciation – Indirect taxes.
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Expenditure Method
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NI

This method measures the total domestic expenditure of the economy. In this Na-
VI

tional Income is measured as flow of expenditure. It consists of two elements, viz.

Consumption expenditure and Investment expenditure.
Consumption expenditure includes consumption expenditure of the household
sector on goods and services and consumption outlays of the business sector and
public authorities. Investment expenditure refers to the expenditure on the making
of fixed capital such as Plant and Machinery, buildings, etc.

20