Ecomonic

Short answer questions
1. Who is the father of economics and why?

Adam Smith is known as the father of economics because he made the first attempt to present a systematic
analysis of economics as a separate discipline in his book "An Enquiry into the Nature and Causes of Wealth of
Nations", published in 1776. Until then, economics was considered to be a part of other disciplines like Logic,
Politics and Ethics.
2. What are the characteristics of wealth definition?

The main characteristics of the wealth definition are as follows:
a. Study of wealth: This definition regards economics as the study of wealth, its production, consumption, exchange
and distribution.
b. Study of economic man: This definition considers the study of economics activities like production, distribution,
consumption etc. all other activities of a person are outside the orbit of this definition. This man is always guided
by self interest.
c. Inclusion of material goods: The definition of wealth given by Adam Smith includes only material goods and
ignores the non-material goods. Material goods are those goods which can be seen, touched and transferred like
pen, pencil, book, car etc. whereas non- material goods cannot be seen, touched or transferred but felt only like
the ability to cure, sing etc.
d. Investigation of the source of wealth: This definition considers increment in production of material goods through
specialization and division of labor as the source of wealth.
3. What are the characteristics of welfare definition?

The main characteristics of welfare definition given by Alfred Marshall are as follows:
a. Primary concern on mankind: Unlike the classical definition, this definition gives more emphasis on human
welfare rather than wealth. It states that wealth is not for its own sake but for the sake of human welfare.
b. Study of material welfare: Welfare definition gives emphasis on material welfare. As such, it studies only material
requisites of well being or causes of material welfare and ignores non-material aspects.
c. study of economic activities: People engage in various kinds of activities like political, social and religious
activities. However, the welfare definition encompasses only economic activities related with the earning of
income and expense and excludes other activities.
d. Social science: Economics is a social science and it is concerned with the study of economic activities of those
people only who live in an organized society. People living in isolation like saints are excluded in the study of
economics.
4 Explain the subject matter of economics. (HSEB 2057)
The subject matter of economics refers to the area of study of economics. It tells us the topics, sub-topics, things
that economics as a separate discipline studies. The subject matter or economics is classified on two basis which
are presented as under:
On the basis of economic activities
Human wants are unlimited. In order to satisfy those want people have to put efforts. The fulfillment of wants
gives satisfaction. This process consists of various economic activities namely production, consumption,
exchange and distribution. Hence, all of these activities come under the scope of economics.
On the basis of Modern Analysis
The Modern analysis of economics divides the area of study of economics into two parts namely Micro and Macro
economics. Microeconomics deals with the economic behavior of individual units like households, firms and
industries. Macroeconomics deals with aggregates of the economy or the economy as a whole. As such it deals
with total output, national income, general price level, inflation, economic growth, consumption, investment etc.
5. Distinguish between positive and normative economics. (HSEB 2056)

The distinction between positive and normative economics are as follows.
Basis of Distinction Positive economics Normative
economics
Nature of study Positive Economics Normative
deals with factual economics deals
statements of a with value
phenomena. judgments.
Inclusion/exclusion of It answers the It does not pass any

suggestions question of what suggestions or value
ought to be rather judgments.
than what is. Hence,
it is also called
prescriptive
economics.
Examples When income of a Progressive taxation

consumer increases system should be
his/her consumption adopted for social
of a commodity at welfare and
the same price level redistribution of
also increases for wealth.
normal goods.
6 Write short notes on microeconomics and macroeconomics. (HSEB 2058)

Microeconomics
Micro is derived from the word 'Mikros' meaning small. Thus, Microeconomics deals with the behavior of individual
units of the economy like individual consumer, individual producer, individual market , individual industry etc.
Microeconomics is the microscopic study of the economy. According to K.E. Boulding, 'Microeconomics is the
study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular
commodities'.
Macroeconomics
The word Macro is derived from the term 'Makros' meaning large. Hence, macroeconomics is concerned with the
study of the economy as a whole. In the words of K.E. Boulding, 'Macroeconomics deals not with individual
quantities but with aggregate of these quantities, not with individual incomes but with national income, not with
individual prices but with price level, not with individual output but with national output'.
7. Explain about the subject matter of economics. (HSEB 2070)

The subject matter of economics refers to the area of study of economics. It tells us the topics, sub-topics, things
that economics as a separate discipline studies. The subject matter or economics is classified on two basis which
are presented as under:
Long Answer Questions
1. Economics is a science of wealth. Discuss.

Adam Smith also known as the 'Father of Economics' made the first attempt to present a systematic analysis of
economics in his book 'An Enquiry into the Nature and causes of Wealth of Nations' published in 1776. Adam
Smith defined economics as an enquiry into the nature and causes of wealth of nations or science of wealth. He
asserted that economics is concerned with the production, consumption, exchange and distribution of wealth.
Other classical economists like J.S. Mill, F.A. Walker, J.B. Say, David Ricardo fully supported the classical
approach to Economics put forward by Adam Smith.
However, economics as a science of wealth has been criticized on various grounds. Some of them are as follows.
a. Excess emphasis of wealth: This definition regards man as means and wealth as ends. However, wealth is for the
sake of man, man is not for the sake of wealth. Hence, this definition has been criticized on the ground for giving
excess importance to wealth.
b. Narrow meaning of wealth: The classical definition includes only material goods under wealth and excludes all
non-material goods.
c. Unrealistic concept of economic man: This definition considers economics as the study of economic man whose
all activities are guided by self interest only. However, this is not always the case in real life scenarios where love,
friendship also carry a lot of value.
d. Neglects economic welfare: This definition considers economics as the study of wealth only and totally neglects
the economic welfare of the society.
2. Explain Adam Smith's definition of economics.
economics in his book 'An Enquiry into the Nature and causes of Wealth of Nations' published in 1776. Adam
Smith defined economics as an enquiry into the nature and causes of wealth of nations or science of wealth. He
asserted that economics is concerned with the production, consumption, exchange and distribution of wealth.
Other classical economists like J.S. Mill, F.A. Walker, J.B. Say, David Ricardo fully supported the classical
approach to Economics put forward by Adam Smith.
Thus Adam Smith's definition of economics can be explained as follows:
a. Study of wealth: This definition regards economics as the study of wealth, its production, consumption,
exchange and distribution.
b. Study of economic man: This definition considers the study of economics activities like production, distribution,
consumption etc. all other activities of a person are outside the orbit of this definition. This man is always guided
by self interest.
c. Inclusion of material goods: The definition of wealth given by Adam Smith includes only material goods and
ignores the non-material goods. Material goods are those goods which can be seen, touched and transferred like
pen, pencil, book, car etc. whereas non- material goods cannot be seen, touched or transferred but felt only like
the ability to cure, sing etc.
d. Investigation of the source of wealth: This definition considers increment in production of material goods
through specialization and division of labor as the source of wealth.
3. Explain Marshall's definition of economics. (HSEB 2059)
The welfare definition of economics was given by Alfred Marshall, an eminent English economist. The wealth
definition given by Adam Smith received many bitter criticisms on various grounds. Marshall enlarged the scope
of economics by shifting the focus of economics from material wealth to material welfare. In his book, 'Principles
of Economics' (1890), he defined economics as 'Economics is the study mankind in ordinary business of life. It
examines that part of individual and social action, which is closely connected with the attainment, and the use of
material requisites of well being. It is on the one side a study of wealth, and on the other and more important side
, a part of the study of man'. A.C. Pigou, Cannan and Beveridge have strongly supported the view of Marshall.
Marshall's definition of economics can be explained by the following points.
a. Primary concern on mankind: Unlike the classical definition, this definition gives more emphasis on human
welfare rather than wealth. It states that wealth is not for its own sake but for the sake of human welfare.
b. Study of material welfare: Welfare definition gives emphasis on material welfare. As such, it studies only
material requisites of well being or causes of material welfare and ignores non-material aspects.
c. study of economic activities: People engage in various kinds of activities like political, social and religious
activities. However, the welfare definition encompasses only economic activities related with the earning of
income and expense and excludes other activities.
d. Social science: Economics is a social science and it is concerned with the study of economic activities of those
people only who live in an organized society. People living in isolation like saints are excluded in the study of
economics.
4. Explain Robbins definition of economics. Also mention its criticisms. (HSEB 2058)
Professor Lionel Robbins, London School of Economics took a new approach to present a new dimension in the
definition of economics in his book 'An Essay on the Nature and Significance of Economic Science' published in
1932. In his words 'Economics is the science which studies human behavior as a relationship between ends and
scarce means which have alternative uses'. This definition of economics has gained a worldwide popularity and
consensus among the economists. Economists like Karl Manger, Peter, Stigler, Scitovosky, etc. supported
Robbins notion of Economics.
The major criticisms of Robbins definition of economics are as follows.
a. Implicit concept of welfare: Marshall's definition of welfare has been criticized by Robbins. However, the idea of
welfare is implicit in the scarcity definition. Whenever one makes choices to use scarce means into a use for
maximum satisfaction, it gives the same notion of choices to maximize welfare.
b. Abundance can create Problems: Robbins attributed scarcity of means in relation to its demand as the source of
the economic problem. However, abundance may also result in problems too. The excessive number of working
population might result in unemployment, excessive money supply in the economy results in inflation etc.
c. Inseparability between means and ends: Something can be both means and ends in life which creates a lot of
confusion. A person studying M.B.B.S. wants to get a medical officer degree. It is an end for him. But the same
degree also acts as a means to get an M.D. degree.
d. Self-contradictory: This definition states that economics is a positive science which is neutral between ends. But,
the idea of choice between alternative uses to maximize satisfaction makes it a normative science. Hence, the
definition is self contradictory.
5. Compare Marshall's definition with that of Robbins definition of economics. (HSEB 2064)
Basis of Neo-Classical Modern Definition
comparison Definition
Nature of study Economics is a Economics is a science of human
science of behavior.
material welfare.
Aim of human To maximize To maximize pleasure or
beings material welfare satisfaction
Role of wealth Wealth is a Wealth is a scarce resource to
means for maximize satisfaction.
material welfare.
Scope of the It considers the It is pervasive and is applicable to
study concept of all people, living in a society or in
people living in isolation.
organized society
only.
6. What do you mean by scope of economics. Describe the subject matter or economics. (HSEB 2061)
The subject matter of economics or its scope refers to the areas of study that falls under the purview of
economics. The scope of economics can be divided on the basis of two criterions.
I. On the basis of economic activities
II. On the basis of Modern Analysis

economics. Microeconomics deals with the economic behavior of
individual units like households, firms and industries. Macroeconomics deals with aggregates of the economy or
the economy as a whole. As such it deals with total output, national income, general price level, inflation,
economic growth, consumption, investment etc.
7. Define micro and macroeconomics. Discuss the importance of economic analysis in policy formulation. (HSEB
2062)
Micro is derived from the word 'Mikros' meaning small. Thus, Microeconomics deals with the behavior of individual
units of the economy like individual consumer, individual producer, individual market , individual industry etc.
Microeconomics is the microscopic study of the economy. According to K.E. Boulding, 'Microeconomics is the
study of particular firms, particular households, individual prices, wages, incomes, individual industries, particular
commodities'.
The word Macro is derived from the term 'Makros' meaning large. Hence, macroeconomics is concerned with the
study of the economy as a whole. It gives the big picture of the large macroeconomic variables like production,
consumption, investment, savings, interest rate etc. In the words of K.E. Boulding, 'Macroeconomics deals not
with individual quantities but with aggregate of these quantities, not with individual incomes but with national
income, not with individual prices but with price level, not with individual output but with national output'.
Economic analysis is very important in policy formulation. Both kinds of economic analysis micro and macro are
essential in policy formulation. It is on the tenets of microeconomics that we ascertain the effects of government
policies on the allocation of resources and pricing of certain public utilities like postal service, railways, water
supply, electricity, etc. Microeconomic analysis is also very useful in policy formulation. Problems like inflation,
unemployment, low economic growth rate etc. are big issues of today's global economy. Huge amount of efforts
are being put to solve these macroeconomic problems. Hence, appropriate policy has to be formulated to fight
with these problems which require thorough macroeconomic knowledge of how macroeconomic variables
behave. Macroeconomic analysis not only helps us in policy formulation but also in checking the effectiveness of
the policies adopted to reach those macroeconomic objectives. For example, if policymakers find out that the high
rate of inflation in an economy is due to the high aggregate demand relative to a given supply, they can take
measures to reduce aggregate demand like increasing the tax rates, reducing the government expenditure etc.
Define economics. What are its subject-matters?
Different economists have defined economics differently according to their own perspectives. Here are some of
the popular definitions of economics.
a. Adam Smith defined economics as an enquiry into the nature and causes of wealth of nations or science of
wealth.
b. Alfred Marshall, in his book, 'Principles of Economics', defined economics as 'Economics is the study mankind in
ordinary business of life. It examines that part of individual and social action, which is closely connected with the
attainment, and the use of material requisites of well being. It is on the one side a study of wealth, and on the
other and more important side , a part of the study of man'.
c. Lionel Robbins states that 'Economics is the science which studies human behavior as a relationship between
ends and scarce means which have alternative uses'.

economics. Microeconomics deals with the economic behavior of
individual units like households, firms and industries. Macroeconomics deals with aggregates of the economy or
the economy as a whole. As such it deals with total output, national income, general price level, inflation,
economic growth, consumption, investment etc.
9. Define economics. Explain its nature.

a. Adam Smith defined economics as an enquiry into the nature and causes of wealth of nations or science of
wealth.
b. Alfred Marshall, in his book, 'Principles of Economics', defined economics as 'Economics is the study mankind
in ordinary business of life. It examines that part of individual and social action, which is closely connected with
the attainment, and the use of material requisites of well being. It is on the one side a study of wealth, and on the
other and more important side , a part of the study of man'.
c. Lionel Robbins states that 'Economics is the science which studies human behavior as a relationship between
ends and scarce means which have alternative uses'.
The nature of economics refers to the question of whether economics is an art or science. However, economics is
both an art as well as science.
a. Economics as a science
Science is a systemized body of knowledge, which explains the cause and effect relationship. Moreover,
scientific laws are universal and based on experiments.
Economics is also a systemized body of knowledge because it studies consumption, production,
exchange and distribution systematically. Like other systematic laws, most of the economic laws establish
cause and effect relationship between various economic variables. For example, law of demand
establishes cause and effect relationship between price and quantity demanded.
Most of the economic laws are universally accepted and derived from experiments. Capitalism, socialism
and mixed economy are the experiments of economics. The laboratory of these experiments is the global
society, not a particular room.
b. Economics as an art
A body of knowledge that guides an action is called an art. Art teaches how practical problems are
solved. Economics prescribes various measures to improve economic phenomena. It provides solutions
to problems of poverty, unemployment, inequality, soaring prices etc. So, economics is an art.
10. Define economics. Explain its scope.

a. Adam Smith defined economics as an enquiry into the nature and causes of wealth of nations or science
of wealth.
b. Alfred Marshall, in his book, 'Principles of Economics', defined economics as 'Economics is the study
mankind in ordinary business of life. It examines that part of individual and social action, which is closely
connected with the attainment, and the use of material requisites of well being. It is on the one side a study of
wealth, and on the other and more important side , a part of the study of man'.
c. Lionel Robbins states that 'Economics is the science which studies human behavior as a relationship
between ends and scarce means which have alternative uses'.


11. Distinguish between microeconomics and macroeconomics. (HSEB 2060)

Microeconomics and Macroeconomics are the part of economics. However, they are different on various grounds.
Some of the major differences between them are as follows.
Basis of Difference Microeconomics Macroeconomics
Economic unit Microeconomics is Macroeconomics is
concerned with the concerned with the
study of individual units study of aggregate units
of an economy. of an economy.
Objective Microeconomics is Macroeconomics is

concerned with the use concerned with the
of scarce means to objectives of full
achieve maximum employment, price
satisfaction. stability, economic
growth and favorable
BOP.
Methodology Microeconomic theories Macroeconomic

are based on the theories are not based
'ceteris paribus' or all on such assumptions.
other things being equal Hence it is known as
assumption. Hence, it is general equilibrium
known as partial analysis.
analysis.
Components of The demand and supply The Aggregate demand
equilibrium forces interact to create and Aggregate supply
an equilibrium price. interact to reach the
general equilibrium.
Theories Price theory, Theory of Theory of output,

value income and
employment
Examples of variables Price, demand, supply National income,
etc. National output,
General Price Level,
Full Employment etc.
12. Explain the interdependence of micro and macroeconomics.

Though microeconomics and macroeconomics are different on many grounds, they are interdependent,
interlinked and exert influence on each other.
a. Dependence of microeconomics on macroeconomics

Although microeconomics is a small part of the economy, the changes in macroeconomic variables shape
and exert an influence on the microeconomic variables. The change in the general wage level also helps
shaping the wage of labor in an individual firm. Here, general wage level is a macroeconomic variable
whereas wage of labor in an individual firm is micro variable.
b. Dependence of macroeconomics on microeconomics
Microeconomics studies the behavior of individual units of an economy. But, macroeconomic units are the
sum of individual microeconomic units and hence the changes in microeconomic units eventually give
shape to the macroeconomic units. For example, changes in the individual outputs of firms results in
changes in national output, saving of individual units determine the national saving. This is because,
macroeconomic variables are the collective result of microeconomic variable. Hence, they are dependent
on small microeconomic units.
13. What are the importances of microeconomics and macroeconomics policy analysis?
Importance of microeconomic policy analysis
a. Helps to know the functioning of the economy: Microeconomics studies the behavior of the individual units of the
economy. It tells us how the individual units of the economy take decisions regarding allocation of scarce
resources to various productive uses. It aids in knowing the working of the economy.
b. Aids in devising appropriate policies: The knowledge and understanding of working and interactions, relationships
between individual units of the economy helps in the formulation of various policies and enhances their
effectiveness.
c. Helps in business decision making: Microeconomics includes the process of price determination, factors affecting
demand, elasticity of demand, demand forecasting tools and techniques which are extremely useful in the
decision making process of firms.
Importance of macroeconomic policy analysis

a. To understand the working of the economy: Macroeconomics studies the economy in its aggregate form. It
studies on how macroeconomic variables are determined, how they are interrelated and how the change in one
macroeconomic variable influences other variables and aspects of the whole economy. Hence, it helps in knowing
the functioning of the economy.
b. Helps in devising suitable policies: The problem of inflation, unemployment and economic growth are the major
reasons of headaches of both developed and underdeveloped countries. These problems carry so much weight
that keeping them under a certain level can keep a government stable and failure to address such problems can
collapse the whole government. The knowledge of working of the economy and the interrelationship between
economic variables helps the government to devise appropriate policies to solve these serious problems.
c. Helps in comparison: The macroeconomic indicators like GDP, Inflation, and Unemployment percentage act as
the standard against which relative developments of countries over time can be compared. A country's relative
development in the present can be known compared to the past.
d. To know the effectiveness of policies: Macroeconomics gives various tools and techniques to know the
effectiveness of using various policies under given situations. Basically, the IS-LM model helps to know the policy
effectiveness of using various policies. It also sheds light on the fact that sometimes a single policy cannot help to
achieve the stated objectives and hence the judicious mix of both the policies is necessary. Moreover, it helps to
throw light on the fact that microeconomic laws do not apply under macro situations.
14. Critically explain the Marshall's definition of economics. (HSEB 2070)

The welfare definition of economics was given by Alfred Marshall, an eminent English economist. The wealth
definition given by Adam Smith received many bitter criticisms on various grounds. Marshall enlarged the scope
of economics by shifting the focus of economics from material wealth to material welfare. In his book, 'Principles
of Economics' (1890), he defined economics as 'Economics is the study mankind in ordinary business of life. It
examines that part of individual and social action, which is closely connected with the attainment, and the use of
material requisites of well being. It is on the one side a study of wealth, and on the other and more important side
, a part of the study of man'. A.C. Pigou, Cannan and Beveridge have strongly supported the view of Marshall.
However, this definition given by Marshall was not free from criticisms. Some of the major criticisms of this
definition are as follows.
a. Connection between economics and welfare: Marshall identifies economics as the science which deals with
human welfare. However, certain economic activities which are disastrous for human health like production and
consumption of wine and cigarettes also fall within the purview of economics.
b. Material and non material welfare: Marshall defined economics as a science concerned with material welfare.
However, sometimes the same activity could be material and non-material at other times. For example, A doctor's
services in exchange for fees would be a material activity whereas a doctor's service for philanthropic reasons
would be non-material because nothing is received in exchange of such services.
c. Use of money as a measurement of welfare: Marshall used money as a measuring rod of welfare. However,
money itself is not an accurate measurement of satisfaction. Different people like rich and poor may derive
different level of satisfaction even from the same amount of money.
d. Social science: Marshall stated economics as a social science. He considered economics as a study of people
living in organized societies only. But, the laws of economics are universally applicable, be it a person living in an
organized society or be it a person living in isolation.
1. Discuss the concept of allocation of resources.

Allocation of resources is defined as the process of selection of resources and their proper utilization. Possession
of resources in an economy is limited and those resources have various uses. Decision makers have to choose
one among those various uses which maximizes its satisfaction. Decision makers have to answer the basic
following questions in the allocation of resources.
1. What to Produce?
2. How to produce?
3. Whom to Produce?
2. What do you mean by production possibility curve?

Human wants are unlimited and resources to achieve those wants are limited. Every society faces the problem of
scarcity and choice. Hence, priorities are set and goods to produce and their quantities are decided. A production
possibility curve is the locus of various combinations of two goods or services that an economy can produce with
the full use of its given resources and state of technology.
In the words of Samuelson, "Production possibility curve is the curve which represents the maximum amount of a
pair of goods or services that can both be produced with an economy's given resources and technique, assuming
that all resources are fully employed".
3. Scarcity and choice are the foundation of economic problem. Discuss.

Scarcity and choice are two sides of the same coin. Choice exists because resources are scarce and choice
involves the use of scarce resources for some particular cause. There are number of things that people, society,
countries want. However, the means to attain those needs, fulfill those desires are limited. Hence, an order of
preference must be listed or choice must be made among those viable and desirable alternatives according to
ones resource endowment. This is known as choice among alternatives.
Both affluent as well as poor countries have the problem of scarcity of resources. One might argue that how could
advanced economies have the problem of resource scarcity but he/she has to understand that the desires of such
economies are also massive in proportion to their resource endowments. Hence, there arises the problem of
scarcity and choice in all sorts of economies.
4. Explain the problems related to the allocation of resources in economics. (HSEB 2070)
The main problems relating to the proper allocation of resources are explained as follows:
1. What to Produce?
An economy endowed with limited resources and unlimited wants have to make a choice about what good to
produce and in what quantities. If an economy decides to produce more of consumer goods, it has to produce
less of the capital goods. There always exists tradeoff between various uses of the precious limited resources.
2. How to produce?
The question of how to produce is related with the use of which resource to use in the production process. It
connects to the question of technique of production in an economy and is concerned with producing the maximum
output at the least cost. The same goods and services can be produced using more labor (labor intensive
technique) or using more capital (capital intensive technique).
3. Whom to Produce?
After deciding on what to produce and how to produce, an economy has to decide on the distribution of the
produced goods and services to different sections of the society.
Long Answer Questions For 10 marks

1. Explain the concept of production possibility curve. Why does it expand outwards?
In the words of Samuelson, " Production possibility curve is the curve which represents the maximum amount of a
that all resources are fully employed". It shows the alternative combinations of maximum goods and services that
can be produced with the given assumptions. It is also called 'production possibility boundary or frontier' because
it shows the limit of what it is possible to produce with the available limited resources. It is also called a
'transformation line or transformation curve' because resources are transformed from one use to the other by
switching to different combinations of production.
A production possibility curve might expand outwards due to the following reasons.
1. Change in resources
The amount of resources an economy has can change over a period of time. The resources can increase due to
population growth, forestation, finding of a new resource source, training programs leading to the availability of
skilled manpower etc. When these resources increase, the production possibility curve shifts outwards.
2. Change in technology
The advancement in technology can take place over a span of time. When such new and efficient technology
becomes available, it enhances the production capacity of an economy. This results in an outward shift in the
production possibility curve of an economy.
2. What are the basic economic problems? How does the problems arise?
The economic problem or the problem of scarcity was first introduced by professor Lionel Robbins in his modern
definition of economics also known as the definition of scarcity. Human wants are limitless. Be it an individual, a
community or a country, everyone is faced with the problem of scarcity. A person has unlimited desires. He might
want to eat a pizza, buy a car, buy a house, go to cinema etc. Likewise a country might have unlimited desires
like producing TV's, Computers, Wheat, Rice, automobiles etc. Not only are these wants recurring, but they
expand as time passes by. For example, a person who eats pizza today might want to eat pizza again after one
week. A person who buys an i-pad today might want to buy an i-phone too. Hence, wants or desires are unlimited.
In order to produce these goods and services factors of production like land, labor, capital and organization are
required. However, these resources are not adequate in relation to unlimited desires. Scarcity is never in absolute
terms but in relation to the unlimited desires which require unlimited resources.
The concept of choice comes from the problem of unlimited wants. As wants are never ending and the means
through which these wants can be fulfilled are fixed or given, people have to make choices. All wants cannot be
satisfied, therefore making a choice between what want to satisfy now and what to leave for future should be
done. This is known as the problem of choice. A country with its resources can do many things like investing in
agriculture sector, or investing in industrial sector or investing in social sector. However, investment in all these
areas is not possible due to the lack of different resources like funds, skilled human resources, advanced
technology etc. Hence, it has to make choice by setting its priority sector.
Scarcity and choice are two sides of the same coin. Choice exists because resources are scarce and choice
involves the use of scarce resources for some particular cause. There are number of things that people, society,
countries want. However, the means to attain those needs, fulfill those desires are limited. Hence, an order of
preference must be listed or choice must be made among those viable and desirable alternatives according to
ones resource endowment. This is known as choice among alternatives.
economies are also massive in proportion to their resource endowments. Hence, there arises the problem of
scarcity and choice in all sorts of economies.
3. What is production possibility curve? Explain it with the help of a table and a diagram.
In the words of Samuelson, " Production possibility curve is the curve which represents the maximum amount of a
that all resources are fully employed". It shows the alternative combinations of maximum goods and services that
can be produced with the given assumptions. It is also called 'production possibility boundary or frontier' because
it shows the limit of what it is possible to produce with the available limited resources. It is also called a
'transformation line or transformation curve' because resources are transformed from one use to the other by
switching to different combinations of production.
Assumptions of Production Possibility Curve
1. Factors of production are fixed
2. There is full employment in the economy
3. Constancy in Technology
4. Short run basis
5. Substitution of factors of production
Production possibility Schedule
Production possibility schedule shows the alternative combinations of goods and services that an economy can
produce with its given resources in tabular format. For example, Let the Nepalese economy with its given
resources produces guns and butter. The production possibility schedule shows the alternative combinations of
both goods that the economy can produce.
The following table shows the different combinations of guns and butter, guns or butter that the Nepalese
economy can produce. The production possibility schedule only shows six different combinations. But there can
be infinite number of alternative combinations in a production possibility schedule.
Combination Guns Butter
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Production Possibility Curve

When the production possibility schedule is plotted on a graph, the outcome is a production possibility curve. A
production possibility curve shows the different alternative combinations of two goods that can be produced with
the given resources. If we plot the above combinations in a graph we get the production possibility curve of the
Nepalese economy.
In the above production possibility curve AF the X axis shows the production of butter while Y axis shows the production
of guns. As we can see, the production possibility curve shows six different combinations of guns and butter that the
economy can produce. At one extreme is the production of 15 units of butter without the production of guns at point A. At
the other extreme is the production of 5 guns without any butter. Other combinations contain both guns and butter. One
point to note in the production possibility curve is that as we go on increasing the production of one commodity the
production of another commodity decreases. There is tradeoff between the production of these two goods. For example if
we move from point B to point C, the production of guns increases from 1 to 2 units. However, the production of butter
decreases from 14 units to 12 units. There can be infinite points in the production possibility curve. An economy can
choose any Combination that lies on the production possibility curve. If an economy decides to produce at any point that
lies inside the production possibility curve, it is not utilizing its resources fully. An economy cannot produce outside the
production possibility curve because the availability of means does not support such production. Hence, it has to produce
at any point that falls on the production possibility curve.
NATURE OF ECONOMICS
Introduction
Economics is a social science. Man performs different activities to fulfill his desires. Desires can be different. Voting ones
favorite political party, visiting temples, dining with relatives are different activities which satisfy different kinds of desires
like political, religious and social activities. However, economics is concerned with economic activities only. Economic
activities are those activities which are concerned with the efficient use of scarce resources, which can satisfy human
wants. Production, consumption, distribution and exchange are the common examples of economic activities.
History of Economics
The term 'Economics' is derived from the two Greek word 'Okios' and 'Nomikos'. The Greek philosopher Xenophon (440-
355 BC) in his treatise 'Oeconomics' regarded economics as the science concerned with the problems of household
management. Aristotle (384-322 BC) regarded economics as an important pillar of politics of the state. Economics was
regarded as a part of other disciplines like logics, politics, ethics etc. until Adam Smith made the first systematic analysis
of economics in his book 'An enquiry into the Nature and causes of Wealth of Nations' published in 1776.
Definition of Economics
Different Economics at different periods of time have defined economics in their own ways. However, we are concerned
with three different definitions given by three different economists which are as follows.
Wealth Definition/Classical Definition
Welfare Definition/ Neo-Classical Definition
Scarcity Definition/Modern Definition
Wealth Definition/ Classical approach
economics in his book 'An Enquiry into the Nature and causes of Wealth of Nations' published in 1776. Adam Smith
defined economics as an enquiry into the nature and causes of wealth of nations or science of wealth. He asserted that
economics is concerned with the production, consumption, exchange and distribution of wealth. Other classical
economists like J.S. Mill, F.A. Walker, J.B. Say, David Ricardo fully supported the classical approach to Economics put
forward by Adam Smith.
Characteristics/Features of the wealth Definition

Study of wealth: This definition regards economics as the study of wealth, its production, consumption, exchange and
distribution.
Study of economic man: This definition considers the study of economics activities like production, distribution,
consumption etc. all other activities of a person are outside the orbit of this definition. This man is always guided by self
interest.
Inclusion of material goods: The definition of wealth given by Adam Smith includes only material goods and ignores the
non-material goods. Material goods are those goods which can be seen, touched and transferred like pen, pencil, book,
car etc. whereas non- material goods cannot be seen, touched or transferred but felt only like the ability to cure, sing etc.
Investigation of the source of wealth: This definition considers increment in production of material goods through
specialization and division of labor as the source of wealth.
Criticisms of the wealth definition
Excess emphasis of wealth: This definition regards man as means and wealth as ends. However, wealth is for the sake
of man, man is not for the sake of wealth. Hence, this definition has been criticized on the ground for giving excess
importance to wealth.
Narrow meaning of wealth: The classical definition includes only material goods under wealth and excludes all non-
material goods.
Unrealistic concept of economic man: This definition considers economics as the study of economic man whose all
activities are guided by self interest only. However, this is not always the case in real life scenarios where love, friendship
also carry a lot of value.
Neglects economic welfare: This definition considers economics as the study of wealth only and totally neglects the
economic welfare of the society.
Welfare Definition/Neo-Classical Definition

The welfare definition of economics was given by Alfred Marshall, an eminent English economist. The wealth definition
given by Adam Smith received many bitter criticisms on various grounds. Marshall enlarged the scope of economics by
shifting the focus of economics from material wealth to material welfare. In his book, 'Principles of Economics' (1890), he
defined economics as 'Economics is the study mankind in ordinary business of life. It examines that part of individual and
social action, which is closely connected with the attainment, and the use of material requisites of well being. It is on the
one side a study of wealth, and on the other and more important side , a part of the study of man'. A.C. Pigou, Cannan
and Beveridge have strongly supported the view of Marshall.
Characteristics of Welfare Definition

Primary concern on mankind: Unlike the classical definition, this definition gives more emphasis on human welfare rather
than wealth. It states that wealth is not for its own sake but for the sake of human welfare.
Study of material welfare: Welfare definition gives emphasis on material welfare. As such, it studies only material
requisites of well being or causes of material welfare and ignores non-material aspects.
Study of economic activities: People engage in various kinds of activities like political, social and religious activities.
However, the welfare definition encompasses only economic activities related with the earning of income and expense
and excludes other activities.
Social science: Economics is a social science and it is concerned with the study of economic activities of those people
only who live in an organized society. People living in isolation like saints are excluded in the study of economics.
Criticisms of Welfare Definition

Connection between economics and welfare: Marshall identifies economics as the science which deals with human
welfare. However, certain economic activities which are disastrous for human health like production and consumption of
wine and cigarettes also fall within the purview of economics.
Material and non material welfare: Marshall defined economics as a science concerned with material welfare. However,
sometimes the same activity could be material and non-material at other times. For example, A doctor's services in
exchange for fees would be a material activity whereas a doctor's service for philanthropic reasons would be non-material
because nothing is received in exchange of such services.
Use of money as a measurement of welfare: Marshall used money as a measuring rod of welfare. However, money
itself is not an accurate measurement of satisfaction. Different people like rich and poor may derive different level of
satisfaction even from the same amount of money.
Social science: Marshall stated economics as a social science. He considered economics as a study of people living in
organized societies only. But, the laws of economics are universally applicable, be it a person living in an organized
society or be it a person living in isolation.
Scarcity Definition/ Modern Definition

Professor Lionel Robbins, London School of Economics took a new approach to present a new dimension in the definition
of economics in his book 'An Essay on the Nature and Significance of Economic Science' published in 1932. In his words
'Economics is the science which studies human behavior as a relationship between ends and scarce means which have
alternative uses'. This definition of economics has gained a worldwide popularity and consensus among the economists.
Economists like Karl Manger, Peter, Stigler, Scitovosky, etc. supported Robbins notion of Economics.
Characteristics of Scarcity Definition

Unlimited Wants: Human wants are unlimited. No one can satisfy all of his/her wants. After a want is satisfied, other
wants come up and hence a person cannot be fully satisfied.
Scarce/Limited means: Wants are unlimited but the means through which wants can be satisfied are limited at a person's
disposal. Here, scarcity is not in absolute terms but in relative terms to the unlimited desires of people.
Alternative uses of scarce means: According to Professor Robbins the limited resources can be put to alternative uses.
For example, a sum of 300 rupees can be used to watch a movie or eat at a restaurant.
Urgency of wants: Professor Robbins states that wants are different in urgency or intensity. The wants which are more
urgent are satisfied first than the wants that are less urgent.
Problem of choice: Since the wants of people are unlimited in relation to the limited means to fulfill those desires, people
have to choose which want to satisfy and which to postpone for a later date. Hence, it is the problem of choice that haunts
each and every person. If resources were abundant to fulfill every want, then there would be no problem of choice. This
problem of choice is the economic problem which forms the subject matter of economics.
Criticisms of the Scarcity Definition/Modern Definition

Implicit concept of welfare: Marshall's definition of welfare has been criticized by Robbins. However, the idea of welfare is
implicit in the scarcity definition. Whenever one makes choices to use scarce means into a use for maximum satisfaction,
it gives the same notion of choices to maximize welfare.
Abundance can create Problems: Robbins attributed scarcity of means in relation to its demand as the source of the
economic problem. However, abundance may also result in problems too. The excessive number of working population
might result in unemployment, excessive money supply in the economy results in inflation etc.
Inseparability between means and ends: Something can be both means and ends in life which creates a lot of
confusion. A person studying M.B.B.S. wants to get a medical officer degree. It is an end for him. But the same degree
also acts as a means to get an M.D. degree.
Self-contradictory: This definition states that economics is a positive science which is neutral between ends. But, the
idea of choice between alternative uses to maximize satisfaction makes it a normative science. Hence, the definition is
self contradictory.
Comparison and Contrast between the three Definitions
Basis of comparison Classical Definition Neo-Classical Definition Modern Definition
Economics is a science Economics is a science Economics is a science
Nature of study
of wealth. of material welfare. of human behavior.
To maximize material To maximize pleasure or
Aim of human beings To maximize wealth
welfare satisfaction
Wealth is a scarce
Wealth is a means for
Role of wealth Wealth is an end in itself. resource to maximize
material welfare.
satisfaction.
It is pervasive and is
It considers the concept
It considers the concept applicable to all people,
Scope of the study of people living in
of economic man only living in a society or in
organized society only.
isolation.
Subject Matter of Economics/Scope of Economics

The subject matter of economics or its scope refers to the areas of study that falls under the purview of economics. The
scope of economics can be divided on the basis of two criterions.
Human wants are unlimited. In order to satisfy those want people have to put efforts. The fulfillment of wants gives
satisfaction. This process consists of various economic activities namely production, consumption, exchange and
distribution. Hence, all of these activities come under the scope of economics.

economics. Microeconomics deals with the economic behavior of individual units like households, firms and industries.
Macroeconomics deals with aggregates of the economy or the economy as a whole. As such it deals with total output,
national income, general price level, inflation, economic growth, consumption, investment etc.
Positive and Normative Economics

Positive Economics deals with factual statements of a phenomena. It answers questions like what is, what was and what
will be about economic phenomena. It describes the relationship between various economic variables in the light of theory
or empirical evidence. For example, when price of a commodity goes up, the quantity demanded of the commodity
decreases.
Normative economics deals with value judgments. It answers the question of what ought to be rather than what is. Hence,
it is also called prescriptive economics. It deals with moral and ethical concerns in economics. It analyses economic
events to draw conclusion what must be done to increase welfare of the society as a whole. For example, Tax rates
should be reduced in export oriented industries to boost exports for reducing BOP Deficit.
Microeconomics VS. Macroeconomics
Microeconomics
Micro is derived from the word 'Mikros' meaning small. Thus, Microeconomics deals with the behavior of individual units of
the economy like individual consumer, individual producer, individual market , individual industry etc. Microeconomics is
the microscopic study of the economy. According to K.E. Boulding, 'Microeconomics is the study of particular firms,
particular households, individual prices, wages, incomes, individual industries, particular commodities'.
Importance of Microeconomics
Helps to know the functioning of the economy: Microeconomics studies the behavior of the individual units of the
economy. It tells us how the individual units of the economy take decisions regarding allocation of scarce resources to
various productive uses. It aids in knowing the working of the economy.
Aids in devising appropriate policies: The knowledge and understanding of working and interactions, relationships
between individual units of the economy helps in the formulation of various policies and enhances their
effectiveness.Helps in business decision making: Microeconomics includes the process of price determination, factors
affecting demand, elasticity of demand, demand forecasting tools and techniques which are extremely useful in the
decision making process of firms.
Macroeconomics
The word Macro is derived from the term 'Makros' meaning large. Hence, macroeconomics is concerned with the study of
the economy as a whole. It gives the big picture of the large macroeconomic variables like production, consumption,
investment, savings, interest rate etc. In the words of K.E. Boulding, 'Macroeconomics deals not with individual quantities
but with aggregate of these quantities, not with individual incomes but with national income, not with individual prices but
with price level, not with individual output but with national output'.
Importance of Macroeconomics
To understand the working of the economy: Macroeconomics studies the economy in its aggregate form. It studies on how
macroeconomic variables are determined, how they are interrelated and how the change in one macroeconomic variable
influences other variables and aspects of the whole economy. Hence, it helps in knowing the functioning of the economy.
Helps in devising suitable policies: The problem of inflation, unemployment and economic growth are the major reasons of
headaches of both developed and underdeveloped countries. These problems carry so much weight that keeping them
under a certain level can keep a government stable and failure to address such problems can collapse the whole
government. The knowledge of working of the economy and the interrelationship between economic variables helps the
government to devise appropriate policies to solve these serious problems.
Helps in comparison: The macroeconomic indicators like GDP, Inflation, Unemployment percentage act as the standard
against which relative developments of countries over time can be compared. A country's relative development in the
present can be known compared to the past.
To know the effectiveness of policies: Macroeconomics gives various tools and techniques to know the effectiveness of
using various policies under given situations. Basically, the IS-LM model helps to know the policy effectiveness of using
various policies. It also sheds light on the fact that sometimes a single policy cannot help to achieve the stated objectives
and hence the judicious mix of both the policies is necessary. Moreover, it helps to throw light on the fact that
microeconomic laws do not apply under macro situations.
Distinction between Microeconomics and Macroeconomics
Basis of Difference Microeconomics Macroeconomics

Microeconomics is concerned Macroeconomics is concerned
Economic unit with the study of individual units of with the study of aggregate units
an economy. of an economy.
Macroeconomics is concerned
Microeconomics is concerned with the objectives of full
objective with the use of scarce means to employment, price stability,
achieve maximum satisfaction. economic growth and favorable
BOP.
Microeconomic theories are
Macroeconomic theories are not
based on the 'ceteris paribus' or
based on such assumptions.
Methodology all other things being equal
Hence it is known as general
assumption. Hence, it is known as
equilibrium analysis.
partial analysis.
The demand and supply forces The Aggregate demand and
Components of equilibrium interact to create an equilibrium Aggregate supply interact to
price. reach the general equilibrium.
Theory of output, income and
Theories Price theory, Theory of value
employment
National income, National output,
Examples of variables Price, demand, supply etc. General Price Level, Full
Employment etc.
Interdependence between Microeconomics and Macroeconomics
Though microeconomics and macroeconomics are different on many grounds, they are interdependent, interlinked and
exert influence on each other.
Dependence of microeconomics on macroeconomics

Although microeconomics is a small part of the economy, the changes in macroeconomic variables shape and exert an
influence on the microeconomic variables. The change in the general wage level also helps shaping the wage of labor in
an individual firm. Here, general wage level is a macroeconomic variable whereas wage of labor in an individual firm is
micro variable.
Dependence of macroeconomics on microeconomics

microeconomics studies the behavior of individual units of an economy. But, macroeconomic units are the sum of
individual microeconomic units and hence the changes in microeconomic units eventually give shape to the
macroeconomic units. For example, changes in the individual outputs of firms results in changes in national output, saving
of individual units determine the national saving. This is because, macroeconomic variables are the collective result of
microeconomic variable. Hence, they are dependent on small microeconomic units
Basic Economics Issues

Introduction
Before going on the topic of basic economic issue facing every society, we have to know what an economy is. An
economy is nothing except the sum of all economic activities like production, consumption, exchange and distribution. If
an economy is the sum of all economic activities, then it should also include those institutions through which all these
economic activities become possible. Hence, it includes Households, firms, government, external sector which are known
as economic units. Thus, an economy consists of economic units who perform economic activities to fulfill economic
wants. Economy includes people and institutions and the set of intricate interrelationship between them. Economies are
different from each other on different respects like size, rich, poor, complex, simple etc.
Economic system is the platform which defines the role of every economic unit in the economy. An economic system
determines the scope of activities that an economic unit can perform. Economic system are of various types. They are as
follows.
Market economic system: The market economic system assumes no intervention of the government in the allocation of
resources or economic activities. The allocation of resources are done by the forces of demand and supply or the market
forces.
Planned economic system: There is no freedom in the allocation of resources in this type of economic system. All the
resources are controlled by the government and their allocation is the decision of the government.
Mixed economic system: This economic system assumes the role of both the government and the private sector. Some
economic activities are controlled by the government while other activities are left to the private sector.
Concept of scarcity
The economic problem or the problem of scarcity was first introduced by professor Lionel Robbins in his modern definition
of economics also known as the definition of scarcity. Human wants are limitless. Be it an individual, a community or a
country, everyone is faced with the problem of scarcity. A person has unlimited desires. He might want to eat a pizza, buy
a car, buy a house, go to cinema etc. Likewise a country might have unlimited desires like producing TV's, Computers,
Wheat, Rice, automobiles etc. Not only are these wants recurring, but they expand as time passes by. For example, a
person who eats pizza today might want to eat pizza again after one week. A person who buys an i-pad today might want
to buy an i-phone too. Hence, wants or desires are unlimited.
In order to produce these goods and services factors of production like land, labor, capital and organization are required.
However, these resources are not adequate in relation to unlimited desires. Scarcity is never in absolute terms but in
relation to the unlimited desires which require unlimited resources.
Concept of choice
The concept of choice comes from the problem of unlimited wants. As wants are never ending and the means through
which these wants can be fulfilled are fixed or given, people have to make choices. All wants cannot be satisfied,
therefore making a choice between what want to satisfy now and what to leave for future should be done. This is known
as the problem of choice. A country with its resources can do many things like investing in agriculture sector, or investing
in industrial sector or investing in social sector. However, investment in all these areas is not possible due to the lack of
different resources like funds, skilled human resources, advanced technology etc. Hence, it has to make choice by setting
its priority sector.
Scarcity and choice

Scarcity and choice are two sides of the same coin. Choice exists because resources are scarce and choice involves the
use of scarce resources for some particular cause. There are number of things that people, society, countries want.
However, the means to attain those needs, fulfill those desires are limited. Hence, an order of preference must be listed or
choice must be made among those viable and desirable alternatives according to ones resource endowment. This is
known as choice among alternatives.
economies are also massive in proportion to their resource endowments. Hence, there arises the problem of scarcity and
choice in all sorts of economies.
Allocation of resources
Allocation of resources is defined as the process of selection of resources and their proper utilization. Possession of
resources in an economy is limited and those resources have various uses. Decision makers have to choose one among
those various uses which maximizes its satisfaction. Decision makers have to answer the basic following questions in the
allocation of resources.
The main problems relating to the proper allocation of resources are explained as follows:
How to achieve fuller utilization or full employment of resources?
Economies have to decide how to optimize the resource use so that maximum output can be produced efficiently. Every
economy is plagued by the problem of scarcity of resources in relation to the unlimited wants. Hence, idle resources are a
curse for every economy. In order to satisfy the demand of the economy full utilization of resource must be ensured.
How to achieve growth of resources?

Another central problem of the economy is to increase the level of production. It is also known as the problem of growth of
resources. Each economy is faced with the problem of how to increase its production capacity so that the total production
can be increased. An economy can achieve the objective of growth of resources through technological advancement.
Concept of production possibility curve

Human wants are unlimited and resources to achieve those wants are limited. Every society faces the problem of scarcity
and choice. Hence, priorities are set and goods to produce and their quantities are decided. A production possibility curve
is the locus of various combinations of two goods or services that an economy can produce with the full use of its given
resources and state of technology.
In the words of Samuelson, " Production possibility curve is the curve which represents the maximum amount of a pair of
goods or services that can both be produced with an economy's given resources and technique, assuming that all
resources are fully employed". It shows the alternative combinations of maximum goods and services that can be
produced with the given assumptions. It is also called 'production possibility boundary or frontier' because it shows the
limit of what it is possible to produce with the available limited resources. It is also called a 'transformation line or
transformation curve' because resources are transformed from one use to the other by switching to different combinations
of production.
Assumptions of Production Possibility Curve

Factors of production are fixed
There is full employment in the economy
Constancy in Technology
Short run basis
Substitution of factors of production
Production possibility Schedule

Production possibility schedule shows the alternative combinations of goods and services that an economy can produce
with its given resources in tabular format. For example, Let the Nepalese economy with its given resources produces guns
and butter. The production possibility schedule shows the alternative combinations of both goods that the economy can
produce.
The following table shows the different combinations of guns and butter, guns or butter that the Nepalese economy can
produce. The production possibility schedule only shows six different combinations. But there can be infinite number of
alternative combinations in a production possibility schedule.
Combination Guns Butter
A 0 15
B 1 14
C 2 12
D 3 9
E 4 5
F 5 0
Production Possibility Curve

When the production possibility schedule is plotted on a graph, the outcome is a production possibility curve. A production
possibility curve shows the different alternative combinations of two goods that can be produced with the given resources.
If we plot the above combinations in a graph we get the production possibility curve of the Nepalese economy.
In the above production possibility curve AF the X axis shows the production of butter while Y axis shows the production
of guns. As we can see, the production possibility curve shows six different combinations of guns and butter that the
economy can produce. At one extreme is the production of 15 units of butter without the production of guns at point A. At
the other extreme is the production of 5 guns without any butter. Other combinations contain both guns and butter. One
point to note in the production possibility curve is that as we go on increasing the production of one commodity the
production of another commodity decreases. There is tradeoff between the productions of these two goods. For example
if we move from point B to point C, the production of guns increases from 1 to 2 units. However, the production of butter
decreases from 14 units to 12 units. There can be infinite points in the production possibility curve. An economy can
choose any Combination that lies on the production possibility curve. If an economy decides to produce at any point that
lies inside the production possibility curve, it is not utilizing its resources fully. An economy cannot produce outside the
production possibility curve because the availability of means does not support such production. Hence, it has to produce
at any point that falls on the production possibility curve.
Shifts in the production possibility curve
An economy's production possibility curve can shift inwards or outwards over time. This might be due to the following
reasons.
Change in resources
The amount of resources an economy has can change over a period of time. The resources can increase due to
population growth, forestation, finding of a new resource source, training programs leading to the availability of skilled
manpower etc. When these resources increase, the production possibility curve shifts outwards. Resources might
decrease due to the depletion of renewable resources, natural calamities, deforestation etc. When resources decrease,
the production possibility curve shifts inwards.
Change in technology
The advancement in technology can take place over a span of time. When such new and efficient technology becomes
available, it enhances the production capacity of an economy. This results in an outward shift in the production possibility
curve of an economy.
National Income Accounting

Introduction
National Income Accounting is the systematic rendering of statements about the performance of an economy during a
period of time. National Income Accounting is the process of measuring the national income of an economy over a period
of time. It tells us about the economic health of a country over a period of time. It is very useful tool of measuring and
comparing living standards as well as formulating economic policies. It shows the share of different sectors of an economy
in the total income of the economy. It helps us to find the per capita income of the country. It is also an important indicator
of economic development.
Definitions of National Income

Different economists have defined national income in their own ways. Here are some of the popular definitions given by
the prominent economists.
Marshall's definition
According to Marshall, "The labor and capital of a country acting upon its natural resources produce annually a certain net
aggregate of commodities, material and immaterial including services of all kinds. This is the net annual income or
revenue of a country or the national dividend."
Pigou's definition
According to Pigou, "National income is that part of objective income of the community, including of course income
derived from abroad which can be measured in money."
Fisher's definition
According to Fisher, "The national dividend or income consists solely of services as received by ultimate consumers,
whether from their material or from their human environments. Thus, a piano or an overcoat made for me this year is not a
part of this year's income, but an addition to capital. Only the services rendered to me during this year by these things are
income."
Simon Kuznets` definition

According to Simon Kuznets, "National income is the net output of commodities and services following during the year
from the country's productive system in the hand of the ultimate consumers."
Concepts of National Income
National Incomes can be of different types. Incomes in an economy can be derived from many sources. Some types of
income include something while others might exclude something out of the income stream. Hence, it is necessary to know
about the various concepts of income, which are as follows:
Gross Domestic Product (GDP)

GDP is defined as the total market value of the final goods and services produced in an economy over a period of time,
usually one year is known as the Gross Domestic Product. GDP is a monetary measure of national income. In order to
calculate the GDP, the quantity of various goods and services are multiplied with their respective prices and added to
come to a monetary figure.
GDP=p1x1+p2x2+....pnxn=i=1npixiGDP=p1x1+p2x2+....pnxn=i=1npixi
The above equation shows that for n number of goods and services produced in an economy over a period of one year,
the GDP equals the summed up monetary value of all goods and services in the economy.
Gross National Product (GNP)
GNP is the total monetary value of the final goods and services in an economy over a period of time plus the net factor
income from abroad. It includes only those goods, which are produced using domestic factors of production. In a time like
this where factor mobility is not a surprising phenomenon, ordinary residents of a country work abroad and are paid for
their services. Foreigners also render services in the domestic economy and are paid their share of contribution. Hence,
GNP subtracts the income paid to the foreigners in the economy and adds the income earned from giving services of
nationals in the foreign economy. The difference between income earned from abroad and income paid to foreigners is
known as the net factor income from abroad.
Therefore, GNP=GDP+netfactorincomefromabroadGNP=GDP+netfactorincomefromabroad
Difference between GDP and GNP

Basis of
distinctio GDP GNP
n
It is the market value of the
Definitio final goods and services It is the market value of final goods and services produced by the ordinary
n produced in a country during a citizens of a country over a period of time.
period of time.
Scope It is a narrow concept. GNP is a broader concept than GDP.
It focuses on the value
Main It focuses on the value produced by the citizens of the country. The focus is on
produced within a 'territory'.
concern citizens, not boundary.
Here, territory is of importance.
Inclusion
of net
factor It excludes the net factor
It includes the net factor income from abroad.
income income from abroad.
from
abroad
GDP is widely used for
Frequent
international comparisons than GNP is less used in international comparisons than GDP.
use
GNP.
Formula GDP=i=1npixiGDP=i=1n GNP=GDP+netfactorincomefromabroadGNP=GDP+netfactorincomefro

pixi mabroad
Net National Product (NNP)

There happens to be wear and tear of machineries and other fixed capital during the production process. This is also
known as depreciation or consumption of fixed capital. NNP is the result of deduction of value of depreciation from the
GNP. NNP allows for the deduction of depreciation, maintenance of fixed capital and gives the true value of goods and
services after excluding such expenses.
NNP=GNPDepreciationNNP=GNPDepreciation
National Income
National income is the total income accruing to all factors of production for the services rendered in the production
process. The household sector provides factors of production in the form of land, labor, capital and organization in the
production of goods and services. They are paid in the form of rent, wages and salaries, interest, profit, mixed income etc.
for their contribution in the production of goods and services by supplying the factors of production. The steps which are
followed to arrive at a figure of national income are as follows.
GDP=GDP=W+R+I+P+Depreciation +Net Indirect Taxes
GNP = GDP + Net factor income from abroad
NNP = GNP - Depreciation
NNP at factor cost = NNP - Indirect Taxes = National Income
One important thing to note in this regard is that some forms of income like transfer payments, capital gains, second hand
sales and illegal incomes do not come under the purview of national income. This is because they are not earned from
expenditures on currently produced goods and services. Transfer payments are not included in national income, because
they simply function as the redistribution of wealth. They are not earned in exchange of goods and services. Capital gains
are also mere claim on financial assets and do not represent expenditure on currently produced goods and services.
Second hand sales do not fall under the national income, because nothing new is produced. It already must have come
under past year's GDP. Illegal incomes form illegal activities like gambling, smuggling, robbery do not fall under national
income because they do not increase the productive capacity of the economy.
Personal Income
The total income received by all individuals and households of a country from all possible sources before payment of
direct taxes during a year is called personal income. There are time when income is received by a firm but not by the
members of the firm. That is why there is a gap between national income and personal income. All of the corporate profits
do not go to shareholders. A part of it is paid as tax and some portion of the corporate profit might be retained in the
business. All of the wages and salary accruing to the workers might not be received. A portion of it is contributed for the
provident fund, pension fund etc. Also, transfer payments accrue to the individuals as income and are hence included in
personal income.
PI = National income - Undistributed corporate profits - Corporate taxes - social security contribution + transfer payments
Disposable Income
The income left for consumption after paying the direct taxes is known as disposable income. In other words, it is the
income left for consumption available at people's disposal. However, not all of the disposable income is used for
consumption.
Disposable income = Personal income - Direct taxes
Per Capita Income

Per Capita Income is the average income of the people of a country in a particular year. It is the income received by a
single person of a country in that year.
Per Capita Income = National Income in a particular year Total population in that year
Measurement of National Income

The production of goods and services requires the use of resources which are in the hands of the household sector of an
economy. Households are paid for their services in the production of goods and services which generates income for the
household. This income stimulates demand for goods and services. The demand of goods and services from the
household sector is satisfied by business firms in an economy. Hence, household sector spend on goods and services of
the firms which acts as income to the firms. The income they get helps in further production of goods and services.
Hence, there is a circular flow of income. Therefore, the national income of a country can be measured using three
different approaches, i.e. production, income as well as expenditure method. These three methods are considered to end
up giving the same figure because an income results into an equal expenditure which again acts as an income to the
producers and the cycle goes on uninterrupted which is why these three approaches are believed to give the same figure
of national income.
Product Method
Product method measures national income by summing up the market value of all the final goods and services produced
in an economy during a certain period of time. Here, final goods are those goods which are in the market for consumption
by the ultimate consumer. In this method, economy is divided into three sectors, primary sector (agriculture, forestry,
fishing, mining), secondary sector (manufacturing, construction, electricity, gas, water supply) and tertiary sector (banking,
transport, insurance, trade and commerce) etc. respectively. The money value of total product of each sector is calculated
and summed up to find out GDP. The GDP so derived can be changed into GNP by adding Net factor income from
abroad.
However, this method results in the problem of double counting. Double counting means certain items are calculated
more than once while calculating national income. Avoiding the problem of double counting is difficult because the same
product is used as an intermediate goods by a firm and as final goods by households. For example, flour is used as the
intermediate good by biscuit industries where it is used as final product by households for making Chapattis.
In order to avoid the problem of double counting, value added method is used. A detailed description of these two
methods are as follows:
Final Product Method
The final product method uses the market value of all the final goods and services to come to a GDP figure from which
national income is deduced.
GDP = p1q1 + p2q2 + + pnqn
GNP = GDP + Net Factor Income From Abroad
NN P =GNP - Depreciation
National Income = NNP - Indirect Taxes
Value Added Method

Unlike final product method, the value added method does not take the final market value of goods. In the process of
production, there are many stages. Value Added Method only takes the added value in each stage of production and adds
them all to come to a single GDP figure. This method is used to avoid the problem of double counting. Value addition
means the addition of the value of raw materials and other inputs in the process of production. Net value added is the
difference between the value of output and intermediate good. The following example will make the concept of value
addition more clearer.
Cost of Intermediate
Stage of production Value of Output Gross Value Added
Goods
Wheat 1000 200 800
Flour 1400 1000 400
Bread 2000 1400 600
Total 4400 2600 1800
The above table shows the different stages in the production of bread. There are three stages involved in the production
of bread. The first stage is where a farmer produces wheat. The wheat thus produced goes to the mill and the resulting
output is flour. The flour then goes further for processing to a factory from where the final product, bread is produced.
Hence, in all the process value is added in the form of the raw material to produce something with more use. This addition
in value can be measured in terms of market price of the product in various stages of production. The first stage of
production in the production of bread starts with the production of wheat by a farmer. Let us suppose, his inputs cost 200
rupees. He sells his production to the mill for 1000 rupees. The mill processes the wheat to produce flour and sells his
product for 1400 rupees to the baker. The baker produces bread and sells it in the market or to the final consumer for
2000 rupees. Here, there is value addition at every stage involved. The farmer buys inputs worth 200 rupees and sells the
wheat for 1000 rupees. Here, the value addition is the difference between the intermediate good and the value of the final
output that the farmer sells, i.e. 800 rupees. Likewise the value addition made by the mill is 400 rupees. Finally the value
addition done by the baker is 600 rupees. Hence, the total value addition done by all three players in the production
process of bread is 1800 rupees which is the value of the bread.
NetvalueAddition=costoffinaloutputcostofintermediategoodNetvalueAddition=costoffinaloutputcostofinter
mediategood
In an economy, if we sum up the value addition in the production of all goods and services, we get the GDP. We can find
out the national income then from the GDP.
GDP=NV1+NV2++NVn=i=1nNViGDP=NV1+NV2++NVn=i=1nNVi
NI = NNP - Indirect Taxes
Income Method
The income approach of measuring national income considers all the payments made to the factors of production to arrive
at a national income figure. Therefore, it is also called the factor payment method. The household sector provide factors of
production like land, labor, capital and organization to produce goods and services. For this, they are paid in terms of rent,
wages and salaries, interest and profits. If we sum up all these values we get the GDP of the country.
GDP = Rent + Wages and Salaries+Interest + Profits + Depreciation + Net indirect taxes
GNP = GDP + Net factor income from abroad
NI = NNP - Net Indirect Taxes
Expenditure Method
Factors of production are paid for their contribution in the production of goods and services. The income they get can be
used in two ways that are consumption expenditure and investment expenditure. Also, the government spends in the
economy. The domestic economy is also linked with the external sector through imports and exports. The difference
between imports and exports is known as net exports. The expenditure method measures national income as the
aggregate of all the final expenditure on gross domestic product at market price in an economy during an accounting year.
GDP = C + I + G + (X - M)

NI = NNP - Net Indirect Taxes
where,
C= Private Consumption Expenditure
I= Private Investment Expenditure
G= Government Expenditure
X= Exports
M= Imports
Notes
While using expenditure method to measure national income, the following things should be kept on mind:
The expenditure on currently produced goods within the period under consideration should only be included. Previously
produced goods should be excluded.
It must also exclude all the expenditures for the purchase of used assets.
Purchase of financial assets such as stocks and bonds must be excluded.
Transfer payments provided by governments must be excluded.
Expenditure on intermediate goods must also be excluded.
Difficulties in Measurement of National Income

Measuring national income is a very important task, because it acts as an indicator of the performance of an economy
over a certain time period. It is useful in international comparisons as well as time series comparison of the same
economy. However, there are many difficulties in the measurement of national income. Some of the major difficulties are
as follows:
Double Counting: The problem of double counting occurs because; the same good is sold and resold many times in the
stages of production. Moreover, it is very difficult to identify which good is final or intermediate. Based upon its use, the
same good can sometimes act as final and sometimes as an intermediate good. Therefore, there is a chance of
overestimation of national income as a result of double counting.
Method used in the calculation of depreciation: Calculating depreciation is a very baffling task. This is because
different firms use different methods to calculate depreciation. There is no universal consensus on which method gives an
accurate measurement of the exact wear and tear of fixed capital used in the production of goods and services. Moreover,
there is also a debate whether depreciation should be deducted from the original cost or replacement cost of the fixed
capital.
Non-marketed goods: All the goods do not come to the market. There are many household services, value addition to
the raw materials in the form of cooking, cleaning, decorating, babysitting which do not come under the purview of
national income. However, the same activities done elsewhere would have generated income.
Changes in price level: National income needs two variables for its calculation, price and quantity of different goods and
services produced in a economy. However, the results can be confusing sometimes. National income may increase
without an increase in production because of increase in price level.
Unreported illegal income: Illegal incomes earned through illegal activities like tax evasion, smuggling, bribery, gambling
are not reported which underestimates national income.
Practical Difficulties in Measuring National Income in Developing Countries

There are certain difficulties in measuring national income in developing countries, which are unique to those countries.
These kinds of difficulties are specific to those countries. Nepal is also a developing country and hence these unique
problems are also relevant in our case. Hence, it is important to know about these problems. They are as follows.
Large non-monetized sector: Nepalese economy is an agriculture-dominated economy. In such economy, a
considerable amount of agricultural produce does not come to the market place because the production is used for self-
subsistence. Hence, there exists a large non-monetized sector, which makes the correct estimation of national income a
tedious task.
Illiteracy: Most of the farmers do not keep record of their production due to illiteracy.
Lack of trained staff: There is a lack of adequate trained statistical staff for the purpose of measuring national income.
Narrow Mindset: The people in these countries are superstitious and hence reluctant to disclose their incomes.
Moreover, people cannot disclose their actual income if it is earned through illegal sources.
Lack of occupational specialization: People depend on various income sources for continuing their livelihood and hence
lack occupational specialization, which makes measuring national income a difficult task.

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Short answer questions

1. Who is the father of economics and why?

2. What are the characteristics of wealth definition?

3. What are the characteristics of welfare definition?

5. Distinguish between positive and normative economics. (HSEB 2056)

Inclusion/exclusion of It answers the It does not pass any

Examples When income of a Progressive taxation

6 Write short notes on microeconomics and macroeconomics. (HSEB 2058)

7. Explain about the subject matter of economics. (HSEB 2070)

Long Answer Questions

1. Economics is a science of wealth. Discuss.

II. On the basis of Modern Analysis

II. On the basis of Modern Analysis

9. Define economics. Explain its nature.

10. Define economics. Explain its scope.

I. On the basis of economic activities

II. On the basis of Modern Analysis

11. Distinguish between microeconomics and macroeconomics. (HSEB 2060)

Objective Microeconomics is Macroeconomics is

Methodology Microeconomic theories Macroeconomic

Theories Price theory, Theory of Theory of output,

12. Explain the interdependence of micro and macroeconomics.

a. Dependence of microeconomics on macroeconomics

Importance of macroeconomic policy analysis

14. Critically explain the Marshall's definition of economics. (HSEB 2070)

1. Discuss the concept of allocation of resources.

2. What do you mean by production possibility curve?

3. Scarcity and choice are the foundation of economic problem. Discuss.

Long Answer Questions For 10 marks

Production Possibility Curve

Characteristics/Features of the wealth Definition

Welfare Definition/Neo-Classical Definition

Characteristics of Welfare Definition

Criticisms of Welfare Definition

Scarcity Definition/ Modern Definition

Characteristics of Scarcity Definition

Criticisms of the Scarcity Definition/Modern Definition

Subject Matter of Economics/Scope of Economics

On the basis of Modern Analysis

Positive and Normative Economics

Microeconomics VS. Macroeconomics

Basis of Difference Microeconomics Macroeconomics

Dependence of microeconomics on macroeconomics

Dependence of macroeconomics on microeconomics

Basic Economics Issues

Scarcity and choice

How to achieve growth of resources?

Concept of production possibility curve

Assumptions of Production Possibility Curve

Production possibility Schedule

Production Possibility Curve

National Income Accounting

Definitions of National Income

Simon Kuznets` definition

Gross Domestic Product (GDP)

Difference between GDP and GNP

Formula GDP=i=1npixiGDP=i=1n GNP=GDP+netfactorincomefromabroadGNP=GDP+netfactorincomefro

Net National Product (NNP)

Per Capita Income

Measurement of National Income

Value Added Method

GNP = GDP + Net Factor Income From Abroad

Difficulties in Measurement of National Income