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What is Economics?

  • Economics is a social science concerned with the production, distribution and consumption of goods and services. It studies how individuals, businesses, governments and nations make choices on allocating resources to satisfy their wants and needs, and tries to determine how these groups should organize and coordinate efforts to achieve maximum output.
  • Economic analysis often progresses through deductive processes, much like mathematical logic, where the implications of specific human activities are considered in a “means-ends” framework.
  • Economics can generally be broken down into macroeconomics, which concentrates on the behavior of the aggregate economy, and microeconomics, which focuses on individual consumers.

Microeconomics

  • Microeconomics (from Greek prefix mikro- meaning “small”) is a branch of economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms.
  • Microeconomics is the study of individuals, households and firms’ behavior in decision making and allocation of resources. It generally applies to markets of goods and services and deals with individual and economic issues.
  • Microeconomic study deals with what choices people make, what factors influence their choices and how their decisions affect the goods markets by affecting the price, the supply and demand.

Macroeconomics

  • Macroeconomics (from the Greek prefix makro- meaning “large” and economics) is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes national, regional, and global economies.
  • Macroeconomics is the branch of economics that studies the behavior and performance of an economy as a whole. It focuses on the aggregate changes in the economy such as unemployment, growth rate, gross domestic product and inflation.
  • Macroeconomics analyzes all aggregate indicators and the microeconomic factors that influence the economy. Government and corporations use macroeconomic models to help in formulating of economic policies and strategies.
  • Macroeconomics and microeconomics, a pair of terms coined by Ragnar Frisch, are the two most general fields in economics. In contrast to macroeconomics, microeconomics is the branch of economics that studies the behavior of individuals and firms in making decisions and the interactions among these individuals and firms in narrowly-defined markets.

Difference between Macroeconomics and Microeconomics

  • Microeconomics focuses on how individual consumers and producers make their decisions. This includes a single person, a household, a business or a governmental organization.  Microeconomics ranges from how these individuals trade with one another to how prices are affected by the supply and demand of goods. Also studied are the efficiency and costs associated with producing goods and services, how labor is divided and allocated, uncertainty, risk, and strategic game theory.
  • Macroeconomics studies the overall economy.  This can include a distinct geographical region, a country, a continent or even the whole world. Topics studied include government fiscal and monetary policy, unemployment rates, growth as reflected by changes in the Gross Domestic Product (GDP) and business cycles that result in expansion, booms, recessions and depressions. 

Types of Economy

Generally, economies are classified in to different types based on extent of government involvement in the economic decision making.

  • Traditional economy: in this type of economy, there is very little government involvement, allocation of resources here done by rituals, habits or customs. Economic roles are defined by the family and people work together for the common good. There is also very little individual choice in this system. Examples of this type exist in tribes in Amazon, aborigines in Australia etc.
  • Free market economy: this type of economy also has very little government interference and control. Economic decisions are made based on market principles. There is a lot of competition between firms, which provides many choices to consumers. Resources for production are under private ownership and they make their decisions with the desire to maximize profit. Although there is no free market economies, but we may consider USA and Australia to this category.
  • Command economy: A command economy is a system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods are offered for sale. The command economy is a key feature of any communist society. Cuba, North Korea and the former Soviet Union are examples of countries that have command economies, while China maintained a command economy for decades before transitioning to a mixed economy that features both communistic and capitalistic elements.
  • Mixed economy: A mixed economic system is an economic system that features characteristics of both capitalism and socialism. A mixed economic system protects private property and allows a level of economic freedom in the use of capital, but also allows for governments to interfere in economic activities in order to achieve social aims. Most modern economies feature a synthesis of two or more economic systems, with economies falling at some point along a continuum. The public sector works alongside the private sector, but may compete for the same limited resources. Mixed economic systems do not block the private sector from profit-seeking, but do monitor profit levels and may nationalize companies that are deemed impediments to the public good. India is the best example of Mixed Economy.
  • Open economy: An open economy is an economy in which there are economic activities between the domestic community and outside. People and even businesses can trade in goods and services with other people and businesses in the international community, and funds can flow as investments across the border. Trade can take the form of managerial exchange, technology transfers, and all kinds of goods and services.
  • An open market is an economic system with no barriers to free market activity. An open market is characterized by the absence of tariffs, taxes, licensing requirements, subsidies, unionization and any other regulations or practices that interfere with the natural functioning of the free market. Anyone can participate in an open market; there may be competitive barriers to entry, but there are no regulatory barriers to entry.
  • Closed Economy: A closed economy is an economy in which no activity is conducted with outside economies. A closed economy is self-sufficient, meaning no imports are brought in and no exports are sent out, the goal being to provide consumers with everything they need from within the economy’s borders. A closed economy is the opposite of an open economy, in which a country conducts trade with outside regions.
  • Capitalist Economy: Capitalism is an economic system in which capital goods are owned by private individuals or businesses. The production of goods and services is based on supply and demand in the general market (market economy), rather than through central planning (planned economy or command economy). The purest form of capitalism is free market or laissez-faire capitalism, in which private individuals are completely unrestrained in determining where to invest, what to produce or sell, and at which prices to exchange goods and services, operating without check or controls. Most modern countries practice a mixed capitalist system of some sort that includes government regulation of business and industry.
  • Socialist Economy: Socialism is a populist economic and political system based on the public ownership (also known as collective or common ownership) of the means of production.  Those means include the machinery, tools and factories used to produce goods that aim to directly satisfy human needs.
  • In a purely socialist system, all legal production and distribution decisions are made by the government, and individuals rely on the state for everything from food to healthcare. The government determines output and pricing levels of these goods and services.
  • Socialists contend that shared ownership of resources and central planning provide a more equal distribution of goods and services, and a more equitable society.

Sectors of an Economy

A sector is an area of the economy in which businesses share the same or a related product or service. It can also be thought of as an industry or market that shares common operating characteristics. Dividing an economy into different pieces allows for more in-depth analysis of the economy as a whole.

A nation’s economy can be broadly divided into various sectors to define the proportion of people engaged in a particular sector. This categorization is seen as a continuum of the distance from the natural environment.

  • The first is called the primary sector and involves companies that participate the extraction and harvesting of natural products from the earth, such as agriculture, mining and forestry.
  • The secondary sector consists of processing, manufacturing and construction companies.
  • The tertiary sector is comprised of companies that provide services, such as retail sales, entertainment and financial organizations. The quaternary sector is made up of companies in the intellectual pursuits, such as educational businesses.

Economic Agents

By economic units or economic agents, we mean those individuals or institutions which take economic decisions.

  • They can be consumers who decide what and how much to consume.
  • They may be producers of goods and services who decide what and how much to produce.
  • They may be entities like the government, corporation, banks which also take different economic decisions like how much to spend, what interest rate to charge on the credits, how much to tax, etc.
Economic Agents

Factors of Production

  • In economics, factors of production, resources or inputs are what is utilized in the production process in order to produce output i.e. finished products. The amounts of the various inputs used to determine the quantity of the output according to a relationship called the production function.
  • There are three basic resources or factors of production- land, labour and capital. Some modern economists also consider entrepreneurship or time a factor of production.
  • These factors are also frequently labeled “producer goods”. In order to distinguish them from the goods and services purchased by consumers, which are frequently labeled “consumer goods”. All three of these are required in combination at a time to produce a commodity.
  • Factors of production may also refer specifically to the primary factors which are land, labour and capital applied to production. Materials and energy are considered as secondary factors in classical economics because they are obtained from land, labour and capital. The primary factors facilitate production but neither become part of the product, nor become significantly transformed by the production process.
  • Land includes not only the site of production but natural resources above or below the soil. Recent usage has distinguished human capital from labour. Entrepreneurship is sometimes considered a factor of production. The number and definition of factors varies depending on theoretical purpose, empirical emphasis, or school of economics.

Financial returns from factors of Production

  1. Land (Rent): the reward for the use of land. Owners earn income by letting out their property for a period of time.
  2. Capital (Interest): the return for the use of capital.
  3. Labour (wage/salaries): the remuneration for labour, given in return for their physical and mental efforts given during the production process.
  4. Entrepreneurship (Profit): received when entrepreneurs take responsibilities and takes risks during the production process

Four Major Sectors in an economy according to the macroeconomic point of View

  1. Private Capitalist Sector: production activities are mainly carried out by capitalist enterprises
  2. Government Sector: role of state includes framing laws, enforcing them and delivering justice. The state in many instances undertakes production- apart from imposing taxes and spending money on building public infrastructure, running schools, providing health services etc.
  3. Household sector: by a household we mean a single individual who takes decisions relating to her own consumption, or a group of individuals for who decisions relating to consumption are jointly determined.
  4. External sector: all the countries of the world are engaged in external trade. Trade with the external sector can be of two types’ exports and imports.
(Financial returns from factors of Production)

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