Basic Economic Concepts

(Question taken from ISC Economics published by Frank Bros for class XI.Suitable for students of ISC Schools.Chapter II,Basic Economic Concepts)


1.What do you understand by human wants? Explain the main features of human wants?
The word ‘want’ normally means a wish or a desire. However, the economic definition of a ‘want’ is “an effective desire for a particular object or service, which can be satisfied by making an effort to acquire it. For example, making an effort to acquire a car is a ‘want’. Desiring a car without making an effort to acquire it is not a ‘want’. Human wants can be divided as under :

Necessities: Necessities are those wants which are required for the very existence of human living and to maintain normal efficiency. Necessities are also called primary or basic wants. These include food, clothing and shelter.
Comforts: Comforts are those wants which makes our lives more comfortable. For example, a refrigerator or a television set are classified under comforts.
Luxuries: Luxuries are those wants which are required to show off wealth and power. The benefits of these luxuries may not be worth the price paid for it but it is required as a status symbol.

The main features of human wants are:
1.Unlimited: Human wants are unlimited. As soon as one want is satisfied another want comes up. Wants are also multiple. There are many wants at the same time. Wants begin with birth and ends only on death of the human.
2.Complementary: When two good are required together wants are called complementary. For example car and petrol are complementary wants. Pen and ink are complementary wants.
3.Substitutability: One want can be satisfied by two o more goods. For example thirst can be quenched with water or a Pepsi.
4.Competitive: Wants are competitive. Mans limited income can be used to purchase either one commodity or the other. If a person has Rs.500/- he can use it to watch a cricket match or go to a movie.
5.Wants multiply: Wants multiply over time. With improvement of technology, new goods are produced leading to new wants.
6.Wants recur: Human wants are satisfied only temporarily. They appear again and again. For example if food is consumed in the morning it is required again in the evening.
7.A single want can be satisfied: All wants cannot be satisfied. However, one want or a few wants can be satisfied. This is because no one has the resources to satisfy all wants.
8.Some wants can be postponed: Not all wants can be postponed. The want for a television set can be postponed. However, the want for food cannot be postponed.
9.Wants differ in urgency: Some wants are more urgent than others. The want to pay school fees may be more urgent than the want to buy a movie ticket.
10.Wants ahead of availability: Human wants are always ahead of availability of good and service.

2.Define utility and explain its basic features.
Utility is the want satisfying power of a commodity. It is the ability or capacity of a commodity to satisfy human wants. Utility is the amount of satisfaction derived from a good or service at a particular time. For example, food has the power or utility to satisfy hunger. Total utility is the satisfaction derived from consuming a given quantity of a commodity. Marginal utility is the additional utility or satisfaction from consuming an additional unit of that commodity.

The characteristics of utility are :

1.Subjective: Utility is subjective. It cannot be observed. It depends on the individuals subjective estimate. For example the utility of an apple for one individual will be different from that of another individual. For a person who does not like apples the apple has low utility even when the person is hungry. For a person who likes apples, the apple has high utility.
2.Not Measurable: The utility of a commodity cannot be measured as it is subjective. The utility of an apple for one person is different from that of another person and there is no device to measure this utility.
3.Relative: Utility is relative to a persons need. The utility of bread to a hungry person is higher than the utility of bread to another person who is not hungry. Utility also varies from time to time and place to place.
4.Different from usefulness: Utility is different from usefulness. A commodity may have utility even if it is not useful. Smoking is not useful as it harms the health. But, to a smoker it has utility since it satisfies his craving for nicotine.
5.No moral or legal connotation : Utility has not moral or legal angle. A commodity may be illegal or immoral but it may still have utility. For example for a vegetarian eating meat is immoral but to another person who is a non-vegetarian eating meat satisfies a want and therefore has utility. Possession of a gun may be illegal but to a dacoit the possession of a gun has utility.
6.It is abstract: Utility is abstract as it cannot be seen or touched.

3.Explain the concepts of production and investment.

Production: Production is the act of making goods and services. It involves converting raw material into finished goods. However, this is an incomplete definition since this does not include services. The revised definition of production is, therefore, “the process of creating utility”. This means that the process of creating goods and services is called production. It includes tangible goods and services like that of Banking, services of Doctors, Lawyers etc. Thus production is the process of adding utility to any object or service. Utility can be created in the following ways:

Form Utility: Form utility is created when the form of the goods is changed from raw material to finished goods. Wood has utility those people who want a table. Therefore making a table from wood increases the utility of wood.

Place Utility: Goods have utility if it is moved from one place to another. When goods are moved from the warehouse to the retail shop place utility is created.

Time utility: Time utility is created when goods are made available when goods are required. For example winter clothing has time utility if they are stored till winter when they are required.

Service Utility: Service utility results from the provision of personal services of the individuals like doctors, teachers, engineers etc.

Thus, production is the process of adding utility tot the object through form, place utility, time utility and service utility.

Investment: Investment is defined as the act of using production resources for the production of investment goods. That is goods are used for producing other goods which can be used for production. Using resources to produce goods like machinery, tools, buildings is called investment. Another name for investment is capital formation. The major components of investment goods are :
a.Capital Goods: The production of new capital goods such as plants, machinery is part of investment. Capital goods are called producers’ fixed investments.
b.Business Construction: The construction of office and factories is also called investment.
c.Investment in residential housing: A residential house gives utility over a long period of time therefore it is classified as investment and not consumption. Investment in housing is different from other forms of investment as it is sold to households while other capital goods are sold to firms.
d.Investment in stocks: Stocks of raw materials, semi-finished goods and finished goods is called investment in stocks. A net addition to stocks is called investment because it represents good produced but not used for current consumption.
The total of all investment goods – capital goods, business construction, residential housing,stocks is called gross investment. Physical wear and tear is called depreciation. Investment to replace what is worn-out is called replacement investment. Investment in the stock market is financial investment. Investment in capital goods is real investment.

4.Discuss the characteristic features of factors of production.

The factors of production are :

Land : This includes all types of land including forest land.
Labour : This includes all human effort, whether mental or physical.
Capital : Capital refers to all man made items like machinery, tools buildings.
Entrepreneurship: This refers to the risk taking ability of a human being to use land, labour, capital to produce goods or services in order to make a profit.

The main features of the factors of production are :

a)All four: Production is the outcome of the use all the four factors of production that is land, labour, capital and entrepreneurship in order to produce goods or services.
b)No fixed ratio: While all four factors of production have to be used in the process of production, these are not used in a fixed ratio. Different activities need a different ratio of all four factors of production.
c)Services: The services of the factor of production, for example the skill of the human rather than the human himself, is important for production.
d)Physical existence: All factors of production has a physical existence. You can touch and feel all factors like land, labour, machinery etc.
e)Derived demand : The demand for factors of production is derived demand. The demand for factors of production increases or decreases when the demand from consumers for goods or services increases of decreases.
f)Mobility: Not all factors of production are mobile. Mobility refers to the ability of the factor to move from place to place. Labour and entrepreneurs are mobile but land is not mobile. Capital is less mobile than labour.

5.Distinguish between value and price.

All goods and services have a price. The price of a commodity is the amount of money that has to given to get a commodity. Goods which are scarce have a higher price. Good which are abundantly available have a lower price. The price of a commodity is determined through the market forces of demand and supply. Equilibrium price is the price at which the quantity demanded equals quantity supplied.

Value is different from price. The value of a commodity is the valuation of a commodity, by a household or individual, for its consumption. For example water has a low price but has a very high value for a thirsty individual. There are two kind of value :

Value-in-use : This is the utility derived from the consumption of a commodity. For example water has a high value-in-use or consumption value.

Value-in exchange : It is the rate at which a particular good or service can be exchanged with another or exchanged with money. It has no necessary connection with value-in-use. For example water has low value-in-exchange but a high value-in-use. Diamonds, for example, have a high value-in-exchange (price) but a low value-in-use (utility)

6. What is meant by a market? Distinguish between goods markets and factor markets.
Market is a system or facility with enables buyers and seller to interact and communicate with each other in order to strike a deal. A market may not be a physical place but is a system or mechanism by which buyers and sellers are brought together.

The two features of a market are :

a)A market need not be located at a particular place. The geographical area of the market may be large or small depending on how scattered the buyers are.
b)Buyers and Sellers need not have personal contact with each other. They need to have a system of communication with each other in order to make a transaction.

Goods and Factor markets are different. The differences are :

a)Goods Market : Goods Market are those market where goods and services are bought and sold. The sellers in this market are usually firms and the buyers are individuals, households or government. The cloth market is an example of a goods market.
b)Factor Market : A factor market is a market where factors of production are bought or sold. For example the labour market, capital market etc. In this case buyers are entrepreneur and sellers are the owners of the factor of production. The banking system is an example of a factor market.

7.Define money. What are its components in a modern economy?
Money is anything that is generally accepted as a means of exchange and at the same time acts as a measure and store of value. Money was devised on account of the inefficiencies of the barter system.
The components of money are :
a)Currency : This consists of currency notes and coins. and are issued by the Central Bank of the country. In India the Rupee is the currency of the government. The symbol for this is M1.
b)Deposit Money : Deposits held in bank against which cheques can be issued is called deposit money or bank money. The symbol for this is M3.

8.Explain the concepts of income, consumption and saving.

Income : Income may be defined as the flow of money or the flow of goods and services accruing to an individual or all the people in the economy over a specified time.

Personal income: Personal income earned by an individual is expressed in terms of money. For example the income of an individual may be Rs.10,000/- per month. People earn a personal income by selling goods or services they have produced.

National income: National income is the value of all the goods and services produced in the country by all the residents in the country in a given period which is usually one year. The three important points of national income are :
a)It is the aggregate value of all goods and services produced in the country. However, since we cannot add different goods like machinery and buildings, the value of the goods produced is expressed in terms of money which is the national income.
b)For calculating the national income only the value of the final goods are considered. The value of intermediate goods is not considered for calculating the national income since this value is already included in the value of the final goods. For example the value of bread produced is considered in national income but the value of flour is not considered as the value of flour is already included in the value of bread.
c)National income is the flow of goods and services. This flow is calculated over a period of one year.

Per Capital income is a part of the definition of National Income. The Per Capita income is the National Income divided by the population of the country. The higher the Per Capita income the higher is the state of development of the nation.

Consumption:
Consumption is the satisfaction of human wants through the use of goods and services. Wants lead to consumption of goods and services. Consumption of goods and services leads to the satisfaction of wants. The factors affecting consumption are :

a)Income & Propensity to consume : The main factor affecting consumption is income. The higher the income the greater the consumption. Also, the propensity to consume also determines consumption. Propensity to consume is the amount of income that the consumer spends. If the consumer spends Rs.800 from his income of Rs.1000 then the propensity to consume is Rs.800/Rs.1,000 ie 0.8%
b)Future income : Current consumption is not only decided by the current income but also by expectations of future earnings. If income is expected to be lower during old age then people spend less when they are young in order to save for old age.
c)Wealth : Consumption may be high even when income is low. This happens when a person has high accumulated wealth.

Savings:
Savings is defined as income minus consumption. Whatever is left in hand after spending is called savings. The difference between saving and savings is that saving is the amount not spend from current income. Savings is the amount not spent from current and past incomes.


9. What do you understand by National Income?
National income: National income is the value of all the goods and services produced in the country by all the residents in the country in a given period which is usually one year. The three important points of national income are :
a)It is the aggregate value of all goods and services produced in the country. However, since we cannot add different goods like machinery and buildings, the value of the goods produced is expressed in terms of money which is the national income.
b)For calculating the national income only the value of the final goods are considered. The value of intermediate goods is not considered for calculating the national income since this value is already included in the value of the final goods. For example the value of bread produced is considered in national income but the value of flour is not considered as the value of flour is already included in the value of bread.
c)National income is the flow of goods and services. This flow is calculated over a period of one year.

Per Capital income is a part of the definition of National Income. The Per Capita income is the National Income divided by the population of the country. The higher the Per Capita income the higher is the state of development of the nation.

10. Define National wealth and state its various components.
National wealth is the stock of all assets, at any point of time, that contributes to the production of goods and services. Assets are of two types:

Reproducible Assets : These are man-made assets and consists of machinery, buildings which contributes to the production of goods.
Non Durable goods:These consists of inventories of good which can be used to satisfy peoples wants like stock of television, refrigerators.

Non Reproducible Assets : These consists of natural resources like land, mineral wealth etc. These assets cannot be created by man.

For anything to be regarded as wealth, it must have the following features:

a)Utility : That is, it must satisfy wants when it is consumed.
b)Scarcity : It must have limited supply.
c)Transferability : The ownership must be transferable from one person to another.
d)Exchange Value : It must have exchange value. That is, one must be able to exchange it with money or must be able to barter it with other items.

11. Distinguish between economic welfare and non-economic welfare.

Welfare is a sense of satisfaction ,happiness and well-being among people.Welfare can be affected by factors like income, consumption,environment, freedom etc. Since some factors affecting welfare like income and consumption can be measure by money these factors are classified as economic welfare. Welfare factors like environment which are not affected by money are classified as non-economic welfare factors.

Total welfare of the people of a country is the sum total of economic and non-economic welfare. The welfare of the society as a whole is called social welfare.

12. Explain basic economic entities in an economy.
Economic entities in an economy are classified into three categories, that is, Households, Firms and Government.

Households : A household is defined as person or group of people who live together and take decisions about the types of commodities to be purchased for satisfying their wants. A household may also be owners of factors of production like land, labour and capital and take decision about the sales of these factors of capital. Thus households take part in economic activities both as consumers and sellers of factors of production.

Firms : A firm is an entity which employs factors to produce commodities to sell to other people. Firms act as producers of commodities as well as consumers of factors of production.

Government : Government is a group of organization which possesses legal and political power and exercises some control over other sectors of the economy. These include the Central Government, State Government and Local Governments. It earn an income from taxes and spends money on administration, law and order and on building infrastructure.