Applied Research

1.0  INTRODUCTION TO ECONOMICS

1.1  The Meaning of Economics

The modern word "Economics" has its origin in the Greek word "Oikonomos" meaning a steward. The two parts of this word "Oikos", a house and "nomos", a manager sum up what economics is all about. How do we manage our house?

There is an economic aspect to almost any topic education, employment, housing, transport, defence etc. Economics is a comprehensive theory of how the society works. Alfred Marshal defined economics as the "Study of man in the ordinary business of life". Paul Samuelson, an American Economist defined it as: "The study of how people and society choose to employ scarce resources that could have alternative uses in order to produce various commodities and to distribute them for consumption, now or in future amongst various persons and groups in society.

The word scarcity as used in economics means that; All resources are scarce in the sense that there are not enough to fill everyone's wants to the point of satiety. i.e We have limited resources, both in rich countries and in poor countries. The economist‘s job is to evaluate the choices that exist for the use of these resources. Thus we have another characteristic of economics; it is concerned with choice.

In summary, Economics is defined as "The social science which is concerned with the allocation of scarce resources to provide goods and services which meet the needs and wants of the consumers"

Reasons for Studying Economics

a)   Economics provides underlying principles for optical resources allocation which enable individuals and firms to make economically rational decision.

b)  Economics enables individuals and organization to appreciate constricts imposed by the economic development within which the entity operate.

c)   Economics enables citizens to the appreciate parameters that determines development process so that they can contribute in facilitating in development and solve economic problems that characterize their society.

d)  Economic is analytical and its study helps to develop logical reasoning

1.2 The Scope of Economics

The study of economics begins with understanding of human ―wants‖. Scarcity forces us to economise. We weigh up the various alternatives and select that particular assortment of goods which yields the highest return from our limited resources. Modern economists use this idea to define the scope of their studies.

Although economics is closely connected with such social sciences as ethics, politics, sociology, psychology and anthropology, it is distinguished from them by its concentration on one particular aspect of human behaviour – choosing between alternatives in order to obtain the maximum satisfaction from limited resources.

In effect, the economist limits the study by selecting four fundamental characteristics of human existence and investigating what happens when they are all found together, as they usually are.

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First, the ends of human beings are without limit. Second, those ends are of varying importance. Third, the means available for achieving those ends – human time and energy and material resources – are limited. Fourth, the means can be used in many different ways: that is, they can produce many different goods.But no single characteristic by itself is necessarily of interest to the economist. Only when all four characteristics are found together does an economic problem arise.

Resources are the ingredients that are combined together by economists and termed economic goods i.e. goods that are scarce in relation to the demand for them.

(i)Economic Goods: All things which people want are lumped together by economists and termed economic goods i.e. goods that are scarce in relation to the demand for them.

(ii)Free Goods: These are goods which people can have as much as they want, e.g. air. Economic resources are scarce or limited in supply and command a price i.e. they have money value. Examples include Land, Labour, and Capital/Entrepreneurship. They are also called factors of production. The rewards from these factors are;

Land-rent/loyalty                          Labour- salary/wages

Capital –interest                           Entrepreneurship – profit/loss

Non-economic resources are unlimited in supply and are free. They do not require the use of scarce resources to produce and have no monetary value e.g. air, sunshine, rain etc. Economics is concerned with economic resources since scarcity poses an economic problem and therefore allocation decisions have to be made.

1.3 Human wants

Human want may be defined as an insatiable desire or need by human beings to own goods or services that give satisfaction or the capacity of satisfying ones needs. The basic needs of man include; food, housing and clothing. They include tangible goods like houses, cars, chairs, television set, radio, e.t.c. while the others are in form of services, e.g. tailoring, carpentry, medical; e.t.c. Human wants and needs are many and are usually described as insatiable because the means of satisfying them are limited or scarce. Human needs are the effective desires for certain things which express themselves in sacrifices or efforts necessary to obtain them.

Types of Human wants

Human wants can be classified into three categories necessaries, comforts and luxuries.

a. Necessaries:

Necessaries refer to the basic or primary wants for food, clothing, shelter, medical care, education, etc. These are the urgent needs of human beings. A person has to face several difficulties without the satisfaction of these wants. Necessaries may be further classified into three categories.

(i)   Necessaries of existence: There are the goods and services without which human life is impossible. Food, water, air, clothing and accommodation are examples of such necessaries.

(ii)  Necessaries for efficiency: These refer to the goods and services which are not required for survival. Rather they are necessary to make people efficient. For example, a person can survive without books and stationery. But their use will make him more efficient.

(iii)   Conventional necessaries: These mean the things which have become necessary due to habits, customs and traditions. For example, wearing of new clothes on marriage, decorating houses, cutting cakes on birthdays are not required for maintaining life or increasing efficiency. These have become necessary by force of habits and social customs.

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b. Comforts:

Comforts refer to the goods and services which make life easier and comfortable. They provide freedom from suffering, anxiety, pain, etc. Comforts improve our health and efficiency.For example, a chair may be necessary for efficiency but a cushion on it will make us comfortable. Comforts like fans, coolers, well furnished houses cheer our minds.

c. Luxuries:

Luxuries refer to the goods and services which give us pleasure and prestige. Motor cars, air conditioners, diamond jewellery, designer clothes, etc. are examples of luxuries. These things may not increase efficiency or comfort but they provide us happiness and status in society.

The above classification of wants is not rigid. A thing which is a comfort or luxury for one person or at one point of time may become a necessity for another person or at another point of time.For example; a car may be a luxury for a laborer, a comfort for a teacher but a necessity for a doctor. Whether a certain want is a necessity, a comfort or a luxury depends upon the person, the place, the time and the circumstances. Sometimes, human wants are also broadly classified into Primary wants which refer to wants for necessaries of life without which man cannot exists and Secondary wants referring to wants for things over and above the necessaries.

Characteristics of Human Wants:

The following are the important characteristics of wants.

(i)     Wants are unlimited: Famous economist Marshall has rightly said that human wants are countless in number and are varied in kind As soon as one want is satisfied another want takes its place. This endless circle of wants continues throughout life. For example, a person who has never used a fan would wish to have a fan. When this want is satisfied, he would wish to get an air cooler .Once these wants are satisfied, and then he would wish to have an air conditioner, a car and so on. Thus, we see wants never come to an end.

(ii)  A single want is satiable: Each want taken separately can be satisfied. It has rightly been said that there is a limit to each particular want. For example, if a man is thirsty he can satisfy his thirst by taking one, two or three glasses of water and after that he does not want water at that point of time.

(iii) Some wants arise again and again: Most wants recur. If they are satisfied once, they arise again after a certain period. We eat food and hunger is satisfied but after a few hours, we again feel

hungry and we have to satisfy our hunger again with food. Therefore, hunger, thirst etc. are such wants which occur again and again.

(iv) Varying nature of wants: Wants vary with time, place and person. They are also influenced by many factors like income, customs, fashion, advertisement etc. For example, we want medicines only when we are sick. Ice is needed in summer season only. We need coats when it is cold. Similarly, people have started using things like T.V. Sets, mobile phones, car and many other luxury goods due to increase in their income and change in fashion. Thus, wants have been found to vary and to multiply with the economic development of a country.

(v)   Present wants are more important than future wants:Present wants are more important. A person uses most of his limited resources for the satisfaction of present wants. He does not worry much about his future wants because future is uncertain and less urgent. For example, providing for the education of children in the present is more important than providing for old age security in future.

(vi) Wants change and expand with development: A simple example to show how wants are changing is the telephone. Earlier, in the rural areas there were not many telephones, but today

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telephone has become a necessity for everybody for keeping in touch with their near and dear ones. People using telephone earlier, are now using mobile phones. They want more and more facilities in their mobile phones such as, Camera, Internet and so on.

(vii)Wants are complementary: It is a common experience that we want things in groups. A single article out of group can not satisfy human wants by itself. It needs other things to complete its use e.g. a motor-car needs petrol and mobile oil it starts working. Thus the relationship between motor-car and petrol is complementary.

(viii)Wants are competitive: Some wants competes to other. We all have a limited amount of money at our disposal; therefore we must choose some things and reject the other. E.g. tea and coffee

(ix)Some Wants are both complimentary and competitive: When use of machinery is done the use of labour needs to be reduced. This indicates competitive nature. But to run the machinery the labour is also required and as such it indicates complimentary relationship.

(x)Wants are alternative: There are several ways of satisfying a particular want. For example, a person who wants to travel from one place to another may hire a taxi or may board a bus or train. The final choice depends upon their relative prices, the money available and the time available.

(ix)Wants create economic activity: Human wants give rise to economic activities. Unlimited and ever increasing human wants accelerate the pace of industry, commerce and trade.

1.4 Economic resources

Economic resources are the goods or services available to individuals and businesses used to produce valuable consumer products. The classic economic resources include land, labor and capital. Entrepreneurship is also considered an economic resource because individuals are responsible for creating businesses and moving economic resources in the business environment. These economic resources are also called the factors of production. The factors of production describe the function that each resource performs in the business environment.

a) Land

The term land in economics is used in a special sense. It does not mean soil or earth surface alone. Land in economics means natural resources. It includes all those things which are found under and over the surface of earth. In the words of Marshall, the land means the material and the forces which Nature gives freely to man‘s aid in land and water, in air and light and heat. Land thus include soil, crops, mineral deposits, forests, oceans etc. Land as a factor of production cannot be increased because it‘s impossible to get additional land apart from one given by nature. It can only be improved in quality so as to produce more goods. Its reward is /remuneration is rent/loyalty.

Characteristics of Land

·         It‘s a basic factor of production i.e. production cannot take place without it

·         It‘s supply is fixed i.e. earth‘s surface cannot be added

·         it lacks geographical mobility i.e. cannot be moved from one geographical area to another

·         it‘s quality is not uniform i.e. productivity of one piece of land is different from another

·         Productivity can be increased by increasing unit of capital and land

·         it‘s a natural resource

·         It‘s subject to the law of diminishing returns.

b)  Labour

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Labour refers to any human effort whether physical or mental applied in production However, not all human effort is labour. For it to be labour, it must be aimed at production i.e. paid for. The reward for labour is wages and salaries.

In economics, the term human resources include both labour and entrepreneurial ability. It may be noted that it is the services‘ of labour which are bought and sold for money and not the labor itself. As regards the supply of labour, it depends upon the (i) size of total population (ii) age composition of the population (iii) the availability working population, (iv) the working hours devoted to production (v) the remuneration paid to the workers, etc., The entrepreneur or enterprise is the person who takes initiative and combines resources for the production of goods and services

c) Capital

The term capital refers to all manmade resources which aid to production. Thus machinery, equipment, tools, factories, storage, transportation, etc., which are used in the production of new goods and supplying them, to the ultimate consumers are capital resources. Capital also includes those goods used to produce other goods (producer goods). Its reward is interest

Characteristics of Capital

·         It‘s man-made hence its supply is under man‘s control

·         it‘s a basic factor of production

·         it‘s subject to depreciation i.e. through wear and tear

·         Can be improved by technology

d)  Entrepreneurship

It‘s the ability to organize other factors of production for effective production. This is done by an entrepreneur an (organizer, a manager or a risk taker) and its reward is Profit or Loss

Functions of Entrepreneur

·         Control of business

·         Start the business

·         Make decisions (policy maker)

·         Acquire and pay for all factors of production

·         Bear all the risks and enjoys the profit

·         owns the whole project

1.5  scarcity and choice

To the economists all things are said to be scarce, since by ―scarce‖ they mean simply ―that there are not enough to fill everyone‘s wants to the point of satiety‖. Most people would probably like to have more of many things or goods of better quality than they possess at present: larger houses perhaps in which to live, better furnished with the latest labour-saving devices, such as electric washers, cookers, refrigeration; more visits to theatre or the concert hall; more travel; the latest models in motor cars; radios and television sets; and most women exhibit an apparently insatiable desire for clothes. People‘s wants are many, but the resources for making the things they want – labour, land, raw materials, factory buildings, machinery – are themselves limited in supply. There are insufficient productive resources in the world, therefore, to produce the amount of goods and services that would be required to satisfy everyone‘s wants fully. Consequently, to the economist all things are at all times said to be ―scarce‖.

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1.6 Opportunity Cost

Because there are not enough resources to produce everything we want, a choice must be made about which of the wants to satisfy. In economics, it is assumed that people always choose the alternative that will yield them the greatest satisfaction. We therefore talk of Economic Man.

Choice involves sacrifice. If there is a choice between having guns and having butter, and a country chooses to have guns, it will be giving up butter to the guns. The cost of having guns can therefore be regarded as the sacrifice of not being able to have butter. The cost of an item measured in terms of the alternative forgone is called its opportunity cost.

1.7 Resource Allocation

Resources are the means to achieve certain ends. One of the most important functions of the economic system is the allocation of scarce resources and commodities. Resource allocation ―refers to the way in which the available factors of production are allocated among the various uses to which they might be put‖. Allocation in economics is therefore studying of how resources that are scarce are delivered by producers. It also examines It also examines how scarce goods and services are among consumers. It is a very important theme in economics.

The allocation of resources enables us to determine how much of the various kinds of goods and services will actually be produced. Uses of resources in one industry should be interpreted as if they have been drawn from some other industry having relationship through common input. If output of one product is increased with given resources, the output of another product is decreased. Therefore, the optimum allocation of resources between two products shall depend upon the degree of urgency of demand for them and the resultant cost savings there from to the society.

Allocation of resources is a problem in welfare economics. It has close relationship with the theory of general equilibrium. It is advisable to introduce the topic of resource allocation at macro level first and then extend the arguments to cover the problems of a firm.

The allocation of resources thus involves sharing of resources among competing sectors. Whatever, the type of economy be it capitalist, socialist or mixed, decision has to be made regarding allocation of resources. In a capitalist economy decision about the allocation of resources are made through the free market price mechanism. A capitalist or free market economy uses impersonal forces of demand and supply to decide what quantities and thereby determining the allocation of resources. The producers in a free market economy motivated as they are by profit consideration take decisions regarding what goods are to be produced and in what quantity by taking into account the relative prices of various goods.

Significance of resource allocation

Resource allocation is important in that it helps solve the following problems:

a)   What to produce? Because resources are scarce production of all goods and services needed by a society are beyond its capacity. It is simply not possible for any economy. So, it has to select a set among various alternatives production which must meet the maximum social need. An economy should follow social efficiency while allocating resources. The social norms and values should guide to maximize social satisfaction so allocation is best which satisfies the most. The problem of what to produce and how much to produce depends on the needs of the citizens of the country

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b) How to produce? This is concerned with the method of production. In some cases, labor may play a major role. It is called labor intensive technology. In others, capital may play a major role. It is called capital intensive. A labor intensive method creates more jobs favouring more employment. It helps in mitigating unemployment problem. Capital intensive production goes for large volume of production. It commends rapid growth rate.

c)For whom to produce? Production for masses or productions for profit are two major choices that every economy has to decide. Basic needs of common people cannot be ignored. Of course, the priority goes to wage goods production. In the quality is determined by the level of living standard, which is the outcome of the development level of the economy. Therefore, as the development level of goods, higher production of superior goods proceeds towards fetching super profits. This issue is also related with maintaining social justice. Meeting the basic requirements of all segments of population is the main criteria of resources allocation.

d)   Promotion of Efficiency in Economy: How to run an economy efficiently is the first concern of resource allocation. Economics efficiency is measured in additional welfare achieved without worsening any result. It means that new reallocation of resource must not only be able to maintain the existing level but also achieving new heights. Alternatively, reallocation may be profitable somewhere but incurring losses elsewhere. The main objective is to increase aggregate profitability of the economy.

e)   Achieving Balance in Economy: Another purpose of resource allocation is the maintenance of balance among different sectors of an economy. The balance between rural and urban sectors, between home consumption and export promotion, between consumer goods and capital goods and regional balance are the healthy signs of an economy. Investments in these different sectors are very important. How much to invest in what sector? This is the major question, which is studied in this topic.

Economic Systems and Resource Allocation

When we look around the world we find that there are only a limited number of ways in which societies have set about answering the four fundamental economic questions. These ways or methods are called Economic systems. They are free enterprise, centrally planned and mixed economies. We will now examine these briefly.

a) The free enterprise (the price system)

The free market system is where the decision about what is produced is the outcome of millions of separate individual decisions made by consumers, producers and owners of productive services. The decisions reflect private preferences and interests. For the free enterprise to operate there must be a price system/mechanism which is a situation where the vital economic decisions in the economy are reached through the workings of the market price.

Thus, everything – houses, labour, food, land etc come to have its market price, and it is through the workings of the market prices that the "What?", "How?", and "For whom?" decisions are taken. The free market thus gives rise to what is called Consumer Sovereignty – a situation in which consumers are the ultimate dictators, subject to the level of technology, of the kind and quantity of commodities to be produced. Consumers are said to exercise this power by bidding up the prices of the goods they want most; and suppliers, following the lure of higher prices and profits, produce more of the goods.

The features of a free market system are:

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(i)Ownership of Means of Production: Individuals are free to own the means of production i.e. land, capital and enjoy incomes from them in the form of rent, interest and profits.

(ii)Freedom of Choice and Enterprise: Entrepreneurs are free to invest in businesses of their choice, produce any product of their choice, workers are free to sell their labour in occupations and industries of their choice; Consumers are free to consume products of their choice.

(iii)Self Interest as the Dominating Motive: Firms aim at maximising their profits, workers aim at maximising their wages, landowners aim at maximising their return from their land, and consumers at maximising their satisfaction

(iv)Competition: Economic rivalry or competition envisages a situation where, in the market for each commodity, there are a large number of buyers and sellers. It is the forces of total demand and total supply which determine the market price, and each participant, whether buyer or seller, must take this price as given since it's beyond his or her influence or control.

(v)Reliance on the Price Mechanism: Price mechanism is where the prices are determined on the market by supply and demand, and consumers base their expenditure plans and producers their production plans on market prices. Price mechanism rations the scarce goods and services in that, those who can afford the price will buy and those who cannot afford the price will not pay.

(vi)Limited Role of Government: In these systems, apart from playing its traditional role of providing defence, police service and such infrastructural facilities as roads for public transport, the Government plays a very limited role in directly economic profit making activities.

Resource allocation in a free enterprise

Although there are no central committees organising the allocation of resources, there is supposed to be no chaos but order. The major price and allocation decisions are made in the markets. The market being the process by which the buyers and sellers of a good interact to determine its price and quantity.

If more is wanted of any commodity say wheat – a flood of new orders will be placed for it. As the buyers scramble around to buy more wheat, the sellers will raise the price of wheat to ration out a limited supply. And the higher price will cause more wheat to be produced. The reverse will also be true. What is true of the market for commodities is also true for the markets for factors of production such as labour, land and capital inputs.

People, by being willing to spend money, signal to producers what it is they wish to be produced. Thus what things will be produced will is determined by the shilling votes of consumers, not every five years at the polls, but every day in their decisions to purchase this item and not that.

The ―How?‖ questions is answered because one producer has to compete with others in the market; if that producer cannot produce as cheaply as possible then customers will be lost to competitors. Prices are the signals for the appropriate technology.

The ―for whom?‖ question is answered by the fact that anyone who has the money and is willing to spend it can receive the goods produced. Who has the money is determined by supply and demand in the markets for factors of production (i.e. land, labour, and capital). These markets determine the wage rates, land rents, interest rates and profits that go to make up people‘s incomes. The distribution of income among the population is thus determined by amounts of factors (person-hours, Acres etc) owned and the prices of the factors (wages-rates, land-rents etc).

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Advantages of a Free Market System

i)    Incentive: People are encouraged to work hard because opportunities exist for individuals to accumulate high levels of wealth.

ii)   Choice: People can spend their money how they want; they can choose to set up their own firm or they can choose for whom they want to work.

iii)   Competition: Through competition, less efficient producers are priced out of the market; more efficient producers supply their own products at lower prices for the consumers and use factors of production more efficiently. The factors of production which are no longer needed can be used in production elsewhere. Competition also stimulates new ideas and processes,

which again leads to efficient use of resources.

iv Flexibility: A free market also responds well to changes in consumer wishes, that is, it is flexible. v)Reduced size of civil service: Because the decision happen in response to change in the market there is no need to use additional resources to make decisions, record them and check on

whether or not they are being carried out.  The size of the civil service is reduced.

Disadvantages of a Free Economy

The free market gives rise to certain inefficiencies called market failures i.e. where the market system fails to provide an optimal allocation of resources. These include:

i)   Unequal distribution of wealth: The wealthier members of the society tend to hold most of the economic and political power, while the poorer members have much less influence. There is an unequal distribution of resources and sometimes production concentrates on luxuries i.e. the wants of the rich. This can lead to excessive numbers of luxury goods being produced in the economy. It may also result to social problems like crimes, corruption, etc.

ii)   Public goods: These are goods which provide benefits which are not confined to one individual household i.e. possess the characteristic of non-rival consumption and non-exclusion. The price mechanism may therefore not work efficiently to provide these services e.g. defence, education and health services.

iii)   Externalities: Since the profit motive is all important to producers, they may ignore social costs production, such as pollution. Alternatively, the market system may not reward producers

whose activities have positive or beneficial effects on society.

iv)Hardship: Although in theory factors of production such as labour are ―mobile‖ and can be switched from one market to another, in practice this is a major problem and can lead to hardship through unemployment. It also leads to these scarce factors of production being wasted by not using them to fullest advantage.

v)    Wasted or reduced competition:  some firms may use expensive advertising campaigns to sell

―new‖ products which are basically the same as many other products currently on sale. Other firms, who control most of the supply of some goods, may choose to restrict supply and therefore keep prices artificially high; or, with other suppliers, they may agree on the prices to charge and so price will not be determined by the interaction of supply and demand.

vi)   The operation of a free market depends upon producers having the confidence that they will be able to sell what they produce. If they see the risk as being unacceptable, they will not employ resources, including labour and the general standard of living of the country will fall.

b)    Planned economies

Is a system where all major economic decisions are made by a government ministry or planning organisation. Here all questions about the allocation of resources are determined by the government.

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Features of this system

The command economies rely exclusively on the state. The government will decide what is made, how it is made, how much is made and how distribution takes place. The resources and factors of production are owned by the government on behalf of the producers and consumers. Price levels are not determined by the forces of supply and demand but are fixed by the government. Although division of labour and specialisation are found, the planned economies tend to be more self-sufficient and tend to take part in less international trade than market economies.

Advantages of Planned System

i)Uses of resources: Central planning can lead to the full use of all the factors of production, so reducing or ending unemployment.

ii)    Large scale production: Economies of scale become possible due to mass production taking place.

iii)  Public services: ―Natural monopolies‖ such as the supply of domestic power or defence can be provided efficiently through central planning.

iv)   Basic services: There is less concentration on making luxuries for those who can afford them and greater emphasis on providing a range of goods and services for all the population.

v)    Wealth and income distribution: There are less dramatic differences in wealth and income distribution than in market economy

Disadvantages of the Planned System

The centrally planned economies suffer from the following limitations:

i)  Lack of choice: Consumers have little influence over what is produced and people may have little to say in what they do as a career.

ii)  Little incentive: Since competition between different producers is not as important as in the market economy, there is no great incentive to improve existing systems of production or work. Workers are given no real incentives to work harder and so production levels are not as high as they could be.

iii)   Centralised control: Because the state makes all the decisions, there must be large influential government departments. The existence of such a powerful and large bureaucracy can lead to inefficient planning and to problems of communication. Furthermore, government officials can

become over privileged and use their position for personal gain, rather than for the good of the rest of the society.

iv)Centralised decision making: The task of assessing the available resources and deciding on what to produce, how much to produce and how to produce and distribute can be too much for the central planning committee. Also the maintenance of such a committee can be quite costly.

c)The Mixed Economy

There are no economies in the world which are entirely ‗free market‘ or planned, all will contain elements of both systems. The degree of mix in any one economy is the result of a complex interaction of cultural, historic and political factors. For example the USA which is a typical example of a largely work-based society, but the government still plans certain areas of the economy such as defence and provides very basic care for those who cannot afford medical insurance.

Features of this system

The mixed economy includes elements of both market and planned economies. The government operates and controls the public sector, which typically consists of a range of public services such as

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