Basic Concept of Economics and Allocation of Resources
Economics is the study of how people use scarce resources to satisfy unlimited wants. The word comes from the Greek "Oikonomikos" (household management). Adam Smith, Marshall and Robbins gave three famous definitions. Economics is divided into micro & macro, and positive & normative branches.
In this chapter
Origin and Development of Economics
The word economics comes from the Greek word "Oikonomikos", which means "management of a household". Ancient Greek thinkers like Plato and Aristotle wrote about household management, trade, and value. In ancient India, Kautilya (also called Chanakya) wrote the Arthashastra around 300 BCE — a complete book on state economy, taxation, and administration. In 1776, Adam Smith published "An Enquiry into the Nature and Causes of the Wealth of Nations" — and economics became a separate science. Smith is therefore called the Father of Economics.
Three Periods of Economics
- Classical Period (1776–1890): Adam Smith, Ricardo, Malthus, J.S. Mill — focus on wealth and production.
- Neo-classical Period (1890–1932): Alfred Marshall — focus on human welfare; "economics is a study of mankind in the ordinary business of life".
- Modern Period (1932–present): Lionel Robbins — focus on scarcity and choice; "economics is a science which studies human behaviour as a relationship between ends and scarce means".
Three Famous Definitions
Comparison of the three leading definitions of economics
| Definition | Economist & Year | Core Idea | Criticism |
|---|---|---|---|
| Wealth Definition | Adam Smith (1776) | Economics is the science of wealth; it studies production, exchange and distribution of wealth. | Made economics a "dismal science"; ignored human welfare. |
| Welfare Definition | Alfred Marshall (1890) | Economics studies mankind in the ordinary business of life; it examines the material welfare side. | Restricted economics to material welfare only; cannot measure welfare. |
| Scarcity Definition | Lionel Robbins (1932) | Economics studies human behaviour as a relationship between unlimited ends and scarce means having alternative uses. | Ignore growth and welfare; purely analytical. |
Positive vs Normative Economics
Positive economics deals with "what is" — facts that can be tested with data. Example: "Nepal's inflation rate in 2023 was about 7.7%." Normative economics deals with "what ought to be" — value judgements and opinions. Example: "The government should reduce tax on cooking gas to help poor families." The first statement can be checked from data; the second is a personal view about what is good.
Two Branches of Economics (Micro vs Macro)
- Microeconomics studies individual units — a consumer, a firm, a market. Example: price of tomatoes in Kalimati market.
- Macroeconomics studies the economy as a whole — national income, total employment, inflation. Example: Nepal's GDP, total exports.
- Micro uses partial equilibrium; macro uses general equilibrium.
- Both branches are complementary — like studying a tree (micro) and the whole forest (macro).
Common types of goods with examples from Nepal
| Type of Good | Meaning | Nepal Example |
|---|---|---|
| Normal Good | Demand rises when income rises. | Branded clothes, motorcycles |
| Inferior Good | Demand falls when income rises. | Cheap rough rice (भट्टा चामल), jute bags |
| Giffen Good | Inferior good whose demand rises when price rises (very rare). | Plain rice for very poor families |
| Substitute | Used in place of each other. | Coca-Cola & Pepsi, tea & coffee |
| Complement | Used together. | Mobile & SIM card, motorbike & petrol |
| Private Good | Rival & excludable. | Your plate of momos |
| Public Good | Non-rival & non-excludable. | Street light, national defence |
| Economic Good | Scarce and has a price. | Petrol, vegetables |
| Free Good | Abundant, no price. | Air, sunlight |
Four Factors of Production and Their Rewards
- Land — gift of nature; reward = rent (e.g., a farmer paying rent for a ropani of land in Bhaktapur).
- Labour — physical & mental effort of humans; reward = wage (e.g., daily wage of a construction worker in Kathmandu).
- Capital — man-made means of production; reward = interest (e.g., a sewing machine in a garment factory).
- Organisation (Entrepreneurship) — combines other factors, takes risk; reward = profit (e.g., the owner of a New Road restaurant).
Rewards of the four factors (rent, wage, interest, profit)
Memory Trick — "RWIP"
Remember the rewards in order: Rent (land), Wages (labour), Interest (capital), Profit (organisation). For Nepali: भाडा, ज्याला, ब्याज, नाफा।
Opportunity Cost & Circular Flow
Opportunity cost is the value of the next best alternative given up when we make a choice. If a farmer uses one ropani of land to grow rice, the opportunity cost is the maize he could have grown on the same land. The concept was popularised by Lionel Robbins.
Opportunity cost = next-best alternative given up = slope of PPF
Circular Flow — Simple Story
Households own factors (land, labour, capital). They sell them to firms and earn rent, wages, interest. Firms use these factors to produce goods & services, which they sell back to households. Money flows in a circle. In Nepal, a tea-shop owner in Pokhara pays wages to workers, who in turn buy tea and snacks from the same shop — a real circular flow.
Practice Problem
Compare Adam Smith's, Marshall's and Robbins' definitions of economics in a short paragraph.
Practice Problem
Identify the type of good in each case and give one reason: (a) A student buys more dal-bhat after his monthly pocket money rises. (b) When the price of LPG gas rises, demand for induction cook-top rises. (c) When the price of iodised salt rises, demand is almost unchanged.
Quick Revision
- Word "economics" comes from Greek "Oikonomikos" = household management.
- Kautilya wrote Arthashastra (≈ 300 BCE); Adam Smith wrote Wealth of Nations (1776).
- Three definitions: Wealth (Smith), Welfare (Marshall), Scarcity (Robbins).
- Positive = "what is"; Normative = "what ought to be".
- Micro = individual units; Macro = whole economy.
- Four factors: Land→Rent, Labour→Wages, Capital→Interest, Organisation→Profit.
- Opportunity cost = next best alternative given up.