Answer Sheet Economics

Q1: Describe the basic assumptions of Economics.
Ans-
The basic problem of economics can be summarized in one sentence: How to best satisfy unlimited wants with unlimited resources.

We can break this problem into two parts:
Preferences - What do we like, what do we dislike.
Resources - We all have limited resources. Even Warren Buffett and Bill Gates have limited resources. They have the same 24 hours in a day that we do and neither is going to live forever.
All of economics, both microeconomics and macroeconomics come back to this basic problem on how to use limited resources to satisfy our preferences and unlimited wants.
Normally Economist looks for fundamental assumption of Human behaviour on which most of the principles of economics emerged. Every decision maker in any economic system whether he is consumer / customer or producer / industrialist , whether it is house hold or firm is assumed to have in a rational manner and go in for maximum gain. Economic rationality presupposes that every persons knows his interest and select that course of action , which promises him teh greatest amount of satisfaction.
Economist have assumed that all human being as are rational and they are generally influenced by the maximising principle . Every customer want maximised satisfaction , maximum value with given amount of expenditure. Similarly every producers / manufacturer want to maximise his production / output and minimise his cost.every seller minimises his profit and so on ...
But rationally and maximisation principles are based on the further assumption of perfect knowledge. Every rational consumer , for example knows the different possible alternatives open to him and will choose that alternatives that promises maximum satisfaction. However, rationality is conditioned and influenced by habits and social customs. Habits are acquired over a number of years influence the consumers in the choice of goods. Similarly , social customs influence guide and modify economic behaviour of individuals.
The assumption of economic rationality does not carry any moral or ethical implication. Rationality implies that in a period of acute shortage, producers and distributors would raise the price and secure higher profit margin. Such a behaviour may be condemned from the social point of view, but economically justified. At teh same time, it is necessary to distinguish between individual rationality and social rationality .An individual entrepreneur may like to set up his workshop in or around Mumbai as he can gets his inputs easily and dispose his output easily , profitably ; rational behaviour indicates that he set up his factory in Mumbai. But from social point of view , this may not be rational and proper. For, Mumbai is already overcrowded by high density of population . Besides , there are so many backward areas , which need industrialisation. From teh social point of view it would have been better that the new factory is set up away from Mumbai. There is thus a possibility of clash between individual rationality and social rationality.
Rational Maximizing Behaviour -In order to simply model how humans attempt to do this, we need a basic behavioural assumption. The assumption is that people attempt to maximize outcomes (that is, to do as well as possible for themselves) as defined by their preferences given their resource constraints. Economists refer to people who do this as exhibiting 'rational maximizing behaviour'. Note that in more complex economic models that this assumption can be weakened, but at a cost of added complexity.
This 'rational maximizing behaviour' assumption doe not necessarily mean that people make, ex ante, perfect decisions. People may be limited by the amount of information they have (e.g. 'It seemed like a good idea at the time!'). As well, 'rational maximizing behavior' says nothing about the quality or nature of people's preferences (But I enjoy hitting myself on the head with a hammer!')
Tradeoffs - You Get What You Give -The struggle between preferences and constraints means that economists must, at their core, deal with the problem of tradeoffs. In order to get something we must use up some of our resources. Examples: You give up Rs200 to obtain the new best seller from Amazon.com. I give up 3 hours of time to watch the Blue Jays game on T.V. ('That's three hours of my life I will never get back!')

Q.2 Discuss the vital functions of an economy.
Ans: Human exists by the vital process of Feeding, digestion and growth. Similarly economy have its vital process – which is production , consumption and growth. All economies perform these three basic functions although they differs with the regard to the volume of production and consumption and rate of growth.
Production of Goods and Services : First and foremost function of an economy is production , which takes place continuously. Different variety of food, clothing, entertainment and amusement, radios, cinemas etc are produces by the economy. Production consists of final – consumption of goods, services of all types, products in different stage of production etc. According to economist , production is not complete unless product is taken to the hands of consumer , and accordingly production embraces trade also. The process of production continues till the product reaches to consumer/ end user.
The term “Production” is a braod one and is includes various kind of production. Production may take the form of transformation of one product into another , that is from a commodity with lower utility to another commodity, which has higher utility. e.g. Production of cloth from a yarn. Here production actual stands manufacturing. In primary productions i.e. in Agriculture and Mining, the farmer does not produce wheat or Miner does not mine coal. Man co operate with nature and extracts them. Extraction is production. Production is also takes place when a commodity is shifted from ne place to another from teh region of lower utility to higher utility. Transportation is also means of production. Finally production takes place where commodity is stores over a time from a period is not so much wanted to another priod when it is wanted one. These three different types of production are generally known as creation of form utility , place utility and time utility. Production refers only to the first and term trade or commerce is used to last two. In economics all three are collectively called production. The farmer , manufacturer , the trader , the banker – all are producers.
The modern economy is a modern economy and hence the products – goods and services which does not command money may be excluded from production, even though they are important from the point of view of welfare of teh community.

Consumption of Goods and Services – Productions of goods and ervices has no meaning unless it is satisfy for human consumption, the act of satisfying one’s want is second vital process of the economy. Consumption implies the using up of material goods and of immaterial services. Consumption may ne be of different types. There are many goods , which are used up and destroyed when they were consumed. E.g. food. There are some goods which are produced and consumed simultaneously - example services of doctors / waiters. But there are many cases , where are number of stages between production and consumption. In case of many finished manufactured articles say a cotton bush shirt, number of intermediate manufacturing process may be involved for instance , the raw material stage, semi finish ed stage, the wholesale stage and retail stage . The goods , which are in the intermediate stages are known as investment goods. There are some goods, which are not consumed away , but continue to provide services for long time as they are available. These are consumer durable goods like refrigerator, furniture , house, clothes etc. It is difficult to estimate how much service a person secures from consumption of durable goods in any period, say a month . Hence Economist includes these goods under the category of consumption at the moment they are brought by consumer.
Growth – Economy needs to grow by using its resources to the fullest possible extent . Failing to this , it will become stagnant . In a growing economy , the rate of output steadily increases. The rate of growth must exceed rate of growth in population. Hence growing economy means growing per capital income of the country. A developing country allocates parts of resources for the production of capital goods which in turn will produce other goods . The greater size of capital stock of the country , the larger will be income of the community. The capital goods refers to machinery , factory buildings, transport systems etc. Those capital goods are used over the years are known as fixed investment goods or fixed capital goods when in course of time these goods becomes worst or obsolete, they have to be repaired or reshaped. This is known as maintaining capital intact. A developing economy should devote its resources not only to maintain capital but also accumulate capital.
Thus the vital functions of the economy are of three of types – production , consumption and investment. Every economy has three vital processes, though they may differ with regard to the volume of production and consumption and rate of growth.

Q.3 Write an essay on a features of the capitalist economy.
Ans –
The capitalist system is an economic order in which all means of production – land , labour , capital and organisation are privately owned and managed and in which production takes placefor private profit. The profit motive in the driving force behind all economic activity in teh capitalist system. As the economy is based on free enterprises and thegovernment does not interfere in the working of the economy, the system has come to be known as free enterprise economy or laissez faire economy. The basic features of a capitalist economy are as followings.
I. The system of Private Property - In a capitalist economy all means of production are privatelt owned i.e they belong to private individuals , institutions and companies. The system of private property implies taht teh owner of property can use it in any way he likes , subjecy, of course , to the rules and the laws of the state.The statet , of curse can place certain restrictions on teh rights and powers of the owner of property. For instances , owners of business may be asked to follow some minimum safety provisions prescribed by the law to protect teh lives of the workers working under them. A company can be prevented from producing obscene books or harmful drugs or anti social things. But subject to teh general restrictions and regulations imposed by the states, the owner of the property are free to utilise them in any way he want to do. The cheif advantage of the private property are teh pride and pleasure of ownership and consequently personal interest in the property, initiative to put it to the best use,
II. Economic Freedoms – The capitalist system is based on a number of economic freedoms. Individuals and business are free to consume whatever they like. Free choice of consumption determines the nature and volume of goods and services which should be produces. Most of common people are easily lead by advertisements. Too much income spent on cinema, liquor etc. Freedom of consumption implies freedom of production too. The economy produces goods and services to satisfy wishes and preference of consumers. Hence freedom of choice of consumers and freedom of production are basic to the capitalist economy.
III. Perfect Competition : Competition is act of striving for something that is sought by another at the same time. It is the basis of the free market mechanism – when there is freedom in choosing an economic activity, there is intense competition in preference of the same or alternate activity. Worker compete with one another and hence only best gets the jobs. Producers compete in obtaining factors of production and only ; thsdi also implies that the factor units will get maximum price for their services . Seller compete in selling their products and their products and their competition will lower the prices. Consumers compete in buying goods and thus help to raise the prices. Competition plays a special role in capitalist economy. The intense competition will lead to lower the profits. Under perfectly competitive conditions , all excess profits will be competed away and only normal profits , which are only compensation for managerial labour exist. From public welfare point of view, competition regulates or reduces the price, improve production efficiency .
IV. Individual Initiative and profit motive : The capitalist economy is based on profits motive and individual initiative. Producers are not concerned about the welfare of teh community or of the interests of any particular group. They take into account only their cost of production and the anticipated prices for their products. They will get a profit if their calculations are correct , if not , they will incur losses. The profit motive encourage productive activity , enterprise and risk taking. It determines the character of business and economic activity , for resources will continuously shift from less profitable uses. It is responsible for efficiency in production. The profit motive is based on, and is related to , teh assumption of risk. There are all kinds of risks, which have to be borne business firm. Changes in market conditions and consumer preferences , strikes and lock outs , cyclic fluctuations , technological changes , new processes and products etc. all these may drive an organiser from the market. At the same time, new taxes may deprive him of all his anticipated profits. Such risk are the prices if industrial progress. The greater the risk , greater possibility of profits.
Related to the profit motive is the main characteristics of the individual initiative. Individual initiative extends to every sphere of economic activity . Individual initiative and economic freedom are restricted by the Government in the interest of Public health , social justice etc.
V. The Role of the Government – In the classical analysis , the government was not expected to interfere with the working of the market mechanism. Apart from defence and maintenance of law and order, the government was to perform only three economic functions
Establish a uniform framework within which the individual could function more efficiently and more effectively e.g. Coinage, Weights and measures, uniformity ikn standards of quality etc.
Provide certain facilities which private enterprise by itself will not provide or will provide only inadequately e.e Educational facilities, Public health etc.
Resolve conflicts among individuals and protect the weak from the exploitation from the rich.

Q.5 Write an essay on Localisation of Industries.
Ans,
Concentration of an industry in an area is known as localisation of industry . Industries tends to be concentrated in particular area, regions. Ths sugar industry in UP, Bihar and Maharashtra, leather goods in UP, West Bengal and cotton textile industry in Mumbai, Coimbatore, Chennai etc are example of localised industries. Just as individual specialise in the production of that commodity of service in which they have special abilities , so alos regions may specialise in the production of that commodity in which they enjoy special advantage. The sugar industry is located in western Maharashtra because sugarcane is grown in these area. Tea plantation are found in Assam because natural advantage , which Assam has for the cultivation of Tea.
Factors Governing Localisation –
The most important factor governing localisation is the special geographical advantages ,. There should be easy availability of raw material , nearness to source of power and proximity to markets. When the industrial units are located near the source of material or of power or of markets, transport costs are minimised, especially when raw materials are bulky. This is the case of sugar industry in UP and Bihar which produce sugarcane in abundance. All steel plants are located either near to mines or near coal mines.
Nearness to source of Power is another important factors which facilitates location of an industry in particular region. In the past , the main sources of power were coal. Therefore , many industries tended to concentrated in those regions where coal was to found in plenty.
Proximity to markets also influence the location of certain industries in certain areas. It is advantageous for an industry to have a wide market , and transport cost is minimised if the industry located near the markets. It is for the reason thatmany industrial units are situated near a large consuming area. Example auto ancillary units are in industrial areas where large auto manufacturing company is situated. Example – Pune, Faridabad , etc.
It is necessary to emphasize the role of transportation in the location of an industry in a particular region. Transport cost induces an industry to be located near an important but bulky raw material, It may also induces the industry to be located near to the market for its products. An industry producing for the export market tends to get localised near ports. This is particularly true when the industry makes use of some imported raw material .
Availability of skilled labour and capital are important factors which may facilitate the localisation of industries. Availability of trained labour is a greater advantage to newly started industrial units . This is probably one of the important reasons which explains why new enterprises are set up in old industrial areas. Finance is very essential to every industry and wherever banks and other financial institutions come together , various industrial units also set up. Mumbai , Pune, Faridabad are leading industrial cities in india because of the availability of credit facilities in abundance. However , it is necessary to appreciate teh fact that banks and financial institutions tends to be stared in those areas which are already developed or which have become industrial area. Abundance of technical labour and supply of capital area as much causes helping localisation of industries as effects of localisation.
Sometimes an industry may get localised not because of any important reason but due to pure chance. In America , Detroit is the centre of the car industry through sheer chance. When Henry Ford , great car manufacturer wanted to set up a factory, he set up in his home town ie. Detroit. In India , we find some industry set up in particular area due to political influence. In the past , Hyderabad , Mysore and other native states provided facilities to industrialist to set up industrial units in their capital town. In India , pressure us brought to bear upon the Union Government to set up particular plant in certain territories.
Religion and Historical factors may also responsible for localisation if certain industry. The concentration of teh bell metal industry in pilgrimage centers and teh location of silk manufacturers , embroidery and similar work in places which were formerly court of native states.
Thus localisation of industry may not be due to one particular reason but combination of multiple reasons. When the government decides to setup important industry in an area, it has to consider all economic and non economic advantages as well as disadvantages.