Chapter 1

Economic Activity

What are Economic Activities?

All humans perform a variety of activities on any given day. There is work that we do every day and other
activities we do for personal fulfillment and joy. So as a general rule, we can say that all the activities we do
to earn a living are economic activities. All other activities are non-economic activities.

One way to identify economic activities is that they are driven by rationality and logic. The reason for
performing such activities is for our own self-interest. We will gauge what returns we get in exchange for
performing such activities. Non-economic activities, on the other hand, are done for emotional reasons or
concern for another person. So all religious, charitable, social, patriotic, recreational activities are non-
economic activities.

But it is not always easy to determine the nature of an activity. If you enjoy painting as a hobby it is a non-
economic activity. However, if you sell your paintings then it becomes an economic activity. So the motive
behind doing any activity is a strong indicator of its nature.

Characteristics of Economic Activities

We will now see some distinguishing characteristics of features of economic activities that will help us
determine and identify economic activities from non-economic activities.

1] Income Generation

All economic activities will generate some form of income. It is not compulsory that such income is in
monetary terms, it can be in different kinds. So, if the activity is a form of livelihood for the person, and it
generates him any form of income then it is an economic activity. For example, a labourer who toils the land
and gets paid in crops, this is an economic activity.

So when you employ any one of the factors of production (land, capital, labour, entrepreneur) and in return
earn an income in form of wages, salary, rent, royalty, profit, etc, we will classify such an activity as an
economic activity. For example, rent earned on a property.

2] Productive in Nature

If the activity is a means of livelihood it means it implies that there was some element of the production
process involved. So an economic activity must be productive in nature, it must involve some aspect of the
production of goods and/or services.
Let us see some examples. A worker in a factory is producing goods, a software engineer is providing
services, a teacher also produces services. Similarly, farming is an economic activity as again it helps in
production.

One point to note is that even if the production is for self-consumption it is still a productive activity and so
it is an economic activity. Because it will still add to the overall supply of the market. Also, all other activities
like warehousing, transporting, etc which help bring the products to the market are also productive
economic activities.

3] Consumption is also an Economic Activity

Consumption is the demand side of the market. It is what generates the production and the supply of goods
and services. The consumption of goods promotes competition and introduction of better products in the
market. So consumption encourages production activities, so it is in itself an economic activity.

4] Savings, Investment, Wealth

Savings is the income that is not spent. Such savings are invested in a variety of instruments such as savings
account, term deposits, the stock market, mutual funds, real estate, gold, etc. So such investment turns to
wealth. Then the private and public companies borrow such monies to invest in their business and further
economic activities in the country.

Source: https://www.toppr.com/guides/commercial-knowledge/business-and-commercial-
knowledge/what-are-economic-activities/

Chapter 2

The Science of Economics

The nature of economics

Economics is the scientific study of the ownership, use, and exchange of scarce resources - often
shortened to the science of scarcity. Economics is regarded as a social science because it uses scientific
methods to build theories that can help explain the behaviour of individuals, groups and organisations.
Economics attempts to explain economic behaviour, which arises when scarce resources are exchanged.

In terms of methodology, economists, like other social scientists, are not able to undertake controlled
experiments in the way that chemists and biologists are. Hence, economists have to employ different
methods, based primarily on observation and deduction and the construction of abstract models.

As the social sciences have evolved over the last 100 years, they have become increasingly specialised.
This is true for economics, as witnessed by the development of many different strands of investigation
including micro and macro economics, pure and applied economics,
and industrial and financial economics. What links them all is the attempt to understand how and why
exchange takes place, and how exchange creates benefits and costs for the participants.

The methods used by economists

Economists use scientific observation and deduction in their investigations. To achieve this they:

Describe and measure the exchanges they observe

Economists describe changes in economic variables, and measure these changes over time. For example,
economists describe and measure how interaction in markets determines the prices of such diverse
products as motor cars, houses, haircuts, and computer software. Measurement in economics can take
many forms, including measuring absolute and relative quantities and values. When measuring relative
values it is common to use index numbers.

Explain how interactions arise and create costs and benefits

Economists try to explain the effects, or results, of economic transactions. For example, economists can
explain why, despite bubbles and crashes, the long-run trend in house prices in the UK has been
upwards over the last 30 years, and can identify those who have been affected positively and negatively
by this increase. Of course, economists also try to explain the short-term movements in prices, and how
they also have costs and benefits.

Propose hypotheses, construct, and apply ‘models’ to test these hypotheses.

Like all scientists, economists develop hypotheses to explain why economic behaviour takes place, and
then construct models to test these hypotheses. For example, economists may propose that price rises
are caused by excess demand, and then attempt to construct a model of price that explains how excess
demand can raise price. Economists frequently use versions of the demand and supply model to help
explain events such as house price trends and movements. Economic models usually employ graphical
and mathematical analysis to help explain and illustrate such economic processes.

Gather data to put into the model

Models must be tested against the real world, which means gathering statistical data about real events.
In this way, a model can be improved and revised when necessary.

Predict behaviour based on these models.

The ultimate goal of the economist is to predict future behaviour. For example, by using a demand and
supply model and by inputting real data about the housing market, economists can show that even a
small fall in bank lending can trigger behaviour that leads to a significant fall in house prices in the short
run. The ultimate value of an economic model is that it can accurately predict the onset and the effect of
an economic event. The better the model is, the more useful it is in helping economists make
predictions.
Economists assume that economic events and phenomena do not occur at random, but are determined
by underlying and understandable causes. Unlike the pure scientist, economists cannot undertake
controlled experiments, so they must test their models in different ways. Statistical analysis of actual
economic data can provide a flow of information from which to build models and test hypotheses. For
example, by gathering data about changes in house prices it is possible to deduce factors that cause
house prices to go up or down, and by how much. Economists use index numbers to help make
comparisons between countries and over time.

Source: https://www.economicsonline.co.uk/Competitive_markets/What_is_economics.html

Chapter 3

Different Economic Systems

The Four Types of Economies

1. Traditional Economic System

The traditional economic system is the most traditional and ancient types of economies in the
world. Vast portions of the world still function under a traditional economic system. These areas tend
to be rural, second- or third-world, and closely tied to the land, usually through farming. In general, in
this type of economic system, a surplus would be rare. Each member of a traditional economy has a
more specific and pronounced role, and these societies tend to be very close-knit and socially
satisfied. However, they do lack access to technology and advanced medicine.

2. Command Economic System

In a command economic system, a large part of the economic system is controlled by a centralized
power. For example, in the USSR most decisions were made by the central government. This type of
economy was the core of the communist philosophy.

Since the government is such a central feature of the economy, it is often involved in everything from
planning to redistributing resources. A command economy is capable of creating a healthy supply of
its resources, and it rewards its people with affordable prices. This capability also means that the
government usually owns all the critical industries like utilities, aviation, and railroad.

In a command economy, it is theoretically possible for the government to create enough jobs and
provide goods and services at an affordable rate. However, in reality, most command economies tend
to focus on the most valuable resources like oil.

China or D.P.R.K. (North Korea) are examples of command economies.

Advantages of Command Economic Systems

 If executed correctly, the government can mobilize resources on a massive scale. This mobility
can provide jobs for almost all of the citizens.
 The government can focus on the good of society rather than an individual. This focus could
lead to a more efficient use of resources.
Disadvantages of Command Economic Systems

 It is hard for central planners to provide for everyone’s needs. This challenge forces the
government to ration because it cannot calculate demand since it sets prices.
 There is a lack of innovation since there is no need to take any risk. Workers are also forced to
pursue jobs the government deems fit.

3. Market Economic System

In a free market economy, firms and households act in self-interest to determine how resources get
allocated, what goods get produced and who buys the goods. This is opposite to how a command
economy works, where the central government gets to keep the profits.

There is no government intervention in a pure market economy (“laissez-faire“). However, no truly

free market economy exists in the world. For example, while America is a capitalist nation, our
government still regulates (or attempts to control) fair trade, government programs, honest business,
monopolies, etc.

In this type of economy, there is a separation of the government and the market. This separation
prevents the government from becoming too powerful and keeps their interests aligned with that of
the markets.

Historically, Hong Kong is considered an example of a free market society.

Advantages of a Free Market Economy

 Consumers pay the highest price they want to, and businesses only produce profitable goods
and services. There is a lot of incentive for entrepreneurship.
 This competition for resources leads to the most efficient use of the factors of production
since businesses are very competitive.
 Businesses invest heavily in research and development. There is an incentive for constant
innovation as companies compete to provide better products for consumers.
Disadvantages of a Free Market Economy

 Due to the fiercely competitive nature of a free market, businesses will not care for the
disadvantaged like the elderly or disabled. This lack of focus on societal benefit leads to higher
income inequality.
  Since the market is driven solely by self-interest, economic needs have a priority over social
and human needs like providing healthcare for the poor. Consumers can also be exploited by
monopolies.

4. Mixed Economic System

A mixed economy is a combination of different types of economic systems. This economic system is a
cross between a market economy and command economy. In the most common types of mixed
economies, the market is more or less free of government ownership except for a few key areas like
transportation or sensitive industries like defense and railroad.

However, the government is also usually involved in the regulation of private businesses. The idea
behind a mixed economy was to use the best of both worlds – incorporate policies that are socialist
and capitalist.

To a certain extent, most countries have a mixed economic system. For example, India and France are
mixed economies.
Advantages of Mixed Economies

 There is less government intervention than a command economy. This results in private
businesses that can run more efficiently and cut costs down than a government entity might.
 The government can intervene to correct market failures. For example, most governments will
come in and break up large companies if they abuse monopoly power. Another example could
be the taxation of harmful products like cigarettes to reduce a negative externality of
consumption.
 Governments can create safety net programs like healthcare or social security.
 In a mixed economy, governments can use taxation policies to redistribute income and reduce
inequality.
Disadvantages of Mixed Economies

 There are criticisms from both sides arguing that sometimes there is too much government
intervention, and sometimes there isn’t enough.
 A common problem is that the state run industries are often subsidized by the government
and run into large debts because they are uncompetitive.

Source: https://www.intelligenteconomist.com/types-of-economies/
 Chapter 4

The Limits on Economic Freedom

Economic freedom

Lane Kenworthy, The Good Society

September 2016

Economic freedom is the ability of people to engage in economic pursuits — producing, selling, and
buying goods, services, and labor — as they choose. What is the role of economic freedom in a good
society? How do we measure it? What is the relationship between economic freedom and economic
affluence? Is a big government compatible with economic freedom?

THE ROLE OF ECONOMIC FREEDOM IN A GOOD SOCIETY

Economic liberty often is promoted as a means to other valuable ends. Milton Friedman, one of
economic liberty’s most forceful advocates, argued that it is key to economic growth, rising living
standards, and political liberty.

Others rest the case for economic liberty on its intrinsic value. Amartya Sen, for instance, argues that the
ability to pursue economic choices is one of the most important elements of human capability. We
should value it as an end in itself, rather than solely or mainly as a means to other ends.

Is individual liberty paramount? Few people think it should trump all other considerations. Virtually
everyone supports government paternalism in the form of property protection, traffic lights, and food
safety regulations, to mention just a few examples. And many people support public social programs.

Once basic needs are met, people tend to want more security, greater opportunity, and enhanced
fairness. They are willing to allocate some of their present and future income to guarantee these things,
and they are willing to allow government to take on that task. Government social programs thus tend to
expand in size and scope as nations grow richer.

MEASURING ECONOMIC FREEDOM

The Heritage Foundation and the Wall Street Journal have created an economic freedom index that
identifies ten dimensions of economic freedom, which can be grouped into three categories.
Good government

 Secure property rights. Individuals are permitted to buy and sell property, and to profit from
doing so. Privately-owned property is protected by law from theft and expropriation. Voluntary
contracts are enforced. And some types of innovations are protected by copyright or patents.
  Low corruption. Bribery, extortion, nepotism, cronyism, patronage, embezzlement, graft, and
other types of corruption impede pursuit of economic activity and exchange. Transparency, an
effective legal regime, and strong norms help to limit corruption.
 Stable currency and market-determined prices (“monetary freedom”). High inflation reduces
economic actors’ ability to plan for the future. Government wage or price controls interfere with
the freedom of firms and workers to buy and sell as they choose.

Light regulation of economic activity

 Ability to establish and run an enterprise (“business freedom”). Regulations (licensing
requirements, safety rules, and others), subsidies to existing firms, and implicit guarantees of
government bailout can impede the creation of new firms and the freedom of firms to operate as
they choose.
 Ability to hire and fire employees and determine work hours and work conditions (“labor
freedom”). Here impediments include rules governing hiring and work hours and restrictions on
firing and working conditions. These restrictions may come from government or from collective
bargaining with unions.
 Ability to import and export (“trade freedom”). The freedom to buy and sell should apply not only
to goods and services produced domestically but also to those from abroad. Tariffs, quotas, and
other restrictions impede this capability.
 Investment freedom. Governments and other economic actors sometimes place restrictions on
the movement of capital. Some limits are needed to protect consumers and safeguard the
financial system, but extensive restrictions impinge on the liberty of investors and of potential
recipients of investment.
 Financial freedom. Equity markets and other financial markets require some regulation,
particularly to ensure transparency and, again, to safeguard the stability and continuation of the
financial system and the broader economy. But excessive intervention unnecessarily reduces
choice.

Low taxes and government spending

 Low taxes (“fiscal freedom”). Taxes reduce individuals’ and firms’ ability to use their income and
wealth as they choose.
 Low government spending. Government expenditures on goods, services, and transfers can crowd
out opportunities for private enterprise.

NEGATIVE AND POSITIVE LIBERTY

Isaiah Berlin, in his essay “Two Concepts of Liberty,” famously distinguished between negative freedom
and positive freedom. Negative freedom refers to the absence of restrictions on choice. Positive
freedom refers to people’s capability to choose and act. Securing positive economic freedom may
require reduction of negative freedom. For instance, establishment and enforcement of property rights
reduces negative economic liberty. But that reduction is more than offset by the fact that property
rights expand people’s capability to produce, buy, and sell. The same is true of bankruptcy laws, patent
protection, public schooling, provision of infrastructure, and many other institutions.

There is no universal law that can tell us whether a particular institution or government policy will
contract or expand economic freedom overall. We have to weigh the evidence on a case-by-case basis.
Source: https://lanekenworthy.net/economic-freedom/

Chapter 5

Central Control of The Economy

Centrally Planned Economy

REVIEWED BY WILL KENTON

Updated Apr 17, 2018

What is a Centrally Planned Economy

A centrally planned economy is an economic system in which the state or government makes economic
decisions rather than the these being made by the interaction between consumers and businesses.
Unlike a market economy — in which private citizens and business owners make production decisions —
a centrally planned economy controls what is produced and the distribution and use of resources. State-
owned enterprises undertake the production of goods and services.

BREAKING DOWN Centrally Planned Economy

Centrally planned economies are also called command economies. In these kinds of economies, prices
are all controlled, the government sets plans for the future and the economy is handled by bureaucrats.
There is generally no reward for taking an economic risk and corporations are not allowed to fail.

Most developed nations have mixed economies that combine aspects of central planning with the free
market systems promoted by classical and neoclassical economists. Most of these systems skew heavily
toward free markets, with government interventions only for certain trade protections and coordination
of certain public services.

Theory of Central Planning

Centrally planned economies assume that the market does not work in the best interest of the people
and that a central authority needs to make decisions to meet social and national objectives. These
justifications are often made on the grounds of egalitarianism, environmentalism, anti-corruption or
anti-consumerism, which proponents of central planning do not consider that the free market
adequately addresses. The state can set prices for goods and determine how much is produced, and it
can focus labor and resources on industries and projects without having to wait for investment capital
from the private sector.

Opponents of economic planning do not believe that a central entity has the capacity to collect or
analyze the financial data required to make major economic determinations. They argue
that socialist and communist systems lead to inefficiencies and lost aggregate utility.

Free market economies are founded on the assumption that people seek to maximize personal financial
utility and firms are profit-seeking. Each economic actor acts in its own best interest given the
consumption, investment or production options before it. In this way, these economic actors assure that
price and quantity equilibrium are met and that utility is maximized. Central planning has a different
motivation at its core, relying instead on moral obligation and membership within a community.

Problems With Centrally Planned Economies

There are several general criticisms regarding centrally planned economies. Those opposed say that
governments just don’t have the ability to properly predict the future, and therefore, cannot come up
with proper plans for the economy. These kinds of economies are also considered inflexible, in that
there is a degree of difficulty when it comes to responding to any surpluses or shortages. Because the
government is responsible for making economic decisions, it’s believed that there is a greater likelihood
of corruption that does not necessarily come with a free market or mixed economy. Finally, there is the
sense that with a centrally planned economy, comes more political repression — because consumers
are not able to freely make choices, the government rules with an iron fist.

Examples of Centrally Planned Economies

Communist and socialist systems are the most noteworthy examples in which governments control the
factors of economic production. Central planning is often associated with Marxist-Leninist theory and
the former Soviet Union, China, Vietnam and Cuba. The economic performance of these states have
been mixed, though they generally trailed more capitalist countries in terms of growth. Historically,
most centrally planned economies have been administered in authoritarian states, though participation
in such an economy could theoretically also be elective.

Source: https://www.investopedia.com/terms/c/centrally-planned-economy.asp

Chapter 6

Mixed Economies

BY KIMBERLY AMADEO

Updated January 20, 2019

3q11

Source: https://www.thebalance.com/mixed-economy-definition-pros-cons-examples-3305594

Chapter 7

Utility and Prices

Utility
REVIEWED BY WILL KENTON

Updated Mar 29, 2019

What is Utility
Utility is an economic term introduced by the noted 18th century Swiss mathematician Daniel Bernoulli
referring to the total satisfaction received from consuming a good or service. The economic utility of a
good or service is important to understand because it will directly influence the demand, and therefore
price, of that good or service. A consumer's utility is hard to measure, however, but it can be
determined indirectly with consumer behavior theories, which assume that consumers will strive to
maximize their utility.

BREAKING DOWN Utility

Classical economists operate under the assumption that all utilities can be measured as a hard number.
To help with this quantitative measurement of satisfaction, the designation of a util was created to
represent the amount of psychological satisfaction a specific good or service generates, for a subset of
people in various situations.

If, for example, an individual judges that a piece of pizza will yield 10 utils and that a bowl of pasta will
yield 12 utils, that individual will know that eating the pasta will be more satisfying. For the producers of
pizza and pasta, knowing that the average bowl of pasta will yield 2 additional utils will help them price
pasta slightly higher than pizza.

Additionally, utils can decrease as the number of products or services as consumption increases. The
first slice of pizza may yield 10 utils, but as more pizza is consumed, the utils may decrease as people
become full. This will help consumers understand how to maximize their utility by allocating their money
between multiple types of goods and services as well as help companies understand how to structure
tiered pricing.

The Definition of Total Utility

Total utility (TU) is defined as the total amount of satisfaction that a person can receive from the
consumption of all units of a specific product or service. Using the example above, if a person can only
consume three slices of pizza and the first slice of pizza consumed yields 10 utils, the second slice of
pizza consumed yields 8 utils and the third slice yields 2 utils, the total utility of pizza would be 20 utils.

TU can be infinite. Its upper boundary is set by the total number of a good or service available for
consumption by a consumer.

The Definition of Marginal Utility

Marginal utility (MU) is defined as the additional utility gained from the consumption of one additional
unit of a good or service. Using the same example, if the utility of the first slice of pizza is 10 utils and the
utility of the second slice is 8 utils, the MU of eating the second slice is 8 utils. If the utility of a third slice
is 2 utils, the MU of eating that third slice is 2 utils.

Source: https://www.investopedia.com/terms/u/utility.asp
 Chapter 8

Supply and Demand

Chapter 9

Some Economic Laws

Chapter 10

Labour and Capital

Chapter 11

Markets and Monopolies

Chapter 12

The Open Market

Chapter 13

Money and Banking