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Unit 1, Nature and Scope of Economics, What is Positive Economics?, Positive economics is a part of economics that contemplates the explanation and elucidation of economic, occurrence. It concentrates on certainty and cause-and-effect behavioural association and incorporates the, development and trial of economics thesis., It is the study of economics grounded on the intentional analysis. Most economists today concentrate on, the positive economic analysis, which follows what is and what has been materializing in an economy as, the rationality for any statement about the upcoming days. Positive economics stands in contradiction to, normative economics, which uses value discernments., What is Normative Economics?, Normative economics is an outlook on economics that contemplates normative or ideologically dictatorial,, discernments toward economic enhancement, statements, investment projects and framework. Disparate to, positive economics, which depends on intentional data analysis, normative economics decisively, solicitudes itself with value discernments and statements of “what has to be” rather than certitude based on, cause-and-effect declarations. Normative economics manifests ideological judgments about what may be, the outcome in an economic pursuit if public policy changes are made., A. DEFINITION OF ECONOMICS BY ADAM SMITH (WEALTH CONCEPT), Definition of Economics by Adam smith (1723 – 1790) a Scottish Philosopher and founder of Economics, wrote a book “An Inquiry into the Nature and Causes of the Wealth of Nations”was published in 1776. In, the book Adam Smith defined economics as a Science of Wealth. Some other economists like J.B Say, F.A, Walker, J.S Mills and other also declared economics as a science of wealth. According to J.B Say, Economics is the science which treats wealth. F.A Walker made it clear that economics is that body of, knowledge which relates to wealth. This view of Economics narrating economics as a science of wealth, was criticized by Carlyle, Ruskin and other economists of the 19th Century., Criticism on Adam Smith Definition of Economics, 1. Too Much Importance to Wealth. Definition of Economics by Adam Smith gives primary importance to, wealth and secondary to human being. This emphasis has now shifted from wealth to human being. Man, occupies primary place and wealth a secondary one. The real fact is that man is more important than study, of wealth., 2. Narrow Meaning of Wealth. In the definition the word “Wealth” means only material goods such as, vehicles, industries, raw material, Banks etc. it does not include immaterial goods like services of doctor,, lawyer and teachers. In modern economics definition the word “Wealth” includes both material and, immaterial goods., 3. Man Welfare is Missing. The other objection by Marshall is that man’s welfare has not been mentioned, in Adam’s definition of economics. He has stressed much on wealth. Wealth is a means to an end, the end, being the human welfare., 5. It does Not Study Means. The definition lays emphasis on the earning of wealth as an end in itself. It, ignores the means for the earning of wealth., B. MARSHALL’S WELFARE DEFINITION (WELFARE CONCEPT), Alfred Marshall in his book ‘Principles of Economics published in 1890 placed emphasis on human, activities or human welfare rather than on wealth. Emphasis on human welfare is evident in Marshall’s, own words: “Political Economy or Economics is a study of mankind in the ordinary business of life; it, examines that part of individual and social action which is most closely connected with the attainment and, with the use of the material requisites of well-being.” It studies how man attains his income and how he, utilizes it. In this way, it studies wealth, on one hand and on the other hand, it is a part of the study of man,, which is more important. According to this definition, it becomes the science of human activities instead of, science of wealth. The main features of this welfare concept is

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1., 2., 3., 4., , Economics is the science of human welfare, Economics is the study of mankind in the ordinary business of life., Economics is a social science., Economics is the study of only economics activities., , Criticism of Marshall Definition, The Marshall definition of Economics is a major improvement over the definition of Adam Smith and other, ancient Economists. This definition was recognized between 1890 to 1932 and it seemed that the controversy, relating to the definition of Economics had ended. But, Prof. Leonel Robbins in his book ‘An Essay of the, Nature and Significance of Social Science’ in 1932 criticized Marshall’s definition in loud words, which are as, follows –, 1. Illusion of Anti-Immateriality. Marshall has restricted the relation of Economics only to the attainment of, material resources and its consumption, whereas, Economics also includes the immaterial resources like, services of advocates, teachers and other employees. That is the reason Robin said “The Economist who, keeps in mind only material study, cannot save themselves from the blame of being biased to one, aspect.”, 2. Vagueness of Ordinary Business Activity. The phrase used by Marshall, “The activities relating to the, ordinary business of life is unclear and vague, because it is not clear, what activities of man comes under, ordinary business and which activities are outside its area.” According to Prof. Robbins, though there are, several such activities which come under an ordinary business of life, yet are studied in Economics, like, – study of economy at the time of war, conditions of Imperfect Competition, Monopoly, etc., 3. Unclear Economic Activities. Marshall has divided human activities in two parts, Economic and Noneconomic, which is unfair because a similar activity of man can be economic and non-economic also at, different times. Like – sweeping his own house by a servant is a non-economic activity, while sweeping, his employer’s house. becomes an economic activity., 4. Unfair to Relies Economics with Human Welfare. According to Prof Robbins, Economics has no relation, with human welfare, under this, all kind of activities must be studied, whether it is related to human, welfare or not. He gives the following arguments to prove this- production and consumption of alcohol, and other intoxicants It is not beneficial for human welfare, still it is studied in Economics., 5. Economics is Neutral between Objectives. According to Robbins, “Economics is neutral against, objectives. Objectives may be good and also bad, but this has no relation with Economics.” In his book,, Prof. Robbins writes, “Whatever Economics is concerned with; it is not concerned with the causes of, material welfare”., C. ROBBINS DEFINITION OF ECONOMICS (SCARCITY CONCEPT), Robbins definition of Economics challenged Marshall definition of Economics which was a major, improvement over the definition of Adam Smith and other ancient Economists. Before Prof. Lionel Robbins,, Prof. Marshall tried to give complete and faultless definition of economics. At that time people started thinking, that the Economic Science has completely develop and matured. But in 1932, after the publication of Prof., Robbins’s book An Essay on the Nature and Significance of Social Science, a controversy roused in the field, of Economics. He tried to give economics another shape, apart from material welfare. In the words of Robbins, Economics is the science which studies human behaviour as a relation between ends and scarce means which, have alternative uses., Characteristics of Robbins Definition, Following are the main characteristics of Robbins’ definition, 1. Unlimited Wants. According to Prof Robbins definition, human wants are unlimited. On satisfaction of, one wants, another want arises immediately and this sequence continues forever., 2. Scarce Means. Robbins definition stated that through on one side human needs are unlimited yet on the, other side, the means to satisfy these wants, like- time, power, money etc. are also limited. Due to this,, many of man’s needs remain unsatisfied., 3. Alternative Use of Scarce Means. In Robbins’s view resources to ‘satisfy man’s needs are scarce, but it, has alternative uses. In other words, he can use every resource in various objectives and activities. For, example – such a resource like land can be used in many ways, such as it can be used for agriculture or, for building a house or to established a factory etc., 4. Variation in the Intensity of wants. Robbins definition states that the intensity of man’s needs is different., Some wants are more intense than the others. Since our means are limited and all wants cannot be

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satisfied with the limited means; as a result, we have to select some more intense wants from our, unlimited wants and the less intense wants have to be either dropped or postponed to a future date., Criticism of Robbins Definition, Robbins definition could be criticized in a way that it does not practically applicable, it provides only a, theoretical view., 1. Unnecessary Enlargement of the Scope of Economics. Robbins’s definition has unnecessarily widened the, scope of economics. According to Robbins, any activity of choosing, whether it is economic or not, comes, under the scope of economics. Example – If a student thinks of choosing between studies and cinema, this, activity of decision making will also come under the scope of economics. But critics are of the opinion that, uneconomic activities should not be included in economics., 2. Unrealistic Assumption. Robbins believes that each individual does only that activities from which he derives, maximum satisfaction. But in practical life, an individual does not always compare the satisfaction he derives, from different activities but usually he acts without thinking so much. Thus, this assumption of Robbins is, unrealistic., 3. Robbin’s definition of economics transformed the subject from a normative social science into a positive, science with an undue emphasis on individual choice., 4. Robbin’s definition prevented it from analysing macroeconomic concepts such as national income, and aggregate supply and demand. Instead, economics was merely used to analyse the action of individuals,, using stylized mathematical models., , D. SAMUELSON DEFINITION OF ECONOMICS (DEVELOPMENT CONCEPT), The modern definition, attributed to the 20th-century economist, Paul Samuelson, builds upon the, definitions of the past and defines the subject as a social science. Samuelson's definition is known as a, modern definition of economics. According to Samuelson, “Economics is the study of how people and, society choose, with or without the use of money, to employ scarce productive resources which could have, alternative uses, to produce various commodities over time and distribute them for consumption now and, in the future among various persons and groups of society.” Samuelson's definition tells us that economics, is a social science and it is mainly concerned with the way how society employs its limited resources for, alternative uses. All this we find in the definition of Robbins. But Samuelson goes a step further and, discusses how a society uses limited resources for producing goods and services for present and future, consumption of various people or groups., The important features of this concept are:, 1. Problem of choice making arise due to unlimited wants and scarce means. We have to decide which, wants are to be satisfied and which of them to be deferred., 2. Wants have tendency to increase in the modern dynamic economics system, so the available, resources should be judiciously used., 3. Economics is not concerned with the identification of economic problems but it should also suggest, ways and means to solve the problems of unemployment, production, inflation etc., 4. Economists should also suggest ways how the resources of the country should be distributed among, various individuals and groups., 5. Economist should also point out the plus and minus points of different economics system., , Methods of Economic Analysis, An economic theory derives laws or generalizations through two methods: (1) Deductive Method and (2), Inductive Method., (1) Deductive Method of Economic Analysis:, The deductive method is also named as analytical, abstract or prior method. The deductive method, consists in deriving conclusions from general truths, takes few general principles and applies them draw

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conclusions. For eg. if we accept the general proposition that man is entirely motivated by self-interest. In, applying the deductive method of economic analysis, we proceed from general to particular., The classical and neo-classical school of economists notably, Ricardo, Senior, Cairnes, J.S. Mill, Malthus,, Marshall, Pigou, applied the deductive method in their economic investigations., Merits of Deductive Method:, The main merits of deductive method are as under:, (i) This method is near to reality. It is less time consuming and less expensive., (ii) The use of mathematical techniques in deducing theories of economics brings exactness and clarity in, economic analysis., (iii) There being limited scope of experimentation, the method helps in deriving economic theories., (iv) The method is simple because it is analytical., Demerits of Deductive Method:, It is true that deductive method is simple and precise, underlying assumptions are valid., (i) The deductive method is simple and precise only if the underlying assumptions are valid. More often the, assumptions turn out to be based on half truths or have no relation to reality. The conclusions drawn, from such assumptions will, therefore, be misleading., (ii) Professor Learner describes the deductive method as ‘armchair’ analysis. According to him, the, premises from which inferences are drawn may not hold good at all times, and places. As such, deductive reasoning is not applicable universally., (iii) The deductive method is highly abstract. It requires a great deal of care to avoid bad logic or faulty, economic reasoning., (2) Inductive Method of Economic Analysis:, Inductive method which also called empirical method was adopted by the “Historical School of, Economists". It involves the process of reasoning from particular facts to general principle., This method derives economic generalizations on the basis of (i) Experimentations (ii) Observations and, (iii) Statistical methods., In this method, data is collected about a certain economic phenomenon. These are systematically arranged, and the general conclusions are drawn from them., Merits of Inductive Method:, (i) It is based on facts as such the method is realistic., (ii) In order to test the economic principles, method makes statistical techniques. The inductive method is,, therefore, more reliable., (iii) Inductive method is dynamic. The changing economic phenomenon are analyzed and on the basis of, collected data, conclusions and solutions are drawn from them., (iv) Induction method also helps in future investigations., Demerits of Inductive Method:, The main weaknesses of this method are as under:, (i) If conclusions drawn from insufficient data, the generalizations obtained may be faulty., (ii) The collection of data itself is not an easy task. The sources and methods employed in the collection of, data differ from investigator to investigator. The results, therefore, may differ even with the same problem., (iii) The inductive method is time-consuming and expensive., , Definition / Meaning of Demand:, Demand is a quantity of a commodity which a buyer desires to, able to and willing to buy at a given price, during given period of time. Thus, we can say that demand can be determined by four factors which are, desire, willingness, ability to buy at particular price and at a particular period period of time., , Determinants of demand / Factors affecting demand:, The determinants of demand or factors affecting demand can be classified into two parts:, • Price of the goods or services

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Factors other than price of goods (Other factors), (A) Price of goods or services:, Price of the commodity or services is the most important factor which determinants of its demand. Law of, demand states that when price of goods or services falls, a rational consumer will buy more amount of it, i.e. demand expands and when price falls a rational consumer will buy lesser amount of commodity, i.e., demand contracts., (B) Factors other than price (other determinants):, (1) Disposable Income of Consumer: The demand for particular goods or services increases when, disposable income of consumer increases. When income of consumer falls, the demand for goods and, services also falls in most of the cases. So, there is a direct relation between income of consumer and, demand for commodity., (2) Tastes, choices and preferences of a consumer: To a considerable extent, demand is ultimately depends, on taste and preferences a consumer. These are associated with consumers directly on the basis of their, likes and dislikes. Taste choices and preferences of consumer changes with gender, age, locality and, trends., (3) Prices of related goods or services: There are two types of related goods: (a) Substitute goods and (b), Complementary goods. The demand for particular commodity depends on the prices and availability of, complementary goods and substitute goods., (a) Price of substitute goods: Substitute goods are those which can be easily used in place of one another., For example: Android phone of two different brands which offer almost the same features. If the price of a, substitute goods falls then a consumer will replace the concerned goods with the substitute ones. Hence,, the demand for concerned goods falls when prices of substitute goods falls., (b) Price of complementary goods: Complementary goods are those which are consumed together. In other, words, one good cannot be consumed without the other. For example, electronics items and electricity. If, the prices of complementary goods increase then the demand for main goods decreases and vice-versa., (4) Expectations about future prices: An expectation about the prices of goods and services affects the, present demand of goods or services. If the consumer expects the price of a goods to rise in the future then, his demand for particular goods increases in the current period and vice-versa., (5) Size of Population: The size of population also affects the demand for goods and services. If the, population increases then demand also increases. It also depends on size of population of particular agegroup for particular commodity., (6) Demonstration effect: Demonstration effect plays an important role in affecting the demand for a, product. An individual may demand something after being affected by external factors., •, , Law of Demand, The law of demand was presented by well-known economist and Prof. Alfred Marshall and it explains an, inverse relationship between price and demand for goods keeping all factors other than price constant., According to Law of Demand, “When other factors influencing demand remain unchanged, if price of a, good falls, its demand expands and if price of good rises, its demand contracts.”, Assumptions of Law of Demand:, The inverse relationship between price of the commodity and its demand is based on certain assumptions., 1. Income of consumer remains constant., 2. Tastes and Preferences of the consumer remain unchanged., 3. Price of substitute and complementary goods remain unchanged., 4. Future expectations regarding price remain the same., 5. Size of consumers remain the same., 6. The product is a normal product., 7. Buyers behave rationally., Explanation of Law of Demand:, Law of demand can be explained with the help of schedule and diagram. The schedule indicates the, willingness of a consumer to buy different amount of commodity at various prices.

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The diagram presents price of the commodity of Y axis and, demand for commodity on X axis. When price is 3; demand, for commodity is 20 units. When price rises to 5; demand, contracts to 10 unit as well as when price falls to 1; demand, expands to 60 units., By plotting the demand in the schedule at various prices, we, will get A B C D E points which represents the various, combination of price and demand. By jointing these points,, we will get demand curve DD which has negative slope;, downward from left to right indicating the inverse, relationship between price and demand of a commodity., Reasons for inverse relationship between price and demand:, 1. Income Effect: When the monetary income of the consumer remains constant but price of the goods, falls then her/his real income means purchasing power of money increases. When real income rises, a, consumer can buy more amount of goods and therefore its demand may rise. Mostly, normal goods have a, positive income effect. Inferior goods (Giffen goods) have a negative income effect. That is, when the, price of inferior goods falls, the real income of the consumer increases but the demand for these goods falls, as consumer will shift to superior goods., 2. Substitution Effect: When price of the concerned good falls, it becomes relatively cheaper than its, substitute good. Hence, a consumer will reduce the consumption of substitute goods and expand the, demand for the concerned good. This is called substitution effect., , Exceptions to the Law of Demand:, Exceptions to the law of demand means that, when price of a good falls, its demand contracts instead of, expanding and vice-versa. Thus, we can say that here, there is a direct relationship between price of a, commodity and demand., 1. Prestigious Goods: Certain goods which are priced very high like, expensive jewellery, expensive cars,, expensive mobile phones etc. and are generally consumed by very rich people are exceptions to the law of, demand. Such goods are used by the rich as their status symbols and hence, even when there is a rise in, their price, their demand expands instead of contracting. And, if their price falls, the rich may contract their, demand thinking that a fall in price means that the good is losing its prestige and losing its status., 2. Extremely Low-Priced Goods: Certain goods are extremely low-priced goods and expenditure on them, does not make any significant impact on consumer’s income. For example; pins, salt, stapler pins etc. Even, if their price rises, a consumer’s demand for these goods may not contract and if their price falls, the, consumers may not expand demand as their consumption remain the same., 3. Giffen Goods: When price of certain goods called inferior goods fall and the real income of a consumer, rises means his/her purchasing power increases, she/he may reduce the consumption of such goods and, substitute these by goods of a superior quality. These goods were named after Robert Giffen who made, such observations and explained this idea. Such goods are necessary goods and are purchased by the lowincome groups., 4. Special Preferences of People: Certain times, people get very accustomed and used to certain goods or, services. As a result, if there is some rise in the price of such goods, an individual’s demand may not, decrease. For example, a particular brand of toothpaste, shoes or clothes etc., 5. Speculative goods: In the speculative market, particularly in the market for stocks and shares, demand, increases when price of shares rise and demand decreases when price of shares reduce., , Price Elasticity of Demand, According to the law of demand, there is inverse relationship between price and demand. This means that, if the price of commodity increases, demand contracts and price decreases, demand extends. But, economists, industrialists and government must know about how much demand will change with price, elasticity of demand. In short, the rate at which demand changes with the change of price is called price, elasticity of demand. “If other factors remain unchanged, the change in demand due to change in price is, called price elasticity of demand.” According to Prof. Meyers, “The change in purchase of goods as a result, of change in price is called price elasticity of demand.”

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Equation of Price elasticity of demand:, Equation explains that price elasticity of demand is percentage change in demand divided by percentage, change in price., , •, , The types / kinds of Price elasticity of demand:, (1) Price elastic demand [PE >1]: When the price of a commodity, change, the percentage change in demand is more, it is called price, elastic demand., In the right diagram, the change in demand MM1 is more than the, change in price PP1. So, in equation the answer is always more than 1., (2) Unitary Price Elasticity [PE=1]:, When the percentage change in price of a commodity and percentage, change in demand for a commodity are equal then it is price elastic equal, to unit. In the right diagram, the change in demand and the change in price, is the same. So, in equation the answer is always 1., (3) Price inelastic demand [PE<1]:, When the percentage change in price of a commodity takes place, the, change in demand of a commodity is less, it is called price inelastic, demand. In the right diagram, the change in demand MM1 is less than the, change in price PP1; so it is called Price inelastic demand and answer of it, in equation is always less than 1., (4) Perfectly Price elastic demand [PE=∞]:, When a consumer is ready to buy maximum goods at a certain price but when, there is slight change in price, he / she is ready to buy any goods, this is called, perfectly price elastic demand. When there is a little change in price, demand, change in a great manner, it is called Perfectly price elastic demand. When, there is slight change in price causes great change in demand, it is called, Perfectly elastic demand. In equation, the answer is infinity.

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(5) Perfectly Price inelastic demand [PE=0]:, When the price of goods changes but demand remain unchanged, it is, called perfectly inelastic demand. When whatever change in price does, not matter and demand remain unchanged, it is called Perfectly inelastic, demand., , Factors affecting Price Elasticity of Demand, There are some factors which determine whether the demand for a good is elastic or inelastic which are as, following:, (1) Availability of substitutes: Availability of close substitutes is one of the most important determinants of, price elasticity of demand. If close substitutes of a concerned goods are available then it is more likely to, elastic. Some commodities like food products have close substitutes, so we can observe price elastic, demand in them as a fall in price leading consumers to buy more of the substitutes. Thus, we can say that, goods which typically have close or perfect substitutes have highly elastic demand curves. Similarly, while, there are no general substitutes for the services like health care so there will be price inelastic., (2) Position of a commodity in the consumer’s budget: If consumer spends major portion of his income on, particular commodity; so generally, such goods have the greater elasticity of demand and vice-versa. The, demand for goods like common salt, matches, buttons, etc. tend to be highly inelastic because a household, spends only nominal portion of their income on each of them., (3) Nature of the need that commodity satisfies: In general, luxury goods are price elastic while necessities, are price inelastic. Thus, while the demand for smart phone is relatively elastic than the demand for food, and housing is inelastic., (4) Number of uses to which a commodity can be put: If the commodity has alternative uses; it demands, expands more when price falls and vice versa. The more the possible uses of a commodity the greater will, be its price elasticity and vice versa. When price rises, the use of commodity become limited to essential, purposes and demand contracts., (5) Time period: The demand for short period is price inelastic and for long period, it is elastic. It is, difficult to change habits in short time as people are accustomed to certain lifestyle., (6) Consumer habits: If a consumer is a habitual consumer of a commodity, no matter how much its price, change, the demand for the commodity will be inelastic., (7) Price range: Goods which are in very high price range or in very low-price range have inelastic, demand, but those in the middle range have elastic demand., , Methods of measuring elasticity of demand., 1. The Percentage Method:, The price elasticity of demand is measured by its coefficient (Ep). This coefficient (Ep) measures the, percentage change in the quantity of a commodity demanded resulting from a given percentage change in, its price. Thus, , Where q refers to quantity demanded, p to price and Δ to change. If EP>1, demand is elastic. If EP< 1,, demand is inelastic, and Ep= 1, demand is unitary elastic., With this formula, we can compute price elasticities of demand on the basis of a demand schedule.

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Let us first take combinations B and D., (i) Suppose the price of commodity X falls from Rs. 5 per kg. to Rs. 3 per kg. and its quantity demanded, increases from 10 kgs.to 30 kgs., Then, , This shows elastic demand or elasticity of demand greater than unitary., Note:, The formula can be understood like this:, Δq = q2-q2 where q2 is the new quantity (30 kgs.) and qi the original quantity (10 kgs.)., ΔP = p2-p1 where p2 is the new price (Rs.3) and pl the original price (Rs. 5)., In the formula, p refers to the original price (p1) and q to original quantity (q1). The opposite is the case in, example (i) below, where Rs. 3 becomes the original price and 30 kgs. as the original quantity., (ii) Let us measure elasticity by moving in the reverse direction. Suppose the price of Arises from Rs. 3 per, kg. to Rs. 5 per kg. and the quantity demanded decreases from 30 kgs. to 10 kgs. Then,, , This shows unitary elasticity of demand., Notice that the value of Ep in example (ii) differs from that in example (i) depending on the direction in, which we move. This difference in the elasticities is due to the use of a different base in computing, percentage changes in each case., 2. The Point Method:, Prof. Marshall devised a geometrical method for measuring elasticity at a point on the demand curve. Let, RS be a straight-line demand curve in Figure. 2. If the price falls from PB ( = OA) to MD ( = OC), the, quantity demanded increases from OB to OD., Elasticity at point P on the RS demand curve according to the formula is:, EP = Δq/Δp x p/q, Where Δq represents change in quantity demanded, Δp changes in price level while p and q are initial price, and quantity levels.

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With the help of the point method, it is easy to point out elasticity at any point along a demand curve., Suppose that the straight line demand curve DC in Figure. 3 is 6 centimeters. Five points L, M, N, P and Q, are taken on this demand curve. The elasticity of demand at each point can be known with the help of the, above method. Let point N be in the middle of the demand curve. So elasticity of demand at point., , We arrive at the conclusion that at the mid-point on the, demand curve, the elasticity of demand is unity. Moving up the demand curve from the mid-point,, elasticity becomes greater. When the demand curve touches the Y- axis, elasticity is infinity. Ipso facto,, any point below the mid-point towards the A’-axis will show elastic demand. Elasticity becomes zero when, the demand curve touches the X -axis., 3. The Arc Method:, When elasticity is measured between two points on the same demand curve, it is known as arc elasticity. In, the words of Prof. Baumol, “Arc elasticity is a measure of the average responsiveness to price change, exhibited by a demand curve over some finite stretch of the curve.” Any two points on a demand curve, make an arc. The area between P and M on the DD curve in Figure. 4 below is an arc which measures, elasticity over a certain range of price and quantities. On any two points of a demand curve, the elasticity, coefficients are likely to be different depending upon the method of computation. Consider the pricequantity combinations P and M as given in Table. 2 below.

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If we move in the reverse direction from M to P, then, Thus, the point method of measuring elasticity at two points on a demand curve, gives different elasticity coefficients because we used a different base in computing the percentage change, in each case., To avoid this discrepancy, elasticity for the arc (PM in Figure 4 below) is calculated by taking the average, of the two prices [(p1 + p2 )½] and the average of the two quantities [(q, +q2 )½]. The formula for price, elasticity of demand at the mid-point (C in Figure 4 below) of the arc on the demand curve is, , On the basis of this formula, we can measure arc elasticity of demand when there is a movement either, from point P to M or from M to P., From P to M at point P, p1 =8, q1 = 10, and at point M, p2 = 6, q2 = 12., Applying these values, we get, , Thus, whether we move from M to P or P to M on the arc PM of the DD curve, the formula for arc, elasticity of demand gives the same numerical value. The closer the two points P and M are, the more, accurate is the measure of elasticity on the basis of this formula., If the two points which form the arc on the demand curve are so close that they almost merge into each, other, the numerical value of arc elasticity equals the numerical value of point elasticity., 4. The Total Outlay Method:, Marshall evolved the total outlay, or total revenue or total expenditure method as a measure of elasticity., By comparing the total expenditure of a purchaser both before and after the change in price, it can be, known whether his demand for a good is elastic, unity or less elastic.

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Total outlay is price multiplied by the quantity of a good purchased: Total Outlay = Price x Quantity, Demanded. This is explained with the help of the demand schedule in Table.3 below., , (i) Elastic Demand:, Demand is elastic, when with the fall in price the total expenditure increases and with the rise in price the, total expenditure decreases. Table.3 shows that when the price falls from Rs. 9 to Rs. 8, the total, expenditure increases from Rs. 18 to Rs. 24 and when price rises from Rs. 7 to Rs. 8, the total expenditure, falls from Rs. 28 to Rs. 24. Demand is elastic(Ep > 1) in this case., (ii) Unitary Elastic Demand:, When with the fall or rise in price, the total expenditure remains unchanged, the elasticity of demand is, unity. This is shown in the table when with the fall in price from Rs. 6 to Rs. 5 or with the rise in price, from Rs. 4 to Rs. 5, the total expenditure remains unchanged at Rs. 30, i.e., Ep = 1., (iii) Less Elastic Demand:, Demand is less elastic if with the fall in price, the total expenditure falls and with the rise in price the total, expenditure rises. In Table 3 when the price falls from Rs. 3 to Rs. 2, total expenditure falls from Rs. 24 to, Rs 18, and when the price rises from Re. 1 to Rs. 2. the total expenditure also rises from Rs. 10 to Rs. 18., This is the case of inelastic or less elastic demand, Ep < 1., Table 4 below summarises these relationships:, , The measurement of elasticity of demand in terms of the total outlay method is explained in the above Fig., 5 where we divide the relationship between price elasticity of demand and total expenditure into three, stages., In the first stage, when the price falls from OP4 to OP3 and to OP2 respectively, the total expenditure rises, from P4 E to P3 D and P2 C respectively. On the other hand, when the price increases from OP2 to OP3 and, OP4, the total expenditure decreases from P2 C to P3 D and P4 E respectively., Thus EC segment of total expenditure curve shows elastic demand (Ep > 1)., In the second stage, when the price falls from OP2 to OP1 or rises from OP1 to OP2, the total expenditure, equals, P2C = P1B, and the elasticity of demand is equal to the unity (Ep = 1)., In the third stage, when the price falls from Op1 to Op, the total expenditure also falls from P1 B to PA., Thus with the rise in price from OP to Op1, the total expenditure also increases from PA to P 1B and the, elasticity of demand is less than unity (Ep < 1).

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Marshall’s Partial Equilibrium Analysis and Walras General Equilibrium, Analysis, In regard to pricing under perfect competition, two main approaches have been adopted. One approach has, been followed by famous English economist Alfred Marshall who adopted the partial equilibrium approach, and the second approach has been adopted up by Walras and is called general equilibrium approach., 1. Marshall’s Partial Equilibrium Analysis, In partial equilibrium approach to the pricing, it seeks to explain the price determination of, commodity, keeping the prices of other commodities constant and also assuming that the various, commodities are not interdependent., In explaining partial equilibrium approach, Marshall writes: “The forces to be dealt with are,, however, so numerous that it is best to analyse a few at a time and to work out a number of partial, solutions as auxiliaries to our main study. Thus, we begin by isolating the primary relations of supply,, demand and price in regard to a particular commodity. We reduce to inaction all other forces by the phrase, ‘other things being equal’., Then Marshall’s partial equilibrium analysis seeks to explain the price determination of a single, commodity through the intersection of demand and supply curves, with prices of other goods, resource, prices etc., remaining the same. Given the assumption of ceteris paribus it explains the determination of a, price of a goods, say X, independently of the prices of all other goods. With the change in the data, new, demand and supply curves will be formed and, corresponding to these, new price of the commodity will be, determined., It should be noted that partial equilibrium analysis is based on the assumption that the changes in a, single sector do not significantly affect the rest of the sectors. Thus, in partial equilibrium analysis, if the, price of a good changes, it will not affect the demand for other goods., 2. Walras General Equilibrium Analysis:, In general equilibrium analysis, put forward by French Economist Walras the price of a good is not, explained to be determined independently of the prices of other goods. Since the changes in price of good, X affect the prices and quantities demanded of other goods and in turn the changes in prices and quantities, of other goods will affect the quantity demanded of the good X, the general equilibrium approach explains, the simultaneous determination of prices of all goods and factors., General equilibrium analysis deals with inter-relationship and inter-dependence between equilibrium adjustments with each other. General equilibrium exists when at the going prices, the quantities, demanded of each product and each factor are equal to their respective quantities supplied., A change in the demand or supply of any good, or factor would cause changes in prices and, quantities of all other goods and factors and there will begin the process of adjustment and readjustment in, demand, supply and prices of other goods and factors till the new general equilibrium is established., Indeed, the general equilibrium analysis is solving a system of simultaneous equations., In a general equilibrium system, the prices of all goods affect the quantity demanded of each good., Further, the prices of the all factors affect the quantity supplied of each good. Besides these crucial, equations, there will be equations determining the price of each of the factors of production. As noted, above, a change in any of the demand or supply equations would cause changes in all prices and quantities, and as a result the system will tend to move to the new general equilibrium., To explain the inter-relationship and interdependence among the prices and quantities of goods and, factors and ultimately to explain the determination of the relative prices of all goods and factors, the, proportion in which different goods are being produced and different factors are being used for the, production of different goods is the essence of general equilibrium analysis.

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Partial Equilibrium, , General Equilibrium, , (a) Micro economics uses partial equilibrium, analysis based on the assumption, other things, remaining constant., , (a) Macro economics uses general equilibrium. It, is not based on any` assumption., , (b) Partial equilibrium studies the equilibrium, of a consumer, a firm, an industry or a market, , (b) It deals with the equilibrium position of the, economy as a whole., , (c) It deals with one or two variables at a time., So it is a simple method. It is independent., , (c) It deals with all the variables of the economic, system simultaneously. So it is sophisticated., There is interdependence between variables., , (d) Partial Equilibrium is regarded as a worm's, eye-view., , (d) General Equilibrium is a bird's eye-view.