Economy is a social science concerned with the production, distribution, exchange, and consumption of goods and services.  Economists focus on the way in which individuals, groups, business enterprises, and governments seek to achieve efficiently and economic objective they select.

Standard economics can be divided into two major fields.

The first, PRICE THEORY OR MICROECONOMICS, explains how the interplay of supply and demand in competitive markets creates a multitude of individual prices, wage rates, profit margins, and rental changes. Microeconomics assumes that people behave rationally.   Consumers try to spend their income in ways that give them as much pleasure as possible.  As economists say, they maximize utility.  For their part, entrepreneurs seek as much profit as they can extract from their operations.

Macroeconomics focuses on the performance, structure, behavious and decision making of the economy as a whole. It focuses factors like national income and employment etc. The aim of macroeconomics is to understand the interrelationship between these factors and between various sectors of economy. Macroeconomics dates from the book, “The General Theory of Employment, Interest, and Money” (1935), by the British economist John Maynard Keynes.  His explanation of prosperity and depression centres on the total or aggregate demand for goods and services by consumers, business investors, and governments.  According to Keynes, inadequate aggregate demand increases unemployment, the indicated cure is either more investment by businesses or more spending and consequently larger budget deficits by government.

History of Economic Thought

Economic issues have occupied people’s minds throughout the ages. Aristotle and Plato in ancient Greece wrote problems of wealth, property, and trade.  Both were prejudiced against commerce, feeling that to live by trade was undesirable.  The Romans borrowed their economic ideas from the Greeks and showed the same contempt for trade.

During the middle Ages the economic ideas of the

Roman Catholic Church were expressed in the canon law, which condemned usury (the taking of interest for money loaned) and regarded commerce as inferior to agriculture. 

Economics as a subject of modern study dates from the work, “Inquiry into the Nature and Causes of the Wealth of Nations” (1776), by the Scottish philosopher and economist Adam Smith.

CLASSICAL ECONOMICS

Classical economics starts with Smith, continues with the British economists Thomas Robert Malthus and David Ricardo, and culminates with John Stuart Mill. From Ricardo, classicists derived the notion of diminishing returns[1], which held that as more labor and capital were applied to land, yields after “a certain and not very advanced stage in the progress of agriculture steadily diminished.”

Through AdamSmith’s emphasis on consumption, rather than production, the scope of economics was considerably broadened. Smith was optimistic about the chances of improving general standards of life.  He called attention to the importance of permitting individuals to follow their self-interest as a means of promoting national prosperity.

Malthus, on the other hand, in his enormously influential book “An Essay on the Principle of Population” (1798), imparted a tone of gloom to classical economics, arguing that hopes for prosperity were fated to founder on the rock of excessive population growth. 

Mill’s Principles of political Economy was the leading text on the subject until the end of the 19th century.  Although Mill accepted the major theories of his classical predecessor, he held out more hope than did Ricardo and Malthus that the working class could be educated into rational limitation of their own numbers.  Mill was also a reformer who was quite willing to tax inheritances heavily and even to allow government a larger role in protecting children and workers. He was far more critical than other classical economists of business behaviour and favoured worker ownership of factories. Mill thus represents a bridge between classical laissez-faire economics and an emerging welfare state.

The classical economists also accepted Say’s Law of Markets, the doctrine of the French economist Jean Baptiste Say.  Say’s law holds that the danger of general unemployment of “glut” in a competitive economy is negligible because production tends to create its own matching demand up to the limit of human labour and the natural resources available for production.  Each enlargement of output adds to the wages and other incomes that constitute the funds needed to purchase added output.

THE NEOCLASSICISTS

Classical economists proceeded from the assumption of scarcity, such as the law of diminishing returns and Malthusian population doctrine.  Dating from the 1870s, neoclassicist economists such as William Stanley Jevons in Great Britain, Leon Walras in France, and Karl Menger in Austria shifted emphasis from limitations on supply in interpretations of consumer choice in psychological terms.

British economist Alfred Marshall, particularly in his masterly neoclassicist work “Principles of Economic” (1890), explained demand by the principle of marginal utility, and supply by the rule of marginal productivity (the cost of producing the last item of a given quantity).

By implication, if not direct statement, the tendency of neoclassical doctrine has been politically conservative.  Its advocates distinctly prefer competitive markets to government intervention and, at least until the Great Depression of the 1930s, insisted that the best public policies were echoes of Adam Smith: low taxes, thrift in public spending, and annually balanced budgets.  Neoclassicists do not inquire into the origins of wealth.  They explain disparities in income as well as wealth for the most part by parallel differences among human beings in talent, intelligence, energy, and ambition. Hence, men and women succeed or failed because of their individual attributes.

Keynesian Economics

John Maynard Keynes was a student of Alfred Marshall and an exponent of neoclassical economics until the 1930s.  The Great Depression bewildered economists and politicians alike.

New explanations and fresh policies were urgently required; this was precisely what Keynes supplied. In his enduring work “The General Theory of Employment, Interest, and Money”. Existing explanations of unemployment he rejected: Neither high price nor high wages could explain persistent depression and mass unemployment. Instead, he proposed an alternative explanation of these phenomena focused on what he termed aggregate demand – that is, the total spending of consumers, business investors, and governmental bodies.  When aggregate demand is low, he theorized, sales and jobs suffer; when it is high, all is well and prosperous.

Types of Economies

Every society has to answer three questions

• What goods and services should be produced in the country?
• How should the goods and services be produced? Should producers use more human labour or more capital (machines) for producing things?
• How should the goods and services be distributed among people?

One answer to these questions is to depend on the market forces of supply and demand. In a market economy, also called capitalism, only those consumer goods will be produced that are in demand, i.e., goods that can be sold profitably either in the domestic or in the foreign markets. If cars are in demand, cars will be produced and if bicycles are in demand, bicycles will be produced. If labour is cheaper than capital, more labour-intensive methods of production will be used and vice-versa. In a capitalist society the goods produced are distributed among people not on the basis of what people need but on the basis of Purchasing Power—the ability to buy goods and services. That is, one has to have the money in the pocket to buy it. Low cost housing for the poor is much needed but will not count as demand in the market sense because the poor do not have the purchasing power to back the demand. As a result this commodity will not be produced and supplied as per market forces. Such a society did not appeal to Jawaharlal Nehru, our first prime minister, for it meant that the great majority of people of the country would be left behind without the chance to improve their quality of life.

A socialist society answers the three questions in a totally different manner. In a socialist society the government decides what goods are to be produced in accordance with the needs of society. It is assumed that the government knows what is good for the people of the country and so the desires of individual consumers are not given much importance. The government decides how goods are to be produced and how they should be distributed. In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. Unlike under capitalism, for example, a socialist nation provides free health care to all its citizens. Strictly, a socialist society has no private property since everything is owned by the state. In Cuba and China, for example, most of the economic activities are governed by the socialistic principles.

The United States of America and the United Kingdom are examples of capitalist economies.  They are also examples of developed economies.  The erstwhile Soviet Union Cuba and China are both socialist economies.  But while the Soviet Union is developed, China like India is still a developing economy.

Most economies (including ours) are mixed economies, i.e. the government and the market together answer the three questions of what to produce, how to produce and how to distribute what is produced. In a mixed economy, the market will provide whatever goods and services it can produce well, and the government will provide essential goods and services which the market fails to do.

Another important distinction that is often made is between developed and developing economies.

Developed, Less Developed, Developing Economies

Countries of the West, which had long been industrialized, and Japan, Korea and other newly industrialized countries of Asia are developed economies.  They are relatively rich countries that have the usual characteristics of a modern industrial society.  The poorer countries have relatively small industrial sectors.  They also have very little access to modern technology whether in industry or agriculture.  The poorest countries are generally described as least developed countries (LDCs). Some of them however, should be called developing economies because through they have only a small modern industrial sector, they are going through a distinct process of industrialization.  In a developing economy the modern industrial sector, though small, keeps increasing in size and the traditional agricultural or rural sector keeps shrinking.

As against them, High Income economies which comprise only 15 per cent of world population account for 78 per cent of world GNP. The situation has worsened during the period 1979-2000 since in 2000, 14.9 per cent of the population of the height income (industrial market) economies accounted for 80 percent of the world GNP. In other words, bulk of the poor people reside in the low income and middle income developing countries.

World Bank classifies all its member countries (188 of them) and all economies with a population of 30,000 or more (another 24; altogether 209) by various classifications. One of the most commonly referred to classifications is by Per Capita income.

World Bank Classification

Each year on July 1, The World Bank revises the classification of the world’s economies based on estimates of gross national income (GNI) per capita for the previous year. The updated GNI per capita estimates are also used as input to the Bank’s operational classification of economies, which determines their loan eligibility, e.g. Low Income countries are eligible for concessional IDA loans.

The classification of countries is determined by two factors:

• A country’s GNI per capita, which can change with economic growth, inflation, exchange rates, and population. Revisions to national accounts methods and data can also influence GNI per capita.
• Classification threshold: The thresholds are adjusted for inflation annually using the SDR deflator.

Low and middle-income economies are sometimes referred to as developing economies. The term is used for convenience; it is not intended to imply that all economies in the group are experiencing similar development or that other economies have reached a preferred or final stage of development.

Sectoral classification of Economy

The sectoral classification of economy is seen as a continuum of distance from the natural environment. The continuum starts with the primary sector. 

Primary Sector: There are many activities that are undertaken by directly using natural resources and the output is natural too. Production of crops using soil rain etc. Similarly, minerals and ores are also natural products. When we produce a good by exploiting natural resources, it is an activity of the primary sector

Secondary Sector - The secondary sector covers activities in which natural products are changed into other forms through manufacturing that we associate with industrial activity. It is the next step after primary

Tertiary Sector - third category of activities that falls under tertiary sector, help in the development of the primary and secondary sectors. These activities, by themselves, do not produce a good but they are an aid or a support for the production process. For example, goods that are produced in the primary or secondary sector need transportation service to be sold in shops. Some essential services may not directly help in the production of goods.

Quaternary Sector - is an extension of three sector hypothesis. It comprises intellectual services e.g. inform generation, information sharing, consultation. Some expert argue that intellectual services are distinct enough to warrants a separate sector

Quinary Sector –also known as golden collar sector consists of highest level of decision makers in any sector or department be it government, businesses and media.Sometimes it considered to comprise of health, education, police, fire services and other govt industries not intended to make a profit etc.

Division of sectors as organised and unorganised

Organised sector covers those enterprises or places of work where the terms of employment are regular and therefore, people have assured work. They are expected to work only a fixed number of hours. They are registered by the government and have to follow its rules and regulations which are given in various laws such as the Factories Act, Minimum Wages Act, Payment of Gratuity Act, Shops and Establishments Act etc. It is called organised because it has some formal processes and procedures

Unorganized sector is characterized by small and scattered units which are largely outside the control of the government. There are rules and regulations but these are not followed. Jobs here are low-paid and often not regular. There is no provision --overtime, paid leave, holidays, leave due to sickness etc. Employment is not secure. People can be asked to leave without any reason.

other ways of classifying Indian Economy

Indian economy can be understood in terms of a number of dichotomies. These dichotomies are the result of nature of Indian economy, geographical factors, historical developments, Government policy.

• One-way is suggested by the definition of the mixed economy itself. The division into the Public and the Private Sectors based on ownership of the enterprise.
• Again, it is sometimes useful to describe a developing economy by dividing it into two broad sectors according to habitation in towns and villages, viz. the Urban and Rural Sectors. The Tertiary Sector produces not goods but services.  Trade, communication, administration, transport, banking and other services belong to this sector.

Apart from the divisions into sectors along the lines of ownership of the enterprise, the type of the activity and urban-rural habitation, and federal structure of the Indian economy indicates the importance of its division in another way: division into regions or the states. 

Role of Government in Economy

The various economic problems of recent years have stimulated serious debate about the proper role of government in economic planning.  Parties on the political left in Europe have advocated more controls and more planning (i.e. socialist pattern). In the 1980s a different solution was offered by the Conservative Party government of Prime Minister Margaret Thatcher in Great Britain and by the Republican administration of President Ronald Reagan in the U.S.  In both countries, attempts were made to diminish taxation and government regulation on private enterprise and thus, by enlarging the potential profits of central elements of supply-side economics, the guiding doctrine of the two leaders (i.e. capitalist pattern).

It can be said that the role of government in any economy depends on the nature of the state.

In a capitalist state the government plays a minimalist role or the role of a facilitator i.e. it allows the free market forces of demand and supply to allocate all resources in the economy. In such an economy the access to resources is governed by one’s purchasing power and the government can do little to change it.

In contrast to this, in a socialist state the government is the owner as well as manager of almost all forces of production and the allocation of resources is governed by the principles of Justice and Equity irrespective of one’s purchasing power. It plays the role of a regulator. The government resorts to tools like progressive taxation (rate of taxation rises with absolute income) to equitably distribute the rewards of growth in the economy.

Such role by government is seen as Interference in the free market forces and is often seen as counter-productive for the economy at large as there is no incentive or disincentive to be efficient and productive.

But today the governments across the world adopt a rational synthesis of the two approaches. While they refrain from any direct interference in the free market forces of demand and supply, they do adopt the policy of what has been termed as the Welfare State i.e. ensuring that every individual gets a minimum standard of goods and services so as to enjoy a minimum standard of living. For this they resort to certain degree of taxation that is seen as just by society as it gets returned as basic services and utilities for all.