In this article, we propose to explain some terms which are frequently used in Economics.
This is essential not only for clear thinking but also for a correct understanding of the language used in books on Economics.
The terms used in Economics are also used in the ordinary speech. But in Economics they are used in a sense different from that in which they are used in ordinary speech. We shall make it clear here in what sense they are used in Economics.
We know that human wants are the starting point of all economic activity. Man has wants which he must satisfy. There are two things with which he can satisfy these wants—goods and services. Goods mean the commodities that we use, and services refer to the work that a person may do. Services are not something tangible or concrete.
The help of a tutor, the advice of a lawyer or a doctor, the work done by railways or domestic servants—these are all services. Goods or commodities, on the other hand, are almost always concrete, material and tangible, “e.g., land, houses, furniture, etc. Goods and services are used to satisfy human wants. Anything that can satisfy a human want is called a ‘good’ in Economics.
Kinds of Goods:
Economic Goods and Free Goods:
The most important classification of goods is as free goods and economic goods.
Free goods are those goods that exist in such plenty that you can have as much of them as you like without any payment, e.g., air, sunshine, etc. They are free gifts of nature. Man has not made them nor has man to pay for them to get them.
Economic goods, on the other hand, are those goods which are scarce and can be had only on payment. Most of the things that a man needs to satisfy his wants fall in this group. They are limited in quantity and are man-made things. Payment has to be made in order to get them. In Economics, we are concerned only with economic goods, for only in their case the question of valuation or payment arises. Economic goods mean wealth and it is with wealth that Economics deals. Thus, there would have been no science of Economics if all goods had been free goods.
This distinction between economic goods and free goods is not permanent. A good may be a free good today and become an economic good tomorrow or the same thing may be free good under certain conditions and an economic good under others. For instance, air is not a free good in a deep mine; water in a city is an economic good and not a free good, because price has to be paid for it.
As population increases, goods which were free before become economic goods (i.e., goods for which a price is paid) later. Increase in economic goods is synonymous with increase in wealth. But that does not necessarily mean that the people are now better off. This is so because many things, like fuel and water, for which the primitive man had to pay nothing, the modern man cannot get without payment.
Even those things which were free goods before have been included in the category of economic goods or wealth and have become scarce. And human welfare is not increased by scarcity. Hence increase in economic goods alone does not necessarily mean increase in economic welfare, because both economic goods and free goods contribute to human welfare.
Consumption Goods and Capital Goods:
Goods can also be classified as consumption goods and capital goods thus:
Consumption Goods are those goods which yield satisfaction directly. They are used by the consumers to satisfy their wants correctly -e.g., food, clothing, pen, ink, etc. They are also called Goods of the First Order. Capital Goods are those goods which help us to produce other goods, e.g., tools, machines, etc. They are also called Producers Goods or Goods of the Second Order. They satisfy our wants only indirectly, because they produce goods which in turn satisfy our wants directly.
In between the consumption goods and capital goods are the intermediate goods. They are the raw materials used in the production of the final or consumption goods. For instance, in the making of cloth or the clothes that we wear (i.e. the consumption), we need capital goods like textile machinery in a big factory or a handloom in a cottage industry. But we also need cotton or silk or some synthetic fibers of which the cloth is made. This is the intermediate good.
Material and Non-Material Goods:
Another classification of goods is between material and non-material goods. The examples of material goods are land, buildings, furniture, cash, books, etc.
Non-material goods are various kinds of services:
They are not tangible. But some of them are scarce and can be transferred. The goodwill of a business falls in this category. It can be bought and sold.
Transferable and Non-transferable Goods:
Most material goods can change their ownership. In such cases, a bodily transfer takes place and the goods may be moved from one place to another. In some cases, however, actual physical transfer cannot take place e.g., in the case of land. In this case, no actual movement is possible, only ownership is changed and this makes them transferable. Hence, goods are called transferable, whether they are physically transferred or ‘heir mere ownership is transferred. Non-transferable goods like skill, ability, intelligence, etc. which is personal qualities cannot be transferred—only their service can be used by others.
Personal and Impersonal Goods:
Personal goods refer to the personal qualities of a person, e.g., his ability and skill. They are non-material and exist inside mm. They are, therefore, also called internal goods. They are what he is and not what he has. Impersonal goods are those that are not personal. They are external and the outs.de a person. They are, therefore, also called External goods. They are what is has. e.g., land, houses, etc.
Private and Public Goods:
Private goods are the property of private individuals, e.g. land or buildings owned by them exclusively and not shared with others. Public goods are those which are common to all and are owned by society collectively, e.g., a town hall, a college, or a hospital.
Necessaries, Comforts and Luxuries:
Goods can also be classified as necessaries, comforts and luxuries. From the above classification, it is clear that the same ‘good’ can fall in several categories. Land, for instance, is a material good, it is transferable and may also be a private or a public good.
Definition of Utility:
We have seen that goods satisfy human wants. This want-satisfying quality in a good is called Utility. Hence utility means the power to satisfy a human want. In order to find out whether a good possesses utility or not, we have simply to ask ourselves the question: ‘Does it satisfy a human want? If so, it has utility, otherwise not. If a person is prepared to pay for it, it is clear that he thinks that it will satisfy his want. For him such a commodity will possess utility. Utility is that quality in a commodity by virtue of which it is capable of satisfying a human want. Air, water, etc. (free goods) and food, clothes, land, house, cash (economic goods) satisfy people’s wants, and as such they possess utility.
Utility and Usefulness Distinguished:
A commodity may satisfy a human want, but may not be useful. On the contrary, it may actually be injurious, e.g., opium and poison. But, because they satisfy a human want and some people are prepared to pay for them, we say in Economics that they possess utility, even though their consumption is injurious. Similarly, a man may have a picture which is indecent and vulgar. But if another person is prepared to pay a price for it, we have to admit, as economists, that the picture possesses utility.
The term ‘utility’, therefore, as used in Economics, has no ethical or moral significance. A thing may be good or it may be bad, but if it satisfies a human want, we shall say it possesses utility. Thus, it is not on moral consideration that the economists decide whether a commodity has utility or not.
Utility is Not Synonymous with Pleasure:
A good which possesses utility may not give pleasure when consumed, e.g., quinine. But, in spite of its bitter taste, quinine is purchased and consumed, for it does fulfill a need. Hence utility is not the same thing as pleasure. A thing which possesses utility may be tasteful and pleasurable or it may be bitter and distasteful and as such may not give any pleasure.
Utility does not mean Satisfaction:
Utility is the quality in a good by virtue of which it gives us satisfaction and it is not itself satisfaction. Satisfaction is what we get, and the utility is the quality in the thing which gives satisfaction. To say that a mango gives utility is incorrect. We should say it possesses utility or it gives satisfaction. A thing possesses utility but it gives satisfaction.
Utility is Subjective:
No commodity possesses utility in itself independently of the consumer. It is the consumer’s mind which gives it utility. A blind ran cannot see a picture; and it has no utility for him. A cigarette has no utility for a non-smoker. Utility varies from individual to individual. Even for the same individual, a commodity may possess different utilities at different times or in different places. A warm suit has greater utility in winter than in summer. A raincoat has greater utility in the hills during the rainy season. It all depends on a man’s circumstances. That is why we say that utility is subjective. It depends on a man’s mind rather than on the things itself.
Utility Varies in Different Situations:
Moreover, the same thing may possess different utilities for different purposes. For example, water has different utilities when used for drinking, bathing or washing. Further, utility changes with the advancement of knowledge. We may discover new uses for a commodity. Many by-products, such as molasses in case of sugar, which used to be thrown away as useless, are being profitably used now. They have, therefore, come to possess utility which they did not have before.
A change in the form of a commodity may bring about a change in its utility. A log of wood has not the same utility as a table into which it has been converted. A good may have different utilities in different hands or when there is a change in the ownership. When a rich man deposits his idle money in the bank, it can be loaned out to some-one in need of it. It thus comes to have utility that it did not possess before.
In the same manner, when a cultivator buys land from a non-cultivating owner, its utility increases. A watch has no utility in the hands of an ignorant and illiterate person who cannot read it but has a great deal of utility for a student. From all this discussion, we come to the conclusion that the utility of an article varies with the change in conditions and circumstances.
Forms of Utility:
The main forms of utility are:
(a) Form Utility:
By changing the form of an article, we can give it greater utility, e.g., the transformation of a log of wood into a piece of furniture. This is called Form Utility.
(b) Place Utility:
Utility can also be increased by transporting a good from one place to another. When timber is brought to the market, it comes to have much greater utility than it had in the forest. That is Place Utility.
(c) Time Utility:
By storing a commodity and selling it at a time of scarcity we can give it greater utility. This is Time Utility.
Meaning of Value:
‘Value’ is another term which has to be frequently used in Economics, but which creates a lot of confusion. In Economics, we do not use it in the same sense as we use it in our ordinary speech. We often say education has great value, or that fresh air is very valuable. Here the term ‘value’ is used in the sense of usefulness. This is value-in-use for which economists use the term ‘utility’. In Economics, the term ‘value’ is not used in this sense, that is, in the sense of value-in-use, for which we use the term ‘utility’.
Economists use the term ‘value’ in the sense of value-in-exchange. Value of a commodity refers to the goods that can be obtained in exchange for it. We cannot exchange fresh air for anything; its value in economic sense is, therefore, zero even though it is otherwise so valuable—nay, indispensable. A pencil, on the other hand, has value because it can be exchanged for something; we may be able to get some ink or piece of paper in exchange for it.
The value of a commodity, thus, means the commodities or services that we can get in return for it; it is, in short, its purchasing power in terms of other commodities and services; it is its power of commanding other things in exchange for itself.
Attributes of Value:
It is clear, then, that in order to have value in the market a commodity must not be a free good, for nobody will give anything in exchange for a free good. One can have as much of it as one likes without paying anything for it. Only economic goods can have value in the economic sense.
Three qualifications are thus essential for a good before it can have value:
(a) It must possess utility;
(b) It must be scarce; and
(c) It must be transferable or marketable.
All these three qualities are required together. In the absence of any one of these qualities, a good will have no value at all. Nobody will be prepared to give anything in exchange for a commodity which is not scarce or which does not possess any utility or which is not transferable. For example, air possesses utility, but it is not scarce. Rotten eggs may be scarce: but since they possess no utility, they have no value in the economic sense. A book has utility; it is also scarce and transferable. It has, therefore, value in the economic sense.
Value is not the same thing as price. When value is expressed in terms of money, it is called price. In pre-historic times, people did not know the use of money. They exchanged goods for other goods. This system is called barter. In those days, the price of a commodity meant the commodity or commodities for which it could be exchanged. In other words, price and value could be used as synonyms. In modern times, however, goods are ordinarily exchanged for money. Therefore, the price of a commodity today means its money-value, i.e., the price it commands in the market. ‘Price’ expresses value in terms of money.
Value is Relative:
Since ‘value’ in Economics means value-in-exchange, it must be relative. It cannot be absolute. It is impossible to speak of the value of a commodity in an absolute manner independently of something else. For example, to say that the value of a fountain pen is great, gives an idea of its utility only. To talk of the value of a fountain pen. In the economic sense, we must relate it to something else which we can get in exchange for it. Value is always in terms of something
Value equates certain commodities, i.e., a fountain pen may fetch 5 dozen pencils in exchange; it is equal to 5 dozen pencils. It expresses relationship between the two commodities; it relates one to the other. That is why value is said to be relative. A thing does not stand alone. When we are thinking of its value, we always think of something else also, in terms of which its value can be expressed, whether it is money or any other commodity.
Value thus is relative and as such represents an equation between two commodities. It is very easy to see that both sides of the equation cannot rise at the same time. Take the previous example: one fountain pen = 5 dozen pencils. If the fountain pen increases in value, it will buy more pencils than before, which means that pencils have gone down in value.
On the other hand, if pencils become more valuable, less than 5 dozen will be needed to buy a fountain pen. This means that the value of the fountain pen has gone down. Thus, if one thing goes up, the other thing comes down in value.
The value of both cannot go up or come down at the same time. Hence there cannot be a general rise or fall in value; But there can be a general rise or fall in prices. We see such a rise in prices now-a-days. The price of everything has gone up at the same time. But here we are looking at one side of the equation only, the goods side, and not the other, the money side. Goods have gone up in value, while money has come down in value. Thus all prices have risen, but all values have not risen. Hence we can conclude that there can be a general rise in prices, but there cannot be a general rise in values.
Meaning of Wealth:
Wealth is another term Used in Economics which requires clear understanding. The term ‘Wealth’ causes a lot of confusion in the mind of a beginner in the study of Economics. This is due to the fact that ‘Wealth’ in Economics is used in a sense different from its use in the ordinary speech. In ordinary language, ‘Wealth’ conveys an idea of prosperity and abundance; it means riches, property, etc.
A man of wealth, as ordinarily understood, is a rich man, i.e., one who is prosperous. But in Economics every man, even the poorest of the poor, possesses some wealth, as we shall see presently. Further, in the ordinary speech, by ‘Wealth’ people mean money. But in Economics money is not the only form of wealth; anything which has value is called wealth in Economics.
In Economics the term ‘Wealth’ is synonymous with economic goods. Economic goods are scarce and command a price in the market. But scarcity alone does not make a ‘good’ wealth. If it is a useless thing, e.g., a rotten egg. Nobody will pay anything for nobody would like to have it; and a will not be wealth. A good’ cannot be wealth by itself apart from man and his wants. It is wealth only if man needs it and uses it.
Therefore, besides being scarce, a commodity must have utility. But it may not be necessarily useful. Even a harmful thing will be regarded as wealth, provided it possesses utility and can satisfy a want. Further, the idea of ownership is also present in wealth. This means that unless an article can be owned and is capable of being transferred from one owner to another, it cannot be regarded as wealth. Thus, we see that before a thing can be called wealth in economics, it must possess certain attributes or qualities which we discuss below.
Attributes on wealth:
There are three attributes of wealth, as in the case of value: Utility, Scarcity and Transferability or Marketability.
If you want to find out whether a good is wealth or not, ask yourself these three questions:
1. Can it satisfy a human want? Or does it possess utility?
2. Is it scarce?
3. Is it transferable?
If the answer to all these three questions is in the affirmative, it is wealth. A negative answer to any one of these questions will exclude it from the category of wealth. For instance, if a thing possesses utility but is not scarce and vice versa, it is not wealth. It must be both scarce and useful if it is to be called wealth. It must also be transferable.
Applying these tests, we find that money, land, buildings, furniture, machinery, clothes, gold, silver, goodwill of a business, in fact all goods, material and non-material, which are objects of human desire, which are scarce, and which can be bought and sold in the market, are wealth.
Documents of title like bills of exchange, bills of lading, documents of property and insurance policies (up to surrender value) are also wealth. They are valuable because they represent titles to property. Hence they are sometimes called Representative Wealth. But free goods like fresh air, water and sunshine are not wealth unless they become scarce as in big cities.
Personal qualities like honesty, skill, ability and intelligence too are not wealth. They are a source of wealth but are not wealth in themselves, because they are not transferable. A surgeon’s skill is not wealth though it brings him wealth. In the same manner, the oceans, the Gulf Stream, the sun, the moon, etc., are not wealth because they cannot be owned or bought and sold. Human beings are not wealth, unless they happen to be slaves. As such they are property of their master and can be transferred.
Money and Wealth:
Money is wealth as defined above—it possesses utility; it is scarce and it is transferable. All money is, therefore, wealth, but all wealth is not money, as wealth is understood in the ordinary speech. Wealth takes so many forms; it consists of all kinds of property and money is only one kind of wealth.
Wealth and Income:
Income is what the yields. A man may possess a lot of immovable property. It may be worth Rs. 2 lakhs. This is his wealth. But how much, does he get from it in a year? Perhaps Rs. 10,000. This is income. Wealth is a fund and income a flow.
Wealth and Welfare:
Wealth and welfare are very closely inter-related. Wealth is the means and welfare the end. Economics studies wealth and not welfare because there is no general agreement on what welfare means. The idea of welfare varies from individual to individual, from time to tine and from country to country. Wealth, on the other hand, has a definite meaning. Economics makes wealth its subject-matter, because wealth happens to be a convenient measure of human motives. Wealth is not studied for its own sake.
Wealth in general promotes welfare. If a man happens to be a rich man, he will be able to live well himself and may also help others. Wealth thus promotes welfare. We repeat that wealth is the means and welfare the end. Wealth can undoubtedly be used to make people happier and more comfortable. Poverty is a great curse and root of many evils. But wealth promotes mental, moral and physical well-being of the people.
It may, however, be pointed out that what is regarded as wealth by economists may not necessarily be good and useful. It may actually be harmful, e.g., a bad book, poisonous drug, opium, wine, tobacco. These are regarded as wealth, but their use does not promote human welfare. Wealth, as understood in Economics, has nothing to do with usefulness. No ethical or moral meaning is attached to it.
Further, as has already been mentioned, increase in wealth does not necessarily mean an increase in welfare. It only means that the number of economic goods, which have become the property of people, has increased, whereas the number of free goods like fresh air and water, which are highly desirable and useful, has decreased. It cannot be claimed that this state of affairs has promoted the welfare of society. Thus, wealth and welfare are not synonymous under all circumstances. But, on the whole, wealth is a powerful means of promoting human welfare.
Classification of Wealth:
Wealth can be classified as follows:
The wealth of an individual consists of:
(a) His material possessions or property like cash, land, buildings, live-stock, furniture and stocks and shares;
(b) Non-material goods like the goodwill of his business which commands a price in the market. But we do not include in wealth his personal qualities like skill and intelligence, for they are not saleable. We also deduct the money he has borrowed and has to pay back.
Personal qualities like skill, ability and intelligence are not wealth as explained above. They are given only the courtesy title of ‘personal wealth.’
Social or Communal Wealth:
It consists of State and Municipal property, that is, things owned by a society or community in common. They include, among other things, the assembly chamber, the secretariat buildups’ road, dams, canals, State railways, public parks and libraries, museums, etc.
The term ‘national wealth may be used in the sense a narrow sense and a wide sense. Narrowly speaking it consists of the aggregate wealth or all citizens, excluding me debts due to one another. Here we use the term wealth as defined above. In the wider sense, however, national wealth may also include rivers, mountains, a good climate, good government, high character of the people, etc. They are valuable national assets. But, in this sense, the meaning of ‘wealth’ is too wide to become synonymous with ‘economic goods’. Such things cannot be called wealth in the strict economic sense.
It is the wealth of the whole world, a sum total of the wealth of all nations. It includes the wealth of all countries in the strict economic- sense as well as rivers, mountains and all other natural resources which are regarded as wealth in the wider sense.
This refers to debts owned by individuals or States. If something is a nuisance, say wild pigs or stray cattle damaging the crops, it may also be regarded as negative wealth. Our sugar factories some time back had to incur a lot of expense in getting molasses removed from their premises; in those circumstances molasses were negative wealth.
Income, Saving and Investment:
We have explained the term ‘wealth’ above. Wealth refers to property or assets. The amount of money which these assets yield is called income. While wealth is a stock, income is a flow. Distinction may also be made between money income and real income. While income of a person expressed in terms of money per month or year is his money income, the Real income of a person consists of goods and services that he purchases with his money income. Real income depends on prices. It rises inversely with the price level.
Income from the point of view of the economy as a whole, i.e., national income may be defined as the aggregate factor income (i.e. earnings of labour and property) which arises from the current production of goods and services by the nation’s economy. It includes income produced both inside the country and that earned by its nationals abroad.
A part of the current income is consumed or spent and a part thereof is saved and invested. The excess of income over consumption is the saving made by the people. Saving may be held in the form of cash or a bank balance or in some investment, i.e. in the form of income-yielding assets.
Investment means an addition made to the nation’s physical stock of capital like the building of new factories, new machines as well as any addition to the stock of finished goods or goods in the pipelines of production. Investment thus includes additions to inventories as well as to fixed capital. It may be clearly understood that when a person buys a share in a company already in existence, what takes place is only a financial transaction and is not ‘investment’ as understood in Economics—what one person invests, the other (who sells the share) must have disinvested, so that as a result of this transaction, there is no net addition to the nation’s stock of capital.
Investment may be autonomous or induced. Autonomous investment is made by the State for promoting public welfare and induced investment is done by businesses as a result of change in the income level or consumption and also depends on price changes, interest charges, etc., which because of possibility of profit make such investment worthwhile analysis.
Equilibrium means a state of balance. When forces acting in opposite direction are exactly equal, the object on which they are acting is said to be in a state of equilibrium. ‘Equilibrium’ also refers to a-state when a situations ideal or optimum so that no advantage can be obtained by making a change.
For example, a consumer is said to be in an equilibrium position when he is deriving maximum satisfaction and a producer or a firm is said to be in equilibrium when it is making a maximum profit or incurring a minimum loss. In both cases, there will be no inducement to change, i.e., buying more or less in the case of a consumer and producing more or less in the case of a firm, because at this particular output the cost per unit is the minimum and the total profit is the maximum.
An industry is said to be in equilibrium when all the firms in the industry are making normal profits so that there is no inducement for the new firms to enter or the old firms to leave the industry. Thus, the term equilibrium’ indicates an ideal condition or when complete adjustment has been made to changes in an economic situation. There is no incentive for any more change.
Types of Equilibrium:
There is said to be a stable equilibrium when the object, on which forces are acting, after having been disturbed, tends to resume its original position.
But, when a slight disturbance evokes further disturbance, so that the original position is never restored, it is a case of unstable equilibrium.
On the other hand, when the disturbing forces neither bring it back to the original position nor do they drive it further away, it is called neutral equilibrium. In economic analysis, stable equilibrium is most commonly used
In the case of short-term equilibrium, economic forces do not get sufficient time to bring about complete adjustment. For example, supply is adjusted to changes in demand with the existing means of production, for there is no time to increase them or decrease them.
However, in the case of long-term equilibrium, there is ample time to change (increase or decrease) even the means of production or the resources available. For instance, if demand is increased, the supply will also be increased not only with the existing plant and machinery but also by installing new plants and machinery and there is enough time for that purpose. In this case, sufficient time is allowed for mutual adjustment of the economic forces.
A partial or a particular equilibrium relates to a single Relation between Income, Consumption, Saving and Investment.
The following equation represents the relation between incomes (Y),
Consumption (C), Saving (S), and investment (I)
Y – C + S (i)
Y = C + I (ii), provided S = I.
Meaning of Equilibrium:
The word ‘equilibrium’ is very frequently used in modern economic individual (consumes or producer), a single firm or a single industry. As already mentioned, consumer’s equilibrium indicates that he is getting the maximum aggregate satisfaction from a given expenditure and in a given set of conditions relating to the price and supply of a commodity. A producer is in equilibrium when he is able to maximise his aggregate net profit in the conditions in which he is working.
A firm is said to be in equilibrium when it has attained the optimum size which is ideal from the point of view of profit and utilisation of resources at its command. Then there is no tendency for it to expand or contract. Equilibrium of our industry refers to a state of industry when there is no incentive for new firms to enter or the existing firms to leave it.
Such an equilibrium is not concerned with a single variable, but with a multiplicity of variables. Particular equilibrium covers a single organisation in the economic system, whereas in general equilibrium all the organisations work the economy is affected. It is, in short, equilibrium of the entire economy. When there are no maladjustments in the economic system as indicated by depression or unemployment and when each part of the system is adjusted with the other we may say that it is a case of general equilibrium.
Statics and Dynamics:
A student of modern economic analysis frequently comes across the terms ‘economic statics’ and economic dynamics’. Let us try to understand them.
In common usage, the term ‘statics’ connotes a position of rest or absence of movement. However, economic statics does not imply absence of movement, rather it denotes a state in which there is a continuous, regular, certain and constant movement without change. It is a state wherein economic activity goes on regularly and constantly on an even keel.
A static state is characterised by the absence of five kinds of change the size of population, the supply of capital, the methods of production, the forms of business organisation and the wants of the people; but all the same the economy continues to work at a steady pace.
According to Hicks, we should call economic statics those parts of economic theory where we do not trouble about dating. He means to say that ‘statics’ studies stationary situations which are devoid of any change and which do not require any relation to the past or future.
Thus, it is a method of dealing with economic phenomena that tries to establish relations between elements of the economic system—prices and quantities of commodities—all of which have the same point of time.
In simple words, economic statics presupposes that the manner in which an economic unit changes is the same as it changed in the past and will change in the future. It suffices, therefore, under economic statics, to study the economy in its present position. It gives only a ‘still picture’ of the economy, a vision of the moment disappearing as soon as it makes its appearance.
Significance or uses of economic statics:
Though economic statics is mostly unrealistic and unsuitable for most of the purposes, yet it enjoys the virtue of simplicity. Again, it is only through the method of economic statics that we study how an individual allocates his income on the purchase of various commodities to maximize the satisfaction, how a producer combines his inputs in an optima! way to maximize his profit, and how the national product is distributed Thus the significance of economic statics lies in penetrating the complex problems in a simple way.
The static analysis suffers from a few serious shortcomings. It takes us far away from the reality. It assumes variable data such as population tastes, resources, and techniques, etc., to remain constant. But the actual world is a dynamic one where the data are continuously changing.
The word ‘dynamics’ means causing to move. In economics, ‘dynamic’ refers to the study of economic change. The main purpose is to know as to how a complex of current events will shape themselves in the future. To do so, it is necessary to visualize the way it has itself arisen out of the past events.
In this view, economics essentially assumes a dynamic character. The moment we talk of sequence of events, the element of time creeps into our analysis. It is this time element and its passage that imparts a dynamic colour to our economic problems. Economic Dynamics is thus a process of change through time. In dynamic economic analysis, we investigate the behaviour of the system which results from the passage of time.
Significance of Economic Dynamics:
Economic Dynamics is more realistic and light-giving than economic statics. It gives us a picture of the process of change and not just an analysis of the equilibrium position. Statics assumes constancy of resources, population, state of technique, investment, tastes, etc., but all these in reality are not constant.
They undergo continuous and endless change and, for a proper understanding of these, there is no escape from the dynamic tools. Dynamic analysis takes us closer to reality. Here is no assumption of other things remaining the same.
Boulding compares static equilibrium with a ball rolling at a constant speed -or a forest where trees sprout, grow and die but where the composition of the forest as a whole, remains unchanged. But in dynamics we consider the real world which is ever changing. It relates to a developing economy.
Though Dynamics is a more realistic method, it is essentially very complex and only a few economists equipped with the techniques of advanced mathematics can make use of it.
In spite of its limitations, static analysis remains useful, for this is a method whereby we can ignore time as a variable and still make a purposeful study of the economic system. This is possible when we are finding out the ultimate effect of a certain initial change and ignore the process through which it is brought about.
We can thus think of an analysis in which we start with a system in equilibrium, then introduce a change and study the ultimate effect of the change. This is the method of comparative statics. Here, we have in a way done away with the time element—we have ignored that time is changing.
We just jump from one equilibrium position to another without taking care of as to what happens in between the two situations. We call such a method as comparative statics because in it we compare one equilibrium position with another and ignore the time element.
Comparative statics suffers from certain limitations, it cannot be used two types of problems:
(a) It fails to predict the oath which the market follows when moving from one equilibrium petition to another, and
(b) It cannot position whether or not a given equilibrium position will ever be achieved. For these purposes we need dynamic analysis.