Nature and Scope of Economics

Recently updated on April 13th, 2023 at 06:16 pm

Economics is that branch of social science which is concerned with the study of how individuals, households, firms, industries and government take decision relating to the allocation of limited resources to productive uses, so as to derive maximum gain or satisfaction.

Simply put, it is all about the choices we make concerning the use of scarce resources that have alternative uses, with the aim of satisfying our most pressing infinite wants and distribute it among ourselves.

Nature of Economics

  1. Economics is a science: Science is an organised branch of knowledge, that analyses cause and effect relationship between economic agents. Further, economics helps in integrating various sciences such as mathematics, statistics, etc. to identify the relationship between price, demand, supply and other economic factors.
    • Positive Economics: A positive science is one that studies the relationship between two variables but does not give any value judgment, i.e. it states ‘what is’. It deals with facts about the entire economy.
    • Normative Economics: As a normative science, economics passes value judgement, i.e. ‘what ought to be’. It is concerned with economic goals and policies to attain these goals.
  2. Economics is an art: Art is a discipline that expresses the way things are to be done, so as to achieve the desired end. Economics has various branches like production, distribution, consumption and economics, that provide general rules and laws that are capable of solving different problems of society.

Therefore, economics is considered as science as well as art, i.e. science in terms of its methodology and arts as in application. Hence, economics is concerned with both theoretical and practical aspects of the economic problems which we encounter in our day to day life.

Positive or Normative:

Another controversial aspect of economics is whether it should be neutral or pass value judgments. The members of the English classical school were of the opinion that economists were not supposed to make any normative statement or pass any value judgment on the desirability or otherwise of the economic decisions.

Some later members of the classical school even went to the extent of suggesting that economists should not give any advice on any issue.

This means that economics should stand neutral as regards ends. However, the same view has been reaffirmed by Robbins, who commented that the function of the economist is to explore and explain, not to uphold or to condemn. This simply means that econo­mists should take ends as given. Their task is just to discover ways and means of achieving these ends (i.e., to find out ways of accomplishing objectives).

The classical economists believed that eco­nomics could not solve practical problems, because there were non-eco­nomic (social, political, ethical, religious and other) aspects of people’s lives.

As J.M. Keynes commented in 1923:

“The theory of economics does not furnish a body of settled conclusions immediately applicable to policy. It is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.”

However, this view is not correct. In fact, the primary function of econo­mists is to formulate policies and to suggest solutions to economic problems. Acknowledge of economics is essential for policymaking.

Policy-makers, who do not understand the consequences of their actions are unlikely to reach their goals. The most important point to note here is that, economists can suggest solutions to society’s economic problems such as unemployment, inflation, trade deficit and slow growth.

This is why modern governments take the help of economists for formulating monetary fiscal and exchange rate policies. Since the New Deal era in the 1930s, economists have moved in the forefront of government policy analysis.

Economics offers a social science with models for organising facts and for thinking about policy alternatives. In fact, the U.S. Council of Economic Advisors is unique; no such permanent agency exists for any other social science. Indeed, few scientists of any kind enjoy so much prestige as the economists J.K. Galbraith, Paul Samuelson, Lester Thurow, or Milton Fried­man.

Scope of Economics

  • Microeconomics: The part of economics whose subject matter of study is individual units, i.e. a consumer, a household, a firm, an industry, etc. It analyses the way in which the decisions are taken by the economic agents, concerning the allocation of the resources that are limited in nature.

It studies consumer behaviour, product pricing, firm’s behaviour. Factor pricing, etc.

  • Macro Economics: It is that branch of economics which studies the entire economy, instead of individual units, i.e. level of output, total investment, total savings, total consumption, etc. Basically, it is the study of aggregates and averages. It analyses the economic environment as a whole, wherein the firms, consumers, households, and governments make decisions.

It covers areas like national income, general price level, the balance of trade and balance of payment, level of employment, level of savings and investment.

The fundamental difference between micro and macro economics lies in the scale of study. Further, in microeconomics, more importance is given to the determination of price, whereas macroeconomics is concerned with the determination of income of the economy as a whole.

Nevertheless, microeconomics and macroeconomics are complementary to one another, as they both aimed at maximising the welfare of the economy as a whole.

From the standpoint of microeconomics, the objective can be achieved through the best possible allocation of scarce resources. Conversely, if we talk about macroeconomics, this goal can be attained through the effective use of the resources of the economy.

Economies of Scope

Economies of scope are “efficiencies formed by variety, not volume” (the latter concept is “economies of scale”). In economics, “economies” is synonymous with cost savings and “Scope” is synonymous with broadening production/services through diversified products. Economies of scope is an economic theory stating that average total cost of production decrease as a result of increasing the number of different goods produced. For example, a gas station that sells gasoline can sell soda, milk, baked goods, etc. through their customer service representatives and thus gasoline companies achieve economies of scope.

Whereas economies of scale for a firm involve reductions in the average cost (cost per unit) arising from increasing the scale of production for a single product type, economies of scope involve lowering average cost by producing more types of products.

Economies of scope make product diversification, as part of the Ansoff Matrix, efficient if they are based on the common and recurrent use of proprietary know-how or on an indivisible physical asset. For example, as the number of products promoted is increased, more people can be reached per unit of money spent. At some point, however, additional advertising expenditure on new products may become less effective (an example of diseconomies of scope). Related examples include distribution of different types of products, product bundling, product lining, and family branding.

Economies of scope exist whenever the total cost of producing two different products or services (X and Y) is lower when a single firm instead of two separate firms produces by themselves.

DSC = TC(q1) + TC(q2) – TC(q1, q2) / TC(q1, q2)

Where:

  • TC(q1) is the cost of producing quantity q1 of good a separately
  • TC(q2) is the cost of producing quantity q2 of good b separately
  • TC(q1+q2) is the cost of producing quantities q1 and q2 together
  • Economies of Scope (S) is the percentage cost saving when the goods are produced together. Therefore, S would be greater than 0 when economies of scope exist.

If DSC > 0, there is economies of scope. It is recommended that two firms can corporate and produce together.

If DSC = 0, there is no economies of scale and economies of scope.

If DSC < 0, there is diseconomies of scope. It is not recommended to work together for the two firms. Diseconomies of scope means that it is more efficient for two firms to work separately since the merged cost per unit is higher than the sum of stand-alone costs.

Joint costs

The essential reason for economies of scope is some substantial joint cost across the production of multiple products. The cost of a cable network underlies economies of scope across the provision of broadband service and cable TV. The cost of operating a plane is a joint cost between carrying passengers and carrying freight, and underlies economies of scope across passenger and freight services.

Natural monopolies

While in the single-output case, economies of scale are a sufficient condition for the verification of a natural monopoly, in the multi-output case, they are not sufficient. Economies of scope are, however, a necessary condition. As a matter of simplification, it is generally accepted that markets may have monopoly features if both economies of scale and economies of scope apply, as well as sunk costs or other barriers to entry.

Advantages

  • Extreme flexibility in product design and product mix
  • Rapid responses to changes in market demand, product design and mix, output rates, and equipment scheduling
  • Greater control, accuracy, and repeatability of processes
  • Reduced costs from less waste and lower training and changeover costs
  • More predictability (e.g., maintenance costs)
  • Faster throughput thanks to better machine use, less in-process inventory, or fewer stoppages for missing or broken parts. (Higher speeds are now made possible and economically feasible by the sensory and control capabilities of the “Smart” machines and the information management abilities of computer-aided manufacturing (CAM) software.)
  • Distributed processing capability made possible and economical by the encoding of process information in easily replicable software
  • Less risk: A company that sells many product lines, sells in many countries, or both will benefit from reduced risk (e.g., if a product line falls out of fashion or if one country has an economic slowdown, the company will likely be able to continue trading).

Strategies Economies of Scope

  1. Related Diversification

If a company is able to use its operational expertise, resources, and capabilities across its organization, then it can take advantage of related diversification. For example, hiring designers and marketers who can use their skills across different product lines allows for the production of a wide range of products.

  1. Flexible Manufacturing

Flexible manufacturing exists if multiple products can be produced using the same manufacturing systems and inputs for example, using the same preparation and storage facilities when making hamburgers and fries, as opposed to using two separate facilities.

  1. Mergers

Mergers often enable a company to share research and development expenses to reduce costs and diversify its product portfolio or knowledge. For example, two pharmaceutical companies might merge to combine their research and development expenses to create new products.

  1. Linking the Supply Chain

Integrating vertical supply chain assists in reducing costs and wastage. For example, operating multiple businesses under the same entity or having combined management rather than running as separate entities.

  1. Acquisition of Companies with Similar Products

Mergers with horizontal acquisition or strategic acquisitions will help achieve the economies of scope as the company will benefit from synergies due to utilization of similar raw materials, production and assembly lines.

  1. Diversification

Companies producing different products using similar inputs and production processes will improve productivity.

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