NATURE AND SCOPE OF ECONOMICS

Economics is defined as the study of how societies allocate scarce resources in an attempt
to meet the virtually unlimited wants of consumers. Economics is a social science which
seeks to explain issues relating to production, distribution and consumption of goods and
services.
Key economic issues include: -
i. The working of the price system in the economy.
ii. Determination of price and output
iii. Impact of production and consumption on environmental pollution.
iv. Determinants of distribution of income and measures to solve them.
v. Costs and benefits of economic growth and development.
vi. Importance of money supply and interest rates.
vii. Exchange rates volatility.
Wealth and welfare
The concepts of wealth and welfare stand at the heart of economics.
Wealth refers to a country’s stock of resources and goods that can be used to satisfy wants this
means machines, buildings and human skills.
Welfare refers to the satisfaction that an individual or society derives from wealth and can be
regarded as being synonymous with that individuals or society’s standard of living.
Economic resources
These are things /items of value that are used to produce goods or services productive
resources are classified under the following categories
a) Natural resources i.e. land, water, air, minerals and forest
b) Human resources i.e. skilled and unskilled labour
c) Capital resources e.g. machines, equipment, buildings e.t.c
d) Entrepreneurial resources. This is a special category of human resources which
consists of people who make decisions on how to combine natural, human and
capital resources to produce output, undertake risks e.t.c
Characteristics of economic resources include: -
i. They have a monetary value
ii. They have alternative uses
iii. They are transferable
iv. They have utility
v. They contribute to production of goods and services
The economic problem.
An economic problem arises when individuals’ wants are virtually unlimited whilst the
resources available to satisfy these wants are scarce. Scarcity means limited in supply than
demand. An economic problem also arises when there are alternative uses of these resources
and when there are varying degrees of importance of each of the needs.
All goods and services are economic in the sense that they are scarce. A decision to satisfy
a set of wants necessary means sacrificing some other set of needs. This is referred to as
Opportunity cost.
Opportunity cost, therefore are the benefits/costs forgone in order to attain the next best
alternative. The opportunity cost of a decision to produce or consume more of one good is the

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next best forgone alternative. For instance, a decision to produce to buy a compact disc
means giving up the purchase of a ticket for a pop concern.
An important consequence of a scarcity is that all societies have to make choices about
what goods and services to produce. A decision to produce more of one commodity means
that less of another commodity can be produced. In making choices about what goods and
services to produce decision makers must weigh up the costs of benefits of alternative
production decisions. Decisions must be made about the following economic questions
i. What to produce
ii. When to produce
iii. What resources to use to produce the goods and services
iv. How to produce goods i.e using which technique?
v. For whom to produce goods
vi. How to distribute the goods
Branches of economics
Economics is divided into two main branches:
a) Microeconomics
Microeconomics is concerned with the analysis of the behavior of individual firms,
industries, market and consumers (or households) and deals with the effects of individual
taxes and specific public spending programmes. The objective of a household is to maximize
utility/satisfaction subject to a budget constraint. The objective of a firm is to maximize profit
by making choices on optimum output levels and prices. The objective of the government is
to maximize the social and economic welfare of the citizens subject to scarce productive
resources.
Areas within the purview of microeconomics include:
i. An examination of the activities of a country’s firms such as monopolies and mergers.
ii. A study of the determination of level of output and employment in a country’s textile
industry.
iii. An investigation into the working of a common agriculture policy in the European
Union.
iv. Resources allocation income distribution and determination of the relative prices of
goods and services.
NB Microeconomics deals with problem resources allocation income distribution, and
determination of the relative prices of goods and services.
b) Macroeconomics
This is a branch of economic that is concerned with the analysis of aggregates, totals or
averages of variables that affect the economy as a whole. Macroeconomics analysis therefore
studies the working of the nation economy as a whole and its interaction with other
economies. It also studies the causes and interrelationships of variables and concepts such
as:-
i. Determination of national output and employment
ii. Determination of the general price level(Inflation)
iii. Total spending and saving in the economy
iv. Total import and exports

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 v. The demand for and supply of money and other financial assets.
vi. An international comparison of the causes of inflation and unemployment.
vii. The problem of stabilizing exchange rates.
Economic Methodology
Methodology refers to the ways/approaches used by economists in studying their subject
matter. There are two main approaches.
a) Positive economics
Positive economics is concerned with investigations of proposition that can be tested by
reference to empirical evidence. It relates to statements of what is, what was or will be and
they are statements whose validity can be tested against the available empirical evidence.
Positive economics is concerned with the investigations of the ways in which the different
economic agents in the society seek to achieve their goals e.g how a firm behaves in trying to
reach the highest attainable level of satisfaction from consumption.
An example of a positive statement: An increased budget deficit will bring down the
present high level of unemployment but will increase the rate of inflation.
b) Normative economics
This is concerned with propositions that are based on value judgments i.e. statements which
are expressions of opinions of what should or ought to be the case. It is concerned with
making suggestions about the ways in which the society’s goals might be more efficiency
realized. This approach involves economists asking ethical questions of what should or ought
to be and therefore take up strong moral positions on the issues of the goals themselves.
An example of a normative statement: -the present high level of inflation and unemployment
in Kenya ought to be reduced and the distribution of income be made more equitable.
ECONOMIC SYTEMS
Economic systems are systems are the methods by which societies make economic decisions
regarding the allocation and control of productive resources in the economy. Economic
systems determine the production, distribution and consumption and consumption of goods
and services.
There are three broad categories/types of economic systems.
1. Free market economy/Capitalistic/Laissez-faire
2. Command /Planned/Communistic economy
3. Mixed economy
1. Market Economies/Capitalist/Laissez-faire
This is an economic system whereby resources are allocated through the price mechanism i.e.
forces of demand and supply and the ownership and control of such important resources such as
land and capital are in the hands of private firms and individuals. Property laws give owner the
right to make decisions concerning access to the resources and determine the purpose for and the
manner in which they are used.
In this economic system, people and firms decide what to produce, for whom, and how much.
This economy allows for change and growth of new ideas. The consumers and businesses
determine the prices of products and how much of them are to be produced. In this economy,
sometimes resources and jobs are not distributed equally. Resources are owned and controlled
by individuals. Economic decisions are made by individuals competing to earn profits./

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Individual economic freedom is considered important. Economic decisions are made by the
basic principles of supply and demand. Profit is the motive for increasing work rather than
quotas. There is competition among businesses. Competition determines price which increase
the quality of the product. Examples of market economies are the United States, EU e.t.c
Characteristics/features of market economies
a) Freedom of Choice and Enterprise. Entrepreneurs are free to invest in any business
enterprise of their choice, sell them to markets of their choice. Workers are free to sell their
labour in occupation; land owners are free to put their land to use of their choice; and
consumers are free to consume products of their choice.
b) Freedom of Ownership of the Means of Production
Individuals are free to own the means of production i.e. land and capital and enjoy income
from them in terms of rent, interest, profits.
c) Self-Interest is the Dominating Motive
Firms aim at maximization of their profits; workers aim at maximizing their wages; land owners
aim at maximizing their returns; and consumers aim at maximizing their satisfactions.
d) Reliance on the Price Mechanism to allocate resources between industries and to ration the
limited goods and services amongst the consumers. Entrepreneurs will invest in industries with
high demand, and that is where worker will sell their labour in over another to maximize their
wages. Also land owners will put their land to use with the highest returns.
e) Limited Role of Government
Apart from providing, defence, police services, infrastructural facilities, roads for public
transport, it plays a very limited role in directly in economic-role of profit making activities.
Limitations of free enterprise
1) Inequalities in income and wealth whereby some people amass extremes of wealth while
other people are very poor resulting in social evils like crimes, corruption and
prostitution.
2) Instabilities in form of trade cycles which exhibits periods of: Prosperity, recession,
depression, recovery. During recession and depression there is a slowing down of economic
activities resulting to unemployment.
4) Technological Changes resulting in new inventions of labour – displacing machinery,
resulting in unemployment.
5) Failure of the price Mechanism - Price of a product is based on demand and supply and on
the production cost. It does not take into account any social cost associated with that product.
e.g. pollution of the atmosphere in the environment, this is a social cost affecting society
members. The price of the product should be higher than the economic price to reflect this
social cost when there is a government intervention is taxed, and the tax revenue to be used to
rectify the situation e.g. to depollusionize the atmosphere to the environment, or the tax may
be aiming at discouraging the consumption of the product e.g. one that is harmful to health
e.g. alcohol, cigarettes.
Advantage of Market economy/capitalism
1. Capitalism is extremely efficient. The society’s resources are put to the best use by the
businesses for the consumers hence no wastage of resources.
2. There is consumer sovereignty i.e individuals have the freedom to decide what they want

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 to buy and when they buy it and they have wide choices for goods and services.
3. This economy and the market are flexible because they respond to changes in demand
and supply.
4. The competition brought about by the large number of buyers and sellers leads to high
quality products, lower prices e.t.c.
5. Higher rates of economic growth because of the incentives available for hard work and
skill such as profits.
Disadvantages of Market economy/capitalism
1. It doesn’t always supply for everyone’s needs. It leaves out those who cannot make a
competitive living, such as the elderly.
2. Pure capitalism would leave out the production of public facilities and a national defense
system, but this pure capitalism has never been achieved.
3. Pure capitalism is also prone to depressions.
4. There is a possibility of rising monopoly power whose aim is to maximize profits and
consumers may be exploited.
5. It may lead to inequalities in wealth and income distribution hence widening the gap
between the rich and the poor.
6. It may lead to externalities (spill over) e.g. negative externalities such as pollution which
may negatively affect the environment.
7. Price mechanism alone cannot allocate resources to produce public goods which are less
profitable e.g street lights defense hence the need for government intervention
2. Command economies/ Communism
In this economic system, the government or other central authority owns all the property and
makes decisions and determines how resources will be used. This is where resources are
allocated by a central planning authority and key industries and resources are owned and
controlled by the state.
The government also makes decisions on all of the choices and expects the common people
to go along with the leader’s decisions. This government is capable of making drastic changes
easily in a short period of time since one unit is controlling everything. The land and other
resources are the distributed equally to everyone because the system works to make everyone
equal. There is little individual freedom. There is no competition. Businesses are not run to
create a profit. Consumers have few choices in the market place. Factories are concerned with
quotas. Shortages are common because of poorly run factories and farms. The government sets
the prices of goods and services. Examples of command economies are Cuba, the former Soviet
Union (USSR) North Korea and the People's Republic of China. There is however no complete
command economy where all allocation decisions are undertaken in this way.
Advantages.:
1.Maximizes the continues utilization of resources.
2. Distributes wealth equally among all people so there are no inequalities.
3. Only products that are required are produced hence prevents production of socially undesired
products.
4. Workers are guaranteed a job thus creating a sense of security.
5. There are public goods and services that the government will provide for everyone, such as,

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health care, education, and a military.
6. It avoids instability which is characteristic of a free market economy.
7. It ensures that negative externalities e.g pollution are minimized.
8. It puts check on monopoly power as such monopoly industries can be controlled by the
government.
Disadvantages.
1. Lack invention and innovation and hard work due to absence of incentives such as profits,
better pay, and promotion.
2. It curtails the power of consumer sovereignty as it cannot detect consumer preferences
accurately.
3. Resources are misallocated as consumer demands are not satisfied by production.
4. Overstaffing problems, poor product quality, lack of efficiency.
5. The consequence of the security a person would receive is little or no individual freedom. A
citizen has almost no say in what he or she does for a living and they cannot change jobs.
6) The task and cost of assessing the available resources, deciding on what to produce, how
much to produce, how to produce, methods of distributions e.t.c. can be too much for the central
planned committee also maintaining of such a committee can be too costly.
7) In the absence of competition there can be inefficiency.
8) In the absence of price mechanism, wrong decision can be made i.e. too much for or too little of
a product may be produced leading to misallocation of resources and wastage.
3. The mixed economy
The mixed economy refers to such an economic system whereby there are two sectors i.e.
Government (public sector) and individuals (private sector) exist, function and share the
decision making process on production, distribution and consumption for achieving national
objectives. It is a mix of capitalism (market) and socialism (command). The government
influences decisions through taxation subsidies and provision of free services such as defense.
The government also guides and regulates production of goods and services offered. It also
guides and control economic pressures. This economic system permits freedom of enterprise,
private ownership and profit earning, but at the same time ensures that the basic needs of all
citizens are met.
Individuals own means of production and can go about their affairs freely but there is some
government intervention. This system allows for change as the people do with some of the
benefits of socialism like welfare. Mixed economy is the best. In a mixed economy the best of
all the economies is offered. A person can choose their job and also receive some of the
benefits of a socialist economy like welfare and social security. This economy will provide
people with the best form birth to death. It is the most effective economy for providing goods
and services. The government protects consumers and workers from unfair policies command
and a market economy.
Role of government in a mixed economy
1) Redistribution of income and wealth by progressive taxation of high income and providing
services free or subsidized largely for the benefit of the low income group.
2) Stabilization of the economy
It stabilizes the economy in that it is the largest employer. It also influences the location of

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industries, Inflow and outflow of foreign exchange level of investments: and sometimes
participate either wholly through public corporations or partnership with private investors.
3) Legal Frame-work of rules and Regulations to govern the economy
It modifies the price system in that not all prices are determined by the forces of demand and
supply thus if the production of a particular commodity involves social cost or is harmful to
health such a product will be taxed slightly higher than the rest. Hence price will be higher than
the cost price.
The tax revenue can be used to rectify the situation or to discourage the consumption of the
product.
4. Provides services considered essential and that when provided by private investors will be
too costly for the low income group. e.g. education, medical services, defence e.t.c. Such
services are provided either subsidized or provided free of charge and private investors can also
provide such services alongside government because of limited resources available to
government.
5. Due to market failure- i.e where price mechanism would either produce the wrong amounts
of certain goods and services and fail to allocate resources to production of certain goods.
6. To maintain competition thus curbing the emergence of monopoly powers that may
undermine efficient allocation of resources
ADVANTAGES
1. The mixed economy is helpful in increasing national production in the country. Both
public and private sectors work hard to bring about more production.
2. The problems created by free enterprise and too much public control are solved through
mixed economy.
3. It provides freedom of enterprise ownership and profit earning as well as social welfare
and political freedom.
4. All the national recourses are utilized under mixed economy.
5. A variety of goods are available. We can find the role of co-operatives in the field of
cultivation diary, poultry.
6. The use of intoxicants and drugs is prohibited and the government never allows black
marketing.
7. Income disparities can be checked.
8. The basic rationale behind under mixed economy is to raise social welfare of the masses
and remove the pitfalls of the free enterprise. Public services are provided for everyone.
DISADVANTAGES
1. It is not helpful in achieving optimal use of national resources.
2. The mixed economy suffers from the drawbacks of both the capitalism and the socialism.
Mixed economy seldom achieved progress.
3. It suffers from continues backwardness.
4. Under mixed economy wastage of different types occurs in the economy.
Many people still pay for their treatment while others cannot afford to do so
5. There lack of co-operation in between private sector and public sector. The public sector
expands more rapidly, as a result the government expenditure increases