Basic Concepts of Economics and Allocation of Resources
Economics — Grade 11 | Chapter 1 / Unit 1 | NEB Nepal
Table Of Contents
Introduction
Every day, every person in Nepal makes economic decisions — a farmer in Mustang decides how much land to plant with apples versus wheat; a student in Kathmandu chooses between buying textbooks or saving for tuition; a government ministry allocates a limited budget among competing priorities. These decisions — individually small, collectively enormous — are the subject of economics. Economics is the study of how individuals, households, businesses, and governments make choices about the use of scarce resources to satisfy unlimited wants.
Unit 1 of NEB Grade 11 Economics begins with the most fundamental questions: What is economics? Who are its great thinkers? What is the scope and purpose of economic study? How is it divided into micro and macro dimensions? And what are the goods, services, and productive resources that economics studies? These questions provide the conceptual foundation for every subsequent unit in the course.
1. Definition of Economics
Economics has been defined in different ways by different scholars across different historical periods. The three definitions that the NEB syllabus specifically requires — and that NEB examinations most frequently test — are those of Adam Smith, Alfred Marshall, and Lionel Robbins.
1.1 Adam Smith’s Definition — Economics as a Science of Wealth
According to Adam Smith, the father of modern economics, in his landmark work The Wealth of Nations (1776), “Economics is the science which enquires into the nature and causes of the wealth of nations.”
Smith’s definition focuses on wealth as the central concern of economics. For Smith, the key economic question was: why are some nations rich and others poor? His answer — that wealth is created through productive labour, specialization, and free exchange — laid the foundation for classical economics.
Key features of Smith’s definition:
- Treats economics as a science — systematic, analytical, based on observation
- Focuses on wealth creation — production and distribution of goods
- Concerned with nations — macroeconomic in orientation
- Emphasizes labour, specialization, and free markets as drivers of prosperity
Criticism of Smith’s definition:
- Too narrow — focuses only on wealth, ignoring human welfare, services, and non-material aspects of economic life
- “Wealth of nations” ignores how wealth is distributed — a nation can be wealthy in total while most of its citizens remain poor
- Reduces economics to a “science of wealth” — a characterization that attracted the label “dismal science” and made economics seem unconcerned with human well-being
1.2 Alfred Marshall’s Definition — Economics as a Science of Material Welfare
According to Alfred Marshall, in his foundational textbook Principles of Economics (1890), “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 use of the material requisites of well-being.”
Marshall’s definition shifts the focus from wealth to human welfare — economics is not about money for its own sake but about how economic activity contributes to human well-being.
Key features of Marshall’s definition:
- Focuses on human beings in ordinary life — not abstract wealth
- Concerned with material welfare — economic activities that contribute to well-being
- Covers both individual and social dimensions of economic action
- Treats economics as a social science — studying human behaviour in its economic dimension
- Introduces the concept of welfare — broader than mere wealth
Criticism of Marshall’s definition:
- Restricts economics to material welfare — ignores non-material economic activities (services, education, health, culture) that also contribute to human well-being
- The word “material” is ambiguous — it is difficult to draw a sharp line between material and non-material welfare
- Still excludes many important economic phenomena from its scope
1.3 Lionel Robbins’ Definition — Economics as a Science of Scarcity and Choice
According to Lionel Robbins, in his influential work An Essay on the Nature and Significance of Economic Science(1932), “Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses.”
Robbins’ definition is the most widely accepted in modern economics. It defines economics in terms of the fundamental economic problem: scarcity. Human wants are unlimited; the means (resources) available to satisfy them are scarce; and those scarce means can be put to alternative uses. Economics is the science of making choices under these conditions.
Key features of Robbins’ definition:
- Unlimited ends (wants): Human wants are infinite — there is always more that people would like to have
- Scarce means (resources): The resources available to satisfy these wants are limited — time, money, land, labour, capital are all finite
- Alternative uses: Scarce resources can be put to different uses — choosing one use means forgoing another
- Choice: Because of scarcity and alternative uses, every economic agent must make choices — and these choices have costs (opportunity costs)
- Universal scope: Robbins’ definition applies to all human societies, all economic systems, all historical periods — wherever scarcity and choice exist, economics is relevant
Criticism of Robbins’ definition:
- Too abstract and too broad — by making economics purely about scarcity and choice, it potentially includes all human decision-making, not just economic decisions
- Ignores the macroeconomic dimension — questions of national income, employment, and economic growth do not fit neatly into the scarcity-and-choice framework
- Treats economics as a positive (value-free) science — but economic policy always involves value judgments that cannot be excluded
1.4 Comparison of the Three Definitions
| Basis | Adam Smith | Alfred Marshall | Lionel Robbins |
|---|---|---|---|
| Focus | Wealth of nations | Material welfare | Scarcity and choice |
| View of economics | Science of wealth | Science of welfare | Science of scarcity |
| Scope | Narrow — material goods | Broader — material welfare | Broadest — all scarce means |
| Orientation | Macro (nations) | Both individual and social | Individual and universal |
| Human element | Implicit | Explicit — human welfare | Central — human behaviour |
| Key concept | Wealth | Material welfare | Scarcity, ends, means, choice |
| Published | 1776 | 1890 | 1932 |
Modern consensus: Robbins’ definition is the most analytically rigorous and is the basis of modern economics. Marshall’s welfare orientation remains important for normative and development economics. Smith’s wealth perspective underlies macroeconomics and growth theory.
2. Positive and Normative Economics
2.1 Positive Economics
Positive economics deals with what is — it describes, explains, and predicts economic phenomena based on facts, evidence, and logical analysis. Positive statements are objective, factual, and can in principle be tested against evidence.
According to Milton Friedman, in his influential essay The Methodology of Positive Economics (1953), “Positive economics is in principle independent of any particular ethical position or normative judgement. Its task is to provide a system of generalizations that can be used to make correct predictions about the consequences of any change in circumstances.”
According to N. Gregory Mankiw, “Positive statements are descriptive — they make a claim about how the world is. When economists try to explain the world, they make positive statements.”
Examples of positive economic statements:
- “When the price of rice rises, the quantity demanded falls.” (testable)
- “Nepal’s GDP grew by 5.8% in fiscal year 2079/80.” (factual)
- “An increase in the money supply leads to higher inflation.” (testable prediction)
- “Unemployment in Nepal’s youth population is higher than the national average.” (empirically verifiable)
Positive economics uses economic theory (models and principles) and empirical data (statistics and research) to explain how the economy works and to predict the effects of policy changes.
2.2 Normative Economics
Normative economics deals with what ought to be — it makes value judgments about economic goals, policies, and outcomes. Normative statements are prescriptive, reflecting ethical positions and value choices that cannot be resolved by evidence alone.
According to N. Gregory Mankiw, “Normative statements are prescriptive — they make a claim about how the world should be. When economists try to improve the world, they make normative statements.”
According to A.C. Pigou, “Normative economics is the economics of welfare — it asks not merely how things work but whether they are good or bad, fair or unfair, and what should be done to improve them.”
Examples of normative economic statements:
- “The government should redistribute income from the rich to the poor.” (value judgment)
- “Nepal should prioritize economic growth over environmental protection.” (policy prescription)
- “Minimum wages should be increased to Rs. 15,000 per month.” (normative prescription)
- “Foreign direct investment should be encouraged to reduce Nepal’s dependence on remittances.” (policy recommendation)
2.3 Difference Between Positive and Normative Economics
| Basis | Positive Economics | Normative Economics |
|---|---|---|
| Nature | Descriptive — what is | Prescriptive — what ought to be |
| Basis | Facts, evidence, logic | Values, ethics, judgments |
| Testability | Can be tested empirically | Cannot be tested empirically |
| Objectivity | Objective | Subjective |
| Agreement | Economists often agree | Economists often disagree |
| Purpose | Explain and predict | Evaluate and prescribe |
| Example | “Inflation is 8%.” | “Inflation should be reduced to 3%.” |
Key insight: Most real economic debates involve both positive and normative elements. The debate over Nepal’s minimum wage law, for example, involves positive questions (what effect does a minimum wage increase have on employment?) and normative questions (is the current wage distribution fair?). Good economic analysis separates these two dimensions clearly.
3. Microeconomics and Macroeconomics
3.1 Microeconomics
Microeconomics is the branch of economics that studies the behaviour and decision-making of individual economic units — individual consumers, households, firms, and industries — and how they interact in specific markets to determine prices and quantities.
According to Alfred Marshall, “Microeconomics studies the economic behaviour of individual agents — how a particular household decides what to consume, how a particular firm decides what to produce and at what price.”
According to Kenneth E. Boulding, “Microeconomics deals with particular firms, particular households, individual prices, wages, incomes, individual industries, particular commodities.”
According to Paul A. Samuelson and William D. Nordhaus, “Microeconomics is the branch of economics that deals with the behaviour of individual units — consumers, firms, and markets — and their interaction to determine prices and quantities in individual markets.”
Key topics in microeconomics:
- Theory of demand and supply
- Consumer behaviour and utility theory
- Theory of production and cost
- Market structures (perfect competition, monopoly, oligopoly)
- Factor markets (labour, capital, land)
- Price determination in individual markets
- Market failures (externalities, public goods, information asymmetry)
3.2 Macroeconomics
Macroeconomics is the branch of economics that studies the economy as a whole — the aggregate level of output, employment, prices, and economic growth — and the policies that affect these aggregates.
According to John Maynard Keynes, whose General Theory of Employment, Interest and Money (1936) founded modern macroeconomics, “The theory of output and employment as a whole must be our starting point. We must understand the economy’s total performance before we can understand the behaviour of its parts.”
According to Kenneth E. Boulding, “Macroeconomics deals not with individual quantities as such but with aggregates of these quantities — not with individual incomes but with the national income as a whole.”
According to Paul A. Samuelson, “Macroeconomics is the study of the behaviour of the economy as a whole — examining the forces that affect many firms, consumers, and workers at the same time.”
Key topics in macroeconomics:
- National income measurement (GDP, GNP, NNP)
- Aggregate demand and aggregate supply
- Inflation and deflation
- Employment and unemployment
- Money, banking, and monetary policy
- Fiscal policy (government spending and taxation)
- Economic growth and development
- Balance of payments and exchange rates
3.3 Difference Between Microeconomics and Macroeconomics
| Basis | Microeconomics | Macroeconomics |
|---|---|---|
| Scope | Individual units — households, firms | Entire economy — aggregate |
| Focus | Individual prices, wages, decisions | National income, price level, employment |
| Founder | Alfred Marshall | John Maynard Keynes |
| Tools | Demand-supply analysis, utility, production theory | National income analysis, AD-AS model |
| Policy | Market regulation, price control | Monetary policy, fiscal policy |
| Examples | Price of rice in Asan market; output of a factory | Nepal’s GDP; national inflation rate |
| Assumption | Ceteris paribus (other things equal) for individual markets | Aggregate effects across all markets |
| Goal | Efficiency in resource allocation | Stability and growth of the economy |
3.4 Interdependence of Micro and Macroeconomics
While micro and macro economics are analytically distinct, they are deeply interdependent in practice. According to Samuelson, “Just as you cannot understand biology by studying only cells or only whole organisms, you cannot understand economics by studying only micro or only macro — you need both.”
- Macroeconomic outcomes (inflation, unemployment, growth) emerge from the aggregate of millions of microeconomic decisions
- Microeconomic behaviour is shaped by macroeconomic conditions — a recession affects individual firms’ output and households’ consumption
- Modern economics increasingly integrates micro foundations into macro models — recognizing that aggregate behaviour must be grounded in individual decision-making
4. Types of Goods and Services
Economics studies how goods and services are produced, distributed, and consumed. Goods and services are classified in several ways, each classification revealing a different dimension of economic analysis.
4.1 Goods vs. Services
Goods are tangible, physical products — things that can be touched, stored, and transported. Examples: rice, clothing, vehicles, machinery.
Services are intangible activities that satisfy wants without producing a physical product. Examples: teaching, medical care, banking, transportation, trekking guiding.
According to Philip Kotler, “Services are characterized by four distinctive features: intangibility, inseparability (produced and consumed simultaneously), variability (quality varies), and perishability (cannot be stored).”
4.2 Free Goods and Economic Goods
Free Goods: Goods available in unlimited supply relative to demand — no price is charged because no choice is required. Examples: fresh air, sunlight, river water in remote areas.
Economic Goods: Goods that are scarce relative to demand — they have a price because they require a choice in production or acquisition. The central subject of economics. Examples: food, clothing, housing, education.
According to Robbins, “The distinction between free goods and economic goods is fundamental to economics — only economic goods require the analysis of scarcity and choice.”
4.3 Consumer Goods and Producer (Capital) Goods
Consumer Goods: Goods purchased for direct personal use and satisfaction — satisfying wants immediately or over a short period. Can be further classified as:
- Durable consumer goods: Last more than one year — television, refrigerator, motor vehicle
- Non-durable (perishable) consumer goods: Used up quickly — food, fuel, medicine
Producer Goods (Capital Goods): Goods used in the production of other goods and services — not for direct consumption. Examples: machinery, factory buildings, tools, computers used in business. Capital goods increase productive capacity.
According to J.B. Clark, “The distinction between consumer goods and producer goods is the distinction between satisfying present wants and building capacity to satisfy future wants — it is the economic expression of the choice between consumption and investment.”
4.4 Private Goods and Public Goods
Private Goods: Goods that are rival (one person’s consumption reduces availability for others) and excludable (people can be prevented from consuming them if they do not pay). Most goods in the market are private goods. Example: a loaf of bread, a mobile phone.
Public Goods: Goods that are non-rival (one person’s consumption does not reduce availability for others) and non-excludable (no one can be prevented from consuming them). Market failure occurs with public goods because producers cannot charge consumers, making private provision insufficient.
According to Paul Samuelson, who first formally analyzed public goods, “A public good is one whose consumption by one individual does not detract from the consumption by another — it is collectively consumed.”
Examples in Nepal:
- Public goods: national defence, street lighting, public parks, flood control infrastructure
- Private goods: food, clothing, mobile phones, private vehicles
The free rider problem: Because non-excludable goods cannot be priced, individuals have an incentive to use them without contributing to their cost — the “free rider problem” is why public goods require government provision funded by taxation.
4.5 Normal Goods and Inferior Goods
Normal Goods: Goods whose demand increases when income increases and decreases when income decreases — income and demand move in the same direction. Most goods are normal goods. Example: quality food, better clothing, private transport.
Inferior Goods: Goods whose demand decreases when income increases and increases when income decreases — as people become richer, they switch to superior substitutes. Example: low-quality rice varieties (replaced by better varieties as income rises), public bus travel (replaced by private vehicles as income rises).
According to Alfred Marshall, “The demand for inferior goods reflects the budget constraints of lower-income consumers — as incomes rise, consumers substitute higher-quality alternatives.”
4.6 Complementary Goods and Substitute Goods
Complementary Goods: Goods used together — an increase in the price of one reduces the demand for both. Examples: dal and rice; printer and ink cartridges; vehicles and fuel.
Substitute Goods: Goods that can replace each other — an increase in the price of one increases the demand for the other. Examples: tea and coffee; butter and margarine; different brands of mobile phones.
5. Factors of Production (Means of Production)
The factors of production are the resources used to produce goods and services. Economics traditionally identifies four factors:
5.1 Land
Land refers to all natural resources — the physical land surface as well as water, minerals, forests, climate, and all other gifts of nature used in production.
According to Alfred Marshall, “Land means the material and forces which Nature gives freely for man’s aid, in land and water, in air and light and heat.”
Characteristics of land:
- Free gift of nature — not created by human effort
- Fixed in total supply — the total area of land on earth cannot be increased (though its productivity can)
- Immobile — cannot be physically moved from one location to another (though ownership can change)
- Original and indestructible in its basic productive powers (though it can be degraded)
- Passive factor — land produces nothing alone without combining with labour and capital
Reward for land: Rent
Land in Nepal: Nepal’s diverse geography — from the Terai plains to the middle hills to the high Himalayas — creates dramatic variation in land productivity and value. Land is the most politically contentious resource in Nepal, with ongoing debates about land reform, tenancy rights, and agricultural modernization.
5.2 Labour
Labour refers to all forms of human physical and mental effort used in production — manual labour, skilled craftsmanship, technical expertise, managerial work, and intellectual activity.
According to Alfred Marshall, “Labour is any exertion of mind or body undergone partly or wholly with a view to some good other than the pleasure derived directly from the work.”
Characteristics of labour:
- Inseparable from the labourer — labour cannot be separated from the person providing it
- Perishable — a day’s labour not used is permanently lost; it cannot be stored
- Active factor — labour is the primary active agent in production
- Variable in quality — workers differ greatly in skill, effort, health, and motivation
- Heterogeneous — no two workers are identical
Reward for labour: Wages and Salaries
Labour in Nepal: Nepal has a large and growing working-age population, but faces significant labour market challenges — underemployment in agriculture, large-scale emigration (over 3 million Nepalis work abroad), skills gaps in high-value sectors, and gender disparities in formal employment.
5.3 Capital
Capital refers to all man-made resources used in the production of other goods and services — tools, machinery, buildings, infrastructure, and financial assets used productively.
According to Alfred Marshall, “Capital consists of all stored-up provisions, materials, machinery, and other means of production. Capital is wealth devoted to the production of further wealth.”
Characteristics of capital:
- Man-made — created through human effort and saving
- Mobile — can be moved from one use or location to another
- Durable — lasts through multiple production cycles (unlike raw materials)
- Productive — increases the productivity of labour and land
- Destructible — can depreciate, wear out, or become obsolete
Types of capital:
- Fixed capital: Used repeatedly over many production cycles — buildings, machinery, equipment
- Working (circulating) capital: Used up in a single production cycle — raw materials, fuel, semi-finished goods
- Human capital: The skills, knowledge, and health embodied in workers — increasingly recognized as the most important form of capital in knowledge-based economies
Reward for capital: Interest
5.4 Entrepreneurship (Organization)
Entrepreneurship refers to the human activity of combining the other three factors of production — land, labour, and capital — into a productive enterprise, bearing the risk of the undertaking and innovating to create value.
According to Joseph Schumpeter, “The entrepreneur is the innovator — the person who introduces new combinations of productive resources, new products, new methods of production, and new organizational forms.”
According to Frank Knight, “The entrepreneur’s distinctive economic function is to bear genuine uncertainty — the risk that cannot be calculated or insured against — in exchange for the prospect of profit.”
Functions of the entrepreneur:
- Combines land, labour, and capital in productive combinations
- Takes decisions about what to produce, how much, and by what methods
- Bears the financial risk of the enterprise — losing money if the business fails
- Innovates — introducing new products, methods, and markets
- Organizes the production process
Reward for entrepreneurship: Profit
Entrepreneurship in Nepal: Nepal’s entrepreneurship ecosystem is growing rapidly — supported by organizations like FNCCI, CAN Federation, and various incubators and accelerators. However, barriers including access to finance, regulatory complexity, infrastructure gaps, and brain drain continue to constrain entrepreneurial activity.
6. The Central Economic Problem: Scarcity and Choice
All economic problems ultimately derive from one fundamental condition: scarcity — resources are limited relative to the unlimited wants of human beings. This condition of scarcity forces every economic agent — individual, household, firm, or government — to make choices.
According to Robbins, “The economic problem arises from the combination of unlimited ends (wants) and scarce means (resources) with alternative uses. Given this condition, choices must be made — and every choice has an opportunity cost.”
Opportunity cost is the value of the best alternative forgone when a choice is made. It is the true economic cost of any decision.
Example: A student who chooses to spend an evening studying economics instead of working a part-time job has an opportunity cost equal to the wages they would have earned. A government that allocates budget to road construction instead of hospital construction has an opportunity cost equal to the health outcomes that could have been achieved.
The Production Possibility Frontier (PPF) illustrates the concept of scarcity and choice graphically — showing the maximum combinations of two goods that can be produced with available resources and technology. Points inside the frontier represent inefficiency; points on the frontier represent full efficiency; points outside are unattainable with current resources.
7. Economics in the Nepali Context
i. Why Economics Matters for Nepal: Nepal is a developing country — characterized by low per capita income, high dependence on agriculture and remittances, limited industrialization, and significant infrastructure gaps. Understanding economics is essential for every educated Nepali — to understand why these conditions exist, what policies can change them, and what role individuals and businesses play in the development process.
ii. Scarcity in Nepal: Nepal faces acute scarcity in several critical areas — capital for investment, skilled labour in high-value sectors, foreign exchange, and physical infrastructure. Every major policy debate in Nepal — hydropower development, agricultural modernization, trade policy, public sector reform — is fundamentally a debate about how to allocate scarce resources.
iii. Adam Smith’s Legacy in Nepal: Smith’s insight that the wealth of nations is created by productive labour and specialization is directly relevant to Nepal’s development challenge. Nepal’s comparative advantages — hydropower, tourism, herbs and agricultural products, cultural heritage — represent the specializations through which Nepal can generate wealth through international trade.
iv. Marshall’s Welfare Economics in Nepal: Nepal’s development goals — as articulated in the Sustainable Development Goals (SDGs) and the periodic plans of the National Planning Commission — are fundamentally about human welfare, not just GDP growth. Marshall’s welfare perspective reminds economists that the ultimate measure of economic success is human well-being.
v. Robbins’ Scarcity Framework in Nepal: Every budget decision made by Nepal’s government — how to allocate the national budget among education, health, infrastructure, defence, and debt service — is a direct application of Robbins’ framework: unlimited needs, scarce resources, alternative uses, compulsory choices.
Conclusion
The basic concepts of economics — definitions, positive and normative analysis, micro and macro dimensions, types of goods, factors of production, and the fundamental problem of scarcity — form the conceptual vocabulary through which all subsequent economic analysis proceeds. Without clarity about these foundations, the more advanced topics of the NEB syllabus — demand and supply, national income, money, development economics — cannot be properly understood.
As Alfred Marshall observed, “Economics is a study of men as they live and move and think in the ordinary business of life.” For students in Nepal, beginning the study of economics means beginning to understand not just abstract theories but the real forces that shape the livelihoods, opportunities, and futures of 30 million people in one of Asia’s most fascinating and complex economies.
Prepared for NEB Grade 11 Economics — Unit 1: Basic Concepts of Economics and Allocation of Resources Aligned with the National Curriculum Framework 2076, Curriculum Development Centre, Sanothimi, Bhaktapur
