Basic assumptions of Economics
Economists have generally looked for some’ fundamental assumption” about human behavior from which most of the principles of economics can be ultimately deduced. Every decision-maker in an economic system-whether he is a consumer or producer, whether it is a house hold or a firm- is assumed to have in a rational manner and go in for maximum gain. Economic rationality presupposes that every person knows his interest and selects that course of action, which promises him the greatest amount of satisfaction.
The economists have, generally assumed that human beings are rational and that they are influenced by the ‘maximization principle’. For example, every consumer is said to maximize his satisfaction with a given amount of expenditure, every producer maximizes his output and minimizes his cost; every seller minimizes his profit, as so on.
But rationality and maximization principles are based on the further assumption of perfect knowledge. Every rational consumer, for example, knows the different possible alternatives open to him and will choose that alternative that promises maximum satisfaction. However, rationality is conditioned and influenced by habits and social customs. Habits acquired over a number of years influence the consumers in the choice of goods. Likewise, social customs influence guide and modify economic behavior of individuals.
The assumption of economic rationality does not carry any moral or ethical implication. Rationality implies that in a period of acute shortage, producers and distributors would raise the price and secure higher profit margins. Such a behavior may be condemned from the social point of view, but economically it is justified. At the same time, it is necessary to distinguish between individual rationality and social rationality.
An individual entrepreneur may like to set up his workshop in or around Bombay as he can get his inputs easily and dispose of his output profitably; rational behavior indicates that he set up his factory in Bombay. But from the social point of view, this may not be rational and proper. For, Bombay is already overcrowded with a high density of population. Besides, there areso many backward areas, which need industrialization. From the social point of view it would have been better that the new factory is set up away from Bombay. There is thus a possibility of clash between individual rationality and social rationality.
Rationality and Concept of Equilibrium
From economic rationality, the economist passes on to the concept of “Equilibrium” which stands for a position of rest, a position of rest, a position of no change or a position of maximum gain. A rational consumer is said to be in equilibrium when he spends his limited income on different items in such a way that he secures maximum satisfaction. A producer is said to reach equilibrium position when he with given technology and resources, produces maximum output at minimum cost.
Likewise, a firm selling a product is said to be in equilibrium when it gets maximum profit. The economists assume that the economy has a natural tendency to reach equilibrium.
Economic analysis, especially microeconomics, dealing with price theory has been developed in the context of a developed capitalist economy. Such an economy assumes the existence of private property, freedom of enterprise, profit motive, private initiative, perfect competition and absence of government interference. The existence of free market conditions with free demand and supply is a necessary feature of a capitalist system. These conditions may not be present in any other economic systems, particularly in back ward and developing economies. Hence the conclusion and policy formulations applicable in the context of developed capitalist economies cannot be applied to developing and under developed economies, or they will have to be suitably modified.
Economics studies, the problem of allocation of limited resources as between different goods and services on the assumption that the technology and resources are given in an economy. The economy is producing maximum amount of national income with the given technology and resources. In other words, economics study a static economy with a given system of want, resources and technology. Naturally, the conditions and policy formulations derived from static economy will have to be changed for a dynamic economy.