INTRODUCTION TO

ECONOMICS
 Economics
• Economics is the science that deals with the
production and consumption of goods and
services and the distribution and rendering of
these for human welfare.
 Economic goals
• A high level of employment
• Price stability
• Efficiency
• An equitable distribution of income
• Growth
 Flow in an Economy
1. The flow of goods, services, resources and money
payments results in a simple economy
2. Households and business firms are the two major
entities in a simple economy.
3. Business organizations use various economic
resources such as land, labour and capital which are
provided by households to produce consumer goods
and services which will be used by them.
4. Business firms make payment to the money to the
households for receiving various resources
5. The households in turn make payments to the business
organizations
Flow in an Economy
 Microeconomics / Macroeconomics
Microeconomics Macroeconomics
It is a study of individuals or groups It is a study of economy as a whole.
A study of particular households, particular Deals with aggregate of these quantities, not
firms, particular industries, particular with individual incomes but with the national
commodities, particular prices etc. income, not with individual prices but with the
price level, not with individual output but with
the national output.

The objective of microeconomics is to The objectives of macroeconomics are full

maximise utility or maximisation of profit or employment, price stability, economic growth,
minimisation of cost. favourable balance of payments etc.
The basis of microeconomics is the price The bases of macroeconomics are the national
mechanism which operates with the help of income, output, employment and the general
demand and supply forces. These forces help to price level which are determined by aggregate
determine the equilibrium price in the market. demand and aggregate supply.

microeconomics uses the technique of partial Macroeconomics uses the technique of general
equilibrium analysis which explains the equilibrium analysis that studies aggregate
equilibrium conditions of an individual, a firm economic variables and their interrelations.
or an industry.
 Microeconomics / Macroeconomics
Microeconomics Macroeconomics
Microeconomics is a static analysis Macroeconomics is a dynamic analysis.

Microeconomic problems are many. Macroeconomic problems are relatively

few
Under micro study the main problem is of Under macro study the main problem is
price determination. income determination.
Micro study is based on the objective of Macro study is based on the objective of
optimum allocation of resources full employment of total resources.
 Law of Supply and Demand
• Demand : The desire for a commodity backed
by necessary purchasing power.
• Supply : It represents how much a market can
offer. It refers to the amount of certain
producers willing to supply when receiving a
certain price.
Law of Supply and Demand
 Law of Demand
1. The law of demand states that if all the other
factors remain equal the higher the price of good
the less people will demand that goods.
2. The amount of goods the buyers purchase at
higher price is less because as the price of a good
goes up, so does the opportunity cost of buying
that good.
3. As a result people will naturally avoid buying a
product that will force them to forgo the
consumption of something else they value more.
 Law of Supply
1. The supply relationship shows that if the price
is low the producers restrain from releasing
more quantities of the product in the market.
2. Hence the supply of the product is decreased.
3. From the above fig the point of intersection of
supply curve and demand curve is called
equilibrium point.
4. At this particular point the quantity of supply
is equal to the quantity of demand
 Factors influencing demand
• The shape of the demand curve is influenced by the
following factors
a) Income of the people
b) Prices of related goods
c) Tastes of consumers.
• If the income of the people increases the purchasing power
increases.
• For e.g. If the cost of TV set is lowered its demand will go
up, as a result the demand for its associated products such
as VCD would increase.
• Over a period of time the preference of the people for a
particular product may increase, which in turn will affect
the demand.
 Factors influencing supply
• The shape of the supply curve is influenced by the following factors
• Cost of the inputs
• Technology
• Weather
• Prices of related goods
• If the prices of fertilizers and cost of labour increases the Profit
margin per bag of paddy will be reduced.
• Hence the farmers will reduce the area of cultivation and the supply
of paddy will be reduced.
• If there is an advancement in technology used to Manufacture the
product then there will be reduction in the production cost of the
product. Hence more quantity will be supplied.
• Weather also plays a major role. During winter the demand for
woollen products will increase.
• So the producers will supply more woollen products during winter.
 CONCEPT OF ENGINEERING ECONOMICS

• Engineering Economics
It is defined as “A set of principles , concepts,
techniques and methods by which alternatives
within a project can be compared and evaluated
for the best monetary return”.
Engineering economics deals with the methods
that enable one to take economic decisions
towards minimizing costs and/or maximizing
benefits to business organizations.
Principles of Engineering Economics
Develop the alternatives : Decisions are made from
the alternatives. The alternatives need to be identified
and then defined for the subsequent analysis.
Focus on the differences : Only the differences in
expected future outcomes among the alternatives are
relevant and should be considered for decision.
Use a consistent view point: The prospective
outcomes of the alternatives, economic and other,
should be consistently developed from a defined
perspective.
Principles of Engineering Economics
Use of common unit of measure : Common unit of
measure to enumerate as many of the prospective outcomes
as possible will make easier the analysis and comparison of
alternatives.
Consider all relevant criteria: Selection of preferred
alternative requires the use of criteria.
Make uncertainty explicit: Uncertainty is inherent in
projecting the future outcomes of the alternatives and
should be recognized in their analysis and comparison.
Revisit your decisions : Improved decision making results
from an adaptive process, the initial projected outcomes of
the selected alternatives should be subsequently compared
with actual results achieved.
 Engineering economics analysis procedure

1. Problem recognition, formulation and

evaluation.
2. Development of feasible alternatives.
3. Development of the cash flows for each
alternative.
4. Selection of criterion.
5. Analysis and comparison of the alternatives.
6. Selection of the preferred alternative.
7. Performance monitoring and post evaluation
results
 Types of Efficiency
• Efficiency of a system is generally defined as the ratio of its output to input.
– Technical efficiency
– Economic efficiency.
Technical efficiency
• It is the ratio of the output to input of a physical system. The physical system may
be a diesel engine, a machine working in a shop floor, a furnace, etc.
 Types of Efficiency
Economic efficiency
• Economic efficiency is the ratio of output to input of a
business system.

• ‘Worth’ is the annual revenue generated by way of

operating the business and ‘cost’ is the total annual
expenses incurred in carrying out the business.
• For the survival and growth of any business, the
economic efficiency should be more than 100%.
 Types of Efficiency
• Economic efficiency is also called ‘productivity’.
There are several ways of improving productivity.
– Increased output for the same input
– Decreased input for the same output
– By a proportionate increase in the output which is
more than the proportionate increase in the input
– By a proportionate decrease in the input which is
more than the proportionate decrease in the output
– Through simultaneous increase in the output with
decrease in the input.
Scope of Engineering Economics
1. Engineering economics plays a very major role in all
engineering decisions.
2. It is concerned with the monetary consequences, financial
analysis of the projects, products and processes that
engineers design.
3. Engineering economics helps an engineer to assess and
compare the overall cost of available alternatives for
engineering projects.
4. According to the analysis an engineer can take decision
from the alternative which is more economic.
5. Engineering economics concepts are used in the fields for
improving productivity, reducing human efforts,
controlling and reducing cost.
Scope of Engineering Economics
6. Engineering economics helps to understand
the market conditions general economic
environment in which the firm is working.
7. It helps in allocating the resources.
8. Engineering economics helps to deal with the
identification of economic choices, and is
concerned with the decision making of
engineering problems of economic nature.
 Production Function
• Explains the relationship between factor input and
output in physical terms.
• PRODUCTION means transformation of physical
“inputs” into physical “outputs”.
• A production function can be represented in the
form of a mathematical model of equation as
Q = f ( a,b,c,…… etc.)
where
Q stands for quantity of output per unit of time
a, b, c, etc are the various factor inputs like land, capital,
labour etc, which are used in the production of output.
 Types of factor input
• FIXED INPUTS
– Fixed inputs are those factors the quantity of which remains
constant irrespective of the level of output produced by a
firm.
– For example, land, buildings, mach ines, tools, equipments,
superi or types of labour, top management etc.
• VARIABLE INPUTS
– Variable inputs are those factors the quantity of which
varies with variations in the levels of output produced by a
firm.
– For example, raw materials, power fuel, water, transport,
labour and communication etc.
 Types of production function
• SHORT RUN
– In this case, the producer will keep all fixed factors
as constant and changes only a few variable factor
inputs. For example, Law of Variable Proportions.
• LONG RUN
– In this case, the producer will vary the quantities of
all factor inputs both fixed as well as variable in
the same proportion. For example, the laws of
returns to scale.
 Law of Variable Proportions
• In the short-run the level of production can be changed
by changing the factor proportions.
• This law examines the production function with on
factor variable, keeping the other factor
• The law explains the short-run production function.
• When the quantity of one input is varied, keeping other
inputs constant, the proportion between factors
changes.
• When the proportion of variable factors increases, the
total output does not always increase in the same
proportion, but in varying proportion.
 Assumption of Law
• Only one factor is variable while others are
held constant.
• All units of the variable factor are
homogeneous.
• There is no change in Technology.
• It is possible to vary the proportions in which
different inputs are combined.
• The products are measured in physical units,
i.e., in quintals, tonnes etc.
 Total, Average & Marginal product
• Total Product
– It refers to the total volume of goods produced during a specified
period of time.
– Total product (TP)can be raised only by increasing the quantity
of variable factors employed in production.
• Average Product
– Average product can be known by dividing total product by the
total number of units of the variable factor. TP/Q
• Eg- 450/5=90
• Marginal Product
– It is output derived from the employment of an additional unit of
variable factor unit.
– The rate at which total product increases is known as marginal
product.
– Addition to the total product resulting from a unit increase in the
quantity of the variable factor.
 Relationship between AP and MP
• When AP rises as a result of an increase in the
quantity of variable input, MP is more then the
average product.
• When AP are maximum then MP is equal to
AP. The MP curve cuts the AP curve at its
maximum.
• When AP falls as a result of decrease in
quantity of variable input, MP is less than the
AP.
 Stages of production
• Stage 1
– THE LAW ON INCREASING RETURNS.
• Stage 2
– THE LAW OF DIMINSHING RETURNS.
• Stage 3
– THE STATE OF NAGATIVE RETURNS
 THE LAW ON INCREASING
RETURNS
• TP increases at an increasing rate up to a point
F.
• MP also rises and is maximum at point F.
• AP goes on rising.
• After point F , TP rises but at diminishing rate.
• MP falls but is positive.
• Stage 1 ends where AP reaches its highest
point.
 THE LAW OF DIMINSHING
RETURNS
• TP continues to increase at a diminishing rate,
until it reaches it maximum point H.
• Both MP and AP continuously fall during this
stage.
• Stage ends when TP reaches its maximum
point H.
THE STATE OF NAGATIVE RETURNS

• TP declines.
• MP negative.
• AP is diminishing.
 Reasons for Law of Proportion
• Increasing Returns to a factor
1. Better utilization of Fixed factor
2. Increased Efficiency of Variable Factor
3. Indivisibility of Fixed Factor
• Diminishing Returns to a factor
1. Optimum combination of factors
2. Imperfect substitutes
• Negative Returns to a factor
1. Limitations of fixed Factor
2. Poor coordination between Variable and fixed factor
3. Decrease in Efficiency of Variable Factor
 Laws of returns to scale
• The law of returns to scale operates in the long
period. It explains the production behaviour of
the firm with all variable factors.
• The law of returns to scale describes the
relationship between variable inputs and
output when all the inputs, or factors are
increased in the same proportion.
 TYPES OF LAWS OF RETURNS
TO SCALE
 Increasing returns to scale
Constant returns to scale
Diminishing returns to scale
 Increasing returns to scale
• If the output of a firm increases more than in
proportion to an equal percentage increase in
all inputs, the production is said to be exhibit
increasing returns to scale.
 Constant returns to scale
• When all inputs are increased by a certain
percentage, the output increases by the same
percentage, the production function is said to
be exhibit constant returns to scale.
 Diminishing returns to scale
• The term ‘diminishing’ returns to scale refers
to scale where output increases in a smaller
proportion then the increase in all inputs.
• For example, if a firm increases inputs by
100% but the output decreases by less than
100%, the firm is said to be exhibit decreasing
returns to scale.
 ELEMENTS OF COSTS
• Cost is defined as the amount, measured in money or cash
expended or other property transfer capital stock issued,
service performed, or liability incurred in consideration of
goods or services received or to be received.
• Cost may be defined as the total of all expenses incurred
whether paid or outstanding in the manufacture and sale of a
product
• Cost can be broadly classified
– variable cost : varies with the volume of production
– overhead cost. : fixed, irrespective of the production
volume.
 ELEMENTS OF COSTS
• Variable cost can be further classified into
– Direct Material Cost : are those costs of materials that are used to
produce the product
– Direct Labour Cost : amount of wages paid to the direct labour
involved in the production activities
– Direct Expenses : expenses that vary in relation to the production
volume, other than the direct material costs and direct labour costs.
• Overhead cost can be classified into
– Factory Overhead : total cost involved in operating all production
facilities of a manufacturing business that cannot be traced directly to a
product.
– Administration Overhead : includes all the costs that are incurred in
administering the business.
– Selling Overhead : total expense that is incurred in the promotional
activities and the expenses relating to sales force.
– Distribution Overhead : total cost of shipping the items from the
factory site to the customer sites.
 The selling price of a product
a) Direct material costs + Direct labour costs + Direct
expenses = Prime cost
b) Prime cost + Factory overhead = Factory cost
c) Factory cost + Office and administrative overhead =
Costs of production
d) Cost of production + Opening finished stock – Closing
finished stock = Cost of goods sold
e) Cost of goods sold + Selling and distribution overhead
= Cost of sales
f) Cost of sales + Profit = Sales
g) Sales/Quantity sold = Selling price per unit
 OTHER COSTS/REVENUES
• MARGINAL COST : It is cost of producing an
additional unit of that product.
• MARGINAL REVENUE : It is the incremental
revenue of selling an additional unit of that product.
• SUNK COST : It is the past cost of an equipment/asset.
This cost is not considered for any analysis.
• OPPORTUNITY COST : The expected return or
benefit foregone in rejecting one course of action for
another. When rejecting one course of action the
rejected alternative becomes the opportunity cost for the
alternative accepted.
 BREAK-EVEN ANALYSIS
Objective :
To find the cut-off production volume from where a firm will make
profit.
Let
s = selling price per unit
v = variable cost per unit
FC = fixed cost per period
Q = volume of production
The total sales revenue (S) of the firm is given by the following formula:
S=s Q
The total cost of the firm for a given production volume is given as
TC = Total variable cost + Fixed cost
= v Q + FC
BREAK-EVEN ANALYSIS
Break-Even Chart
 BREAK-EVEN ANALYSIS
• Break-Even point:
– The intersection point of the total sales revenue line and the
total cost line
– At the intersection point, the total cost is equal to the total
revenue.
– This point is also called the no-loss or no-gain situation.
• For any production quantity which is less than the
break even quantity the firm will make loss because
total cost > total revenue.
• For any production quantity which is more than the
break even quantity the firm will make profit because
total revenue > total cost.
BREAK-EVEN ANALYSIS
 BREAK-EVEN ANALYSIS
Margin of Safety
– It is defined as the difference between the sales and variable cost.
– The margin of safety (M.S.) is the sales over and above the break-even
sales.
 PROFIT/VOLUME RATIO (P/V RATIO)

P/V ratio is a valid ratio which is useful for further analysis.

The relationship between BEP and P/V ratio is as follows:

The following formula helps us find the M.S. using the P/V ratio: