MODULE I – INTRODUCTION

CHAPTER 1 - SCOPE AND IMPORTANCE OF BUSINESS

ECONOMICS

Economics a social science deals with the economic behaviour of mankind it studies the
utilisation of scarce resources of the society and how the various goods and services produced
at distributed among the different sections of the society.

SCARCITY
Every economy has a limited stock of resources namely land labour capital technology exit
from these have to be used for the production of various goods and services in the best
possible manner. Goods and services are scared in relation to wants does the problem of
scarcity exists even in the richest of the rich countries and in today's world a world of scarcity
is filled with economic goods.

CHOICE
Due to the problem of scarcity choice has been exercised by every economy in the utilisation
of resources and satisfaction of once the choice has to be made in such a way that optimum
resource allocation can be insured what to produce, how to produce and for whom to produce
are the three main issues faced while making a choice this implies that every corner me must
make the right choice about factor inputs and outputs.

EFFICIENCY
Efficiency implies the effective use of scarce resources in such a manner that maximum ones
can be satisfied if there is no efficiency then people may be worse off than the phone
ensuring efficiency in new resource utilisation is the essence of economics.

OPPORTUNITY COST
Opportunity cost in an important cost concept it arises due to the universal economic problem
that is want unlimited means are limited and they have alternative uses the use of resources
has to be selected. At particular time they can be used for a particular purpose. The other
users have to be sacrificed when a factor of production is employed in one you and the
production of the other good where it can be used is sacrificed. Therefore opportunity cost of
a factor of production is a best next alternative that is sacrificed it is also called an alternative
cost or social cost of production.

PRODUCTION POSSIBILITIES CURVE / PRODUCTION

POSSIBILITIES FRONTIER
The concept of production possibilities curve is given by the famous economist Professor
Samuelsson. He explains the basic subject matter of economics namely scarcity of resources
and the problem of economizing resources like land, labour, capital and technology. Experts
are available to any company is limited and they to be utilised in the best possible manner to
produce the maximum output. An economy said to be efficient when the maximum output is
produced at minimum cost of production. This is also termed as the least cost output.

The production possibility curve is also known as a transformation curve. To explain this
concept Professor Samuelson has assume the following three conditions:

A. There is full employment and full production of goods and services.

B. The supply of factors of production is fixed and have a work they can be shifted
among different users within limits
C. The state of technology remains the same.

The production possibility frontier can be illustrated by an example. Let us suppose an

economy has certain amount of resources which can be used for producing to goods namely
rifles and bread. While the former is a defence good the latter is consumption good. If all the
resources are used for producing rifles the production of bread is impossible and vice versa.
The economy is supposed to produce a combination of both the good. The various production
possibilities of both the goods can be depicted through a table and a diagram.

Possibilities Bread (`000) Rifles

A 0 20
B 1 19
C 2 17
D 3 14
E 4 10
F 5 0
In the above possibilities, if all the resources are used for the production of rifles then
production of bread will be zero. On the other hand if the resources are entirely used for the
production of bread then the production of rifles will be nil. In between these two extremes
there are a number of other possibilities.

The economy has to make a choice are as to what quantities of bread and rifles after be
produced. The resources are limited. Hence only unlimited output can be produced. If the
production of bread has to be increased the production of rifles has to be reduced and vice
versa to increase the production of bread resources have to be transferred from the production
of rifles. Does a choice has to be made and this is the core of the economy is growing
problem. The PPC curve can be vividly explain with the following diagram.

In the above diagram PP1 is the production possibilities curve. It shows the schedule along
with the two goods that can be substitute for each other. If all the resources are used for the
production of bread production of rifle will be cleaned and vice versa. Points B, C, D and E
represent the combination of both goods. If combination B is selected then more of rifles and
less of bread would be produced. On the other hand combination E signifies production of
both more of bread and less of rifles. PPF shows the maximum amount of the two goods that
can be produced given the input and technology. In the other words PPC is nothing but the
menu available to the society regarding goods and services.

In the above diagram point R is not possible as it is outside the PPF. If point S is selected and
indicate inefficiency as all the resources are not used. Thus economy should select a point on
the curve for optimum use of resources.
The production possibilities curve is also known as the transformation curve. This is because
when the output of the bread is increased resources are shifted from the production of the
rifles. This in effect is nothing but transforming rifles to bread by transferring the resources.
Thus in a full employment economy production of one good can be increased only by
sacrificing the production of the other good. It is not possible to increase the production of
both as the resources at scarce.

BASIC ECONOMIC RELATIONS

A. Function –

Function explains the relationship between two economic variables. It explains how one
variable depends on the other. Example demand of a good depends on the price. It is
expressed as D = (p), where , D is demand and p is the price and f represents functions.
Functions are classified into two types namely explicit function and implicit function.
Explicit function is one in which the value of one variable depends on the other in a definite
form. Implicit function is one in which variables are interdependent.

B. Equations and Identities –

An equation explains the relationship between two economic variables namely the dependent
and the independent variable and equation is true only for a specific value. An equation is
true only for a specific value. The symbol equal to is used in equation. Equation can be linear
or quadratic. Identities are those in which relationship is always true identities are denoted by
the sign equal to.

C. Graphical Techniques –

Graphs are considered as a very important economic analysis. A graph is a diagram which
shows the relationship between two variables. A graph about a vertical axis termed as y axis
and a horizontal Axis term as x axis. When the relationship between two variables has to be
expressed one has to be shown on the x-axis and the other on the y-axis. All the points are
plotted, a graph can be obtained.

D. Slope –

It refers to the change in one variable due to change the other variable. In other words this is a
change in variable y which is represented in the y axis due to per unit change in the variable x
on the x-axis. Slope measures numerically the relationship between change in y and the
change in X. Slope is popularly termed as the Rise over the run. Here rise is a vertical
distance while run is the horizontal distance.

E. Variables –

Variable play an important role in the economic theories. It is the magnitude of interest which
can be defined and quantified. It is a symbol whose value keeps on changing. It assumes
different values at different times or places. Variables can be endogenous or exogenous.
Endogenous are those which lie within the theory while exogenous lie outside the theory.

F. Constant –

Constant is the symbol whose values remain the same throughout a particular problem.
Constants are of two types namely absolute and arbitrary. In the case of absolute constant the
value will remain the same. In the case of arbitrary constant the value will remain the same in
a particular problem but it will change its value in other problems.

G. Ceteris Paribus –

It implies other things being equal. Economic theories of a use ceteris paribus assumptions.
When the relationships between two variables are explained other factors which affect the
variables are assumed to be constant. This is termed as ceteris paribus and set assumptions
help to simplify the theories.

H. Time series –

The relationship between time and a set of data is called time series. It raises the movement in
the variable or a period of time. Time series graph have a variable like GDP on the y-axis and
time on the x-axis. The relationship between the variable and time can be traced in the graph.

I. Incremental concept –

Incremental concept analysis impact of decision on investment, production, prices, etc. and
ultimately on the total cost and total revenue. Thus this concept can be viewed in terms of
incremental cost and incremental revenue. Due to the change in the decision of an
organisation total cost and total revenue will change. This change in total cost is called the
incremental cost and the change in the revenue is called the incremental revenue

J. Marginal concept –
Marginal concept indicates the change in total revenue and total cost due to the unit change.
Marginal cost is the cost incurred in producing an additional unit of the output. Marginal
revenue is the addition made to the total revenue by selling one more unit of the output.

TOTAL, AVERAGE & MARGINAL RELATIONS

Revenue

Revenue function refers to the sales receipts. The revenue of a firm depends upon the
quantity of output sold & price per unit of the commodity. There are three concepts of
revenue namely.

(a) Total Revenue – It is the total receipts earned by the firm by selling the output. It is
calculated as,

TR = P x Q

Where,

TR = Total Revenue

P = Price of the commodity per unit

Q = Total quantity of output sold

(b) Average Revenue – It is the revenue obtained per unit of the output.

AR = TR / Q

AR = (P x Q) / Q

AR = Price

(c) Marginal Revenue – It is the addition made to the total revenue by selling one more
unit of output. Symbolically,

MR = TRn – TR n-1

MR = Change in TR / Change in Quantity

Cost

(a) Total Cost (TC) – It is the total expenditure incurred by the firm in producing a given
level of output. It is obtained by multiplying factor prices with their quantities.
TC = f (Q)
 TC = TVC + TFC
(b) Total Fixed Cost (TFC) – It is the total cost incurred on the fixed factors of
production. It remains the same at all the levels of output in the short run.
(c) Total Variable Cost (TVC) – The cost incurred on these variable factors is called the
total variable cost. It varies with the level of output.
(d) Average Fixed Cost (AFC) – It is the TFC divided by the total units of the output.
AFC = TFC / Q
(e) Average Variable Cost (AVC) – It is the TVC divided by the total units of output.
AVC = TVC / Q
(f) Average Total Cost (ATC) – It is total cost divided by the units of output.
ATC = TC / Q
ATC = (TVC + TFC) / Q
(g) Marginal Cost – It is the cost of producing an extra unit of the output.
MC = TCn – TCn-1
 CHAPTER 2 - DEMAND AND SUPPLY ANALYSIS

DEMAND ANALYSIS
The term demand refers to desire backed by willingness to pay and ability to pay.

DD = Desire + Ability to Pay + Willingness to Pay

Demand Schedule – When a relationship between quantity demanded of a commodity and

prices are tabulated it is called a demand schedule. It is a table or chart which shows the
quantities of a commodity demanded at different prices during a given period of time.

Individual Demand Schedule

Price per litre of milk (Rs.) Quantity Demanded (in litres)

30 1
25 2
20 3
15 4
10 5

Market Demand Schedule

Price per litre DD of DD of DD of Total DD (A +

of milk (Rs.) Consumer A Consumer A Consumer A B +C)
30 1 2 3 6
25 2 3 4 9
20 3 4 5 12
15 4 5 6 15
10 5 6 7 18
The demand schedule can be used to draw the demand curve. When the relationship between
price and quantity is plotted on a graph is a downward sloping demand curve can be obtained
this is called the demand curve. It is a negative slope. It indicates the inverse relationship
between price and quantity demanded.
In the above diagram x axis represents quantity demanded while y axis represents price. The
downward sloping demand curve indicate that higher the price lower the demand and vice
versa

Law of Demand – The functional relationship between price and quantity demanded of a
commodity is explained by the law of demand. This law is also known as the first law of
purchase.

It states “other things being equal if the price of a commodity Falls the quantity demanded of
eight will rise and if the price of the commodity Rises if quantity demanded will decline.”

The demand curve slopes downward due to Income effect and substitution effect. When the
price of a commodity falls a unit of money goes father and one can buy more. With the fall in
prices the real income of the consumer increases. He feels better off and tends to buy more.
Secondly when the price falls it becomes relatively cheaper and consumers tend to substitute
it for dearer goods. While the former refers to income effect the latter refers to the
substitution effect. Due to the combined operation of these two effects the demand curve
slopes downward from left to right. Moreover when a commodity becomes cheaper it is put
two more uses. While the existing customers buy more new customers also enter the market.
The law of diminishing marginal utility also state that when the price of the commodity falls
more has to be purchased to bring out the equilibrium between the price and the marginal
utility.
Exceptions to the demand curve

A. If people expect a shortage in the future they tend to buy more when the prices rise
B. Search in precious items like diamonds are purchased more when their prices are
high. Such goods are called status symbol commodity.
C. Due to ignorance also people may buy more when the prices are high
D. Sometimes people think that higher the price better the quality, hence they buy more.
E. In case of necessary items even the prices goes up people may buy more of them by
re-adjusting their expenditures
F. The demand for inferior goods will fall with the fall in price and will write the rise in
price. This behaviour was observed by Sir Robert Gibson and hence named after him.
He found that in Britain when the price of bread increased for families reduce the
demand for meat in order to spend on bread full stop these goods are known as Giffen
goods and this exception of demand is known as Giffen’s Paradox.

Demand Function

Demand function explain the relationship between the demand for a commodity and its
determinants full stop in precise terms it refers to the relationship between the various units
of commodity that might be purchased and the various factors which determine the demand
during a given period of time. The relationship between demand and its determinants can be
expressed in the form of a function as

Qx = f (Px, Pr, Y, E, T, O)

Here,
Qx refers to the quantity demanded of commodity x

F refers to functional relationship

Px refers to price of x

Pr refers to prices of related goods

Y refers to the income of the consumer

E refers to expectation about future prices

T refers to the taste and preferences and

O refers to other factors

Factors determining demand

Individual demand

A. Income of the consumer – Demand for a good is directly related to the income of the
consumer. Higher the income greater the demand for a product and vice versa
B. Price of the commodity - It is the main determinant of the demand. Demand will be
more if the price is low it will be less if the price is high. There is an inverse
relationship between the price and the quantity demanded
C. Taste and preferences - The demand for many good depends on the taste and
preferences of the people. This factor is a subject factor as influenced by the cultural
and historical factors also
D. Price of the related goods - The demand for certain goods depend on the price and
availability of the related with some with the substitute for each other while others are
complementary goods
E. Future Expectations - If a consumer expects a rise in the price of a good in the future
the demand for it would increase now and vice versa
F. Effect of advertisement - Advertisement has a significant impact on the consumption
of the people in the modern days full stop demand for certain goods are highly
influenced by the advertisement campaign

Market demand

A. Change in weather - According to change in whether the demand for certain goods
will also change
 B. Changing fashion - The demand for good will be more if it is in fashion and vice
versa
C. Change in money circulation - If the supply of money is more the demand for goods
will be more and vice versa
D. Change in the size of the population - When the population increases the demand
for various goods and services will go up and vice versa
E. Technological changes - Better technology and new inventions will lead to the
production of new goods and services they will replace the old goods and hence the
demand for the new goods would increase
F. Discovery of cheap substitute - Availability of substitute affect the demand for
certain goods
G. Advertisement effect - The demand for various good will significantly influenced by
the advertisement at present. A persistent campaign will influence the customers and
increase the demand for such goods.

Classification of Demand

A. Direct demand and derived demand - The demand for final goods and services is
said to be a direct demand. Consumer goods and services which can be readily used
belong to the direct demand. Derived demand on the other hand refers to the demand
for factors of production or anything that is required to produce other goods and
services. It is also known as induced demand.
B. Company demand and industry demand - The demand for a commodity produced
by individual firm is called a company demand. Industry demand refers to the total
demand faced by all the firms constituting the industry
C. Demand for durable goods and demand for non-durable goods - Durable goods
are those which can be used over a long period of time they are used to meet the
current needs and future demand. Demand for durable good can be because of a
replacement demand or new demand. If the demand for a good is for maintaining the
capital asset it is called replacement demand. When a demand for good is for addition
of the stock taken it is known as new demand. Non-durable goods out single use
goods. They are perishable in nature and other single use goods. They are mainly used
to meet the current demand only
D. Short run demand and long run demand - Based on the time period demand is
classified as short run demand and long run demand. While short run demand refers to
 the existing demand long run demand refers to the size and pattern of demand which
will exist in the long run. Short run demand is influenced by the price and change in
income. Long run demand is affected by the factors like growth in population
technological changes
E. Total market demand and market segment demand - The total demand for a
commodity from all sectors or sources is termed as total market demand. When this
market is sub-divided it is termed as market segment and the demand in these
segments is known as market segment demand
F. Individual demand and market demand - The demand for a good from the
individual consumer is known as individual demand. Market demand refers to the
summation of demand of all the consumers for a product
G. Joint demand and composite demand - when two or more goods and demanded at
the same time to satisfy a particular what it is called a joint demand. Composite
demand refers to the demand for those good and services which can be used for more
than one purpose.

SUPPLY ANALYSIS
The term supply refers to the quantities that a seller is willing and able to sell at different
prices during a given period of time. Supply is related to price and time. Generally supply
will be more when the price goes up and vice versa. Like a demand schedule a supply
schedule shows the various quantities of a commodity offered for sale at different prices. It
shows a direct relationship between the quantity and price. On the other hand the basis of the
supply schedule the supply curve can be drawn. The supply curve slopes upward indicating
the direct relationship between price and quantity supplied.

Price per litre Quantity Supplied

1 2
2 4
3 6
4 8
5 10
Law of Supply

“Other things being equal as a price of the commodity Rises its supply is extended and as the
price fall if supply is contracted.”

Exceptions to the Law of Supply

A. Labour supply - in case of labour as a wage rate in an industry rises the supply of
labour that is number of hours of work would rise up to a point. Hence the supply will
slow backward up to that point. But beyond that point with the further rise in the wage
rate the supply curve of labour will slope backward. This is because the workers main
pay for more leisure to work after receiving a certain fixed amount of income in the
form of wages.
It is given in the figure that the supply of labour rises with every rise in the wage rate
up to OW. But there after as the wage rate rises from OW to OW2 the supply of
labour Falls from OM hours to ON2 hours, thus we get a backward sloping supply
curve of labour full stop it is called as an exceptional supply curve.
 B. Saving: Supply of Capital: Normally when the rate of interest rises the amount of
savings would rise. But the savings of some people may fall with the rise in the rate of
interest and rise in the fall of interest. This is usually the case with those people who
are interested in fixed income in the form of interest
C. Expectations of a Change in Price in the Immediate Future - with the slight rise in
the price of a commodity some of its seller expect a further rise in its price in the
immediate future if total supply may decline in the current period. Opposite would be
the case if the price of the commodity falls
D. Immediate Need of Cash - if a spell is hard pressed for money and if required
immediately a particular amount of money you would supply a large amount of a
commodity at lower price and a smaller amount of that commodity at a higher price
E. Rare Collection - in the case of rare collection like coins stamps painting supply can
not be increased even if there is an increase in price
F. Closure of Business - if a business firm is closing down the formula of the goods at a
lower price to clear the stock

EQUILIBRIUM PRICE DETERMINATION

The equilibrium price in the market is determined by the point where demand and supply are
in balance. At this point the quantity demanded by the consumer is equal to the quantity
supplied by the producer. The determinant of equilibrium price can we explain with the help
of the following diagram and the table.
Price Per Litre Qty. Demanded Qty. Supplied Market Status Price Changes
of Milk (in Rs.) (in Litres) (in Litres)
5 8 16 Surplus Decline
4 10 14 Surplus Decline
3 12 6 Equilibrium Balance
2 14 6 Deficit Increase
1 18 2 Deficit Increase

In the above table initially with the prices higher supply is more than demand. This leads to a
decline in price when the price is rupees 3 per litre demand is equal to supply. If the price is
rupees to per litre the demand will increase and demand will be more than supply. This
excess demand will lead to a rise in price and equilibrium price will be restored. At the
equilibrium point that is neither a shortage nor a surplus. The same table can be represented
in the form of a diagram.

In the above diagram the demand curve slopes downward from left to right indicating the
inverse relationship between price and the quantity demanded. The supply curve slopes
upward implying more will be supplied at a higher price and less will be supplied at a lower
price. The two curves intersect at point E where quantity demanded is equal to the quantity
supplied. The equilibrium price is rupees 3 per litre and the equilibrium quantity demanded
and supplied is 12 litres of milk
The equilibrium price will change whenever there is a change in demand or supply or both.
For example supply remaining the same if the demand increases the curve will shift to the
right and there will be a rise in the equilibrium price full stop on the other hand if there is an
increase in supply demand remaining the same prices will fall.
 MODULE II – DEMAND ANALYSIS

CHAPTER 3 - NATURE OF DEMAND CURVE UNDER

DIFFERENT MARKETS
The term market refers to the link between the buyer and the seller. The link can be
established through a number of ways. Market are classified as product Markets and factor
market. The product market is the market with goods and services a bottom sold. The product
market is classified on the basis of the commodity sold that is whether they are homogeneous
for heterogeneous or on the basis of the number of buyers and sellers. It is also classified on
the basis of time and place. The broad classification of market is as follows

A. On the basis of place it is classified as local national and international

B. On the basis of time is classified as very short period short period long period and a
very long period
C. On the basis of the nature of the product number of sellers and degree of competition
market are classified into perfect competition and imperfect competition

DEMAND CURVE UNDER DIFFERENT MARKET STRUCTURES

A. Perfect competition –

It is a market structure where there are a large number of sellers and buyers. The products
sold by them are homogeneous and they have single price. The product a perfect substitute
for each other. Both the sellers and buyers have perfect knowledge about the market. In this
market structure and individual seller is a price taker not a price maker. He cannot influence
the price by adjusting his supply.

Under perfect competition and individual firm faces perfectly elastic demand curve. The
price per unit of the average revenue remains the same. Hence, average or the demand curve
is a horizontal straight line. All additional units are sold at the same fries. Hence the total
revenue increases in a constant proportion. Therefore the total revenue curve will be an
upward sloping straight line and it is also a 45 degree line originating from the origin. This
implies that the total revenue will change with the change in the unit of output sold. Singh the
single price prevails in the market at all the additional units are sold at the same price
marginal revenue will remain constant at it will be equivalent to the average revenue. Hence
the average revenue and marginal revenue curve coincide with each other and the perfect
competition.
 Units of Output Price Per Unit (AF) Total Revenue Marginal Revenue
Sold
1 10 10 -
2 10 20 10
3 10 30 10
4 10 40 10
5 10 50 10

In the above table TR is increasing in a constant proportion. Price per unit remains the same
at Rs. 10. All additional units are sold at the same price. Therefore, MR = Rs. 10. Since AR =
MR, the respective curves will coincide with each other. This can be depicted as follows:

Revenue TR

AR = MR

Output
B. Monopoly –

Monopoly refers to a market situation where there is a single seller. There are no close
substitute and the free entry and exit. Do he is a single seller we cannot decide upon output
and price at the same time. He does not have exclusive control over the aspects of the market
would stop if he decides the price that he has to leave it to the market and the quantity to be
sold and vice versa. Under Monopoly the average revenue curve slopes downward from left
to right at the marginal curve lies below the average revenue curve. The downward sloping
average revenue curve implies that the monopolistic can sell more at a lower price and you
can sell less at a higher price. Since the average revenue was following the total revenue will
increase the diminishing rate. The marginal revenue curve will try between the average
revenue curve and the y-axis at it will like exactly at half the distance between the average
revenue curve and the y-axis.
Units of Output Price Per Unit Total Revenue Average Marginal
Sold (AF) Revenue Revenue
1 15 15 15 -
2 14 28 14 13
3 13 39 13 11
4 12 48 12 9
5 11 55 11 7

In the above table it can be seen that the monopolist is able to sell more when the price falls.
When the AR falls, MR is also falling & it is falling faster than AR. Due to this both AR &
MR are downward sloping & MR lies below AR.

Revenue

AR

MR

Output

Here AR & MR curves are downward sloping. When AR & MR are straight lines, they are
linear curves.
 CHAPTER 4 - ELASTICITY OF DEMAND

Elasticity of demand the concept given by the famous economist professor Alford Marshall.
It explains the degree of responsiveness of demand to a given change in price. The law of
demand simply explained the demand will change whenever there is a change in the price. It
is not give the extent of change of demand. It is given by the concept of elasticity of demand

Elasticity of demand is defined as the sensitiveness or responsiveness of demand to change in

price. According to Alfred Marshall the elasticity of demand in the market is great or small
according as the amount demanded increases much all little for a given fall in price and
diminishes as much or as little for a given rise in price.

Symbolically elasticity of demand is expressed as:

Ed = Proportionate change in quantity demanded / Proportionate change in price

Elasticity of demand can also be expressed in percentage as follows:

Ed = Percentage change in quantity demanded / Percentage change in price

If the percentage changes in quantity and price and loan elasticity of demand can be easily
calculated. Price elasticity of demand refers to change in quantity demanded to change in the
price. Sometimes demand changes due to change in the income of the consumer and change
in the price of the other commodities.

Elasticity of demand is broadly classified as

A. price elasticity
B. Income elasticity
C. cross elasticity
D. promotional elasticity
E. arc elasticity

TYPES OF ELASTICITY OF DEMAND

A. Price elasticity of demand –

A change in price brings about change in quantity demanded other things remain in the same.
State of change in demand did change in the price is called price elasticity of demand.
If this coefficient of elasticity of demand that is Ed is greater than 1 demand is said to be
relatively elastic and if it is less than one demand is set to be relatively inelastic

Degrees of price elasticity of demand

1. Perfectly inelastic demand - at a given price and amount of the commodity

can be demanded and a small change in price would bring about infinite
change in the quantity demanded. Demand and said to be highly sensitive to
change in price. In this case the demand curve is horizontal straight line
parallel to the axis and symbolically will be represented as Ed is equal to
infinity.
2. Perfectly inelastic demand - in this case the quantity demanded remains the
same whatever be the change in price. The demand curve is a vertical line
parallel to the y-axis and coefficient of elasticity of demand is equal to zero
3. Relatively elastic demand - in this case the change in the price will bring
about a more than proportionate change in quantity demanded. The coefficient
of elasticity of demand is greater than 1
4. Relatively inelastic demand - the change in demand will be less than the
change in the price. You are the demand curve is a steeper 1 foot of the
coefficient of elasticity of demand will be less than 1
5. Unitary elastic demand - in this case the change in the price brings about a
proportionate change in the quantity demanded and elasticity of demand is
equivalent to Unity.
 B. Income elasticity of demand

It is the responsiveness of quantity demanded of a commodity when there is a change in the

income.

Types of income elasticity of demand

1. Unitary income elasticity – Here the change in quantity demanded is equal to

the change in the income. The elasticity ratio is equivalent to one. In this case
a curve will be a perfectly positive slope and is represented by a 45 degree line
 2. Income elasticity greater than Unity - In this case the change in quantity
demanded will be more than the change in the income. Therefore Ed will be
greater than 1. The curve will be a positive slope but less steeper
3. Income elasticity less than 1 - In this case the change in the quantity
demanded will be less than the change in the income. Therefore Ed will be
less than one. The curve has a positive slope but it is steeper.
4. Income elasticity equivalent to zero - In this case when income changes the
quantity demanded will remain the same. Here elasticity of demand is said to
be equivalent to zero. Curve will be a vertical straight line
5. Negative income elasticity - In this case the curve will bend backward. It
implies that when the income increases the quantity demanded will decline. It
happened in the case of inferior goods

Income elasticity of demand also depends upon the nature of the goods. In case of normal
goods it is positive. In case of inferior goods it will be negative. In case of luxury goods it is
positive and greater than 1. In case of necessity is it is positive but the elasticity ratio is less
than one. In the case of certain goods like salt, matchbox etc. it is zero.

C. Cross elasticity of demand –

It is a change in the quantity demanded of a commodity to the change in the price of the other
commodities. It is defined as the ratio of the proportionate change in the quantity demanded
of commodity x to the given proportionate change in the price of the related commodity.
Cross elasticity depends upon the type of goods consumed by the people. If two goods are
complementary to each other cross elasticity of demand is said to be negative. In case of
substitute cross elasticity of demand is set to be positive. If commodities are perfect substitute
then cross elasticity is set to be infinity. If two commodities are not related to each other then
cross elasticity of demand will be zero

D. Promotional elasticity of demand –

It is the change in the quantity demanded of a commodity to the change in the advertisement
expenditure. This elasticity of demand is very useful to business firms to find out the impact
of the advertisement expenditure on the demand for the commodity.

E. Arc elasticity of demand –

This concept is used to measure the elasticity over drain of the demand curve. When elasticity
is measured at a particular point it is called the point elasticity but when it is measured over a
range is known as arc elasticity.

MEASUREMENT OF ELASTICITY OF DEMAND

A. Percentage or ratio method –

In this method elasticity is measured by dividing the percentage change in quantity demanded
by the percentage change in the price.

B. Geometric method or point method –

To measure elasticity of demand at a point or demand curve this method is used. To explain
this method is considered a linear demand curve. At the point of this curve elasticity is
measured using the formula.

Ed = lower segment / upper segment

If the coefficient is greater than 1 the demand is said to be relatively elastic and vice versa.
In the case of non-linear demand curve elasticity is measured at a particular point the curve
the time to has to be drawn to that point and then the same formula is to be used.

FACTORS DETERMINING ELASTICITY OF DEMAND

A. Nature of the commodity - if the commodities and necessities demand will be right
to be inelastic. In case of comfort and luxury item the demand will be elastic
B. Availability of substitute - if the commodity has a number of substitute the demand
will be elastic and vice versa
C. Number of uses – if the commodity can be used for a variety of purpose in the
demand is elastic and vice versa
D. Habit and Custom - the people habit way to a particular commodity demand will be
inelastic
E. Level of income - in the case of high-level income groups demand will be inelastic
whereas in case of poor people the demand will be elastic
F. Time - in the short run demand for certain goods and services in elastic whereas in the
long run command becomes elastic
G. Range of prices - if the commodities expensive the demand is elastic and if the
commodities are less expensive than the demand remains inelastic
H. Proportion of income spent by the people – if the people spend a small percentage
of the income of certain goods the demand for study goods will be inelastic full stop
on a contrary if a larger percentage of income spent on a certain good demand for it
will be elastic
 I. Possibility of postponement - if the consumption of goods can be postponed demand
will be elastic and vice versa
J. Complementary goods and their prices – A change in the availability of
complementary goods and their prices with effect the demand for certain goods. If the
price of a petrol increases the demand for cars with the client and vice versa. In this
case demand will be relatively elastic. In certain other goods like the salt which is
used with other good demand with relatively inelastic.

RELATIONSHIP BETWEEN AVERAGE REVENUE MARGINAL

REVENUE AND PRICE ELASTICITY OF DEMAND
There is a very useful relationship between elasticity of demand, average revenue and
marginal revenue at any level of output. We will make use of this relation extensively when
we come to the study of price determination under different market conditions. Let us study
what this relation is.

We have stressed above that the average revenue curve of a firm is really the same thing as
the demand curve of consumers for the firm’s product. Therefore, elasticity of demand at any
point on a consumer’s demand curve-is the same thing as the elasticity of demand on the
given point on the firm’s average rev­enue curve.

We know that elasticity of demand at point R on the average revenue curve DD in Fig. 21.6 =
RD’/RD. With this measure of point elasticity of demand we can study the relationship
between average revenue, marginal rev-enue and price elasticity at any level of output.
In Fig. 21.6, AR and MR are respec-tively the straight lines average and mar-ginal revenue
curves of a firm.

Elasticity of demand at point R on the average revenue curve:

Ep = RD’/RD

Now, in triangles PDR and QRD’

<DPR = <RQD’ (right angles)

<DRP = <RD’ Q (corresponding angles)

<PDR = <QRD’

Therefore, triangles PDR and QRD’ are equiangular RD’ RQ

Hence = RD’/RD = RQ/PD …………….. (i)

In the triangles PDC and CRH

PC = RC

< PCD = < RCH (vertically opposite angles)

< DPC = < CRH (right angles)

Therefore, triangles PDC and CRH are congruent (i.e., equal in all respects).

Hence PD = RH …………..................... (ii)

From (i) and (ii), we get

Price elasticity at R = RD’/RD = RQ/PD = RQ/RH

Now, it is seen from Fig. 21.6 that

RQ/RH = RQ/RQ-HQ

Hence, price elasticity at point R = RQ/RQ-HQ

It will be seen from Fig. 21.6 that RQ is the average revenue (AR) and HQ is the marginal
revenue (MR) at the level of output OQ corresponding to point R on the demand or average
revenue curve DD’. Therefore,

Average Revenue, Marginal Revenue and Price Elasticity of Demand

Where e stands for price elasticity of demand at a given point on the average revenue curve.

With the help of the above formulae we can find out marginal revenue at any level of output
from average revenue at the same output provided we know the point price elasticity of
demand on the average revenue curve. If the price elasticity of a firm’s average revenue curve
at a given level of output is equal to one marginal revenue equals zero.
 CHAPTER 5 - DEMAND FORECASTING

A focus is an estimation of a situation the future. Demand forecasting estimating the demand
for a product in future. Past experience is analysed and demand forecasting is done on the
basis. It is based on scientific method and statistical tool are used to arrive at the good
forecast.

TYPES OF DEMAND FORECASTING

A. Passive and active demand forecasting –

The demand of a previous year extrapolated and future demand is predicted and the impact of
new policies of demand can be analysed in passive demand forecasting. In active demand
forecasting the future demand is estimated by taking into account the impact of new policies
and their impact on its own plans and actions. This type is considered better than the passive
forecasting.

B. Firm level, industry level and national level demand forecasting –

When the demand for a product of an individual firm is forecasted it is called firm-level a
micro forecasting. When the demand for the product of an entire industry is estimated it is
termed as industry level demand forecasting. National level demand forecasting refers to the
estimation of demand at a macro level that is estimation of future demand of all the goods
produced in the economy.

C. Short term, medium term and long term demand forecasting –

If the demand is forecasted for a less than a your it is known as short term demand
forecasting full stop if the demand is forecasted for a period of 1 to 5 years it is included and
the medium term demand forecasting. When the demand forecasting is related to five years of
more it is said to be long term demand forecasting

D. Ex-ante and ex-post forecast –

When the forecasting is done for the number of period in future it is called ex Ante forecast.
when the forecast for the past and the present are considered to find the credibility of the
forecasting model then it is termed as Ex Post forecast

STAGES INVOLVED IN DEMAND FORECASTING

A. Determination of objectives –
The business firm should clearly identify the objective of demand forecasting and the utility
of the forecast for its future plans

B. Nature of the product –

In the market the nature of the demand forecasting depends upon the type of product and the
nature of the market in which it is sold. Different types of products required different types of
demand forecasting. The nature of the market structure doesn’t and the significant factor
which influences the demand forecasting. Different market structure required different type
of demand forecasting

C. Identification of demand determinants –

The various determinants of demand should be clearly identified. The demand determinants
are different for different types of products.

D. Selection of the method of demand forecasting –

There are various methods of demand forecasting. Depending upon the nature of the product
of particular method has to be selected. Sometime it may be necessary to select the
combination of two or three methods. The selection of a particular method depends upon the
time period available for forecasting and the accuracy expected.

E. Interpretation of data and testing the accuracy of forecasting –

Once the required statistical data is collected it has to be processed and interpreted properly.
Interpretation of statistical data is a complicated process. On the basis of the data collected
demand estimate have to be made. The statistical accuracy of demand forecasting can be
tested by various methods. The testing is done to avoid or minimise error. The difference
between the forecast value and the actual value indicates the absolute level of forecasting
error.

METHODS OF DEMAND FORECASTING

A. Survey method –
1. Census method and sample method –

It is a direct method of collecting information about future demand. Survey the generally
conducted through interviews or by sending question. Surveys are of two types namely
complete enumeration or census survey and sample survey method.
 a. Complete enumeration method is a method in which all the
consumers of a product a question about the product. The future
plans for the product of their reaction to change in the price of the
product design advertisement etc. The information that is collected is
classified tabulated and analysed. This network is highly reliable as it
covers the entire group of customers and is free from the personal
prejudice of the investigator. However it is an expensive method and
time consuming process.
b. Sample Survey method is an alternative to the census method. From
this large group of consumers summer selected at random and they
are interviewed about the demand for the product in the future. The
information is then processed and used for demand forecasting and
stop the method is a simple one as it is less time consuming and less
expensive.
2. Expert Opinion method –

In this method the opinion of the experts are taken into account to predict the future demand
for a product. The expert may be from within the organisation or hired from outside full stop
one popular method is a Delphi Technique. This method involves the opinion of three or four
experts. Each export will be asked to give the opinion about the future demand. Then the
opinion of other experts would be revealed to them and they are blue in reviewing the opinion
in the light of the comment from other experts will be obtained. The process of reviewing
will continue to the consensus is reached. It may be expensive method but the views of the
others and their consensus can be rightly known

3. Sales force opinion –

Another method is to obtain the opinion of the sales force. The sales for the while actually the
market and hence the opinion is sought. The period of all the sales people as some that and
then the information is used for demand forecasting. The advantage of this method is that it
can be done in a cheaper way and it is easier to be done.

4. Market experimentation –

It is also used by firm for demand forecasting. Sometimes survey method does not give the
expected results and hence it is used. It is of two types namely test marketing and controlled
experimentation.
 a. Test marketing a particular area or a particular region is selected. A
new product will be introduced in this area and the behaviour of the
consumers will be judged. The firm can conduct the same experiment
in more than one area and the response of the consumers can also be
a certain by the phone full stop the technique is used on the actual
behaviour of the consumer and hence the results may be reliable.
How many it is expensive and time consuming.
b. Another method of market experimentation is controlled
experiment a sample of the customers for a product is selected and
the answers to visit a nearby shopping store where weed is brand the
product will be displayed. The customer or Express the preferences
and the same is recorded. Sometime a certain amount of money is
given to them to make purchases and their preferences are observed.
The opinion we also be obtained through a questionnaire.
B. Statistical methods
1. Time series analysis –

This method is widely used by the business firm as it uses a historical data to explain the
future demand. It is not explain the casual relationship between variables and how they will
behave in the future. If we assume the past behaviour of the variable will continue in future
also full stop the data is related to the time period and hence its find out the factors which
affect the behaviour of the variables.

2. Econometric method –

This method combine economic and statistics. It explains the cause and effect relationship
between economic variables and the change in the variables can be quantitatively measure.
Both magnitude and direction of the change can be estimated with the help of this technique.
Econometric model can be adjusted according to the requirement and the model can be a
single equation for a multiple equation model.