BUSINESS ECONOMICS

Economics

Definition: Economics is that branch of social science which is concerned with the study of how
individuals, households, firms, industries and government take decision relating to the allocation
of limited resources to productive uses, so as to derive maximum gain or satisfaction.

Simply put, it is all about the choices we make concerning the use of scarce resources that have
alternative uses, with the aim of satisfying our most pressing infinite wants and distribute it
among ourselves.

1. Economics is a science: Science is an organised branch of knowledge, that analyses cause and
effect relationship between economic agents. Further, economics helps in integrating various
sciences such as mathematics, statistics, etc. to identify the relationship between price, demand,
supply and other economic factors.

1. Positive Economics: A positive science is one that studies the relationship between two
variables but does not give any value judgment, i.e. it states ‘what is’. It deals with facts
about the entire economy.
2. Normative Economics: As a normative science, economics passes value judgment, i.e.
‘what ought to be’. It is concerned with economic goals and policies to attain these goals.
2. Economics is an art: Art is a discipline that expresses the way things are to be done, so as to
achieve the desired end. Economics has various branches like production, distribution,
consumption and economics that provide general rules and laws that are capable of solving
different problems of society.

Therefore, economics is considered as science as well as art, i.e. science in terms of its
methodology and arts as in application. Hence, economics is concerned with both theoretical and
practical aspects of the economic problems which we encounter in our day to day life.
SCOPE OF ECONOMICS

1. Microeconomics: The part of economics whose subject matter of study is individual units, i.e.
a consumer, a household, a firm, an industry, etc. It analyses the way in which the decisions are
taken by the economic agents, concerning the allocation of the resources that are limited in
nature.

It studies consumer behaviour, product pricing, firm’s behaviour. Factor pricing, etc.

2. Macro Economics: It is that branch of economics which studies the entire economy, instead
of individual units, i.e. level of output, total investment, total savings, total consumption, etc.
Basically, it is the study of aggregates and averages. It analyses the economic environment as a
whole, wherein the firms, consumers, households, and governments make decisions.

It covers areas like national income, general price level, the balance of trade and balance of
payment, level of employment, level of savings and investment.

The fundamental difference between micro and macroeconomics lies in the scale of study.
Further, in microeconomics, more importance is given to the determination of price, whereas
macroeconomics is concerned with the determination of income of the economy as a whole.

Nevertheless, microeconomics and macroeconomics are complementary to one another, as they

both aimed at maximizing the welfare of the economy as a whole.

From the standpoint of microeconomics, the objective can be achieved through the best possible
allocation of scarce resources. Conversely, if we talk about macroeconomics, this goal can be
attained through the effective use of the resources of the economy.

Economic principles assist in rational reasoning and defined thinking. They develop logical
ability and strength of a manager. Some important principles of managerial economics are:
PRINCIPLES OF ECONOMIC

The followings are the principles of economics in the managerial/ business or general economics

1. Marginal and Incremental Principle

2. Equi-marginal Principle

3. Opportunity Cost Principle

4. Time Perspective Principle

5. Discounting Principle

1. Marginal and Incremental Principle

This principle states that a decision is said to be rational and sound if given the firm’s objective
of profit maximization, it leads to increase in profit, which is in either of two scenarios-

 If total revenue increases more than total cost.

 If total revenue declines less than total cost.
Marginal analysis implies judging the impact of a unit change in one variable on the other.
Marginal generally refers to small changes.
Marginal revenue is change in total revenue per unit change in output sold.

Marginal cost refers to change in total costs per unit change in output produced (While
incremental cost refers to change in total costs due to change in total output).

The decision of a firm to change the price would depend upon the resulting impact/change in
marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost,
then the firm should bring about the change in price.

Incremental analysis differs from marginal analysis only in that it analysis the change in the
firm's performance for a given managerial decision, whereas marginal analysis often is generated
by a change in outputs or inputs.

Incremental analysis is generalization of marginal concept. It refers to changes in cost and

revenue due to a policy change. For example - adding a new business, buying new inputs,
processing products, etc.

Change in output due to change in process, product or investment is considered as incremental

change.
Incremental principle states that a decision is profitable if revenue increases more than costs; if
costs reduce more than revenues; if increase in some revenues is more than decrease in others;
and if decrease in some costs is greater than increase in others.
2. Equi-marginal Principle

Marginal Utility is the utility derived from the additional unit of a commodity consumed. The
laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the
marginal utilities of various commodities he consumes are equal.

According to the modern economists, this law has been formulated in form of law of
proportional marginal utility. It states that the consumer will spend his money-income on
different goods in such a way that the marginal utility of each good is proportional to its price,
i.e.,

MUx/Px = MUy/Py = MUz/Pz

Where, MU represents marginal utility and P is the price of good.

Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique
of production which satisfies the following condition:

MRP1/MC1 = MRP2/MC2 = MRP3/MC3

Where, MRP is marginal revenue product of inputs and MC represents marginal cost.

Thus, a manger can make rational decision by allocating/hiring resources in a manner which
equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific
use.

3. Opportunity Cost Principle

By opportunity cost of a decision is meant the sacrifice of alternatives required by that decision.
If there are no sacrifices, there is no cost.

According to Opportunity cost principle, a firm can hire a factor of production if and only if that
factor earns a reward in that occupation/job equal or greater than it’s opportunity cost.

Opportunity cost is the minimum price that would be necessary to retain a factor-service in it’s
given use. It is also defined as the cost of sacrificed alternatives.

For instance, a person chooses to forgo his present lucrative job which offers him INR 50,000
per month, and organizes his own business. The opportunity lost (earning INR 50,000) will be
the opportunity cost of running his own business.
4. Time Perspective Principle

According to this principle, a manger/decision maker should give due emphasis, both to short-
term and long-term impact of his decisions, giving apt significance to the different time periods
before reaching any decision.

Short-run refers to a time period in which some factors are fixed while others are variable. The
production can be increased by increasing the quantity of variable factors. While long-run is a
time period in which all factors of production can become variable. Entry and exit of seller firms
can take place easily.

From consumers point of view, short-run refers to a period in which they respond to the changes
in price, given the taste and preferences of the consumers, while long-run is a time period in
which the consumers have enough time to respond to price changes by varying their tastes and
preferences.

5. Discounting Principle

According to this principle, if a decision affects costs and revenues in long-run, all those costs
and revenues must be discounted to present values before valid comparison of alternatives is
possible. This is essential because a rupee worth of money at a future date is not worth a rupee
today.

Money actually has time value. Discounting can be defined as a process used to transform future
dollars into an equivalent number of present dollars. For instance, $1 invested today at 10%
interest is equivalent to $1.10 next year.

FV = PV*(1+r)t

Where, FV is the future value (time at some future time), PV is the present value (value at t0, r is
the discount (interest) rate, and t is the time between the future value and present value.

MEANING OF BUSINESS ECONOMICS

Business economics focuses on using economic principles to make practical decisions in

businesses. It helps firms use their aids to make more profits, spend less money, and become
more effective. Business economics covers many topics. Including the study of demand and
production and deciding pricing policies. Analyzing different market types, managing risks, and
making good decisions.

Business economics is a branch of applied economics. It examines financial, organizational,

market, and environmental issues that corporations encounter. This field uses economic theories
and methods. It assesses factors that influence firms, including management, expansion, and
strategy.

Business economics focuses on firm operations and their relation to the economy. It deals with
economic principles, capital acquisition, profit generation, production efficiency, and
management strategy. Additionally, it feels like external factors, such as industry regulations and
shifts in raw material prices. It affects firm decisions.

Definitions

“Business Economics is economics applied in decision making. It is a special branch of

economics bridging the gap between abstract theory and Business practice.”
Haynes,Mote and Paul.

“Business Economics consists of the use of economic modes of thought to analyse

business situations.”
McNair and Meriam

“Business Economics (Business Economics) is the integration of economic theory with

business practice for the purpose of facilitating decision making and forward planning by
management.”
Spencerand Seegelman.

“Business economics is concerned with application of economic concepts and economic

analysis to the problems of formulating rational Business decision.”
Mansfield

CHARACTERISTICS OF BUSINESS ECONOMICS

Characteristics of business economics are:
1. Microeconomics
2. Normative science
3. Pragmatic
4. Prescriptive
5. Uses macroeconomics
6. Management oriented

1. Microeconomics
Business economics is microeconomic in character. This is so because it studies the problems of
an individual business unit. It does not study the problems of the entire economy.

2. Normative science
Managerial economics is a normative science. It is concerned with what management should do
under particular circumstances. It determines the goals of the enterprise. Then it develops the
ways to achieve these goals.

3. Pragmatic
Business economics is pragmatic. It concentrates on making economic theory more application-
oriented. It tries to solve the managerial problems in their day-to-day functioning.

4. Prescriptive
Managerial economics is prescriptive rather than descriptive. It prescribes solutions to various
business problems.

5. Uses macroeconomics
Macroeconomics is also useful to business economics. Macro-economics provides an intelligent
understanding of the environment in which the business operates.

6. Management oriented
The main aim of managerial economics is to help the management in taking correct decisions
and preparing plans and policies for the future.

NATURE OF BUSINESS ECONOMICS

For a layman, the economic world is a complex place. Usually, economic theories are simple
and hypothetical in nature. Hence, most managers find a difference between the propositions of
these theories and the real economic world. This is where Business Economics steps in. It
enables the application of economic logic and analytical tools and attempts to bridge the gap
between theory and practice. In this article, we will describe the nature of business economics to
help understand the economic theories better. Before we start to study the nature of business
economics, it is important to understand that economics is broadly divided into two major parts:

1. Micro Economics
2. Macro Economics

1. Micro Economics
This is the study of the way individual units make decisions regarding the efficient allocation of
their scarce resources. Also, these individual units are consumers or firms. In microeconomics,
the focus is on a small number of units rather than all units combined. Further, it does not give us
a picture of the happenings in the wider economic environment. The study includes:

 Product pricing;
 Consumer behavior;
  Factor pricing;
 The economic conditions of a section of people;
 The behavior of firms; and
 Location of the industry.

ECONOMICS IS BOTH POSITIVE AND NORMATIVE SCIENCE.

a) Positive science:
It only describes what it is and normative science prescribes what it ought to be. Positive science
does not indicate what is good or what is bad to the society. It will simply provide results of
economic analysis of a problem.

b) Normative science:
It makes distinction between good and bad. It prescribes what should be done to promote human
welfare. A positive statement is based on facts. A normative statement involves ethical values.

For example, “12 per cent of the labour force in India was unemployed last year” is a positive
statement, which could is verified by scientific measurement. “Twelve per cent unemployment is
too high” is normative statement comparing the fact of 12 per cent unemployment with a
standard of what is unreasonable. It also suggests how it can be rectified. Therefore, economics
is a positive as well as normative science.

2. Macro Economics
This is the study of the behavior of large economic aggregates like overall output levels, total
consumption, etc. The study also includes the shift of these aggregates over time. Therefore,
macroeconomics analyzes the overall economic conditions which are an overall effect of
millions of decisions made by different firms and consumers.

 National Income and National Output;

 The general price level and interest rates;
 A balance of trade and balance of payments;
 The external value of currency;
 The overall level of savings and investment; and
 Level of employment and rate of economic growth.
SCOPE OF BUSINESS ECONOMICS
The scope of business economics is vast. It covers several aspects of a firm, from demand
analysis and forecasting to cost and production analysis, costing decisions and strategies, profit
management, and wealth management.

Demand Analysis and Forecasting

1. Cost and Production Analysis

2. Market and Pricing

3. Profit Management

4. Wealth Management

1. Demand Analysis and Forecasting

Demand analysis and forecasting are vital to business economics. To learn clients' purchasing
behavior, we analyze their actions, including factors such as the desired product's price, their
financial standing, and picks.

We predict future demand using demand forecasting, which involves studying past consumer
behavior to determine their future preferences. This is crucial for companies to produce enough
of the products people want and acquire necessary resources on time.

Business economics provides scientific tools to aid in demand forecasting. Ultimately, demand
analysis and forecasting are vital tools firms can utilize to stay ahead of the match and remain
profitable.

2. Cost and Production Analysis

Cost and production analysis are pivotal in business economics. Business economics involves
studying the costs of other products and knowing why the costs might be other than what was
gauged. The goal is to choose the best output levels to reduce costs and increase profits. This
also includes using Break-even analysis to help make decisions. The manager should also try to
avoid wasting time and materials.

3. Market and Pricing

Every firm must know about its rivals and assess their position in the market. To accomplish this,
the firm must conduct a thorough market analysis. This analysis can aid the firm in establishing
pricing and devising plans to guide competitive market needs.

Price theory is another useful tool. Firms utilize it to comprehend how prices are established in
various market types. It can also assist companies in developing pricing policies.
4. Profit Management

Various factors, such as prices and market needs, can affect profits. When tension exists, it can
be difficult for firms to count and work profits. Hence, profit theories prove useful as they aid in
future profit planning. To maximize profits, the manager must evaluate the earnings at different
output levels. This estimation can reduce uncertainty and boost revenue.

5. Wealth Management

Effective wealth management helps a firm's assets and investments to maximize yields while
underrating likely hazards. This contains the regulation of cash flows, the discerning evaluation
of investment prospects, and the use of financial tools like results and options to oversee risks. It
is of utmost priority for firms to carry out efficient wealth management practices to preserve
financial stability and achieve long-standing expansion.

OBJECTIVES OF BUSINESS ECONOMICS

Business economics aims to achieve diverse goals that are basic to the triumph of any firm.
In this part of the article, let's dive into the basic goals of business economics and its function in
identifying and fixing commercial plights, devising lucrative firm policies, predicting upcoming
trends, and forging links amidst various fiscal details.

1. Identification and Resolution of Business Problems

2. Designing Numerous Profitable Business Policies
3. Future Prediction
4. Building Relations between Distinct Financial Aspects

1. Identification and Resolution of Business Problems

Business economics is a discipline that can effectively detect and solve various business
challenges. It involves examining data and economic patterns to pinpoint the basic causes of
such issues. The insights derived can be used to create remedies that address the root problems.
Suppose, for instance, a firm is grappling with plummeting sales. In that case, business
economics can be a useful tool in recognizing the underlying factors donating to the decline and
proposing strategic solutions to ramp up sales figures.

2. Designing Numerous Profitable Business Policies

Business economics is pivotal in formulating profitable business strategies. Enterprises must

devise strategies that ensure profitability and sustainability in the long term. A firm's primary
objective is to generate profit for its owners or shareholders. Nonetheless, prioritizing profits at
any cost is not acceptable. Businesses must adhere to rules and ethical standards while earning
profits. Thus, causing profits through ethical practices is the correct approach for a firm to
achieve success.

3. Future Prediction

Business economics also can prognosticate the future. Enterprises are required to foresee shifts in
the marketplace and strategize accordingly. By scrutinizing economic patterns and figures, firms
can predict upcoming demand, prices, and client conduct. Such insights can be utilized to create
plans that equip companies for future market fluctuations.

4. Building Relations between Distinct Financial Aspects

Business economics is pivotal in establishing connectivity amid various financial details.

Enterprises must apprehend the interrelationship between sundry monetary facets, such as sales,
expenses, gains, and investments. By scrutinizing these interdependencies, companies can
pinpoint weak spots that necessitate rectification and devise effective methods to enhance their
fiscal performance.

IMPORTANCE OF BUSINESS ECONOMICS

It is a vital tool for firms to make informed decisions based on the economic environment in
which they operate. Here are some key reasons why business economics is vital.

1. Optimal resource allocation

2. Competitive advantage
3. Forecasting and planning
4. Risk management

1. Optimal resource allocation

Business economics enables companies to utilize their resources in a cost-effective and efficient
manner. It assists them in making decisions regarding project investments. It helps them in the
allocation of funds for each project and resource utilization. This helps firms optimize their
available aids to achieve maximum benefits.

2. Competitive advantage

Firms with knowledge of economics gain an edge over rivals. They analyze the economic
environment to make informed choices. This leads to a stronger market position. Pricing
decisions rely heavily on pricing strategies to increase revenue and stay competitive. Business
economics provides various tools and methods to aid decision-making on pricing. Understanding
the complex relationship between pricing and demand can help firms select the most profitable
price points. These price points should balance profitability and competitiveness. This will
ensure firm survival in their industries.

3. Forecasting and planning

Business economics is a crucial field that assists enterprises in anticipating future demand for
their offerings. Firms can strategically prepare for future expansion, invest in new ventures, or
scale up their existing operations.

4. Risk management

Business economics provides firms with a valuable tool. It enables them to decrease risk by
analyzing economic trends and identifying likely hazards. By comprehending the economic
environment, businesses can make informed decisions that safeguard their assets and minimize
risk.

LIMITATIONS OF BUSINESS ECONOMICS

The limitations of business economics are listed below:

 Business economics focuses on business analysis based on financial and costing data.
The reliability of this data, therefore, depends on the accuracy of the financial accounting
information.

 This analysis is based on historical information. But things change when new systems are
introduced, and conclusions cannot be predicted from this previous information.
Management controls are subject to the personal preferences of individual managers,
which may influence to some extent, the final decisions of managers.

 It is a costly process as the company usually needs a certain number of managers to keep
it functioning properly.

 The science of business management is relatively new and not fully developed. So, it can
be ambiguous in certain scenarios.

TYPES OF BUSINESS ECONOMICS

Business economics, also known as managerial economics, is a branch of economics that

applies economic theory and quantitative methods to solve practical business problems. There
are several types of subfields within business economics that focus on specific aspects of
decision-making and analysis in the business world.
Here are some common types of business economics:

1. Demand Analysis: This area of business economics examines consumer behavior and the
factors that influence demand for products and services. It helps businesses understand how
changes in price, income, and other variables affect the quantity demanded.

2. Production and Cost Analysis: Production and cost analysis involves studying the production
process within a firm and analyzing the costs associated with producing goods and services. It
helps businesses make decisions about production levels, cost reduction, and efficiency
improvements.

3. Market Structure and Pricing: This type of analysis focuses on market structures, such as
perfect competition, monopoly, oligopoly, and monopolistic competition. It helps businesses
determine pricing strategies and market positioning.

4. Risk and Uncertainty Analysis: Businesses often face uncertainty and risk in decision-
making. This branch of business economics helps firms assess and manage risks associated with
various business activities, such as investments and product launches.

5. Capital Budgeting: Capital budgeting decisions involve evaluating investment projects and
determining which projects to undertake based on their expected returns, costs, and risks. It helps
firms allocate their capital efficiently.

6. Financial Economics: Financial economics examines financial markets and the behavior of
financial assets, such as stocks, bonds, and derivatives. It helps businesses make financial
decisions related to investments, financing, and risk management.

7. Managerial Decision-Making: The managerial decision-making process in business

economics involves applying economic principles to various business decisions, such as pricing,
resource allocation, and strategic planning.

8. Game Theory: Game theory is used to analyze strategic interactions among firms in situations
where the outcome of one firm's decision depends on the decisions of others. It is often applied
in scenarios like pricing competition and negotiations.

9. International Business Economics: This subfield focuses on the economic aspects of

international trade, foreign exchange, and global market entry strategies. It helps businesses
navigate the complexities of the global economy.

10. Environmental Economics: Environmental economics examines the economic aspects of

environmental issues, such as pollution control, natural resource management, and sustainability.
It assists businesses in making environmentally responsible decisions.

11. Health Economics: Health economics applies economic principles to the healthcare industry,
helping businesses in healthcare management, cost containment, and policy analysis.
12. Labor Economics: Labor economics explores issues related to labor markets, including labor
supply and demand, wage determination, and labor market policies. It aids businesses in
workforce planning and labor-related decisions.

13. Regulatory Economics: Regulatory economics deals with the economic impact of
government regulations on businesses. It helps firms understand and comply with regulations
while minimizing their costs.

14. Public Economics: Public economics assesses the economic implications of government
policies, taxation, and public expenditures. Businesses may use this analysis to understand how
government actions affect their operations.

ROLE OF A BUSINESS ECONOMIST

A Business economist plays a vital role in the decision-making process of an

organization. He/she is responsible for assisting the top management of an organization to make
efficient decisions in the business. A Business economist is also called business economist or
economic advisor. He/she makes use of a number of complicated and specialized techniques
required in the process of business decision making. a Business economist needs to carefully
study and analyze the internal and external factors

a. Forecasting sales of an organization

b. Performing individual market research
c. Performing economic analysis of rival organizations
d. Analyzing the pricing policy of the industry; thereby formulating the pricing policy of the
e. organization
f. Performing investment analysis
g. Assisting the top management in making decisions related to trade and public relations
and
h. foreign exchange
i. Performing capital budgeting and production planning
j. Measuring the earning capacity of an organization
k. Keeping the top management informed regarding any changes in the business
environment

RESPONSIBILITIES OF BUSINESS ECONOMIST

The following points highlight the top five responsibilities of Business economist.
1. To make a reasonable profit on capital employed: He must have a strong conviction that
profits are essential and his main obligation is to assist the management in earning reasonable
profits on capital employed in the firm.

2. He must make successful forecasts by making in depth study of the internal

and external factors: This will have influence over the profitability or the working of the firm.
He must aim at lessening if not fully eliminating the risks involved in uncertainties. He has a
major responsibility to alert management at the earliest possible time in case he discovers any
error in his forecast, so that the management can make necessary changes and adjustments in the
policies and programmes of the firm.

3. He must inform the management of all the economic trends: A Business economist should
keep himself in touch with the latest developments of national economy and business
environment so that he can keep the management informed with these developments and
expected trends of the economy.

4. He must establish and maintain contacts with individuals and data sources: (i) To
establish and maintain contacts: A Business economist should establish and maintain contacts
with individuals and data sources in order to collect relevant and valuable information in the
field.

(ii) To develop personal relations: To collect information he should develop personal relations
with those having specialized knowledge of the field.

(iii) To join professional associations and should take active part in their activities: The success
of this lies in how quickly he gathers additional information in the best interest of the firm.

5. He must earn full status in the business and only then he can be helpful to the
management in good and successful decision-making:
(i) He must receive continuous support for himself and his professional ideas by performing his
function effectively.

(ii) He should express his ideas in simple and understandable language with the minimum use of
technical words, while communicating with his management executives.

DIFFERENCE BETWEEN POSITIVE AND NORMATIVE ECONOMICS

Parameters Positive Economics Normative Economics

Describing different economic Provides solutions to these economic
Purpose
phenomena issued based on value
 Positive economics relies on the past
Normative economics deals with the
Definition and present data for determining future
fairness and value of economic principles
situations
Discusses Cause and effect relationship Opinion and judgments
Nature Factual and descriptive Prescriptive
Uses data and facts for behavorial
Action Making assumptions based on the opinions
assessment.
Nature Descriptive Prescriptive
What it does? Analyses cause and effect relationship. Passes value judgment.
Perspective Objective Subjective
Study of What actually is What ought to be
It provides solution for the economic
Economic issues It clearly describes economic issue.
issue, based on value.
Verifiable Yes No

MICROECONOMICS

Microeconomics is the study of individual and business decisions about resource allocation and
the pricing of goods and services. The government determines tax regulations. Microeconomics
focuses on the supply that determines the economy’s price level.

The bottom-up approach is used to analyze the economy. In other words, microeconomics seeks
to comprehend human decisions and resource allocation. It does not decide what changes are
occurring in the market; rather, it explains why changes are occurring in the market.

The primary role of microeconomics is to investigate how a company can maximize its
production and capacity in order to lower prices and compete in its industry. The financial
statements contain a wealth of microeconomic information.

KEY FACTORS OF MICROECONOMICS

The following are the key microeconomic factors:

Production Theory – This theory proposes an investigation into how goods and services are
manufactured or produced.

Demand, Supply, and Equilibrium – Prices are determined by supply and demand principles.
In a perfectly competitive market, suppliers give the same rate or price as buyers or customers
demand. This results in an economic balance of supply and demand.
Production Costs – This principle determines the cost of goods and services, which is limited by
the cost of supplies used during the production phase.

Labour Economics – This economic concept examines the pattern and model of employment,
wages, and income, as well as the basic principles of workers and employers.

Examples of Microeconomics

 Inflation
 GDP
 Unemployment rates
 Economic outputs
 Price Stability
 Goods
 Productivity
 Stability

Pros of Microeconomics
It aids in the determination of product prices as well as the prices of various production factors
such as land, labor, capital, organization, and entrepreneur.

It is based on a free enterprise economy, which means that the enterprise is free to make its own
decisions.

Cons of Microeconomics

Full employment is a completely unrealistic assumption. It only examines a small portion of an

economy, leaving a larger portion untouched.

MACROECONOMIC

Macroeconomics is an economic branch that depicts the big picture. It examines the economy on
a massive scale, and several economic issues are considered. The issues that an economy faces
and the progress that it makes are measured and understood as part of macroeconomics.

Macroeconomics is the study of the relationships between various countries and how one
country’s policies affect the other. It limits its scope by analyzing the success and failure of
government strategies.

In macroeconomics, we typically examine the relationship of the nation’s total manufacturing

and employment with specific features such as cost prices, wage rates, interest rates, profits, and
so on, by focusing on a single fictitious good and what happens to it.
KEY FACTORS OF MACROECONOMICS

The following are the key concepts covered by macroeconomics:

Gross Domestic Product (GDP) – As one of the most important indicators, GDP is used to
assess the strength of a country’s economy. The GDP of a country is the monetary value of all
finished goods and services produced within its borders.

National Income – This is an economic indicator that determines the true state of the economy
and the purchasing power of the people in the country. It is the total of the country’s profits,
wages, interest rents, and pension payments to its citizens.

Unemployment – This factor depicts the measurement of unemployment in the country, as well
as the rate at which people look for work or a job. This rate is calculated by dividing the number
of unemployed people by the labour force.

Economic Growth – Economic growth is the positive effect of GDP on a country’s economy
that increases the market value of goods and services produced by an economy over a given
period.

Inflation – This is the loss of the value of money and the depreciation of economic growth. It is
usually caused when goods and services are in high demand, resulting in a drop in the
availability of goods and services, forcing customers to pay more for the products and services.

Examples of Macroeconomics

 Supply
 Demand
 Prices
 Elasticity
 Competition
 Opportunity Cost
 Competitive Advantage
 Consumer Choice
 Welfare Economics

Pros of macroeconomics

It aids in determining the balance of payments, as well as the causes of the deficit and surplus.

It aids in the formulation of economic and fiscal policies, as well as the resolution of public-
finance issues.
Cons of macroeconomics

Its analysis indicates that the aggregates are homogeneous, but this is not always the case
because they can be heterogeneous.

It only considers aggregate variables and ignores individual welfare.

DIFFERENCE BETWEEN MICRO ECONOMICS AND MACRO ECONOMICS

Parameter Microeconomics Macroeconomics

Microeconomics is a branch of Macroeconomics is the branch of
economics concerned with the study of Economics that studies the overall
individual, household, and firm behaviour and performance of the
Definition behavior in decision making and economy. The most important factors
resource allocation. It includes markets studied in macroeconomics include
for goods and services and addresses GDP, unemployment, inflation, and
economic issues. growth rate, among others.
Microeconomics is the study of a Macroeconomics is the study of the
Area of
specific or Individual market segment entire economy, which includes several
Study
of the economy. market segments.
Demand, supply, factor pricing,
Macroeconomics is concerned with
product pricing, economic welfare,
issues such as national income,
Deal with production, consumption, and other
distribution, employment, general price
issues are addressed in
level, money, and others.
microeconomics.
Business It is used to address environmental and
It is used to address internal issues.
Application external issues.
It addresses a variety of issues,
It addresses a variety of issues, including
including demand, supply, factor
distribution, national income,
Scope pricing, product pricing, economic
employment, money, the general price
welfare, production, consumption, and
level, and others.
others.
It is useful in regulating product prices It maintains price stability in the
as well as the prices of production aggregate and addresses major economic
Significance factors (labour, land, entrepreneur, issues such as deflation, inflation, rising
capital, and others) within the prices (reflation), unemployment, and
economy. poverty in general.
It has been examined that the
It is based on impractical assumptions,
misunderstanding of composition’
such as the assumption in
incorporates, which sometimes fails to
Limitation microeconomics that there is full
prove accurate because what is true for
employment in the community, which
aggregate (comprehensive) may not be
is not at all feasible.
true for individuals as well.
THE ECONOMIC PROBLEM: SCARCITY AND CHOICE

Economy is derived from two Greek words which mean house and distribute. Economy was
studied to understand the management of a household that later started being used to manage
resources.

The basic problem of an economy deals with the needs and wants of a man being unlimited and
the resources are scarce. The resources include the factors of production that are land, labour,
capital and entrepreneurship.

Economics is the social science that studies how people use their scarce resources to satisfy
unlimited needs and wants. From a teenager to a homemaker and then to a businessman all face
the same issue of how to spend their income to attain maximum satisfaction.
Scarcity

The purpose of production is to satisfy one’s want but as the resources are limited, not enough
output is available to fulfill every man’s want. This explains that human wants are unlimited
which are not fulfilled by the limited resources as stated by the Law of scarcity.

The demand is high as compared to the supply, and due to insufficient resources satisfaction is
not achieved. To overcome this, the choice is made available to man to allocate their resources in
such a way that maximum satisfaction can be achieved.

For instance, a man walks into a grocery store with ₹500, he would buy products in a way that
when he walks out the products with him would be equal to the value of ₹500. He might want
food grains, toiletries, milk, cooking essentials, etc but he would allocate the money available to
him in such a way that he attains maximum satisfaction from his purchase.

Choices

Scarcity gives rise to the economic problem of choice. As there are limited resources, the choice
is given to decide what one wishes to get by sacrificing one of its demands. When the choice is
made there is sacrifice involved in it. The decision to consume a product also means a decision to
not consume another. One product can only be consumed by giving up something in exchange.
Opportunity Cost refers to the cost of sacrifice that is done to choose the next best alternative

To Exemplify, a farmer has 10 acres of land he has a choice to either grow wheat or cotton on it.
The limited land is a scarcity of the resource. The alternative crops wheat and cotton show how
we have choices. To grow one of the two crops the other crop’s production has to be sacrificed,
this is the opportunity cost involved.
Production Possibility Curve (PPC) gives a graphical representation of how two alternatives can
be used in combination to achieve maximum satisfaction.

The above PPC curve shows different possible points of attaining satisfaction. Points A and B
give two different combinations. At point A, X8 and Y10 goods are produced and at point B X12
and Y7 goods are produced. To produce more of product X, Product Y is to be produced less this
is seen at point B, X12 goods are produced only when good Y is decreased to Y7. This shows
that more and more of good X is to be produced only when good Y is sacrificed at its place. A
choice needs to be made as to what amount of a particular good can be produced to get the
maximum satisfaction from the available resources.

PRODUCT POSSIBILITY CURVE

In business, a production possibility curve (PPC) is made to evaluate the performance of

a manufacturing system when two commodities are manufactured together. The management
utilizes this graph to plan the perfect proportion of goods to produce in order to reduce the
wastage and costs while maximizing profits.

The production possibilities curve (PPC) is a method used to describe how two commodities are
related to each other in terms of the ability to produce both within an economy. It is also called
the production possibilities frontier (PPF). Since there are only a certain number of available
resources, then decisions need to be made to determine how the resources will be divided in the
production of different resources. This can be within an entire economy (such as a country) or
within a single company.

The PPC assumes that the economy only makes those two products and that all resources are
applied to creating those two products.

The PPC shows the trade-off between two productions along the curve. When the production of
one is increased, production of the other needs to decrease. The opportunity cost of using more
land to grow potatoes means that there is less land to grow wheat. The PPC does not attempt to
determine what division between the two products is the most efficient. It simply indicates what
production is utilizing all of the available resources. The trade-off isn't always on a one-to-one
ratio. For example, it may require one trained employee to make a screwdriver, but five trained
employees to make a car.

OPPORTUNITY COST

Opportunity cost represents the potential benefits that a business, an investor, or an individual
consumer misses out on when choosing one alternative over another. While opportunity costs
can't be predicted with total certainty, taking them into consideration can lead to better decision
making.

 Opportunity cost is the forgone benefit that would have been derived from an option
other than the one that was chosen.

 To properly evaluate opportunity costs, the costs and benefits of every option available
must be considered and weighed against the others.

 Considering potential opportunity costs can guide individuals and organizations to more
profitable decision making.

Examples:1

Below is an example of opportunity cost that accounts for other factors beyond the monetary
gains and losses:

Sometimes, you consider more than just the money you spend when calculating opportunity cost.
For example, suppose you choose to go to a movie with your friends and spend $20 on the
tickets and popcorn. You could spend that time working instead, so you include that when
calculating the opportunity cost. In this situation, you choose to spend $20 when you might have
used that same time to earn $45 by completing work at home. In this case, the opportunity cost is
not $20. It's actually $65 because you've spent $20 and missed out on earning $45.

Examples:2

Below is an example of someone who wants to know the opportunity cost of visiting two of their
family members:

Gavin wants to spend a year visiting his uncle in Delhi or his cousin in Mumbai. He's equally
happy to visit either of them, so he has researched the cost of both trips to decide which one he
wants to take. If he travels to Delhi, he estimates he might spend about $10,000 for travel and the
cost of living. Visiting his cousin in Mumbai might cost him $20,000. Working part-time for a
year in Delhi allows him to make $13,000, while he makes around $26,000 in Mumbai.

Now, Gavin can calculate the cost of both trips. Because he earns money working with both
relatives, he can't simply review the cost of the trips alone. His Delhi trip earns an overall profit
of $3,000. In Mumbai, he would end the year with $6,000. This means his opportunity cost is
$3,000 if he visits his uncle in Delhi. Even though the trip to Mumbai costs twice as much, the
wages are higher. Gavin's most financially sound decision is to visit his cousin in Delhi.
Examples:3

Below is an example of an organization that wants to start a new product but wants to know the
opportunity cost of the decision:

Mohan wants to start a new factory. Its factory is currently operating at capacity, so the company
has determined it requires an expansion or opening a second factory. After some research, they
estimate the cost of building a new factory is $45,000, and the cost of expanding their current
factory is $20,000.

If the company expands its current factory, it loses two weeks of production, which costs around
$17,000. So, the total cost is $37,000 if it expands its factory. In this situation, the opportunity
cost of building a new factory is $8,000 ($45,000 - $37,000). Even with the cost of closing the
factory for two weeks, mohan saves money by expanding its factory instead of building a new
one.
 UNIT – 2

DEMAND, DEMAND SCHEDULE, INDIVIDUAL DEMAND CURVE, MARKET

DEMAND CURVE, LAW OF DEMAND, CHANGES IN DEMAND, EQUILIBRIUM
AND ELASTICITY OF DEMAND AND SUPPLY

Meaning of Demand

In ordinary speech, the term demand is many times confused with ‘desire’ or ‘want’.

 Desire is only a wish to have anything. In economics demand means more than mere
desire.

 Demand in economics means an effective desire for a commodity i.e. desire backed by
the ‘ability to pay’ and ‘willingness to pay’ for it.

 Thus, demand refers to the quantity of a good or service that consumers are willing and
able to purchase at different prices during a period of time.

Thus, defined, the term demand shows the following features:

 Demand is always with reference to a PRICE.

 Demand is to be referred to IN A GIVEN PERIOD OF TIME.

 Consumer must have the necessary purchasing power to back his desire for the
commodity.

 Consumer must also be ready to exchange his money for the commodity he desires.

E.g. Mr. A’s demand for sugar at ` 15 per kg. is 4 kgs. per week.

TYPES OF DEMAND

Few important different types of demand are as follows:

1. Price demand: changes of price influence the demand of particular products and services

2. Income demand: there is no change in price of products, but change in the level of income
people will change the demand of the products

3. Cross demand: Not depend on its own cost but depends on the cost of the other related
commodities.
As an example, Pepsi and Coca-cola. If you assume the two brands of soda are substitutes, if the
price of Coke falls, consumer demand for Pepsi will fall because more consumers will choose to
buy Coke over Pepsi

4. Direct demand: When goods or services satisfy an individual’s wants directly, it is known as
direct demand. Example: food, shelter, clothes, particular brands of things like soaps,paste and
vehicles

5. Derived demand or Indirect demand: The goods or services demanded or needed for
manufacturing the goods and satisfying the consumer indirectly is known as derived demand. For
example, the demand for building is a direct demand and demands for cement, bricks, sand,
timber, labour, etc., are called as derived demands

6. Joint demand: Joint demand refers to a scenario where the demand for one product is directly
proportional to the demand for another.. car and petrol, bread and butter, pen and refill, shoes
and shocks, bat and ball etc.

7. Composite demand: A composite demand can be described when goods and services are
utilized for more than one cause.

 Example:
 People may demand wheat for producing bread, biofuels or feeding livestock.
 Land can be used for farming or building houses.
 Steel could be used for building tanks or it could be used for building bicycles.
 Coal or Service of Electricity is used in many places

DETERMINANTS OF DEMAND`

Price of the commodity:

Price of the related commodities:

a. Substitutes or competitive goods

Price of the commodity:

Other things being equal, the demand for a commodity is inversely related with its price. It
means that a rise in price of a commodity brings about fall in its demand and vice versa. This
happens because of income and substitution effects.

Price of the related commodities:

The demand for a commodity also depends on the prices of related commodities.
1. Related commodities are of two types namely—

a. Substitutes or competitive goods, &

b. Complementary goods.

2. Income of the consumers

a. Necessaries

b. Comforts and Luxurious

c. Inferior goods

a. Substitutes or competitive goods

3. Tastes and Preferences of the consumers

Related commodities

a. Substitute goods are those goods which can be used with equal ease in place of one another.
E.g. Essar Speed Card and Airtel Magic Card; Coke and Pepsi; ball pen and ink pen; tea and
coffee; etc. Demand for a particular commodity is affected if the price of its substitute falls or
rises. E.g. If the price of Airtel Magic card falls, its demand will increase and demand for Essar
Speed Card would fall and vice versa.

Thus, there is a POSITIVE RELATIONSHIP between price of a commodity and demand for its
substitutes.

b. Complementary good

Complementary good are those goods whose utility depends upon the availability of both the
goods as both are to be used together. E.g. a ball pen and refill; car and petrol; a hand set and
phone connection; a tonga and horse, etc.

The demand for complementary goods have an INVERSE RELATIONSHIP with the price of
related goods.

E.g. If the price of Scooters falls, its demand will increase leading to increase in demand for
petrol.

2. Income of the consumers

Other things being equal, generally the quantity demanded of a commodity bear a DIRECT
RELATIONSHIP to the income of the consumer i.e.with an increase in income, the demand for a
commodity rises.

However, this may not always hold true. It depends upon the class to which commodity belongs
i.e. Necessaries or comforts and luxuries or inferior goods:

a. Necessaries (E.g. Food, clothing and shelter). Initially, with an increase in the income, the
demand for necessaries also rises up to some limit. Beyond that limit, an increase in income will
leave the demand unaffected.

b. Comforts and Luxurious (E.g. Car; Air-Conditioners; etc.) Quantity demanded of these
group of commodities have a DIRECT RELATIONSHIP with the income of the consumers. As
the income increases, the demand for comforts and luxuries also increases.

c. Inferior goods (E.g. Coarse grain; rough cloth; skimmed milk; etc.). Inferior goods are those
goods for which superior substitutes are available Quantity demanded of this group of
commodities have an INVERSE RELATIONSHIP with the income of the consumer. E.g. A
consumer starts consuming full cream milk (normal good) in place of toned milk (inferior good)
with an increase in income.

Therefore, it is essential that business managers must know—

(a) The nature of good they produce,

(b) The nature of relationship between the quantities demanded and changes in consumer’s
income, and

(c) The factors that could bring about changes in the incomes of the consumers.

3. Tastes and Preferences of the consumers

1. Tastes and preferences of consumers generally change over time due to fashion,
advertisements, habits, age, family composition, etc. Demand for a commodity bears a direct
relationship to those determinants.

2. Modern goods or fashionable goods have more demand than the goods which are of old design
and out of fashion.

E.g. People are discarding Bajaj Scooter for say Activa Scooter.

3. The demand of certain goods is determined by ‘bandwagon effect’or ‘demonstration effect’. It

means a buyer wants to have a good because others have it. It means that an individual
consumer’s demand is conditioned by the consumption of others.
REASONS FOR THE LAW OF DEMAND AND DOWNWARD SLOPE OF A DEMAND
CURVE

The Law of Diminishing Marginal Utility:

According to this law, other things being equal as we consume a commodity, the marginal utility
derived from its successive units go on falling. Hence, the consumer purchases more units only
at a lower price. A consumer goes on purchasing a commodity till the marginal utility of the
commodity is greater than its market price and stops when MU = Price i.e. when consumer is at
equilibrium.

When the price of the commodity falls, MU of the commodity becomes greater than price and so
consumer start purchasing more till again MU = Price.

It therefore, follows that the diminishing marginal utility implies downward sloping demand
curve and the law of demand operates.

Change in the number of consumers:

Many consumers who were unable to buy a commodity at higher price also start buying when the
price of the commodity falls. Old customers starts buying more when price falls.

Various uses of a commodity:

Commodity may have many uses. The number of uses to which the commodity can be put will
increase at a lower price and vice versa.

Income effect:

When price of a commodity falls, the purchasing power (i.e. the real income) of the consumer
increases. Thus he can purchase the same quantity with lesser money or he can get more quantity
for the same money. This is called income effect of the change in price of the commodity.

Substitution effect:

When price of a commodity falls it becomes relatively cheaper than other commodities. As a
result the consumer would like to substitute it for other commodities which have now become
more expensive.

E.g. With the fall in price of tea, coffee’s price remaining the same, tea will be substituted for
coffee. This is called substitution effect of the change in price of the commodity.
TYPES OF DEMAND CURVE

1. Individual Demand

2. Market Demand

There are two types of demand curve: an individual demand curve and a market demand curve.

1. INDIVIDUAL DEMAND

Individual demand refers to the quantity of a particular good or service that an individual
consumer is willing and able to buy at a specific price and time. Various factors such as income,
taste and preferences, price of the good, availability of alternate goods, and advertising influence
it.

Example of Individual Demand

Consider a person who loves coffee. For $5 per cup, he might be willing to buy 2 cups of coffee
every day. If the price drops to $3 per cup, his daily consumption might increase to 3 cups, as the
lower price makes it more affordable or justifiable to consume more.

Conversely, if the price rises to $7 per cup, he might reduce his consumption to 1 cup daily or
switch to a cheaper alternative like tea. This behaviour reflects the individual's demand for coffee
at different price points.

2. MARKET DEMAND

Market demand refers to the total amount of a product or service that consumers are willing and
able to purchase at various price levels over a given period. Various factors, such as the price of
the product or service, consumer preferences, income levels, and availability of substitutes,
influence it. Market demand helps businesses and policymakers understand the overall demand
for a product or service in a given economic environment.

Example of Market Demand

A new smartphone is released for $800, and 1 million people want to buy it. If the phone price is
reduced to $600, 1.5 million people might be interested in buying it. But if the price increases to
$1000, only 800,000 people might be interested in purchasing it.

The market demand curve for this smartphone would be created by considering the different
prices and the number of people willing to buy it at those prices. This example shows how the
demand for a product can change based on the price.
A graph illustrating the aggregation of individual demand curves to derive the market demand
curve.

Example:

Imagine at a price of £20, four consumers desire 2, 3, 4, and 5 units respectively. The market
demand at this price would be 14 units (2+3+4+5).

DIFFERENCE BETWEEN INDIVIDUAL AND MARKET DEMAND

Basis Individual Demand Market Demand

The quantity of a commodity that a The quantity of a commodity that all

consumer is willing and able to consumers are willing and able to
Meaning purchase at every possible price purchase at every possible price during a
during a specific time period is specific time period is known as Market
known as Individual Demand. Demand.
Individual Demand may or may not
Market Demand always follows the Law
follow the Law of Demand. It means
Law of of Demand. It means that the demand for
that there is a possibility of a
Demand a product always reduces when there is a
product’s demand to be higher at a
rise in its price, and vice-versa.
higher price.
The individual demand for a product The market demand for a product is
Affect of
is not affected by every factor affected by every factor affecting its
factors
affecting its market demand. individual demand.
 Various determinants of Individual In addition to the different determinants
Demand, include Price of the given of individual demand, other
Commodity, Price of Related Goods, determinants of Market Demand are
Determinants
Income of the Consumer, Tastes and Size and Composition of Population,
Preferences, and Expectation of Season and Weather, and Distribution of
Change in the Price in Future. Income.
The curve of Individual Demand The curve of Market Demand shows the
shows the quantity demanded by one relationship between the total quantity
Curve
consumer when there is a change in demanded and the market prices of the
the price of the commodity. commodity.
Slope of
The slope of the individual demand The slope of the market demand curve is
Demand
curve is steeper. relatively flatter.
Curve

DEMAND SCHEDULE

It is a table that shows the relationship between the price of a product and how much of that
product customers purchase. Demand schedules typically show that as the price of a product
increases, the demand decreases. This is the same for the inverse as well because as the price of a
product decreases, the demand typically increases.

IMPORTANT OF THE DEMAND SCHEDULES

Economists create demand schedules by gathering and analyzing data to predict the future
demand of materials or goods based on their price. These are some reasons why demand
schedules are important:

1. Determine which price is most appealing

2. Calculate the elasticity of the product
3. Predict the potential demanded quantity
4. Identify other determinants of demand
5. Create a demand curve using the data

1. Determine which price most is appealing: For marketing teams or other administration,
demand schedules may be useful to help determine the price to sell their products or services.
The curve of a demand schedule can show at what price the buyer purchases fewer of the item,
reducing profits.
2. Calculate the elasticity of the product: Elasticity is the relationship between the price of a
product and how much of the product the market demands. If the price significantly affects the
quantity demanded, the elasticity is high, and if it does not the product is inelastic.

3. Predict the potential demanded quantity: Demand schedules can be used to predict the
amount of material necessary based on the price of a product. If the demand schedule predicts
that the quantity demanded rises as the price decreases, the company may need more supplies to
produce more products.

4. Identify other determinants of demand: Demand schedules may be used to identify if other
determinants of demand are affecting the quantity demanded. Other determinants can include
trends, incomes, competition and expectations.

5. Create a demand curve using the data: You can use the data from a demand schedule to
create a visual representation of the relationship between price and consumption. By plotting the
price vertically and the quantity horizontally, you can create a demand curve.

WHAT'S INCLUDED IN A DEMAND SCHEDULE

Consumer groups: Some demand schedules may include information about where the quantity
demand is coming from by separating the consumer base into various groups.

Labels for values: Many demand schedules include this information to provide a more detailed
account of the values. A label for the values may indicate whether the price is per pound or other
units.

Month or year: Though not all demand schedules include time or date information, those that
are tracking specific periods in time or predictions for future price and quantity might.

Price of a product: The price of the product is one of the two elements vital to the demand
schedule and represents how much money is exchanged for the product.

Quantity demand: This is the second element vital to the demand schedule. This value
represents how much of the product consumers purchase.

Quantity supplied: Quantity supplied represents how much of the product actually exchanges
between the seller and the buyer. When this value is included, the table becomes a supply and
demand schedule.
THE LAW OF DEMAND

The Law of Demand expresses the nature of functional relationship between the price of a
commodity and its quantity demanded. It simply states that demand varies inversely to the
changes in price i.e. demand for a commodity expands when price falls and contracts when price
rises.

“Law of Demand states that people will buy more at lower prices and buy less at higher prices,
other things remaining the same.”

~Prof. Samuelso

EXCEPTIONS TO THE LAW OF DEMAND

Unlike the laws of mathematics or physics, the laws of economics are not universal. For
example, the law of demand comes with a few exceptions. Some goods do not show an inverse
relationship between the price and the quantity. Therefore, the demand curve for these goods is
upward-sloping.

1. Giffen goods

These are inferior goods that lack close substitutes that represent a large portion of the
consumer’s income. Scottish economist Sir Robert Giffen proposed the existence of such goods
in the 19th century. Giffen goods violate the law of demand because the prices of these goods
increase with the increase in the quantity demanded. However, Giffen goods remain mostly a
theoretical concept as there is limited empirical evidence of their existence in the real world.

2. Veblen goods

Certain types of luxury goods violate the law of demand. Veblen goods are named after
American economist Thorstein Veblen. Generally, they are luxury goods that indicate the
economic and social status of the owner. Therefore, consumers are willing to consume Veblen
goods even more when the price increases. Some examples of Veblen goods include luxury cars,
expensive wines, and designer clothes

CHANGE IN DEMAND

Understanding Change in Demand

A change in demand refers to a shift in the entire demand curve, which is caused by a variety of
factors (preferences, income, prices of substitutes and complements, expectations, population,
etc.). In this case, the entire demand curve moves left or right.

There are a number of factors that influence market demand for a particularly good or service.
The main determinants are:

 Changes of income due to Nature of business and job

 Consumer preferences may change depends on trends at the time
 Buyer expectations about price of particular product in future date
 Prices of related items may change in demand of similar products

A change in demand occurs when appetite (interest) for goods and services shifts, even though
prices remain constant. When the economy is flourishing (developing rapidly and gradually) and
incomes are rising, consumers could feasibly purchase more of everything. Prices will remain the
same, at least in the short-term, while the quantity sold increases.

In contrast, demand could be expected to drop at every price during a recession. When economic
growth abates, jobs tend to get cut, incomes fall, and people get nervous, refraining from making
discretionary expenses and only buying essentials.

So there are two possible changes in demand:

1. Increase (shift to the right) in demand

2. Decrease (shift to the left) in demand

Increase (shift to the right) in demand

Suppose, the income of the consumer increases. The price of the product and supply of the
product remain the same. Due to an increase in income of the consumer, the purchasing power of
consumption increases.

So the demand for the product in the market will also increase. Resultantly demand will change
even if the price and supply of the product remain the same. This is called an increase in demand.

The Demand curve will shift rightward. Keep in mind the following points:

 No change in the price of the product

 No change in the supply of product

 Income of Consumer is increasing

 Demand is increasing

Change in Demand. A change in demand means that the entire demand curve shifts either left or
right. The initial demand curve D0 shifts to become either D1 or D2. This could be caused by a
shift in tastes, changes in population, and changes in income, prices of substitute or complement
goods, or changes future expectations.
 SUPPLY – Meaning, Determinants, Supply Schedule, Law of supply, Assumptions,
Importance, and Changes in supply

Supply refers to the quantity of a commodity that producers are willing to produce and sell at a
given price per unit of time. The word 'supply' has the following features.

1) The supply of a commodity is stated in quantitative terms as the desired quantities.

2) The supply of a commodity is always with reference to the price at which the desired quantity
is supplied. For example, to say that producers of blankets are supplying one thousand blankets
does not carry any economic meaning. At the same time, if it is stated that producers supply one
thousand blankets at a price of Rs 500 per blanket, “supply” will start conveying economic
meaning.

3) The supply is always measured as a flow or expressed with reference to a unit of time which
may be a day, a week, a fortnight, a month, or a year or any other period of time.

Let us take an example. Consider the statement: “Producers supplied 1,000 blankets at a rate of
Rs 500 per blanket during December 2020”. This statement mentions the quantity supplied, the
price per unit at which the quantity is supplied and also the period during which the quantity is
supplied. So, it is a complete statement about the supply of a commodity.

DETERMINANTS OF SUPPLY

The factors on which the supply of a commodity depends are known as the determinants of
demand. These are:

 Price of the Commodity

 Firm Goals

 Price of Inputs or Factors

 Technology

 Government Policy

 Expectations

 Prices of other Commodities

 Number of Firms

 Natural Factors
1. Price of the Commodity

It is the main and the most important determinant of demand. When the price of the commodity
is high, the producers or suppliers are willing to sell more commodities. Thus, the supply of the
commodity increases. Similarly, when the price is low the supply of the commodity decreases
owing to the direct relationship between the price of a commodity and its supply.

2. Firm Goals

The supply of goods also depends on the goals of an organization. An organization may have
various goals such as profit maximization, sales maximization, employment maximization, etc.
Where the firm’s objective is the maximization of profit, it will sell more goods when profits are
high and less quantity of goods when the profits are low.

3. Price of Inputs or Factors

The price of inputs or the factors of production such as land, labor, capital, and entrepreneurship
also determine the supply of the goods. When the price of inputs is low the cost of production is
also low. Thus, at this point, the firms tend to supply more goods in the market and vice-versa.

4. Technology

When a firm uses new technology it saves the inputs and also reduces the cost of production.
Thus, firms produce more and supply more goods.

5. Government Policy

The taxation policies and the subsidies given by the government also impact the supply of goods.
When the taxes are high the producers are unwilling to produce more goods and thus, the supply
will decrease. On the other hand, when the government grants various subsidies and gives
financial aids to the producers, they increase the production of goods. Thus, the supply also
increases.

6. Expectations

When the producers or suppliers expect that the price shall increase in future they hoard the
goods so that they can sell them at higher prices later. This will result in a decrease in the supply
of goods. Similarly, in case they expect a fall in price, they will increase the supply of goods.

7. Prices of other Commodities

When the price of complementary goods increases their supply also increases. Thus, this results
in the increase in the supply of commodity also and vice-versa. Also, when the price of the
substitutes increases their supply also increases. This results in a decrease in the supply of goods.

8. Number of Firms
When the number of firms in the market increase the supply of goods also increases and vice-
versa.

9. Natural Factors

The factors like weather conditions, flood, drought, pests, etc. also affect the supply of goods.
When these factors are favorable the supply will increase.

THE SUPPLY SCHEDULE

A supply schedule shows different prices of a commodity and the quantities which a producer is
willing to supply, per unit of time, at each price, assuming other factors influencing the supply to
be constant. A supply schedule of a product based on imaginary data is given in Table.

A Supply Schedule of a Pen Producer

The table shows that at a price of Rs 2 per pen the producer is willing to supply 25 thousand pens
per month. And at a higher price of Rs 3 per pen he is willing to supply 40 thousand pens per
month and as price of pens keep rising he is willing to supply more and more quantity of pens
per month as shown in the supply schedule. This supply schedule has been so drawn as to depict
a direct relationship between price per pen and quantity supplied of pens per month.

LAW OF SUPPLY

Businesses are out to make money. This is not a secret and most people understand that the main
reason companies sell goods or provide services is to make a profit. Keeping that in mind, think
about what a company might want to do if the price that they can sell a good or service at rises?
It would make sense that if the price a company sells something at rises, they would want to sell
more goods. That would translate to them needing to produce more of the good. This is called
the law of supply.
What is the law of supply? The law of supply definition explains that when there are no other
expounding or extreme economic factors, the quantity of goods and services offered will increase
as the price of those goods and services increase. So what is the principle of the law of supply?
The principle is that supply and prices correlate to one another.

It's important to recognize the difference in price of the good and price to produce a good. The
law of supply is based on the price that the good sells to the consumer for. Let's look at two
examples that highlight the difference.

Price of a good: An electronics company sells a video system to the public for $300 a unit, and
they produce 100,000 units a year. If the price of the game rises to $400 a unit, they will increase
production to 175,000 units a year.

Price to produce a good: The same electronics company that sells a video game system for $300
a unit and produces 100,000 units a year can produce the system for $100 per unit. If the price to
produce the unit increases to $150, the company will reduce the units produced to 75,000 a year.

The price of a good has the opposite effect as the price to produce a good.

ASSUMPTIONS OF LAW OF SUPPLY

The phrase “keeping other factors constant or ceteris paribus” is used when describing the law of
supply. This expression refers to the following presumptions that the law is based on:

1. The price of other commodities is constant.

2. The state of technology has not changed.
 3. The price of factors of production is constant.
4. The taxation laws remain the same.
5. The producer’s objectives are constant.

IMPORTANT POINTS ABOUT LAW OF SUPPLY:

 The law of supply states the positive relationship between price and quantity supplied of
a commodity after assuming that the other factors remain constant.

 As the law of supply indicates the direction of the changes in quantity supplied of a
commodity and not the magnitude of the change. it is considered as a quantitative
statement.

 The law of supply does not establish any proportional relationship between the change in
price and the respective change in quantity supplied of the commodity.

 The law of supply is one sided. It is because the law explains only the effect of change in
price on the supply of the commodity and not the effect of change in supply on the price
of the commodity.

REASON FOR THE LAW OF SUPPLY

The main reasons behind the law of supply are as follows:

1. Profit Motive:

Maximizing profits is the primary goal of producers when they supply a good or service. Their
profits grow when the price of a commodity rises without a change in costs. Therefore, by
increasing production, manufacturers increase the commodity’s supply. On the other hand, as
price fall, supply also declines since low price result in lower profit margins.

2. Change in Number of Firms:

When the price of a specific commodity increases, potential producers are encouraged to enter
the market and produce the good to make money. The market supply rises as the number of
businesses increases. However, once the price begins to decline, some businesses that do not
anticipate making any money at a low price may stop production or cut it back. As the number of
businesses in the market declines, it decreases the supply of the given commodity.

3. Change in Stock:

When the price of an item rises, sellers are eager to supply additional things from their stocks.
However, the producers do not release significant amounts from their stock at a significantly
cheaper price. They work on building up their inventory in anticipation of potential price
increases in the future.

EXCEPTIONS TO THE LAW OF SUPPLY

Generally, the slope of the supply curve is upwards, showing that with the rise in the price of a
commodity, its quantity supplied also rises. However, there may be some cases when there is no
positive relationship between the supply and price of a commodity. These cases are as follows:

1. Future Expectations:

The law of supply is not valid if sellers expect a fall in the price in the future. The sellers will be
willing to sell more in this situation, even at a cheaper price. However, if sellers expect an
increase in the future price, they will reduce supply to deliver the item later at a higher price.

2. Agricultural Goods:

Agricultural products are exempted from the rule of supply as they are produced in response to
climatic circumstances. If the production of agricultural goods is low because of unexpected
weather changes, supply cannot be expanded, even at higher prices.

3. Perishable Goods:

Sellers are willing to offer more perishable commodities, such as fruits, vegetables, and other
foods, even if prices are dropping. This occurs because sellers cannot keep such things for an
extended period.
4. Rare Articles:

The law of supply does not apply to precious, rare, or artistic items. For example, even if the
price increases, the number of rare items like the Mona Lisa artwork cannot be increased.

5. Backward Countries:

Due to the scarcity of resources, output and supply cannot be enhanced in economically
underdeveloped countries.

CHANGE IN SUPPLY

Changes in Supply A change in supply means that at each price, a different quantity of a
commodity will be supplied than previously. Changes in supply can be two types:

1) A Decrease in Supply: When the quantity of a commodity supplied falls, at the same price, it
is referred to as a 'Decrease in Supply' which if represented in the form of a curve, implies a
leftward shift of the supply curve.

2) An Increase in Supply: When the quantity of a commodity supplied increases, at the same
price, it is known as an 'Increase in Supply' which amounts to a rightward shift in the supply
curve.

In this given diagram, it can be seen that as we move from point a on S curve to a' at price Rs 3,
supply or quantity supplied falls from 30,000 to 20,000. Similarly, at Rs 2 price at point c on S-
curve, supply was 20,000 which falls to 10,000 at point c'.
So, if points like c', a' are joined a new supply curve labelled S' can be drawn. This shift in curve
from S to S' is referred to as a 'Decrease in Supply'. Instead if we move from point a on S-curve
to point a”, we get increase in supply from 30,000 to 40,000 at Rs 3 price. At price Rs 2, the
supply increases from 20,000 to 30,000 as we move from point c to c’. If points like c" and a"
are joined, a new supply curve S" is arrived. The shift in supply curve from S to S" is referred to
as an ‘Increase in Supply’. In short, a rise in supply implies a rightward shift of the supply curve
showing that producers are willing to supply more at each price. A fall in supply, on the other
hand, implies a leftward shift of the supply curve indicating that producers are willing to supply
less at each price.

Reasons for the shift of Supply Curve

The reasons for the changes in supply (both increase and decrease in supply) can be stated as
follows:

1) Change in the prices of other commodities: A decrease in the prices of other commodities
increases the supply of the commodity in question at each price because relatively profits by
supplying other products fall. An increase in the prices of other commodities decreases the
supply of the commodity in question at each price.

2) Change in the prices of factors of production: An increase in the prices of factors of

production used in producing the commodity tends to reduce the supply of the commodity at
each price, since the cost of production rises and at the given price, profits fall. Conversely, a
decrease in the prices of factors of production used in making a commodity leads to an increase
in supply, at each price.

3) Change in technology: An improvement in technology normally leads to a fall in cost of

production and given the price of the product, a producer tends to produce more of that
commodity, at each price. Conversely loss in technical knowledge (the chances of which are
meagre) will lead to a fall in supply, at each price.

4) Change or expectation of change in other factors: Sometimes, supply of a commodity may

change because of the change in government policies relating to taxes or rate of interest or
because of fear of war or because of changing inequalities of income and wealth which influence
the demand of particular types of goods and hence making it more or less profitable to produce
that commodity. Accordingly, if producers expect more profits because of change in other
factors, supply increases at each price. Conversely, if producers expect less profits because of
change in other factors, supply decreases at each price.

ELASTICITY OF DEMAND
To begin with, let’s look at the definition of the elasticity of demand: “Elasticity of demand is the
responsiveness of the quantity demanded of a commodity to changes in one of the variables on
which demand depends. In other words, it is the percentage change in quantity demanded divided
by the percentage in one of the variables on which demand depends.”

The variables on which demand can depend on are:

 Price of the commodity

 Prices of related commodities

 Consumer’s income, etc.

Let’s look at some examples:

The price of a radio falls from Rs. 500 to Rs. 400 per unit. As a result, the demand increases
from 100 to 150 units.

Due to government subsidy, the price of wheat falls from Rs. 10/kg to Rs. 9/kg. Due to this, the
demand increases from 500 kilograms to 520 kilograms.

In both cases above, you can notice that as the price decreases, the demand increases. Hence, the
demand for radios and wheat responds to price changes.

TYPES OF ELASTICITY OF DEMAND

The elasticity of demand is classified into different types. The three main types of elasticity of
demand include

Although all these three types are important to understand, it should also be noted that whenever
the elasticity of demand is mentioned, it is considered to be price elasticity unless it has been
mentioned otherwise. Now, let us have a look at all these three types separately to understand
them a little better.

1. Price elasticity: The price elasticity of demand refers to the response of the product’s quantity
of demand to the price of the product or commodity. When talking about this particular variable,
it is assumed that all the other variables including the consumer’s income, tastes, and prices of all
other goods are steady or constant. You can easily calculate the price elasticity of demand by
dividing the percentage change in demand quantity with the percentage change in price. The
formula for calculating the price elasticity of demand is as follows:

Ep = percentage change in the demand quantity / percentage change in price

In the above formula, Ep represents the symbol for price elasticity of demand.

2. Income Elasticity: Another variable that affects the demand of the products or commodities is
the income of the consumer. Income elasticity of demand is the degree of responsiveness of the
quantity of demand to the change in the consumer’s income. It should come as no surprise that
an increase in the consumer’s income will cause the demand of the product to rise and the
decrease in consumer’s income will cause the demand of the product and commodity to fall. The
income elasticity of demand can be easily calculated by dividing the percentage change in the
quantity of demand by the percentage change in the consumer’s income. The formula for
calculating the income elasticity of demand is as follows:

EI = percentage change in the quantity of demand / percentage change in the consumer’s income
In the above formula, the symbol EI Represents the income elasticity of demand.

3. Cross Elasticity: As we discussed above, the third variable that may affect the demand of the
product or commodity is the change in price of other related goods and commodities. This is
what cross elasticity of demand represents. Cross elasticity of demand is the responsiveness of
the quantity of demand of one product or commodity to the change in price of some other related
product or commodity. For example, let’s consider there are two commodities, commodity X and
commodity Y. The change in demand of commodity X due to the change in price of commodity
Y is what cross elasticity of demand represents.

4. Advertising Elasticity of Demand: The responsiveness of the change in demand to the

change in advertising or rather promotional expenses, is known as advertising elasticity of
demand. In other words, the change in the demand as a result of the change in advertisement and
other promotional expenses is called as the advertising elasticity of demand.

1. TYPES OF PRICE ELASTICITY OF DEMAND

1. Perfectly Elastic Demand (Ep = ∞): The demand is said to be perfectly elastic when a slight
change in the price of a commodity causes a major change in its quantity demanded. Such as,
even a small rise in the price of a commodity can result into fall in demand even to zero.
Whereas a little fall in the price can result in the increase in demand to infinity. In perfectly
elastic demand the demand curve is a straight horizontal line which shows, the flatter the demand
curve the higher is the elasticity of demand.
2. Perfectly Inelastic Demand (Ep =0): When there is no change in the demand for a product
due to the change in the price, then the demand is said to be perfectly inelastic. Here, the demand
curve is a straight vertical line which shows that the demand remains unchanged irrespective of
change in the price. i.e. quantity OQ remains unchanged at different prices, P1, P2, and P3.

3. Relatively Elastic Demand (1 to ∞): The demand is relatively elastic when the proportionate
change in the demand for a commodity is greater than the proportionate change in its price. Here,
the demand curve is gradually sloping which shows that a proportionate change in quantity from
OQ0 to OQ1 is greater than the proportionate change in the price from OP1 to Op2.
4. Relatively Inelastic Demand (0-1): When the proportionate change in the demand for a
product is less than the proportionate change in the price, the demand is said to be relatively
inelastic demand. It is also called as the elasticity less than unity, i.e. 1. Here the demand curve is
rapidly sloping, which shows that the change in the quantity from OQ0 to OQ1 is relatively
smaller than the change in the price from OP1 to Op2.

5. Unitary Elastic Demand (Ep =1): The demand is unitary elastic when the proportionate
change in the price of a product results in the same change in the quantity demanded. Here the
shape of the demand curve is a rectangular hyperbola, which shows that area under the curve is
equal to one.

Thus, these are some of the types of the price elasticity of demand that helps the firms to price
their product in accordance with the demand patterns of an individual which changes with the
change in the price of the commodity.
2. INCOME ELASTICITY OF DEMAND

The income elasticity of demand (ey) measures how sensitive the quantity demanded of a
commodity is to change in the income of the consumer. It is one of the three main types of
elasticity of demand, the others being the price elasticity of demand and the cross elasticity of
demand.

In terms of its numerical value, it can be broadly categorized into three types:

1. Positive Income Elasticity

2. Negative Income Elasticity

3. Zero Income Elasticity

1. Positive Income Elasticity

The income elasticity of demand is said to be positive when the percentage (%) change in the
quantity of demand is greater than the percentage (%) change in the income.

In other words, when the amount purchased of a commodity increases due to an increase in the
income of the consumers, the income elasticity is termed positive.

Similarly, when the amount purchased of a commodity decreases with a decrease in the income
of the consumer, it is said to be positive elasticity of demand.

2. Negative Income Elasticity

Income elasticity of demand is said to be negative when an increase in income of the consumers
leads to a fall in the amount purchased of a commodity and when a decrease in income of the
consumer leads to an increase in the amount of commodity purchased. (ey < 0)
This type of elasticity is mostly seen in the case of inferior goods such as frozen or canned foods,
instant noodles, etc. Less quantity is demanded at higher incomes, and high quantity is demanded
at lower incomes.

For example, the income elasticity of instant noodles is negative. When income increases,
consumers will switch from instant noodles to takeout or home-cooked meals with proper
nutrition.

3. Zero Income Elasticity

Zero income elasticity of demand for a good implies that a rise in the consumer's income does
not impact the quantity demanded. It leaves the demand for the commodity unchanged.

This may be possible in exceptional cases such as salt, for example. The demand elasticity for
salt may be zero because an increase in the income beyond a certain level may not bring any
change in the quantity of salt demanded.

3. CROSS ELASTICITY OF DEMAND

Cross elasticity of demand is the relation between the percentage change in demand for a
commodity to the percentage change in the price of related commodity. It is an economic
concept that measures the responsiveness in the quantity demand of one good when a change in
price takes place in another good.

Types of Cross Elasticity of Demand

Theoretically, there are two types of cross elasticity of demand:

1. Positive Cross Elasticity of Demand

In the case of substitute goods, the cross elasticity of demand is positive. If the price of tea rises,
it will lead to increase in the demand for coffee. Similarly, a fall in price of tea will cause a
decrease in the demand for coffee.

When goods are substitute of each other then cross elasticity of demand is positive. In other
words, when an increase in the price of Y leads to an increase in the demand of X. For instance,
with the increase in price of tea, demand of coffee will increase.

2. Negative Cross Elasticity of Demand

In the case of complementary goods, cross elasticity of demand is negative. If the price of car
rises, it will lead to decrease in the demand for petrol. Similarly, the fall in the price of car will
bring the increase in the demand for petrol. Since, the price and demand change in opposite
direction, the cross elasticity of demand is negative.

In case of complementary goods, cross elasticity of demand is negative. A proportionate increase

in price of one commodity leads to a proportionate fall in the demand of another commodity
because both are demanded jointly.

3. Zero Cross Elasticity of Demand

Cross elasticity of demand is zero when two goods are not related to each other. For instance,
increase in price of car does not affect the demand of cloth. Thus, cross elasticity of demand is
zero.

4. ADVERTISING ELASTICITY OF DEMAND (AED)

Advertising elasticity of demand (AED) measures a market's sensitivity to increases or decreases

in advertising saturation. Advertising elasticity measures an advertising campaign's effectiveness
in generating new sales. It is calculated by dividing the percentage change in the quantity
demanded by the percentage change in advertising expenditures. A positive advertising elasticity
indicates that an increase in advertising leads to a rise in demand for the advertised goods or
services.
CONSUMER EQUILIBRIUM

Definition: Consumer equilibrium is when the customer attains maximum satisfaction from his
present consumption pattern with given income and prevailing market prices. Here, the customer
is not likely to change his expenditure and units consumed. This is because, he derives the
highest utility from the commodities purchased with the given income.

Consumer Equilibrium refers to a state of maximum satisfaction. A situation where a consumer

spends his given income purchasing one or more commodities to get maximum satisfaction and
has no urge to change this level of consumption is known as the consumer's equilibrium. A state
of equilibrium can be achieved by spending money on different goods and services with the
given income. At this point, the consumer cannot change his situation by either earning more,
spending more, or changing the quantity.

It is assumed that consumers aim to maximize overall utility when deciding how much of a given
commodity or service to purchase. The consumer has several limitations when attempting to
maximize total utility, the most important of which are the consumer's income and the prices of
the goods and services that the consumer wishes to consume. It allows consumers to get the most
out of the consumption of one or more items. It assists customers in combining two or more
products for optimal utility based on their tastes and preferences. Here, the customer is not likely
to change his expenditure and units consumed, and they derive the highest utility from the
commodities purchased with the given income.

For example, Person "A" to the market and purchases two chocolate bars. They decide to get
four extra bars because they anticipate having several guests join them that day. The marginal
utility is positive in this situation since they do not need to go back to the market to make a fresh
buy and His budget covers the extra things.

Concepts of Consumer Equilibrium

Following are some of the important concepts that one must comprehend in order to get a grasp
of consumer equilibrium and how it works. The list is as follows-

Marginal Utility -Utility is defined as the pleasure or advantage obtained from using a product.
The marginal utility of a good or service, on the other hand, explains how much customers like
or are satisfied with after increasing or decreasing their use by one unit.

Law of Diminishing Marginal Utility-According to the economics principle known as the rule of
decreasing marginal r, increasing more factors of production would actually lead to lesser
improvements in output once a certain level of capacity has been reached.

According to the law of diminishing marginal utility, when consumption rises, the marginal
utility gained from each extra unit decreases, all other things being equal. The incremental
improvement in utility brought on by consuming one more unit is known as marginal utility.
Conditions of Consumer's Equilibrium:

The consumer's equilibrium under the indifference curve theory must meet the following two
conditions:

Conditions of consumer's equilibrium using indifference curve analysis are

(i) MRS = P X P Y

(ii) IC is convex at the point of equilibrium.

Assumptions:

 The income of the consumer is constant.

 The two goods purchased with income can be substituted for one another.
 The rational customer always aims to maximise their level of satisfaction.
 The price of goods is constant.
 The consumer knows the prices of the commodities.
 Consumer can spend the income in small quantities.
 The market is in perfect competition.
 The goods can be divided.
 The indifference map is well known to the consumer.
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