Chapter 1

BASIC PRINCIPALS OF ECONOMICS

DEMAND AND SUPPLY ANALYSIS Income Elasticity of Demand: Price is not only determinant of demand Income is another important determinant It is expressed asEY = (% change in demand) / (% change in income) Types of Income Elasticity: 1. EY > 1 i.e. greater portion of income is being spent on commodity with an increase in income 2. EY = 1 i.e. unitary income elasticity 3. EY < 1 4. EY = 0 5. Negative income elasticity of demand: with increase in income, the person buys less of inferior good and switches to superior good. Cross Elasticity of Demand: Demand for commodity some times also depends upon price of relative commodity
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e.g. if X and Y are related commodities, then cross elasticity demand for X can be expressed asEC = (% change in demand for X) / (% change in price of Y) Relation between 2 commodities can be of types: 1. Complementary goods e.g.----------------? 2. Substitutes e.g. ------------------?. EC for complementary goods --(-ve) EC for substitute goods ------ (+ve) EC for unrelated goods ------- (zero) Importance of Elasticity: 1. Analysis of price demand relationship (qualitative and quantitative) 2. Deciding the pricing policy for commodity Inelastic demand --- high price --- beneficial Elastic demand-----low price ---- beneficial Practicing price discrimination for monopolist 3. Fixing the price of joint product (joint product with inelastic demand---high price; joint product with elastic demand-----low price)
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4. helpful to Government for fixing prices of public utilities 5. Also helpful in fixing prices of labour, employee, workers, wages, etc. 6. Government----for fixing economic policies related to taxation, international trade 7. Guiding Finance Minister in imposing commodity taxes 8. Government----for formulating commercial policies, protection and subsidy to be granted to industries which face elastic demand SUPPLY: Quantities of goods offered for sale at various prices Schedule of amount of goods that would be offered for sale at all possible prices at any one instant of time, or during any one period of time, e.g. a day, a week, a month, etc. in which the conditions of supply remain the same Supply is different than stock---------3 Compiled by Prof. Prasad Parulekar

 Stock---- reservoir ; Supply----Flow Supply-----part of stock (at any time, stock > supply) Supply----actual quantity offered for sale at prevailing price; Stock-----potential supply Supply---more elastic than stock Law of Supply: Functional relationship between price of commodity and quantity supplied for same In a given market, at any given time, the quantity of any goods which people (supplier) are ready to offer for sale generally varies directly with the price Other things remaining same, as the price of commodity rises, its supply is extended and as the price falls, its supply is contracted Individual supply: to earn more profit, supplier wish to supply more at high price (hence direct relation ) Market supply: similar to that of individual supply (At high price-----existing suppliers supply more; new suppliers may enter the market; At low price-----existing
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suppliers supply less; present supplier may exit from firm) Supply Schedule: Shows different quantities of commodity that are offered for sale at a particular time (Individual and Market) e.g. Price (Rs./Kg) S1 2 3 4 5 6 20 30 40 45 50 Individual supply schedule (Kg) S2 35 45 50 55 60 S3 40 50 55 60 65 Market supply schedule (Kg) 500 700 1000 1200 1500

Supply Curve: Graphical representation of price supply relationship Determinants of Supply: 1. Price: as discussed earlier
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2. Production cost: if rises, production may curtailed, supply reduces (inverse relation) 3. Factors of production (raw material, utilities, labour, etc.): if changes, production may change, supply changes 4. Transport increases 5. Future trends in price: possibility of rise in future, present supply decreases 6. Natural factors: weather conditionsfavorable, no natural calamities, supply increases 7. Abnormal circumstances: e.g. war; supply may decrease 8. Monetary policy of Government: if liberal, production increases, supply increases. Extension & contraction of Supply: Due to changes in price facilities and Communication: if improved, adequate, efficient and economical, supply

Compiled by Prof. Prasad Parulekar

Increase & Decrease in supply: Due to changes in factors other than price (production cost, price of factors of production, techniques of production) Elasticity of Supply: (es) Responsiveness or sensitiveness of supply to changes in price Es = (% change in supply) / (% change in price) =(change in S/original S)/(change in P/original P) = (S / S) / (P / P) = (S / P) (P / S) Where, S = original quantity supplied P = original price offered = change Types of Elasticity of supply: 1. Perfectly inelastic supply (es = 0) 2. Perfectly elastic supply (es = ) 3. Unitary elasticity supply (es = 1) 4. Elastic supply (es > 1) 5. Inelastic supply (es < 1)
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Measurement of elasticity of supply: Elasticity of supply at a point on supply curve can be measured by drawing a tangent to curve at that point and extending it to cut X or Y axis or through origin ES = (NM / OM) ---------(refer the graph) 1. If tangent passes through origin--------es = 1 2. If tangent cuts Y axis------- es > 1 3. If tangent cuts X axis-------- es < 1 Determinants of Elasticity: 1. Time element: longer the time period, more elastic is the supply 2. Production technique: if improved, supplyfairly elastic; if rigid, supply----less elastic 3. Availability of variable input: if abundantly available, production and supply----easily adjusted, supply----elastic 4. Behavior of cost: if rise in cost---sharp and rigid, supply----difficult to expand, hence less elastic; if rise gradually, supply-----more elastic 5. Availability of markets:
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Compiled by Prof. Prasad Parulekar