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(Economics argue that they have observed the reality and found that people behave as
described above according to the law. Such a common behavior is believed to be a general
phenomenon of human behavior. As a result, it is regarded as a law.)
Assumptions of the Law
Income:
It is assumed that there is no change in the size and distribution of individual income. If
there is a change, the law will not operate. If income increases, consumer's purchasing
power increases and so demand may increase even if there is a rise in price.
Tastes and Preferences:
It is assumed that taste and preferences for a commodity remains unchanged and do not
population increases, demand for commodities would increase even when prices are rising.
Price of substitutes and complementary:
The price of substitutes and complimentary are assumed to be constant. If they fall in greater
proportion consumer's demand for the substitute will increase and that of the commodity
will decrease.
Speculation or Expectation regarding future prices:
If consumers expect a further fall in the price of the commodity the demand for it would be
low in the present even though its price falls. Hence, it is assumed that there should be no
only, for example: demand for sugarcane juice, and ice creams are made during summer
season only.
Advertisements:
Advertisement and publicity attracts the attention of the consumers. Due to this, there are
might be changes in the consumption pattern/ so it is assumed that there is no new product
introduced in the market or any new advertisement for the existing product.
Note: These Assumptions are expressed in the phrase other things remaining equal or
Ceteris Paribus.
Demand Curve DD
It is a geometrical device to express the inverse price-demand relationship, i.e. the law of
demand. A demand curve can be obtained by plotting a demand schedule on a graph and
joining the points so obtained, like the demand schedule we can derive an individual
demand curve as well as a market demand curve. The former shows the demand curve of an
individual buyer while the latter shows the sum total of all the individual curves i.e. a
market or a total demand curve. The following diagram shows the two types of demand
curves.
In the above diagram, figure (A) shows an individual demand curve of any individual
consumer while figure (B) indicates the total market demand. It can be noticed that both the
curves are negatively sloping or downwards sloping from left to right. Such a curve shows
the inverse relationship between the two variables. In this case the two variable are price on
Y axis and the quantity demanded on X axis. It may be noted that at a higher price OP the
quantity demanded is OM while at a lower price say OP1, the quantity demanded rises to
OM1 thus a demand curve diagrammatically explains the law of demand.
three categories
which can be discussed as follows: Economic Theory: - it is theoretical part of economics. It contains economic theories and
economic tools. It is divided into static and dynamic economics. It is also known as
Economic Analysis.
Applied Economics: - It attempts to apply the results of economic analysis to descriptive
economics. Industrial economics, managerial economics, and agricultural economics are
some of the examples of applied economics.
Descriptive Economics: - In descriptive economics, relevant facts about a particular
economic subject or topic are collected for the purpose of study. The subject Indian
Economics is the example of descriptive economics.
4
We know economics as a branch of knowledge which deals with the allocation of scarce
resources. The problem of resource allocation has been regularly faced by the individuals,
enterprises, and nations over the years. In the field of economics in recent decades the use of
mathematical tools and statistical methodology has become increasingly important. Further
economics is not the study of choice making behavior only. Major national and international
issues become the part of modern economic science. Currently the theory of economic
growth has occupied an important place in the study of economics and it studies how the
national income grows over the years.
Economics has two major branches:
(1) Microeconomics
(2) Macroeconomics
(1) Microeconomics: It can be defined as that branch of economic analysis which studies the
economic behavior of the individual unit,may be a person, a household, a firm, or a n
industry. It is a study of one particular unit rather than all the units combined together. An
important tool used in microeconomics is that of Marginal Analysis. Some of the important
laws and principles of microeconomics have been derived directly from the marginal
analysis.
The followings are the fields covered by microeconomics:
Theory of Consumer Behaviour and Demand
Theory of Production and Costs
Theory of Distribution or Factor pricing
Theory of Economic Welfare
national income
Theory of National Income
Theory of Money
5
following as the scope of managerial economics:Demand analysis and forecasting: Demand analysis is of great importance in managerial
economics. it seeks to identify and measure the factors that determine the demand for a
product in the product market. The demand for a firms product reflects what the consumers
actually buy. In every business firm, executive manager has to estimate current demand and
forecast future demand for the output produced by the firm. Such demand decisions can be
evaluated through an analysis of consumer behaviour. The important aspects dealt with
under demand analysis are: individual and market demand; demand estimation; demand
function; demand distinctions; demand forecasting and elasticity of demand and its
relevance in decision- making in business.
Demand forecasting attempts to estimate the likely demand for a product in future
periods. If future demands are identified, production can be better planned.
(ii)
Production analysis: Production analysis helps the firm to achieve the optimal levels in the
production process. It helps to get maximum output with minimum level of inputs of a firm.
The main concepts dealt under the production analysis are: production functions, returns to
(iii)
(iv)
decision-making.
Pricing analysis: pricing analysis is a core concept of managerial economics. It plays an
important role in profit planning. The success of a firm depends upon correct price decisions
taken by it. If the price is too high, the firm may not find enough consumers to buy its
product. If the price is set too low, the firm may not be able to cover its costs. Thus, setting
an appropriate price is important for every business firm. The pricing decision depends on
the types of market. If the market is perfect competition, monopoly, monopolistic, oligopoly
and duopoly etc, the firm takes the decision about fixation of price accordingly. The main
aspects dealt with under pricing analysis are: concepts of market mechanism, price
(v)
determination under different markets, pricing policies, pricing methods and approaches.
Profit analysis: profit is the index of good performance of a business firm. Generally, firms
aim at making profits. But the survival of every business firm depends upon its ability to
earn profit. Hence, decisions concerning level of profit, rate of profit, reinvestment of profit,
etc., are relevant in every business firm now a days. The main aspects covered under the
profit analysis are: nature and measurement of profit, profit theories, profit policies, profit
(vi)
(vii)
firm to come up with decisions related to the strategic planning and to achieve those
strategic goals and objectives.
1. External or Environmental Issues
In managerial economics the external or environmental issues refer to the business
environment of a firm in which it operates. These external or Environmental issues can be
either political, social or economic within which the firm is operating. A study of these
(i)
(ii)
(iii)
(iv)
(v)
(vi)
of
Hundred)
Output
(in
Total
Fixed
Total Cost
Cost
1000
1000
1000
60
1060
9
1000
100
1100
1000
150
1150
1000
200
1200
1000
400
1400
1000
700
1700
1000
1100
2100
The short run cost data of the firm shows that total fixed cost TFC (column 2) remains
constant at $1000/- regardless of the level of output.
The column 3 indicates variable cost which is associated with the level of output. Total
variable cost is zero when production is zero. Total variable cost increases with the increase
in output. The variable does not increase by the same amount for each increase in output.
Initially the variable cost increases by a smaller amount up to 3 rd unit of output and after
which it increases by larger amounts.
Column (4) indicates total cost which is the sum of TFC + TVC. The total cost increases for
each level of output. The rise in total cost is more sharp after the 4 th level of output.
The concepts of costs, i.e., (1) total fixed cost (2) total variable cost and (3) total cost can be
illustrated graphically.
(i) Total Fixed Cost Curve/Diagram:
10
In this diagram (13.1) the total fixed cost of a firm is assumed to be $1000 at various levels
of output. It remains the same even if the firm's output is zero.
(ii) Total Variable Cost Curve/Diagram:
In the figure (13.2), the total variable cost curve (TVC) increases with the higher level of
output. It starts from the origin. Then increases at a diminishing rate up to the 4th units of
output. It then begins to rise at an increasing rate.
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In the figure (13.3), total cost curve which is the sum of the total fixed cost and variable cost
at various levels of output has nearly the same shape. The difference between the two is by
only a fixed amount of $1,000. The total variable cost curve and the total cost curve begin to
rise more rapidly as production is increased. The reason for this is that after a certain output,
the business has passed its most efficient use of its fixed costs machinery, building etc., and
its diminishing return begins to set in.
a) Income: The relationship between income and the demand is a direct one. It means the
demand changes in the same direction as the income. An increase in income leads to rise in
demand and vice versa.
b) Population: The size of population also affects the demand. The relationship is a direct one.
The higher the size of population, the higher is the demand and vice versa.
c) Tastes and Habits: The tastes, habits, likes, dislikes, prejudices and preference etc. of the
consumer have a profound effect on the demand for a commodity. If a consumer dislikes a
commodity, he will not buy it despite a fall in price. On the other hand a very high price also
may not stop him from buying a good if he likes it very much.
d) Other Prices: This is another important determinant of demand for a commodity. The effect
depends upon the relationship between the commodities in question. If the price of a
complimentary commodity rises, the demand for the commodity in reference falls. E.g. the
demand for petrol will decline due to rise in the price of cars and the consequent decline in
their demand. Opposite effect will be experienced incase of substitutes.
e) Advertisement: This factor has gained tremendous importance in the modern days. When a
product is aggressively advertised through all the possible media, the consumers buy the
advertised commodity even at a high price and many times even if they dont need it.
f) Fashions: Hardly anyone has the courage and the desire to go against the prevailing fashions
as well as social customs and the traditions. This factor has a great impact on the demand.
g) Imitation: This tendency is commonly experienced everywhere. This is known as the
demonstration effects, due to which the low income groups imitate the consumption patterns
of the rich ones. This operates even at international levels when the poor countries try to
copy the consumption patterns of rich countries.
h) countries try to copy the consumption patterns of rich countries.
Qualitative Method
Jury
of
Description
opinion
Delphi method
Consumer
survey
market The customers are asked about their purchasing plans and their
projected buying behavior. A large number of respondents is
needed here to be able to generalize certain results.
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Thus, above statement indicates that face to face contact of buyer and seller is not necessary
for market. e.g. in stock or share market, buyer and seller can carry on their transactions
through internet. So internet, here forms an arrangement and such arrangement also is
included in the market.
On the basis of Place, market is classified into :1.
2.
3.
1.
2.
3.
4.
1.
2.
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b) Plot and describe about the short-run equilibrium of a perfectly competitive firm.
Ans: PERFECT COMPETITION
In economic theory, perfect competition describes markets such that no participants are large
enough to have the market power to set the price of a homogeneous product. Because the
conditions for perfect competition are strict, there are few if any perfectly competitive
markets. Still, buyers and sellers in some auction-type markets, say for commodities or
some financial assets, may approximate the concept. Perfect competition serves as a
benchmark against which to measure real-life and imperfectly competitive markets.
16
Infinite buyers and sellers Infinite consumers with the willingness and ability to buy
the product at a certain price, and infinite producers with the willingness and ability to
supply the product at a certain price.
Zero entry and exit barriers It is relatively easy for a business to enter or exit in a
perfectly competitive market.
Perfect factor mobility - In the long run factors of production are perfectly mobile
allowing free long term adjustments to changing market conditions.
Perfect information - Prices and quality of products are assumed to be known to all
consumers and producers.
Zero transaction costs - Buyers and sellers incur no costs in making an exchange
(perfect mobility).
Profit maximization - Firms aim to sell where marginal costs meet marginal revenue,
where they generate the most profit.
Non-increasing returns to scale - Non-increasing returns to scale ensure that there are
sufficient firms in the industry.
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In the short-run, it is possible for an individual firm to make an economic profit. This
situation is shown in this diagram, as the price or average revenue, denoted by P, is above
the average cost denoted by C.
C)
with diagrammatic
presentation.
Ans: BUSINESS CYCLES
Definition: A business cycle is the periods of growth and decline in an economy. There are
four stages in the business cycle:
1.
2.
3.
4.
1. Prosperity Phase
When there is an expansion of output, income, employment, prices and profits, there is also
a rise in the standard of living. This period is termed as Prosperity phase.
The features of prosperity are :1.
2.
3.
4.
5.
Inflation.
6.
7.
8.
2. Recession Phase
The turning point from prosperity to depression is termed as Recession Phase.
During a recession period, the economic activities slow down. When demand starts falling,
the overproduction and future investment plans are also given up. There is a steady decline
in the output, income, employment, prices and profits. The businessmen lose confidence and
become pessimistic (Negative). It reduces investment. The banks and the people try to get
greater liquidity, so credit also contracts. Expansion of business stops, stock market falls.
19
Orders are cancelled and people start losing their jobs. The increase in unemployment
causes a sharp decline in income and aggregate demand. Generally, recession lasts for a
short period.
3. Depression Phase
When there is a continuous decrease of output, income, employment, prices and profits,
there is a fall in the standard of living and depression sets in.
The features of depression are :1.
2.
3.
4.
5.
Deflation.
6.
7.
8.
4. Recovery Phase
The turning point from depression to expansion is termed as Recovery or Revival Phase.
During the period of revival or recovery, there are expansions and rise in economic
activities. When demand starts rising, production increases and this causes an increase in
investment. There is a steady rise in output, income, employment, prices and profits. The
businessmen gain confidence and become optimistic (Positive). This increases investments.
The stimulation of investment brings about the revival or recovery of the economy. The
banks expand credit, business expansion takes place and stock markets are activated. There
20
is an increase in employment, production, income and aggregate demand, prices and profits
start rising, and business expands. Revival slowly emerges into prosperity, and the business
cycle is repeated.
Thus we see that, during the expansionary or prosperity phase, there is inflation and during
the contraction or depression phase, there is a deflation.
Causes of Inflation
Cost Push InflationCost-push inflation occurs when businesses respond to rising
production costs, by raising prices in order to maintain their profit margins. There are many
reasons why costs might rise:
Rising imported raw materials costs perhaps caused by inflation in countries that are heavily
dependent on exports of these commodities or alternatively by a fall in the value of the
21
pound in the foreign exchange markets which increases the UK price of imported inputs. A
good example of cost push inflation was the decision by British Gas and other energy
suppliers to raise substantially the prices for gas and electricity that it charges to domestic
and industrial consumers at various points during 2005 and 2006.
Rising labour costs - caused by wage increases which exceed any improvement in
productivity. This cause is important in those industries which are labour-intensive. Firms
may decide not to pass these higher costs onto their customers (they may be able to achieve
some cost savings in other areas of the business) but in the long run, wage inflation tends to
move closely with price inflation because there are limits to the extent to which any business
can absorb higher wage expenses.
Higher indirect taxes imposed by the government for example a rise in the rate of excise
duty on alcohol and cigarettes, an increase in fuel duties or perhaps a rise in the standard
rate of Value Added Tax or an extension to the range of products to which VAT is applied.
These taxes are levied on producers (suppliers) who, depending on the price elasticity of
demand and supply for their products, can opt to pass on the burden of the tax onto
consumers. For example, if the government was to choose to levy a new tax on aviation
fuel, then this would contribute to a rise in cost-push inflation.
Cost-push inflation can be illustrated by an inward shift of the short run aggregate supply
curve. This is shown in the diagram below. Ceteris paribus, a fall in SRAS causes a
contraction of real national output together with a rise in the general level of prices.
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Demand Pull Inflation: Demand-pull inflation is likely when there is full employment of
resources and when SRAS is inelastic. In these circumstances an increase in AD will lead to
an increase in prices. AD might rise for a number of reasons some of which occur together
at the same moment of the economic cycle
A depreciation of the exchange rate, which has the effect of increasing the price of
imports and reduces the foreign price of UK exports. If consumers buy fewer imports,
while foreigners buy more exports, AD will rise. If the economy is already at full
employment, prices are pulled upwards.
A reduction in direct or indirect taxation. If direct taxes are reduced consumers have
more real disposable income causing demand to rise. A reduction in indirect taxes will
mean that a given amount of income will now buy a greater real volume of goods and
services. Both factors can take aggregate demand and real GDP higher and beyond potential
GDP.
The rapid growth of the money supply perhaps as a consequence of increased bank
and building society borrowing if interest rates are low. Monetarist economists believe that
the root causes of inflation are monetary in particular when the monetary authorities
permit an excessive growth of the supply of money in circulation beyond that needed to
finance the volume of transactions produced in the economy.
23
Rising consumer confidence and an increase in the rate of growth of house prices
both of which would lead to an increase in total household demand for goods and services
Cost of production:
(a) Purchase of raw machinery, (b) Installation of plant and machinery, (c) Wages of labor,
(d) Rent of Building, (e) Interest on capital, (f) Wear and tear of the machinery and building,
(g) Advertisement expenses, (h) Insurance charges, (i) Payment of taxes, (j) In the cost of
production, the imputed value of the factor of production owned by the firm itself is also
added, (k) The normal profit of the entrepreneur is also included In the cost of production.
b) Price Elasticity:
Ans: Price Elasticity
25
The concept of price elasticity reveals the percentage change in quantity demanded due to
the percentage change in price assuming other thing as constant (ceteris paribus). Demand
for some commodities is more elastic while that for certain others are less elastic.
Types/Degrees of Price Elasticity
Using the formula of elasticity, it possible to mention following different types of price
elasticity:
A.
B.
C.
D.
E.
26
a. In the fig (e) percentage change in demand is smaller than that in price. It means the
demand is relatively less elastic to the change in price. This is referred as relatively an
inelastic demand. When the percentage change in quantity demanded is equal to percentage
change in price, it is a case of unit elasticity. The rectangular hyperbola as shown in the Fig
(c) represents this type of elasticity. In this case percentage change in demand is equal to
percentage change in price, hence e = 1.
4. Relatively Elastic (more elastic) Demand (e > 1)
a. In case of certain commodities the demand is relatively more responsive to the change in
price. It means a small change in price induces a significant change in, demand. This can be
understood by means of the alongside figure.Hence, the elastic demand (e>1) Fig d
5. Perfectly Elastic Demand (e = )
a. This is experienced when the demand is extremely sensitive to the changes in price. In this
case an insignificant change in price produces tremendous change in demand. The demand
curve showing perfectly elastic demand is a horizontal straight line. Fig b
From the above analysis it can be concluded that theoretically five different types of price
elasticity can be mentioned. In practice, however two extreme cases i.e. perfectly elastic and
perfectly inelastic demand, are rarely experienced. What we really have is more elastic (e >
1) or less elastic (e < 1 ) demand. The unitary elasticity is a dividing line between these two
cases.
c) Production Function
Ans: Production Function: A given output can be produced with many different combinations of
factors of production (land, labor, capita! and organization) or inputs. The output, thus, is a function of
inputs. The functional relationship that exists between physical inputs and physical output of a firm is
called production function.
Formula:
In abstract term, it is written in the form of formula:
Q = f (x1, x2, ......., xn)
Q is the maximum quantity of output and x 1, x2, xn are quantities of various inputs. The
functional relationship between inputs and output is governed by the laws of returns.
27
(i) The law of variable proportion seeking to analyze production in the short period.
(ii) The law of returns to scale seeking to analyze production in the long period.
d) Oligopoly:
Ans: OLIGOPOLY
Oligopoly is that market situation in which the number of firms is small but each firm in the
industry takes into consideration the reaction of the rival firms in the formulation of price
policy. The number of firms in the industry may be two or more than two but not more than
20. Oligopoly differs from monopoly and monopolistic competition in this that in monopoly,
there is a single seller; in monopolistic competition, there is quite a larger number of them;
and in oligopoly, there are only a small number of sellers.
CHARACTERISTICS OF OLIGOPOLY:
1.
Every seller can exercise an important influence on the price-output policies of his
rivals.
2. It is more elastic than under simple monopoly and not perfectly elastic as under perfect
competition.
3.
It is often noticed that there is stability in price under oligopoly. This is because the
oligopolist avoids experimenting with price changes. He knows that if raises the price, he
will lose his customers and if he lowers it he will invite his rivals to price war.
PRICE DETERMINATION MODELS OF OLIGOPOLY Kinky Demand Curve):
The kinky demand curve model tries to explain that in non-collusive oligopolistic industries
there are not frequent changes in the market prices of the products. The demand curve is
drawn on the assumption that the kink in the curve is always at the ruling price. The reason
28
is that a firm in the market supplies a significant share of the product and has a powerful
influence in the prevailing price of the commodity. Under oligopoly, a firm has two choices:
(a) The first choice is that the firm increases the price of the product. Each firm in the
industry is fully aware of the fact that if it increases the price of the product, it will lose most
of its customers to its rival. In such a case, the upper part of demand curve is more elastic
than the part of the curve lying below the kink.
(b) The second option for the firm is to decrease the price. In case the firm lowers the price,
its total sales will increase, but it cannot push up its sales very much because the rival firms
also follow suit with a price cut. If the rival firms make larger price cut than the one which
initiated it, the firm which first started the price cut will suffer a lot and may finish up with
decreased sales. The oligopolists, therefore avoid cutting price, and try to sell their products
at the prevailing market price. These firms, however, compete with one another on the basis
of quality, product design, after-sales services, advertising, discounts, gifts, warrantees,
special offers, etc.
In the above diagram, we shall notice that there is a discontinuity in the marginal revenue
curve just below the point corresponding to the kink. During this discontinuity the marginal
cost curve is drawn. This is because of the fact that the firm is in equilibrium at output ON
where the MC curve is intersecting the MR curve from below.
e) GDP:
29
Ans: Gross Domestic Product (GDP): Gross Domestic Product (GDP) is the total market
value of all final goods and services currently produced within the domestic territory of a
country in a year.
Four things must be noted regarding this definition.
First, it measures the market value of annual output of goods and services currently
produced. This implies that GDP is a monetary measure.
Secondly, for calculating GDP accurately, all goods and services produced in any given year
must be counted only once so as to avoid double counting. So, GDP should include the
value of only final goods and services and ignores the transactions involving intermediate
goods.
Thirdly, GDP includes only currently produced goods and services in a year. Market
transactions involving goods produced in the previous periods such as old houses, old cars,
factories built earlier are not included in GDP of the current year.
Lastly, GDP refers to the value of goods and services produced within the domestic territory
of a country by nationals or non-nationals.
f) Law of returns to scale:
30
proportionate change in the quantities of all inputs. The answer to this question helps a firm
to determine its scale or size in the long run.
It has been observed that when there is a proportionate change in the amounts of inputs, the
behavior of output varies. The output may increase by a great proportion, by in the same
proportion or in a smaller proportion to its inputs. This behavior of output with the increase
in scale of operation is termed as increasing returns to scale, constant returns to scale and
diminishing returns to scale. These three laws of returns to scale are now explained, in brief,
under separate heads.
(1) Increasing Returns to Scale:
If the output of a firm increases more than in proportion to an equal percentage increase in
all inputs, the production is said to exhibit increasing returns to scale.
For example, if the amount of inputs are doubled and the output increases by more than
double, it is said to be an increasing returns returns to scale. When there is an increase in the
scale of production, it leads to lower average cost per unit produced as the firm enjoys
economies of scale.
(2) Constant Returns to Scale:
When all inputs are increased by a certain percentage, the output increases by the same
percentage, the production function is said to exhibit constant returns to scale.
For example, if a firm doubles inputs, it doubles output. In case, it triples output. The
constant scale of production has no effect on average cost per unit produced.
(3) Diminishing Returns to Scale:
The term 'diminishing' returns to scale refers to scale where output increases in a smaller
proportion than the increase in all inputs.
31
For example, if a firm increases inputs by 100% but the output decreases by less than 100%,
the firm is said to exhibit decreasing returns to scale. In case of decreasing returns to scale,
the firm faces diseconomies of scale. The firm's scale of production leads to higher average
cost per unit produced.
Graph/Diagram:
The three laws of returns to scale are now explained with the help of a graph below:
The figure 11.6 shows that when a firm uses one unit of labor and one unit of capital, point
a, it produces 1 unit of quantity as is shown on the q = 1 isoquant. When the firm doubles its
outputs by using 2 units of labor and 2 units of capital, it produces more than double
from
q = 1 to q = 3.
So the production function has increasing returns to scale in this range. Another output from
quantity 3 to quantity 6. At the last doubling point c to point d, the production function has
32
decreasing returns to scale. The doubling of output from 4 units of input, causes output to
increase from 6 to 8 units increases of two units only.
33