MODULE 2.pdf. MBA 1st sem economics for managers

economics for managers

1. MODULE 2

2. INTRODUCTION
Desire-isjustawishonthepartoftheconsumertopossessacommodity.
Want-Ifthedesiretopossessacommodityisbackedbythepurchasingpowerand
theconsumerisalsowillingtobuythatcommodity,itbecomeswant.
Demand–referstoconsumer'sdesiretopurchasegoodsandservicesand
willingnesstopayaspecificpriceforthemoveraperiodoftime.Quantitybacked
bypurchasingpower

3. AccordingtoProf.Benham,
“Thedemandforanythingatagivenpriceistheamountofitwhichwillbebought
perunitoftimeatthatprice.”
Demandforagoodistheamountofitthataconsumerwillpurchaseatavarious
pricesduringaperiodoftime.

5. DETERMINANTS OF DEMAND
i) Price of the commodity in question
ii) Prices of other related commodities
iii) Income of the consumers, and
iv) Taste of the consumers.

6. DEMAND FUNCTION
Demand function refers to the rule that shows how the quantity demanded depends upon above factors.
A demand function can be shown as:
Dx = f (Px, Py,Pz, M, T)
where,
Dx is quantity demanded of X commodity,
Pxis the price of X commodity,
Pyis the price of substitute commodity,
Pzis price of a complement good,
M stands for income,
T is the taste of the consumer.
Let us assume that the quantity demanded of a commodity X is D x, which depends only on its price P x, while other
factors are constant.
It can be mathematically represented as: Dx = f (Px)

7. LAW OF DEMAND
MEANING
Theinverserelationshipbetweenthe
quantityofacommodityanditsprice,
givenallotherfactorsthatinfluencethe
demandremainconstant,iscalled‘law
ofdemand’.
DEFINITION
AccordingtoSamuelson:“Lawof
demandstatesthatpeoplewillbuy
moreatlowerpricesandbuylessat
higherprices,ifotherthingsremainsthe
same(ceterisparibus).

8. ASSUMPTIONS OF THE LAW
According to Stigler and Boulding, the law of demand based on the following
assumptions:
1. There should be no change in the income of consumers.
2. There should be no change in the taste and preferences of the consumer.
3. There should be no change in the prices of related goods.
4. There should be no change in the size of population.
5. Consumer is a rational consumer.
6. There should be no expectation of rise or fall in price of related goods in future.
7. There should be perfect competition in the market.

9. DEMAND SCHEDULE
Demand Schedule -It shows the relationship between price and quantities demanded
at different
Demand Schedule

10. DEMAND CURVE
Demandcurveisagraphical
presentationofdemandschedule.
Thedemandcurveisagraphthat
depictstheconnectionbetweenprice
andquantitydemandedbyconsumers.
Thegraphshowshowthepriceofa
commodityorservicevariesasthe
quantitydemandedrises.
Onceplotted,thedemandcurveslopes
downward,fromlefttoright.Asprices
increase,consumersdemandlessofa
goodorservice.

11. WHY DOES A DEMAND CURVE SLOPE DOWNWARDS?
Substitution Effect
Income Effect
Price Effect
Psychological effect
Law of diminishing marginal utility
New consumer

12. EXCEPTIONS TO THE LAW OF DEMAND
1.Prestigiousgoods:Vebleneffect---AccordingtoVeblen(Americaneconomist)some
consumermeasuretheutilityofcommoditybyitsprice,theyconsidergreatertheprice
ofacommodity,thegreateritsutility.SoincaseofVeblengoodspeoplebuymoreat
higherpricesjusttoshowofftheirstatus.forexample,diamondsareconsidered
prestigegoodsinthesocietyandforupperstrataofasocietythehigherthepriceof
diamondhighertheprestigevalueforthem.
2.Giffengoods—SirRobertGiffenobservedthatincaseofinferiorgoodswiththe
fallinpricespeoplebuylessquantitiesofit,becausetheyarereadytopurchase
somesuperiorgoodsaswiththefallinpricetheirRealincomeincreased.Afterthe
nameofSirRobertGiffen,suchgoodsinwhosecasethereisadirectrelationshipare
calledGiffengoods.

13. 3.Expectations—peoplewillbuymoreevenwhenthereisincreaseinprices,iftheyexpect
thatpricemayriseinnearfuture.Similarlytheywillbuylessevenatlowerpricesifthey
expectthatpricesofcommoditiesgoesdowninnearfuture.Sothatisthereasonofupward
slopingofdemandcurve.
4.Duringwaroremergency—duringtheperiodofwar,peoplemaystartbuyingfor
hoardingorbuildingstocksevenathigherprices.Butincaseofdepression,theywilllesseven
atlowerprices.
5.Ignorance—someconsumersthinkthatmorewillbethepricehigherwillbethequality.Or
sometimestheypurchasesgoodathigherpricesoutofsheerignorance

14. CHANGE IN DEMAND AND SUPPLY

15. CHANGE IN DEMAND

16. CHANGEINQUANTITYDEMANDED–
Whenthedemandforacommoditychangesbecauseofthechangeinitsprice,itis
called‘changeinquantitydemanded’.
ThischangeiscalledMovementalongthedemandcurve.
CHANGEINDEMAND–
whenthechangeindemandisduetothefactorsotherthanitspricecauseachangeit
iscalled‘changeindemand’.
ThischangeiscalledShiftofdemandcurve.

17. EXTENSION AND CONTRACTION IN DEMAND OR
MOVEMENT ALONG DEMAND CURVE.
Ithappenswhenreasonofchangeindemandispriceonly.
Extension(expansion)-Ifafallinthepricecausesthequantitydemandedtorises,itis
calledextensionindemand.
Contraction-Ifwithariseinthepriceofacommodity,itsquantitydemandfalls,we
callitcontractionindemand.

18. EXTENSION OF DEMAND
Price (per Unit) Quantity Demanded
5 14
4 16
3 18
2 20

19. CONTRACTION IN DEMAND
Price (per Unit) Quantity Demanded
2 20
3 28
4 16
5 14
Demand

20. INCREASE AND DECREASE IN DEMAND CURVE OR
SHIFT OF DEMAND CURVE
Whendemandchangesduetochangeinotherfactorsinsteadofpricelikefashion,
tasteandpreference.Itisincreaseordecreaseindemand.
Increaseindemand-(a)sameprice,moredemand(b)Moreprice,samedemand
Decreaseindemand—Demandcanbedecreaseintwoways(a)Sameprice,less
demand(b)Lessprice,samedemand

21. INCREASE IN DEMAND
Same price, more demand
More price, same demand

22. DECREASE IN DEMAND
Same price, less demand
Less price, same demand

23. FACTORS FOR SHIFT A DEMAND CURVE
1)Ariseinincomeoftheconsumercanenablehimtodemandmoreofacommodity
atagivenpriceandafallinincomewillgenerallyforcehimtocurtailhisdemand.
2)Arightwardshiftinthedemandcurvecanalsotakeplacebecauseofincreasein
priceofasubstitute.Similarly,aleftwardshiftinthedemandcurvecanbebecause
ofdecreaseinpriceofasubstitute.
3)Iftheconsumerdevelopsatasteforacommodity,hemaydemandmoreofiteven
ifthepriceremainsunchanged,shiftingthedemandcurvetotheright.Ontheother
hand,aleftwardshiftinthedemandcurvecanindicatethatourconsumerhasstarted
dislikingthecommodity.

24. SUPPLY
Supplyreferstothequantityofacommoditythatproducersarewillingtosellat
differentpricesperunitoftime.
Features:
1)Thesupplyofacommodityindicatestheofferedquantities.Infact,currentsupply
canbedifferentfromcurrentproduction,thedifferenceisaccountedforbythe
changesintheinventoriesorthestocks.
2)Likethedemand,thesupplyisalsowithreferencetothepriceatwhichthat
quantityissupplied.
3)Thesupplyisaflow.Ithasatimeunitattachedtherewith.Thesupplyhastobe
perday/weekormonth.

25. DETERMINANTS OF SUPPLY
1) Price of the commodity supplied
2) The prices of factors of production or cost of production
3) Prices of other goods
4) The state of technology
5) Goals of the producer

26. THE LAW OF SUPPLY
Aproduceraimstomaximiseprofits,thedifferencebetweentotalrevenueandtotal
cost.Profit=TR–TC
TR=TotalRevenue(quantityxprice).
TC=TotalCost(quantityxaveragecost)Ahigherpricewouldmeanmoreprofits.
Theproducerwillsupplymoreatahigherprice.Similarly,aproducerwillsupply
smallerquantityatalowerprice.
Thisisadirectrelationshipbetweenthepriceandthequantitysuppliedofa
commodityandiscalledthe‘LawofSupply’.
Thus,thesupplyfunctionis:
S=f(P)

27. EXCEPTIONS TO THE LAW OF SUPPLY
Non-maximisationofprofits
Factorsotherthanpricenotremainingconstant

28. SUPPLY SCHEDULE
Asupplyscheduleshowsquantitiesofacommoditythataselleriswillingtosupply,perunit
oftime,ateachprice,assumingotherfactorsremainingconstant.

29. THE SUPPLY CURVE
HerepriceisplottedontheY-axisandquantity
suppliedonX-axis.
ThesupplycurveSisasmoothcurvedrawn
throughthefivepointsa,b,c,dande.Thiscurve
showsthequantityofpensofferedforsaleat
eachprice.
Thesupplycurve(justlikeademandcurve)can
belinearstraightline,orintheshapeofan
upwardsloppingcurveconvexdownwards.
Thesupplycurvehaspositiveslope
Ariseinpriceresultsingreaterquantitiesin
greaterquantitysuppliedandlowerpriceresults
inlowerquantitysupplied

30. CHANGESINQUANTITYSUPPLIED–
Therecanbechangesinthequantityofferedforsaleduetochangesinthepriceof
thecommodityonly,allotherfactorsremainingconstant.Thisistermedaschangein
quantitysuppliedandMovementalongthesupplycurve
CHANGEINSUPPLY–
Ifsupplyofacommodityundergoesachangebecauseofchangesinfactorsother
thanthepriceofthecommodity,wecallthischangeinsupply.Itisshownbyashiftin
thepositionofthesupplycurve.

31. MOVEMENT ALONG THE SUPPLY CURVE
Achangeinthepriceofgoodresultsina
changeinthequantitysuppliedwhichwill
resultinthemovementalongthesupply
curve
Thechangeinquantitysuppliedcanbeof
twotypes,
1)Whenthepriceofacommodityfallsand
itsquantitysuppliedfalls.Itistermedas
‘contractionofsupply’.
2)Whenthepriceofacommodityrisesand
itsquantitysuppliedrises,providedthelaw
ofsupplyapplies,itistermedas“extension
ofsupply”.

32. SHIFT OF THE SUPPLY CURVE
Adecreaseinsupply:Whenthequantity
ofacommoditysupplieddeclines,atthe
samepriceitisreferredtoasa
‘decreaseinsupply’.Itimpliesa
leftwardshiftofthesupplycurve.
Anincreaseinsupply:Whenthequantity
ofacommoditysuppliedincreases,at
thesameprice,itisknownasanincrease
insupply.Thisisshownbyarightward
shiftinthesupplycurve.

33. WHY THE SUPPLY CURVE SHIFTS?
Changeinthepricesofothercommodities
Changeinthepricesoffactorsofproduction
Changeintechnology
Changeorexpectationofchangeinotherfactors

34. ELASTICITY

35. MEANING OF ELASTICITY
TheelasticityofavariableXwithrespecttosomeothervariableYshowsresponsivenessorsensitivityofXto
changesinY.
TheelasticityofXwithrespecttoYisdefinedastheratioofpercentchangeinXtopercentchangeinY.
Symbolically:
Wecanalsowriteitas:
Sotheelasticityofdemandwithrespecttoachangeintheirpricewillbe:
WhereQrepresentsquantityofandPrepresentstheirprice.

36. ELASTICITY OF DEMAND
ZEROELASTICITY
Achangeinpricehasnoimpactonthe
quantitydemanded.Suchacommodityis,
sometimes,calledanabsolutenecessity.

37. InfiniteElasticityofDemand
Averysmallfallinpricecanleadtoan
extremelylargeincreaseinquantity
demanded.

38. CONCEPT OF ELASTICITY OF DEMAND
Lawofdemandtellsthatafallinpricewillleadtoanincreaseinquantity
demandedandviceversa
Inadditiontothedirectionofthechangeinquantitydemanded,managersaremore
interestedinfindingthemagnitudeofthechangeorthedegreeofresponsivenessof
consumerstoachangeinanydeterminantsorvariable
Tomeasurethis,theyusetheconceptofelasticityofdemand.Elasticityofdemand
measureshowmuchthequantitydemandedchangeswithagivenchangeina
particulardetermentofdemand(i.e.priceoftheitem,changeinconsumers’income,
orchangeinpriceofrelatedproductandadvertisementetc.).

39. 1. PRICE ELASTICITY OF DEMAND
ThePriceElasticityofDemandistheratiowithwhichdemandforaproductwill
contractorexpandwithriseorfallinitsprices.Itiscalculatedasfollow;

40. Thepriceelasticityofdemandfallsintothreecategories:
1. Elastic demand
2. Unit elastic demand
3. Inelastic demand
There are two extreme cases:
4. Perfectly elastic demand
5. Perfectly inelastic demand

43. METHODS OF MEASURING PRICE ELASTICITY OF
DEMAND
1.Total Expenditure Method
2.Proportionate Method
3.Point Elasticity Method
4.Arc Elasticity Method
5.Revenue Method

44. 1. TOTAL OUTLAY METHOD
Totaloutlaymethodofmeasuringpriceelasticityofdemandwasintroduced
byDr.AlfredMarshall.Accordingtothismethod,thepriceelasticityofa
productismeasuredonthebasisofthetotalamountofmoneyspent(total
expenditure)byconsumersontheconsumptionofthatproduct.
Inthismethod,thetotalexpenditureofconsumersontheconsumptionofa
particularproductbeforechangeinthepriceiscomparedwiththetotal
expenditureofconsumersafterchangeinthepriceofthatproduct.Thetotal
expenditureafteragivenchangeinthepricemaybesameastheearlier
amount,increase,ordecrease.
TotalOutlay=PriceXQuantityDemanded

45. This can be expressed with the help
of a Chart.

46. 2. PROPORTIONATE METHOD
Thismethodisalsoassociatedwith
thenameofDr.Marshall.According
tothismethod,“priceelasticityof
demandistheratioofpercentage
changeintheamountdemandedto
thepercentagechangeinpriceofthe
commodity.”
ItisalsoknownasthePercentage
Method,FluxMethod,Ratio
Method,andArithmeticMethod

47. 3. POINT METHOD
Thepriceelasticityofdemandvaries
atdifferentpointsinthegiven
demandcurve.Therefore,itis
measuredseparatelyatdifferent
pointsinthegivendemandcurve.
Theformulaforcalculatingprice
elasticityofdemandthroughpoint
methodisasfollows:
e=∆Q/∆P*P/Q

48. 4. ARC ELASTICITY METHOD
Whilepointelasticitymeasurestheprice
elasticityofdemandatapointonthe
demandcurve,arcelasticitymethod
measuresthepriceelasticityofdemand
betweenanytwopointsonthedemand
curve.

49. 5. REVENUE METHOD
Elasticityofdemandcanbemeasuredwith
thehelpofaveragerevenueandmarginal
revenue.Therefore,saleproceedsthata
firmobtainsbysellingitsproductsare
calleditsrevenue.However,whentotal
revenueisdividedbythenumberofunits
sold,wegetaveragerevenue.
Onthecontrary,whenadditionismadeto
thetotalrevenuebythesaleofonemore
unitofthecommodityiscalledmarginal
revenue.Therefore,theformulatomeasure
elasticityofdemandcanbewrittenas,
E
A= A/ A-M
Where E
drepresents elasticity of demand,
A = average revenue and
M = marginal revenue.

50. DETERMINANTS OF PRICE ELASTICITY OF
DEMAND
1.The availability of close substitutes
2.The importance of the product's cost in one's budget
3.Number of uses of the good
4.Income of consumer
5.How high the price of the good is
6.Nature of the good
7.The period of time under consideration
8.Joint Demand
9.Time elapsed since a price change

51. 2. INCOME ELASTICITY OF DEMAND
Incomeelasticityofdemandmeasures
thepercentagechangeinabuyer's
purchaseofaproductasaresultofa
percentagechangeinher/hisincome.So
incomeelasticityofdemandis

52. CHARACTERISTICS
Ey>1,QDandincomearedirectlyrelated.Thisisanormalgoodanditisincome
elastic.
0<Ey<1,QDandincomearedirectlyrelated.Thisisanormalgoodanditis
incomeinelastic.
Ey<0,QDandincomeareinverselyrelated.Thisisaninferiorgood
Eyapproaches0,QDstaysthesameasincomechanges,indicatinganecessity.

53. 3. CROSS PRICE ELASTICITY OF DEMAND
Inthecaseofaproductthathasa
substitute(likeorangesandapples),the
pricechangeofoneproductaffectsthe
demandfortheother.Crossprice
elasticityofdemandmeasuresthis
effect.SoCrosselasticityofdemandis;
forsubstitutegoods
forcomplementarygoods

54. LIMITATIONS OF THE CONCEPTS OF ELASTICITY
OF DEMAND
Irrelevant and Unreliable Data
Unrealistic Assumption

55. ELASTICTIY OF SUPPLY

56. MEANING OF ELASTICITY OF
SUPPLY :
Theelasticityofsupplyistheresponsivenessofquantitysuppliedofaproduct
tochangesinoneofthevariablesonwhichsupplydepends.Accordingto
basiceconomictheory,thesupplyofacommodityincreaseswithariseinprice
anddecreaseswithafallinprice.
Definition:
According to Bilas,
“Elasticity of Supply is defined as the percentage change in quantity supplied
divided by percentage change in price.”

57. It can be calculated by using the following formula:
E
S= % change in quantity supplied/% change in price
Symbolically,
E
S= ∆Q/Q ÷∆P/P = ∆Q/∆P ×P/Q

58. DEGREES OF ELASTICITY OF SUPPLY
1.Perfectly elastic
2.Perfectly inelastic
3.Unitary elastic
4.Relatively elastic
5.Relatively inelastic

59. PERFECTLY ELASTIC SUPPLY
Thesupplyissaidtobeperfectlyelastic
whenasmallriseinpricewouldresult
insupplytobecomeinfinite,whilea
smallfallinpricewouldresultinafall
insupplytozero.Itisalsoknownas
infiniteelasticity.
Thisisshownbyastraightlinesupply
curveparalleltothehorizontalaxis.
ForExample,
Supposethepriceofacommodityis
Rs.10anditsSupplyis50units.Asthe
priceincreasestoRs.15,itssupply
increasestoinfinity.

60. PERFECTLY INELASTIC SUPPLY
Whenthesupplydoesn’tchangewith
thechangeinprice(whetherfallingor
rising),thesupplyissaidtobeperfectly
inelastic.Itmeanssupplyremains
constantagainstanyvalueofpriceinthe
market.Thisisrepresentedbyastraight
lineparalleltotheverticalaxis.
Forexample,
SupposethepriceofacommodityisRs
10,andsupplyis200units.Astheprice
increasestoRs20,theSupplyremains
constantat200units.Itimpliesthatthe
supplyisperfectlyinelastic.

61. UNITARY ELASTIC SUPPLY
Whenthechangeinthesupplyofa
commodityisinthesameratioasthe
changeinitsprice,itisknownas
unitaryelasticsupply.
ForExample,
Supposethepriceofacommodityis
Rs.50andthequantitysuppliedina
specificmarketis200units.Astheprice
increasestoRs.55,itssupplyrisesto
220units.Itimpliestheunitaryelastic
supply.

62. ELASTIC SUPPLY
RelativelyElasticSupplyoccurswhenthe
proportionatechangeinsupplyisgreaterthan
proportionatechangeinprice.Itmeansthatthere
willbeagreaterchangeinsupplyduetoasmall
changeinprice.Itisalsoknownashighlyelastic
supplyandmorethanunitaryelasticsupply.
For Example,
Suppose the price of a commodity is Rs50 and
quantity supplied is 200 units. As the price increases
to Rs55, its supply increases to 250 units. It implies
the supply to be relatively elastic.

63. INELASTIC SUPPLY
Thesupplyissaidtoberelativelyinelasticwhena
proportionatechangeinquantitysuppliedisless
thanproportionatechangeinprice.Itmeansthat
greaterchangeinpriceleadstoasmallerchangein
quantitysupplied.
ForExample,
SupposethepriceofacommodityisRs50and
quantitysuppliedis200units.Astheprice
increasestoRs70,itssupplyincreasesto220units.
Itimpliesthesupplytoberelativelyinelastic.

64. MEASUREMENT OF ELASTICITY OF
SUPPLY
Following two methods of the measurement of elasticity of supply are discussed:
(1) Percentage or Proportionate Method.
(2) Geometric or Diagrammatic Method.

65. PROPORTIONATE OR PERCENTAGE METHOD
Accordingtothismethod,the
elasticityofsupplycanbedefinedas
theratiobetween‘percentagechange
inquantitysupplied’and‘apercentage
changeinprice’ofthecommodity.
E
s=Percentagechangeinquantity
supplied/Percentagechangeinprice

66. GEOMETRIC METHOD :
Geometrically,theelasticityof
supplydependsontheoriginof
thesupplycurve.Assumingthe
supplycurvetobeastraightline
andpositivesloped,thegeometric
methodmeasurestheelasticityof
supplyasfollows:

67. FACTORS AFFECTING OF ELASTICITY
SUPPLY
(1) Nature of the inputs used
(2) Natural constraints
(3) Risk taking
(4) Nature of the commodity
(5) Cost of production
(6) Time factor
(7) Technique of production

68. DEMAND FORECASTING

69. MEANING
InDemandestimatingmanagerattemptstoquantifythelinksorrelationshipbetweenthe
levelofdemandandthevariableswhicharedeterminantstoitandisgenerallyusedin
designingpricingstrategyofthefirm.Indemandestimationmanageranalysetheimpactof
futurechangeinpriceonthequantitydemanded.Firmcanchargeapricethatthemarketwill
readytoweartosellitsproduct.Overestimationofdemandmayleadtoanexcessiveprice
andlostsaleswhereasunderestimatesmayleadtosettingoflowpriceresultinginreduced
profits.Indemandestimationdataiscollectedforshortperiodusuallyayearorlessand
analysedinrelationtovariousvariablestoknowtheimpactofeachvariablesmainlythe
priceonthedemandbehaviourofthecustomers.Itisforashortperiod.

70. FEATURES OF DEMAND FORECASTING
The main features of the demand forecasting are;
1.DemandForecastingisaprocesstoinvestigateandmeasuretheforcesthatdeterminesalesfor
existingandnewproducts.
2.Itisanestimationofmostlikelyfuturedemandforaproductundergivenbusinessconditions.
3.Itisbasicallyaneducatedandwellthoughtoutguessworkintermsofspecificquantities
4.DemandForecastingisdoneinanuncertainbusinessenvironment.
5.DemandForecastingisdoneforaspecificperiodoftime(i.e.thesufficienttimerequiredtotakea
decisionandputitintoaction).
6.Itisbasedonhistoricalandpresentinformationanddata.
7.Ittellsusonlytheapproximateexpectedfuturedemandforaproductbasedoncertainassumptions
andcannotbe100%precise.

71. DEMAND FORECASTING PROCESS
1. Specifying the objective of Demand Forecasting
2. Determining the nature of goods
3. Determining the time perspective
4. Determining the level of forecasting
5. Selection of proper method or technique of forecasting
6. Data Collection and modification
7. Data analysis and estimations

72. METHODS OF DEMAND FORECASTING

74. ORDINARY LEAST SQUARE METHOD
Regression Analysis is a statistical technique that studies the relation between
independent variable and dependent variable. The data collected is represented on
a scatter plot and these scatter plot of points are translated are translated into
demand equation.
It helps to find the regression equation that best fits the observed data.
The technique that regression analysis uses to minimize the error term is called the
OLS –ORDINARY LEAST SQUARE MODEL

75. TREND ANALYSIS AND TREND PROJECTION
Classical method of business forecasting
Relies on time series data
The trend projection method is used under the assumption that the factors responsible
for the past trends, will continue to play their part in future in the same manner and
to the same extent as they did in the past
Technique of trend projection based on Time Series data –
LEAST SQUARE METHOD/STRAIGHT LINE METHOD