Business economics is a field in applied economics which uses economic theory and quantitative methods to

analyze business enterprises and the factors contributing to the diversity of organizational structures and the
relationships of firms with labour, capital and product markets. Business economics is an integral part of
traditional economics and is an extension of economic concepts to the real business situation
Scope of Business Economics:
1. Analyzing Demand and Forecasting : Analyzing demand is all about understanding buyer behavior. It
studies the preferences of consumers along with the effects of changes in the determinants of demand. Also,
these determinants include the price of the good, consumer’s income, tastes/ preferences, etc. Forecasting
demand is a technique used to predict the future demand for a good and/or service. Further, this prediction is
based on the past behavior of factors which affect the demand. This is important for firms as accurate
predictions help them produce the required quantities of goods at the right time. Further, it gives them enough
time to arrange various factors of production in advance like raw materials, labor, equipment, etc. Business
Economics offers scientific tools which assist in forecasting demand.
2. Cost analysis : Business Economics deals with the analysis of different costs incurred by the business firms.
Every firm desires to minimize its costs and increase its output by securing several economies of scale. But it
do not know in advance about the exact costs involved in production process. Business Economics deals with
the cost estimates and acquaints the entrepreneurs with the cost analysis of their firms.
3. Profit analysis : Every business firm aims to secure maximum profits. But at the same time it faces
uncertainty and risk in getting profits. It has to make innovations in production and marketing of its
goods. Business Economics deals with the matters relating to profit analysis like profit techniques and break-
even analysis.
4. Capital management : Capital management is another topic dealt in Business Economics. It denotes
planning and control of capital expenditure in business organization. It studies matters like cost of capital, rate
of returns, selection or best project etc.
Thus, Business Economics deals with several matters relating to the business management like demand, costs,
profits and capital. All these elements under the scope of Business Economics are variable. So entrepreneurs
face risk, bear uncertainty and made innovations for boosting up the demand, sale, production and profits of
their goods.Business Economics analyses and applies the economic laws and theories to the problems faced by
the entrepreneurs. It provides remedies for overcoming such problems in business.
5. Production and Cost Analysis
A business economist has the following responsibilities with regards to the production:
 Decide on the optimum size of output based on the objectives of the firm.
 Also, ensure that the firm does not incur any undue costs.
By production analysis, the firm can choose the appropriate technology offering a technically efficient way of
producing the output. Cost analysis, on the other hand, enables the firm to identify the behavior of costs when
factors like output, time period, and the size of plant change. Further, by using both these analyses, a firm can
maximize profits by producing optimum output at the least possible cost.
7. Inventory Management
Firms can use certain rules to reduce costs associated with maintaining inventory in the form of raw materials,
work in progress, and finished goods. Further, it is important to understand that the inventory policies affect the
profitability of a firm. Hence, economists use methods like the ABC analysis and mathematical models to help
the firm in maintaining an optimum stock of inventories.
8. Market Structure and Pricing Policies
Any firm needs to know about the nature and extent of competition in the market. A thorough analysis of the
market structure provides this information. Further, with the help of this, firms command a certain ability to
determine prices in the market. Also, this information helps firms create strategies for market management under
the given competitive conditions.
Price theory, on the other hand, helps the firm in understanding how prices are determined under different kinds
of market conditions. Also, it assists the firm in creating pricing policies.
9. Resource Allocation
Business Economics uses advanced tools like linear programming to create the best course of action for an
optimal utilization of available resources.
10. Theory of Capital and Investment Decisions
Among other decisions, a firm must carefully evaluate its investment decisions an allocate its capital sensibly.
Various theories pertaining to capital and investments offer scientific criteria for choosing investment projects.
Further, these theories also help the firm in assessing the efficiency of capital. Business Economics assists the
decision-making process when the firm needs to decide between competing uses of funds.
11. Risk and Uncertainty Analysis
Most businesses operate under a certain amount of risk and uncertainty. Also, analyzing these risks and
uncertainties can help firms in making efficient decisions and formulating plans.
Importance of Business Economics:
 Helpful in organizing, 
 Helpful in planning,
 Helpful in decision making, 
 Helpful in coordination,
 Helpful in foreword plug, 
 Helpful in cost control,
 Helpful in demand forecasting,  
 Minimizing uncertainties,
 Helpful in chalking out business policies, 
 Helpful understanding external environment. 

Factors of Demand :
1. Price of the Commodity:
It is the most important factor affecting demand for the given commodity. Generally, there exists an inverse
relationship between price and quantity demanded. It means, as price increases, quantity demanded falls due to
decrease in the satisfaction level of consumers.
Demand (D) is a function of price (P) and can be expressed as: D = f (P). The inverse relationship between price
and demand, known as ‘Law of Demand’.
2. Price of Related Goods:
Demand for the given commodity is also affected by change in prices of the related goods. Related goods are of
two types:
(i)  Substitute Goods:
Substitute goods are those goods which can be used in place of one another for satisfaction of a particular want,
like tea and coffee. An increase in the price of substitute leads to an increase in the demand for given
commodity and vice-versa. For example, if price of a substitute good (say, coffee) increases, then demand for
given commodity (say, tea) will rise as tea will become relatively cheaper in comparison to coffee. So, demand
for a given commodity is directly affected by change in price of substitute goods.
(ii)  Complementary Goods:
Complementary goods are those goods which are used together to satisfy a particular want, like tea and sugar.
An increase in the price of complementary good leads to a decrease in the demand for given commodity and
vice-versa. For example, if price of a complementary good (say, sugar) increases, then demand for given
commodity (say, tea) will fall as it will be relatively costlier to use both the goods together. So, demand for a
given commodity is inversely affected by change in price of complementary goods.
3. Income of the Consumer:
Demand for a commodity is also affected by income of the consumer. However, the effect of change in income
on demand depends on the nature of the commodity under consideration.
i. If the given commodity is a normal good, then an increase in income leads to rise in its demand, while a
decrease in income reduces the demand.
ii. If the given commodity is an inferior good, then an increase in income reduces the demand, while a decrease
in income leads to rise in demand.
4. Tastes and Preferences:
Tastes and preferences of the consumer directly influence the demand for a commodity. They include changes
in fashion, customs, habits, etc. If a commodity is in fashion or is preferred by the consumers, then demand for
such a commodity rises. On the other hand, demand for a commodity falls, if the consumers have no taste for
that commodity.
5. Expectation of Change in the Price in Future:
If the price of a certain commodity is expected to increase in near future, then people will buy more of that
commodity than what they normally buy. There exists a direct relationship between expectation of change in the
prices in future and change in demand in the current period. If due to some reason, consumers expect that in the
near future prices of the goods would rise, then in the present they would demand greater quantities of the goods
so that in the future they should not have to pay higher prices. Similarly, when the consumers expect that in the
future the prices of goods will fall, then in the present they will postpone a part of the consumption of goods
with the result that their present demand for goods will decrease.
 Increase in Demand and Shifts in Demand Curve:
When demand changes due to the factors other than price, there is a shift in the whole demand curve. As
mentioned above, apart from price, demand for a commodity is determined by incomes of the consumers, his
tastes and preferences, prices of related goods. Thus, when there is any change in these factors, it will cause a
shift in demand curve.
 Decrease in Demand and Shift in the Demand Curve:
If there are adverse changes in the factors influencing demand, it will lead to the decrease in demand causing a
shift in the demand curve. For example, if due to inadequate rainfall agricultural production in a year declines
this will cause a fall in the incomes of the farmers. This fall incomes of the farmers will cause a decrease in the
demand for industrial products, say cloth, and will result in a shift in the demand curve to the left.
6. The Number of Consumers in the Market:
The market demand for a good is obtained by adding up the individual demands of the present as well as
prospective consumers of a good at various possible prices. The greater the number of consumers of a good, the
greater the market demand for it. If the consumers substitute one good for another, then the number of
consumers for the good which has been substituted by the other will decline and for the good which has been
used in place of the others, the number of consumers will increase. Besides, when the seller of a good succeeds
in finding out new markets for his good and as a result the market for his good expands the number of
consumers for that good will increase. Another important cause for the increase in the number of consumers is
the growth in population. For instance, in India the demand for many essential goods, especially food grains,
has increased because of the increase in the population of the country and the resultant increase in the number
of consumers for them.
Introduction to the Law of Demand:
The law of demand expresses a relationship between the quantity demanded and its price. It may be defined in
Marshall’s words as “the amount demanded increases with a fall in price, and diminishes with a rise in
price”. Thus it expresses an inverse relation between price and demand. The law refers to the direction in which
quantity demanded changes with a change in price.
On the figure, it is represented by the slope of the demand curve which is normally negative throughout its
length. The inverse price- demand relationship is based on other things remaining equal. This phrase points
towards certain important assumptions on which this law is based.

These assumptions are:

(i) There is no change in the tastes and preferences of the consumer;
(ii) The income of the consumer remains constant;
(iii) There is no change in customs;
(iv) The commodity to be used should not confer distinction on the consumer;
(v) There should not be any substitutes of the commodity;
(vi) There should not be any change in the prices of other products;
(vii) There should not be any possibility of change in the price of the product being used;
(viii) There should not be any change in the quality of the product; and
(ix) The habits of the consumers should remain unchanged. Given these conditions, the law of demand operates.
If there is change even in one of these conditions, it will stop operating.
Given these assumptions, the law of demand is explained in terms of Table and Figure.

The above table shows that when the price of say, orange, is Rs. 5 per unit, 100 units are demanded. If the price
falls to Rs.4, the demand increases to 200 units. Similarly, when the price declines to Re.1, the demand
increases to 600 units. On the contrary, as the price increases from Re. 1, the demand continues to decline from
600 units.
In the figure, point P of the demand curve DD1 shows demand for 100 units at the Rs. 5. As the price falls to Rs.
4, Rs. 3, Rs. 2 and Re. 1, the demand rises to 200, 300, 400 and 600 units respectively. This is clear from points
Q, R, S, and T. Thus, the demand curve DD1 shows increase in demand of orange when its price falls. This
indicates the inverse relation between price and demand.
Exceptions to the Law of Demand:
In certain cases, the demand curve slopes up from left to right, i.e., it has a positive slope. Under certain
circumstances, consumers buy more when the price of a commodity rises, and less when price falls, as shown
by the D curve in Figure 8. Many causes are attributed to an upward sloping demand curve
(i) War: If shortage is feared in anticipation of war, people may start buying for building stocks or for hoarding
even when the price rises.
(ii) Depression: During a depression, the prices of commodities are very low and the demand for them is also
less. This is because of the lack of purchasing power with consumers.
(iii) Giffen Paradox:
If a commodity happens to be a necessity of life like wheat and its price goes up, consumers are forced to curtail
the consumption of more expensive foods like meat and fish, and wheat being still the cheapest food they will
consume more of it. The Marshallian example is applicable to developed economies.
In the case of an underdeveloped economy, with the fall in the price of an inferior commodity like maize,
consumers will start consuming more of the superior commodity like wheat. As a result, the demand for maize
will fall. This is what Marshall called the Giffen Paradox which makes the demand curve to have a positive
slope.
(iv) Demonstration Effect: If consumers are affected by the principle of conspicuous consumption or
demonstration effect, they will like to buy more of those commodities which confer distinction on the possessor,
when their prices rise. On the other hand, with the fall in the prices of such articles, their demand falls, as is the
case with diamonds.
(v) Ignorance Effect:
Consumers buy more at a higher price under the influence of the “ignorance effect”, where a commodity may
be mistaken for some other commodity, due to deceptive packing, label, etc.
(vi) Speculation: Marshall mentions speculation as one of the important exceptions to the downward sloping
demand curve. According to him, the law of demand does not apply to the demand in a campaign between
groups of speculators. When a group unloads a great quantity of a thing on to the market, the price falls and the
other group begins buying it. When it has raised the price of the thing, it arranges to sell a great deal quietly.
Thus when price rises, demand also increases.
(vii) Necessities of Life: Normally, the law of demand does not apply on necessities of life such as food, cloth
etc. Even the price of these goods increases, the consumer does not reduce their demand. Rather, he purchases
them even the prices of these goods increase often by reducing the demand for comfortable goods. This is also a
reason that the demand curve slopes upwards to the right.
(viii) Articles of distinction: Articles of distinction have more demand only if their prices are relatively high.
Diamonds, jewellery, costly carpets, etc., have more demand because their prices are abnormally high. If their
price fall, they will no longer be considered as articles of distinction and so their demand will decrease.

EASTICITY OF DEMAND : The elasticity of demand is an economic term. It refers to demand sensitivity. In

other words, it helps to understand how the demand for good changes is when there are changes in other
economic variables. These economic variables include factors such as prices and consumer income.
Demand elasticity is calculated as the percent change in the quantity demanded divided by a percent change in
another economic variable.  A higher value for the demand elasticity with respect to an economic variable means
that consumers are more sensitive to changes in this variable.
The elasticity of demand = (% Change in demanded quantity)/(% Change in another economic variable)
Types of Demand Elasticity
1] Price Elasticity of Demand
A price is the quantity of payment or compensation given by one party to another in return for one unit of goods
or services. A price is influenced by both production costs and demand for the product. ... In modern economies,
prices are generally expressed in units of some form of currency.
This refers to the change or sensitivity in the customer’s demand for the quantity of a good with respect to a
change in its price. Companies often collect this data on the consumer response to price changes. This helps them
adjust the price to maximize profits.
2] Income Elasticity of Demand
This is the responsiveness of demand for a product with respect to the change in income. So it will help measure
the increase or decrease in demand when the income of the consumer increases or decreases.
Types of Income Elasticity of Demand
There are five types of income elasticity of demand:
 High: A rise in income comes with bigger increases in the quantity demanded.
 Unitary: The rise in income is proportionate to the increase in the quantity demanded. 
 Low: A jump in income is less than proportionate than the increase in the quantity demanded. 
 Zero: The quantity bought/demanded is the same even if income changes
 Negative: An increase in income comes with a decrease in the quantity demanded.
The income elasticity of demand (ey) can be measured by the following formula:
 ey = Percentage change in quantity demanded/Percentage change in income
 Percentage change in quantity demanded = New quantity demanded (∆Q)/Original quantity demanded
(Q)
 Percentage change in income = New income (∆Y)/original income (Y)
3] Cross Elasticity of Demand
This value is calculated by using the percent change in demanded quantity for a good and dividing it by the
percent change in the price of some other good. Moreover, this indicates the consumer reaction to demand a
particular good in accordance with price changes of other goods.
Cross-elasticity of demand expresses the ratio of percentage change in demand of good X produced due to the
percentage change in price of related good Y.
Therefore, the formula for cross-elasticity (ec) of demand is as follows:
ec = Percentage change in quantity demanded of X/Percentage change in price of Y
Percentage change in quantity demanded of X= New demand for X (∆QX)/Original demand for X (QX)
The various types of cross-elasticity of demand are as follows:
i. Positive Cross Elasticity of Demand:
Implies that the cross elasticity of demand would be positive when increase in the price of one good (X) causes
increase in the demand for the other good (Y). In simple terms, cross elasticity would be positive for substitutes.
For example, the quantity demanded for coffee has increased from 500 units to 550 units with increase in the
price of tea from Rs. 8 to Rs. 10. Calculate the cross elasticity of demand and state the type of relationship
between coffee (X) and tea(Y).
Solution:
QX1 =550 units
QX =500 units
PY1 = Rs. 10
PY = Rs. 8
Therefore, ∆QX = QX1 – QX = 550 – 500 = 50 units
Similarly, ∆PY = PY1 – PY = Rs. 2
Now ec = 50/2*8/500= 0.4
The cross elasticity of “demand is positive; therefore, X and Y are substitutes.

ii. Negative Cross Elasticity of Demand:

Refers to a situation when the rise in the price of one good (X) reduces the demand for the other good (Y). The
cross elasticity of demand would be negative for complementary goods. For example, the quantity demanded
for X decreases from 220 to 200 units with the rise in prices of Y from Rs. 10 to 12.
Now, the cross elasticity of demand would be as follows:
QX1 =200 units
QX =220 units
PY1 = Rs. 12
PY = Rs. 10
Therefore, ∆QX = QX1 – QX = 200 – 220= – 20 units
Similarly, ∆PY = PY1 – PY = Rs. 12 – Rs. 10 = Rs. 2
Now ec = – 20/2* 12/200= -0.6
The cross elasticity of demand is negative; therefore, X and Y are complementary to each other.
iii. Zero Cross Elasticity of Demand:
Implies that the cross elasticity of demand would be zero when two goods X and Y are not related to each other.
In other words, the increase or decrease in the price of one good (X) would not affect the demand of other good
(Y). Demand elasticity is generally measured in absolute terms. This implies the sign of the variable is ignored. If
the value is greater than 1, it is elastic. Furthermore, this implies demand is responsive to economic changes (like
price). If the value is less than 1 is inelastic.
This further implies demand does not show change according to economic changes such as price. Demand is unit
elastic when its value is equal to 1. This implies the value of demand moves proportionately with economic
changes.
Demand forecasting:
According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values
for demand in future time periods.”
In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period
based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”
Methods of Demand Forecasting:
There is no easy or simple formula to forecast the demand. Proper judgment along with the scientific formula is
needed to correctly predict the future demand for a product or service. Some methods of demand forecasting are
discussed below:
1] Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a year, then the most feasible method is to ask the
customers directly that what are they intending to buy in the forthcoming time period. Thus, under this method,
potential customers are directly interviewed. This survey can be done in any of the following ways:
a. Complete Enumeration Method: Under this method, nearly all the potential buyers are asked about
their future purchase plans.
b. Sample Survey Method: Under this method, a sample of potential buyers are chosen scientifically and
only those chosen are interviewed.
c. End-use Method: It is especially used for forecasting the demand of the inputs. Under this method, the
final users i.e. the consuming industries and other sectors are identified. The desirable norms of
consumption of the product are fixed, the targeted output levels are estimated and these norms are applied to
forecast the future demand of the inputs.
Hence, it can be said that under this method the burden of demand forecasting is on the buyer. However, the
judgments of the buyers are not completely reliable and so the seller should take decisions in the light of
his judgment also.
The customer may misjudge their demands and may also change their decisions in the future which in turn may
mislead the survey. This method is suitable when goods are supplied in bulk to industries but not in the case of
household customers.
2] Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in their region. The individual
estimates are aggregated to calculate the total estimated future sales. These estimates are reviewed in the light of
factors like future changes in the selling price, product designs, changes in competition, advertisement
campaigns, the purchasing power of the consumers, employment opportunities, population.
The principle underlying this method is that as the salesmen are closest to the consumers they are more likely to
understand the changes in their needs and demands. They can also easily find out the reasons behind the change
in their tastes.
Therefore, a firm having good sales personnel can utilize their experience to predict the demands. Hence, this
method is also known as Salesforce opinion or Grassroots approach method. However, this method depends on
the personal opinions of the sales personnel and is not purely scientific.
3] Barometric Method
This method is based on the past demands of the product and tries to project the past into the future. The
economic indicators are used to predict the future trends of the business. Based on future trends, the demand for
the product is forecasted. An index of economic indicators is formed. There are three types of economic
indicators, viz. leading indicators, lagging indicators, and coincidental indicators.
The leading indicators are those that move up or down ahead of some other series. The lagging indicators are
those that follow a change after some time lag. The coincidental indicators are those that move up and down
simultaneously with the level of economic activities.
4] Market Experiment Method
Another one of the methods of demand forecasting is the market experiment method. Under this method, the
demand is forecasted by conducting market studies and experiments on consumer behaviour under actual but
controlled, market conditions.
Certain determinants of demand that can be varied are changed and the experiments are done keeping other
factors constant. However, this method is very expensive and time-consuming.
5] Expert Opinion Method
Usually, market experts have explicit knowledge about the factors affecting demand. Their opinion can help in
demand forecasting. The Delphi technique, developed by Olaf Helmer is one such method.
Under this method, experts are given a series of carefully designed questionnaires and are asked to forecast the
demand. They are also required to give the suitable reasons. The opinions are shared with the experts to arrive at
a conclusion. This is a fast and cheap technique.
6] Statistical Methods
The statistical method is one of the important methods of demand forecasting. Statistical methods are scientific,
reliable and free from biases. The major statistical methods used for demand forecasting are:
a. Trend Projection Method: This method is useful where the organization has a sufficient amount of
accumulated past data of the sales. This date is arranged chronologically to obtain a time series. Thus, the
time series depicts the past trend and on the basis of it, the future market trend can be predicted. It is
assumed that the past trend will continue in the future. Thus, on the basis of the predicted future trend, the
demand for a product or service is forecasted.
b. Regression Analysis: This method establishes a relationship between the dependent variable and the
independent variables. In our case, the quantity demanded is the dependent variable and income, the price of
goods, the price of related goods, the price of substitute goods, etc. are independent variables. The
regression equation is derived assuming the relationship to be linear.
Regression Equation: Y = a + bX. Where Y is the forecasted demand for a product or service.
7] Econometric Methods:
Econometric models are an extension of the regression technique whereby a system of independent regression
equation is solved. The requirement for satisfactory use of the econometric model in forecasting is under three
heads: variables, equations and data.
The appropriate procedure in forecasting by econometric methods is model building. Econometrics attempts to
express economic theories in mathematical terms in such a way that they can be verified by statistical methods
and to measure the impact of one economic variable upon another so as to be able to predict future events

LAW OF DIMINISHING MARGINAL UTILITY : The law of diminishing marginal utility is one of the
vital laws of economics.
The law represents the fundamental tendency of human behaviour.
According to the law, when a consumer increases the consumption of a good, there is a decline in MU derived
from each successive unit of that good, while keeping the consumption of other goods constant.

Law of equi-Marginal utility : The law of equi-marginal utility states that the consumer will distribute his
money income between the goods in such a way that the utility derived from the last rupee spend on each good
is equal. In other words, consumer is in equilibrium position when marginal utility of money expenditure on
each goods is the same. This law is also known as the Law of substitution or the Law of Maximum Satisfaction.
Now, the marginal utility of money expenditure on a good is equal to the marginal utility of goods divided by
the price of the goods.
In symbols:
MUe= MUZ/PZ
Where MUe is marginal utility of money expenditure and MUz is the marginal utility of the goods X and Pz is
the price of X. The law of equi-marginal utility can, therefore, be stated thus: the consumer will spend his
money income on different goods in such a way that marginal utility of each good is proportional to its price.
That is, consumer is in equilibrium in respect of the purchases of two goods X and Y when
MUz/ PZ = MUz / PZ
Now, if MUz / PZ and MUy/ PZ are not equal and MUz / PZ -is greater than MUz / PZ then the consumer will
substitute goods X for goods Y. As a result of this substitution the marginal utility of goods Y will rise. The
consumer will continue Substituting goods X for goods Y till MUy/ PZ becomes equal to MUy / PZWhen MUZ/
PZ becomes equal to the Muy/ PZy consumer will be in equilibrium.
But the equality of MUZ / PZ with MUy/PZ can be achieved not only at one level but at different levels O
expenditure. The question is how far a consumer goes on purchasing the goods he wants. This is determined by
the size of his money expenditure. With a given expenditure a rupee has a certain utility for him: this utility is
the marginal utility of money by him.
INDIFFERENCE CURVE : It is a curve that represents all the combinations of goods that give the same
satisfaction to the consumer. Since all the combinations give the same amount of satisfaction, the consumer
prefers them equally.
An indifference curve is a graph showing combination of two goods that give the consumer equal satisfaction
and utility. Each point on an indifference curve indicates that a consumer is indifferent between the two and all
points give him the same utility.
Properties of an Indifference Curve or IC
1.An IC slopes downwards to the right
This slope signifies that when the quantity of one commodity in combination is increased, the amount of the
other commodity reduces. This is essential for the level of satisfaction to remain the same on an indifference
curve.
2.An IC is always convex to the origin
From our discussion above, we understand that as Peter substitutes clothing for food, he is willing to part with
less and less of clothing. This is the diminishing marginal rate of substitution. The rate gives a convex shape to
the indifference curve. However, there are two extreme scenarios:
 Two commodities are perfect substitutes for each other – In this case, the indifference curve is a straight
line, where MRS is constant.
 Two goods are perfect complementary goods – An example of such goods would be gasoline and water
in a car. In such cases, the IC will be L-shaped and convex to the origin.
3.Indifference curves never intersect each other
Two ICs will never intersect each other. Also, they need not be parallel to each other either. Look at the
following diagram:

Fig 3 shows two ICs intersecting each other at

point A. Since A and B lie on IC1, the give the
same satisfaction level. Similarly, A and C give
the same satisfaction level, as they lie on IC2.
Therefore, we can imply that B and C offer the
same level of satisfaction, which is logically
absurd. Hence, no two ICs can touch or intersect
each other.

4.A higher IC indicates a higher level of satisfaction as compared to a lower IC

A higher IC means that a consumer prefers more goods than not.

5.An IC does not touch the axis

This is not possible because of our assumption that a consumer considers different combinations of two
commodities and wants both of them. If the curve touches either of the axes, then it means that he is satisfied
with only one commodity and does not want the other, which is contrary to our assumption.
6.Indifference curves are not necessarily parallel to each other : Though they are falling, negatively inclined
to the right, yet the rate of fall will not be the same for all indifference curves. In other words, the diminishing
marginal rate of substitution between the two goods is essentially not the same in the case of all indifference
schedules. The two curves I1and I2shown in figure 11 are not parallel to each other.

Optimum Factor Combination: In the long run, all factors of production can be varied. The profit
maximization firm will choose the least cost combination of factors to produce at any given level of output. The
least cost combination or the optimum factor combination refers to the combination of factors with which a firm
can produce a specific quantity of output at the lowest possible cost.
There are two methods of explaining the optimum combination of factor:
(i) The marginal product approach : In the long run, a firm can vary the amounts of factors which it
uses for the production of goods. It can choose what technique of production to use, what design of
factory to build, what type of machinery to buy. The profit maximization will obviously want to use
that mix of factors of combination which is least costly to it. In search of higher profits, a firm
substitutes the factor whose gain is higher than the other. When the last rupee spent on each factor
brings equal revenue, the profit of the firm is maximized. When a firm uses different factors of
production or least cost combination or the optimum combination of factors is achieved.
(ii) The Isoquant / Isocost Approach: The least cost combination of-factors or producer's equilibrium is
now explained with the help of iso-product curves and isocosts. The optimum factors combination or
the least cost combination refers to the combination of factors with which a firm can produce a
specific quantity of output at the lowest possible cost. As we know, there are a number of
combinations of factors which can yield a given level of output. The producer has to choose, one
combination out of these which yields a given level of output with least possible outlay. The least cost
combination of factors for any level of output is that where the iso-product curve is tangent to an
isocost curve. It is also called “Equal Product Curve” or “Production Indifference Curve” or “Iso-
Product Curve”.
What is Production Function? : Production of goods requires resources or inputs. These inputs are called
factors of production named as land, labour, capital and organization. A rational producer is always interested
that he should get the maximum output from the set of resources or inputs available to him. He would like to
combine these inputs in a technical efficient manner so that he obtains maximum desired output of goods. The
relationship between the inputs and the resulting output is described as production function. A production
function shows the relationship between the amounts of factors used and the amount of output generated per
period of time.
Concept of Product:
The product is the most tangible and important single component of the marketing programme. The product
policy and strategy is the cornerstone of a marketing mix. If the product fails to satisfy consumer demand, no
additional cost on any of the other ingredients of the marketing mix will improve the product performance in the
market Place.
To the marketer products are the building blocks of a marketing plan. Good products are key to market success.
Product decisions are taken first by the marketers and these decisions are central to all other marketing
decisions such as price, promotion and distribution. \
It is the engine that pulls the rest of the marketing programme. Products fill in the needs of society. They
represent a bundle of expectations to consumers and society.
The product concept has three dimensions:
i. Managerial Dimension: It covers the core specifications or physical attributes, related service, brand,
package, product life-cycle, and product planning and development. As a basis to planning, product is second
only to market and marketing research.
The product offering must balance with consumer-citizen needs and desires. Product planning and development
can assure normal rate of return on investment and continuous growth of the enterprise.
ii. Consumer Dimension:
To the consumer a product is actually a group of symbols or meanings. People buy things not only for what they
can do, but also for what they mean. Each symbol communicates a certain information. A product conveys a
message indicating a bundle of expectations to a buyer. Consumer’s perception of a product is critical to its
success or failure. A relevant product is one that is perceived by the consumer as per intentions of the marketer.
Once a product is bought by a consumer and his evaluation, i.e., post-purchase experience is favourable,
marketers can have repeat orders.
iii. Social Dimension:
To the society salutary products and desirable products are always welcome as they fulfill the expectations of
social welfare and social interests. Salutary products yield long-run advantages but may not have immediate
appeal. Desirable products offer both benefits, immediate satisfaction and long-run consumer welfare. Society
dislikes the production of merely pleasing products which only give immediate satisfaction but which sacrifice
social interests in the long-run.
TOTAL PRODUCT : Total product is the output from a production system. It is synonymous with Qin
Equation. Total product is the overall output that results from employing a specific quantity of resources in a
given production system. The total product concept is used to investigate the relation between output and
variation in only one input in a production function.
MARGINAL PRODUCT : The marginal product of a factor, MPx, is the change in output associated with a
one unit change in the factor input, holding all other inputs constant. The change in total product from one
product to the other is known as the marginal product. Thus, it can also be said that Total Product is the
summation of Marginal products at different input levels.

AVERAGE PRODUCT: Average product is total product divided by the number of units of input employed.
Average Product = Total Product/ Units of Variable Factor Input
Law of variable proportions occupies an important place in economic theory. This law examines the
production function with one factor variable, keeping the quantities of other factors fixed. In other words, it
refers to the input-output relation when output is increased by varying the quantity of one input. This law is also
known as Law of Proportionality.
“The law of variable proportion states that if the inputs of one resource is increased by equal increment per unit
of time while the inputs of other resources are held constant, total output will increase, but beyond some point
the resulting output increases will become smaller and smaller.” Leftwitch
Keeping other factors fixed, the law explains the production function with one factor variable. In the short run
when output of a commodity is sought to be increased, Therefore, when the number of one factor is increased or
decreased, while other factors are constant, the proportion between the factors is altered. For instance, there are
two factors of production viz., land and labour.
Land is a fixed factor whereas labour is a variable factor. Now, suppose we have a land measuring 5 hectares.
We grow wheat on it with the help of variable factor i.e., labour. Accordingly, the proportion between land and
labour will be 1: 5. If the number of labourers is increased to 2, the new proportion between labour and land
will be 2: 5. Due to change in the proportion of factors there will also emerge a change in total output at
different rates. This tendency in the theory of production called the Law of Variable Proportion.

Explanation of the Law:

In order to understand the law of variable proportions we take the example of agriculture. Suppose land and
labour are the only two factors of production.
By keeping land as a fixed factor, the production of variable factor i.e., labour can be shown with the help of
the following table, there are three stages of the law of variable proportion.
In the first stage average production increases as there are more and more doses of labour and capital
employed with fixed factors (land). We see
that total product, average product, and
marginal product increases but average
product and marginal product increases up to
40 units. Later on, both start decreasing
because proportion of workers to land was
sufficient and land is not properly used. This
is the end of the first stage.
The second stage starts from where the first
stage ends or where AP=MP. In this stage,
average product and marginal product start
falling. We should note that marginal product
falls at a faster rate than the average product. Here, total product increases at a diminishing rate. It is also
maximum at 70 units of labour where marginal product becomes zero while average product is never zero or
negative.
The third stage begins where second stage ends. This starts from 8th unit. Here, marginal product is negative
and total product falls but average product is still positive. At this stage, any additional dose leads to positive
nuisance because additional dose leads to negative marginal product.

COST CONCEPT :
Accounting cost : Accounting costs are the explicit costs, also known hard costs that are seen as money out of
your bank account that you need to run your business. These are production costs, lease payments, marketing
budgets and payroll. In other words, these are the real costs in manufacturing, marketing and delivering your
products.
Economic cost : Economic costs include the same explicit costs that accounting costs use in calculations, but
economic costs also include implicit costs. Implicit costs are those values that are not listed on the ledger, and
they are assumed by the business to utilize resources. The idea with implicit costs is that the business could
make more by using an asset in a different, more traditional fashion. A paper company with a tree grove could
yield more money from the resource, if it sold lumber rather than if it harvested the trees for paper production.

Accounting costs account only for the explicit costs incurred in conducting a business and not the implicit costs.
The explicit costs include the direct costs to the company, such as employee wages, utility bills (water,
electricity, etc.), raw material cost, premises cost, transportation and storage costs, etc. Since these are expenses
for which bills or receipts are available, such costs can be objectively verified. In fact, accountants only account
for accounting costs in the financial statement of the company. Since these expenses are already incurred,
accounting costs are backward looking. Economic costs, on the other hand, account for both explicit and
implicit costs. Implicit costs is the opportunity cost in terms of revenue lost by forgoing the next best
alternative, say renting out premises instead of conducting the business there. Implicit costs do not appear on
the financial statements and are not objectively verifiable, since there can be a number of alternative to any
given course of action. Implicit costs are forward looking, since they include the what if (say, we rented out the
premises for next year instead of using it to conduct the business) scenario.
Opportunity cost : Opportunity costs represent the benefits an individual, investor or business misses out on
when choosing one alternative over another. Opportunity cost is an economics term that refers to the value of
what you have to give up in order to choose something else.

Fixed cost : The cost which remains constant at different levels of output
produced by an enterprise is known as Fixed Cost. They are not affected by
the momentary fluctuations in the activity levels of the organization. A fixed
cost is a cost that does not change with an increase or decrease in the amount
of goods or services produced or sold. It must be paid by an organization on
a recurring basis, even if there is no business activity. The concept is used
in financial analysis to find the breakeven point of a business, as well as
to determine product pricing.

Fixed Cost remains constant does not mean that they are not going to change
in future, but they tend to be fixed in the short run.

Variable cost : The cost which changes with the changes in the quantity of
output produced is known as Variable Cost. They are directly affected by
the fluctuations in the activity levels of the enterprise. A variable cost is a
corporate expense that changes in proportion to production output. Variable
costs increase or decrease depending on a company's production volume;
they rise as production increases and fall as production decreases. Examples
of variable costs include the costs of raw materials and packaging.

Variable cost varies with the variations in the volume, i.e. when there is an
increase in the production, variable cost will also increase
proportionately with the same percentage and when there is no production
there will be no variable cost. The Variable cost is directly proportional to
the units produced by the enterprise.

Marginal cost : Marginal cost is the additional cost incurred for the production of an additional unit of output.
The formula is calculated by dividing the change in the total cost by the change in the product output. MC
indicates the rate at which the total cost of a product changes as the production increases by one unit. However,
because fixed costs do not change based on the number of products produced, the marginal cost is influenced
only by the variations in the variable costs.
Average cost : The Average Cost is the per unit cost of production obtained by dividing the total cost (TC) by
the total output (Q). By per unit cost of production, we mean that all the fixed and variable cost is taken into the
consideration for calculating the average cost. Thus, it is also called as Per Unit Total Cost.
AC = TC/Q Also, AC = Average Variable cost (AVC) + Average Fixed cost (AFC)
Total cost : The Total Cost is the actual cost incurred in the production of a given level of output. In other
words, the total expenses (cost) incurred, both explicit and implicit, on the resources to obtain a certain level of
output is called the total cost. The total cost includes both the variable cost(that varies with the change in the
total output) and the fixed cost (that remains fixed irrespective of the change in the total output). Thus, total
cost includes the cost of all the input factors used for producing a certain level of output.
TC = FC + VC

Relation between Average Cost and Marginal

Cost: Using figures and table.

(1) When AC Falls, MC is Lower than AC:

When average cost falls, marginal cost is less than
AC. In Table 8, AC is falling till it becomes Rs.8,
and MC remains less than Rs.8. In Fig. 9, AC is
falling till point E, and MC continues to be lower
than AC. In this case, marginal cost falls more
rapidly than the average cost. That is why when
marginal cost (MC) curve is falling, it is below the
average cost (AC) curve. It is shown in Fig. 9.
(2) When AC Rises, MC is Greater than AC:
When average cost starts rising, marginal cost is
greater than average cost. In Table 8, when AC rises
from Rs.8 to Rs.9, MC rises from Rs.8 to Rs.16. In
Fig. 9, AC starts rising from point E. And, beyond
E, MC is higher than AC.
(3) When AC does not Change, MC is Equal to
AC:
When average cost does not change, then MC = AC.
It happens when falling AC reaches its lowest point.
In Table 8, at the 7th unit, average cost does not
change. It sticks to its minimum level of Rs.8. Here,
marginal cost is also Rs.8. Thus, Fig. 9 shows that
MC curve is intersecting AC curve at its minimum
point E.