Economics Lecture Notes

CE2451 Engineering Economics and Cost Analysis
CE 2451 ENGINEERING ECONOMICS AND COST ANALYSIS LTPC

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OBJECTIVE
The main objective of this course is to make the Civil Engineering student know about the basic
law of economics, how to organize a business, the financial aspects related to business,
different methods of appraisal of projects and pricing techniques. At the end of this course the
student shall have the knowledge of how to start a construction business, how to get finances,
how to account, how to price and bid and how to assess the health of a project.
UNIT I BASIC ECONOMICS 7

Definition of economics - nature and scope of economic science - nature and scope of
managerial economics - basic terms and concepts - goods - utility - value - wealth - factors of
production - land - its peculiarities - labour - economies of large and small scale - consumption -
wants - its characteristics and classification - law of diminishing marginal utility – relation
between economic decision and technical decision.
UNIT II DEMAND AND SCHEDULE 8

Demand - demand schedule - demand curve - law of demand - elasticity of demand - types of
elasticity - factors determining elasticity - measurement - its significance - supply – supply
schedule - supply curve - law of supply - elasticity of supply - time element in the determination
of value - market price and normal price - perfect competition - monopoly – monopolistic
competition.
UNIT III ORGANISATION 8

Forms of business - proprietorship - partnership - joint stock company - cooperative organization
- state enterprise - mixed economy - money and banking - banking - kinds - commercial banks -
central banking functions - control of credit - monetary policy - credit instrument.
UNIT IV FINANCING 9
Types of financing - Short term borrowing - Long term borrowing - Internal generation of funds -
External commercial borrowings - Assistance from government budgeting support and
international finance corporations - analysis of financial statement – Balance Sheet - Profit and
Loss account - Funds flow statement.
UNIT V COST AND BREAK EVEN ANALYSES 13

Types of costing – traditional costing approach - activity base costing - Fixed Cost – variable
cost – marginal cost – cost output relationship in the short run and in long run – pricing practice
– full cost pricing – marginal cost pricing – going rate pricing – bid pricing – pricing for a rate of
return – appraising project profitability –internal rate of return – pay back period – net present
value – cost benefit analysis – feasibility reports – appraisal process – technical feasibility -
economic feasibility – financial feasibility. Break even analysis - basic assumptions – break even
chart – managerial uses of break even analysis.
TOTAL: 45 PERIODS
TEXT BOOKS
1. Dewett K.K. & Varma J.D., Elementary Economic Theory, S Chand & Co., 2006
2. Sharma JC “Construction Management and Accounts” Satya Prakashan, New Delhi.
REFERENCES
1. Barthwal R.R., Industrial Economics - An Introductory Text Book, New Age
2. Jhingan M.L., Micro Economic Theory, Konark
3. Samuelson P.A., Economics - An Introductory Analysis, McGraw-Hill
4. Adhikary M., Managerial Economics
5. Khan MY and Jain PK “Financial Management” McGraw-Hill Publishing Co., Ltd
6. Varshney RL and Maheshwary KL “ Managerial Economics” S Chand and Co
Prepared By: V. Karthik Raja B.E., M.B.A

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UNIT 1
BASIC ECONOMICS
DEFINITION
Economics is the study of the production and consumption of goods and the transfer of wealth
to produce and obtain those goods. Economics explains how people interact within markets to
get what they want or accomplish certain goals. Since economics is a driving force of human
interaction, studying it often reveals why people and governments behave in particular ways.
In general, Economics is the social science that analyzes the production, distribution, and
consumption of goods and services. Also, Economics is a social science which study how the
scarce resources are utilized for the benefit of the members of the community.
There are two main types of economics: macroeconomics and microeconomics.

Microeconomics focuses on the actions of individuals and industries, like the dynamics
between buyers and sellers, borrowers and lenders. Macroeconomics, on the other hand,
takes a much broader view by analyzing the economic activity of an entire country or the
international marketplace.
A study of economics can describe all aspects of a country’s economy, such as how a country
uses its resources, how much time laborers devote to work and leisure, the outcome of
investing in industries or financial products, the effect of taxes on a population, and why
businesses succeed or fail.
People who study economics are called economists. Economists seek to answer important
questions about how people, industries, and countries can maximize their productivity, create
wealth, and maintain financial stability. Because the study of economics encompasses many
factors that interact in complex ways, economists have different theories as to how people and
governments should behave within markets.
HISTORY
Adam Smith, known as the Father of Economics, established the first modern economic theory,
called the Classical School, in 1776. Smith believed that people who acted in their own self-
interest produced goods and wealth that benefited all of society. He believed that governments
should not restrict or interfere in markets because they could regulate themselves and, thereby,
produce wealth at maximum efficiency. Classical theory forms the basis of capitalism and is still
prominent today.
A second theory known as Marxism states that capitalism will eventually fail because factory
owners and CEOs exploit labor to generate wealth for themselves. Karl Marx, the theory’s
namesake, believed that such exploitation leads to social unrest and class conflict. To ensure
social and economic stability, he theorized, laborers should own and control the means of
production. While Marxism has been widely rejected in capitalistic societies, its description of
capitalism’s flaws remains relevant.
A more recent economic theory, the Keynesian School, describes how governments can act
within capitalistic economies to promote economic stability. It calls for reduced taxes and
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increased government spending when the economy becomes stagnant and increased taxes and
reduced spending when the economy becomes overly active.
SCOPE OF ECONOMICS
The horizon of economics is gradually expanding. It is no more a branch of knowledge that

deals only with the production and consumption. However, the basic thrust still remains on using
the available resources efficiently while giving the maximum satisfaction or welfare to the people
on a sustainable basis. Given this, we can list some of the major branches of economics as
under:
1. Microeconomics: This is considered to be the basic economics. Microeconomics may be

defined as that branch of economic analysis which studies the economic behavior of the
individual unit, may be a person, a particular household, or a particular firm. It is a study of one
particular unit rather than all the units combined together. The microeconomics is also described
as price and value theory, the theory of the household, the firm and the industry. Most
production and welfare theories are of the microeconomics variety.
2. Macroeconomics: Macroeconomics may be defined as that branch of economic analysis

which studies behavior of not one particular unit, but of all the units combined together.
Macroeconomics is a study in aggregates. Hence it is often called Aggregative Economics. It is,
indeed, a realistic method of economic analysis, though it is complicated and involves the use of
higher mathematics. In this method, we study how the equilibrium in the economy is reached
consequent upon changes in the macro-variables and aggregates. The publication of Keynes’
General Theory, in 1936, gave a strong impetus to the growth and development of modern
macroeconomics.
3. International economics: As the countries of the modern world are realising the significance
of trade with other countries, the role of international economics is getting more and more
significant nowadays.
4. Public finance: The great depression of the 1930s led to the realization of the role of
government in stabilizing the economic growth besides other objectives like growth,
redistribution of income, etc. Therefore, a full branch of economics known as Public Finance or
the fiscal economics has emerged to analyze the role of government in the economy. Earlier the
classical economists believed in the laissez faire economy ruling out role of the government in
economic issues.
5. Development economics: As after the Second World War many countries got freedom from
the colonial rule, their economics required different treatment for growth and development. This
branch developed as development economics.
6. Health economics: A new realization has emerged from human development for economic
growth. Therefore, branches like health economics are gaining momentum. Similarly,
educational economics is also coming up.
7. Environmental economics: Unchecked emphasis on economic growth without caring for

natural resources and ecological balance, now, economic growth is facing a new challenge from

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the environmental side. Therefore, Environmental Economics has emerged as one of the major
branches of economics that is considered significant for sustainable development.
8. Urban and rural economics: Role of location is quite important for economic attainments.
There is also much debate on urban-rural divide. Therefore, economists have realized that there
should be specific focus on urban areas and rural areas. Therefore, there is expansion of
branches like urban economics and rural economics. Similarly, regional economics is also being
emphasized to meet the challenge of geographical inequalities.
There are many other branches of economics that form the scope of economics. There are
welfare economics, monetary economics, energy economics, transport economics,
demography, labour economics, agricultural economics, gender economics, economic planning,
economics of infrastructure, etc.
MANAGERIAL ECONOMICS
Managerial economics applies economic theory and methods to business and administrative
decision making. Managerial economics prescribes rules for improving managerial decisions.
Managerial economics also helps managers recognize how economic forces affect
organizations and describes the economic consequences of managerial behavior. It links
traditional economics with the decision sciences to develop vital tools for managerial decision
making.
The Role of Managerial Economics in Managerial Decision Making:
Managerial economics uses economic concepts and decision science techniques to solve
managerial problems.

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Managerial economics identifies ways to efficiently achieve goals. For example, suppose a
small business seeks rapid growth to reach a size that permits efficient use of national media
advertising. Managerial economics can be used to identify pricing and production strategies to
help meet this short-run objective quickly and effectively.
SCOPE OF MANAGERIAL ECONOMICS
Well scope is something which tells us how far a particular subject will go. As far as Managerial
Economic is concerned it is very wide in scope. It takes into account almost all the problems
and areas of manager and the firm. ME deals with Demand analysis, Forecasting, Production
function, Cost analysis, Inventory Management, Advertising, Pricing System, Resource
allocation etc. Following aspects are to be taken into account while knowing the scope of ME:
1. Demand analysis and forecasting: Unless and until knowing the demand for a product how
can we think of producing that product. Therefore demand analysis is something which is
necessary for the production function to happen. Demand analysis helps in analyzing the
various types of demand which enables the manager to arrive at reasonable estimates of
demand for product of his company. Managers not only assess the current demand but he has
to take into account the future demand also.
2. Production function: Conversion of inputs into outputs is known as production function.

With limited resources we have to make the alternative uses of this limited resource. Factor of
production called as inputs is combined in a particular way to get the maximum output. When
the price of input rises the firm is forced to work out a combination of inputs to ensure the least
cost combination.
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3. Cost analysis: Cost analysis is helpful in understanding the cost of a particular product. It
takes into account all the costs incurred while producing a particular product. Under cost
analysis we will take into account determinants of costs, method of estimating costs, the
relationship between cost and output, the forecast of the cost, profit, these terms are very vital
to any firm or business.
4. Inventory Management: What do you mean by the term inventory? Well the actual meaning
of the term inventory is stock. It refers to stock of raw materials which a firm keeps. Now here
the question arises how much of the inventory is ideal stock. Both the high inventory and low
inventory is not good for the firm. Managerial economics will use such methods as ABC
Analysis, simple simulation exercises, and some mathematical models, to minimize inventory
cost. It also helps in inventory controlling.
5. Advertising: Advertising is a promotional activity. In advertising while the copy, illustrations,

etc., are the responsibility of those who get it ready for the press, the problem of cost, the
methods of determining the total advertisement costs and budget, the measuring of the
economic effects of advertising ---- are the problems of the manager. There’s a vast difference
between producing a product and marketing it.It is through advertising only that the message
about the product should reach the consumer before he thinks to buy it. Advertising forms the
integral part of decision making and forward planning.
6. Pricing system: Here pricing refers to the pricing of a product. As you all know that pricing
system as a concept was developed by economics and it is widely used in managerial
economics. Pricing is also one of the central functions of an enterprise. While pricing commodity
the cost of production has to be taken into account, but a complete knowledge of the price
system is quite essential to determine the price. It is also important to understand how product
has to be priced under different kinds of competition, for different markets.
Pricing = cost plus pricing and the policies of the enterprise Now it is clear that the price
system touches the several aspects of managerial economics and helps managers to take valid
and profitable decisions.
7. Resource allocation: Resources are allocated according to the needs only to achieve the
level of optimization. As we all know that we have scarce resources, and unlimited needs. We
have to make the alternate use of the available resources. For the allocation of the resources
various advanced tools such as linear programming are used toarrive at the best course of
action.
ENGINEERING ECONOMICS
Engineering economics is the practical application of economic principles in the field of

engineering technology. While engineers look for solutions to problems, engineering economists
look at the economic appropriateness of the project objectively and assesses the value of the
project. It simply helps to choose a more economically viable solution among all potential
solutions.

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Concepts
The major concept engineering economics covers is the consideration of the time value
of money. It understands cash flows and how they can be discounted through an interest
rate. Manufacturing economy is also considered and various industrial economics topics
are covered. These concepts relate directly to assessment of management, growth and
profit of an industry.
Process
The principles of engineering economics state that out of all the alternatives available in
a given situation, there is one option that must be considered in all cases. All the choices
available are then evaluated through attributes that directly or indirectly affect the cost of
choosing one of them. Then, costs and revenues for each choice are considered, and
each alternative is also denoted a salvage value, which is the decommissioning cost
involved in the case that the project fails after an observation period called the analysis
period.
Functions
This subject is involved in many economic analyses, which include simple and
discounted paybacks, inflation, depreciation, taxes, resource utilization, accounting,
present and future worth, rate of returns and cost estimations. It also applies to the
manufacturing industry through analyses of profitability and growth, trends and issues in
the field of industrial engineering economics, market demand and supply influences, and
the development and marketing of new technologies.
GOODS
In economics, a good is something that is intended to satisfy some wants or needs of a

consumer and thus has economic utility. It is normally used in the plural form—goods—to
denote tangible commodities such as products and materials.
Although in economic theory, all goods are considered tangible; in reality certain classes of
goods, such as information, only are in intangible forms. For example, among other goods an
apple is a tangible object, while news belongs to an intangible class of goods and can be
perceived only by means of an instrument such as print, broadcast or computer.
Types of Goods
Types of Goods - Related to Income:
Inferior good: goods for which demand decreases as consumer income rises. Thus, it’s
“income elasticity” will be negative. Example: Inter-city bus service and inexpensive foods such
as bologna, hamburger, and frozen dinners.
Normal good: goods for which demand increases as consumer income rises. Thus, it’s “income
elasticity” will be positive. Most goods are normal goods, hence the name “normal.”

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Superior good: goods that will tend to make up a larger proportion of consumption as income
rises. As such, they are an extreme form of normal good. Thus, a superior good’s “income
elasticity” will be both positive and greater than 1. A superior good might be a luxury good that is
not purchased at all below a certain level of income, such as a luxury car.
Luxury good: a more colloquial term that is synonymous with “superior good.”
Types of Goods - Related to Price:
Ordinary good: goods for which quantity demanded increases as the price for the good drops;
conversely, quantity demanded decreases as the price for the good increases, ceteris paribus
(all other things being equal).
Giffen good: a good that will experience an increase in quantity demanded in response to an
increase in price. In order to be a true Giffen good, price must be the only thing that changes to
prompt a change in quantity demand. Conspicuous consumption (such as found with Veblen
goods) is not a factor. The classic example is of inferior staple foods, whose demand is driven
by poverty that makes their purchasers unable to afford superior foodstuffs. As the price of the
cheap staple rises, consumers can no longer afford to supplement their diet with superior foods,
and must consume more of the staple food.
Veblen good (aka ostentatious goods): often confused with Giffen goods, Veblen goods are
goods for which increased prices will increase quantity demanded. However, this is not because
the consumers are forced into buying more of the good due to budgetary constraints (as in
Giffen goods). Rather, Veblen goods are high-status goods such as expensive wines,
automobiles, watches, or perfumes. The utility of such goods is associated with their ability to
denote status. Decreasing their price decreases the quantity demanded because their status-
denoting utility becomes compromised.
Types of Goods - Related to Consumption Ability:
Rival good (aka rivalrous good): goods whose consumption by one consumer prevents
simultaneous consumption by other consumers. For example, food, cars, and clothing.
Non rival good: goods that may be consumed by one consumer without preventing
simultaneous consumption by others. Most examples of non rival goods are intangible goods.
For example, television and radio are non rival goods.
Excludable good: goods or service that enable a seller to prevent non-paying customers from
enjoying the benefits of it. Market allocation of such goods is feasible. Examples: public
transportation, haircuts, movie theatre, food, clothing, housing, rental accommodations.
Non-excludable good: goods or service whereby it is impossible to prevent an individual who

does not pay for that thing from enjoying the benefits of it. Market allocation of such goods is not
feasible. Examples: beautiful scenery, fresh air.
Public good: goods those are non-excludable as well as non-rival. This means it is not possible
to exclude individuals from the good's consumption. Fresh air may be considered a public good

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as it is not generally possible to prevent people from breathing it. However, technically speaking
such goods should be called pure public goods.
Private good: goods those are both excludable and rival. Example: bread (eaten by a given
person cannot be consumed by another [rival], and a baker can refuse to sell [excludable]).
Club good: goods those are excludable but non-rivalrous, at least until reaching a point where
congestion occurs. Examples of club goods would include private golf courses, cinemas, cable
television, access to copyrighted works, and the services provided by social or religious clubs to
their members.
Common-pool resource: goods those are non-excludable but rivalrous. Examples of common-
pool resources include irrigation systems, fishing grounds, pastures, and forests. A pasture, for
instance, allows for a certain amount of grazing to occur without the core resource being
harmed. In the case of excessive grazing, however, the pasture may become more prone to
erosion and eventually yield less benefit to its users. Thus, the core resource is vulnerable to
the problems of congestion, overuse, pollution, and potential destruction unless harvesting or
use limits are devised and enforced.
UTILITY
Individuals consume goods and services because they derive pleasure or satisfaction from
doing so. Economists use the term utility to describe the pleasure or satisfaction that a
consumer obtains from his or her consumption of goods and services. Utility is a subjective
measure of pleasure or satisfaction that varies from individual to individual according to each
individual's preferences. For example, if an individual's choices for a Saturday evening are to
watch television, go out to dinner, or go to a movie, then, depending on that individual's
preferences, he or she will attribute different levels of utility to each of these three activities. Of
course, it is not possible to measure utility, nor is it possible to claim that one individual's utility is
higher than another's. Utility is just a unitless measure that economists have found useful in
their explanation of consumer choice.
Total and marginal utility: The utility that an individual receives from consuming a certain
amount of a particular good or service is referred to as that individual's total utility. The
marginal utility of a good or service is the addition to total utility that an individual receives from
consuming one more units of that good or service.
Law of diminishing marginal utility: The law of diminishing marginal utility states that the
marginal utility that one receives from consuming successive units of the same good or service
will eventually decrease as the number of units consumed increases. As an example of the law
of diminishing marginal utility, consider the utility that one obtains from drinking successive
glasses of lemonade on a hot day. Suppose the first glass just begins to quench one's thirst.
After two glasses, however, the thirst has all but disappeared. A third glass of lemonade might
also provide some utility, but not as much as the second glass. A fourth glass cannot be
finished. In this example, the marginal utility—the addition to total utility that one obtains from
drinking lemonade on a hot day—is increasing for the first two glasses but is decreasing
beginning with the third glass and would continue to decrease if one were to consume further
glasses.

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VALUE
Economic value is a measure of the benefit that an economic actor is able to gain from good or
service. It is generally measured relative to units of currency, and the interpretation is therefore
"what is the maximum amount of money a specific actor is willing and able to pay for the good
or service"?
Note that economic value is *not* the same as market price. If a consumer is willing to buy a
good, it implies that the customer places a higher value on the good than the market price. The
difference between the value to the consumer and the market price is called "consumer
surplus". It is easy to see situations where the actual value is considerably larger than the
market price: purchase of drinking water is one example.
The economic value of a good or service has puzzled economists since the beginning of the
discipline. First, economists tried to estimate the value of a good to an individual alone, and
extend that definition to goods which can be exchanged. From this analysis came the concepts
value in use and value in exchange.
 Value in use is the utility of consuming a good.

 Exchange value refers to one of four major attributes of a commodity, i.e., an
item or service produced for, and sold on the market. The other three aspects are
use value, value and price
Value is linked to price through the mechanism of exchange. When an economist observes an
exchange, two important value functions are revealed: those of the buyer and seller. Just as the
buyer reveals what he is willing to pay for a certain amount of a good, so too does the seller
reveal what it costs him to give up the good.
WEALTH
Wealth is the abundance of valuable resources or material possessions.
In Economics, Wealth is the total of all assets of an economic unit that generate current income
or have the potential to generate future income. It includes natural resources and human capital
but generally excludes money and securities because the represent only claims to wealth. Two
common types of economic wealth are (1) Monetary wealth: anything that can be bought and
sold, for which there is market and hence a price. The market price, however, reflects only the
commodity price and not necessarily its value. For example, water is essential for human
existence but is usually very cheap. (2) Non-monetary wealth: things which depend on scarce
resources, and for which there is demand, but are not bought and sold in a market and hence
have no price. Examples are education, health, and defense.
Wealth in a commonly applied accounting sense is the net worth of a person, household, or
nation, that is, the value of all assets owned net of all liabilities owed at a point in time. For
national wealth as measured in the national accounts, the net liabilities are those owed to the
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rest of the world. The term may also be used more broadly as referring to the productive
capacity of a society or as a contrast to poverty.
Wealth is a person's net worth, expressed as: wealth = assets – liabilities
FACTORS OF PRODUCTION IN ECONOMICS
Economics is a social science that studies the distribution, production and consumption of
various goods or services in the marketplace. A main focus of economic study is the factors of
production, which represent items individuals and businesses use to create valuable products
desired by consumers. Most economists boil down all resources into three main factors of
production: land, labor and capital. A fourth item, entrepreneurship is often attributed as an
additional factor of production.
Land
Land represents the physical assets or resources in the economic marketplace. Natural
resources include land, a timber, fisheries, farms and other similar items. This factor of
production is often seen as a passive or fixed economic resource. Nations are usually limited in
the amount of physical resources they can produce in their economy. In addition, larger nations
have more physical resources because they have a larger area of land mass in which to harvest
natural resources. Large nations can also maximize their physical economic resources by
building large buildings or facilities on certain land parcels and leaving other parcels for
replenishing natural resources.
In economics, land comprises all naturally occurring resources whose supply is inherently fixed.
Examples are any and all particular geographical locations, mineral deposits, and even
geostationary orbit locations and portions of the electromagnetic spectrum. Land itself is a
resource like labor or capital, especially when the land harbors deposits of natural resources like
minerals, oil, or timber. It is also a fixed resource: the amount of available land on Earth is finite,
although land speculation may create situations in which the supply of land cannot meet the
demand. The way in which land is used can have a profound impact on a local or national
economy, whether that use is urban or rural. Public and private uses of land and their
sometimes conflicting needs are also of interest in land economics.
Labor
Labor represents the human effort needed to transform physical resources into consumer
products. Almost all individuals are capable of providing labor as a factor of production. Labor is
seen as an active factor of production because nations can transfer, move or shift this resource
according to the needs of individual consumers in the economy. Workers are usually
compensated for their services when companies pay wages to individuals responsible for
transforming raw physical assets into consumer products.
Capital
Capital represents the monetary or physical items used to produce goods or services. Monetary
capital represents the money companies use to purchase physical assets or pay workers for
transforming assets into consumer products. In the modern economy, capital also includes
buildings, production facilities, equipment, technology and other tangible items. The capital
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factor of production is also called the means of production. The means of production represents
all inputs used--excluding human labor--for producing goods or services. Capital is also seen as
an active resource because these resources can also be allocated or shifted to meet the needs
of individuals and businesses in the economic market.
Entrepreneurship
Entrepreneurship is sometimes considered a factor of production as individuals usually have

ideas and attempt to make an economic profit from their idea using the factors of production.
Entrepreneurs often have education or knowledge that helps them gather, transform and
produce products for individuals or businesses to use in their daily lives or operations. The
entrepreneur also carries most if not all risks associated with turning his idea into a lucrative
business.
LARGE SCALE INDUSTRIES
Large scale industries refers to those industries which require huge infrastructure, man power
and a have influx of capital assets. The term 'large scale industries' is a generic one including
various types of industries in its purview. All the heavy industries of India like the Iron and steel
industry, textile industry, automobile manufacturing industry fall under the large scale industrial
arena. However in recent years due to the IT boom and the huge amount of revenue generated
by it the IT industry can also be included within the jurisdiction of the large scale industrial
sector. Last but not the least the telecoms industry also forms and indispensable component of
the large scale industrial sector of India. Indian economy is heavily dependent on these large
industries for its economic growth, generation of foreign currency and for providing job
opportunities to millions of Indians
Importance of Large Scale Industries

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Every country needs exploring of coal, iron and steel, exploring of oil and its purification, heavy
machineries, heavy electrical equipments, heavy chemicals, ships and aero planes, industries of
heavy and basic industries for its development. All these industries help to develop agriculture,
transport, communication facilities and other industries. It means development of large scale
industries is almost essential for the development of heavy and basic industries.
Improvement in Productivity:
In large scale industries work is distributed among the labourers according to their
efficiency which improves the productivity. These industries also use huge modern
capital which raises productivity and reduces cost per head. It enables the consumer to
get commodities at a cheaper rate.
Import Substitution:
Capital goods and consumer goods which are imported from the foreign countries can
be produced inside the country through large scale industries. Our country will depend
upon foreign countries on heavy chemicals, heavy electricity, chemical fertilizers and
other consumer goods, unless we develop large scale industries. Due to the
development of large scale industries, all these commodities are produced inside the
country and there is no need of import which is known as import substitution.
Export Promotion:
Large scale industries change the pattern of export. In the old days, we exported skin,
tea, jute, jute products, spices of different types, and cotton clothes to foreign countries.
Due to the development of large scale industries, we are now able to export engineering
products, heavy electric products and other industrial products. It means large scale
industries have changed the pattern of export and increased the quantity of export.

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Small Scale Industries:
“An industrial undertaking in which the investment in fixed assets in plant and machinery
whether held on ownership terms on lease or on hire purchase does not exceed Rs 10 million.
The industries in India which are organized on a small scale and produce goods with the help of
small machines, hired labor and power, are the small scale industries present in India.”
A small scale industry is a business or project is created on either a small budget or for a small
group of people. For instance if someone starts a laundry service just around their
neighborhood, that is small, not too expensive to start or manage but not too cheap either.
Another example is a small pizzeria or a kiosk or says a moving around with an ice-cream van,
these are types of small scale industries.
In most of the developing countries like India, Small Scale Industries (SSI) constitutes an
important and crucial segment of the industrial sector. They play an important role in
employment creation, resource utilization and income generation and helping to promote
changes in a gradual and phased manner. They have been given an important place in the
framework of Indian planning since beginning both for economic and ideological reasons. The
reasons are obvious.
The scarcity of capital in India severely limits the number of non-farm jobs that can be created
because investment costs per job are high in large and medium industries. An effective
development policy has to attempt to increase the use of labor, relative to capital to the extent
that it is economically efficient.
Small scale enterprises are generally more labor intensive than larger organizations. As a
matter of fact, small scale sector has now emerged as a dynamic and vibrant sector for the
Indian economy in recent years. It has attracted so much attention not only from industrial
planners and economists but also from sociologists, administrators and politicians.
Advantages:
1. Employment
2. Meets the demand of local market
3. Gainful Employment to women
4. Less burden on imports
5. Less Capital
6. Less sophisticated technology
7. Good use of raw material
Disadvantages:
1. Cost of Production
2. Marketing and Distribution
3. Access to Funding

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CONSUMPTION:
Significance
Consumption is the value of goods and services bought by people. Individual buying acts are
aggregated over time and space.
Consumption is normally the largest GDP component. Many persons judge the economic
performance of their country mainly in terms of consumption level and dynamics.
Composition
First, consumption may be divided according to the durability of the purchased objects. In this
vein, a broad classification separates durable goods (as cars and television sets) from non-
durable goods (as food) and from services (as restaurant expenditure). These three categories
often show different paths of growth.
Second, consumption is divided according to the needs it satisfies. A commonly used

classification identifies ten chapters of expenditure:
 Food
 Clothing and foot wear
 Housing
 Heating and energy
 Health
 Transport
 House furniture and appliances
 Communication
 Entertainment
People in different position in respect to income have systematically different structures of

consumption. The rich spend more for each chapter in absolute terms, but they spend a lower
percentage in income for food and other basic needs. The percentage values of an aggregation
over all the households in a country can thus be used for judging income distribution and the
development level of the society.
The rich have both higher levels of consumption and savings. In differentiated product markets,
the rich can usually buy better goods than the poor. This happens also because they tend to
use different decision making rules. In other words, consumption depends on social groups and
their behaviours, as well as their proneness to advertising.
Third, one should distinguish "consumption" as use of goods and services from "consumption
expenditure" as buying acts. For durable goods this difference may be relevant, since they are
used for long time periods.
Determinants:
Current income is the most relevant determinant of consumption. Income comes from
labor (employment and wages), capital (e.g. profits leading to dividends, rents, etc.),

15
remittances from abroad. Income from consumer's cumulative bundle (including

dividends and interests on wealth) provides an additional flow to available income.
Cumulated savings in the past can be squeezed in case of necessity and give rise to a
jump in consumption, similarly with what happens with wealth increase, due for instance
to stock exchange boom or house prices boom. Family debt can mount to fund
consumption, while repayments brake its dynamics.
Expectations on future income, especially if concerning short-term credible events,

may also play an important role.
WANT:
In economics, a want is something that is desired. It is said that every person has unlimited
wants, but limited resources. Thus, people cannot have everything they want and must look for
the most affordable alternatives.
Wants are often distinguished from needs. A need is something that is necessary for survival
(such as food and shelter), whereas a want is simply something that a person would like to
have. Some economists have rejected this distinction and maintain that all of these are simply
wants, with varying levels of importance. By this viewpoint, wants and needs can be understood
as examples of the overall concept of demand.
Characteristics of wants:
1. Wants are unlimited

2. Each Particular want can be satisfied
3. Wants are competitive
4. Some wants are complementary
5. Some wants are competitive and complementary
6. Some wants are alternative
7. Wants differ in urgency
8. Present want is more important than future want
9. Some wants become habits
10. Wants are influenced
11. Wants are the mother of invention
Classification of Human Wants:
Human wants can be classified into three categories necessaries, comforts and luxuries.
1. Necessaries:
Necessaries refer to the basic or primary wants for food, clothing, shelter, medical care,
education, etc. These are the urgent needs of human beings. A person has to face several
difficulties without the satisfaction of these wants.
Necessaries may be further classified into three categories.
(a) Necessaries of existence:

16
There are the goods and services without which human life is impossible. Food, water, air,
clothing and accommodation are examples of such necessaries.
(b) Necessaries for efficiency:
These refer to the goods and services which are not required for survival. Rather they are
necessary to make people efficient. For example, a person can survive without books and
stationery. But their use will make him more efficient.
(c) Conventional necessaries:
These mean the things which have become necessary due to habits, customs and traditions.
For example, wearing of new clothes on marriage, decorating houses on Diwali, cutting cakes
on birthdays are not required for maintaining life or increasing efficiency. These have become
necessary by force of habits and social customs.
2. Comforts:
Comforts refer to the goods and services which make life easier and comfortable. They provide
freedom from suffering, anxiety, pain, etc. Comforts improve our health and efficiency.
For example, a chair may be necessary for efficiency but a cushion on it will make us
comfortable. Comforts like fans, coolers, well furnished houses cheer our minds.
3. Luxuries:
Luxuries refer to the goods and services which give us pleasure and prestige. Motor cars, air
conditioners, diamond jewellery, designer clothes, etc. are examples of luxuries. These things
may not increase efficiency or comfort but they provide us happiness and status in society.
The above classification of wants is not rigid. A thing which is a comfort or luxury for one person
or at one point of time may become a necessity for another person or at another point of time.
For example, a car may be a luxury for a laborer, a comfort for a teacher but a necessity for a
doctor. Whether a certain want is a necessity, a comfort or a luxury depends upon the person,
the place, the time and the circumstances.
The things which were considered luxuries in the past have become comforts and necessaries
today.
For example, television was a luxury twenty years ago. But now it is a comfort. Similarly,
computers may be comfort for many in India but it has become a necessity in America.
LAW OF DIMINISHING MARGINAL UTILITY:
In economics, the marginal utility of a good or service is the gain (or loss) from an
increase (or decrease) in the consumption of that good or service. Economists sometimes
speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a
good or service yields more utility than the second and subsequent units.[citation needed] The
marginal decision rule states that a good or service should be consumed at a quantity at which
the marginal utility is equal to the marginal cost.
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A principle stating that as the quantity of a good consumed increases, eventually each
additional unit of the good provides less additional utility--that is, marginal utility decreases.
Each subsequent unit of a good is valued less than the previous one. The law of diminishing
marginal utility helps to explain the negative slope of the demand curve and the law of demand.
The notion that marginal utilities diminish across the ranges relevant to decision-making
is called the "law of diminishing marginal utility" (and is also known as Gossen's First Law). This
refers to the utility which one obtains with the increase in the stock that one already had. "The
law of diminishing marginal utility is at the heart of the explanation of numerous economic
phenomena, including time preference and the value of goods... The law says, first, that the
marginal utility of each homogenous unit decreases as the supply of units increases (and vice
versa); second, that the marginal utility of a larger-sized unit is greater than the marginal utility
of a smaller-sized unit (and vice versa). The first law denotes the law of diminishing marginal
utility, the second law the law of increasing total utility."
That the utility of a total amount of stock may reach a tipping point (where a new or
absolute use occurs) does not imply that marginal utility will continue to increase indefinitely
thereafter: For example, beyond some point, further doses of antibiotics would kill no pathogens
at all, and might even become harmful to the body. Enough calories sustains a population, yet
beyond a point, more calories cannot be consumed and are simply discarded. A market may
absorb a number of widgets, but each additional widget added to the market is of less value.
Simply put, as the rate of commodity acquisition increases, marginal utility decreases. If
commodity consumption continues to rise, marginal utility at some point falls to zero, reaching
maximum total utility. Further increase in consumption of units of commodities causes marginal
utility to become negative; this signifies dissatisfaction. The diminishing of marginal utility should
not necessarily be taken to be itself an arithmetic subtraction; it may be no more than a purely
ordinal change.
DECISION MAKING:
Managers are constantly called upon to make decisions in order to solve problems. Decision
making and problem solving are ongoing processes of evaluating situations or problems,
considering alternatives, making choices, and following them up with the necessary actions.
Sometimes the decision-making process is extremely short, and mental reflection is essentially
instantaneous. In other situations, the process can drag on for weeks or even months. The
entire decision-making process is dependent upon the right information being available to the
right people at the right times.
Economic models help managers and economists analyze the economic decision-making
process. Each model relies on a number of assumptions, or basic factors that are present in all
decision situations. Almost everyone in society engages in economic decision making at some
point, from the billionaire investing in real estate, to the small business owner signing a contract
with a supplier, to the teenager buying a video game or applying for a job; and these basic
factors almost always come into play.

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Working on a Budget
Even the wealthiest individuals and organizations have a limited amount of capital resources to
work with. The constraints of a budget influence nearly all economic decisions, since the sum of
all expenditures should never exceed the availability of capital. Cash availability is not always a
direct limiting factor in economic decision making, since credit arrangements can allow people
to spend more than they have. Even with credit purchase agreements, however, borrowers still
take into account the ability to repay the debt over time, which brings the decision back to the
issue of budgets and limited resources.
Maximizing Value
The fundamental basis of economic decision making is individuals' or organizations' desire to

maximize benefits while minimizing costs. This balancing act is referred to as maximizing value,
and it is a skill that takes practice to master. For individuals, value maximization decisions may
include choosing between name-brand products and generic products, and choosing between
small or bulk sizes. For a company, value maximization involves finding the lowest-cost
suppliers that meet the company's quality standards, then determining the economic order
quantity (EOQ) for each purchase. Economic order quantity is the perfect amount of a product
or material to order at a time, taking advantage of quantity discounts while also keeping holding
and transportation costs under control.
Rational Decision Making
Nearly all economic models and theories have one irreconcilable flaw: they assume that all
economic decision makers act logically and rationally, taking all available information into
account in an objective manner before making a decision. While it is true that most people and
organizations attempt to do this, the reality of economic decisions is slightly different. Emotional
theory in the stock market is a prime example of people's inability to make purely rational
decisions on a consistent basis. Emotional theory states that everyone is influenced by his past
experiences, expectations, emotional state and emotional memory when making a decision.
People can place too much emphasis on certain information, such as recent news or bad news,
which can skew their rational decision making as well.
Costs versus Benefits
Costs and benefits are key factors that all economic decision makers take into account.
Families, small business owners and others weigh the benefits and costs of decisions related to
purchases, investments, sales and other expenditures before making a decision. This concept is
similar to the idea of value maximization, with a distinct difference. Cost-benefit analyses
assume that for every decision, something must be gained and something must be lost. Even in
investment decisions, there is an opportunity cost—the cost of not using the money in another
way—that must be considered. The goal of economic decision making is to make tradeoffs that
allow you to gain more than you lose each time.

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The decision-making process involves the following steps:
1. Define the problem.

2. Identify limiting factors.
3. Develop potential alternatives.
4. Analyze the alternatives.
5. Select the best alternative.
6. Implement the decision.
7. Establish a control and evaluation system.

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UNIT – 2
DEMAND AND SCHEDULE
DEMAND:
In economics, demand is an economic principle that describes a consumer's desire and

willingness to pay a price for a specific good or service. Demand refers to how much (quantity)
of a product or service is desired by buyers. The quantity demanded is the amount of a product
people are willing to buy at a certain price; the relationship between price and quantity
demanded is known as the demand relationship. The term demand signifies the ability or the
willingness to buy a particular commodity at a given point of time.
Factors affecting demand:
Demand schedule:
In economics, the demand schedule is a table of the quantity demanded of a good at different
price levels. Thus, given the price level, it is easy to determine the expected quantity demanded.
This demand schedule can be graphed as a continuous demand curve on a chart having the Y-
axis representing price and the X-axis representing quantity. The graphical representation of a
demand schedule is called a demand curve.
Demand curve:
In economics, the demand curve is the graph depicting the relationship between the price of a
certain commodity and the amount of it that consumers are willing and able to purchase at that
given price. It is a graphic representation of a demand schedule. The demand curve for all
consumers together follows from the demand curve of every individual consumer: the individual
demands at each price are added together.
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Demand curves are used to estimate behaviors in competitive markets, and are often combined
with supply curves to estimate the equilibrium price (the price at which sellers together are
willing to sell the same amount as buyers together are willing to buy, also known as market
clearing price) and the equilibrium quantity (the amount of that good or service that will be
produced and bought without surplus/excess supply or shortage/excess demand) of that
market. In a monopolistic market, the demand curve facing the monopolist is simply the market
demand curve.
Shift of a demand curve
The shift of a demand curve takes place when there is a change in any non-price determinant of
demand, resulting in a new demand curve. Non-price determinants of demand are those things
that will cause demand to change even if prices remain the same—in other words, the things
whose changes might cause a consumer to buy more or less of a good even if the good's own
price remained unchanged. Some of the more important factors are the prices of related goods
(both substitutes and complements), income, population, and expectations. However, demand
is the willingness and ability of a consumer to purchase a good under the prevailing
circumstances; so, any circumstance that affects the consumer's willingness or ability to buy the
good or service in question can be a non-price determinant of demand. As an example, weather
could be a factor in the demand for beer at a baseball game.

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When income rises, the demand curve for normal goods shifts outward as more will be
demanded at all prices, while the demand curve for inferior goods shifts inward due to the
increased attainability of superior substitutes. With respect to related goods, when the price of a
good (e.g. a hamburger) rises, the demand curve for substitute goods (e.g. chicken) shifts out,
while the demand curve for complementary goods (e.g. tomato sauce) shifts in (i.e. there is
more demand for substitute goods as they become more attractive in terms of value for money,
while demand for complementary goods contracts in response to the contraction of quantity
demanded of the underlying good).
Demand shifters:
 Changes in disposable income

 Changes in tastes and preferences - tastes and preferences are assumed to be fixed in
the short-run. This assumption of fixed preferences is a necessary condition for
aggregation of individual demand curves to derive market demand.
 Changes in expectations.
 Changes in the prices of related goods (substitutes and complements)
 Population size and composition
 Changes that decrease demand
Some circumstances which can cause the demand curve to shift include:
 decrease in price of a substitute

 increase in price of a complement
 decrease in income if good is normal good
 increase in income if good is inferior good
Law of demand:
In economics, the law of demand is an economic law, which states that consumers buy more of
a good when its price is lower and less when its price is higher.

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When the price of a product is increased then less will be demanded. Also is the same for the
opposite, when the price of a product is decreased then more will be demanded.
The Law of demand states that the quantity demanded and the price of a commodity are
inversely related, other things remaining constant. That is, if the income of the consumer, prices
of the related goods, and preferences of the consumer remain unchanged, then the change in
quantity of good demanded by the consumer will be negatively correlated to the change in the
price of the good. There are some exceptions to this rule, however. see giffen goods and veblen
goods.
Assumptions of the 'Law of Demand'
The law of demand in order to establish the price-demand relationship makes a number of
assumptions as follows:
 Income of the consumer is given and constant.

 No change in tastes, preference, habits etc.
 Constancy of the price of other goods.
 No change in the size and composition of population.
These Assumptions are expressed in the phrase “other things remaining equal”.
Exceptions to the law of demand
Generally, the amount demanded of a good increases with a decrease in price of the good and
vice versa. In some cases, however, this may not be true. Such situations are explained below.
Giffen goods: Initially discovered by Robert Giffen, economists disagree on the existence of
Giffen goods in the market. A Giffen good describes an inferior good that as the price increases,
demand for the product increases. As an example, during the Irish Potato Famine of the 19th
century, potatoes were considered a Giffen good. Potatoes were the largest staple in the Irish
diet, so as the price rose it had a large impact on income. People responded by cutting out on
luxury goods such as meat and vegetables, and instead bought more potatoes. Therefore, as
the price of potatoes increased, so did the demand.
Commodities which are used as status symbols: Some expensive commodities like
diamonds, air conditioned expensive cars, etc., are used as status symbols to display one’s
wealth. The more expensive these commodities become, the higher their value as a status
symbol and hence, the greater the demand for them. The amount demanded of these
commodities increase with an increase in their price and decrease with a decrease in their price.
Also known as a Veblen good.
Expectation of change in the price of commodity: If a household expects the price of a

commodity to increase, it may start purchasing a greater amount of the commodity even at the
presently increased price. Similarly, if the household expects the price of the commodity to
decrease, it may postpone its purchases. Thus, law of demand is violated in such cases. In this
case, the demand curve does not slope down from left to right; instead it presents a backward
slope from the top right to down left. This curve is known as an exceptional demand curve.
Technically, this is not a violation of the law of demand, as it violates the ceteris paribus
condition.
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ELASTICITY OF DEMAND:
Price elasticity of demand (PED or Ed) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its
price. More precisely, it gives the percentage change in quantity demanded in response to a
one percent change in price. It was devised by Alfred Marshall.
It is a measure of responsiveness of the quantity of a good or service demanded to changes in

its price. The formula for the coefficient of price elasticity of demand for a good is
Price elasticities are almost always negative, although analysts tend to ignore the sign even
though this can lead to ambiguity. Only goods which do not conform to the law of demand, such
as Veblen and Giffen goods have a positive PED. In general, the demand for a good is said to
be inelastic (or relatively inelastic) when the PED is less than one (in absolute value): that is,
changes in price have a relatively small effect on the quantity of the good demanded. The
demand for a good is said to be elastic (or relatively elastic) when its PED is greater than one
(in absolute value): that is, changes in price have a relatively large effect on the quantity of a
good demanded.
Revenue is maximized when price is set so that the PED is exactly one. The PED of a good can
also be used to predict the incidence (or "burden") of a tax on that good. Various research
methods are used to determine price elasticity, including test markets, analysis of historical
sales data and conjoint analysis.
Determinants
The overriding factor in determining PED is the willingness and ability of consumers after a price
change to postpone immediate consumption decisions concerning the good and to search for
substitutes ("wait and look"). A number of factors can thus affect the elasticity of demand for a
good:
 Availability of substitute goods: the more and closer the substitutes available, the
higher the elasticity is likely to be, as people can easily switch from one good to another
if an even minor price change is made; There is a strong substitution effect. If no close
substitutes are available the substitution of effect will be small and the demand inelastic.
 Breadth of definition of a good: the broader the definition of a good (or service), the
lower the elasticity. For example, Company X's fish and chips would tend to have a
relatively high elasticity of demand if a significant number of substitutes are available,
whereas food in general would have an extremely low elasticity of demand because no
substitutes exist.
 Percentage of income: the higher the percentage of the consumer's income that the
product's price represents, the higher the elasticity tends to be, as people will pay more
attention when purchasing the good because of its cost; The income effect is substantial.
When the goods represent only a negligible portion of the budget the income effect will
be insignificant and demand inelastic,

25
 Necessity: the more necessary a good is, the lower the elasticity, as people will attempt
to buy it no matter the price, such as the case of insulin for those that need it.
 Duration: for most goods, the longer a price change holds, the higher the elasticity is
likely to be, as more and more consumers find they have the time and inclination to
search for substitutes. When fuel prices increase suddenly, for instance, consumers may
still fill up their empty tanks in the short run, but when prices remain high over several
years, more consumers will reduce their demand for fuel by switching to carpooling or
public transportation, investing in vehicles with greater fuel economy or taking other
measures. This does not hold for consumer durables such as the cars themselves,
however; eventually, it may become necessary for consumers to replace their present
cars, so one would expect demand to be less elastic.
 Brand loyalty: an attachment to a certain brand—either out of tradition or because of
proprietary barriers—can override sensitivity to price changes, resulting in more inelastic
demand.
 Who pays: where the purchaser does not directly pay for the good they consume, such
as with corporate expense accounts, demand is likely to be more inelastic.
TYPES OF ELASTICITY:
The degree of responsiveness of quantity demanded of a commodity to the change in
price is called elasticity of demand. price elasticity of demand is popularly called elasticity of
demand. It is the rate of which quantity demanded changes in response to the change in price.
Elasticity of demand expresses the magnitude of change in quantity of a commodity.
Precisely stated, price elasticity demand is defined as the ratio of percentage change in
quantity demanded to a percentage change in price. Thus elasticity of demand can be
expressed in form of the following as price and quantity demanded move opposite.
Five types of Elasticity of Demand:
 Perfectly inelastic demand (ep = 0)
 Inelastic (less elastic) demand (e < 1)
 Unitary elasticity (e = 1)
 Elastic (more elastic) demand (e > 1)
 Perfectly elastic demand (e = ∞)

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Perfectly inelastic demand (ep = 0)

This describes a situation in which demand shows no response to a change in price. In
other words, whatever be the price the quantity demanded remains the same. It can be depicted
by means of the alongside diagram.The vertical straight line demand curve as shown alongside
reveals that with a change in price (from OP to Op1) the demand remains same at OQ. Thus,
demand does not at all respond to a change in price. Thus ep = O. Hence, perfectly inelastic
demand. Fig a
Inelastic (less elastic) demand (e < 1)
In this case the proportionate change in demand is smaller than in price. The alongside
figure shows this type. In the alongside figure percentage change in demand is smaller than that
in price. It means the demand is relatively c less responsive to the change in price. This is
referred to as an inelastic demand. Fig e
Unitary elasticity demand (e = 1)
When the percentage change in price produces equivalent percentage change in
demand, we have a case of unit elasticity. The rectangular hyperbola as shown in the figure
demonstrates this type of elasticity. In this case percentage change in demand is equal to
percentage change in price, hence e = 1. Fig c
Elastic (more elastic) demand (e > 1)
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. It can be noticed that in the above example the
percentage change in demand is greater than that in price. Hence, the elastic demand (e>1)
Fig d
Perfectly elastic demand (e = ∞)
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. It can be noticed that
at a given price an infinite quantity is demanded. A small change in price produces infinite
change in demand. A perfectly competitive firm faces this type of demand.
Factors Determining Elasticity of Demand:

There are several factors which determine the elasticity of demand.
(i) For necessaries and conventional necessaries the demand is inelastic or less elastic-
We have to buy these commodities whatever be the price. A change in price, therefore, does
not matter so far as the demand for such commodities is concerned. Salt is one such thing and
wheat another. But in a poor country like India-even the demand for such things is somewhat
elastic. The change in the price of wheat may be immaterial for upper and middle classes, but
its consumption will certainly increase among the poor when its price falls.
(ii) Demand for luxuries is elastic- When the price of luxuries falls; people buy much more of
them, and when the price raises the demand contracts. But luxury is a relative term. A high-
priced luxury of the poor man is a low-priced necessary for the rich. For the same thing demand
of the lower classes may be elastic and that of the rich classes less elastic.

27
(iii) For substitutes the demand is also elastic- For example, when price of tea rises, we may
buy less of tea but more of coffee, and vice versa. We must, however, remember that very few
things can serve as suitable substitutes.
(iv)Demand for goods having several uses is elastic- Coal is such a case. When cheap, its
use for less urgent needs will extend and when the price goes up, it will be put only to more
urgent uses, and its demand will contract
(v) Demand for goods the use of which can be postponed is elastic- When, for example,
the building material is very costly, and building activity is very much reduced. The demand has
contracted. When cheap material becomes available, the demand will extend.
(vi) Elasticity also depends on the price level- If the price is either too high or too low, the
demand will be less elastic. When the prices are moderate, elasticity will be greater.
(vii) The same commodity may have inelastic demand for certain uses and elastic for
certain other uses- For example, wheat as human food has inelastic demand, but its demand
as cattle feed is elastic.
(viii) Proportion of total expenditure allocated for the commodity- If the proportion of total
expenditure devoted to a commodity is small, the demand for it tends to be inelastic. For
example, the percentage of budget devoted by a typical household to soap, salt and ink is quite
small and consequently the demand for these goods is relatively inelastic.
(ix) Habit and fashion- The demand for those goods which are habitually consumed or which
are in fashion is inelastic. The reason is that such commodities become more or less a
necessity for the consumer
(x) Future expectations about price changes- The future expectations about the price of any
commodity also influence the elasticity of demand for it. For instance, if the price of any
commodity is expected to rise in future, then a small decrease in its price will produce a
considerable increase in its price.
(xi) The state of joint demand- In case of commodities having joint demand, the elasticity of
demand for a good depends upon the elasticity of demand for other jointly-produced goods. For
example, if the demand for cars increases, the demand for petrol will also increase with the
same rapidity as the demand for carS does.
Measurement of Elasticity of Demand:

Price elasticity of demand can be measured through three popular methods. These
methods are:
1. Percentage method or Arithmetic method
2. Total Expenditure method
3. Graphic method or point method.

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1. Percentage method:-
According to this method price elasticity is estimated by dividing the percentage change
in amount demanded by the percentage change in price of the commodity. Thus given the
percentage change of both amount demanded and price we can derive elasticity of demand. If
the percentage charge in amount demanded is greater that the percentage change in price, the
coefficient thus derived will be greater than one.
If percentage change in amount demanded is less than percentage change in price, the
elasticity is said to be less than one. But if percentage change of both amount demanded and
price is same, elasticity of demand is said to be unit.
2. Total expenditure method:-

Total expenditure method was formulated by Alfred Marshall. The elasticity of demand
can be measured on the basis of change in total expenditure in response to a change in price. It
is worth noting that unlike percentage method a precise mathematical coefficient cannot be
determined to know the elasticity of demand.
By the help of total expenditure method we can know whether the price elasticity is equal
to one, greater than one, less than one. In such a method the initial expenditure before the
change in price and the expenditure after the fall in price are compared. By such comparison, if
it is found that the expenditure remains the same, elasticity of demand is One (ed=I).
If the total expenditure increases the elasticity of demand is greater than one (ed>l). If
the total expenditure diminished with the change in price elasticity of demand is less than one
(ed<I). The total expenditure method is illustrated by the following diagram.
3. Graphic method:-
Graphic method is otherwise known as point method or Geometric method. This method
was popularized by method. According to this method elasticity of demand is measured on
different points on a straight line demand curve. The price elasticity of demand at a point on a
straight line is equal to the lower segment of the demand curve divided by upper segment of the
demand curve.
Thus at mid point on a straight-line demand curve, elasticity will be equal to unity; at
higher points on the same demand curve, but to the left of the mid-point, elasticity will be greater
than unity, at lower points on the demand curve, but to the right of the midpoint, elasticity will be
less than unity.
IMPORTANCE OF PRICE ELASTICITY OF DEMAND:

Importance’s of price elasticity of demand are given below:
Determination of price policy:

While fixing the price of this product, a businessman has to consider the elasticity of
demand for the product. He should consider whether a lowering of price will stimulate demand
for his product, and if so to what extent and whether his profits will also increase a result
thereof. If the increase in his sales is more than proportionate, to the reduction in price his total
revenue will increase and his profits might be larger. On the other hand, if increase in demand
is less than proportionate to fall in price, his total revenue we will fall and his profits would be
certainly less. Therefore, knowledge of elasticity of demand may help the businessman to make

29
a decision whether to cut or increase the price of his product or to shift the burden of any
additional cost of production on to the consumers by charging high price.
In general, for items having inelastic demand, the producer will fix a higher price and
items whose demand is elastic the businessman will fix a lower price.
Price discrimination:
Price discrimination refers to the act of selling the technically same products at different
prices to different section of consumers or in different in sub-markets. The policy of price-
discrimination is profitable to the monopolist when elasticity of demand for his product is
different in different sub-markets. Those consumers whose demand is inelastic can be charged
a higher price than those with more elastic demand.
Shifting of tax burden:

To what extent a producer can shift the burden of indirect tax to the buyers by increasing
price of his product depends upon the degree of elasticity of demand.
If the demand is inelastic the larger part of the indirect tax can be shifted upon buyers by
increasing price. On the other hand if the demand is elastic than the burden of tax will be more
on the producer.
Taxation and subsidy policy:

The government can impose higher taxes and collect more revenue if the demand for
the commodity on which a tax is to be levied is inelastic. On the other hand, in ease of a
commodity with elastic demand high tax rates may fail to bring in the required revenue for the
government. Govt., should provide subsidy on those goods whose demand is elastic and in the
production of the commodity the law of increasing returns operates.
Importance in international trade:

The concept of elasticity of demand is of crucial importance in many aspects of
international trade. The success of the policy of devaluation to correct the adverse balance of
payment depends upon the elasticity of demand for exports and imports of the country. The
policy of devaluation would be benificial when demand for exports and imports is price-elastic.
A country will benefit from international trade when: (i) it fixes lower price for exports
items whose demand is price elastic and high price for those exports whose demand is inelastic
(ii) the demand for imports should be inelastic for a fall in price and inelastic for arise in price.
The terms of trade between the two countries also depends upon the elasticity of
demand of exports and imports of two countries. If the demand is inelastic, the terms of trade
will be in favour of the seller country.
Importance in the determination of factors prices:

Factor with an inelastic demand can always command a higher price as compared to a
factor with relatively elastic demand. This helps the trade unions in knowing that where they can
easily get the wage rate increased. Bargaining capacity of trade unions depend upon elasticity
of demand for workers services.

30
Pricing of joint supply products:

The goods that are produced by a single production process are joint supply products.
The cost of production of these goods is also joint. Therefore, while determining the prices of
these products their elasticity of demand is considered. The price of a joint supply product is
fixed high if its demand is inelastic and low price is fixed for that joint supply product whose
demand is elastic.
Effect of use of machines on employment:

Ordinarily it is thought that use of machines reduced the demand for labour. Therefore,
trade unions often oppose the use of machines fearing unemployment. But this fear is not
always true because use of machines may not reduce demand for labour. It depends on the
price elasticity of demand for the products.
The use of machines may reduce the cost of production and price. If the demand of the
product is elastic then the fall in price will increase demand significantly. As a result of
increased demand the production will also increase and more workers will be employed. In
such cases concept of elasticity of demand help the management to pacify the trade unions. But
if the demand of the product is inelastic than use of more machines will cause unemployment.
Public utilities:
The nationalization of public utility services can also be justified with the help of elasticity
of demand. Demand for public utilities such as electricity, water supply, post and telegraph,
public transportation etc. is generally inelastic in nature. If the operation of such utilities is left in
the hand of private individuals, they may exploit the consumers by charging high prices.
Therefore, in the interest of general public, the government owns and runs such services.
The public utility enterprises decide their price policy on the basis of elasticity of
demand. A suitable price policy for public utility enterprises is to charge from consumers
according to their elasticity of demand for public utility.
Explanation of paradox of poverty:

Exceptionally good harvest brings poverty to the farmers and this situation is called
‘Paradox of Poverty’. This paradox is easily explained by the inelastic nature of demand for
most farm products. Since the demand is inelastic, prices of farm products fall sharply as a
result of large increase in their supply in the year of bumper crops. Due to sharp fall in prices,
the farmers get less income even by selling larger quantity.
This paradox of poverty is the basis of regulation and control of farm products prices.
Government fixes the minimum prices of farm products because the demand for farm products
is inelastic. Thus, the concept of elasticity of demand helps the government in determining its
agricultural policies.
Output decisions:
The elasticity of demand helps the businessman to decide about production. A
businessman chooses the optimum product- mix on the basis of elasticity of demand for various
products. The products having more elastic demand are preferred by the businessmen. The
sale of such products can be increased with a little reduction in their prices.

31
From the above discussion it is amply clear that price elasticity of demand is of great
significance in making business decisions.
SUPPLY:
In economics, supply is the amount of some product producers are willing and able to
sell at a given price all other factors being held constant. Supply curve, in economics, graphic
representation of the relationship between product price and quantity of product that a seller is
willing and able to supply. Product price is measured on the vertical axis of the graph and
quantity of product supplied on the horizontal axis.
QA
Supply schedule:
A supply schedule is a table which shows how much one or more firms will be willing to supply
at particular prices. The supply schedule shows the quantity of goods that a supplier would be
willing and able to sell at specific prices under the existing circumstances. Some of the more
important factors affecting supply are the goods own price, the price of related goods,
production costs, technology and expectations of sellers.
Under the assumption of perfect competition, supply is determined by marginal cost. Firms will
produce additional output while the cost of producing an extra unit of output is less than the
price they would receive.
By its very nature, conceptualizing a supply curve requires the firm to be a perfect competitor,
namely requires the firm to have no influence over the market price. This is true because each a
point on the supply curve is the answer to the question "If this firm is faced with this potential
price, how much output will it be able to and willing to sell?" If a firm has market power, its
decision of how much output to provide to the market influences the market price, then the firm
is not "faced with" any price, and the question is meaningless.
Economists distinguish between the supply curve of an individual firm and between the market
supply curve. The market supply curve is obtained by summing the quantities supplied by all
suppliers at each potential price. Thus, in the graph of the supply curve, individual firms' supply
curves are added horizontally to obtain the market supply curve.
Factors affecting supply:
Innumerable factors and circumstances could affect a seller's willingness or ability to produce
and sell a good. Some of the more common factors are:
Goods own price: The basic supply relationship is between the price of a good and the
quantity supplied. Although there is no "Law of Supply", generally, the relationship is positive or
direct meaning that an increase in price will induce and increase in the quantity supplied.
Price of related goods: For purposes of supply analysis related goods refer to goods from
which inputs are derived to be used in the production of the primary good. For example, Spam
is made from pork shoulders and ham. Both are derived from Pigs. Therefore pigs would be
considered a related good to Spam. In this case the relationship would be negative or inverse. If

32
the price of pigs goes up the supply of Spam would decrease (supply curve shifts up or in)
because the cost of production would have increased. A related good may also be a good that
can be produced with the firm's existing factors of production. For example, a firm produces
leather belts. The firm's managers learn that leather pouches for smartphones are more
profitable than belts. The firm might reduce its production of belts and begin production of cell
phone pouches based on this information. Finally, a change in the price of a joint product will
affect supply. For example beef products and anani sikim leather are joint products. If a
company runs both a beef processing operation and a tannery an increase in the price of steaks
would mean that more cattle are processed which would increase the supply of leather.
Conditions of production: The most significant factor here is the state of technology. If there is
a technological advancement in one's good's production, the supply increases. Other variables
may also affect production conditions. For instance, for agricultural goods, weather is crucial for
it may affect the production outputs.
Expectations: Sellers expectations concerning future market condition can directly affect
supply. If the seller believes that the demand for his product will sharply increase in the
foreseeable future the firm owner may immediately increase production in anticipation of future
price increases. The supply curve would shift out. Note that the outward shift of the supply curve
may create the exact condition the seller anticipated, excess demand.
Price of inputs: Inputs include land, labor, energy and raw materials. If the price of inputs
increases the supply curve will shift in as sellers are less willing or able to sell goods at existing
prices. For example, if the price of electricity increased a seller may reduce his supply because
of the increased costs of production. The seller is likely to raise the price the seller charges for
each unit of output.
Number of suppliers: The market supply curve is the horizontal summation of the individual
supply curves. As more firms enter the industry the market supply curve will shift out driving
down prices.
Government policies and regulations: Government intervention can have a significant effect
on supply. Government intervention can take many forms including environmental and health
regulations, hour and wage laws, taxes, electrical and natural gas rates and zoning and land
use regulations.
LAW OF SUPPLY:
The "law of supply" is a fundamental principal of economic theory which is that quantities
respond in the same direction as price changes. In other words, the law of supply states that
(all other things unchanged) an increase in price results in an increase in quantity supplied. This
means that producers are willing to offer more products for sale on the market at higher prices
by increasing production as a way of increasing profits.
A microeconomic law stating that, all other factors being equal, as the price of a good or service
increases, the quantity of goods or services offered by suppliers increases and vice versa.
There is a direct relationship between price and quantity supplied.
 Quantity supplied rises as price raises, other things constant.

33
 Quantity supplied falls as price falls, other things constant.
As the price of a product rises, producers will be willing to supply more.
The height of the supply curve at any quantity shows the minimum price necessary to induce
producers to supply that next unit to market.
The height of the supply curve at any quantity also shows the opportunity cost of producing
the next unit of the good.
PRICE ELASTICITY OF SUPPLY:
Price elasticity of supply (PES or Es) is a measure used in economics to show the
responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its
price. When the coefficient is less than one, the said good can be described as inelastic; when
the coefficient is greater than one, the supply can be described as elastic. An elasticity of zero
indicates that quantity supplied does not respond to a price change: it is "fixed" in supply. Such
goods often have no labor component or are not produced, limiting the short run prospects of
expansion. If the coefficient is exactly one, the good is said to be unitary elastic.
The quantity of goods supplied can, in the short term, be different from the amount
produced, as manufacturers will have stocks which they can build up or run down.
A measure of the extent to which the quantity supplied of a good changes when the
price of the good changes. To determine the price elasticity of supply, we compare the
percentage change in the quantity supplied with the percentage change in price.
In other words, it the percentage changes in supply as compared to the percentage change in
price of a commodity.
% change in quantity Supplied

Price Elasticity of Supply =
% Change in price
Kinds of Elasticity of Supply:
There are five types of elasticity of supply which are given below
(I) perfectly elastic supply:
It is a case where a very slight change in price causes an Infinite change in supply. A slight fall
in prices brings quantity supplied to zero. In such a case the supply curve runs parallel to X
-axis. The supply curve takes the shape of a horizontal straight lit line.

34
(2) Perfectly inelastic supply:
The supply of a commodity is said to be perfectly inelastic when the supply of commodity is
completely non-responsive to changes in price. It is a case where quantity supplied remains the
same despite the change in price. A perfectly inelastic supply curve is a vertical straight line
which is parallel to OY-axis.
(3) Relatively elastic supply:
The supply is relatively elastic when a given change in price produces more than proportionate
change in quantity supplied. A doubling in price will result in more than double the quantity
supplied.
(4) Relatively inelastic supply:
When a certain change in price causes a smaller proportionate change in quantity supplied of a
Commodity, the supply is said to be relatively less elastic. The percentage change in price is
more than the percentage change in quantity supplied.

35
(5) Unitary elastic supply:
In such a situation the proportionate change in supply equals the proportionate change in price.
SUPPLY AND DEMAND:
In microeconomics, supply and demand is an economic model of price determination in a

market. It concludes that in a competitive market, the unit price for a particular good will vary
until it settles at a point where the quantity demanded by consumers (at current price) will equal
the quantity supplied by producers (at current price), resulting in an economic equilibrium for
price and quantity.
The four basic laws of supply and demand are:
 If demand increases and supply remains unchanged, a shortage occurs, leading to a

higher equilibrium price.
 If demand decreases and supply remains unchanged, a surplus occurs, leading to a
lower equilibrium price.
 If demand remains unchanged and supply increases, a surplus occurs, leading to a
lower equilibrium price.
 If demand remains unchanged and supply decreases, a shortage occurs, leading to a
higher equilibrium price.

36
TIME ELEMENT IN THE DETERMINATION OF VALUE:
Marshall was the first economist who analysed the importance of time in price
determination. When the demand for a product hikes or drops, its supply does not hike or
diminish at the same time. Variations in supply depend on technical factors which take time to
change. Hence the adjustment amidst demand and supply does not take place at once. The
period involved in adjustment will depend on the extent to which it is possible to make variations
in the volume of manufacture, dimension and functioning of the industry in accordance with the
varied demand for its commodities.
The pricing of non-durable commodities has more significance in the very limited time,
while that of non-perishable commodities in the long time. Marshall has divided the pricing of
products into four time periods: market period, long period, short period and secular period.
Market Period Price
Market period is a very short period in which supply being fixed, price is determined by demand.
The time period is of few days or weeks in which the supply of a product can be amplified out of
given stock to match the demand. This is possible for durable goods. The determination of
market price is described separately for non-durable goods and non-perishable goods.
Non-durable Goods – the price of a non-durable goods like milk, vegetables, fish etc
are primarily influenced by its demand. Supply has no influence on price because it is
fixed. Hence the price of a non-durable commodity hikes with the hike in its demand and
drops with the diminishing demand.
Non-Perishable Goods – Most goods are durable which can be kept in stock. When the
price of a non-durable good hikes with the hike in the demand, its supply can be hiked
out of given stock. Such goods are cloth, wheat, tea etc.
Perishability of the goods – The reserve price depends on the perishability of the
good. The more non-perishable a product is the higher will be its reserve price.
Future Cost of Production – The reserve price is also based on the future cost of
production of the good. If the sellers expect prices to hike in future he will a high reserve
price and vice versa.
Expenses on storage – The reserve price also depends on the time and expense
involved in the storage of the good. The greater the time and expense in storing the

37
good, the lower will be the reserve price, since the seller would like to dispose off his
good at the earliest so as to avoid the expenses of storage and vice versa.
Liquidity Preference – The reserve price depends on the liquidity preference of the
sellers. The higher the liquidity preference, the lower will be the reserve since the seller
would try to sell his good at the earliest in order ti has cash in hand. Conversely, if the
liquidity preference is low the reserve price will be high.
Long Period Price
The long period is of many years in which supply can be fully adjusted to demand. This is
done by changing the fixed factors. During this period, the old machines, equipments and plants
can be replaced by the new. New firms can enter the industry and old firms can leave it. The
scale of production, organisation and management can also be changed. Thus supply can be
adjusted to demand in every possible way in the long-term.
Long period price is also known as the normal price. Normal price is that price which is likely
to prevail in the long run. In the words of Marshall: “Normal or natural value is that which
economic forces would tend to bring about in the long-run.”
Long period is determined by the equilibrium of demand and supply. For the equilibrium of
firms and industry in the long run it is essential that normal price should equal the long run
average cost, all the firms into industry. If the price is above the minimum long run average cost
all the firms would be earning super normal profits. These extra profits would attract new firms
into the industry. Consequently supply would increase and price would come down the minimum
long run average cost, firms would incur losses. Some of the firms that cannot sustain losses
would leave the industry, supply would be reduced and price would rise to the level of the
minimum long run average cost.
Short Period Price
The short period relates to a few months in which supply can be changed in accordance with
demand. This is feasible by changing the variable factors. For instance if the firm wants to hike
the supply of its product it can do so by working the fixed factors like existing plants, machines,
etc.
In the short period, is not feasible to change the fixed factors, the scale can be hiked or
diminished to match the variable factors. In the short period, price is determined by the forces of
demand and supply. The short run supply curves inclines upward from left to right like the
ordinary supply curve.
It establishes the short run equilibrium price when it is intersected by the demand curve.
Secular Period

38
The secular period is very long. As per Marshall, it is a period of more than ten years in which
changes in demand fully adjust themselves to supply. Because it is not feasible to estimate the
changes in demand due to changes in techniques of production, population, raw materials, etc.
MARKET PRICE AND NORMAL PRICE:
In the context of the pricing of a commodity in the perfectly competitive market, generally a
distinction is made between market price and normal price. The following points of distinctions
may be noted.
 Market price refers to the market-period price, whereas the normal price is the long-
period price.
 Market price represents temporary equilibrium between the forces of demand and
supply, whereas the normal price represents stable equilibrium between long-run
demand and supply established after the supply has fully adjusted itself to the changed
demand.
 Market price may be above, below or equal to the average cost of production of the firms
thereby yielding super-normal profit, loss or normal profit respectively, whereas the
normal price must be equal to both the long-run marginal cost (LMC) and long-run
average cost (LAC) yielding only normal profit.
 Market price is influenced only by the demand force because supply is perfectly inelastic
in the market-period, whereas the normal price is influenced both by demand and supply
forces because in the long-period all the determinants of demand and supply can
undergo changes.
 Market price can be higher or lower than the normal price. In fact, it tends to oscillate
around the normal price and tends to be equal to it.
 Market price is a reality as the day-to-day transactions do take place at this price,
whereas the normal price is a Utopian concept.

39
MARKET STRUCTURE
In economics, market structure is the number of firms producing identical products which are
homogeneous. The types of market structures include the following:
 Monopolistic competition also called competitive market, where there is a large

number of firms, each having a small proportion of the market share and slightly
differentiated products.
 Oligopoly in which a market is dominated by a small number of firms that
together control the majority of the market share.
 Duopoly a special case of an oligopoly with two firms.
 Monopsony when there is only one buyer in a market.
 Oligopsony a market where many sellers can be present but meet only a few
buyers.
 Monopoly where there is only one provider of a product or service.
 Natural monopoly a monopoly in which economies of scale cause efficiency to
increase continuously with the size of the firm. A firm is a natural monopoly if it is
able to serve the entire market demand at a lower cost than any combination of
two or more smaller, more specialized firms.
 Perfect competition a theoretical market structure that features no barriers to
entry, an unlimited number of producers and consumers, and a perfectly elastic
demand curve.
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.
Specific characteristics may include:
 Infinite buyers and sellers – An infinite number of 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 – A lack of entry and exit barriers makes it extremely easy
to enter or exit 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 - All consumers and producers are assumed to have perfect
knowledge of price, utility, quality and production methods of products.
 Zero transaction costs - Buyers and sellers do not incur costs in making an exchange
of goods in a perfectly competitive market.
 Profit maximization - Firms are assumed to sell where marginal costs meet marginal
revenue, where the most profit is generated.

40
 Homogenous products - The qualities and characteristics of a market good or service

do not vary between different suppliers.
 Non-increasing returns to scale - The lack of increasing returns to scale (or
economies of scale) ensures that there will always be a sufficient number of firms in the
industry.
 Property rights - Well defined property rights determine what may be sold, as well as
what rights are conferred on the buyer.
Short Run Price and Output for the Competitive Industry and Firm
In the short run the equilibrium market price is determined by the interaction between market
demand and market supply. In the diagram shown above, price P1 is the market-clearing price
and this price is then taken by each of the firms. Because the market price is constant for each
unit sold, the AR curve also becomes the Marginal Revenue curve (MR). A firm maximises
profits when marginal revenue = marginal cost. In the diagram above, the profit-maximising
output is Q1. The firm sells Q1 at price P1. The area shaded is the economic (supernormal
profit) made in the short run because the ruling market price P1 is greater than average total
cost.
Not all firms make supernormal profits in the short run. Their profits depend on the position of
their short run cost curves. Some firms may be experiencing sub-normal profits because their
average total costs exceed the current market price. Other firms may be making normal profits
where total revenue equals total cost (i.e. they are at the break-even output). In the diagram
below, the firm shown has high short run costs such that the ruling market price is below the
average total cost curve. At the profit maximizing level of output, the firm is making an economic
loss (or sub-normal profits)

41
The Effects of a change in Market Demand
In the diagram below there has been an increase in market demand (ceteris paribus). This
causes an increase in market price and quantity traded. The firm's average revenue curve shifts
up to AR2 (=MR2) and the profit maximizing output expands to Q2. Notice that the MC curve is
the firm's supply curve. Higher prices cause an expansion along the supply curve. Following the
increase in demand, total profits have increased. An inward shift in market demand would have
the opposite effect. Think also about the effect of a change in market supply - perhaps arising
from a cost-reducing technological innovation available to all firms in a competitive market.
MONOPOLY:
A monopoly exists when a specific person or enterprise is the only supplier of a particular
commodity. Monopolies are thus characterized by a lack of economic competition to produce
the good or service and a lack of viable substitute goods. In economics, a monopoly is a single
seller. In law, a monopoly is a business entity that has significant market power, that is, the
power, to charge high prices. Although monopolies may be big businesses, size is not a
characteristic of a monopoly. A small business may still have the power to raise prices in a small
industry (or market).

42
Characteristics:
 Profit Maximizer: Maximizes profits.

 Price Maker: Decides the price of the good or product to be sold.
 High Barriers to Entry: Other sellers are unable to enter the market of the monopoly.
 Single seller: In a monopoly, there is one seller of the good that produces all the output.
Therefore, the whole market is being served by a single company, and for practical
purposes, the company is the same as the industry.
 Price Discrimination: A monopolist can change the price and quality of the product. He
sells more quantities charging less price for the product in a very elastic market and sells
less quantities charging high price in a less elastic market.
A company with a monopoly does not experience price pressure from competitors, although it
may experience pricing pressure from potential competition. If a company increases prices too
much, then others may enter the market if they are able to provide the same good, or a
substitute, at a lesser price. The idea that monopolies in markets with easy entry need not be
regulated against is known as the "revolution in monopoly theory".
MONOPOLISTIC COMPETITION:
Monopolistic competition is a type of imperfect competition such that many producers sell
products that are differentiated from one another as goods but not perfect substitutes (such as
from branding, quality, or location). In monopolistic competition, a firm takes the prices charged
by its rivals as given and ignores the impact of its own prices on the prices of other firms.
Characteristics:
There are six characteristics of monopolistic competition (MC):
 Product differentiation
 Many firms
 Free entry and exit in the long run
 Independent decision making
 Market Power
Market Structure comparison
Number Market Elasticity Product Excess Profit Pricing

Efficiency
of firms power of demand differentiation profits maximization power
condition
Perfect Perfectly Price
Infinite None None No Yes P=MR=MC
Competition elastic taker
Monopolistic Highly Yes/No Price

Many Low High No MR=MC
competition elastic (long (Short/Long) setter
run)
Relatively Absolute (across Price
Monopoly One High Yes No MR=MC
inelastic industries) setter

43

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CE2451 Engineering Economics and Cost Analysis

CE 2451 ENGINEERING ECONOMICS AND COST ANALYSIS LTPC

UNIT I BASIC ECONOMICS 7

UNIT II DEMAND AND SCHEDULE 8

UNIT III ORGANISATION 8

UNIT V COST AND BREAK EVEN ANALYSES 13

Prepared By: V. Karthik Raja B.E., M.B.A

There are two main types of economics: macroeconomics and microeconomics.

The horizon of economics is gradually expanding. It is no more a branch of knowledge that

1. Microeconomics: This is considered to be the basic economics. Microeconomics may be

2. Macroeconomics: Macroeconomics may be defined as that branch of economic analysis

7. Environmental economics: Unchecked emphasis on economic growth without caring for

Prepared By: V. Karthik Raja B.E., M.B.A

The Role of Managerial Economics in Managerial Decision Making:

Prepared By: V. Karthik Raja B.E., M.B.A

SCOPE OF MANAGERIAL ECONOMICS

2. Production function: Conversion of inputs into outputs is known as production function.

5. Advertising: Advertising is a promotional activity. In advertising while the copy, illustrations,

Engineering economics is the practical application of economic principles in the field of

Prepared By: V. Karthik Raja B.E., M.B.A

In economics, a good is something that is intended to satisfy some wants or needs of a

Types of Goods - Related to Income:

Prepared By: V. Karthik Raja B.E., M.B.A

Types of Goods - Related to Price:

Types of Goods - Related to Consumption Ability:

Non-excludable good: goods or service whereby it is impossible to prevent an individual who

Prepared By: V. Karthik Raja B.E., M.B.A

Prepared By: V. Karthik Raja B.E., M.B.A

 Value in use is the utility of consuming a good.

Wealth is the abundance of valuable resources or material possessions.

Wealth is a person's net worth, expressed as: wealth = assets – liabilities

FACTORS OF PRODUCTION IN ECONOMICS

Entrepreneurship is sometimes considered a factor of production as individuals usually have

LARGE SCALE INDUSTRIES

Importance of Large Scale Industries

Prepared By: V. Karthik Raja B.E., M.B.A

Prepared By: V. Karthik Raja B.E., M.B.A

Small Scale Industries:

Prepared By: V. Karthik Raja B.E., M.B.A

Second, consumption is divided according to the needs it satisfies. A commonly used

People in different position in respect to income have systematically different structures of

Prepared By: V. Karthik Raja B.E., M.B.A

remittances from abroad. Income from consumer's cumulative bundle (including

Expectations on future income, especially if concerning short-term credible events,

1. Wants are unlimited

Classification of Human Wants:

Necessaries may be further classified into three categories.

(a) Necessaries of existence:

Prepared By: V. Karthik Raja B.E., M.B.A

(b) Necessaries for efficiency:

(c) Conventional necessaries:

LAW OF DIMINISHING MARGINAL UTILITY:

Prepared By: V. Karthik Raja B.E., M.B.A

The fundamental basis of economic decision making is individuals' or organizations' desire to

Rational Decision Making

Costs versus Benefits

Prepared By: V. Karthik Raja B.E., M.B.A

The decision-making process involves the following steps:

1. Define the problem.

Prepared By: V. Karthik Raja B.E., M.B.A

DEMAND AND SCHEDULE

In economics, demand is an economic principle that describes a consumer's desire and

Factors affecting demand:

Shift of a demand curve