UNIT-1 Introduction to Engineering Economics Engineering Economics: Engincering is the profession in which knowledge of the mathematical and natural sciences gained by study experience and practice is applied with judgment to develop ways to utilise economically the material and forces of nature for the benefit of mankind. Engineering Economies is a subject of vital importance to Engineers. This subject helps one understand the need for the knowledge of Economics for being an effective manager and decision maker. ‘The Economics theories are used to take decisions related to uncertain and changing business environment. Economies theories deal with the principles of demand, pricing, cost, production, competition, trade cycles, and national income and so on. As the design and manufacturing process become more complex, the engineer is making decisions that involve money more than ever before. The competent and successful engineer at present must have an improved understanding of the principles of economics. The engineering economics is concerned the systematic evaluation of the benefits and costs of projects involving engineering design and analysis. Engincering economics quantifies the benefits and costs associating with engineering projects to determine if they save enough money to warrant their capital investments. Engineering economics requires the application of engineering design and analysis principles to provide goods and services that satisfy the consumer at an affordable cost. Engineering economics is also relevant to the design engineer who considers material sclection. Engincers are planners and builders. They are also problem solvers, managers and decision makers. In the beginning of the 20" century, engincers were mainly concerned with the design, construction, operation of machines structures and processes. They have accorded least attention to the human and physical resources that have provided the final products. Many factors have contributed to an expansion of engineering responsibilities and concerns. Apart from the conventional work, now engincers are expected not only to create novel technological solutions but also to make skilful financial analysis of the effects of implementation. 39 ‘Scanned with CamScannerEngineering economics involves the systematic evaluation of the economic benefits of proposed solutions to engineering problems. The engineering economics involves technical analysing with emphasis on the economic aspects and has the objective of assisting decisions Engineering economies is closely aligned with Conventional Micro-Economics. It is devoted to problem solving and decision making at the operational level, Thus “Engineering Economics refers to those aspects of economics and its tools of analysis most relevant to the Engineer's decision making process” PRINCIPLE |: Develop the Alternatives * Carefully define the problem! Then the choice (decision) is among altematives. * The alternatives need to be identified and then defined for subsequent analysis. + A decision situation involves making a choice among two or more alternatives. + Developing and defining the alternatives for detailed evaluation is important because of the resulting impact on the quality of the decision. + Engineers and managers should place a high priority on this responsibility + Creativity and innovation are essential to the process. PRINCIPLE 2 :Focus on the Differences * Only the differences in the future outcomes of the alternatives are important. * Outcomes that are common to all alternatives can be disregarded in the comparison and decision. * For example, if your feasible housing alternatives were two residences with the same purchase (or rental) price, price would be inconsequential to your final choice. Instead, the decision would depend on other factors, such as location and annual operating and maintenance expenses. This simple example illustrates Principle 2, which emphasizes the basic purpose of an engineering economic analysis: to recommend a future course of action based on the differences among feasible alternatives PRINCIPLE 3: Use a Consistent Viewpoint ‘The prospective outcomes of the alternatives, economic and other should be consistently developed from a defined viewpoint (perspective). The perspective of the decision maker, which is often that of the owners of the firm, would Department of CIVIL, ‘SMSOSMS; ENGINEERING ECONOMICS AND ACCOUNTANCY an ‘Scanned with CamScannernormally be used. The viewpoint for the particular decision be first defined and then used consisteatly in the description, analysis, and comparison of the alternatives, Principle 4:Use a Common Unit of Measure For measuring the econemie consequences, a monetary unit such as dollars is the common measure. You should also try to translate other outcomes (which do not initially appear to be economic) into the monetary unit. Using more than one monetory unit for Economic Analysis will complicate the over all analysis of a project. Principle 5: Consider All relevant Criteria The decision maker will normally select the alternative that will best serve the long-term interests of the owners of the organization. In engineering economic analysis, the primary criterion relates to the long-term financial interests of the owners. This is based on the assumption that available capital will be allocated to provide maximum monetary return to the owners. Often, though, there are other organizational objectives you would like to achieve with your decision, and these should be considered and given weight in the selection of an alternative. PRINCIPLE 6: Make Risk and Uncertainty Explicit Risk and uncertainty are inherent in estimating the future outcomes of the altematives and should be recognized. ‘The analysis of the ‘alternatives involves projecting ot estimating the future consequences Associated with each of them. ‘The magnitude and the impact of future outcomes of any course of action are uncertain. the probability is high that today’s estimates of, for example, future cash receipts and expenses will not be what eventually occurs. ‘Thus, dealing with uncertainty is an important aspect of engincering economic analysis. PRINCIPLE 7: Revisit Your Decisions A good decision-making process can result ina decision that has an undesirable outcome. Other decisions, even though relatively successful, will have results significantly different from the initial estimates of the consequences Learning from and adapting based on our experience are essential and are indicators of a good organization. Department of CIVIL 'SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY at ‘Scanned with CamScannerDEMA Demand in common practice / ordinary language means the desire for an object. Suppose a person desires to have a car. It is called demand in ordinary usage. But in economics demand has a separate meaning which is quite distinct trom the above meaning. A mere desire cannot become demand in Economics. A desire which is backed up by (i) ability to buy and (ii) willingness to pay the price, is called demand. Unless the desire is accompanied by ability to buy and willingness to pay, it cannot be called demand in Economies. Definitions of Demand 1. According to Stonicr and Hague, “Demand in economics means demand backed up by enough money to pay for the goods demanded”. ‘This means that the demand becomes effective only if it is backed by purchasing power in addition to this there must be willingness to buy a commodity. ‘Thus, demand in economics means the desire backed by the willingness to buy a commodity and the purchasing power to pay. 2. In the words of Benham, “The demand for anything at a given price is the amount of it which will be bought per unit of time at that price”, (Thus demand is always at a price for a definite quantity at a specified time.) Thus, demand has three essentials i.e., price, quantity and time. Without these three demand has no significance in economics. Determinants or Factors Affecting Demand: ‘There are factors on which the demand for a commodity depends. These factors are economic, social as well as political factors. The effect of all the factors on the amount demanded for the commodity is called Demand Function. ‘These factors are as follows: 1, Price of the Commodity: Department of CIVIL 'SMSOSMS; ENGINEERING ECONOMICS AND ACCOUNTANCY 42 ‘Scanned with CamScannerThe most important factor-affecting amount demanded is the price of the commodity. The amount of a commodity demanded at a particular price is more properly called price demand. The relation between price and demand is called the Law of Demand. It is not only the existing price but also the expected changes in price, which affect demand 2. Income of the Consumer: The second most important factor influencing demand is consumer income. In fact, we can establish a relation between the consumer income and the demand at different levels of income, price and other things remaining the same. The demand for a normal commodity goes up when income rises and falls down when income falls. But in case of Giffen goods the relationship is the opposite. 3. Prices of related goods: The demand for a commodity is also affected by the changes in prices of the related goods also. Related goods can be of two types: (i). Substitutes which can replace each other in use; for example, tea and eofiee are substitutes. ‘The change in price of a substitute has effect on a commodity’s demanding the same direction in which price changes. The rise in price of coffee shall raise the demand for tea; i). Complementary foods are those which are jointly demanded, such as pen and ink. In such cases complementary goods have opposite relationship between price of one commodity and the amount demanded for the other. If the price of pens goes up, their demand is less as a result of which the demand for ink is also less. The price and demand go in opposite direction. The effect of changes in price of a commodity on amounts demanded of related commodities is called Cross Demand, 4. Tastes of the Consumers: The amount demanded also depends on consumer's taste, Tastes include fashion, habit, customs, ete. A consumer's taste is also affected by advertisement. If the taste for a commodity goes up, its amount demanded is more even at the same price. This is called increase in demand. The ‘opposite is called decrease in demand. §. Wealth: The amount demanded of commodity is also affected by the amount of wealth as well as its distribution. The wealthier are the people: higher is the demand for normal commodities. If wealth is more equally distributed, the demand for necessaries and comforts is more. On the other hand, if some people are rich, while the majorities are poor, the demand for luxuries is generally higher. 6, Population: Department of CIVIL 'SMS0SMS; ENGINEERING ECONOMICS AND ACCOUNTANCY 43 ‘Scanned with CamScannerIncrease in population increases demand for necessaries of life. The composition of population also affects demand. Composition of population means the proportion of young and old and children as well as the ratio of men to women, A change in composition of population has an effect on the nature of demand for different commodities. 7. Government Policy: Government policy affects the demands for commodities through taxation, Taxing a commodity creases its price and the demand goes down. Similarly, financial help from the government increases the demand for a commodity while lowering its price. 8. Expectations regarding the future: If consumers expect changes in price of commodity in future, they will change the demand at present even when the present price remains the same. Similarly, if consumers expect their incomes to rise in the near future they may increase the demand for a commodity just now, 9. Climate and weather: The climate of an area and the weather prevailing there has a decisive effect on consumer's demand. In cold areas woolen cloth is demanded. During hot summer days, ice is very much in demand. On a rainy day, ice eream is not so much demanded. 10. State of business: The level of demand for different commodities also depends upon the business conditions in the country. If the country is passing through boom conditions, there will be a marked increase in demand. On the other hand. the level of demand goes down during depression. Demand function A mathematical expression of relationship between quality demanded of the commodity and its determinants is known as the demand function. Explained below. Qx = f( Px,Ax, Dx,0x,Ic,¥c,Tc, Be, Py, Ay, Dy, Oy, G,N, W) © Qx=Quantity demanded of product, per period © Px = Price of Product © Ax= Advertising for Product © Dx = Design’style‘quality-Cost of product © Ox = Outlets, Distribution © Ie= Incomes of consumers/customers/clientele Deparment of CIVIL, SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY ‘Scanned with CamScanner© Ye = Consumer Expenditures on related goods © Te= Tastes © Ee = Expectations of consumers regarding future prices * Py = Prices of related goods © Ay = Advertising/Promotion of related goods © Dy = Design’Styles of related goods © Oy = Outlets of related goods © G= Goverment Policy * N=Number of People in the Economy © W = Weather Conditions Law of Demand: Law of demand shows the relation between price and quantity demanded of a commodity in the market. In the Words of Marshall, “the amount demand increases with a fall in price and diminishes with a rise in price”. A rise in the price of a commodity is followed by a reduction in demand and a fall in price is followed by an increase in demand, if a condition of demand remains constant. ‘The law of demand may be explained with the help of the following demand schedule. Demand Schedule. Price of Appel (In. Rs.) | Quantity Demanded 10 1 8 2 6 3 4 4 2 Ss When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same way as price falls, quantity demand increases on the demand curve. basis of the demand schedule we can draw the Department of CIVIL 'SMSOSMS; ENGINEERING ECONOMICS AND ACCOUNTANCY ac ‘Scanned with CamScanner» Price ‘The demand curve DD shows the inverse relation between price and quantity demand of apple. It is downward sloping. Assumptions: Law is demand is based on certain assumptions: This is no change in consumers taste and preferences. Income should remain constant. Prices of other goods should not change. There should be no substitute for the commodity The commodity should not confer at any distinction ‘The demand for the commodity should be continuous - People should not expect any change in the price of the commodity whune aes Exceptional demand Curve or Exceptions to the law of demand: Sometimes the demand curve slopes upwards from left to right. In this case the demand curve has a positive slope. ¥ vy PL P ° «& aunt Department of CIVIL SADUDMD: ENGINEERING ECONOMICS AND ACCOUNTANCY an ‘Scanned with CamScannerWhen price increases from OP to Op! quantity demanded also increases from to OQI and vice versa. The reasons for exceptional demand curve are as follows. 1. Giffen paradox: The Giffen good or inferior good is an exception to the law of demand. When the price of an inferior good falls, the poor will buy less and vice versa. For example, when the price of maize falls, the poor are willing to spend more on superior goods than on maize if the price ‘of maize increases, he has to increase the quantity of money spent on it. Otherwise he will have to face starvation. thus a fall in price is followed by reduction in quantity demanded and vice versa. “Giffen” first explained this and therefore it is called as Giffen’s paradox. 2. Veblen or Demonstration effect: *Veblen’ has explained the exceptional demand curve through his doctrine of conspicuous consumption. Rich people buy certain good because it gives social distinction or prestige for cxample diamonds are bought by the richer class for the prestige it possess. It the price of diamonds falls poor also will buy is hence they will not give prestige. Therefore, rich people may stop buying this commodity. 3. Ignorance: Sometimes, the quality of the commodity is Judge by its price. Consumers think that the product is superior if the price is high. As such they buy more at a higher price. peculative effect: If the price of the commodity is increasing the consumers will buy more of it because of the fear that it increase still further, Thus, an increase in price may not be accomplished by a decrease in demand, 5. Changes in Expectations; When people expect a further rise in prices, people buy more when prices rise They want avoid paying more in future. Similarly, when people expect the prices to fall in further, they buy less and less as prices fall, ‘They may be expecting a further in prices. 6. Fear of shortage: During the times of emergency of war People may expect shortage of a commodity, At that time, they may buy more at a higher price to keep stocks for the future. Demand Distinctions; Demand may be defined as the quantity of goods or services desiredby an individual, backed by the ability and willingness to pay. ‘Types of Demand: 1, Direct and indirect demand: demand for goods that are direetly used for consumption by the ultimate consumer is known as direct demand (example: Demand for T shirts), On the other hand demand for goods that are used by producers for producing goods and services. (example: Demand for cotton by a textile mill) Department of CIVIL SMSOSMS: ED ERING ECONOMICS AND ACCOUNTANCY 47 ‘Scanned with CamScanner2. Derived demand and autonomous demand: when a produce derives its usage from the use of some primary product it is known as derived demand (example: demand for tyres derived from demand for car) Autonomous demand is the demand for a product that can be independently used.(example: demand for a washing machine) 3. Durable and nondurable goods demand: durable goods are those that ean be used more than once, over a period of time (example; Microwave oven) Nondurable goods can be used ‘only once (example: Band-aid) 4. Firm and industry demand: firm demand is the demand for the product of a particular firm. (example: Dove soap) The demand for the product/of a particular industry is industry demand (example: demand for stec! in India) §. Total market and market segment demand: « particular segment of the markets demand is called as segment demand (example; demand for laptops by engineering students) the sum total of the demand for laptops by various segments in India is the total market demand. (example: demand for laptops in India) 6. Short run and long run demand: short run demand refers to demand with its immediate reaction to price changes and income fluctuations. Long run demand is that which will ultimately exist as a result of the changes in pricing. promotion or product improvement aftermarket adjustment with sufficient time. 7, Joint demand and Composite demand: when two goods are demanded in conjunction with one another at the same time to satisfy a single want, itis called as joint or complementary demand. (example: demand for petrol and two wheelers) A composite demand is one in which a good is wanted for several different uses. ( example: demand for iron rods for various purposes) 8, Price Demand: The ability and willingness to buy specific quantities of a good at the prevailing price in a given time period. 9, Income Demand: The ability and willingness to buy a commodity at the available income in a given period of time. 10. Market Demand: The total quantity of a good or service that people are willing and able to buy at prevailing prices in a given time period. It is the sum of individual demands. 11, Cross Demand: The ability and willingness to buy a commodity or service at the prevailing price of the related commodity ic. substitutes or complementary products. For example, people buy more of wheat when the price of rice increases. Department of CIVIL SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY ‘Scanned with CamScannerDEMAND FORECASTING: Demand forecasting refers to an estimate of future demand for the product. It is an objective assessment of the future course of demand, in recent times, forecasting plays an Important role in business decision ~ making, The survival and prosperity of a business firm depend on its ability to meet the consumer's needs efficiently and adequately. Demand forecasting has an important influence on production planning. It is essential for a firm to produce the required quantities at the right time. It is also essential to distinguish between forecasting of demand and forecast of sales, sales forecasts are important for estimating revenue, cash requirements and expenses whereas, demand fore ting relate to production, inventory control, timing, reliability of forecast etc, however, there is not much difference between these terms Methods of Demand forecasting: Several methods are employed for forecasting demand. All these methods can be grouped under survey method and statistical method, Survey methods and statistical methods are further subdivided in to different categories, 1. Survey Method: Under this method, information about the desires of the consumer and opinion of exports are collected by interviewing them. Survey method ean be divided into four type’s viz., Option survey method; expert opinion; Delphi method and consumers interview methods. a. Opinion survey method: This method is also known as sales-force composite method (or) collective opinion method. Under this method, the company asks its salesman to submit estimate of future sales in their respective territories. Since the forecasts of the salesmen are biased due to their optimistic or pessimistic attitude ignorance about economic developments ete, these estimates are consolidated, reviewed and adjusted by the top executives. In case of wide differences, an average is struck to make the forecasts realistic B, Expert opinion method: Apart from salesmen and consumers, distributors or outside experts may also © used for forecasting. In the United States of America, the automobile companies get sales estimates directly from their dealers, Firms in advanced countries make use of outside experts for Department of CIVIL 'SMS(SMS; ENGINEERING ECONOMICS AND ACCOUNTANCY aa ‘Scanned with CamScannerestimating future demand. Various public and private agencies all periodic forecasts of short or Jong term business conditions. C. Delphi Method: A variant of the survey method is Delphi method, It is a sophisticated method to arrive at a consensus. Under this method, a panel is selected to give suggestions to solve the problems in hand, Both internal and external experts can be the members of the panel. Panel members one kept apart from cach other and express their views in an anonymous manner. There is also a coordinator who acts as an intermediary among the panellists, He prepares the questionnaire and sends it to the panellist. At the end of cach round, he prepares a summary report, D. Consumers interview method: In this method the consumers are contacted personally to know about their plans and preference regarding the consumption of the product, A list of all potential buyers would be drawn and each buyer will be approached and asked how much he plans to buy the listed product in future. He would be asked the proportion in which he intends to buy. This method seems to be the most ideal method for forecasting demand. 2. Statistical Methods: Statistical method is used for long run forecasting. In this method, statistical and mathematical techniques are used to forecast demand, This method relies on post data. a. Time series analysis or trend projection methods: A well-cstablished firm would have accumulated data. These data are analyzed to determine the nature of existing trend. Then, this trend is projected in to the future and the results are used as the basis for forecast. This is called as time series analysis. This data can be presented either in a tabular form or a graph. In the time series post data of sales are used to forecast future. b. Barometric Technique: ‘Simple trend projections are not capable of forecasting turning paints, Under Barometric method, present events are used to predict the directions of change in future. This is done with the help of economics and statistical indicators. Those are (1) Construction Contracts awarded for building materials (2) Personal income (3) Agricultural Income. (4) Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits etc. ¢. Regression and correlation method: Regression and correlation are used for forecasting demand, Based on post data the future data trend is forecasted. If the functional relationship is analyzed with the independent variable it is simple conection. When there are several independent variables it is multiple correlation. In Department of CIVIL SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY 50 ‘Scanned with CamScannercorrelation we analyze the nature of relation between the variables while in regression; the extent of relation between the variables is analyzed. The results are expressed in mathematical form Steps of Demand Forecasting: The Demand forecasting process of an organization can be effective only when it is conducted systematically and scientifically. It involves a number of steps, which are shown in Figure-3: a fares ‘The steps involved in demand forecasting (as shown in Figure-3) are explained as follows: 1. Setting the Objective: Refers to first and foremost step of the demand forecasting process. An organization needs to clearly state the purpose of demand forecasting before initiating it, Setting objective of demand forecasting involves the following: A. Deciding the time period of forecasting whether an organization should opt for short-term forecasting or long-term forecasting B. Deciding whether to forecast the overall demand for a product in the market or only- for the organizations own products. C. Deciding whether to forecast the demand for the whole market or for the segment of the market D. Deciding whether to forecast the market share of the organization 2. Determining Time Period: Involves deciding the time perspective for demand forecasting. Demand can be forecasted for a long period or short period. In the short run, determinants of demand may not change significantly or may remain constant, whereas in the long run, there is a significant change in the determinants of demand. Therefore, an organization determines the time period on the basis of its set objectives. 3. Selecting a Method for Demand Forecasting: Department of CIVIL SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY SI ‘Scanned with CamScannerConstitutes one of the most important steps of the demand forecasting process Demand ean be forecasted by using various methods. The method of demand forecasting differs from organization to organization depending on the purpose of forecasting, time frame, and data requirement and its availability. Selecting the suitable method is necessary for saving time and cost and ensuring the reliability of the data. 4. Collecting Data: Requires gathering primary or secondary data, Primary’ data refers to the data that is collected by researchers through observation, interviews, and questionnaires for a particular research. On the other hand, secondary data refers to the data that is collected in the past; but can be utilized in the present scenario/research work. 5. Estimating Results: Involves making an estimate of the forecasted demand for predetermined years, The results should be casily interpreted and presented in a usable form. The results should be casy to understand by the teaders or management of the organization. Elasticity of Demand: Elasticity of demand explains the relationship between a change in price and consequent change in amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of demand shows the extent of change in quantity demanded to a change in price. In the words of “Marshall”, “The elasticity of demand in a market is great or small according as the amount demanded inereases much or little for a given fall in the price and diminishes much or litile fora given rise in Price” Elasticity of demand = percentage change in the quantity demanded / percentage change in price Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case, demand is elastic, In-clastic demand: Ifa big change in price is followed by a small change in demanded then the demand in “inelastic ‘Types of Elasticity of Demand: There are three types of elasticity of demand: |. Price elasticity of demand 2. Income elasticity of demand Department of CIVIL, SMSOSMS; ENGINEERING ECONOMICS AND ACCOUNTANCY 52 ‘Scanned with CamScanner3. Cross elasticity of demand 1. Price clasticity of demand: Marshall was the st economist to define price elasti of demand, Price elasticity of demand measures changes in quantity demand to a change in Price. It is the ratio of percentage change in quantity demanded to a percentage change in price. Proportionate change in the quantity demand of commodity Price elasticity = Proportionate change in the price of commodity There are five cases of price elasticity of demand A. Perfectly elastic demand: When small change in price leads to an infinitely large change is quantity demand, it is called perfectly or infinitely elastic demand. In this ease E=c0 ‘The demand curve DD1 is horizontal straight line, It shows the at “OP" prive any amount is demand and if price increases, the consumer will not purchase the commodity. B, Perfectly Inelastic Demand In this case, even a large change in price fails to bring about a change in quantity demanded. 52 ‘Scanned with CamScannerWhen price increases from ‘OP" to ‘OP’, the quantity demanded remains the same. In other words the response of demand to a change in Price is nil. In this case “E’=0. C. Relatively elastic demand: Demand changes more than proportionately to a change in price. ic. a small change in price loads to a very big change in the quantity demanded. In this ease E> 1, This demand curve will be flatter. When price falls from ‘OP’ to ‘OP’, amount demanded increase from “OQ* to “OQI1* which is larger than the change in price, D. Relatively in-clastic demand. Quantity demanded changes less than proportional to a change in price. A large change in price leads to small change in amount demanded. Here E < |. Demanded carve will be steeper. ¥ > r x rate \s . a & nn avant’ ty Department of CIVIL SMSO5MS: ENGINEERING ECONOMICS AND ACCOUNTANCY, 54 ‘Scanned with CamScannerWhen price falls from “OP" to ‘OPI amount demanded inereases from OQ t OQI, which is smaller than the change in price. E. Unit elasticity of demand: The change in demand is exactly equal to the change in price. When both are equal E=1 and clasticity if said to be unitary. When price awontt hy falls from *OP* to “OPI quantity demanded increases from OP" to “OPI”, quantity demanded increases from ‘OQ’ to ‘OQ’, thus a change in price has resulted in an equal change in quantity demanded so price elasticity of demand is equal to unity 2. Income elasticity of demand: Income elasticity of demand shows the change in quantity demanded as a result of a change in income. Income elasticity of demand may be slated in the form of a formula Proportionate change in the quantity demand of commodity Income Elasticity = —— Proportionate change in the income of the people Income elasticity of demand can be classified in to five types. A. Zero income elasticit Quantity demanded remains the same, even though money income increases. Symbolically, it can be expressed as Ey=0. It can be depicted in the following way: Department of CIVIL S AND ACCOUNTANCY ‘Scanned with CamScannerAs income increases from OY to OY 1, quantity demanded never changes. B. Negative Income elasticity: When income increases, quantity demanded falls. In this case, income clasticity of demand is negative. ic., Fy< 0. When income inereases from OY to OY 1, demand falls from OQ to OQ1. ¢. Unit income elasticity: When an increase in income brings about a proportionate increase in quantity demanded, and then income elasticity of demand is equal to one. Ey= 1 ye ‘a7 eye) a cy & . Gout When income increases from OY to OY1, Quantity demanded also increases from OQ to OQI. 4. Income elasticity greater than unity: Department of CIVIL 'SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY 56 ‘Scanned with CamScannerIn this case, an increase in come brings about a more than proportionate increase in quantit demanded. Symbolically it can be written as Ey> 1 It shows high-income elasticity of demand. When income increases from OY to OY1, Quantit demanded increases from OQ to OQI. E. Income elasticity leas than unity: When income inereases quantity demanded also increases but less than proportionately. In thi case E < 1. euenntty An increase in income from OY to OY, brings what an increase in quantity demanded from O¢ to OQI, But the increase in quantity demanded is smaller than the increase in income, Hene: income elasticity of demand is less than one. 3. Cross elasticity of Demand: A change in the price of one commodity leads to a change in the quantity demanded of anothe commodity. This is called a cross elasticity of demand. The formula for cross elasticity ¢ demand is Proportionate change in the quantity demand of commodity “X” Cross elasticity = — Departinent of CIVIL SMS0SMS: ENGINEERING ECONOMICS AND ACCOUNTANCY 57 ‘Scanned with CamScannerProportionate change in the price of commodity “W" A. ln case of substitutes, cross clasticity of demand is positive. Eg: Coffee and Tea When the price of coffee increases, Quantity demanded of tea increases, Both are substitutes. B. Ln case of compliments, cross clasticity is negative. If increase in the price of one commodity leads toa decrease in the quantity demanded of another and vie versa. evry de Pat When price of car goss up from OP to OP}, the quantity demanded of petrol decreases from OQ to OQL The cross-demanded curve has negative slope. C. tn case of unrelated commodities, cross clasheity of demanded i» zero, A change in the pre of one commodity will not affect the quantity demanded of another. Department of CIVIL eveni @ 8)” MICS AND ACCOUNTANCY 58 ‘Scanned with CamScannerQuantity demanded of commodity “b” remains unchanged duc to a change in the price of “A’, as both are unrelated goods 4. Advertising elasticity of demand: It refers to increase in the sales revenue because of change in the advertising expenditure. In other words, there is a direct relationship between the amount of moncy spent on advertising and its impact on sales. Advertising clasticity is always positive. Proportionate change in the quantity demand f product “X" Advertising clasticity = Proportionate change in advertisement costs. ‘Theory of Firm: The theory of firm is the micro economic concept founded in neoclassical economic that states the firm concluding business and corporations exist and make decision (© maximize profits firm indirect with the market determine pricing and demand and then allocated resources according to models that looks to maximize nct profits. Factors affecting the choice of form of business organization = Before we choose a particular form of business organization, let us study what factors affect such a choice? The following are the factors affecting the choice of a business organization: 1. Easy to start and easy to clase: The form of business organization shauld be stick that it should be easy to close. There should not be hassles or long procedures in the process of setting up business or closing the same 2 Division of labour: There should be possibility to divide the work among the available owners. 3. Large amount of resources: Large volume of business requires large volume of resources. Some forms of business organization do not permit to raise langer resources Select the one which permits to mobilize the large resources 4 Liability: The liability of the owners should be limited to the extent of moncy invested in business. It is better if their personal propertics are not brought into business to make up the losses of the business Department of CIVIL, SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY so ‘Scanned with CamScanner§ Scerecy: The form of business organization you select should be such that it should permit to take care of the business secrets. We know that century old business units are still surviving only because they could successfully guard their business secrets, 6 Transfer of ownership: There should be simple procedures to transfer the ownership to the next legal heir. 7. Ownership, Management and control: If ownership, management and control are in the hands of one or a small group of persons, communication will be effective and coordination will be easier. Where ownership, management and control are widely distributed, it calls for a high degree of professional's skills to monitor the performance of the business % Continuity: The business should continue forever and ever irrespective of the uncertainties in future. 9% Quick decision-making: Select such a form of business organization, which permits you to take decisions quickly and promptly. Delay in decisions may invalidate the relevance of the decisions. 10. Personal contact with customer: Most of the times, customers give ts clues to improve business. So choose such a form, which keeps you close to the customers. 11, Flexibility: In times of rough weather, there should be enough flexibility to shift from one business to the other. The lesser the funds committed in a particular business, the better itis. 12. Taxation: More profit means more tax. Choose such a form, which permits to pay low tax. These are the parameters against which we can evaluate cach of the available forms of business organizations. ‘Supply Analysis When price changes. quantity supplied will change. That is a movement along the same supply curve. When factors other than price changes, supply curve will shift. Here are some determinants of the supply curve. Determinants of Supply: 1. Production cost: Since most private companies’ goal is profit maximization. Higher production cost will lower profit, thus hinder supply. Factors affecting production cost are: imput prices, wage rate, government regulation and taxes, etc. 2. Technology: Department of CIVIL SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY 60 ‘Scanned with CamScannerTechnological improvements help reduce production cost and increase profit, thus stimulate higher supply. 3. Number of sellers: More sellers in the market increase the market supply 4. Expectation for future prices: If producers expect future price to be higher, they will try to hold on to their inventories and offer the products to the buyers in the future, thus they ean capture the higher price. Definition of “Law of Supply’ Definition: Law of supply states that other factors remaining constant, price and quantity supplied of a good are directly related to each other. In other words, when the price paid by buyers for a good rises, then suppliers increase the supply of that good in the market Description: Law of supply depicts the producer behavior at the time of changes in the prices of goods and services. When the price of a good rises, the supplier increases the supply in order to eam a profit because of higher prices. The above diagram shows the supply curve that is upward sloping (positive relation between the price and the quantity supplied). When the price of the good was at P3, suppliers were supplying Q3 quantity. As the price starts rising, the quantity supplied also starts rising. The supply curve is a graphical representation of the relationship between the price of a good or service and the quantity supplied for a given period of time. In a typical representation, the price will appear on the left vertical axis, the quantity supplied on the horizontal axis. Supply Function: Sx = f(px,pf,o... ...T,t,s) The supply function is the mathematical expression of the relationship between supply and those factors that affect the willingness and ability of a supplier to offer goods for sale Department of CIVIL SMSOSMS: ENGINEERING ECONOMICS AND ACCOUNTANCY fil ‘Scanned with CamScannerSX = Supply of goods PX = Price PF = Factor input employed (used) for production. 1. Raw material 2. Human resources: 3. Machinery O = Factors outside economic sphere. T = Technology. t= Taxes. SS = Subsidies. There is a functional (direct) relationship between price and supply. Elasticity of Supply ‘The law of supply states that there is a direct relationship between the quantity supplied and the price of a commodity. To point out, this is a very qualitative statement. However, markets for different commodities differ in ways we can’t even imagine, Interestingly, the concept of elasticity of supply handles all this with ease. The elasticity of supply establishes a quantitative relationship between the supply of 3 commodity and it’s pice. Hence, we can express the numeral change in supply with the change in the price of a commodity using the concept of elasticity. Note that clasticity can also be calculated with respect to the other determinants of supply. However, the major factor controlling the supply of a commodity is its price. Therefore, we generally talk about the price elasticity of supply. The price elasticity of supply is the ratio of the percentage change in the price to the percentage change in quantity supplied of a commodity. Eve [(Aq/q)* 100] + [(Ap/p)* 100] = (Aq/q) + (Ap/p) Age The change in quantity supplied > The quantity supplied Ap= The change in price ‘wepanment or Livit, SMDUD MIO: ENUHEVEERING BUUNUMLS ANU ALLUUN EARLY 62 ‘Scanned with CamScannerp> The price Elasticity from a Supply Curve Along with the method mentioned above, there are two more ways to calculate the price elasticity of supply, both of which make use of the supply curve. We can cither calculate the clasticity at a specific point on the supply curve, known as point elasticity or between two prices, known as arc elasticity. The formula for calculating the point clasticity of supply is: Es= (dq/dp)*(p/q) Here da/dp is the slope of the supply curve. ‘The formula for calculating the arc-elasticity of supply is: Es= ligt q2y(al + 42)» [Cpl + p2y(pt ~ p2)] t of lasticity of rox Perfectly inelest Unit stosucay ° Partectty elastic e OL atte (Source: economicsonline) Department of CIVIL SMSO0SMS: ENGINEERING ECONOMICS AND ACCOUNTANCY 63 ‘Scanned with CamScanner1. Perfectly Inclastic Supply A service or commodity has a perfectly inelastic supply if a given quantity of it can be supplied whatever might be the price. The elasticity of supply for such a service or commodity is zero. A perfectly inelastic supply curve as a straight line parallel to the Y-axis, This is representative of the fact that the supply remains the same irrespective of the price. The supply of exclusive items, like the painting of Mona Lisa, falls into this category. Whatever might be the price on offer, there is no Way We can increase its supply. 2. Relatively Less-Blastic Supply When the change in supply is relatively less when compared to the change in price, we say that the commodity has a relatively-less clastic supply. In such a case, the price elasticity of supply assumes a value less than 1. 3. Relatively Greater-Elastic Supply When the change in supply is relatively more when compared to the change in price, we say that the commodity has a relatively greater-clastic supply, In such a case, the price clasticity of supply assumes a value greater than | 4. Unitary Elastic For a commodity with a unit elasticity of supply, the change in quantity supplied of a commodity is exactly equal to the change in its price. In other words, the change in both price and supply of the commodity are proportionately equal to cach other. To point out, the elasticity of supply in such a case is equal to one. Further, a unitary clastic supply curve passes through the origin. 5. Perfectly Elastic supply A commodity with a perfectly elastic supply has an infinite elasticity. In such a case the supply becomes zero with even a slight fall in the price and becomes infinite with a slight rise in price. This is indicative of the fact that the suppliers of such a commodity are willing to supply any quantity of the commodity at a higher price. A perfectly elastic supply curve is a straight line parallel to the X- axis. Department of CIVIL SMSOSMS; ENGINEERING ECONOMICS AND ACCOUNTANCY ca ‘Scanned with CamScanner