Ee For Students-1

ENGINEERING ECONOMICS
CODE : MGT 112

2. COURSE CONTENT (SYLLABUS):
MODULE I
INTRODUCTION TO ENGINEERING ECONOMY AND ENGG ECONOMIC DECISIONS
01 Introduction, Origins and Principles of engineering economy, engineering economy and design
process (02 hours Blooms level : Knowledge)
02 Rational decision making and economic decisions, types of strategic engg economic decisions (02
Hours. Blooms level: Comprehension)
03 Circular flow of income, difference between micro and macroeconomics, Production possibility curve
(02 Hours. Blooms Level: Comprehension)
MODULE II
THEORY OF DEMAND AND SUPPLY
Demand-law of demand, demand curve, determinants of demand, exceptions to Law of demand. (03
hours, Blooms Level: Knowledge)
Elasticity of demand-Price elasticity and income elasticity. Calculation of Price and income elasticity
of demand. (05 Hours, Blooms level: Application)
Supply-law of supply, supply curve and determinants of supply. Elasticity of supply-its type
(02 hours, Blooms level: Comprehensive)
Equilibrium of demand and supply. (02 hours, Blooms level: Application)

MODULE III
THEORY OF PRODUCTION AND COST
Production function, Factors of Production, Law of Variable Proportion and Returns to Scale
04 hours, Blooms level: Application
Cost and its classification, short and long run cost curves, cost behavior, cost concepts and decision
making, breakeven analysis Calculation of costs and Break even point. 06 hours Analysis
MODULE IV
TIME VALUE OF MONEY AND DEPRECIATION
Cost of money, Interest formulas, Present, Future Values, Internal Return method. 05 hours,
Blomms level: Knowledge
Payback period method, rate of return method, Internal rate of return methods 03 hours,
Blooms level: Application
Concept of Depreciation, factors and methods of depreciation 02 hours Blooms level: Application
MODULE V
RATIO ANALYSIS
Meaning of ratio, Nature of Ratio analysis, Interpretation of ratios (01hour,
Blooms level: Knowledge)
Classification of ratios, Liquidity ratios, current ratio, Acid test ratio (01hour
Blooms level: Comprehensive)
Inventory turnover or stock turnover ratio, working capital turnover ratio, debt equity ratio,
Proprietary ratio Interest coverage ratio, gross profit ratio, operating ratio expenses ratio, net profit
ratio (03 hours
Blooms level: Knowledge)
COURSE OUTCOME
On completion of the course the students are able to :
1. Apply the appropriate engineering economics analysis methods for problem solving.
2. Evaluate the cost effectiveness of individual engineering projects.
3. Compare the life cycle cost of multiple projects and make a quantitative decision between alternative projects.
4. Perform ratio analysis and calculate time value of money to prepare and understand engineering project
development and report generation.
5. Compute the depreciation of an asset using standard depreciation techniques to assess its impact.
Production Possibility Curve (PPC) / Production Possibility Frontier (PPF) /Transformation Curve
Like an individual, a society as a whole, has limited resources. It has to decide what to produce with
The limited resources. It has to make a choice about the quantity of different commodities.
Choice emanates from scarcity. Thus our choice is always constrained or limited by scarcity of resources.
All such choices can be made with the help of PPC.
This curve separates outcomes that are possible for the society to produce from those which cannot
be produced subject to availability of resources.
In economics, PPC is a graph which shows the different combinations of two goods that an individual
Or group can effectively produce with limited productive resources.
Assumptions of PPC
• There are only 2 types of goods produced and minimum quantity of each good to be produced.
• Technology remains constant
• Resources are fixed
• Resources are neither unemployed or underemployed.
The concept of PPC can be understood with the help of a Production Possibility Schedule and
Production possibility curve.
Y
A
I
15
Product wheat cloth Opportunity B
ion Cost
possibil C
12
I
ities ABCDEF is the
A 0 15 - Production Possibility Curve/PPF
Cloth
B 1 14 15 -14=1 9 D
I
C 2 12 14 -12=2
D 3 9 12 – 9=3 6
I
E 4 5 9 – 5=4 E
F 5 0 5 – 0=5
3
I F
O I I I I I X
1 2 3 4 5
Wheat
Unemployment and PPC
When an economy operates on PPC, it means there is no unemployment

P or underemployment of resources and all resources are efficiently used.
B It means that all goods and services are produced with least cost.
S
C
A point inside the PPC (Point ‘R’) indicates that there is under or unemploy-
Cloth
ment / underutilization of resources and production can be increased.

D
R In this graph Point ‘R’ shows that resources are not being used fully.
Points ‘B’, ‘C’ and ‘D’ shows the resources are fully utilized.
Point ‘S’ shows the economy’s incapability to produce with the given
P Technology and resources.
Wheat
If there is a shift from a point inside PPC to any point on PPC, it indicates
that the resources which were under utilized are now being utilized fully.
Economic growth and PPC
In this graph Growth of an economy is indicated by a right ward
P1 shift from PP to P1P1.
P This shift is due to improvement in technology; New ways of production

are found, Greater savings, investment and capital formation, when
Cloth
P2 skill and efficiency of human resources increases.
A shift towards left from PP to P2P2 as shown in this graph indicates

that
there is reduction in resources due to natural calamities or war,
there prevails unemployment to a large extent.
Under-utilization of resources.
P2 P P1
Wheat
BASIC CONCEPTS IN ECONOMICS
ECONOMY, TYPES OF ECONOMY, TYPES OF ECONOMIC MODELS,

ECONOMIC SYSTEMS; ITS TYPES,
COST, REVENUE, PROFIT, SUPERNORMAL PROFIT, NORMAL PROFIT,
MEANING OF SHORT RUN & LONG RUN, MARGINALISM, EQUILIBRIUM,
SCIENCE – Process of exploring new knowledge
TECHNOLOGY – Application of scientific principles in practical life
OR
Use of laws of science to create new products.
ENGINEERING – Application of technology
Establishes varied application systems based on
different scientific principles.
TECHNOLOGY REFERS TO RESULTS
ENGINEERING REFERS TO PROCESS
EFFICIENCY is defined as the ratio of its output and input
TECHNICAL EFFICIENTY – Ratio of output to input of a physical system
ECONOMIC EFFICIENCY – Ratio of output to input of a business system
EE=output/input X 100 = Worth/Cost X 100
INTRODUCTION TO ENGG. ECONOMICS
Nature and scope of economics

Economics is an important branch of social science which deals with the behavior of human
Beings in relation to economic activities.
Derived from two Greek words “Okios” – Household

“Nomia” – Management
Hence economics can be understood as “Household Management” – Managing a household

with ltd resources available in an economical manner.
Later the scope of economics has been extended to Nation’s Management.
Economics is regarded as “Queen of Social Sciences” since it has more applicability in our
Practical life.
The science of economics was born in 1776 with the publication of Adam Smith’s
“An Enquiry into Nature and Causes of Wealth of Nations”
Adam Smith is known as “Father of Economics”.
Basic Premise of Economics

*Human wants are unlimited
*Means of satisfying these wants are scarce.
Definitions given by different economists
Adam Smith - Wealth Definition
Alfred Marshall - Welfare Definition
L Robbins - Scarcity Definition
P A Samuelson - Growth Oriented Definition
Economics is divided into two main parts.
MICRO ECONOMICS MACRO ECONOMICS

which divides the which studies the
economy into small performance of an
Units and studies economy.
Individually. Macro Economics is
Micro economics is called as “Income Theory”
called as “Price as it deals with
Theory” as it deals determination of
with determination Income and employment.
of prices of commo-
dities and factors.
It solves 3 economic
problems.
1. What to Produce?
2. How to produce?
3. For Whom to produce?
Economics is both Science as well as an Art.
It is a science as it tells us about the Cause and Effect

Relationships between variables.
It is an Art as it is used for practical application.
Economics is both a Positive Science as well as a Normative Science.
It is a Positive Science as it studies things as they are.
It is a Normative Science as it prescribes certain norms .

CIRCULAR FLOW OF INCOME
An economy is an integrated system of production, exchange and consumption.

In carrying out these activities people buy and sell goods and services. Income generated in
the production process flows in a circular manner. It is called as “Circular Flow of Income”.
The modern economy uses various factors of production namely Land, Labour, Capital and
Enterpreneurship.
CIRCULAR FLOW OF INCOME IN TWO SECTOR ECONOMY
Factor Services
Factor Payments
BUSINESS
HOUSEHOLDS
FIRMS
*buy and consume
*produce and sell
goods and services
goods and services
*own and sell
*Hire and use factors
factors of
of production
production
Expenditure on Goods & Services
Flow of Goods & Services
Households spendings on goods and services through markets and revenue of goods sold will flow from markets
To business firms.
Households provide factors of production like land, labour & capital to business firms and inturn household get
Wages and profits.
ASSUMPTIONS
1. This economy has no international economic relations(Closed ECONOMY)
2. Production occurs only in business sector
3. Producers sell all that they produce, ie there is no inventory
4. Consumers spend their entire income and there is no savings.
5.There are no govt operations in the economy such as govt expenditures and taxes.
Govt expenditures Govt expenditures
and transfer payments and subsidies
GOVERNMENT
Taxes Taxes
Factor Services
Factor Payments
BUSINESS
HOUSEHOLDS Savings investments FIRMS
CAPITAL
MARKET

CIRCULAR FLOW OF INCOME IN THREE SECTOR ECOCNOMY

This model shows the economic transactions between households, business firms and govt. sector.
1. A part of the flows between households and the business firms gets diverted to govt sector.
2. A part of the household income goes to govt sector in the form of taxes.
3. A part of the business firms’ earnings goes to govt in the form of taxes.
4. A part of the tax revenue is spent by the govt as govt expenditure on services and transfer
payments to the households
5. A part of the tax revenue is spent by govt as govt expenditure on goods and subsidies to the
business firms.
In case govt follows a deficit budget and govt expenditure is greater than revenue (G>T), the difference
Is financed from loans from the capital market. Hence money will flow from capital market to govt.
In case govt follows a surplus budget and the govt expenditure is less than the revenue (G<T), money
Will flow to capital market from govt sector.
GOVERNMENT
Taxes Taxes
Factor Services
Factor Payments
BUSINESS
CAPITAL
MARKET

Payment for Imports

FOREIGN
SECTOR Payment for Exports
CIRCULAR FLOW OF INCOME IN A FOUR SECTOR ECONOMY

No economy in the world functions in isolation. It is linked with other economies through trade.
This brings us to the analysis of a four sector economy where besides the households, business
firms and the govt the fourth sector is the foreign sector.
Imports leads to a decrease in the circular flow of income.
Exports leads to increase in the circular flow of income.
If the exports of a country are less than its imports (X<M) there is foreign trade deficit equal to
(M-X) which is known as unfavourable balance of trade.
If the exports of a country are more than its imports (X>M) there is foreign trade surplus equal to
(X-M) which is known as favourable balancd of trade.
Significance of Circular Flow of Income
1. Knowledge of Interdependence – we can understand interdependence between different sectors of the
economy.
2. Identification of Injections and Leakages – we can understand injections (Investment and Exports)
and leakages (saving and Imports)
3. Estimation of National Income - we can understand that how the circular flow of income facilitates the
estimation of national income.
4. Level of structure of Economic Activity – we can get information on various macro variables like national
Income, consumption, savings, investment, etc.
5. Fiscal and Monetary Policies-we can understand the importance of both Fiscal & Monetary Policies.
The importance of monetary policy can be observed when savings exceeds investment/investment exceeds
savings it means that the disequilibria can be set by suitable credit and monetary policy.
similarly, if savings and taxes amount exceeds the investment and govt spending amount should adopt such
fiscal measures as reduction in taxes. Therefore, with the help of circular flow of income and expenditure
the problem of disequilibria and the restoration of equilibrium can be observed.
Introduction to engineering
economy
• The technological and social environments in which we live
continue to change at a rapid rate.
• In recent decades, advances in science and engineering have
transformed our transportation systems, revolutionized the
practice of medicine, and miniaturized electronic circuits so
that a computer can be placed on a semiconductor chip.
▪ The utilization of scientific and engineering knowledge for our
benefit is achieved through the design of things we use, such as
furnaces for vaporizing trash and structures for supporting
magnetic railways.
▪ However, these achievements don’t occur without a price,
monetary or otherwise. Therefore, the purpose of this COURSE
is to develop and illustrate the principles and methodology
required to answer the basic economic question of any design:
Do its benefits exceed its costs?
ENGINEERING
• is the profession in which a knowledge of the
mathematical and natural sciences gained by study,
experience, and practice is applied with judgment
to develop ways to utilize, economically, the
materials and forces of nature for the benefit of
mankind.
• Engineering economics involves the systematic evaluation of the economic merits

of proposed solutions to engineering problems. To be economically acceptable (i.e.,
affordable), solutions to engineering problems must demonstrate a positive balance
of long-term benefits over long-term costs, and they must also
• promote the well-being and survival of an organization
• embody creative and innovative technology and ideas
• permit identification and scrutiny of their estimated outcomes
▪ Engineering economy involves technical analysis, with emphasis on the economic

aspects, and has the objective of assisting decisions.
▪ This is true whether the decision maker is an engineer interactively analyzing
alternatives at a computer-aided design workstation or the Chief
Executive Officer (CEO) considering a new project.
▪ An engineer who is unprepared to excel at engineering economy is not
properly equipped for his or her job.
The Principles of Engineering Economy
• The development, study, and application of any discipline must begin with a
basic foundation.
• We define the foundation for engineering economy to be a set of principles
that provide a comprehensive doctrine for developing the methodology.
• These principles will be mastered by students as they progress through this
course.
• Once a problem or need has been clearly defined, the foundation of the
discipline can be discussed in terms of seven principles.
PRINCIPLES OF ENGG ECONOMICS.
1.Develop the alternatives
2.Focus on the difference
3.Use a consistent view point
4.Use a common unit of measure
5.Consider all relevant criteria
6.Make uncertainty explicit
7.Revisiting decisions.
PRINCIPLE 1: Develop the Alternatives
• Carefully define the problem! Then the choice

(decision) is among alternatives.
• 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
Defining Creativity and Innovation
Creativity is the act of turning new and imaginative ideas into reality. Creativity is
characterised by the ability to perceive the world in new ways, to find hidden
patterns, to make connections between seemingly unrelated phenomena, and to
generate solutions. Creativity involves two processes: thinking, then producing.
Innovation is the implementation of a new or significantly improved product,
service or process that creates value for business, government or society.

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.
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 normally be used.
✓ The viewpoint for the particular decision be first defined and then
used consistently in the description, analysis, and comparison of
the alternatives.
Principle 4:Use a Common Unit of Measure
▪ For measuring the economic consequences, a monetary unit such

as Rupees 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 monetary 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
alternatives and should be recognized.
▪ The analysis of the alternatives involves projecting or 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 engineering economic

analysis.
PRINCIPLE 7: Revisit Your Decisions
A good decision-making process can result in a 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.
THEORY OF DEMAND
DEMAND refers to the quantity of a good or service that the consumers are willing and able
to purchase at various prices during a period of time.
DEMAND depends on the factors like
Desire + Ability to pay + Willingness to buy
Example: If an economically poor person wants to buy a car, it is only a desire, but
not a demand as he cannot pay for the car. If a rich man wants to buy a car and is
willing to spend money to buy it, it is a demand as he will be able to pay for the car. Thus
A desire backed up by purchasing power and willingness to buy is known as demand.
DEMAND SCHEDULE is a tabular representation which shows the relationship between Price and
Quantity demanded.
The two types of demand schedule are
Individual Demand Schedule MARKET DEMAND SCHEDULE
PRICE QTY PRICE QUANTITY DEMANDED BY TOTAL MARKET DEMAND

((Rs) DEMANDED (Rs) A B C
(KgS)
5 10 8 12 10+8+12=30
5 15
4 15 12 18 15+12+18=45
4 25
3 20 17 23 20+17+23=60
3 30
2 35 2 35 25 40 35+25+40=100
1 60 1 60 35 45 60+35+45=140
DEMAND CURVE
A Demand Curve is a graphical representation of the demand schedule.
A Demand Curve always slopes downward from left to right and has a
negative slope as shown below.
Y
l
D
5
l
P
R 4 l
I
C
3
l
E
2
l
1
l
I I I I I X
O 15 25 30 35 60
QUANTITY DEMANDED
DETERMINANTS OF DEMAND
PRICE OF COMMODITY
TASTES AND
PREFERENCES
DETERMINANTS
CONSUMERS INCOME
OF DEMAND
ADVERTISEMENT PRICE OF RELATED

EFFECT COMMODITIES
(Complementary
goods
and Substitute goods)
DEMAND FUNCTION
The demand for any commodity mainly depends on the price of the commodity.
The other determinants are income of consumers, tastes and preferences, prices
of related commodities.
Symbolically Demand Function can be expressed as
Dx = f (Px, Ps, Y, T, A)
where Dx = demand for good X

Px = price of good X
Ps = price of related good
Y = Income of consumers
T = Tastes and preference of consumers
A = Advertisement effect
Problem 1 on Demand Function
1. The given demand function is Qd=60-10P. Based on this fill up the blanks in the
table
First let us find out the Price for Sl. No. 1
Serial Price (Rs.) (P) Quantity (in Kgs.) (Qd)
Number Qd=60-10P
1 5 10 10=60-10P
2 4 20 10P=60-10
3 3 30 10P=50
4 2 40 P=50/10 =Rs.5
5 1 50
6 0 60
Next let us find out the Quantity Demanded (Qd) for serial No. 2
Qd=60-10P
Qd=60-10(4)
Qd=60-40
Qd=20 kgs.
Thirdly let us calculate the price for Sl. No. 3 Fourthly let us calculate the Qty. for Sl. No. 4
Qd=60-10P Qd=60-10P
30=60-10P Qd=60-10(2)
10P=60-30 Qd=60-20
P=30/10=Rs. 3 Qd=40 kgs.
Fiflthly let us calculate the price for Sl. No. 5 Lastly let us calculate the price for Sl. No. 6
Qd=60-10P Qd=60-10P
50=60-10P Qd=60-10(0)
10P=60-50 Qd=60-0
P=10/10=Rs. 1 Qd=60 kgs.
Problem 2 on demand function
The demand function for an engg component is Qd=3000-5P.
Where Qd=Quantity demanded of the component
P=Price.
From this equation a) Develop a demand schedule and plot the demand diagram at
prices Rs. 150, 250, 325, 400 and 500.
b) At what price Qd=0
c) If the seller wants to sell 2500 units, what price he should fix?
Qd=300-5P
When Price is Rs. 150=3000-5(150)=2250 units
When price is Rs. 250=3000-5(250)=1750 units
When price is Rs. 500=3000-5(500)=500 units.
b) At what price Qd=0?
Qd=3000-5P
0=3000-5P
5P=3000-0
5P=3000
P=3000/5
P=600
c) What price to be fixed if seller wants to sell 2500 units?

Qd=3000-5P
2500=3000-5P
5P=-2500+3000
5P=500
P=500/5
P=Rs.100
Problem for practice
Excel engineers estimated following demand function for 100 ltr. Of
solar water heater Q =1500-0.04P
1. Develop the demand schedule at prices Rs.12,000,

13,000,14,000,15,000 and 16,000
2. if the seller wants to sell 860 units what price he should fix?
Problem 3 on demand equation
An engineering company conducted a study of demand for its component. It found that
the average daily demand (D) in terms of Price (P) is given by equation as D=700-5P
1. How many components per day can be sold at a price of Rs.100?
2. What price it should fix if 100 components to be sold?
3. What is the highest price any one would be willing to pay?
1. Number of components that can be sold at Rs. 100

D=700-5P
700-5(100)
700-500
200 components
2. To sell 100 components what price it should fix?
D=700-5P
100=700-5P
-700-100=5P 800/5= Rs.160
What is the highest price any one would be willing to pay?
D=700-5P
5P=700
700/5=Rs. 140
The demand function for a computer spare part is given as Q=400-4P
1. Determine demand if price is Rs.10, 15 and 20
2. At what price demand would be zero?
3. What price producer would charge if he want to sell 380 units per week?
when price is Rs. 10 Q=400-4P =400-4(10) = 360 units Price Quantity

when price is Rs. 15 Q=400-4P =400-4(15)=340 units 10 360
when price is Rs. 20 Q=400-4P =400-4(20)=320 units 15 340
20 320
The demand would be zero at what price?
Qd=400-4P 0=400-4P 4P=400-0 P=400/4 Rs. 100
What price to be charged if seller wants to sell 380 units?

Qd=400-4P 380=400-4P 4P=400-380 4P=20 P=20/4=Rs.5
The demand function for a software is Qd=3000-5P, where Qd=quantity demanded
P= Price of software
1. Calculate the demand at Rs.150, 250, 325, 400 and 500
2. At what price Qd=0
3. If the seller wants to sell 2500 units, what price he should fix?
1. Calculation of demand at Rs. 150, 250 325, 400 and 500

Qd=3000-5(150)=2250
3000-5(250)=1750
3000-5(325)=1375
3000-5(400)=1000
3000-5(500)=500
2. At what price Qd=0
Qd=3000-5P
0=3000-5P
5P=3000-0
P=3000/5
Rs. 600
3. What price to be fixed if seller wants to sell 2500 units?

Qd=3000-5P
2500=3000-5P
5P=3000-2500
5P=500
P=500/5
Rs. 100
Problems on equilibrium price and quantity:
Problem 1
Given the data: Widgets P=80-Q (demand)
P=20+2Q (supply)
Calculate Equilibrium Price and Quantity
To find the Equilibrium quantity, set both equations equal to each other
80-Q=20+2Q
60=3Q
Q=20
To find equilibrium price substitute Q=20 into one of the equations’
Let us substitute into demand equation
P=80-Q
P=80-20
P=60
Problem 2 on Calculation of Equilibrium Price and Quantity
If Qd = 100-3P and Qs=2P-20

Calculate Equilibrium Price and Equlibrium Quantity
Problem 3 on Calculation Of Equilibrium Price and Quantity
Given demand function Qd=60-3P and Supply function Qs=-40+5P

Problem 4 on calculation of Equilibrium Price and quantity
The demand for water is Qd=100-6P and Qs=28+3P

What is Equilibrium Price and Quantity?
Problem 5
1. Given the data: Radios D=70-Q (demand) P=30+3Q (supply)

What is the Equilibrium Price and Quantity?
Solution:
To find Equilibrium quantity, simply set both equations equal to each other.
70-Q=30+3Q
70-30=4Q
40=4Q
Q=40/4
=10 is Equilibrium quantity.
Now, to find Equilibrium Price simply substitute Q=10 into one of the equations.
P=70-10
=60
OR
30+3(10)
30+30
60
LAW OF DEMAND
The law of demand explains the functional relationship between price of a commodity and quantity demanded.
The law of demand is under Cateris Paribus assumption, which means that only one variable is being changed
while other things being equal or unchanged.
The Law of Demand states that “if the price of a commodity falls, the quantity demanded of it will rise, and
if the price of the commodity rises, its quantity demanded will fall, all other factors affecting demand
remaining constant.”
This shows that there is an inverse relationship between price and quantity demanded. Here price is an
independent factor and demand is dependent factor.
Assumptions of the law: 1) No change in the consumers’ income

2) No change in consumers’ tastes and preferences
3) No changes in the prices of related goods.
4) consumers have perfect knowledge of the market
5) consumers are rational human beings.
EXCEPTIONS TO LAW OF DEMAND
According to law of demand, there exists an inverse relationship between price of a commodity and its
Quantity demanded. However there are certain exceptions to this rule which are :
1. Giffen Goods Y
2. Conspicuous consumption (Veblen Effect)
3. Fear of shortage
4. Fear of future rise in price D
5. Speculation 25
I
PRICE (Rs.)
6. Emergency
20
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15
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10
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5 D
I
O I I
1 2
I
4
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6
I
9
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11
X
QUANTITY DEMANDED (in Kgs)
MOVEMENT ALONG THE DEMAND CURVE
Y Y
D D
A B
8 8
PRICE
PRICE
2 A
2 B
D D
0 X O X
10 KGS 30 KGS 10 KGS 30 KGS
QUANTITY QUANTITY
DEMANDED DEMANDED
DIFFERENCE BETWEEN MOVEMENT ALONG THE DEMAND CURVE AND SHIFT OF THE DEMAND CURVE
BASIS OF DIFFERENCE MOVEMENT ALONG SHIFT OF THE DEMAND

THE DEMAND CURVE CURVE
Meaning Change in the quantity Change in demand
demanded because of because one or more
change in price; other factors influencing
factors remaining demand changes other
constant than price
Effect Expansion and Increase or decrease in
contraction of demand demand
Demand curve Remains the same. Shifts to the right in
Downward movement case of increase in
indicates expansion and demand and to the left
upward movement in case of decrease in
indicates contraction demand.
SHIFT OF THE DEMAND CURVE
INCREASE in Demand Y DECREASE in Demand
Y D1
D
D D1
5 5
PRICE
PRICE
D1
D
D
D1
O X O X
10 KGS 30 KGS 10 KGS 30 KGS
QUANTITY QUANTITY
DEMANDED DEMANDED
Reasons
Reasons
Fall in Income, fall in price of substitutes
Rise in Income, Rise in price of substitutes
Raise in the price of complement,
Fall in the price of complement,
Decrease in population, Change in taste against,
Increase in population, Change in tastes in favour,
Decrease in advertising
Increased advertising
ELASTICITY OF DEMAND
The Law of Demand simply explains the inverse relationship between Price and Demand. In other
words it tells us the direction of change in Price and Quantity demanded.
In order to understand the quantitative changes in Price and Demand, we need to study the
concept of Elasticity of Demand.
Elasticity is an index of reaction.
There are 3 types of Elasticity of Demand

1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross (Price) Elasticity of Demand
Price Elasticity of Demand

It is generally defined as the responsiveness of demand to a given change in price of a commodity.
Price Elasticity of Demand is a ratio of two pure numbers, the numerator is the percentage
change in quantity demanded and the denominator is the percentage change in price of the commodity.
It is measured by using the following formula
Percentage change in quantity demanded

Ep =
Percentage change in price
For example, when quantity demand increase by 80% as a result of 20% fall in price, the Elasticity of Demand
will be
80
Ep = = -4
-20
It implies that at the present level with every change in price, there will be a change in demand four times
inversely.
Generally, the co-efficient of price elasticity of demand always holds a negative sign because there is
an inverse relationship between price and quantity demanded.
THE FIVE DEGREES OF PRICE ELASTICITY OF DEMAND
Y Y Y
D
D
D
5%
PRICE
PRICE
PRICE
10%
D 5%
5% D
10% D
X 5% X
O QUANTITY
O O X
QUANTITY QUANTITY
DEMANDED DEMANDED
DEMANDED
THIS GRAPH IS SHOWING THIS GRAPH IS SHOWING THIS GRAPH IS SHOWING
THE CASE OF THE CASE OF THE CASE OF
RELATIVELY ELASTIC RELATIVELY INELASTIC UNITARY ELASTIC
Numerical co efficient is Numerical co efficient is Numerical co efficient is
Ep > 1 Ep < 1 Ep = 1
Y
Y D
10
PRICE
D
PRICE
D
O X O X
QUANTITY QUANTITY
DEMANDED DEMANDED
THIS GRAPH IS SHOWING THIS GRAPH IS SHOWING
THE CASE OF THE CASE OF
PERFECTLY INELASTIC PERFECTLY ELASTIC
Numerical co efficient is
Numerical co efficient is
Ep = α
Ep = 0
DETERMINANTS OF PRICE ELASTICITY
1. Nature of Commodity – luxurious goods are more elastic to changes in price while necessities like salt, food
etc are inelastic.
2. Number of uses of the commodity – goods which are put to many uses are more elastic.
eg. Steel
3. Tied demand – car and petrol, ink and pen( jointly demanded goods) have less elastic demand than
goods which have independently demanded.
4. Consumer habits – goods which are not used habitually have elastic demand than goods which
are used habitually.
5. Position in consumers’ budget – goods which have a major portion in budget have more elastic demand.
eg. Clothing, provisions, etc.
goods which have a minor portion in budget have less elastic demand.
eg. Salt, sugar,
Problems on price elasticity of demand using proportionate method
Price (Rs.) Quantity Price (Rs.) Quantity Price (Rs.) Quantity Price (Rs.) Quantity
demanded demanded demanded demanded
10 500 10 100 10 100 10 100
15 350 4 150 5 100 5 150
You are provided with the following information

Commodity Original Price New Price Original Demand New Demand
X 10 11 50 45
Y 2 1.2 10 18
Z 90 92 40 35
W 5 4 25 30
1. Find elasticity of demand for each commodity

2. Shows that each commodity obeys law of demand
3. Which commodity has the greatest elasticity and which is the least?
The price of a good decreases from Rs. 6 to Rs. 4 and qty. demanded increases from 10 to 15 units. Find the
price elasticity
∆𝑄 = Q2 – Q1 Q1=Original Quantity - 10 units

∆𝑄 P Q2=New Quantity - 15 units
Formula is ×
∆𝑃 Q Now ∆𝑄 𝑖𝑠 5 𝑢𝑛𝑖𝑡𝑠
∆𝑃 = 𝑃2 − 𝑃1 𝑃1 = original price – Rs. 6

P2 = New price - Rs.4
5 6 Now ∆P is -2
× = -1.5
-2 10
Since it is 1.5, this is the case of Relatively Elastic

price elasticity

Formula is ×

50 10 Now ∆P is -5
× = -1
-5 100
Since it is 1, this is the case of Unitary Elastic

price elasticity

Formula is ×

5 6 Now ∆P is -2
× = -1.5
-2 10

Consider change in demand of a commodity as 20% when price changes by 40%. Calculate Price
Elasticity of demand
Solution=
Ep=
20%
= 0.5
40%
Since it is less than 1 it is Inelastic

The price of an engg component increases by 15% and quantity demanded falls by 25%
Calculate elasticity.
price elasticity

Formula is ×

5 6 Now ∆P is -2
× = -1.5
-2 10

Suppose the price of a good decreases from Rs. 100 to Rs. 50 and qty. demanded increases from 30 to 60 units.
Find the price elasticity

Formula is ×

30 100 Now ∆P is -50
× = -2
-50 30
Since it is 2, this is the case of Relatively Elastic

Income Elasticity of demand may be defined as the ratio or proportionate change in the
quantity demanded of a commodity to a given proportionate change in the income.
Symbolically,
Percentage Change in demand
Ey=
Percentage change in income
Generally speaking, Ey is positive and this is because there is direct relationship

Between income and demand, i.e. higher the income, higher would be the demand
And viceversa.
When Ey is positive, the commodity is normal.

When Ey is negative, the commodity is inferior
When Ey is positive and greater than one, the commodity is luxury
When Ey is positive and less than one, the commodity is essential.
When Ey is zero, the commodity is neutral.
Y
D5 D4
D3
Ey = 0
D1
INCOME
D2
O X
DEMAND FOR GOODS
When income of a consumer increases by 30% demand also increases by 30% what is income
Elasticity of demand?

Ey =
30%
=1
30%
X demands 4units of a product when his income is Rs.2000. when his income increases to Rs.2400 his
Demand increases to 5 units. Calculate income elasticity and name the good.
INCOME ELASTICITY GREATER THAN ONE (Ey > 1) – if income increases say by 25% and demand
increases more than proportionate say by 45% (D2 is the demand curve in the graph) This situation
happens for luxury goods like TVs Fridge, etc.
INCOME ELASTICITY IS EQUAL TO ONE (Ey=1) – if income increases say by 30% and demand
increases by exactly say by 30% (D1 is the demand curve in the graph) this situation falls between
The categories of necessities and luxuries
INCOME ELASTICITY IS LESS THAN ONE (Ey < 1) – if income increases say by 30% and demand
Increases say by 10% (D3 is the demand curve in the graph) This situation happens for necessity goods
ZERO INCOME ELASTICITY (Ey = 0) – Any change in income will not have effect on demand for goods.
(D4 is the demand curve in the graph) This situation can happen for goods like salt, matchbox, etc.
(neutral goods)
INCOME ELASTICITY IS LESS THAN ZERO (Ey < 0)– if with an increase in income there is decrease
in demand.(D5 is the demand curve in the graph) This situation can happen for inferior goods
like ragi, jower, bajara, etc.
PROBLEMS ON INCOME ELASTICITY OF DEMAND
INCOME QTY. INCOME QTY. INCOME QTY.

(Rs.) DEMANDED (Rs.) DEMANDED (Rs.) DEMANDED
400 25 kgs 2000 4 kgs 1000 500 kgs
500 40 kgs 2400 5 kgs 1100 550 kgs
INCOME QTY. INCOME QTY.

(Rs.) DEMANDED (Rs.) DEMANDED
1000 50 kgs 1000 20 kgs
1500 50 kgs 2000 30 kgs
When income of a consumer increases by 20%, the demand also increased by 20%.
Find out income elasticity of demand
The income of a person increases from Rs. 1000 to Rs. 1500 and qty. demanded
remains same at 50. Find the income elasticity and indicate the type of product
∆𝑄 Y Q2=New Quantity - 50 units
Formula is ×
∆𝑌 Q Now ∆𝑄 𝑖𝑠 0 𝑢𝑛𝑖𝑡𝑠
∆𝑌 = 𝑌2 − 𝑌1 𝑌1 = original INCOME – Rs. 1000

Y2 = New INCOME - Rs.1500
0 1000 Now ∆Y is 500
× =0
500 50
Since it is 0, this is the case of Neutral Good.

The Income of a person increases from Rs. 400 to Rs. 500 and qty. demanded
increases from 25 to 40 units. Find the Income elasticity and type of good.
∆𝑄 Y Q2=New Quantity - 40 units
Formula is ×
∆𝑌 Q Now ∆𝑄 𝑖𝑠 15 𝑢𝑛𝑖𝑡𝑠
∆𝑌 = 𝑌2 − 𝑌1 𝑌1 = original INCOME – Rs.400

Y2 = New INCOME - Rs.500
15 400 Now ∆Y is 100
× = 2.4
100 25
Since it is 2.4, this is the case of luxury good

CLASSIFICATION OF WANTS / GOODS
COMFORTS LUXURIES
After satisfying our Means superfluous
NECESSITIES
necessities we desire to consumption. After
They refer to things
have comforts. getting comforts, man
without which we
Eg. Table and Chair for desires luxury. They are
cannot exist. Eg. Water,
a student to increase not essential. Eg. Gold
food, clothing.
the efficiency of & Silver, Costly
learning furniture
CROSS (Price) ELASTICITY OF DEMAND
Cross Elasticity is defined as the proportionate change in the quantity demanded of a
particular commodity in response to a change in the price of another related
commodity.
Percentage change in quantity demanded of commodity X
Symbolically Exy =
Percentage change in the price of commodity Y
The types of cross elasticity of demand are Positive Cross Elasticity

Negative Cross Elasticity
Zero Cross Elasticity
When the goods are substitutes (say coffee and tea) the Cross Elasticity is Positive
When the goods are complementary (say Car and Petrol) the Cross Elasticity is Negative
When the goods are unrelated (say bath soaps and ceiling fans) the cross elasticity is Zero
COMPLEMENTARY GOODS UNRELATED GOODS
SUBSTITUTE GOODS Y D
Y
Y
D D
Exy > 0 Exy < 0 Exy = 0
PRICE PRICE
PRICE OF OF
OF CAR ONIONS
COFFEE
D
D D
O O X O X
DEMAND FOR TEA
X DEMAND FOR PETROL DEMAND FOR MATCH BOX
Cross Elasticity in case of Cross Elasticity in case of
Cross Elasticity in case of Complementary goods Unrelated goods
Substitutes Is NEGATIVE Is ZERO
Is POSITIVE
PROBLEMS ON CROSS ELASTICITY OF DEMAND
BEFORE CHANGE AFTER CHANGE

GOODS
Price per Kg. Qty. demanded Price per Kg. Qty. demanded
A 150 40 150 30
B 15 100 20 80
BEFORE CHANGE AFTER CHANGE

GOODS
Price per Kg. Qty. demanded Price per Kg. Qty. demanded
X 20 400 20 500
Y 30 500 40 300
If the demand for X increases by 5 % when the price of Y increases by 20%, the cross elasticity of
Demand will be
Percentage change in Quantity demanded of commodity X 5%

= + 0.25
Percentage of change in Price of commodity Y 20%
Since it is positive, the goods
Are substitute to each other
The quantity demanded of good A increases by 10% when the price of good B decreases by 20%.
Calculate cross elasticity
Percentage change in quantity demanded of good A 10%

= -0.50
Percentage change in Price of good B -20%
Since there is a negative sign
The goods are complimentary
If there is an increase in the price of a component A from Rs. 15 to 20 and as a result the demand for
component B decreases from 40 to 30. calculate cross elasticity.
∆𝑄𝑏 = Qb 2 – Qb 1 Qb 1=Original Quantity - 40 units

∆𝑄𝑏 Pa Qb 2=New Quantity - 30 units
Formula is ×
∆𝑃𝑎 Qb Now ∆𝑄𝑏 𝑖𝑠 − 10 𝑢𝑛𝑖𝑡𝑠
∆𝑃𝑎 = 𝑃𝑎 2 − 𝑃𝑎 1 𝑃𝑎 1 = original price – Rs. 15

Pa 2 = New price - Rs. 20
-10 15 Now ∆Pa is 5
× = -0.75
5 40
Since it is -0.75, this is the case of complimentarygoods.

If there is an increase in price of product X from Rs. 30 to 40, the demand for product Y increases from 400 to
500 kgs. Calculate Cross Elasticity.
∆𝑄𝑦 = Qy 2 – Qy 1 Qy 1=Original Quantity of y - 400 units

∆𝑄𝑦 Px Qy 2=New Quantity of y - 500 units
Formula is ×
∆𝑃𝑥 Qy
Now ∆𝑄𝑦 𝑖𝑠 100 𝑢𝑛𝑖𝑡𝑠
100 30 ∆𝑃𝑥 = 𝑃𝑥 2 − 𝑃𝑥 1 𝑃𝑥 1 = original price – Rs. 30

× = 0.75 Px 2 = New price - Rs.40
10 400
Now ∆Px is 10
Since it is 0.75 , this is the case of substitute goods

1. If there is an increase in price of an engg component A from Rs.100 to Rs. 125 and as a result the
Demand for engineering component B increases from 10 units to 15 units. Calculate CROSS elasticity and
State whether the goods are substitutes or complements.
2. If there is an increase in price of good X from Rs. 30 to Rs. 40, the demand for good Y increases from 400
to 500 kgs. Calculate cross elasticity and state the goods substitutes or complements.
3. Quantity demanded of commodity X increases from 8 units to 12 units in response to increase in price of
commodity Y from Rs. 23 to Rs. 27. calculate crosss elasticity and name the type of goods.
COMBINED PROBLEM ON PRICE, INCOME AND CROSS ELASTICITY
PROBLEM 1
SUPPOSE DEMAND FOR INKJET PRINTERS IS ESTIMATED TO BE
Q=1000-5P+10Px-2Pz+0.1Y
Where P=80, Px=50, Pz=150, Y=20000
1. What is Price Elasticity of Demand?

2. What is Cross Elasticity of Demand for X?
3. What is Cross Elasticity of Demand for Z?
4. What is income elasticity?
Solution for Problem 1
Q=1000-5P+10Px-2Pz+0.1Y
Q= 1000-5(80)+10(50)-2(150)+0.1(20000)
Q=1000-400+500-300+2000
Q=2800
Ep= ∆Q/∆P X P/Q = -5 X 80/2800= -0.143

Ex=∆Q/∆P X P/Q= 10X 50/2800= 0.179
Ez=∆Q/∆P X P/Q= -2X150/2800= -0.107
Ey=∆Q/∆Y X Y/Q= 0.1X20,000/2800= 0.714
Problem 2
ABC Ltd. Concludes the demand function for Product X is

Qx=1000-0.2Px+0.5Py+0.04Y+0.01A
Where Qx=Quantity demanded of product X
Px=Price of X
Py=Price of Y
Y=Income Calculate
A=Advertisement expenditure 1. Price Elasticity of product X
2. Income elasticity
At present Px=Rs.100 3. Advertisement elasticity
Py=Rs.120
Y=Rs.10,000
A=Rs.6000
Solution for problem 2
Qx=1000-0.2(100)+0.5(120)+0.04(10000)+0.01(6000)
=1000-20+60+400+60
=1500
EPx = ∆Q/∆P X P/Q = -0.2 X 100/1500 = 0.0133

FROM THE TABLE GIVEN BELOW CALCULATE
PRICE OF ‘A’ (RS.) QUANTITY QUANTITY INCOME OF
DEMANDED OF ‘A’ DEMANDED OF ‘B’ CONSUMER (Rs)
(Kgs) (Kgs.)
6 100 20 2000
6.5 90 30 1800
7 70 50 1600
7.5 40 70 1400
8 10 85 1200
1. Calculate price elasticity of demand for ‘A’, if the price of ‘A increases from Rs.7 to Rs.8 per kg.
and indicate whether the demand is elastic or inelastic.
2. Calculate income elasticity of demand for A and B when income of consumers increases from Rs.1400
to Rs. 1800. what type of products A and B?
DEMAND CLASSIFICATIONS/DEMAND DISTINCTIONS
1. DIRECT DEMAND/AUTONOMOUS DEMAND AND INDIRECT DEMAND/DERIVED DEMAND
2. PRODUCERS’ GOODS AND CONSUMERS’ GOODS
3. DEMAND FOR DURABLE GOODS AND DEMAND FOR NON-DURABLE GOODS
4. INDUSTRY DEMAND AND COMPANY DEMAND
5. SHORT RUN DEMAND AND LONG RUN DEMAND
6. JOINT DEMAND AND COMPOSITE DEMAND

POINT METHOD OF ELASTICITY
Y IN THIS GRAPH THE LENGTH OF DEMAND CURVE
A (E=α) HAS EQUAL PARTS AB, BC, CD, DE
*
B (E > 1
*
PRICE C (E=1)
*
D (E<1)
*
E (E=0)
0 * X
QUANTITY DEMANDED
SL Ep* AT DIFFERENT POINTS ON THE DEMAND Ep = LOWER SEGMENT /UPPER PRICE
N CURVE AS SEEN IN THE GRAPH SEGMENT ELASTICITY
O.
1 Ep AT POINT ‘C’(EXACTLY AT THE MIDDLE CE/CA = 2/2 =1 Ep = 1
POINT OF THE DEMAND CURVE)
2 Ep AT POINT ‘D’ (MIDDLE POINT OF CE DE/DA = 1/3 = 0.33 Ep < 1
PORTION OF THE DEMAND CURVE)
3 Ep AT POINT ‘B’ (MIDDLE POINT OF AC BE/AB = 3/1 = 3 Ep > 1
PORTION OF THE DEMAND CURVE)
4 Ep AT POINT ‘E’ (BOTTOM OF DEMAND 0/AE = 0/4 = 0 (ZERO BY Ep = 0
CURVE) ANYTHING IS ZERO, A
MATHEMATICAL PRINCIPLE
5 Ep AT POINT ‘A’ (TOP OF THE DEMAND AE/0 = 4/0 = α (ANYTHING BY Ep = α
CURVE) ZERO BECOMES INFINITY, A
MATHEMATICAL PRINCIPLE)
*Ep is price elasticity
LAW OF SUPPLY
Supply is the “quantity of a commodity which a seller offers for sale in the market at a particular price
And at a particular time”.
Supply is different from stock. Stock is the total quantity of goods which is stored in the warehouse.
Supply is only a part of the stock which is offered for sale.
FACTORS INFLUENCING SUPPLY:
1. Price of the commodity- if price increases, supply will also increase and if the price decreases
supply also decreases. This is because of profit motive by the sellers.
2. Prices of related goods – if prices of other goods increases they become relatively more profitable
to produce and sell than the goods in question. It implies that for example, if the price of automatic
printing machines increases the producers may shift to automatic printing machines production and go
away from producing semi automatic printing machines.
3. Factors of production – if factors of production are very expensive, the cost of production may increase
and may affect the profitability. Hence the prices of factors of production plays an important role
in the supply.
4. Technology – Inventions and innovations tend to make it possible to produce more or better goods
with same resources and tend to increase the quantity supplied of some products and reduce the
quantity supplied of goods that are displaced.
5. Government policy – production of goods may be subject to imposition of taxes, excise duty, etc. these
increases the price of goods. Subsidies, on the other hand, reduce the cost of production and provide incentive
to the firm to increase supply.
The law of supply explains the functional relationship between price of a good and quantity supplies. It states
That “other things being equal (ceteris paribus), the quantity of a good produced and offered for sale will
increase as the price of the good rises and decreases when the price falls”. The law of supply can be
understood with the help of a supply schedule and a supply curve
Y GRAPH SHOWING SUPPLY CURVE

SUPPLY SCHEDULE
PRICE (Rs.) QTY. SUPPLIED

S
100 200 KGS.
500
PRICE
200 400 KGS.
300 600 KGS 400
400 800 KGS. 300
500 1000 KGS. 200

100
S
O I I I I I I I X
200 400 600 800 1000
QUANTITY SUPPLIED
MOVEMENT ALONG THE SUPPLY CURVE
EXTENSION OF SUPPLY CONTRACTION OF SUPPLY

Y
Y
S S
A
P2 B P2
PRICE
PRICE
P1
A B
P1
S S
O X X
Q1 Q2 O Q1 Q2
QUANTITY SUPPLIED QUANTITY SUPPLIED
When a supply of a good increases as a When a supply of a good decreases as a
Result of rise in price. It is known as Extension Result of fall in price. It is known as Contraction
Of supply. In this graph at P1 price Q1 is the Qty and Of supply. In this graph at P2 price Q2 is the Qty and
This is at point A on supply curve SS. When price this is at point A on supply curve SS. When price
Increased to P2 Qty also increased to Q2 and thus Decrfeases to P1 Qty also decreases to Q1 and thus
There is a shift from point A to point B on supply There is a shift from point A to point B on supply
Curve SS (upward) Curve SS (downward)
SHIFT OF THE SUPPLY CURVE
INCREASE IN SUPPLY DECREASE IN SUPPLY
Y Y
S
S1 S1
S
PRICE
5
5
S S1
S1 S
O X O X
REASONS REASONS
1. Fall in the cost of prodn. 1. Rise in the cost of prodn
2. Favourable changes in govt policy 2. Unfavorable changes in govt policy
3. Improved techniques of prodn. 3. Obsolete techniques of prodn.
DIFFERENCE BETWEEN MOVEMENT ALONG THE SUPPLY CURVE AND SHIFT OF THE SUPPLY CURVE
BASIS OF DIFFERENCE MOVEMENT ALONG SHIFT OF THE CURVE

THE SUPPLY CURVE
Meaning Change in the quantity Change in supply
supplied because of because one or more
change in price; other factors influencing
factors remaining supply changes other
constant than price
Effect Expansion and Increase or decrease in
contraction of supply supply
Supply curve Supply curve remains Supply curve shifts
the same. either to the right or to
the left.
DEGREES OF SUPPLY ELASTICITY
Y Y
Y
S S
S
PRICE
PRICE
PRICE
2% 5%
S
5%
5%
S
5% S
O X O 2% X O X
QUANTITY SUPPLIED QUANTITY SUPPLIED QUANTITY SUPPLIED
THIS GRAPH IS THE CASE OF THIS GRAPH IS THE CASE OF THIS GRAPH IS THE CASE OF
RELATIVELY ELASTIC RELATIVELY INELASTIC UNITARY ELASTIC
SUPPLY Es > 1 SUPPLY Es < 1 SUPPLY Es = 1
Y Y
S
PRICE
S
PRICE
6 S
3
S
O X O X
THIS GRAPH IS THE CASE OF THIS GRAPH IS THE CASE OF

PERFECTLY INELASTIC PERFECTLY ELASTIC
SUPPLY Es = 0 SUPPLY Es = α
PROBLEMS ON SUPPLY ELASTICITY
Price (Rs.) Quantity Price (Rs.) Quantity

supplied supplied
(Kgs) (Kgs)
10 500 10 50
15 800 15 75
Solution:
∆S P
X
∆P S
300 10
X
5 500
1.6
EQUILIBRIUM PRICE
A point at which Demand equals Supply is called Equilibrium Price. At equilibrium situation there is
no impact on price. When a demand and supply quantities are drafted on graph, the point
where both curves meet is called Equilibrium Price or Market Clearing Price. This concept can be
understood with the help of a table and graph
Y
Possib Total Total Pressure on price
le S
Demand Supply D
Price (Kgs.) (Kgs.)
(Rs.)
10 1000 10000 downward E EQUILIBRIUM
PRICE
Rs. 5 POINT
8 3000 8000 downward
6 4000 6000 downward
5 5000 5000 Neutral S D
(Equilibrium price)
4 7000 4000 Upward
O 5000 Kgs.
X
3 10000 2000 Upward
QUANTITY DEMANDED AND SUPPLIED
THE FOUR LAWS OF SUPPLY AND DEMAND S
S1
Y D1 Y D
S
D
PRICE
E1 P
P1 E1
PRICE
S
E D1 P1
P S1
S D
D
O X O Q Q1 X
Q Q1
QUANTITY DEMANDED QUANTITY DEMANDED
1. An increase in demand causes an increase 3. An increase in supply causes decrease in

in both equilibrium price and equilibrium equilibrium price and increase in equilibrium
quantity. quantity
2. A decrease in demand causes a decrease 4. A decrease in supply causes increase in
in both equilibrium price and equilibrium equilibrium price and decrease in equilibrium
quantity. quantity.
Calculation of equilibrium Qty. and Equilibrium Price
Problem 1
Suppose the demand and supply equations for an an engineering component is as
given below. Calculate the Equilibrium Price and Equilibrium Quantity.
Qd=100-6P and Qs=28+3P where= Qd is Quantity demanded, Qs is Qty. supplied

P= Price
First let us calculate Equilibrium Price
100-6P = 28+3P
100-28=3P+6P
72=9P
P=72/9=8 Price is Rs.8
Next let us calculate Equilibrium Quantity
Qd=100-6P
We know that P is 8,
Now Qd= 100-6(8)
100-48=52
Next let us calculate Equilibrium Supply

Qs=28+3P
We know that P is 8
Now Qs=28+3(8)
28+24=52
So, Qd=Qs and Price Rs. 8

Problem 2
If quantity demanded of an engg. Item is Qd=100-3P and supplied is Qs=2P-20.
Calculate the Equilibrium price and quantity.
First let us calculate the Equilibrium Price

Qd100-3P=2P-20
100+20=3P+2P
120=5P
120/5=24
Equilibrium Price is Rs. 24 (P=24)
Next let us calculate Equilibrium Quantity

Qd 100-3P
=100-3(24)
100-72=28
Equilibrium Quantity is 28 units
Now let us calculate Equilibrium supply
Qs 2P-20
Qs 2(24)-20
=48-20
28
Equilibrium Supply is 28
Therefore at price Rs. 24 Q=S

Problem 3
You are provided with the following demand and supply equations. With the help of these fill up the blanks and
Show the equilibrium Quantity and Supply at what price? Qd 60-10P=Qs 0+10P
Serial Quantity Rupees Quantity

Number Demanded Supplied (Qs)
(Qd)
1 10 5 50
2 20 4 40
3 30 3 30
4 40 2 20
5 50 1 10
6 60 0 0
First let us calculate Qd and Qs and fill the Serial Number 1

Qd 60-10P Qs 0+10P
60-10(5) 0+10(5)
60-50 = 10 0+50
Qd=10 Qs=50
Next let us calculate Qd and Qs and fill Serial Number 2 (the Price)
Qd= 60-10P Qs=0+10P
20=60-10P 40=0+10P
10P=60-20 -10P=0-40
P=40/10 = Rs. 4 P=-40/-10=Rs. 4
Now let us calculate Qd and Qs and fill Serial Number 3 (the Price)
Qd=60-10P Qs=0+10P
30=60-10P 30=0+10P
10P=60-30 -10P=-30
P=30/10 = Rs. 3 P=-30/-10 = Rs. 3
Next let us calculate Qd and Qs and fill Serial Number 4 (the Price)
Qd=60-10P Qs=0+10P
40=60-10P 20=0+10P
10P=60-40 -10P=0-20
P=20/10 = Rs. 2 P=-20/-10 = Rs. 2
To fill Serial number 5 let us calculate the Qd and Qs
Qd=60-10P Qs=0+10P
Qd=60-10(1) Qs=0+10(1)
Qd=60-10 = 50 Qs=0+10 = 10
Now the last step is to be calculated and fill Rupees and Qd

Qd=60-10P Qs=0+10P
Qd=60-10(0) Qs=0+10(0)
Qd=60-0 = 60 Qs=0+0 = 0
Complete The Table Using The Demand Function and
Supply Function
Qd P Qs
Qd = 500-5P
Qs = -500+10P 49 59
120 170
Where, 100 70
Qd=Quantity demanded 90 30
Qs=Quantity supplied
Problem 3
Suppose, The Quantity Supplied (S) and Quantity Demanded (D) Of An
Engineering Component is
S(P)= -200+50P
D(P)= 1000-25P
Find Equilibrium Price and Quantity
Problem 4
An enginnering company manufacturing a small part has given demand function

Qd=60-3P and supply function Qs=-40+5P.

THEORY OF PRODUCTION
Meaning of production -The term production means transformation of physical “inputs” into physical
“outputs” . The term “inputs” refers to all those things which are required by a firm to produce a
particular product.
In addition to four factors or production, inputs also includes raw materials, power, fuel, transport
Warehousing, banking, etc. Thus the term “inputs” has a wider meaning in economics. What we get
At the end of the productive process is called as “Outputs”. In short output refers to finished products.
Meaning of Production Function- production function expresses the technological or engg relationship
between physical inputs and physical outputs.
A production function can be expressed in the form of a mathematical model Q = f (L, N, K, etc)
Where Q = Quantity of output
LNK, etc = various factor inputs like land, labour, capital, etc.
The rate of output Q is thus a function of the factor inputs LNK etc. employed by firm per unit of time.
Laws of production
Short run
Long run
Law of Variable Proportion
(only labour input is made variable)
Assumptions : Isoquant Analysis Returns to Scale
1. Only one factor is variable while (two variable inputs) (all inputs are variable)
others are constant. Assumptions: Assumptions:
1. There are only 2 1. All factor inputs are
2. All units of variable factor are factor inputs i.e. variable but
homogenous. Labour and Capital enterprise is fixed
3. Technology is constant 2. Technology is 2. Technology is
constant constant
The Law of Variable Proportion
This is one of the most fundamental laws of production. It gives us one
of the key insights to the working out of the ideal combination of Fixed
inputs and Variable inputs.
Additional units of the variable inputs on the fixed inputs certainly mean
a variation in output.
Statement of the Law

As the quantity of different units of only one factor input are increased
to a given quantity of fixed inputs, the Total, Average and Marginal
output varies in different proportions.
The old name of this law is the Law of Diminishing Returns.

BASIS OF DIFFERENCE Law of Variable proportion Law of Returns to scale
Time period Applies in the short run Applies in the Long run
Variable & Fixed Factors Only one variable input factor is All factor inputs are changed
changed all other input factors are simultaneously. No distinction
unchanged like fixed factor inputs and
variable factor inputs.
Stages 1. Increasing returns to factor 1. Increasing returns to scale

2. Diminishing returns to factor 2. Constant returns to scale
3. Negative returns to factor 3. Decreasing returns to scale
Optimum stage Stage 2 is considered to be the There is no stage which is the

optimum stage of production. best in the long run.
TOTAL PRODUCT (TP) is defined as the total quantity of
goods produced with a given inputs.
in short run TP can be increased by employing more
units of a variable factor, where as in the long run
all input factors can be increased.
AVERAGE PRODUCT (AP) is defined as the amount of output
produced per unit of variable factor
AP=total product/input of variable factor.
MARGINAL PRODUCT (MP) is defined as the change in TP
resulting from the employment of additional
unit of a variable factor.
symbolically
MP = CHANGE IN TOTAL PRODUCT/CHANGE IN VARIABLE INPUT
SYMBOLICALLY MP = TPn – TPn-1 difference between TP of the
Present and TP of the previous.
Y
STAGE- 2
STAGE- 3
Units of Total Average Marginal 70 - STAGE- 1
DIMINISHING
NEGATIVE
RETURNS
variable Product Product product (MP) INCREASING RETURNS
input (TP) (AP) 60 - RETURNS
(Labour)
LEVEL OF OUTPUT
1 10 10 10 Stage I 50 -
Increasing
2 24 12 14
Returns 40 -
3 39 13 15 To Factor TP
4 52 13 13 Stage I I 30 -
5 61 12.2 9 Diminishing
Returns 20 -
6 66 11 5 To Factor
10 - AP
7 66 9.1 0
8 64 8 -2 Stage III O I I I I I I I I I I X
Negative
1 2 3 4 5 6 7 8 9 10
Returns
UNITS OF VARIABLE FACTOR
To Factor McGraw-Hill/Irwin Colander, Economics
MP
Behaviour of TP, AP and MP – Law of Variable Proportions
TOTAL PRODUCT (TP) MARGINAL PRODUCT AVERAGE PRODUCT (AP)
(MP)
Stage I : Increases at an Increases and reaches its Increases (but slower
increasing rate. maximum than MP)
Stage II : Increases at a Starts diminishing and Starts diminishing
diminishing rate and becomes equal to zero
becomes maximum.
Stage III : Reaches its Keeps on declining and Continues to diminish but
maximum, becomes becomes negative. must always be greater
constant and then starts than zero.
declining.
PRACTICAL IMPORTANCE OF THE LAW
1. It helps to work out the most ideal combination of factor inputs or the least
cost combination of factor inputs.
2. It is useful to a businessman in the short run production planning at the micro

level.
3. The law give guidance that by making continuous improvements in science and
technology, the producer can postpone the occurrence of diminishing returns.
LAWS OF RETURNS TO SCALE
The law of returns to scale refers to long run production function wherein all factors
of production becomes Variable. There is no distinction between fixed inputs and
variable inputs.
Statement of the law

As a firm in the long run increases the quantities of all factors of production the
output may rise initially at a more rapid rate the than rate of increase in input,
then the output may increase in the same proportion of input and ultimately the
output increases less than proportionately.
This law has three stages as shown in the table:

1. Increasing Returns to Scale
2. Constant Returns to Scale
3. Decreasing Returns to Scale
STAGE 1 – INCREASING RETURNS TO SCALE
When the increase in output is more than proportional to the increase in input, it is referred as
law of increasing to scale.
For example, if labour and capital are increased by 15% and output increases by 25%.
This increase is due to the expansion of the business firm with large scale production and it enjoys
economies of scale.
STAGE 2 – CONSTANT RETURNS TO SCALE

When the increase in output is proportional to the increase in inputs, it is referred as law of
constant returns to scale.
For example, 10% increase in labour and capital will result in an equal proportion of 10% increase
in the output.
This is due to the reason that as a firm expands its output, a stage comes when all economies have
been fully exploited.
STAGE 3 – LAW OF DECREASING RETURNS TO SCALE
When an increase in the output is less than proportional to the increase in inputs, it is referred as
Decreasing
Returns to Scale.
For example, if all factors inputs are increased by 5% the output will increase by 3%.
This is due to diseconomies of scale, lack of coordination, difficulties of management, etc. Hence
due to diseconomies of scale, the management has to use inputs in greater proportions, thus giving
rise to decreasing returns to scale.
LAW OF RETURNS TO SCALE
SCALE LAWS
TOTAL OF RETURNS TO SCALE
PRODUCT MP
(TP)
1L + 3C 2 2
2L + 6C 5 3 I Stage
INCREASING RETURNS
3L + 9C 9 4
4L + 12C 14 5
5L + 15C 19 5 II Stage
6L + 18C 24 5 CONSTANT RETURNS
7L + 21C 28 4
III Stage
8L + 24C 31 3 DECREASING RETURNS
9L + 27C 33 2
McGraw-Hill/Irwin Colander, Economics 128

Y
7—
6—
MARGINAL PRODUCT
5— CONSTANT
B C
4---
3---
2---
A D
1---
O X
2 I 3I 4I 5 I 6 I 7 I 8 I 9
SCALE
McGraw-Hill/Irwin Colander, Economics 129
ECONOMIES OF SCALE
Economies of scale can be defined as “anything which serves to minimize average cost of production
in the long run as the scale of output increases is known as “Economies of Scale”.
Economies of Scale is classified into two broad categories
INTERNAL ECONOMIES EXTERNAL ECONOMIES

1) Labor Economies 1) Economies of Localisation
2) Technical Economies 2) Economies of Information
i) Economies of superior technique 3) Economies of disintegration
ii) Economies of Linked Process
iii) Economies of by-products
3) Managerial Economies
4) Market Economies
5) Financial Economies
6) Risk Minimising Economies
i) By diversification of output
ii) By diversification of market
From Point A to B E>D (Economies is Greater than Diseconomies)
At Point B E=D (Economies = Diseconomies)
From Point B to C E<D (Economies is Lesser than Diseconomies)
C
A
LAC (Rs.)
10,000 Long Run Average Cost Curve

E>D E<D (LAC Curve)
8,000
E=D
7500 * B
X
100 150 300
Output (units)
Meaning of Internal Economies: Internal Economies are those economies which are open to an individual
firm when its size expands.
They emerge within the firm itself as its scale of production expands.
Internal economies are the function of the size of the firm.
Meaning of External Economies: External Economies are those economies which are shared by all the
firms in an industry when their size expands.
They are available for all firms from outside, irrespective of their size and scale of production.
They are the result of the growth and expansion of any particular industry or a group of industries as a whole.
External Economies are function of the size of the industry.

FACTORS OF PRODUCTION
There are mainly four factors of production which help in the production process.
They are LAND, LABOUR, CAPITAL & ENTERPRISE/ORGANISATION.
LAND – refers to soil or earth’s surface. It includes all the free gifts of nature like natural resources,
Fertility of soil, etc.
Its features:
1. Land is free gift of nature

2. Land is limited in area
3. Land lacks mobility
4. Land varies in quality
5. Land differs in value
6. Land is the primary and passive factor of production
LABOUR-refers to all kinds of human efforts (both physical and intellectual) which result in the production
For which monetary paymants are made. Thus the services of a doctor, engineer, lawyer, accountant, etc
Are all considered to be labour.
Its features:
1. Labour is perishable
2. It is inseparable from the labourer
3. It differs in efficiency
4. Labour has imperfect mobility
CAPITAL-refers to all man made goods which can be used for further production. For example, plant, machinery
Dams and canals, equipment, etc. are all known as capital. Capital has been defined as ‘produced means of
Production’. This is because unlike land and labour which are primary factors of prodn, capital is produced by man
To help in the production of further goods.
Money is regarded as capital because it can be used to buy rawmaterials, tools, machinery, equipments, etc. for
Production.
The terms capital and wealth are not synonyms.
Capital is that part of wealth which is used for further production of wealth.
Thus, all wealth is not capital, but all capital is wealth.
Its types:
1. Fixed capital- refers to durable capital goods which used in prodn again and again till they wear out.
example, Machinery, Tools, etc.
2. Working capital-refers to capital used to buy rawmatersls and to meet the day to day expenses.
3. Human Capital-refers skills, knowledge and abilities possessed by individuals
4. Intangible capital-refers to some benefits and rights, which cannot be perceived by senses.
example, copyright, patent, etc.
ENTREPRENEUR or ENTERPRISE- An entrepreneur is a person who combines the three factors of
production Land, Labour and Capital in the right proportion and initiates the process of production
and also bears the risk Involved in it. The entrepreneur is also called as an ‘Organiser’.
Functions of an Entrepreneur:
1. Starting a business and resource mobilization-an entrepreneur collects the different factors of
production like land, labour and capital and coordinates them in order to initiate a business
Enterprise.
2. Risk and Uncertainty – an enterprise operates in a constantly changing environment. Thus it

depends on the ability of entrepreneur to bear risks. An entrepreneur has to bear risks because of
uncertainty of the future.
3. Innovations-the actual function of an entrepreneur is to bring innovations. Innovation includes

introduction of new production methods, utilization of new sources of raw materials, introduction
of New products, opening of new markets, etc.
Problem on production theory
M/s Reliable Enterprises has found that the most profitable output occurs when they produce
Rs. 17,200 worth of output of a particular product. They can choose from three possible
Techniques A, B and C that will produce the desired level of output. The table below shows
The amount of inputs these techniques use along with each input price.
Price of input Input Production Techniques
per unit
A (units) B (units) C (units)
Rs. 100 Land 70 40 10
Rs. 20 Labour 60 70 180
Rs.150 Capital 20 60 30
Rs. 80 Entrepreneurship 10 20 20
If Reliable Enterprises chooses technique ‘C’ for production, is this choice correct?
What will be the maximum profit?
If the price of labour increases to Rs. 40 per unit, which technique now they should choose?
How will their profit be affected?
Theory of cost
Cost of production refers to total money expenses incurred by the producer in the process
Of transforming inputs into outputs.
In other words, it refers to the total money expenses incurred to produce a particular
Quantity of output by the producer.
The knowledge of various cost concepts in cost analysis is important for a business manager/Production
engineers.
Uses of cost analysis
1. To findout the most profitable rate of operation.
2. To determine the quantity of output to be produced.
3. To locate weak points in production management to minimize cost.
4. To fix the price for the product.
5. To have a clarity about various concepts.
Cost-output relationship
Cost and output are correlated. Cost output relations play an important role in almost all
Business decisions. It throws light on cost minimization and profit maximization.
Cost output relationship is studied in two forms; short run and long run.
In producing products a firm has to use various inputs like fixed inputs and variable Inputs.
Fixed inputs are those which remain unchanged over a period of time. Example land,
Building, machinery etc.
Variable inputs are those which varies along with the level of output. Example
Raw material, direct labour, etc.
The cost incurred on fixed inputs are known as Fixed cost. These costs never varies with the level
Of outputs.
Example, rent, licence fee, interest on borrowed funds, managers salary, etc.
The cost incurred on variable inputs are known as variable cost. These cost varies along with the
Level of output.
Example, raw material, direct labour, etc.
In the cost analysis only in the short run we classify inputs into fixed and variable.
In the long run all inputs are considered as variable inputs.
Short run cost schedule
OUTPUT TOTAL TOTAL TOTAL AVERAGE AVERAGE AVERAGE MARGINAL
(Q) FIXED VARIABLE COST (TC) FIXED VARIABLE TOTAL COST (MC)
COST (TFC) COST (TVC) COST (AFC) COST (AVC) COST (ATC)
0 300 0 300 300 0 300 -
1 300 300 600 300 300 600 300
2 300 400 700 150 200 350 100
3 300 450 750 100 150 250 50
4 300 500 800 75 125 200 50
5 300 600 900 60 120 180 100
6 300 720 1020 50 120 170 120
7 300 890 1190 42.9 127.1 170 170
8 300 1100 1400 37.5 137.5 175 210
9 300 1350 1650 33.3 150 183.3 250
10 300 2000 2300 30 200 230 650
Y TC TVC
Cost of production formulas
TC = TFC + TVC
TFC = TC – TVC or AFC X Q
COST
TVC = TC – TFC or AVC X Q
AFC = AC – AVC or TFC/Q
AVC = AC – AFC or TVC/Q

Rs.300 TFC
AC = AFC + AVC or TC/Q
MC = TCn – TCn-1 O X
OUTPUT
AVERAGE FIXED COST (AFC) is the fixed cost per unit of output. When TFC is divided by total units of output, we
Get AFC
AFC and output have inverse relationship. It is higher at smaller level of output and lower at the higher
Level of output.
It is pure mathematical result that the numerator remaining unchanged the increasing denominator causes
Diminishing product.
COST
AFC
OUTPUT
AVERAGE VARIABLE COST (AVC)
AVC is variable cost per unit of output. AVC can be

Computed by dividing the TVC by total units of output.
Thus, AVC=TVC/Q. AVC CURVE IS ‘U’ SHAPED
AVC will come down in beginning and then rise as more
COST OF PRODUCTION
units of output are produced with a given plant.
This is because as we add more units of variable
factors in a fixed plant, the efficiency of inputs first
increases and then it decreases.
AVC curve is “U” shaped and it has 3 phases.
1. Decreasing Phase – in the graph from A to B, AVC
decreases. As output expands, AVC decreases because
when we add more units of variable factors to a given B
Fixed factors output increases more efficiently and
More than proportionately due to increasing returns. OUTPUT
2. Constant Phase – in the graph at point “B” AVC reaches its minimum point. When the proportion of
both fixed and variable factors are the most ideal, the output will be the optimum.
3. Increasing phase – in the graph from B to C, AVC rises. This is because additional units of variable
factors will not result in more than proportionate output. Hence greater output is obtained at higher
AVC
AVERAGE TOTAL COST (ATC) / AVERAGE COST (AC)
ATC can be obtained by dividing the TC by total

Output. Thus AC=TC/Q.
In the short run AC tends to be ‘U’ shaped.
The combined influence of AFC and AVC curves
Cost of production
Will shape the nature of AC curve.
As long as the falling effect of AFC is much more
than the rising effect of AVC, the AC tends to fall.
At this stage increasing returns and economies
Of scale operate.
When the firm produces optimum output, AC will
Become minimum. Again at the point where the
Rise in AVC exactly counter balances the fall in AFC,
The balancing effect causes AC to remain constant.
In third stage when the rise in AVC is more than drop output
in AFC, then AC shows a rise. When output is
expanded beyond the optimum level diminishing returns set in and diseconomies of scale starts
operating. The short-run AC curve is also called as “plant curve”
RELATION BETWEEN AVERAGE COST (AC) AND MARGINAL COST (MC)
1. Both AC and MC fall at a certain range of output and rise
afterwards. Y
2. When AC falls, MC also falls but at certain range of output.
MC tends to rise even though AC continues to fall. AC
However, MC would be less than AC. This is because MC
is attributed to a single marginal unit whereas in case of AC MC
the decreasing AC is distributed over all the units of
COST
output produced.
3. So long as AC is falling, MC is less than AC. Hence, MC curve
lies below AC curve, which indicates that fall in MC is more
than the fall in AC.
4. When AC is rising, after the point of intersection, MC will
be greater than AC.
5. So long as AC is rising, MC is greater than AC. Hence MC curve
lies to the left side of the AC curve, which indicates that MC is
O X
OUTPUT
more than the rise in AC.
6. MC cuts AC curve at minimum point of the AC curve only. This is because when MC decrease, it pulls AC
down and when MC increases, it pushes AC up. When AC is at its minimum it is neither being pulled
down nor being pushed up by MC. MC=AC. The point of intersection is least cost combination.
Complete the following table
OUTPUT TC MC TFC TVC AFC AVC AC

0 250
1 100
2 210
3 220
4 510
5 60
6 100
7 60
8 590
OUTPUT TC MC TFC TVC AFC AVC AC
0 250 0 250 0 250 0 0
1 350 100 250 100 250 100 350
2 420 70 250 170 125 85 210
3 470 50 250 220 83.3 73.3 156.6
4 510 40 250 260 62.5 65 127.5
5 550 40 250 300 50 60 110
6 600 50 250 350 41.6 58.3 100
7 660 60 250 410 35.7 58.5 94.28
8 840 180 250 590 31.25 73.75 105
COMPLETE THE FOLLOWING TABLE
OUTPUT AFC ATC AVC MC

1 140 50
2 45
3 45
4 48
5 18 52
COMPLETE THE FOLLOWING TABLE
OUTPUT AFC ATC AVC MC

1 90 140 50 50
2 45 90 45 40
3 30 75 45 45
4 22.5 70.5 48 57
5 18 70 52 68
SAMPLE PROBLEMS ON COST ANALYSIS
PROBLEM 1
Excel engineers have provided the following information:
Output 0 1 2 3 4 5 6 7 8
(in units)
Total Cost (Rs.) 400 480 550 590 620 650 730 820 950
Calculate TVC, AFC, AVC, and MC
PROBLEM 2
A manufacturing firm incurs a TFC of Rs. 120. with the help of the information given below calculate:
TVC, AVC, TC, AFC, AC
Output 0 1 2 3 4 5 6
(in
units)
Marginal -- 60 20 10 15 35 70
Cost
(Rs.)
Solution to Problem 1
(TFC+TVC) (TC-TVC) (TFC/Q) (TC-TFC) (TVC/Q) (TCn – TCn-1))

OUTPUT TOTAL COST TOTAL FIXED AVERAGE TOTAL AVERAGE MARGINAL
(Q) (TC) COST (TFC) FIXED COST VARIABLE VARIABLE COST (MC)
(AFC) COST (TVC) COST (AVC)
0 400 400 - - - -
1 480 400 400 80 80 80 (480-400)
2 550 400 200 150 75 70 (550-480)
3 590 400 133.3 190 63.3 40 (590-550)
4 620 400 100 220 55 30 (620-590)
5 650 400 80 250 50 30 (650-620)
6 730 400 66.6 330 55 80 (730-650)
7 820 400 57.14 420 60 90 (820-730)

Output (Q) TOTAL MARGINAL AVERAGE TOTAL AVERAGE TOTAL AVERAGE

FIXED COST (MC) FIXED VARIABLE VARIABLE COST (TC) TOTAL
COST COST COST COST COST (ATC)
(TFC) (AFC) (TVC) (AVC)
0 120 - - - - 120 -
1 120 60 120 60 60 180 180
2 120 20 60 80 40 200 100
3 120 10 40 90 30 210 70
4 120 15 30 105 26.25 225 56.25
5 120 35 24 140 28 260 52
6 120 70 20 210 35 330 55

Problem 3
Problem 4
With the help of the following
Find out the TC, AFC, AVC, AC,and MC of a firm
data calculate TFC, TVC, TC, AFC
With the help of the given data below.
AVC and MC
OUTPUT AVERAGE OUTPUT TFC TVC
COST (AC) 0 100 0
0 300 1 100 50
1 350 2 100 90
2 190 3 100 120
3 180 4 100 140
4 180 5 100 175
5 190 6 100 230
6 200 7 100 310
Solution For Problem 3
TFC TVC TC AFC AVC MC
300 - 300 - - -
300 50 350 300 50 50
300 80 380 150 40 30
300 240 540 100 80 160
300 420 720 75 105 180
300 650 950 60 130 230
300 900 1200 50 150 250
TC AVC AFC AC MC
100 - - - -
150 50 100 150 50
190 45 50 95 40
220 40 33.3 73.3 30
240 35 25 60 20
275 35 20 55 35
330 38.3 16.6 55 55
410 44.28 14.2 58.5 80
Problem 5
The Fixed cost is Rs. 20. TVC is as follows:
OUTPUT TVC (Rs.)

(UNITS)
1 30
2 56
3 75
4 80
5 105
6 132
7 182
Calculate TC, AFC, AVC, AC and MC

TFC (Rs.) TC (Rs.) AFC (Rs.) AVC (Rs.) AC (Rs.) MC (Rs.)

20 50 20 30 50 -
20 76 10 28 38 26
20 95 6.67 25 31.6 19
20 100 5 20 25 5
20 125 4 21 25 25
20 152 3.3 22 25.3 27
20 202 2.85 26 28.8 50
PROBLEM 4 PROBLEM 5
XYZ Engineers provided the following M/s. Instrumentation Engineers have
information. provided the following cost data.
Calculate TFC, TVC, AC and MC. Calculate TVC, AFC,AVC, AC and MC.
Give a graphic illustration
to explain the relationship between OUTPUT TC
Output and TC. (Rs.)
OUTPUT TC (Rs.) 0 360
0 150 1 540
1 200 2 600
2 240 3 630
3 270 4 675
4 360 5 780
5 400 6 990
OUTPUT TOTAL TFC TVC AC MC

COST
0 150 150 - - -
1 200 150 50 200 50
2 240 150 90 120 40
3 270 150 120 90 30
4 360 150 210 90 90
5 400 150 250 80 40
SOLUTION FOR PROBLEM 5
OUTPUT TC TFC TVC AFC MC AC AVC

(Rs.)
0 360 360 - - - - -
1 540 360 180 360 180 540 180
2 600 360 240 180 60 300 120

360 270 120 30 210 90
3 630
4 675 360 315 90 45 168.75 78.75
5 780 360 420 72 105 156 84

6 990 360 630 60 210 165 105
ECONOMIES OF SCALE
Economies of scale can be defined as “anything which serves to minimize average cost of production
In the long run as the scale of output increases is known as “Economies of Scale”.
Economies of Scale is classified into two broad categories
INTERNAL ECONOMIES EXTERNAL ECONOMIES

1) Labor Economies 1) Economies of Localisation
2) Technical Economies 2) Economies of Information
i) Economies of superior technique 3) Economies of disintegration
ii) Economies of Linked Process
iii) Economies of by-products
3) Managerial Economies
4) Market Economies
5) Financial Economies
6) Risk Minimising Economies
i) By diversification of output
ii) By diversification of market
Meaning of Internal Economies: Internal Economies are those economies which are open to an individual
firm when its size expands.
They emerge within the firm itself as its scale of production expands.
Internal economies are the function of the size of the firm.
Meaning of External Economies: External Economies are those economies which are shared by all the
firms in an industry when their size expands.
They are available for all firms from outside, irrespective of their size and scale of production.
They are the result of the growth and expansion of any particular industry or a group of industries as a whole.
External Economies are function of the size of the industry.

REVENUE CONCEPTS
Revenue means the sale receipts of the output produced by the firm. It depends on the market price.
The amount of money which the firm receives by the sale of its output in the market is known as Revenue.
Revenue concepts are 3 in number: Total Revenue (TR), Average Revenue (AR) and Marginal Revenue (MR).
Total Revenue: TR refers to the total amount of money that the firm receives from the sale of its products.
i.e. gross revenue. TR = f(q), this implies that higher the sales, larger would be the TR and vice-versa.
TR is calculated by multiplying the quantity sold by its price, thus, TR=P X Q.
for example, a firm sells 5000 units of a product at the rate of Rs.5 per unit, then TR would be
TR = P X Q = 5 X 5000 = 25,000.
Average Revenue: AR can be obtained by dividing the TR by number of units sold. Then AR = TR/Q
for example a firm sells 15 units of a product and gets TR Rs. 150, then AR would be
AR= TR/Q= 150/15=10.
Marginal Revenue: refers to the additional revenue earned by selling an additional unit of a product by
the seller. For example, let us suppose, a seller earns a TR of Rs. 500 by selling 100 units
of a product. Suppose by selling 101 units in all, the seller earns Rs. 508. In this case, Rs.8
constitutes MR, because it is the addition made to TR.
thus, MR=TRn – TRn-1= Rs.508-500=Rs.8 is the Marginal Revenue
Behaviour of TR, AR and MR and Relationship between TR, AR and MR in Monopolistic
Competition and Oligopoly
30 --
Number Total Average Marginal TR

of Units Revenue Revenue Revenue 20 --
Sold (TR) (AR) (MR)
1 10 10 - 10 --
Revenue
2 18 9 8 I I I I I I I I
1 2 3 4 5 6 7 8
3 24 8 6 Number of Units
4 28 7 4 30 --
5 30 6 2
6 30 5 0 20 --
7 28 4 -2 AR
10 --
I I I I I I I I
MR
1) A firm can sell large quantities only at lower prices. In that case, AR falls and when AR falls
MR will also falls. But fall in MR is more than the fall in the AR. Hence the MR curve lie below
The AR curve.
2) TR increases as more units are sold but at a diminishing rate.
3) TR is the highest when MR is zero
4) TR falls when MR becomes negative.

5) AR and MR both declines. But fall in MR will be greater than the fall in AR
This pattern of behavior can happen in Monopolistic Competition and Oligopoly. But in case of Perfect
Competition the behavior of TR AR and MR is different. Next slide explains
Under perfect competition condition an individual firm
Price per unit Rs. 8=00 Cannot influence the market price. The market price is
Determined by the interaction between demand and supply
Number Total Average Marginal Forces. A firm can sell any number of units of goods at the
of Units Revenue Revenue Revenue Existing market price.
Sold (TR) (AR) (MR) Hence the TR of the firm would increase Proportionately
with the output sold.
1 8 8 - The AR remains constant. Since the market price of it is
2 16 8 8 Constant without any variation due to changes in the
Units sold by individual firm, the extra units would fetch
3 24 8 8 The proportionate revenue.
Hence AR and MR will be equal to each other and remain
4 32 8 8 Constant. This will be equal to price.
5 40 8 8 Y
6 48 8 8
7 56 8 8
AR=MR=Price
O X
Output
Hence, under perfect competition, the AR curve will be a horizontal straight line and paralled to OX axis.
This is because a firm has to sell its product at the constant existing market price.
Since the seller is Price Taker (Since he cannot influence price)
Hence AR=MR=Price
But in other types of market structures like Monopolistic competition, Oligopoly and Monopoly
The seller can influence is price and hence he is a Price Maker
MEANING OF MARKET AND BASIS OF CATEGORISATION OF MARKET

A market refers to a wide range of area where the buyers and sellers come into close contact with
One another for the settlement of their transactions.
BASIS FOR CATEGORISING MARKET
AREA VOLUME OF BUSINESS COMPETITION

Local market Whole sale market Perfect competition
Regional Market Retail market Monopolistic competition
National market Oligopoly
Global market
BREAK EVEN ANALYSIS (BEA)
The BEA helps in understanding the relationship between revenues and costs of a
firm in relation to its volume of sales.
It helps in determining the volume at which the firm’s cost and revenue are in
equilibrium.
It is a technique which helps to analyse the effect of change in the level of
production and total profit of a company.
The BEA establishes the relationship between cost, volume and profits. Hence it is
also known as “Cost-Volume-Profit analysis”.
In BEA more prominence to identify the Break Even Point (BEP).
BEP refers to that level of sales volume at which there is neither profit nor loss,
Costs being equal to its sales value and the contribution is equal to fixed costs.
BEP is defined as “that level of sales at which the total revenue is equal to total costs
and the net income is equal to zero.
Break even chart and diagrammatic representation
Selling Price is Rs. 4 per unit

Output Total Revenue Total Fixed Total Variable Total Cost
(TR) Cost (TFC) Cost (TVC) (TC)
0 0 300 0 300
100 400 (100 x 4) 300 300 600
200 800 (200 x 4) 300 600 900
300 1200 (300 x 4) 300 900 1200
400 1600 (400 x 4) 300 1200 1500
500 2000 (500 x 4) 300 1500 1800
600 2400 (600 x 4) 300 1800 2100
TR
Y
TC
Total Cost and Total Revenue
PROFIT ZONE
LOSS ZONE
BEP
1200--
300 -- TFC
O I I I I I i X
100 200 300 400 500 600
Output
CALCULATION OF BREAK EVEN POINT
The two methods of calculation of BEP are 1) BEP in terms of physical units 2) BEP in terms of sales value
BEP in terms of physical units is suitable for a firm producing a single product.
BEP in terms of sales value is suitable for a firm producing multi products.
Illustration for calculating BEP in terms of physical units
Selling Price Rs. 15 per engg component

Variable cost Rs. 10 per engg component
Total Fixed cost (TFC) Rs. 1,50,000
First step is to calculate Contribution Margin (CM)

Selling Price per unit – Variable cost per unit.
Rs. 15 – Rs. 10 = Rs. 5 is the CM
TFC Rs. 1,50,000
Now, BEP = = = 30,000 Units
CM Rs. 5
Hence, the firm reaches BEP by producing 30,000 units
Illustration for calculating BEP in terms of sales value
This method is useful for a firm producing multi products
Total Sales Value Rs. 10,000 (TR)

Total Variable Costs Rs. 6,000 (TVC)
Total Fixed Cost Rs. 3,000 (TFC)
First step is to calculate Contribution Ratio
TR – TVC Rs. 10,000 – Rs. 6,000

= 0.4 (CR)
=
TR Rs. 10,000
It implies that for every one rupee sales value the TFC is 0.40 paise
TFC Rs. 3,000
Now BEP = = = Rs. 7,500
CR 0.4
Hence it is clear from this calculations that at sales value of Rs. 7500 (BEP)
There is no profit and no loss.
BREAK EVEN CONCEPT HELPS IN MAKE OR BUY DECISIONS
Some firms often make certain components or ingredients which may be a part of their finished
product
The break even concept helps the firm to take a decision whether it will be more profitable to produce
or purchase from outside manufacturer or supplier for final assembly of the finished product.
Illustration No.1
A firm purchases certain components at Rs. 10 each. In case it makes itself, its TFC is Rs. 12,000 and
Variable Cost is Rs. 4 per unit, should a firm Make or Buy.
TFC Rs. 12,000
BEP = = = 2000
Price – VC (CM) Rs. 10 - 4
Hence, if the firms requirements is less than 2000 units then it is profitable to buy than to manufacture them
Illustration No 2
An engineering firm buys certain components for producing a component at Rs. 20 per unit. If he has
to make these components, it would require a TFC Rs. 15,000 and VC Rs. 5. His present requirement is
1000 units of these components.
Advise him whether he should make or buy them, if he intents to double the output.
Solution
TFC Rs. 15000

BEP = = = 1,000
Price - VC Rs. 20 – Rs. 5
Hence, at 1,000 units requirement it makes no difference whether the firm buys or makes the components
But when requirement increases, it is profitable to make the components.
SAMPLE PROBLEMS FOR CALCULATING BREAK EVEN POINT
PROBLEM 1
A firm incurs fixed cost of Rs. 4000 and variable cost of Rs. 10000 and its total sales receipts are
Rs.15000. determine Break even point.
PROBLEM 2
M/s. Gayatri Engineering furnishes the following information.. On the basis of the information
a) Find BEP in physical units and BEP in sales value
b) Show the amount of Variable Cost at BEP
c) Profit made by the company at 20,000 units when the selling price is increased by 25%.
Annual Sales 20,000 units

Selling Price Rs. 8.00
VC Rs. 6.00
TFC Rs. 60,000
Solution to problem 1
First let us calculate CR
CR=TR-TVC/TR
= Rs. 15,000-Rs. 10,000/Rs. 15,000
=0.33
Next let us calculate Break even sales

BE Sales=TFC/CR
=Rs.4,000/0.33
=Rs. 12,121
Solution to problem 2
a) First let us calculate CM
SP-VC
Rs.8-Rs.6=Rs.2
Next let us calculate BEP in Physical Units.
TFC/CM = Rs.60000/2 =30,000 units
Now BEP in Sales Value is TR-TVC/TR

Rs.1,60000-1,20000/Rs.1,60000=0.25
BEP in sales value is TFC/CR=Rs.60,000/0.25=Rs.2,40,000
c) Profit made by the company at 20,000 units when Selling Price is increased by 25%
Total Revenue = SP X 20,000 = Rs.10 X 20,000 units Rs.2,00,000
Total Cost (TFC+TVC)
Rs.60,000+Rs.1,20,000 Rs.1,80,000 (-)
Profit is Rs.20,000
Problems to calculate Break Even using TR and TC functions.
Problem 1
Given the TC and TR functions, calculate Break Even. TC Rs.12000+5Q TR 8Q
12000=-5Q+8Q
12000=3Q
Q=12000/3=4000 units.
Problem 2
An engineering firm has provided the following TR and TC functions, You are
required to calculate BEP.
TC Rs. 54000+15Q TR 20Q
54000=-15Q+20Q
54000=5Q
Q=54000/5=10800 units.
Problem 3
Given the TR & TC functions, determine the Break Even Point
TC 480+10Q, = TR 50Q
480=-50Q+10Q
480=40Q
Q=480/40
12 units
Problem 4
Given the TR and TC functions, calculate Break Even Point
TC 300+3Q=TR 4Q
300=3Q
PROBLEM 3
ABC Enterprises with annual sales of small ball bearings 8000 units. It is selling at Rs. 9.50 per unit.
The TFC of the company is Rs. 18000 and VC per unit is Rs. 6.50. on the basis of above calculate:
a) BEP in physical units and sales value in rupees.
b) Show the amount of VC at BEP.
c) Profit made by the company at 8000 units.
PROBLEM 4
Expert Engineering Pvt. Ltd. Manufactures automobile lamps and sells them at Rs. 25 per unit.
And average Variable cost is Rs. 13 per unit. Their fixed cost is Rs. 12,000.
Determine a) Break even sales
b) Firm’s profit if its normal production capacity of 2000 lamps.
PROBLEM 5
Premier Engineering Co. incurs a FC of Rs. 4000 and VC of Rs. 10000 and its total sales receipts
Are Rs.15000. Determine Break Even point.
Solution for Problem 3
a) BEP in physical units= TFC/CM=Rs.18000/3=6000 units
BEP in sales value CR=TR-TVC/TR=Rs.76000-Rs.52000/Rs.76000=0.32
TFC/CR=Rs.18000/0.32=Rs.56250
b) Amount of VC at BEP= 6000 units X Rs. 6.50 =Rs.39,000
c) Profit made by the company at 8000 units

Total Revenue 8000 units X Rs. 9.50 = Rs 76,000.
Total Cost
TFC+TVC = Rs.18000+52,000 = Rs.70,000 (-)
Profit Rs. 6,000

Time Value of
Money and
Depreciation
Engineering Economics
Cost of Money IRR Method Depreciation
Factors and
Interest Rate of return
methods of
Formulas method
Depreciation
Topics
Payback
Present Value
period method
Internal Rate
Future Value of Return
method
TIME VALUE OF MONEY (TMV)
TMV refers to “time has got a value’. The rupee value keeps on changing over a period
of time.
The concept TMV refers to the money received today is different in its worth from the
money receivable at some other time in future.
In other words, TMV is its rate of return which the firm can earn by reinvesting its
present money.
Reasons for time preference for money

1) Risk
2) Inflation
3) Present consumption and satisfaction.
There are two techniques of calculation of TMV
1) Compounding technique: Future Value
2) Discounting technique: Present Value
Compounding technique is used to find out the future value of present money.
Here the interest earned in preceding year is reinvested at prevailing rate of interest for
the next period.
The compounding technique is to find out Future Value of present worth of can be
explained in 3 ways.
1) Future Value of Single Cash Flow
2) Future Value of Annuity/Series of Cash Flows
3) Future Value of Multiple Cash Flows.
Future value (FV) of single present cash flow can be:
a) In case of Annual Compounding
Problem 1
Calculate the FV of Rs. 2000, if it is invested @ 8% interest per year
Formula is FV=PV(1+r)n
Where FV=Future Value
PV=Present Value
r= Rate of interest
n= Number of years
Solution
FV=? FV=2000(1+0.08)1
PV=Rs.2000 =2000(1.08) 1
r=8% or 0.08 =Rs.2160
n= 1 year
Problem 2
Calculate the compounding value of Rs. 4000 if it is invested at 12% for two years.
Problem 3
Calculate the future sum of money if it is invested at 10% for four years of Rs. 25000
Problem 4
Arun deposits Rs. 10000 in a bank which pays 8% interest compounded annually for 8
years. Calculate the amount
To be received after 8 years.
b) In case of multiple compounding
In this method if the compounding period varies, interest earned will also vary, viz., if the
Interest Is compounded semi-annually (2), quarterly (4) or monthly (12), such future value is
calculated by using the Following formula
Where, FV=Future Value

mn PV=Present Value
( i
FV=PV 1+ m ) i=Rate of Interest
m=number of times interest is compounded in a year
n=Number of years
Problem 1 on Multiple Compunding
Calculate the future value of sum of Rs. 2000 if it is invested for a year with compounding
period of semi annually at 10%.
Solution
FV = ?
PV=2000 (0.1
FV=2000 1+ 2 ) 2X1
i=10% or 0.1
m=2 =2000(1+0.05)2
n=1 =2000(1.05) 2
=2000(1.1025)
FV=2205
Problem 3 on Multiple Compounding
Calculate the Future Value of Rs. 1000 if it is invested for 1 year with a compounding
period of quarterly
At 10%

National bank pays 10% interest compounded half yearly, if Rs. 100000 is deposited
initially how much
It shall grow at the end of 5th year?

Indian bank pays 12% interest compounded quarterly, if Rs. 1000 is made as an initial
deposit, how much
It will be at end of 5th year.
Future Value of Annuity of Cash flows (Series of Equal cash flows)
Annuity is even cashflows of a certain period of time
Annuity is fixed payment each year for a specified number of years.
Formula= FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 ……………………………
Where, FVA=Future Value of Annuity

R=Even cash flows
i=interest rate
n= number of years.
Problem 1
Calculate the FVA of Rs. 4000 deposited at end of each year at 6% for a period of 5 years.
FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 + R(1+i)n-4 + R(1+i)n-5

=4000(1+0.06)5-1+4000(1+0.06)5-2+4000(1+0.06)5-3+4000(1+0.06)5-4+4000(1+0.06)5-5
=4000(1.06)4+4000(1.06)3+4000(1.06)2+4000(1.06)1+4000(1.06)0
=4000(1.262)+4000(1.191)+4000(1.123)+4000(1.06)+4000(1)
=5048+4764+4494+4240+4000
FVA=22,546
Problem 2
Kumar deposits Rs.6000 at the end of every year for 5 years and the deposit earns
compound interest @ 12% per annum. Caluculate how much money he will have
at the end of five years.
Future Value of Annuity of Cash flows (Series of Equal cash flows)
Annuity is even cashflows of a certain period of time
Annuity is fixed payment each year for a specified number of years.
Formula= FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 ……………………………
Where, FVA=Future Value of Annuity

R=Even cash flows
i=interest rate
n= number of years.
Problem 1
Calculate the FVA of Rs. 4000 deposited at end of each year at 6% for a period of 5 years.
FVA=R(1+i)n-1 + R(1+i)n-2 + R(1+i)n-3 + R(1+i)n-4 + R(1+i)n-5

=4000(1+0.06)5-1+4000(1+0.06)5-2+4000(1+0.06)5-3+4000(1+0.06)5-4+4000(1+0.06)5-5
=4000(1.06)4+4000(1.06)3+4000(1.06)2+4000(1.06)1+4000(1.06)0
=4000(1.262)+4000(1.191)+4000(1.123)+4000(1.06)+4000(1)
=5048+4764+4494+4240+4000
FVA=22,546
Problem 2
Kumar deposits Rs.6000 at the end of every year for 5 years and the deposit earns
compound interest @ 12% per annum. Caluculate how much money he will have
at the end of five years.
FUTURE VALUE OF UNEVEN CASH FLOWS
Formula R1(1+i)n-1+R2(1+i)n-2+R3(1+i)n-3……………………………………………
Where, R1, R2, R3……….uneven cash flows
i = Interest rate
n = Number of years.
Problem 1
Calculate FV of the following cash flows, if it invested at 8% interest per annum.
Year Amount deposited

1 500
2 1000
3 1500
4 2000
5 2500
Solution
FVUECF=R1(1+i)n-1+R2(1+i)n-2+R3(1+i)n-3+R4(1+i)n-4+R5(1+i)n-5
=500(1+0.08)5-1+1000(1+0.08)5-2+1500(1+0.08)5-3+2000(1+0.08)5-4+2500(1+0.08)5-5
=500(1.08)4+1000(1.08)3+1500(1.08)2+2000(1.08)1+2500(1.08)0
=500(1.36)+1000(1.26)+1500(1.17)+2000(1.08)+2500(1)
=680+1260+1750+2160+2500
Rs.8355
Problem 2
Calculate the future value at the end of five years of the following series of payment
at 9% interest per annum
1 1000
2 2000
3 3000
4 4000
5 5000 Answer Rs.16920
Problem 3
Calculate the future value at the end of five years of the following series of payment at 10%
Interest per year.
1 2000
2 2500
3 3000
4 3500
5 4000 Answer 17725
Discounting Technique or Present Value technique
This method is reverse of compounding technique.
This method helps to find out the present value of future money.
I method – Present Value of Single Cash Flows

Problem 1
Find out the PV of Rs. 3000 received at the end of a year, if the discount rate is 9%
Solution 3000
=
P1 or FV (1+0.09)1
n
Formula PV=(1+r)
3000
=
Where, FV or P1=future value 1.09
r=discount rate
n= number of years = 2752.29
Problem 2
Calculate the PV of Rs.6000 received after 8 years, if the discount rate is 10%
Answer Rs.2,799.04
Problem 3
Calculate the PV of a sum of Rs. 50000 received after 2 years, if the discount rate is 8%
Answer Rs.42866.94
Calculation of Present Value in case of Multiple Compounding
WHERE, PV=Present Value

P1 or FV P1 or FV=Future Value
r = Discount Rate
( ( mn
FORMULA = PV = 1+ r n = Number of years
m m = Number of times discount is compounded
Problem 1 on Present Value of Multiple Compounding
Find out the Present Value of Rs.10,000 receivble after 3 years at the rate of 12% interest.
Calculate semi-annually.
P1 or FV
FORMULA = PV = mn
Solution
PV = ?
(
1+
r
m
(
FV = Rs.10,000
r = 12% or 0.012
m=2
n=3
Problem 3 on Present Value on Multiple Compounding
Calculate the Present Value of Rs. 12,000 receivable after 4 years at the rate of 12%
Interest compounded quarterly.
Problem 4 on Present Value on Multiple Compounding
What is the Present Value of Rs.10,000 receivable after 3 years at the rate of 10%
Interest. Calculate semi annually.
PAY BACK PERIOD
The Pay Back Period is a capital budgeting technique based on establishing how
long it takes to recover the initial investment from the cumulative cash flows.
Pay Back Period can be calculated in two ways

1) Non Discounted Pay Back
2)Discounted Pay Back
Problem1 on Non Discounted Pay Back

A project requires Rs.20000 initial investment. It generates cash flows of Rs. 8000,
7000, 4000, and 3000 during 4 years. Calculate payback period.
Uncovered amount
Formula = Years before full recovery +
Next year cash flow
Solution
First step: prepare cumulative cash flow
Year cash flow cumulative cash flow
1 8000 8000
2 7000 15000
3 4000 19000
4 3000 22000
In the cumulative total it can be noted that 3years + requires for payback period
1000
Hence 3 years + Uncovered amount (20000-19000=1000) = 3+
3000
3000 (cash flow of next year) = 0.33
Hence the payback period is
3.33 years
Problem 2
Calculate pay back period for two machines. Each machine requires an investment of
Rs.50000
MACHINE X MACHINE Y
YEAR CASH FLOWS CASH FLOWS
1 25000 15000
2 30000 25000
3 35000 30000
4 25000 40000
5 20000 30000
ANSWER = MACHINE X 1.83 YEARS

MACHINE Y 2.33 YEARS
Problem 3
Nagarjuna Engineers intend investing Rs.2,00,000 each in 3 projects. Calculate

Pay Back and suggest them as to which project is best to choose.
YEAR PROJECT A PROJECT B PROJECT C
CASH FLOW (Rs.) CASH FLOW (Rs.) CASH FLOW (RS.)
1 90,000 1,30,000 1,66,667
2 90,000 1,30,000 1,66,667
3 90,000 1,30,000 76,667
4 90.000 80,000 80,000
5 2,30,000 60,000 90,000
DISCOUNTED PAY BACK PERIOD CALCULATION
In this method of calculation we consider Time Value of Money (TMV). The calculation is
Done after considering TMV and discounting the future cash flows.
Problem 1
A project with an investment of Rs.1000 and has the cash flows as follows. If cost of
capital is 10%, calculate Pay back period.
Solution is in red colour
YEAR CASH FLOWS DISCOUNTING PRESENT CUMULATIVE
Factor AT 10% VALUE OF DISCOUNTED
CASH INFLOWS CASH INFLOWS
1
1 500 0.909 454.5 454.5
(1 + r)n
2 400 0.826 330.4 784.9
Where r=rate of discount
3 300 0.751 225.3 1010.20 n=number of years
4 100 0.683 68.3 1078.2
Years before 2 years + 215.10 = 2+0.954 years = 2.954 years

uncovered cost
full recovery + 225.3
Next year cash flow
Problem 2
Project M with an initial investment of Rs. 50 has the following cash flows. Calculate
pay back if the discounting Rate is 12%
Year Cash flows
1 11
2 19
3 32
answer 3.096 years
4 37
Problem 3
The investment of a project is Rs. 200000 and the cash flows are as follows. Calculate
payback if the discount rate is 10%
Year Cash flows
1 1,66,667
2 1,66,667 Answer 1.352 years
3 76,667 (4m, 6w & 5d)
DEPRECIATION
Depreciation is a measure of the wearing out, consumption or other loss of
value of a depreciable asset arising from use, obsolescence through technology
and market changes.
Straight line method of calculating depreciation.
Original cost – estimated scrap value

Formula is Depreciation =
Estimated useful life in years
Problem 1
Cost of machine is Rs. 7800000 and estimated useful life is 5 years at the end of life
the salvage value is expected of Rs. 390000. calculate depreciation using straight
line method.
Solution : original cost Rs. 7800000 Rs. 7800000 – Rs. 390000
estimated scrap value Rs.390000 5 Years
estimated useful life 5 years = Rs. 14,82,000 per annum
Problem 2
A machine cost is Rs. 1000000 and expected life of machine is 6 years at the end of life the salvage value is
Expected of Rs. 100000. calculate depreciation using straight line method.
Answer Rs. 150000 per annum
Problem 3 (if salvage value is not given in the problem)

A co. considering to purchase a machine costing Rs.250000. The machine has a life of 5 years. Calculate
Depreciation using straight line method.
Solution
Original investment Rs. 250000
Depreciation = = = Rs. 50000 per annum
Estimated life 5 years
Problem 4
Suresh & co. is considering to purchase a machine to manufacture chocolates which is costing Rs.
500000. The Machine has a life of 5 years. Calculate depreciation using straight line method.
Answer Rs. 100000 per annum

NET PRESENT VALUE (NPV)
NPV refers to ‘net benefit’ from the project in today’s value. This is the most
effective and popular technique for making capital budget decisions.
It can be computed thus NPV=Present value of cash inflows – Present value

of cash outflows.
Given an independent proposal/project accept if NPV is positive.
Given exclusive alternatives invest in the alternative with highest NPV

NET PRESENT VALUE (NPV)
NPV is a classic economic method of evaluating the investment proposals.
Problem 1
The initial outlay/investment is Rs. 200000 and the cash flows are as follows. If the
discounted rate is 10%, calculate NPV
Solution in Red Colour
First step – calculate discount factor for each year.
YEAR CASH DISCOUNTING PRESENT
Second step – Multiply cash inflow with discounting factor
INFLOW FACTOR @ VALUE Third step – Total all present value of cash inflow
10% OF CASH
INFLOW Formula is NPV=Cash inflow – Cash outflow(investment)
1 130000 0.909 = 118170 377820 – 200000 = 177820
1/(1+0.1)^1 If the answer is positive then such projects can be
2 130000 0.826 = 107380
accepted.
1/(1+0.1)^2 If the answer is negative then such projects cannot be
accepted.
3 130000 0.751= 97630
1/(1+0.1)^3
In this problem the answer is 177820 which is a positive
4 80000 0.683= 54640
Number. It can be accepted.
1/(1+0.1)^4
TOTAL 377820
Problem 2
Project X cost Rs. 2500 and cash flows are as follows. If the discounted rate is 10%,
calculate NPV.
YEAR CASH INFLOW
1 900
2 800 Answer Rs. 225
3 700
4 600
5 500
Problem 3 :
A project costs Rs. 16000 and expected cash inflows are as follows: Calculate NPV @ 20%
YEAR CASH INFLOW
1 8000
2 7000
Answer Rs. -1004
3 6000
Problem 4
Calculate Discounted Pay back period and Net Present Value for the
Following two Projects. The firm anticipates its cost of capital to be 10%. Suggest which
Project is profitable
Year Project A cash inflows Project B cash inflows

0 (2,00,000) (2,00,000)
1 35,000 2,18,000
2 80,000 10,000
3 55,000 10,000
4 75,000 4,000
5 20,000 3,000
Problem 5
Calculate NPV at a discount factor of 7% for the following cash flows with an investment of
YEAR CASH INFLOWS Rs. 2,00,000.
1 20,000
2 60,000
3 40,000
4 30,000
5 20,000
Problem 6
Calculate NPV at a discount factor of 10% for the following cash flows with investment of
YEAR CASH INFLOWS Rs. 2,00,000.
1 90,000
2 90,000
3 90,000
4 90,000
5 2,30,000
Problem 7
Calculate Net Present Value (NPV) for the following two business proposals. Suggest which business proposal
Is acceptable? Why? (Proposal A investment Rs.9,500, Proposal B investment Rs.20,000)
Discounting Factor @ 12%
YEAR PROPOSAL “A” PROPOSAL “B”

CASH INFLOWS (Rs.) CASH INFLOWS (Rs.)
1 4,000 8,000
2 4,000 8,000
3 4,500 12,000
INTERNAL RATE OF RETURN (IRR)
The IRR method is another discounted cash flow technique which takes account of the
magnitude and timing of cash flows.
IRR is the rate that equates the investment outlay with the present value of cash flow. This
implies that the rate of return is the discount rate at which makes NPV=0.
The IRR is also known as Break even discount rate. In other words, the present value of cash
inflows equals the present value of cash outflows.
Importance of IRR
We know that as borrowing cost raises the NPV declines. Hence, IRR is the limit of cost of
capital for a project.
If borrowing cost exceeds IRR, the NPV turns negative and the project would be rejected.
IRR is related NPV in the sense that a project with a positive NPV will have cost of capital less
than IRR.
Problem 1
Calculate IRR @ 40% and 50% on the basis of following information. The investment is Rs. 50000. Show
the exact IRR with proof.
Year Cash flow Present Present Present Present
Value factor Vlaue @ Value factor Value @
@40% 40% @ 50% 50%
1 25000 0.714 17850 0.666 16650
2 30000 0.510 15300 0.444 13320
3 35000 0.364 12740 0.296 10360
4 25000 0.260 6500 0.197 4925
5 20000 0.185 3700 0.131 2620
TOTAL 56090 47875
It can be observed that Total PV @ 40% is 56090 which is more than cash outflow(investment) i.e. Rs. 50000.
Hence we can understand that IRR lie between 40% and 50%. Now let us increase PVF to 50% and verify.
When we increase to 50% PV is 47875 which is less than cash outflow (investment) i.e. Rs. 50000.
Hence let us calculate, using the formula

Original PV – Investment
LDR + X (HDR – LDR)
Original PV – New PV LDR = Lower Discount Rate
HDR = Higher Discount Rate
56090 – 50000
40 + X (50 – 40)
56090 - 47875
6090
40 + X 10
8215
40 + 0.741 X 10
= 47.41% is the IRR

Problem 2
Calculate IRR between 40% and 42% on the basis of the following information. The investment is Rs. 50000.
Show the exact IRR.
Year Cash inflows
1 15000
2 25000
3 30000
4 40000 Answer is IRR 40.38
5 30000
Problem 3
Calculate IRR between 40% and 50% on the basis of following information. The investment is Rs.200000
Year Cash inflows
1 90000
2 90000
3 90000
4 90000 Answer is IRR 42.65%
5 230000
Calculate the exact IRR between 10% and 15% for the following project -S
YEAR CASH FLOWS

(Rs.)
0 -1000
1 500
2 400
3 300
4 100
1449/5600
Problems for practice 1
1. The cash flows of the two projects of Galantac company is given below. The company is
faced with the situation of choosing between the two. Find out the Net Present Value
(NPV) of these projects at 8% discount Rate and indicate which project is preferred.
Also calculate Internal Rate of Return (IRR) for project Boeing(discount range from 13%
to 15%.)
YEAR PROJECT PROJECT
‘AIRBUS’ ‘BOEING’
0 -240000 -240000
1 120000 70000
2 100000 70000
3 70000 70000
4 20000 70000
5 10000 70000
Based on the following data calculate IRR at 9% and 10% and show the exact IRR for a
investment of Rs. 1,38,500
YEAR CASH INFLOWS (RS.)
1 30,000
2 40,000
3 60,000
4 30,000
5 20,000
995/491
A small engineering enterprise with an investment of Rs.3,10,500 provides the following data. Based on the
data calculate IRR at 13% and 15% and find out the exact IRR.
YEAR CASH INFLOWS (RS.)
1 70,000
2 1,00,000
3 1,30,000
4 90,000
5 60,000
1401 /494
Problem for practice 2
Ajith Singh wants to invest in two projects Air India and Indigo, each of which requires
an outlay of Rs. 50 million. The expected cash inflow from these projects are as follows.
Year Project Project

AIR INDIGO
INDIA
1 20 15
2 10 20
3 15 25
4 30 30
1. What is the pay back period for Air India and IndiGo?
2. If the two projects are independent and cost of capital 12% which project the firm should invest in ? (Hint NPV)
3. Find the IRR for project IndiGo and Air India
ABC engineering company wants to invest in one machine. There are two machines
available namely A and B, each costing Rs. 50000. following table shows cash flows of
two machines.
YEAR MACHINE A MACHINE B
Cash Flows Cash Flows
1 15000 5000
2 20000 15000
3 25000 20000
4 15000 30000
5 10000 20000
1. What is the non discounted Pay Back Period for Machine A and B?
2. What is the discounted Pay Back Period at 10% for machine A and B?
3. If the two machines are independent and cost of capital is 10% which machine should the firm
invest in? Calculate NPV
Consider that an investor has an opportunity of receiving Rs. 1000, 1500, 800, 1100 and Rs. 400 respectively
At the end of one through five years. Find the Present Value of this stream of uneven cash flows, if the
Interest rate is 8%.

Calculate Future Value of the following uneven cash flows if it is invested @ 8% interest per annum.
YEAR AMOUNT
DEPOSITED
1 500
2 1000
3 1500
4 2000
5 2500
Calculate the Future Value at the end of five years of the following series of payments at 10% rate of
interest.
Year Amount
deposited
1 2000
2 2500
3 3000
4 3500
5 4000

Find out the present value of Rs. 3000 received at the end of the year, if the discount rate is 9% p.a.

Calculate the present value of Rs. 50000 received after 2 years, if the discount rate is 8% p.a.
Problems for Practice on Time Value of Money
1. complete the following, solving for the Present Value (PV)
CASE FUTURE VALUE INTEREST RATE NUMBER OF ANSWER

PERIODS (PRESENT
VALUE)
A Rs.10,000 5% 5 years ?
B Rs.5,63,000 4% 20 years ?
C Rs.5,000 5.5% 3 years ?
2. What is the balance in an account at the end of 10 years if Rs.2,500 is deposited today
and the account earns 4% interest, compounded annually? Quarterly?
Answers i) 10 years annualy = Rs.3,700.61

ii) 10 years quarterly = Rs.3,722.16
3. If you deposit Rs.10 in an account that pays 5% interest, compounded annually, how much
will you have at the end of 10 years? 50 years? 100 years?
answers : for 10 years=Rs.16.29
for 50 years=Rs.114.67
for 100 years=Rs.1,315.01
4. How much will be in an account at the end of 5 years the amount deposited today
is Rs.10,000 and interest 8% per year, compounded semi-annually?
answer : Rs.14,802.44
5. How much interest on interest is earned in an account by the end of 5 years if Rs.1,00,000
is deposited and interest is 4% per year, compounded continuously?
Note: interest on interest is the difference between the FV calculated using compounded interest and the FV calculated using simple interest,
because simple interest included only interest on the principle amount, not the interest-on-interest.
answer: continuously compounded Rs.1,22,140.28
Simple interest Rs.1,20,000
Interest on interest Rs.14,802.44
6. How much I have to deposit in an account today that pays 12%, compounded
quarterly, so that I have a balance of Rs.20,000 in the account at the end of 10 years?
Answer: PV Rs.6,131.14
7. Suppose I want to be able to withdraw Rs.5,000 at the end of 5 years and withdraw
Rs.6,000 at the end of six years, leaving a zero balance in the account after
the last withdrawal. If I can earn 5% on my balances, how much must I deposit today
to satisfy my withdrawal needs?
Given: hint—there are two different future values. Treat as two separate present values,
then combine.
FV=Rs.5,000; n=5, i=5%
PV=Rs.3,917.63
FV=Rs.6,000; n=6, i=5%

PV=Rs.4,477.29
PV of the two Future Values=Rs.3,917.63+Rs.4,477.29=Rs.8,394.92
NATIONAL INCOME ACCOUNTING
National Income (NI) is the money value of all final goods and services produced by a country during a
Period of one year.
The money value all final goods and services from Primary Sector (agriculture, Forestry, Mining and fishery)
Secondary sector (Manufacturing industries)
Tertiary Sector (Service industries like tourism, insurance, banking, healthcare, etc.) are taken into account
For calculating NI.
In India Ministry of Statistics and Programming (Central Statistical Organization) is responsible for accounting
and publishing NI.
The measuring and analysis of NI is called “Social Accounting”.
USES OF NATIONAL INCOME/PRACTICALE IMPORTANCE OF N I.

1. It helps to know about the productive performance and achievements of a country.
2. It indicates the living standards of people to compare with other country.
3. It helps to know whether a country is growing, stagnant or declining.

4. It shows the contribution made by various sectors of an economy such as agriculture, industry and
tertiary sector.
5. It contains the figure of consumption, savings, investment, imports, exports, etc. Information regarding
these factors are indispensable for any economic study concerning economic growth and planning.
6. In a mixed economy like our country, it helps to know the relative role played by the public and private
Sectors in the economy.
7. It is a valuable guide to formulate economic policies by govt especially in these days of active participation
of the govt in economic management of a nation.
8. It helps to study the problems of an underdeveloped economy.
9. It is the basis to determine subscription quotas to world bodies such as World Bank, IMF, etc.
10. NI data of the various states helps the central govt to decide the amounts of grants-in-aid to be given
to different state govts.
CONCEPTS OF NATIONAL INCOME
The various concepts of National income (NI) are:
1. Gross National Product (GNP)

2. Net Natonal Product (NNP)
3. National Income at Factor Cost and National Income at Market Price
4. Gross Domestic Product (GDP)
5. Net Domestic Product (NDP)
6. Personal Income (PI)
7. Disposable Personal Income (DPI)
GNP: it is defined as the total market value of all final goods and services produced in a year. The concept
Of final goods and services stands for finished goods and services ready for consumption.
Thus GNP at market prices represents GNP=C+I+G+(X-M)+(R-P)
Where, C=Cosumption goods
I=Capital goods or gross investment
G=Govt services
X=Exports
I=Imports
R=Income receipts from abroad
P=Income paid abroad
NNP: it is defined as net output of a country during the year. NNP is obtained by deducting the value of
Depreciation or replacement allowance of the capital assets from GNP
Thus NNP=GNP minus Depreciation
National Income at Market Price and National Income at Factor Cost: a distinction between NI at Factor
Cost and NI at Market Price is that NI at Market price means the money value of goods produced.
Its price of the aggregate output at current prices. This price also includes some amount of taxes and
Subsidies.
Example, the price of car is Rs. 3 Lakhs. In this case the NI at Market price is Rs. 3 lakhs.
But there is some elelment of tax in the above price. Let us suppose the tax is Rs. 20,000.
Then NI at factor Cost is Rs. 2,80,000. because the factors of production which have
contributed for the production Of one car will get only Rs.2,80,000 and the balance
Rs. 20,000 will go to govt as tax.
Let us now analyse the implication of the element of subsidy.

Let us suppose the fair price of a kg of Sugar as Rs. 10. but its actual cost of production
is Rs. 15/-Per kg. The difference between the actual cost of production and the fair price
is Rs. 5.
This difference is borne by the govt.
In this case, NI at Market price is Rs. 10 and NI at factor cost is Rs. 15

GDP- when we take the sum total of values of output of goods and services in the country
Without adding net factor income received from abroad , the figure so obtained is called
GDP.
In other words, GDP is the aggregate money value of the final goods and services produced
In the domestic territory of a country during a year. GDP is a territorial concept.
NDP- it is defined as net output of a country during the year. NDP is obtained by
deducting the value of Depreciation or replacement allowance of the capital assets
from GDP, Thus NDP=GDP minus Depreciation.
PI- it is the total money income received by individuals in a country. The concept of PI
Is very useful as it indicates the potential purchasing power of households in a country.
It enables us to measure the welfare of consumers of a country.
DPI – Disposable Personal Income
is the sum of Consumption and Savings of individuals. DPI rather than NI is the
Determinant of consumption, because the consumption of a person depends on
His take home pay.
Thus DPI = Personal Income minus Personal taxes

MEASUREMENT OF NATIONAL INCOME
There are three methods of measurement of National Income
I. Census of Product method
II. Census of Income method
III. Census of Expenditure method
I. Census of product Method: according to this method the economy is divided into different sectors
like agriculture, mining, manufacturing, transport and communication and the gross output obtained
in these sectors will be taken into account. This value is GNP at Market price.
In using this method it is necessary to take utmost care to avoid double counting. Economists have
suggested two alternative approaches to avoid the problem of double counting. Namely
i) the final goods method ii) the value added method.
In the final goods method only final values of goods and services are computed ignoring all intermediate
transactions. Intermediate goods are involved in the process of producing final goods. (eg. Cotton is an
intermediate goods to produce final good, cloth. Similarly, sugarcane is an intermediate good to produce
Sugar)
Precautions to calculate NI using census of product method
1. To avoid double counting only the value of final goods should be taken. The value of raw materials and
intermediate goods should not be taken as this would lead to the problem of double counting.
EXAMPLE OF VALUE ADDED METHOD
PRODN. FIRM SALES COST OF VALUE
STAGE REC. INTERMEDIATE ADDED NET
(RS.) GOOD (Rs.) INCOME (Rs.)
1 2 3 4 (3 Minus 4)
WHEAT FARMER 500 0 500
FLOUR FLOUR MILL 700 500 200
BREAD BAKER 900 700 200
TRADING MERCHANT 1000 900 100
TOTAL SUM OF 1000

VALUE ADDED
2. The value of final goods should be calculated at current prices.
3. Indirect taxes included in prices of final goods to be deducted and subsidies given by govt for certain
products are to be added.
4. Add the value of exports or income earned abroad and deduct the value of imports.
II. Census of Income Method: in this method the total of all money incomes such as wages, salaries
rent, profit by persons and enterprises in the country during a year are totaled up.
the following classification of income is considered comprehensive.
a) Wages & Salaries, b) supplementary labour income (Social security, etc.) c) earnings of self
employed and professionals d) dividends e) interest f) Rent g) profit of state enterprises.
Precautions to calculate NI using Census of Income method
1. All transfer payments such as unemployment allowance, pension, charity, etc. are not to be
included. Similarly, earnings from gambling lottery prize being transfer payments are to be
excluded. Likewise scholarship received by students are also transfer payments and should
be excluded.
2. Sales receipts of old property to be excluded.
3. Direct taxes revenue to the govt should be deducted from the total income as it is only
a transfer income.
4. Govt. subsidies should be deducted from profits of the subsidized industries.
III. Census of Expenditure Method : this method is used by adding all the expenditure made on goods
and services during a year. Expenditure may be on consumer goods or investment goods.
thus, we can get NI by summing up all consumption expenditure and investment expenditure
by individuals and govt.
Precautions to calculate NI using Expenditure method

1. The expenditure on second hand goods should not be taken as they do not contribute to current
year’s production.
2. Expenditure on transfer payments by govt. such as unemployment benefit, old age pensions,
interest on public debt should not be included as there is no productive service is rendered in
exchange by recipients of these payments.
Difference between GNP and GDP
GROSS DOMESTIC PRODUCT (GDP) GROSS NATIONAL PRODUCT (GNP)

The monetary value of goods and services The monetary value of goods and services by
produced within the geographical limits of a the citizens of the country, no matter where
nation. they dwell.
Gauges production of products within the Gauges the production of products by the
country’s boundary companies and industries owned by the
residents of a nation
Basis for calculating is the location Basis for calculating is citizenship
Focuses on measuring domestic production Focuses on measuring production by the
nationals.
Outlines the strength of the domestic Outlines how the residents are contributing
economy of a country. towards the economy of the
country.
FORMULAS TO REMEMBER FOR UNDERSTANDING RELATIOSHIPS AMONG NI CONCEPT
1. GNP at Factor cost = GNP at Market price minus Indirect taxes
2. GDP at Factor cost = GDP at Market price minus indirect taxes
3. NNP at Factor cost = NNP at market price minus indirect taxes
4. NNP = GNP minus depreciation
5. NDP = GDP minus depreciation
6. NDP at Factor cost = NDP at market price minus indirect taxes
7. GDP at market price = GNP at market price minus net fact income from abroad
With the given data on NI concepts answer the question below.
GNPMP = Rs. 1000

NFIA = Rs. 100 Net Factor Income from Abroad (NFIA)
Indirect Tax = Rs. 80
Subsidies = Rs. 50
Depreciation = Rs. 100
Calculate GDPMP ?
GNPMP minus NFIA = GDP
=1000 minus 100 = 900
Calculate GDPFC?
GDPMP minus IT+Subsidies
=900 minus 80 + 50 = 870
GNPMP minus Depreciation = NNP MP
GNPMP minus NIFA = GDPMP
GNPMP minus indirect taxes = GNPFC
NNPMP minus Net Income From Abroad = NDPMP
NNPMP minus indirect taxes =NNPFC
GDPMP minus indirect taxes = GDPFC
GNPFC minus depreciation=NNPFC
NDPMP minus indirect taxes NDPFC
GDPFC minus depreciation = NDPFC
GNPMP = Rs. 1000

NFIA = Rs. 100
Subsidies = Rs. 50
Calculate GDPMP ?
=1000 minus 100 = 900
Calculate GDPFC?
=900 minus 80 + 50 = 870
Calculate NDPFC?
GDPFC minus Depreciation
=870 minus 100 = 770
Calculate NNPFC ?
NDPFC+NFIA=NNPFC
=770+100=870
Calculate GNPFC ?
GDPFC + NFIA=GNPFC
=870+100=970
Numerical problems on National Income (NI) concepts

GNPMP = Rs. 1000
NFIA = Rs. 100
Subsidies = Rs. 50
What is GDPMP ?
=1000 minus 100 = 900
What is GDPFC?
=900 minus 80 + 50 = 870
What is NDPFC?
GDPFC minus Depreciation
=870 minus 100 = 770
What is NNPFC
NDPFC+NFIA=NNPFC
=770+100=870
What is GNPFC
GDPFC + NFIA=GNPFC
=870+100=970
INFLATION
INFLATION is associated with high prices, which causes decline in the purchasing
power / value of money.
Inflation refers to the substantial and rapid increase in the general Price level.
Inflation is primarily a monetary phenomenon. Prices keep on rising due to excess
Supply of money and lower production of exchangeable goods.
According to Coulborn, “Inflation is too much of money chasing too few goods”
Types of Inflation
According to rate of rise in price According to Time According to
a) Demand Pull Inflation
a) Creeping Inflation (less than 3%) a) War Time Inflation Coverage
b) Cost Push Inflation
b) Walking Inflation (3 to 4%) b) Post war Inflation a) Comprehensive
c) Running Inflation (More than 10%) Inflation
d) Galloping Inflation/Hyper Inflation (100%) b) Sporadic
Inflation
H – HYPER INFLATION
H
120 -
R – RUNNING INFLATION
Price Rise in percentage
100 -
R
80 - W – WALKING INFLATION
W
60 -
C – CREEPING INFLATION
40 -
C
20 -
I I I I I I I I I I I
1 2 3 4 5 6 7 8 9 10 11
Time in years
CAUSES OF INFLATION
INCREASE IN DEMAND FOR GOODS & DECREASE IN SUPPLY FOR GOODS AND
SERVICES SERVICES
Increase In Public Expenditure Shortages of supplies of factors of
production
Increase in private expenditure Hoarding by traders
Increase in exports Hoarding by consumers
Reduction in taxation Natural calamities
Repayment of past internal debts War
Rapid growth of population International causes(prices of basic
material like Petrol)
CONTROL OF INFLATION
MONETARY MEASURE FISCAL MEASURES

CREDIT CONTROL REDUCTION IN UNNECESSARY
EXPENDITURE
DEMONETISATION OF CURRENCY INCREASE IN TAXES
ISSUE OF NEW CURRENCY INCREASE IN SAVINGS
SURPLUS BUDGETS
STOPPING AND POSTPONEMENT
REPAYMENT OF PUBLIC DEBT
Differences Between Fiscal Policy and Monetary Policy
The following are the major differences between fiscal policy and monetary policy.
1. The policy of the government in which it utilises its tax revenue and expenditure policy to
influence the aggregate demand and supply for products and services the economy is known
as Fiscal Policy. The policy through which the central bank controls and regulates the
supply of money in the economy is known as Monetary Policy.
2. Fiscal Policy is carried out by the Ministry of Finance whereas the Monetary Policy is
administered by the Central Bank (Reserve Bank of India) of the country.
3. Fiscal Policy is made for a short duration, normally one year, while the Monetary Policy
lasts longer.
4. Fiscal Policy gives direction to the economy. On the other hand, Monetary Policy brings
price stability.
5. Fiscal Policy is concerned with government revenue and expenditure, but Monetary Policy
is concerned with borrowing and financial arrangement.
6. The major instrument of fiscal policy is tax rates and government spending. Conversely,
interest rates and credit ratios are the tools of Monetary Policy.
7. Political influence is there in fiscal policy. However, this is not in the case of monetary
policy.
CIRCULAR FLOW OF ECONOMIC ACTIVITY
An economy is an integrated system of production, exchange and consumption.

In carrying out these activities people buy and sell goods and services. Income generated in
the production process flows in a circular manner. It is called as “Circular Flow of Income”.
The modern economy uses various factors of production namely Land, Labour, Capital and
Enterpreneurship.
GOVERNMENT
Taxes Taxes
Factor Services
Factor Payments
BUSINESS
CAPITAL
MARKET

Payment for Imports

FOREIGN
CIRCULAR FLOW OF INCOME IN TWO SECTOR ECONOMY
Factor Services
Factor Payments
BUSINESS
HOUSEHOLDS
FIRMS
*buy and consume
*produce and sell
goods and services
goods and services
*own and sell
*Hire and use factors
factors of
of production
production
Households spendings on goods and services through markets and revenue of goods sold will flow from markets
To business firms.
Households provide factors of production like land, labour & capital to business firms and inturn household get
Wages and profits.
ASSUMPTIONS
1. This economy has no international economic relations(Closed ECONOMY)
2. Production occurs only in business sector
3. Producers sell all that they produce, ie there is no inventory
4. Consumers spend their entire income and there is no savings.
5.There are no govt operations in the economy such as govt expenditures and taxes.
GOVERNMENT
Taxes Taxes
Factor Services
Factor Payments
BUSINESS
CAPITAL
MARKET

CIRCULAR FLOW OF INCOME IN THREE SECTOR ECOCNOMY

This model shows the economic transactions between households, business firms and govt. sector.
1. A part of the flows between households and the business firms gets diverted to govt sector.
2. A part of the household income goes to govt sector in the form of taxes.
3. A part of the business firms’ earnings goes to govt in the form of taxes.
4. A part of the tax revenue is spent by the govt as govt expenditure on services and transfer
payments to the households
5. A part of the tax revenue is spent by govt as govt expenditure on goods and subsidies to the
business firms.
In case govt follows a deficit budget and govt expenditure is greater than revenue (G>T), the difference
Is financed from loans from the capital market. Hence money will flow from capital market to govt.
In case govt follows a surplus budget and the govt expenditure is less than the revenue (G<T), money
Will flow to capital market from govt sector.
GOVERNMENT
Taxes Taxes
Factor Services
Factor Payments
BUSINESS
CAPITAL
MARKET

Payment for Imports

FOREIGN
CIRCULAR FLOW OF INCOME IN A FOUR SECTOR ECONOMY

No economy in the world functions in isolation. It is linked with other economies through trade.
This brings us to the analysis of a four sector economy where besides the households, business
firms and the govt the fourth sector is the foreign sector.
Imports leads to a decrease in the circular flow of income.
Exports leads to increase in the circular flow of income.
If the exports of a country are less than its imports (X<M) there is foreign trade deficit equal to
(M-X) which is known as unfavourable balance of trade.
If the exports of a country are more than its imports (X>M) there is foreign trade surplus equal to
(X-M) which is known as favourable balancd of trade.
Significance of Circular Flow of Income
1. Knowledge of Interdependence – we can understand interdependence between different sectors of the
economy.
2. Identification of Injections and Leakages – we can understand injections (Investment and Exports)
and leakages (saving and Imports)
3. Estimation of National Income - we can understand that how the circular flow of income facilitates the
estimation of national income.
4. Level of structure of Economic Activity – we can get information on various macro variables like national
Income, consumption, savings, investment, etc.
5. Fiscal and Monetary Policies-we can understand the importance of both Fiscal & Monetary Policies.
The importance of monetary policy can be observed when savings exceeds investment/investment exceeds
savings it means that the disequilibria can be set by suitable credit and monetary policy.
similarly, if savings and taxes amount exceeds the investment and govt spending amount should adopt such
fiscal measures as reduction in taxes. Therefore, with the help of circular flow of income and expenditure
the problem of disequilibria and the restoration of equilibrium can be observed.
Industrial Policy 1991
INDUSTRIAL POLICY 1991
Generally speaking Industrial Policy refers to the policy of the govt towards industries. An industrial policy
covers who should manufacture what, how, where and the key industries for the growth and development
of economy.
In India, pvt. Sector was regulated with the help of number of acts like Industrial Devpt & Regulation Act,
Foreign Exchange Regulation Act (FERA), Monopolies Restrictive Trade Practices Act (MRTP), etc.
These acts and regulations strangulated the initiative of the pvt sector to grow and resulted in inefficiencies,
Corruptions and mismanagement.
To meet these challenges economic reforms were introduced in industrial, financial, external and fiscal areas
With a new industrial policy 1991 during the period of PV Narasimha Rao, the then Prime Minister of India.
Liberalisation, Privatisation and Globalisation (LPG) is the main outcome of this industrial policy 1991.
Liberalisation refers to the process of removing the govt’s control and restrictions on economic activities.
Liberalisation means greater freedom to economic agents.
Liberalization reduces govt’s role.
DEREGULATION OF
INDUSTRIAL SECTOR FINANCIAL SECTOR
TAX REFORMS
REFORMS
LIBERALISATION
MEASURES
FOREIGN EXCHANGE
REFORMS TRADE AND INVESTMENT
REFORMS
Privatisation refers to a partial or full transfer of ownership and control of Public Sector Units (PSU) to
the private sector.
Globalisation refers to the process of integrating the domestic economy with the world economy through
The movement of goods, services, people and information across national boundaries
Disinvestment is one of the methods of privatization. It means selling of govt share in one PSU to other PSUs
Or private sector. In India, privatization is mainly in the form of disinvestment of equity. Privatisation does
Not lead to 100% transfer of control from public sector to pvt sector, other than in exceptional cases
Like that of Centaur Hotel. Examples of privatized PSUs are
1. Modern Food Industries Ltd.
2. Videsh Sanchar Nigam Ltd. (VSNL)
3. Bharath Aluminium Ltd. (BALCO)
4. Hindustan Zinc Ltd. (HZL)
5. Maruti Udyog Ltd………………….and so on
Main Reasons for Economic Reforms in India
Rise in Prices
• Price rise continuously in India. The inflation rate increased from
6.7% to 16.7%.
• Due to inflation country’s economic position became worse.
• Main reason for inflation was rapid increase in money supply.
• It was due to deficit financing Deficit financing means borrowing
from Reserve Bank of India by Government to meet its deficit.
• RBI provides this loan by printing new currency notes.
• Cost of production increases due to inflation. This affects demand for
products
Rise in Fiscal Deficit
• Due to increase in non- development expenditure fiscal deficit of
the Govt. had been increasing.
• Fiscal deficit means difference between total expenditure and total
receipts minus loans. To cover the fiscal deficit, the Govt. has to
raise loans and pay interest on it.
• Due to rise in fiscal deficit there was rise in public debt and
interest.
• In 1991 interest liability became 36.4% of total govt. expenditure.
The Govt. caught in debt trap. So Govt. has to resort to economic
reforms.
Increase in Adverse Balance of Payments
• So deficit of balance of payments had been rising continuously.
• In 1980-81 it was Rs. 2214 crore and rose in 1990- 91 to Rs. 17,367
crores.
• To cover this deficit large amount of foreign loans had to be obtained.
• So liability of loan and its interest payment goes on increasing.
• It made balance of payments adverse.
Iraq War
• In 1990-91, war in Iraq broke, and this led to rise in

petrol prices.
• The flow of foreign currency from Gulf countries
stopped
• and this further aggravated the problem
Dismal Performance of PSU’s (Public Sector
Undertakings)
• PSU’s are enterprises wholly owned by Govt. Govt. have invested
crores of rupees in these enterprises.
• These are not performing well due to political interference and
became big liability for Govt.
Fall in Foreign Exchange Reserves
• Indians foreign exchange reserve fell to low ebb in 1990-91 and it was
insufficient to pay for an import bill for 2 weeks.
• 1986-87----Rs. 8151 crores
• 1989-90----Rs. 6252 crores.
• Chandershekhar: Govt. had to sell Gold to meet the import liability.
So Govt. had to think about policy of liberalization.
India’s New Industrial Policy 1991
• With the gradual liberalisation of the 1956 Industrial policy in the

mid-eighties the tempo of industrial development started picking
up.
• But the industry was still feeling the burden of many controls and
regulations.
• For a faster growth of industry, it was necessary that even these
impediments should be removed.
• The new government by Shri Narasimha Rao, which took office
in June 1991, announced a package of liberalisation measures
under its Industrial Policy on July 24, 1991.
Objectives
• (i) Liberalizing the industry from the regulatory devices such as
licenses and controls.
• (ii) Enhancing support to the small scale sector.
• (iii) Increasing competitiveness of industries for the benefit of the
common man.
• (iv) Ensuring running of public enterprises on business lines and thus
cutting their losses.
• (v) Providing more incentives for industrialisation of the backward
areas, and
• (vi) Ensuring rapid industrial development in a competitive
environment.
(1) Abolition of Industrial Licensing
• In the earlier industrial policy, industries were subjected to tight regulation
through the licensing system.
• Though some liberalisation measures were introduced during 1980’s that
positively affected the growth of industry.
• Still industrial development remained constrained to a considerable extent.
• The new industrial policy abolishes the system of industrial licensing for most
of the industries under this policy no licenses are required for setting up new
industrial units or for substantial expansion in the capacity of the existing
units,
• Except for a short list of industries relating to country’s security and strategic
concerns, hazardous industries and industries causing environmental
degradation.
• To begin with, 18 industries were placed in this list of
industries that require licenses.
• Through later amendment to the policy, this list was
reduced.
• It now covers only five industries relating to health
security and strategic concerns that require compulsory
licensing.
• Thus the industry has been almost completely made free
of the licensing provisions and the constraints attached
with it.
(2) De-reservation of Industries for Public
Sector
• The public sector which was conceived as a vehicle for
rapid industrial development, largely failed to do the job
assigned to it.
• Most public sector enterprises became symbols of
inefficiency and imposed heavy burden on the government
through their perpetual losses.
• Since a large field of industry was reserved exclusively for
public sector where it remained a virtual non performer
(except for a few units like the ONGC).
• The industrial development was thus the biggest casualty.
• The new industrial policy seeks to limit the role of public sector
and encourage private sector’s participation over a wider field of
industry.
• With this view, the following changes were made in the policy
regarding public sector industries:
• (i) Reduced reservation for public sector
• (ii) Efforts to revive loss making enterprise
• (iii) Disinvestment in selected public sector industrial units
(i) Reduced reservation for public sector
• Out of the 17 industries reserved for the public sector under the 1956
industrial policy, the new policy de-reserved 9 industries and thus limited
the scope of public sector to only 8 industries.
• Later, a few more industries were de-reserved and now the exclusive
area of the public sector remains confined to only 4 industrial sectors
which are:
• (i) defence production,
• (ii) atomic energy,
• (iii) railways and
• (iv) minerals used in generation of atomic energy.
• However, if need be even some of these areas can be opened up for
the private sector.
• The public sector can also be allowed to set up units in areas that
have now been thrown open for private sector, if the national interest
so demands.
(ii) Efforts to revive loss making enterprise
• Those public enterprises which are chronically sick and
making persistent losses would be returned to the Board of
Industrial and Financial Reconstruction (BIFR) or similar
other high level institutions created for this purpose.
• The BIFR or other such institutions will formulate schemes
for rehabilitation and revival of such industrial units.
(iii) Disinvestment in selected public sector
industrial units
• As a measure to raise large resources and introduce wider
private participation in public sector units, the government
would sell a part of its share holding of these industries to
Mutual Funds, financial institutions, general public and
workers.
• For this purposes, the Government of India set up a
‘Disinvestment Commission’ in August 1996 which works
out the modalities of disinvestment.
• On the basis of recommendations of the ‘Disinvestment
Commission’ the government sells the shares of public
enterprise.
(3) Liberalised Policy Towards Foreign Capital and
Technology
• The inflow of foreign capital and import of technology was

tightly regulated under the earlier Industrial policy.
• Each proposal of foreign investment was to be cleared by
the Government in advance.
• Wherever foreign investment was allowed, the share of
foreign equity was kept very low so that majority of
ownership control remains with Indians.
• But such a policy kept the inflow of foreign capital very small and
industrial development suffered for want of capital resources
and technology.
• The July, 1991 Industrial policy made several concessions to
encourage flow of foreign capital and technology into India,
which are follows:
• (i) Relaxation in Upper Limit of Foreign Investment
• (ii) Automatic Permission for Foreign Technology Agreement
Relaxation in Upper Limit of Foreign
Investment
• The maximum limit of foreign equity
participation was placed at 40 per cent in the
total equity capital of industrial units
• which were open to foreign investments under
the 1991 policy; this limit was raised to 51 per
cent. 34 specified more industries were added to
this list of 51 per cent foreign equity
participation.
• In some industries the ratio of foreign equity was raised
to 74 percent.
• Foreign Direct Investments (FDI) was further liberalised
• Now 100 per cent foreign equity is permitted the case
of mining, including coal and lignite, pollution control
related equipment, projects for electricity generation,
transmission and distribution, ports, harbours etc.
• Recent decision taken to further liberalise FDI include
permission for 100 per cent FDI in oil refining, all
manufacturing activities in Special Economic Zones
(SEZ’s), some activities in telecom see tor etc.
(ii) Automatic Permission for Foreign Technology
Agreement
• The New Industrial Policy states that automatic permission will
be granted to foreign technology agreements in the high priority
industries.
• Previously technology agreement by an Indian company with
foreign parties for import of technology required advance
clearance from the government.
• This delayed the import of technology and hampered
modernisation of industries.
• Now the Indian companies could enter into technology
agreements with foreign companies and import foreign
technology for which permission would be automatically
granted.
(4) Changes in the MRTP Act
• According to the Monopolies and Restrictive Trade
Practices (MRTP) Act, 1969, all big companies and large
business houses (which had assets of Rs. 100 crores or
more, according to the 1985 amendment to the Act) were
required to obtain clearance from the MRTP Commission
for setting up any new industrial unit.
• because such companies (called MRTP companies) were
allowed to invest only in some selected industries.
• Thus, besides obtaining a licence they were also required to get MRTP
clearance.
• This was a big impediment for industrial development as the big business
firms which had the resources for development could not grow and
diversify their activities.
• The Industrial Policy, 1991 has put these industries on par with others by
abolishing those provisions of the MRTP Act which mediate mandatory
for the large industrial houses to seek prior clearance from MRTP
Commission for their new projects.
• No prior approval of or clearance from the MRTP Commission is now
required for setting up industrial units by the large business houses.
(5) Greater Support to Small-Scale Industries
• The New Industrial Policy seeks to provide greater

government support to the small-scale industries.
• So that they may grow rapidly under environment of
economic efficiency and technological upgradation.
• A package of measures announced in this context
provides for setting up of an agency to ensure that
credit needs of these industries are fully met.
• It also allows for equity participation by the large industries in the
small scale sector not exceeding 24 per cent of their total
shareholding.
• This has been done with a view to provide small scale sector an
access to the capital market
• To encourage their upgradation and modernisation the
government would also encourage the production of parts and
components required by the public sector industries in the small-
scale sector.
BUSINESS CYCLES / TRADE CYCLES
A Business Cycle/Trade Cycle refers to a wavelike fluctuations in aggregate economic activity
particularly in national income, employment and output. The phases of business cycle are:
Y
E
ECONOMIC ACTIVITY
BOOM
TROUGH
O X
TIME
CHRACTERISTICS OF BUSINESS CYCLE/TRADE CYCLE
1. Cyclical fluctuations are wave like movements.
2. Fluctuations are recurrent in nature.
3. Booms and troughs do not occur at regular intervals.
4. They occur in such aggregate variables as output, income, employment and prices
5. These variables move at about the same time in the same direction but at different rates.
6. Business cycles/Trade cycles are international in character.
PHASES OF BUSINESS CYCLE/TRADE CYCLE
1. Depression: it is the first phase of trade cycle. This period is charactirised by
a) reduction in volume of output, trade and transaction
b) increase in level of unemployment
c) fall in prices
d) fall in interest rates
e) contraction in bank credit
f) high rate of business failures
During this period, on can notice that all round pessimism, frustration and despair. It is
Period of great suffering and hardship to the people.
2. Recovery/Revival: Depression cannot last long for ever. After a period of depression, recovery
starts. This is the lower turning point from depression to revival towards upswing. After some
time the rays of hope appear on the business horizon. Pessimism gets slowly replaced by
optimism. The depression carries within itself the seeds of recovery. The recovery many be
initiated by the following factors.
a) government expenditure
b) changes in production techniques
c) investment in new regions
d) exploitation in new sources of energy
e) new innovations.
Increase in government expenditure stimulates the demand for consumption goods which in turn
Pushes up the demand for capital goods. Construction activity receives an impetus. As a result
Output, income, employment, wages, prices, profits starts rising. Attracted by profits, bank lend
More money. The upward trend in business give a sort of fillip to economic activity. Through
Multiplier and acceleration effects, the economy proceed upwards steadily and rapidly.
3. Prosperity Phase: prosperity is a stage of affairs in which the real income
consumed, produced and the level of employment are high or rising and
there are no idle resources.
during this phase, a) high level of output and trade
b) high level of employment and output
c) large expansion of bank credit
d) overall business optimism.
e) high level of effective demand
4. Boom Phase : The prosperity phase does not stop at full employment. It gives
way to the emergence of a boom. Business optimism stimulate further
investment. Soon a situation develop in which the number of jobs exceed the
number of workers available in the market. Thus there is overfull employment.
Prices, wages, interests, profits move in the upward direction. Business people
borrow more and invest it. This adds fuel to the fire. The tempo of boom
reaches new heights. There is an atmosphere of “over optimism” all round.
The boom carries with it the seed of self-destruction. The prosperity phase comes to an
end when the forces favouring expansion becomes progressively weak. Bottlenecks begin
to appear. Labour, Raw materials, etc., become scarce commanding higher wages and
prices. This disturbs the cost calculation of the business people. Now the business people
realize that they have over stepped the mark and become over cautious and their over
optimism paves the way for their pessimism. Thus prosperity digs its own grave.
5. Recession – A turn from prosperity to depression: the period of recession begins when
the phase of prosperity ends. Recession exists for a short period of time. Business
pessimism during this period is characterized by feeling of hesitation, doubt and fear.
it leads to a) downfall in the activities of stock exchange market.
b) failure of some business creates panic among businessmen
c) loss of confidence
d) no new ventures are taken up
e) banks curtail credit
f) new orders are cancelled and workers are laid off
g) unemployment sets in the capital goods industries and it spreads to other
industries also.
The unemployment multiplier begins to work in the downward direction. Its consequence
are—fall in income, expenditure, prices, profits, industrial and trade activities. Recession
has cumulative effects. When once business and economic activity starts declining, it
becomes almost difficult to stop the rot. Thus it ends in a hopeless depression which is the
period of utmost suffering for businessmen.
A detailed study of the various phases of business cycle is of paramount importance to

business enterprises. It helps in demand forecasting, capital budgeting, production
planning, etc. A firm can avoid either over or under production and take precautionary
steps to avoid all kinds of losses.
EFFECTS AT DIFFERENT PHASES OF BUSINESS CYCLE/TRADE CYCLE AT A GLANCE
FEATURES PROSPERITY RECESSION DEPRESSION RECOVERY
INCOME High Starts Falling Lowest Starts Rising
OUTPUT High Starts Falling Lowest Starts Rising
EMPLOYMENT High Starts Falling Lowest Starts Rising
WAGES High Starts Falling Lowest Starts Rising
PRICES High Starts Falling Lowest Starts Rising
INTEREST High Starts Falling Lowest Starts Rising
BANK CREDIT High Starts Falling Lowest Starts Rising
MEC High Starts Falling Lowest Starts Rising
INVESTMENT High Starts Falling Lowest Starts Rising
FEELING Optimism Doubt & Fearful Pessimism Start of Optimism
(Business
Sentiment)
AGGREGATE High Starts Falling Lowest Start Rising
ECONOMIC
ACTIVITY
Remedies to control evil effects of trade cycles
Trade cycles produce a reaching effects on the working of a business firm. In order to minimize
the evil effects of a trade cycle, a business firm can adopt two distinct measures. They are
Preventive and Relief measures
Preventive Measures – generally speaking these measures are taken during the period of
Expansion. A prudent producer will think in advance and take all possible precautionary measures
To avoid and minimize business problems as much as possible. He makes an attempt to prevent
Over expansion of business. He follows a policy of utmost restraint to safeguard his long tem
Interest sacrificing short run tempting gains.
Relief Measures – these measures are generally adopted during the period of contraction and
Recession. The basic objective is to fight against pessimism and to give boost to all kinds of
Business activities. There are must be a strong psychological shifts during this period.

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ENGINEERING ECONOMICS

CODE : MGT 112

Equilibrium of demand and supply. (02 hours, Blooms level: Application)

On completion of the course the students are able to :

2. Evaluate the cost effectiveness of individual engineering projects.

When an economy operates on PPC, it means there is no unemployment

ment / underutilization of resources and production can be increased.

P This shift is due to improvement in technology; New ways of production

P2 skill and efficiency of human resources increases.

A shift towards left from PP to P2P2 as shown in this graph indicates

ECONOMY, TYPES OF ECONOMY, TYPES OF ECONOMIC MODELS,

Nature and scope of economics

Derived from two Greek words “Okios” – Household

Hence economics can be understood as “Household Management” – Managing a household

Later the scope of economics has been extended to Nation’s Management.

Adam Smith is known as “Father of Economics”.

Basic Premise of Economics

MICRO ECONOMICS MACRO ECONOMICS

It is a science as it tells us about the Cause and Effect

It is an Art as it is used for practical application.

Economics is both a Positive Science as well as a Normative Science.

It is a Positive Science as it studies things as they are.

It is a Normative Science as it prescribes certain norms .

An economy is an integrated system of production, exchange and consumption.

2. Production occurs only in business sector

3. Producers sell all that they produce, ie there is no inventory

4. Consumers spend their entire income and there is no savings.

Expenditure on Goods & Services

CIRCULAR FLOW OF INCOME IN THREE SECTOR ECOCNOMY

Expenditure on Goods & Services

Payment for Imports

CIRCULAR FLOW OF INCOME IN A FOUR SECTOR ECONOMY

Imports leads to a decrease in the circular flow of income.

Exports leads to increase in the circular flow of income.

• Engineering economics involves the systematic evaluation of the economic merits

▪ Engineering economy involves technical analysis, with emphasis on the economic

• Carefully define the problem! Then the choice

patterns, to make connections between seemingly unrelated phenomena, and to

generate solutions. Creativity involves two processes: thinking, then producing.

Innovation is the implementation of a new or significantly improved product,

service or process that creates value for business, government or society.

• Only the differences in the future outcomes of the

• For example, if your feasible housing alternatives were two

✓ The prospective outcomes of the alternatives, economic and

✓ The perspective of the decision maker, which is often that of the

▪ For measuring the economic consequences, a monetary unit such

▪ You should also try to translate other outcomes (which do not

▪ In engineering economic analysis, the primary criterion relates to

▪ This is based on the assumption that available capital will be

▪ The analysis of the alternatives involves projecting or estimating the future

Thus, dealing with uncertainty is an important aspect of engineering economic

A good decision-making process can result in a decision that has an

▪ Other decisions, even though relatively successful, will have

• Learning from and adapting based on our experience are essential

PRICE QTY PRICE QUANTITY DEMANDED BY TOTAL MARKET DEMAND

ADVERTISEMENT PRICE OF RELATED

Symbolically Demand Function can be expressed as

where Dx = demand for good X

c) What price to be fixed if seller wants to sell 2500 units?

1. Develop the demand schedule at prices Rs.12,000,

1. Number of components that can be sold at Rs. 100

when price is Rs. 10 Q=400-4P =400-4(10) = 360 units Price Quantity

What price to be charged if seller wants to sell 380 units?