Commerce Sample 1

Unit-3 Business Economics
1. Meaning and Scope of Business Economics
Business Economics is playing an important role in our daily economic life and business practices. In actual practice
different types of business are existing and run by people so study of Business Economics become very useful for
businessmen. Since the emergence of economic reforms in Indian economy the whole economic scenario regarding
the business is changed. Various new types of businesses are emerged, while taking the business decisions businessmen
are using economic tools.
Business involves decision-making; and business economics serves as a bridge between economic theory and decision-
making in the context of business. Economic theories, economic principles, economic laws, economic equations, and
economic concepts are used for decision making.
The word "Economics" originates from the Greek Word "Oikonomia" which can be divided into two parts.
 "Oikos" which means House and
 "Nomia" which means Management.
The Economic System comprises human being having variety of Wants. These wants may be classified into two basic
types.
 Economic Wants
 Non-Economic Wants.
According to Mc Nair and Meriam , "Business economic consists of the use of economic
modes of thought to analyse business situations."
According to E. F. Brigham and J. L. Pappas, "Managerial Economics is the application of
Economic theory and methodology to business administration practice."
According to Joseph L Messey, "Business Economics is the use of economics theories by the
Management in Marking business decision."
According to Hauge, "Managerial Economics is concerned with using logic of economics,
mathematics & statistics to provide effective ways of thinking about business decision
problems."
According to Joel Dean, "The purpose of Managerial Economics is to show how economic
analysis can be used in formulating business policies."
Business Economics is also known as "Managerial Economics". It is also known as
"Applied Economics". Business Management means any activity undertaken to earn
profit, run by a person and managed with the help of economics.
Therefore Managerial Economics is also called Business Economics. In Managerial Economics the concepts, principles
and theories in pure economic science are applied to any business activities. Therefore it is also called as Applied
Economics.
Objectives of Business Firms

1. Profit Maximization : In the conventional theory of the firm, the principal objective of a business firm is
profit maximization. It is prime objective of Business entity. According to this a firm prefers to produce at that point
where it can make maximum of profit. To gain that level of production a firm may follow to different rules i.e. total
revenue, total cost rule and marginal cost marginal revenue rule.
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Business Economics
Profit is the difference between total Revenue and total cost. It can be calculated by deducting the total cost from
total revenue.
Profit = Total Revenue – Total Cost
In order to maximize the profit there are two conditions which must be fulfilled in
any form of market.
1. Marginal cost must be equal to marginal Revenue.
i. e. MC = MR.
This condition is called the necessary condition.
2. Marginal cost curve must intersect Marginal revenue from below.
i. e. MC = MR.
2. Market Share : Business must outshine its competitors in every aspect of quality, availability, and price of goods
and services. It must improve its quality of goods and services, reduce its price and improve the distribution system
in order to maintain its market standing.
The basic objective of managerial economics is to analyse economic problems of business and suggest solutions and
help the managers in decision-making. The objectives of business economics are outlined as below :
 To integrate economic theory with business practice.
 To apply economic concepts: and principles to solve business problems.
 To employ the most modern instruments and tools to solve business problems.
 To allocate the scarce resources in the optimal manner.
 To make overall development of a firm.
 To help in achieving other objectives of a firm like attaining industry leadership, expansion of the market
share etc.
 To minimize risk and uncertainty
 To help in demand and sales forecasting.
 To help in operation of firm by helping in planning, organizing, controlling etc.
 To help in formulating business policies.
Business economics is useful because :

 It provides tools and techniques for managerial decisions.
 It gives answers to the basic problems of business management.
 It supplies data for analysis and forecasting.
 It provides tools for demand forecasting and profit planning.
 It guides the managerial economist.
Stages as Economics as Subjects

1. Wealth Definition or Classical : Economics as a Science of Wealth: Adam Smith
Adam Smith systematized the concept in the form of the book which was entitled as "An enquiry into the
nature and cause of the wealth of Nations" Published in 1776. The famous economists of this period were
Adam Smith, T.R. Malthus, J.B. Say, David Ricardo, etc.
2. Material Welfare Definition or Neo-Classical : Economics is a science of Material welfare: A. Marshall
Alfred Marshall Published his book "Principle of Economics" in 1890. The famous economists of this period
were Alfred Marshall, A.C. Pigou, Carl Marx, etc. The study of economics as the satisfaction or welfare
derived from the consumption of material goods.

Business Economics
3. Scarcity and Choice Definition or Modern : Economics as a Science of Scarcity and Choice : L. Robbins
Lionel Robbins has offered most scientific definition in his famous book Published in 1932. "An Essay on
the nature and Significance of Economic Science" The famous economists of this period were Lionel
Robbins, J.M. Keynes, etc. The study of economics for changing the focus of the study is 'wealth and aspect'
and 'material welfare' to 'scarcity and choice' and 'human development'.
4. Development and Growth Definition : Economics as a Science of Development and Growth : Paul Samuelson.
He Published book "Economics: An Introductory Analysis" first Published in 1948 was one of his famous
works on economics."
Difference between Economics and Business Economics

Economics Business Economics
1 It is a pure Economics. 1 It is applied Economics.
2 It consists of economic theories and principles. 2 Managerial economics applies economic theories
and principles to solve the business problems.
3 Economics has similar emphasis on 3 Managerial economics relatively give more stress on
both Micro and Macro- economics. micro economics than macro-economics.
4 Micro economics part of Economics considers both 4 It's micro economic part considers only individual
Individual consumer as well as firm. firm.
5 It's micro economic analysis deals with rent, 5 Micro Economic part of managerial Economics is
Interest, wages and profit. related only with profit.
Features of Business Economics

Following are the main characteristic features of Business Economics which constitute the nature and subject matter.
(1) Business Economics means the application of economic concepts, theories and principles to the business
activities.
(2) Business Economics is related with the micro-economics. It is micro in nature. It is mainly related with the
problems of individual unit.
(3) Also it deals with the macro-economics. Manager of the firms has to study the macro - economic concepts
like National Income, Business Cycles, Labour Relations, Government Policies on taxation, budget, monetary
issues and international trade etc. By studying these macro-economic concepts Manager of a business firm
takes the decisions in respect of his firm.
(4) Managerial economics deals with the theory of firm which is pure theory of economics. Economic principles
of this theory are applied to his firm to decide profit. It means that managerial economics deals with the theory
of distribution.
Micro and Macro Economics

It should be clear by now that economics covers a lot of ground. That ground can be divided in two parts :
Microeconomics focuses on the actions of individual agents within the economy, like households, workers, and
businesses;
Macroeconomics looks at the economy as a whole. It focuses on broad issues such as growth of production, the
number of unemployed people, the inflationary increase in prices, government deficits, and levels of exports and
imports. Microeconomics and macroeconomics are not separate subjects, but rather complementary perspectives on
the overall subject of the economy.
Microeconomics and macroeconomics are two different perspectives on the economy. The microeconomic
perspective focuses on parts of the economy: individuals, firms, and industries. The macroeconomic perspective looks
at the economy as a whole, focusing on goals like growth in the standard of living, unemployment, and inflation.
Macroeconomics has two types of policies for pursuing these goals: monetary policy and fiscal policy.

Business Economics
Comparison between Macro-Economics & Micro-Economics

Basis for Comparison Micro-Economics Macro-Economics
Meaning The branch of economics that studies the The branch of economics that studies the
behavior of an individual consumer, firm, behavior of the whole economy, (both
family is known as Microeconomics. national and international) is known as
Macroeconomics.
Deals with Individual economic variables Aggregate economic variables
Business Application Applied to operational or internal issues Environment and external issues
Tools Demand and Supply Aggregate Demand and Aggregate Supply
Assumption It assumes that all macro-economic It assumes that all micro-economic
variables are constant. variables are constant.
Concerned with Theory of Product Pricing, Theory of Theory of National Income, Aggregate
Factor Pricing, Theory of Economic Consumption, Theory of General Price
Welfare. Level, Economic Growth.
Scope Covers various issues like demand, supply, Covers various issues like, national income,
product pricing, factor pricing, production, general price level, distribution,
consumption, economic welfare, etc. employment, money etc.
Importance Helpful in determining the prices of a Maintains stability in the general price level
product along with the prices of factors of and resolves the major problems of the
production (land, labor, capital, economy like inflation, deflation, reflation,
entrepreneur etc.) within the economy. unemployment and poverty as a whole.
Limitations It is based on unrealistic assumptions, i.e. It has been analyzed that 'Fallacy of
in microeconomics it is assumed that there Composition' involves, which sometimes
is a full employment in the society which is doesn't proves true because it is possible
not at all possible. that what is true for aggregate may not be
true for individuals too.
Scope of Business Economics

Business Economics is mainly concerned with the application of economic principles and theories. The scope of
Business economics covers two areas of decision making.
Scope of Business Economics

Environmental or
Demand Analysis Social

External Issues
Theory of Production
Operational or Internal Issues
Economic
Cost-Analysis Political Environment
Pricing Theory
Economic Environment
Theory of Profit
Resource Allocation
Capital-Investment Analysis
Inventory Management
Advertising

Business Economics
(A) Operational or Internal Issues

The manager of business firm faces the problems, which are related to the internal issues of the firm. They are
controlled by the manager with the help of economic theories and principles. They are as follows :
1. Demand Analysis : The manager thinks about the demand for his firm's product. A firm can only survive
if it is able to cater the demand for its product in market at the proper time and in the right quantity. A firm
can economically stand in the market, when it's goods are continuously demanded and sold in the market.
Manager looks to the market demand of his firm's product. He made the accurate estimate of demand and
make the decisions. Before he come to the final conclusions manager of every business firm can study the
basic concepts and theories of demand analysis in economics as law of demand, demand forecasting, elasticity
of demand and their variant factors.
2. Theory of Production : Theory of production is also called as the theory of firm. Along with the cost
of production it also consists of the firm's revenue. It includes the relationship between various factors of
production, input-output analysis, capital - labour ratio, optimum production, break even analysis etc. These
economic concepts help to business manager in solving the problems related with the production.
3. Cost-Analysis : Cost of production is very significant factor in the process of production. Therefore every
manager must to possess a good knowledge of cost analysis it includes various kinds of costs, which are very
essential in decision making.
4. Pricing Theories : Managerial economics deals with the pricing theories. Pricing of a product incurs income
to the firm. The success of the firm can be comprised in a sound pricing policy of its product, how the price
is to be determined in various forms of market such as perfect competition, monopoly, monopolistic competition,
oligopoly, duopoly etc.
5. Theory of Profit : Profit maximization is a aim of business firm. Making profit in long run is a sign of
successful entrepreneur. Profit depends on various factors such as internal factors and external factors. These
factors are many in number e.g. demand for product, input prices, factor prices, competition, economic
policy, business risks and the amount of investment etc. Knowledge of sound profit earning policy and
techniques of profit planning are also important to business manager.
6. Resource Allocation : Managerial economics also deals with the problem of optimum allocation of resources.
Resources are scare, so they should be allocated efficiently to different uses by the manager.
7. Capital-Investment Analysis : Capital is scare and fundamental factor of production. It is the foundation
of business. Large amount of capital is invested in big firms. So many problems come up before management.
In order to solve these problems enough time and labour are required. In brief, the capital budgeting involves
planning and control of capital expenses.
8. Inventory Management : Every firm requires raw material. It would be stored in inventories. Knowledge
of this stock inventory is achieved from economic theory.
9. Advertising : Advertising is the heart of modern business practices. It is one of the features of modern
marketing system. It helps to increase the scale of a product. Therefore every businessman can follow these
techniques.
(B) Environmental or External Issues

These issues are related to the general business environment in which the firm or business operates. These are social,
economic and political environment's, economic environment includes kinds of economic systems, situations existing
in the field of production, income, employment, prices, saving and investment, financial institutions as banks, financial
corporations, Insurance companies, trends in international trade. It also includes the conditions prevailing in labour and
capital markets, government policy, industrial policy, monetary policy consumer's co-operatives etc. Political environment
is related to state activities. It includes the state's attitude towards business firms.

Business Economics
Natures of Economics
1. Micro Economic Nature : Business Economics is Microeconomics in nature because it deals with the matters
of a particular business firm only.
2. Use of Economic Theories : Business Economics uses all economic theories relating to the profits, distribution
of income etc.
3. Realistic One : Business Economics is a realistic science. It studies all matters concerning business organization
by considering the real conditions existing in the business field.
4. Normative Science : Business Economics is a normative science. It studies the matters concerning the aims
and objectives of a business firm. It determines the methods to be adopted for achieving such objectives. It
also makes inquiry into the good and bad in decision making. Hence it is a normative science.
5. Use of Macroeconomics : Even though Business Economics has the nature of Microeconomics, it also uses
Macroeconomics approaches frequently. Certain matters in Macroeconomics like business cycles, national
income, public finance, foreign trade, etc. which are essential for Business Economics. So, Business Economics
uses the Macro Economics phenomenon for taking business decisions.
6. Economics as a Science : Science is a branch of knowledge that defines the relationship between cause and
effect. As results observed in science are measurable and based on facts, economics also endeavours to find
a relationship between cause and effect and provides measurable results.
7. Economics is an Art : Art is a branch of study that deals with expressing or applying the creative skills and
imagination of humans to perform a certain activity. Similarly, economics also requires human imagination for
the practical application of scientific laws, principles, and theories to perform a particular activity.
Ques. : Which kind of economics explains the phenomenon of cause and effect relationship ?
(NTA UGC-NET Dec. 2012 P-II)
(A) Normative (B) Positive
(C) Micro (D) Macro
Ans. : (B)
Positive economics is a stream of economics that focuses on the description, quantification, and explanation of
economic developments, expectations, and associated phenomena. It relies on objective data analysis, relevant facts,
and associated figures. It attempts to establish any cause-and-effect relationships or behavioral associations which can
help ascertain and test the development of economic theories.
Ques. : Business Economics is a subject which (NTA UGC-NET Dec. 2013 P-II)
(A) studies economic relationships
(B) studies economic activities at the aggregate level
(C) deals with the tools of economics used for decision making in business
(D) studies optimum allocation of limited resources
Ans. : (C)
Business Economics is a subject which deals with the tools of economics used for decision making in business
Ques. : Which one of the following does not explain the basic nature of Business economics ?
(NTA UGC-NET June 2014 P-II)
(A) Behaviour of firms in theory and practice.
(B) Distribution theories like rent, wages and interest along with the theory of profit.
(C) Use of the tools of economic analysis in clarifying problems in organising and evaluating information and in
comparing alternative courses of action.
(D) Integration of economic theory with business practices for the purpose of facilitating decision making.

Business Economics
Ans. : (B)
Distribution theories like rent, wages and interest along with the theory of profit does not explain the basic nature of
Business economics.
Ques. : Which one is not the item of economic cost to the business ? (NTA UGC-NET June 2013 P-II)
(A) Owner supplied resources.
(B) Market supplied resources.
(C) Implicit costs.
(D) Non-monetary opportunity costs of using owner supplied resources.
Ans. : (B)
The item of economic cost to the business includes :
1. Owner supplied resources.
2. Implicit costs.
3. Non-monetary opportunity costs of using owner supplied resources
2. Demand Analysis
The term demand implies a desire for a commodity backed by the ability and willingness to pay for it. Demand is the
mother of production.
According to Prof. Bober, "By demand we mean the various quantities of a given
commodity or service which consumers would buy in one market in a given period of time at
various prices or at various incomes or at various prices of related goods."
Demand is a relationship between the price and quantity demanded other things of constant.
Three things are essential for desire a commodity to become effective demand.
 Desire a commodity
 Willingness to pay
 Abilityto pay for the commodity
The Three alternative way to expression of demand :

Demand Analysis
A Demand Function
A Demand Schedule
A Demand Curve
A Demand Function
Demand function is a function that describe how much of a commodity will be purchased at the prevailing prices
of that commodity and related commodities, alternative income levels, and alternative values of other variables
affecting demand.
 Price is not the only factor which determines the level of demand for a good.

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 Other important factor is income. The rise in income will lead to an increase in demand for a normal
commodity.
 A few goods are named as inferior goods for which the demand will fall, when income rises. Another
important factor which influences the demand for a good is the price of other goods.
Other factors which affect the demand for a good apart from the above mentioned factors are :
 Changes in Population
 Changes in Fashion
 Changes in Taste & Preferences
 Changes in Advertising
A Demand Schedule
The demand schedule is generally represented by a table which show how quantity demanded of goods varies the
price other things remain constant.
Price of Bread Qty. of Demand
50 1
45 2
40 3
35 5
30 7
25 9
20 12
15 15
10 20
A Demand Curve
A graphical representation of the demand schedule is the demand curve as shown in figure. Demand curves
generally have a negative gradient indicating the inverse relationship between quantity demanded and price.
There are at least three accepted explanations of why demand curves slope
downwards 1:
 The law of diminishing marginal utility
Did You  The Income effect
Know ?
 The substitution effect
Price Per
Bread
A
50
B
40
Demand
Curve
1 3 Quantity
Per Week
Fig. : Demand Curve

Business Economics
Types of Demand
Demand for Consumer Goods v/s Producer Goods
The different in these two types of demand are that consumer goods are needed for direct consumption, while the
producer goods are needed for producing other goods. Soft drink, milk, bread etc. are the examples of industrial goods.
Autonomous Demand v/s Derived Demand

Autonomous demand refers to the demand for products and services directly. The demand for the services of a super
specialty hospital can be considered as autonomous whereas the demand for the hotels around the hospital is called
a derived demand.
Demand for Durable Goods v/s Perishable Goods

Here the demand for goods is classified based on their durability. Durable goods are those goods which gives services
relatively for a longer period. The use of perishable goods is very less may be in hours or few days. Durable goods
meet both the current as well as future demand, whereas perishable goods meet only the current demand. Example
of perishable goods: milk, vegetables, fish etc. Example of durable goods: rice, wheat, sugar etc.
Firm Demand v/s Industry Demand

The firm is a single business unit whereas industry refers to the group of firm carrying on similar activity. The quantity
of goods demanded by single is called firm demand and the quantity demanded by industry as a whole is called industry
demand.
Short Run Demand v/s Long Run Demand

The short run and long run cannot be clearly defined other than in terms of duration of time. The demand for particular
product /service in a given region for a particular day can be viewed as long run demand. Short run refers to a period
of shorter duration and long run refers to the relatively period of longer duration.
New Demand v/s Replacement Demand

New demand refers to the demand of the new products and it is the addition to the existing stock. In replacement
demand, the item is purchased to maintain the asset in good condition. The demand for cars in new demand and the
demand spare parts is replacement demand. Replacement demand may also refer to the demand resulting out of
replacing the existing assets with the new ones.
Total Market v/s Segment market Demand

Let us take the consumption of sugar in a given region. The total demand for sugar in the region is the total market
demand. The demand for the sugar from the sweet making industry from a particular region is the segment market
demand. The aggregate demand for all the segment market is called the total market demand.
Factor Affecting of Demand

Price of the Commodity
Income of the Consumer

Factor Affecting of Demand
Prices of Related Goods
Tastes of the Consumers
Wealth
Population
Government Policy
Expectations Regarding the Future
Climate and Weather
State of Business

Business Economics
1. Price of the Commodity : The most important factor-affecting demand is the price of the commodity. The amount
of a commodity demanded at a particular price is more properly called price demand. The relation between price and
demand is called the Law of Demand. It is not only the existing price but also the expected changes in price, which
affect demand.
2. Income of the Consumer : The demand for goods also depends upon the income of consumers. With an increase
in income, the consumer's purchasing power increases, because he is now in a position to buy more goods. Consequently,
the consumer's demand for goods increases.
There are three types of goods for each of which the effect of income differs :
Normal Goods : Increase in income has effect on the demand for goods. Generally, income of the people is directly
related to their demand. That is when "I" goes up, demand for normal goods goes up and when "I" falls, demand
also falls, example laptop, etc. Thus there is a direct relationship between income and demand of normal goods.
Necessity Goods : For certain goods called necessities, demand is not related to income. Salt, petrol, and LPG are
considered necessity goods.
Demand for salt does not increase with the increase in income and does not decrease with the decrease in income. It
means that it is irrespective of income.
Inferior Goods : Goods are said to be inferior goods if its demand falls with increase in income of the consumer. Thus
there is an inverse relationship between income and demand of inferior goods.
3. Prices of Related Goods : The demand for a commodity is also affected by the changes in prices of the related
goods also. Related goods can be of two types :
(i) Substitutes which can replace each other in use; for example, tea and coffee are substitutes. The change in
price of a substitute has effect on a commodity's demand in the same direction in which price changes. The
rise in price of coffee shall raise the demand for tea;
(ii) Complementary foods are those which are jointly demanded, such as pen and ink. In such cases complementary
goods have opposite relationship between price of one commodity and the amount demanded for the other.
If the price of pens goes up, their demand is less as a result of which the demand for ink is also less. The
price and demand go in opposite direction. The effect of changes in price of a commodity on amount
demanded of related commodities is called Cross Demand.
4. Tastes of the Consumers : The amount demanded also depends on consumer's taste. Tastes include fashion, habit,
customs, etc. A consumer's taste is also affected by advertisement. If the taste for a commodity goes up, its amount
demanded is more even at the same price. This is called increase in demand. The opposite is called decrease in demand.
5. Wealth : The amount demanded of commodity is also affected by the amount of wealth as well as its distribution.
The wealthier are the people; higher is the demand for normal commodities. If wealth is more equally distributed, the
demand for necessaries and comforts is more. On the other hand, if some people are rich, while the majorities are
poor, the demand for luxuries is generally higher.
6. Population : Increase in population increases demand for necessaries of life. The composition of population also
affects demand. Composition of population means the proportion of young and old and children as well as the ratio
of men to women. A change in composition of population has an effect on the nature of demand for different
commodities.
7. Government Policy : Government policy affects the demands for commodities through taxation. Taxing a commodity
increases its price and the demand goes down. Similarly, financial help from the government increases the demand
for a commodity while lowering its price.
8. Expectations Regarding The Future : If consumers expect changes in price of commodity in future, they will
change the demand at present even when the present price remains the same. Similarly, if consumers expect their
incomes to rise in the near future they may increase the demand for a commodity just now.

Business Economics
9. Climate and Weather : The climate of an area and the weather prevailing there has a decisive effect on consumer's
demand. In cold areas woolen cloth is demanded. During hot summer days, ice is very much in demand. On a rainy
day, ice cream is not so much demanded.
10. State of Business : The level of demand for different commodities also depends upon the business conditions
in the country. If the country is passing through boom conditions, there will be a marked increase in demand. On the
other hand, the level of demand goes down during depression.
Law of Demand
The law of demand expresses a relationship between the quantity demanded and its price. The law refers to the
direction in which quantity demanded changes with a change in price.
It may be defined in Marshall's words as "the amount demanded increases with a

fall in price and diminishes with a rise in price".
According to Prof. Samuelson "When the price of goods is raised (at the same time that all
things are held constant) less of the demanded or if a great quantity of a of goods is put in the
market then other things being equal it can be sold only at lower price."
Therefore, The law of demand states that other factors being constant price and quantity demand of any good and
service are inversely related to each other. When the price of a product increases, the demand for the same product
will fall.
These assumptions are :

 There is no change in the tastes and preferences of the consumer;
 The income of the consumer remains constant;
 There is no change in customs;
 The commodity to be used should not confer distinction on the consumer;
 There should not be any substitutes of the commodity;
 There should not be any change in the prices of other products;
 There should not be any possibility of change in the price of the product
being used;
 There should not be any change in the quality of the product; and
 The habits of the consumers should remain unchanged. Given these
conditions, the law of demand operates. If there is change even in one of
these conditions, it will stop operating.
Reason for Law of Demand

Law of Diminishing Marginal Utility : The law of demand is based on the law of diminishing marginal utility which
define that as the consumer purchase more and more units of commodity the utility reduce from each successive unit
goes on decreasing.
Substitute Effect : Substitution effect also affects the demand curve to slope from left to right. As the price of a
commodity falls price of its substitute goods remain the same. The consumer will buy more that of commodity. For
instance tea and coffee are the substitute goods. If the price of tea goes down the consumer may substitute tea or
coffee although price of coffee remains the same. Therefore with fall in price the demand falls due to unfavorable
substitution effect.
Income Effect : If the price of commodity falls the real income of consumer goes up. For example Ram buy Rs.20
Per dozen banana. He is able to buy 1 dozen banana but now the price of banana falls to Rs. 15 per dozen which
leads increase in his real income by Rs.5 in case either consumer will buy more quantity of banana.

Business Economics
Exceptions Law of Demand

Law of Demand indicates the inverse relationship between price and quantity demanded of a commodity. It is generally
valid in most of the situations but there are some situations under which there may be direct relationship between price
and quantity demanded of a commodity. These exceptions are known as exceptions to the law of demand.
Consumer Ignorance : Consumer's ignorance induce them to buy/purchase more in the costly market. Sometimes
they think that high price commodity is better in quality. Thus with the increase in price, demand increases.
Necessary Goods : There are some commodities which are not necessities/necessary but have become necessities
because of their constant use and fashion. For example: LPG gas, Petrol, etc. prices of such commodities increases,
demand does not show any tendency to contract and it negatives the law.
Conspicuous and Consumption : If consumers measure the desired ability of the utility of a commodity, solely by
its price and nothing else, then they tend to buy more of the commodity at higher price and less of it at lower price.
Hence, there is a direct relationship between price & quantity demanded. For example: gold ornaments, diamonds, hair
paintings. Higher the price of the good, greater will be the prestige of the buyer in the society and vice-versa. When
price falls, the commodity comes within the reach of lower class people and they tend to demand more because of
demonstration effect.
Speculation : If people expect the price of good to rise in near future, they demand more even at higher price and
if they expect the price to fall in near future, they demand less of it even at lower price. Thus more quantity of goods
is demanded at rising prices and less quantity of goods is demanded at falling prices. This seems contrary to law of
demand.
Giffen Goods : These are special type of inferior goods named after Sir Robert Giffen. According to him, when price
of inferior goods increases, demand increases, & when price falls, demand falls. So there is direct relationship
between price and demand.
People increase preferences towards superior goods due to rise in their real income. This tendency is found in low
class people. However if price increases beyond certain limit, naturally demand may fall as people prefer superior
goods.
Emergencies : During emergencies like war, famine etc. households behave in an abnormal way. Households accentuate
scarcities and induce further price rise by making increased purchases even at higher prices because of the apprehension
that they may not be available. On the other hand during depression, fall in prices is not a sufficient condition for
consumers to demand more if they are needed.
Change In Fashion : A change in fashion and tastes affects the market for a commodity. When a digital camera
replaces a normal manual camera, no amount of reduction in the price of the latter is sufficient to clear the stocks.
Digital cameras on the other hand, will have more customers even though its price may be going up. The law of
demand becomes ineffective.
Snob Effect : Some buyers have a desire to own unusual or unique products to show that they are different from
others. In this situation even when the price rises the demand for the commodity will be more.
Seasonal Goods : Goods which are not used during the off-season (seasonal goods) will also be subjected to similar
demand behavior.
Goods In Short Supply : Goods that are available in limited quantity or whose future availability is uncertain also
violate the law of demand.
Demonstration Effect : It refers to a tendency of low income groups to imitate the consumption pattern of high
income groups. They will buy a commodity to imitate the consumption of their neighbors even if they do not have
the purchasing power.

Business Economics
Extension and Contraction Demand

The demand for a commodity changes due to a change in price. It is called extension and contraction of demand.
When there is decrease in price of commodity there is in increase in demand of that commodity. This is called
extension of demand.
D
Price
15
10
D1
0 50 60 x
Demand
Fig. : Extension Demand
The diagram shows extension of demand. Quantity of demand is shown on OX axis. The price is shown on OY axis.
DD is demand curve. When price comes down the quantity demanded extends and demand curve moves downward.
When there is increase in price of a commodity there is decrease in the demand for that commodity. This called
contraction of demand. Thus demand varies in opposite direction due to change in price.
D
Price
20
10
D1
0 30 40 x
Demand
Fig. : Contraction Demand
The diagram shows contraction of demand. Quality of demand is shown on OX axis. The price is shown on OY axis.
DD is demand curve. When price increases the quantity demanded comes down and demand curve moves upward.
Increase in Demand and Decrease in Demand

Increases in demand are shown by a shift to the right in the demand curve. This could be caused by a number of
factors, including a rise in income, a rise in the price of a substitute or a fall in the price of a complementary good.

Business Economics
Price Per
Bread
A B
60
D1
D
500 600 Quantity Demanded

Per Week
Fig. : Increase in Demand or Right Shift
in Demand Curve
An increase in demand can be illustrated by a shift in the demand curve to the right.
Decrease in Demand : Conversely, demand can decrease and cause a shift to the left of the demand curve for
a number of reasons, including a fall in income, assuming a good is a normal good, a fall in the price of a
substitute and a rise in the price of a complementary good.
Price Per
Bread
B A
60
D
D1
400 500 Quantity
Per Week
Fig. : Decrease in Demand or Left Shift in
Demand Curve
Decrease in demand are shown by a shift of the demand curve to the left.
Ques. : Normally Demand curve slopes (NTA UGC-NET June 2012 P-II)
(A) Upward (B) Downward
(C) Horizontal (D) Vertical
Ans. : (B)
The demand curve generally slopes downward from left to right. It has a negative slope because the two important
variables price and quantity work in opposite direction. As the price of a commodity decreases, the quantity demanded
increases over a specified period of time, and vice versa, other, things remaining constant.

Business Economics
Ques. : A commodity is used for multiple purposes, then the demand for it is known as
(NTA UGC-NET Dec. 2012 P-II)
(A) Joint Demand (B) Composite Demand
(C) Direct Demand (D) Autonomous Demand
Ans. : (B) Composite demand is where goods have more than one use.
Ques. : Match the items of List-I with those of List-II and indicate the correct code :
List-I List-II
(a) Substitute Goods (i) Negative Cross Elasticity
(b) Complementary Goods (ii) Low Price Elasticity
(c) Giffen Goods (iii) Positive Cross Elasticity
(d) High Income Group Consumption Goods (iv) Positive Price Elasticity
Codes : (NTA UGC-NET Dec. 2015 P-II)
(1) (a)-(iii), (b)-(iv), (c)-(ii), (d)-(i) (2) (a)-(iii), (b)-(i), (c)-(iv), (d)-(ii)
(3) (a)-(ii), (b)-(iii), (c)-(i), (d)-(iv) (4) (a)-(i), (b)-(ii), (c)-(iii), (d)-(iv)
Ans. : (2) Correct match is given below :
List-I List-II
(a) Substitute Goods (i) Positive Cross Elasticity
(b) Complementary Goods (ii) Negative Cross Elasticity
(c) Giffen Goods (iii) Positive Price Elasticity
(d) High Income Group Consumption Goods (iv) Low Price Elasticity
Ques : A rectangular hyperbola shaped demand curve on all its points has : (NTA UGC-NET June 2015 P-II)
(A) Equal slopes of the price demand curve (B) Price elasticity equal to unity
(C) Varying price elasticity (D) Both slope and price elasticity equal
Ans. : (B) A rectangular hyperbola shaped demand curve on all its points has price elasticity equal to unity.
3. Elasticity of Demand and Its Measurement
Price elasticity of demand is generally defined as the responsiveness or sensitiveness of demand for a commodity to
the change in its price. More precisely, elasticity of demand is the percentage changes in demand as a result of one
per cent in the price of the commodity.
Firms may have decided to change the price even without any change in the cost of production but whether rising
price following the rise in cost or otherwise proves beneficial depends on :
(a) The price elasticity of demand for the product i.e. how high or low is the proportionate change in its demand
in response to a certain percentage change in its price.
(b) Price elasticity of demand for its substitute because when the price of product increases the demanded for
its substitute increases automatically even if their prices remain unchanged.

Business Economics
Concept of Price Elasticity of Demand

Price Elasticity of Demand

Income Elasticity of Demand
Cross Elasticity of Demand
Elasticity of Substitute
Price of Elasticity of Demand

Price Elasticity of Demand is generally define as the responsiveness or sensitiveness of demand for a commodity to
change in its price. More precisely elasticity of demand is the percentage change in demand as a result of percentage
change in the price of a commodity.
A formal definition of price-elasticity of demand (ed) is given as :
F ocus
ormula ed 
% change in quantity demanded
% change in price
Q / Q
Price elasticity of demand 
P / P
Where Q = Original Quantity Demanded
P = Original Price
Q = Change in Quantity Demanded
and P = Change in Price
For example, if the price of a daily newspaper increases from Rs. 1.00 to Rs. 1.20, and the daily sales falls from
500,000 to 250,000, the PED will be
 5, 00, 000  2, 50, 000   1.00 
     = (–) 2.5
 5, 00, 000   1.20  1.00 
Price
P1
P
P0
Q1 Q0 Quantity
Q Demanded
Fig. : Price Elasticity of Demand
The price elasticity of demand is the proportional change in the quantity demanded, relative to the proportional change
in the price of the good.

Business Economics
Income Elasticity of Demand

Income elasticity of demand measures the responsiveness of quantity demanded to a change in income. It is measured
by dividing the percentage change in quantity demanded by the percentage change in income. If the demand for
a commodity increases by 20% when income increases by 10% then the income elasticity of that commodity is said
to be positive and relatively high.
F ocus
ormula Ey 
% change in quantity demanded of A
% change in income
Q / Q
Income elasticity of demand 
I / I
The following are the various types of income elasticity :

 Zero Income Elasticity : The increase in income of the individual does
not make any difference in the demand for that commodity. (E i = 0)
 Negative Income Elasticity : The increase in the income of consumers
leads to less purchase of those goods. (E i < 0).
 Unitary Income Elasticity : The change in income leads to the same
percentage of change in the demand for the good. (Ei = 1).
 Income Elasticity is Greater than 1 : The change in income increases the
demand for that commodity more than the change in the income. (Ei > 1).
 Income Elasticity is Less than 1 : The change in income increases the
demand for the commodity but at a lesser percentage than the change in the
Income. (E i < 1).
Price
De
m
an Income
d
1 Increase
D
De em
m an
an d
d 0
Income 2
Decrease
Quantity
Fig. : Income Elasticity of Demand
The income elasticity of demand is the proportional change in the quantity demanded, relative to the proportional
change in the income.

The cross-elasticity is the measure of responsiveness of demand for a commodity to the changes in the price of its
substitutes and complementary goods. For instance, cross-elasticity of demand for tea is the percentage change in its
quantity demanded with respect to the change in the price of its substitute, coffee.

Business Economics
F ocus
ormula
% change in quantity demanded of A
E A.B 
% change in price of product B
Cross Price Elasticity
Qx 2  Qx 1
 100
Qx 1
Exy 
Py 2  Py 1
 100
Py1
 Q x  Q x   Py
2 1
 1
   
 Qx   Py  Py 
1 2 1
Q x Py 1
 
 Py Qx 1
Qx Py1
or  
Q x1  Py
where Exy > 0 Substitutes (+/+ or –/–)
Exy < 0 Complements (+/– or –/+)
Exy = 0 Unrelated goods (0/+ or 0/–)
 A positive cross elasticity of demand means that the products are

substitute goods.
 A negative cross elasticity of demand means that the products are
Did You complementary goods.
Know ?  A near zero cross elasticity of demand means that the products are
independent goods i.e. quantity demanded of product A is not affected
by any movement in price of product B.
Price
The price of a
substitute increase
De
m
an
d
The price of
a substitute
decreases
Quantity
Fig. : Cross Elasticity of Demand
The cross elasticity of demand is the proportional change in the quantity demanded, relative to the proportional change
in the price of another good. Looking at the chart, the change in the price of another good shifts the demand curve
to the left or to the right.
 If the two goods are substitutes, the cross elasticity of demand is positive.
 If the two goods are complements, the cross elasticity of demand is negative.

Business Economics
Degree’s of Elasticity of Demand

(i) Perfectly Elastic Demand (ed = ) : In a market that has perfectly elastic demand for a product, even a small
change in price causes an infinite change in the quantity demanded. Likewise a very insignificant rise in price is
reduces to zero. This case is generally theoretical which never found in real life.
Perfectly Elasticity of Demand
Price Demand (Qty.)
10 100
10 110
10 120
Price
Quantity Demanded
Fig. : Perfectly Elastic Demand
(ii) Highly Elastic Demand (ed > 1) : The demand is relatively more elastic when small change in price cause a greater
change in quantity of demand. In such case proportionate change in price of commodity causes more than proportionate
change in quantity of demand.
 If income goes up 10%, and you spend 20% more on foreign holidays. The ed = 2.0 (luxury goods) (ed > 1).
 If income goes up 10%, and you spend 5% less on Tesco value baked beans. The ed = – 0.5 (inferior good)
(ed< 0).
Highly Elasticity of Demand

Price Demand (Qty.)
50 100
60 50
Price Elastic Demand

change in price leads to
bigger percentage
change in demand
60p
50p
D
50 100 Quantity
Demanded
Fig. : Highly Elastic Demand

Business Economics
(iii) Unitary Elastic Demand (ed = 1) : The demand is said to be unitary when a change in price result in exactly
the same percentage change in quantity demanded of a commodity. In such situation the percentage change in both
price and quantity demanded is the same. For example if the price falls by 25% the quantity demanded rise by the
same 25%.
Elasticity of Demand
Price Demand (Qty.)
10 100
8 125
6 167
Y
D
P2
Price
P1
D1
X
Q2 Q1
Quantity Demanded
Fig. : Unitary Elastic Demand
Observe the graph, price of the goods increased from P1 to P2 and eventually the demand for the goods decreases
from Q1 to Q2. The proportionate change in price is equal to the proportionate change in demand.
(iv) Less Elastic Demand or Relatively Inelastic Demand (ed < 1) : Where a greater change in price leads to
smaller change in Quantity demanded. The demand is said to relatively inelastic when a proportionate change in price
is greater than the proportionate change in quantity demanded. For example if price increase by 10% than quantity
demand is less than by 2%.
Less Elasticity of Demand

Price Demand (Qty.)
10 100
8 102
6 103
Price
D
P2
20%
P1
2% D1
Q2 Q1 Quantity
Demanded
Fig. : Less Elastic Demand

Business Economics
Relatively Elastic Demand, Unitary Elasticity Demand and Relatively Inelastic Demand
Price
Relatively Elastic
Unitary Elasticity
Relatively Inelastic
Quantity
Demanded
Fig. : Relatively Elastic Demand, Unitary
Elasticity Demand and Relatively
Inelastic Demand
 Relatively elastic demand: The elasticity is between – 1 and – 

 Unitary elasticity demand: The elasticity is – 1.
 Relatively inelastic demand: The elasticity is between 0 and – 1.
(v) Perfectly Inelastic Demand (ed = 0) : The demand is said to be perfectly inelastic when a change in price
produces no changes in the quantity of demanded of a commodity. In such case quantity demanded remains constant
regardless to change in price. The amount of demand is totally unresponsive changes in price. The elasticity of demand
is zero.
Perfect Inelasticity of Demand

Price Demand (Qty.)
10 100
8 100
6 100
Price
D
Quantity Demanded
Fig. : Perfectly Inelastic Demand

Business Economics
A Concept of Elasticity of Demand

Price Elasticity Relation Significance
Perfect Elastic ed =  Small change in price causes an infinite change in the quantity
demanded.
Highly Elasticity of ed > 1 Proportionate change in price of commodity cause more than
Demand proportionate change in quantity of demand.
Unitary Elastic ed = 1 change in price result in exactly the same percentage change
Demand in quantity demanded of a commodity
Less Elastic Demand ed > 1 Demand is said to relatively inelastic when a proportionate
or Relatively Inelastic change in price is greater than the proportionate change in
Demand quantity demanded.
Perfectly Inelastic ed = 0 Change in price produces no changes in the
Demand quantity of demanded of a commodity.
Cross Elasticity Relation Significance
Perfect Substitutes ed =  The smallest possible increase (decrease) in the price of one
good cause an infinite large increase (decrease) in the Qty.
demanded of the other goods.
Substitute 0 < ed <  If the price of one goods increases or decreases the Qty. of
demanded of other goods also increases or decreases.
Independent ed = 0 The Qty. of demanded of one good remain constants
regardless of the price of the other goods.
Complements ed < 0 The qty. of demanded of one good decreases or increases
when the price of the other goods increases or decreases.
Income Elasticity Relation Significance
Income Elastic ed > 1 Proportionate change in price of Qty. cause more than
proportionate change in income.
Income Inelastic 0 < ed < 1 when a proportionate change in income is greater than the
(Normal Goods) proportionate change in quantity demanded.
Negative Income Elastic ed < 0 The qty. of demanded of one good decreases or increases
(Inferior Goods) when the income of the other goods increases or decreases.
Methods of Measurements of Price Elasticity of Demand

1. Proportionate or Percentage Method of Flux : This method also known as the Percentage Method, Flux Method,
Ratio Method, and Arithmetic Method is also associated with the name of Dr. Marshall. According to this method,
"Price elasticity of demand is the ratio of percentage change in the quantity demanded to the percentage change in
price of the commodity."
F ocus
ormula
Proportionate or Percentage Method of Flux
% Change in Quantity Demanded
ed 
% Change in Pr ice
% Q
ed 
% P
(Q1  Q ) / Q
ed 
( P1  P ) / P
Suppose Ram is selling 50 candles for 50 Rs. You find that decrease of 10 Rs. increases the demand for 60. What
would be the price elasticity of demand?
ed = ((60 – 50)/50) / ((40 – 50)/50)
ed = 0.2/–0.2 = –1
ed = 1

Business Economics
2. Point Method : Graphic method is otherwise known as point method or Geometric method. This method was
popularized by point method. According to this method elasticity of demand is measured on different points on a
straight line demand curve. The price elasticity of demand at a point on a straight line is equal to the lower segment
of the demand curve divided by upper segment of the demand curve.
This method is explained with the help of (A) straight line demand curve and (B) convex demand curve.
(A) Straight Line Demand Curve : The diagram shows a straight line demand curve. We join both sides of the
straight line demand curve with the two axes at points D and C. Elasticity at any points is equal to the ratio of the
distance from the point P to the X axis and the distance to the Y axis.
D EP = C Point P is less than 1
M EP > 1
Price
N EP = 1
M
P EP < 1
Q EP > C
Quantity D X
Fig. : Straight Line Demand Curve
(B) Convex Demand Curve : There is convex demand curve DD. Suppose we want to check price elasticity at point
A. We can draw a tangent RS at the point A. The elasticity is found as AM / AR. Similarly for finding out elasticity
at point B we draw a tangent at this point to the demand curve. The elasticity at this point is given by the ratio of
the distance along the tangent to the X-axis divided by the distance of the Y-axis.
R1 D
Price
N1 A1
B1
D1
S1 M1 D x
Quantity
Fig. : Convex Demand Curve
3. ARC Method : Arc elasticity of demand measures elasticity between two points on a curve. On most curves the
elasticity of a curve varies depending upon where you are. Therefore elasticity needs to measure a certain sector of
the curve. "Arc elasticity is a measure of the average responsiveness to price change exhibited by a demand
curve over some finite stretch of the curve" Prof. Baumol.

Business Economics
Y
D
P1 A
P2 B
Price
D1
X
O Q1 Q2
Quantity
Fig. : ARC Method
4. Total Expenditure Method : Total expenditure method was formulated by Alfred Marshall. The elasticity of demand
can be measured on the basis of change in total expenditure in response to a change in price. It is worth noting that
unlike percentage method a precise mathematical coefficient cannot be determined to know the elasticity of demand.
By the help of total expenditure method we can know whether the price elasticity is equal to one, greater than one,
less than one. In such a method the initial expenditure before the change in price and the expenditure after the fall
in price are compared. By such comparison, if it is found that the expenditure remains the same, elasticity of demand
is One (ed = 1).
If the total expenditure increases the elasticity of demand is greater than one (ed > 1). If the total expenditure diminished
with the change in price elasticity of demand is less than one (ed).
Schedule for Expenditure Elastic Demand
Price Quantity Demand Outlay

12 2 24
6 4 24
3 8 24
Y
D
12
Price
6
D1
X
0 2 4
Quantity Demanded
Fig. : Total Expenditure Method
5. Revenue Method : Mrs. Joan Robinson has given this revenue method and elasticity of demand is measured with
the help of average revenue and marginal revenue. Therefore, sale proceeds that a firm obtains by selling its products
are called its revenue. However, when total revenue is divided by the number of units sold, we get average revenue.

Business Economics
Determinants of Price Elasticity of Demand

1. The Availability of Close Substitutes : If a product has many close substitutes, for example, cold drink,
then people tends to react strongly to a price increase of one firm's cold drink. Thus, the price elasticity of
demand of this firm's product is high. The more the number of substitutes of the good, higher is likely to
be the ed of that good. This is so because the consumer can easily shift from one substitute to another in
case of price change.
2. The Importance of the Product's Cost in One's Budget : If a product, such as salt, is very inexpensive,
consumers are relatively indifferent about a price increase. Therefore, salt has a low price elasticity of demand.
Cars are expensive and a 10% increase in the price of a car may make the difference whether people will
choose to buy the car or not. Therefore, cars have a higher price elasticity of demand. Higher the proportion
of income of consumer spends on a good, higher is the ed of that good and vice versa.
3. Number of uses of the Good : More the number of uses of a good more likely are to be the Ed of that
good. For example electricity has many uses and can be used for lighting, heating, cooling etc. so the demand
for electricity is more elastic as any increase in electricity charges will reduce the demand for it because
consumer will use it only for heating and not for heating and cooling.
4. Income of Consumer : Richer the consumer, more likely the demand for a good by him is less elastic. A
rich consumer is less likely to reduce consumption of a good when its price rises.
5. How High The Price of The Good : Higher the price of the good, higher is the elasticity. It is so because
a change in price of a high priced good affects the total budget significantly.
6. Nature of The Good : The elasticity of demand also depends on the nature of commodity or how important
or necessary the good is for the consumer. In case of essential goods like salt, kerosene oil or match box
or wheat or rice the demand will be less than unitary elastic i.e. inelastic. In case of luxury goods like air-
conditioner, costly TV or furniture, gold etc. the demand will be more than unitary elastic i.e. elastic.
However, in case of comfort goods like fans, coolers, heaters etc., the demand will be unitary elastic. It is
a matter of habit also. If the consumer is habitual to a certain product like liquor or cigarettes etc., he is less
likely to shift to other goods in case of rise in price of the good thus demand for these products are inelastic.
7. The Period of time under Consideration : Price elasticity of demand is greater if you study the effect of
a price increase over a period of three years rather than one week. Over a longer period of time, consumers
have more time to adjust to the price change. If the price of petrol increases considerably, buyers may not
decrease their consumption much after one week. However, after three years, they have the ability to move
closer to work or school, arrange carpools, use public transportation, or buy a more fuel-efficient vehicle.
8. Joint Demand : Goods demanded jointly have inelastic demand than demanded separately. For example car
and petrol pen and ink and camera and film, house and cement. Rise in price of cement may not contract
its demand if there is no fall in the demand for houses.
9. Time Elapsed since a Price Change : The longer the time that has elapsed since a price change, the more
elastic will be the demand.
Ques. : Match the items of List-I with the items of List-II. (NTA UGC-NET June 2014 P-II)
List-I List-II
(a) A market having high price elasticity. (i) Skimming pricing
(b) A market having high price inelasticity (ii) Differential pricing
(c) A market having several segments differing (iii) Penetrating pricing
prominently with regard to price elasticities of
their demand.
Codes :
(A) (a)-(ii), (b)-(iii), (c)-(i) (B) (a)-(i), (b)-(ii), (c)-(iii)
(C) (a)-(ii), (b)-(i), (c)-(iii) (D) (a)-(i), (b)-(iii), (c)-(ii)
Ans. : (A) (a)-(ii), (b)-(iii), (c)-(i)

Business Economics
Ques. : Match the items of the following two lists and suggest the correct code :
List-I List-II
(a) Zero Income Elasticity (i) Substitute goods
(b) Unit Cross Elasticity (ii) Complementary goods
(c) Positive Cross Elasticity (iii) Indifferent goods
(d) Negative Cross Elasticity (iv) Independent goods
Codes : (NTA UGC-NET Dec. 2014 P-II)
(A) (a)-(iii), (b)-(ii), (c)-(i), (d)-(iv) (B) (a)-(ii), (b)-(iii), (c)-(iv), (d)-(i)
(C) (a)-(iii), (b)-(iv), (c)-(i), (d)-(ii) (D) (a)-(iv), (b)-(i), (c)-(ii), (d)-(iii)
Ans. : (C) (a)-(iii), (b)-(iv), (c)-(i), (d)-(ii)
Ques. : If price of any commodity decreases by 20% and the demand for that commodity increases by 40%, then
elasticity of demand would be (NTA UGC-NET Dec. 2012 P-III)
(A) perfectly elastic (B) perfectly inelastic
(C) unit elastic (D) highly elastic
Ans. : (D)
If price of any commodity decreases by 20% and the demand for that commodity increases by 40%, then elasticity of
demand would be highly elastic.
Ques. : A measure of the responsiveness of quantity demanded to changes in the price of a related good is known
as (NTA UGC-NET Dec. 2013 P-III)
(A) Cross Elasticity of Demand (B) Substitution Elasticity of Demand
(C) Complementary Elasticity of Demand (D) Price Elasticity of Demand
Ans. : (A)
The cross elasticity of demand is an economic concept that measures the responsiveness in the quantity demanded of
one good when the price for another good changes. Also called cross-price elasticity of demand, this measurement is
calculated by taking the percentage change in the quantity demanded of one good and dividing it by the percentage
change in the price of the other good.
4. Supply Analysis
Supply of a commodity refers to the various quantities of the commodity which a seller is willing and able to sell at
different prices in a given market at a point of time, other things remaining the same (ceteris paribus). Supply is what
the seller is able and willing to offer for sale. The Quantity supplied is the amount of a particular commodity that a
firm is willing and able to offer for sale at a particular price during a given time period.
The law of supply states that “a firm will produce and offer to sell greater quantity of product/service as the
price of product or service rises, Other things remaining constant.”
Law of supply states that “other factors remaining constant, price and quantity supplied of a good are directly
related to each other.” In other words, when the price paid by buyers for a good rises, then suppliers increase the
supply of that good in the market.
Law of supply depicts the producer behavior at the time of changes in the prices of goods and services. When
the price of a good rises, the supplier increases the supply in order to earn a profit because of higher prices.

Business Economics
Supply Curve
P1
Price
P2
P3
Q3 Q2 Q1
Quantity Supply
Fig. : Supply Analysis
The above diagram shows the supply curve that is upward sloping (positive relation between the price and the quantity
supplied). When the price of the good was at P3, suppliers were supplying Q3 quantity. As the price starts rising, the
quantity supplied also starts rising.
Explaining the Law of Supply

There are three main reasons why supply curves are drawn as sloping upwards from left to right giving a positive
relationship between the market price and quantity supplied :
The Law of Supply states that "when the price of a good rises, and everything else remains the same, the
quantity of the good supplied will also rise."
In short,
 P  Qs
1. The Profit Motive : When the market price rises following an increase in demand, it becomes more profitable
for business to increase their output.
2. Production and Costs : When output expands, a firm's production costs tend to rise, therefore a higher price
is needed to cover these extra costs of production. This may be due to the effects of diminishing returns as
more factor inputs are added to production.
3. New Entrants Coming into The Market : Higher prices may create an incentive for other businesses to enter
the market, leading to an increase in total supply.
Interpreting changes Price and Quantity

Demand And Supply Shifted Effect on Price and Quantity
If Demand Rises The Demand Curve Shifts to the Right Both Price and Qty. Increases
If Demand Falls The Demand Curve Shifts to the Left Both Price and Qty. Falls
If Supply Rises The Supply Curve Shifts to the Right Price falls but Qty. Increases
If Supply Falls The Supply Curve Shifts to the Left Price Increase but Qty. Decreases
Assumptions
1. No Change in Cost of Production : It is assumed that there is no change in cost of production because
of the profit decreases with the increase in cost of production and causes the decrease in supply. If price of
a commodity decreases and cost of production also decreases, at the same time, the quantity supplied does
not decrease and profit remains constant.

Business Economics
2. No Change in Technology : It is also assumed that technique of production does not change. If better
methods of production are invented, profit increases at the previous price. The sellers increase supply and law
of supply does not operate.
3. No Change in Climate : It is also assumed that there is no change in climatic situation. For example, at any
place flood or earthquake occurred. The supply of goods decreases at that place at previously prevailing price.
4. No change in Prices of Substitutes : If the prices of substitutes of a commodity fall then the tendency of
consumers diverts to substitutes therefore, the supply of a commodity falls without any change in price.
5. No Change in Natural Resources : If the quantity of natural resources (minerals, gas, coal, oil etc)
increases, the cost of production decreases. It causes to increase in quantity supplied.
6. No Change in Price of Capital Goods : The capital goods are raw material, machinery, tools etc. The cost
of production increases due to increase in prices of capital goods. It can lead to decrease in quantity supplied.
7. No Change in Political Situation : The amount of investment is affected by the change in political situation
of a country. The production of goods decreases due to decrease in investment.
8. No Change in Tax Policy : It is also assumed that the taxation policy of government does not change. The
increase in taxes effects the investment and production and supply of goods decreases.
Factors that Shift the Demand Curve

1. Change in Consumer Income : An increase in income shifts the demand curve to the right because a consumer's
demand for goods and services is constrained by income, higher income levels relax somewhat that constraint, allowing
the consumer to purchase more products. Correspondingly, a decrease in income shifts the demand curve to the left.
When the economy enters a recession and more people become unemployed, the demand for many goods and services
shifts to the left.
2. Population Change : An increase in population shifts the demand curve to the right. Imagine a college town
bookstore in which most students return home for the summer. Demand for books shifts to the left while the students
are away. When they return, however, demand for books increases even if the prices are unchanged. As another
example, many communities are experiencing "urban sprawl" where the metropolitan boundaries are pushed ever wider
by new housing developments. Demand for gasoline in these new communities increases with population. Alternatively,
demand for gasoline falls in areas with declining populations.
3. Consumer Preferences : If the preference for a particular good increases, the demand curve for that good shifts
to the right. Fads provide excellent examples of changing consumer preferences. Each Christmas season some new
toy catches the fancy of kids, and parents scramble to purchase the product before it is sold out.
4. Prices of Related Goods : If prices of related goods change, the demand curve for the original good can change
as well. Related goods can either be substitutes or complements.
 Substitutes goods are those goods that can be consumed in place of one another. If the price of a substitute
increases, the demand curve for the original good shifts to the right. For example, if the price of Pepsi rises,
the demand curve for Coke shifts to the right. Conversely, if the price of a substitute decreases, the demand
curve for the original good shifts to the left.
 Complements goods are those goods that are normally consumed together. Pen and Ink are complements.
If the price of a complement decreases, the demand curve for the original good shifts to the right. If, for
example, the price of computers falls, then the demand curve for computer software shifts to the right.
Exceptions to the Law of Supply

 It explain only static situation
 Hope of change in price of commodity in Near future
 It does not apply on agricultural Products

Business Economics
 It does not apply on Artistic Goods

 It does not apply on the goods of Auction
 It does not apply on the supply of labour in under Developed Countries
Elasticity of Supply
Elasticity of Supply is defined as the percentage change in quantity supplied divided by percentage change in price,
price and quantity supplied, in usual cases, move in the same direction, thus the coefficient of ES is positive.
According to Lipsey, "Elasticity of supply is the ratio of percentage change in quantity

supplied over the percentage change in price."
In the words of Prof. Bilas, "Elasticity of supply is defined as the percentage change in
quantity supplied divided by percentage change in price."
Price elasticity of supply measures the relationship between change in quantity supplied and a change in price.
F ocus
ormula
Price Elasticity of Supply
Percentage Change in Quantity S up plied Q P1
PES  or 
Percentage Change in Price P Q 1
where Q = change in the demand (difference in demand)
P = change in the price (difference in the price)
P1 = initial price (first price/ old price)
Q 1 = initial demand (first demand/ old demand)
The value of elasticity of supply is positive, because an increase in price is likely to increase the quantity supplied
to the market and vice versa.
Types of Elasticity of Supply

1. Unit Elastic Supply : When change in price of X brings about exactly proportionate change in its quantity supplied
then supply is unit elastic i.e. elasticity of supply is equal to one, e.g. if price rises by 10% and supply expands by
10% then change in the quantity supplied, the supply is relatively inelastic or elasticity of supply is less than one.
% Change in Quantity Supplied of X
Es 
% Change in Price of X
Y
S
Price
PES = 1
P2
P
P1
S Q
0 Q1 Q2 X
Quantity Supplied
Fig. : Unit Elastic Supply
2. Highly Elastic Supply Curve : Ratio of change in quantity supplied is greater than the ratio of change in price.
As a result, when we put their values in the above mathematical expression, we get Price Elasticity Supply >1.

Business Economics
Price
PES > 1
P2
P
P1
S
Q
0 Q1 Q2 X
Quantity Supplied
Fig. : Highly Elastic Supply Curve
3. Less Elastic Supply or Inelastic Supply : When change in price brings about more than proportionate change
in the quantity supplied, then supply is relatively elastic or elasticity of supply is greater than one.
Y S
PES < 1
P2
Price
P
P1
S Q
0 Q1 Q2 X
Quantity Supplied
Fig. : Less Elastic Supply or Inelastic Supply
4. Perfectly Inelastic Supply : When a change in price has no effect on the quantity supplied then supply is perfectly
inelastic or the elasticity of supply is zero.
Y S
P2
PES = 0
Price
P1
S
0 Q 1/Q2 X
Quantity Supplied
Fig. : Perfectly Inelastic Supply
5. Perfectly Elastic Supply : When a negligible change in price brings about an infinite change in the quantity
supplied, then supply is said to be perfectly elastic or elasticity of supply is infinity.

Business Economics
PES = 
P1/P2
S S
Price
0 Q1 Q2 X
Quantity Supplied
Fig. : Perfectly Inelastic Supply
Supply and Demand

Alfred Marshall published his books "Principle of Economics" which define how supply and demand interacted to
determine of Price. The price level of goods essentially is determined by point at which quantity supplies equal quantity
of demand.
Supply and Demand
D S
Price P
Quantity Q
Fig. : Supply and Demand
5. Consumer Behavior
Consumer Behavior is the process of how consumers behave in situations involving goods, services, ideas and
experiences. Consumer behavior is about the behavior of consumers in different situations. The behavior that consumers
display in searching for, purchasing, using, evaluating and disposing of products, services and ideas.
 A discipline dealing with how and why consumers purchase (or do not purchase) goods and services.
 Consumer behavior can be thought of as the actions, reactions, and consequences that take place as the
consumer goes through a decision-making process, reaches a decision, and then puts the product to use.
 The dynamic interaction of affect and cognition, behavior, and environmental events by which individuals
conduct the exchange aspects of their lives ... the overt actions of consumers.
The American Marketing Association (AMA) defines consumer behavior as "The

dynamic interaction of cognition, behavior and environmental events by which human beings
conduct the exchange aspect of their lives."

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Unit-3 Business Economics

1. Meaning and Scope of Business Economics

Objectives of Business Firms

Business economics is useful because :

Stages as Economics as Subjects

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Difference between Economics and Business Economics

Features of Business Economics

Micro and Macro Economics

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Comparison between Macro-Economics & Micro-Economics

Scope of Business Economics

Scope of Business Economics

Demand Analysis Social

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(A) Operational or Internal Issues

(B) Environmental or External Issues

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The Three alternative way to expression of demand :

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Autonomous Demand v/s Derived Demand

Demand for Durable Goods v/s Perishable Goods

Firm Demand v/s Industry Demand

Short Run Demand v/s Long Run Demand

New Demand v/s Replacement Demand

Total Market v/s Segment market Demand

Factor Affecting of Demand

Income of the Consumer

Prices of Related Goods

Tastes of the Consumers

Expectations Regarding the Future

Climate and Weather

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It may be defined in Marshall's words as "the amount demanded increases with a

These assumptions are :

Reason for Law of Demand

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Exceptions Law of Demand

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Extension and Contraction Demand

Increase in Demand and Decrease in Demand

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500 600 Quantity Demanded

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3. Elasticity of Demand and Its Measurement

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Concept of Price Elasticity of Demand

Price Elasticity of Demand

Cross Elasticity of Demand

Price of Elasticity of Demand

Price Elasticity of Demand

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Income Elasticity of Demand

The following are the various types of income elasticity :

Cross Elasticity of Demand

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 A positive cross elasticity of demand means that the products are

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Degree’s of Elasticity of Demand

Highly Elasticity of Demand

Price Elastic Demand