ME Introduction

Dr Mohan B
MBA
What is Economics?
The word economy comes from
oikonomia a Greek word for “
managing household.”

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Definitions of Economics
“The study of people in the ordinary business of life"
(Alfred Marshall)
“The science which studies human behavior as a
relationship between given ends and scarce means
which have alternative uses" (Lionel Robbins )
Study of how societies use scarce resources to
produce valuable commodities and distribute them
among different people“ ( Paul A. Samuelson)

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Economics and life.
Economics use scientific approach to understand
economic life.
It observes and collect data from history and
current ; uses statistics to analyse and relies on
theories.
Ultimate aim of economics is to help people live a
better life.
For people to work economic rationality holds good.
From him according to his ability and to him
according to his need does not work.
Cool heads needed to support warm hearts.
Scarcity and efficiency
Key idea behind these definitions are the
following
1. Resources are scarce
2. Society should use them efficiently.
An economy is working efficiently when no one
can be made better off with out making
someone worse off.
Adam Smith and Microeconomics
Micro economics is concerned with the
behavior of individual entities like households,
firms and markets.
Adam Smith studied how prices are set and
studied the determination of prices of land ,
labour and capital and enquired into the
strength and weakness of market mechanism
He realised that economic benefit comes from
self interested actions of individuals.
The three problems of economics
Every society would confront the three
economic problems
What to produce
How to produce
For whom to produce.
Factors of Production
Labor
Labor is the mental and physical efforts of
humans (excluding entrepreneurial
organization) used for the production of goods
and services. Labor includes both the physical
effort of factory workers and farmhands often
associated with labor, as well as the mental
effort of executives and supervisors.

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labor
Factors of Production - Capital
Capital is the manufactured, artificial, or synthetic
goods engaged for the production of other goods,
including machinery, equipment, tools, buildings,
and vehicles. Capital is the produced factor of
production.
This factor must be produced using other factors of
production, which means that society is often faced
with the choice between producing consumption
goods that satisfy wants and needs and capital
goods that are engaged for future production.
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Write 5 examples of capital resources
Factors of Production - Land
Land : It is the naturally occurring materials of
the planet that are used for the production of
goods and services, including the land itself;
the minerals and nutrients in the ground; the
water, wildlife, and vegetation on the surface;
and the air above.
 The natural resources and materials of the
land get converted to goods produced.
Without these materials of the land, there is
no production. 12
Land
Factors of Production - Entrepreneurship

Entrepreneurship is the special human

effort that takes the risk of bringing labor,
capital, and land together to produce
goods. It organizes the other three To
produce.
A key component of entrepreneurship is
risk. This resource takes the risk of
organizing production BEFORE anything is
produced with no guarantee that
production will be successful.
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Needs Vs Wants
Needs are things we need for
survival, such as food, clothing, and
shelter. It is associated with a
requirement.
Wants are things we would like to
have. It is associated with a desire.
Wants - Options available to
satisfy the need
Notion of Market
A market is an institutional arrangement under
which buyers and sellers can voluntarily
exchange some quantity of a good or service at
a mutually agreeable price.
It can, but need not be, a specific place or
location where buyers and sellers actually come
face to face for the purpose of transacting their
business – a weekly market for provisions and
website for a supermarket
It is a collection of buyers and sellers who
engage in transacting goods at an agreed price
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Micro and Macro Economics
Micro Economics: The study of how
households and firms make decisions and
how they interact in markets

Macro Economics: The study of

economy-wide phenomena, including
inflation, unemployment and economic
growth
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POSITIVE AND NORMATIVE ECONOMICS

Positive economics: The study of what is, of how the

economy works. Study and explanation of facts.
(If we lower income tax rates in India next year, will the
economy grow faster? If so, by how much? And what
effect will this have on total employment? These are
all positive economic questions. We may disagree
about the answers, but we can all agree that the
correct answers to these questions do exist—we just
have to find them).

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POSITIVE AND NORMATIVE
ECONOMICS
Normative economics: The study of what should be; It
has ethical precepts and norms of farness.
it is used to make value judgments, identify problems,
and prescribe solutions which may benefit few or all.
Normative economics requires us to make value
judgments. When an economist advises that we cut
government spending—an action that will benefit
some citizens and harm others—the economist is
engaging in normative analysis.

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 Dr Mohan B

Demand and Supply

Analysis
Demand Curve
 Demand
Demand for a commodity refers to the
quantity that will be purchased at a particular
price during a particular period of time.
There is a relationship between price and
quantity bought. This relationship is called
demand schedule.
Graphical representation of demand
schedule is demand curve.
Demand
 Demand for a Commodity
Implies
a) Desire to acquire it
b) Willingness to pay for it
c) Ability to pay for it
Downward sloping demand curve.
Demand curve is empirically tested and verified for
practically all commodities.
It is downward sloping due to
Substitution effect
Income effect.

When the price goes up substitute commodities are used

When price goes up consumer becomes poorer and
consumption is reduced.
 Law of Demand
When the price of a good rises, the demand for it
generally falls
There is an inverse relationship between the demand
for a good and the price of its complement.
There is a direct relationship between the demand
for a good and the price of its substitutes
When income rises demand for a normal good rises
but demand for an inferior good falls; demand for
necessities is independent of the level of income
beyond a particular level of income
Forces behind Demand curve

Average Income of the consumer

Consumers tastes and preferences
Price and availability of related goods
Consumers’ expectations
Size and composition of the market or
population
Distribution of income
Government policy
Demand
Individual Demand for a commodity refers to
the amount purchased by a single consumer at
a given price during a particular period of time
Market Demand refers to the total quantity of
a commodity that all the house holds are
prepared to buy at a given price during a
specified period of time.
Demand Curve
Theory of supply and demand
How consumer preferences
determine consumer demand for
commodities.
Price increases either because the
demand increased or supply
decreased.
Ceteris Paribus ..
...implies that all the relevant variables (e.g.
determinants of demand) are held constant, except
the one(s) being studied at the time. Among other
variables held constant are consumers’ incomes,
tastes and preferences, prices of related
commodities (substitutes and complements), number
of consumers in the market, weather, future
expectations, etc.

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Assumptions underlying the law of demand
No change in consumer’s income
No change in consumer’s preference
No change in the price of related goods
No expectation of future price changes
No change in size, age composition and sex ratio of the
population
No change in the range of the goods available to the
consumers
No change in distribution of income and wealth of the
community
No change in government policy
No change in weather conditions
Type of goods
A Normal Good is a good, the demand for
which increases with an increase in income
An Inferior Good is a good, the demand for
which tends to fall with an increase in the
income of the consumer.
Giffen goods are those inferior goods on
which the consumer spends his large part of
his income and whose demand falls with the
fall in their price.
Goods
Complementary Goods are those goods
which are used jointly or together.
Substitute goods are those goods which
satisfies the same type of demand and
can be used in place of the other.
Demand Curve
Movement along the demand curve
Shift in the demand curve
 Shift of Demand Versus Movement Along a
Demand Curve
• A change in demand is
not the same as a change
in quantity demanded.

• In this example, a higher

price causes lower
quantity demanded.

• Changes in determinants of demand, other than price, cause

a change in demand, or a shift of the entire demand curve,
from DA to DB.
A Change in Demand Versus a Change in Quantity
Demanded

• When demand shifts to the

right, demand increases. This
causes quantity demanded
to be greater than it was prior
to the shift, for each and
every price level.
A Change in Demand Versus a Change in
Quantity Demanded
To summarize:
Change in price of a good or service
leads to

Change in quantity demanded

(Movement along the curve).

Change in income, preferences, or

prices of other goods or services
leads to

Change in demand
(Shift of curve).
From Household to Market Demand
Demand for a good or service can be
defined for an individual household, or for
a group of households that make up a
market.
Market demand is the sum of all the
quantities of a good or service demanded
per period by all the households buying in
the market for that good or service.
From Household Demand to Market Demand
Assuming there are only two households in the market,
market demand is derived as follows:
Exceptions to the Law of Demand
1. Giffengoods
2. Articles of Snob appeal
3. Expectation regarding the Future Prices
4. Emergencies
5. Quality - Price relationship
Giffen good
Giffen good a theoretical good which is inferior in
quality and has no substitutes, with the result that
the demand falls if the price falls and the demand
rises if the price rises.
 It comes from observations of poor consumers in
the 19th century: if the price of bread rose they spent
more on it and less on other more expensive
commodities.
Elasticity
Elasticity is simply a way of quantifying
cause and effect relationships
It is defined generally as a numerical
measure of the responsiveness of one
economic variable (the dependent
variable) following a change in another
influencing variable (the causal variable

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Elasticity of Demand
Price Elasticity of Demand
Income Elasticity of
Demand
Cross Elasticity of Demand

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Price Elasticity of Demand
Price Elasticity of Demand
The responsiveness of demand
to changes in price

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Feature of price elasticity of demand
There is case that quantity change with price or not.
Case is how much it changes
Case is whether quantity change in percentage is greater
than the percentage change in price or is it less.
That is when the price changed from 100 to 110 the
quantity demanded dropped to 90 or less than 90 and
when the price dropped from 100 to 90 the quantity
demanded increased from 100 to 110 or more. If the
percentage change in quantity is more than the percentage
change in price then the good under consideration has an
elastic demand. Result is more than the cause.
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Classification of Price Elasticity
Perfectly elastic demand
Perfectly inelastic demand
Inelastic demand
Elastic demand
Unit elastic
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Elastic and Inelastic demand
• Elastic demand -
Where % change in demand
is greater than % change in price
Result is more than the cause
• Inelastic demand -
Where % change in demand is less
than % change in price
Result is less than the cause
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Perfectly Elastic Demand: Elasticity Equals Infinity

Price

At any price
1.
above Rs4, quantity
demanded is zero.
Rs4
Demand
2. At exactly Rs 4,
consumers will
buy any quantity.
0 Quantity
3. At a price below Rs4,
quantity demanded is infinite.

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Perfectly Inelastic Demand: Elasticity = 0

Price
Demand
5
4
1. An
increase
in price . . .
0 100 Quantity

2. . . . leaves the quantity demanded unchanged.

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Copyright©2003 Southwestern/Thomson Learning
 Inelastic Demand: Elasticity Is Less Than 1

Price

4
1. A 25% Demand
increase
in price . . .

0 90 100 Quantity

2. . . . leads to an 10% decrease in quantity demanded.

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Inelastic Economic Relations
When an elasticity is small
(between 0 and 1 in absolute value),
we call the relation that it describes
inelastic.
Inelastic demand means that the
quantity demanded is not very
sensitive to the price.
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Elastic Demand: Elasticity Is Greater Than 1

Price

Rs5

4 Demand
1. A 25%
increase
in price . . .

0 50 100 Quantity

2. . . . leads to a 50% decrease in quantity demanded.

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Elastic Economic Relations
When an elasticity is large
(greater than 1 in absolute
value), we call the relation that
it describes elastic.
Elastic demand means that the
quantity demanded is sensitive to
the price. 53
 Unit Elastic Demand: Elasticity Equals 1

Price

4
1. A 25% Demand
increase
in price . . .

0 75 100 Quantity

2. . . . leads to a 25% decrease in quantity demanded.

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Copyright©2003 Southwestern/Thomson Learning
Size of Price Elasticities
Unit elastic
Inelastic Elastic

0 1 2 3 4 5 6

• Unit elastic: price elasticity equal to 1

• Inelastic: price elasticity less than 1
• Elastic: price elasticity greater than 1

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Price Elasticity of Demand
The concept of elasticity helps understand how
responsive demand is to price changes
Intuitively, if we are a businessperson and we want
to increase revenues, one important question is
whether we increase price or decrease price
 Increases in price decreases the quantity demanded, but we
get more for each unit we sell
 Decreases in price increases the quantity demanded, but we
get less for each unit we sell
 How can we tell whether the price or the quantity effect wins
out to increase our revenues
The answer is the concept of elasticity

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Calculation of Price elasticity of demand by using
the percentage method by taking a numerical
example
 Example: Suppose the price of the commodity falls
from Rs 5 to Rs 4 and quantity demanded increases
from 100 units to 150 units.
Answer : Q=100 Change in Q=150-100=50
P=5 Change in P=5-4=1
Elasticity of Price = change in Q/Change in P X P/Q
=50/1 X 5/100 = 2.5

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Elasticity
Price
Total
The revenue is
importance of price x
elasticity
quantity
is sold. Initthis
the information
example, TR = Rs5 x
provides on the effect on
100,000 = Rs500,000.
total revenue of changes in
price.
This value is represented
by the shaded rectangle.
5

Total Revenue

100 Quantity Demanded (000s)

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 Elasticity
Price
If the firm decides to
decrease price to (say)
Rs3, the degree of price
elasticity of the demand
curve would determine
the extent of the
increase in demand and
5 the change therefore in
total revenue.

Total Revenue
D
100 140 Quantity Demanded (000s)

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Elasticity
If demand is price If demand is price
elastic: inelastic:
Reducing price would Reducing price would
increase TR reduce TR (%Δ Qd <
(%Δ Qd > % Δ P) % Δ P)
Increasing price would Increasing price would
reduce TR (%Δ Qd > increase TR
% Δ P) (%Δ Qd < % Δ P)

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The Determinants of Price Elasticity of
Demand
Availability of substitutes: a commodity with more and
close substitutes tends to have an elastic demand and one
with a few and weak substitutes has an inelastic demand
Nature of the commodity : the demand for necessities
inelastic and the demand for luxuries and comforts is
elastic
Proportion of the income spent : smaller is the
proportion of income spent on a commodity, the smaller
will be the elasticity of demand and vice versa
Recurrence of demand
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The Determinants of Price Elasticity of
Demand
The Number of uses of the commodity : the greater is the
number of uses to which a commodity can be put to, the
greater will be its price elasticity of demand
Time : price elasticity is generally low for the short period as
compared to long period
Postponement of consumption : demand for a commodity
is elastic if its consumptions can be postponed
Price range : demand for a commodity tends to be inelastic
at very high and very low prices, and elastic with in the
moderate range of prices.
Habits of the consumers:
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Importance of Elasticity
Relationship between changes
in price and total revenue
Importance in determining
what goods to tax (tax revenue)
Importance in analysing time lags in production
Influences the behaviour of a firm

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The

Farmer’s Dilemma
For many crops, a strange situation arises a bad crop year
results in a good year for farm incomes, and a good crop year
results in a bad year for farm incomes. How can this be?
 Price elasticity gives us the answer:
 Bad crop year: supply decreases, prices for farm products rise, but
quantity demanded doesn’t fall very much. The quantity demanded
of farm products is not very responsive to changes in prices
 Good crop year: supply increases, prices for farm products fall, but
quantity demanded doesn’t increase very much. The quantity
demanded of farm products is not very responsive to changes in
prices
 It is easy to show this with a graph. But first we need yet
another concept: Total Revenue = Price x Quantity

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The Farm Example
During bad crop years, prices rise and quantity falls
(but not that much) so total revenue to farmers goes
up.
During good crop years, prices fall and quantity
increases (but not that much) so total revenue to
farmers goes down.
The graphs….

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Price elasticity of demand
Estimated price elasticities of demand
elasticity coefficient
item short run long run
Airline travel 0.1 2.4
Medical care 0.3 0.9
Percentage Change in Natural gas 1.4 2.1
E = Quantity Demanded Auto tires 0.9 1.2
d Percentage Change in Price Stationery 0.5 0.6
Gasoline 0.2 0.7
Housing 0.3 1.9
Automobiles 1.9 2.2
Movies 0.9 3.7
Jewelry & watches 0.4 0.7
Radio & TV repair 0.5 3.8
Foreign travel 0.1 1.8
Glass, china, etc. 1.5 2.5

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 Estimates of Price Elasticities

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Income Elasticity
Income Elasticity of Demand:
The responsiveness of demand to changes in incomes
Normal Good – demand rises as income rises and
vice versa
Inferior Good – demand falls as income rises and
vice versa

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Types of Income elasticity
Positive income elasticity : (a) Income elasticity (b)
Income Inelasticity (c) unitary income elasticity
Negative income elasticity :
Zero income elasticity:

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Income Elasticity

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Cross Elasticity
Cross Elasticity:
The responsiveness of demand
of one good to changes in the price of a related good –
either
a substitute or a complement

% Δ Qd of good t
__________________
Xed =
% Δ Price of good y

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Types of cross elasticity of demand
Positive : increase in the price of one commodity leads
to increase in the demand for the other commodity.
Substitute goods
Negative : Increase in the price of one commodity
leads to fall in the demand for other commodity.
Complementary goods
Zero : when a change in the price of one commodity
does not affect the demand for another commodity

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Uses of elasticity of demand for Managerial
decision making
To business man: for pricing and revenue
To the government and financial sector: Taxation
International trade: formulating export and import policies
Policy makers: Like farmers income after a bumper crop
Trade unions: bargaining power for higher wages depends
on the demand for the product
Long term business planning
Market strategy
Housing Development strategies

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 Elasticity and its impact on revenue
For elastic goods % delta Quantity/ Average Quantity is
greatar than % delta price change/ Average price. So
when price of a commodity is reduced the quantity sold
increases to a greater degree. Revenue being price x
quantity there will be net revenue gain.
On the contrary if the commodity is price inelastic the
quantity sold does not increase proportionately to the
price reduction and hence the revenue loss occurs.
For uni elastic materials there will not be any change in
revenue earned.
 Demand Forecasting
Meaning : expectation about the future course of the
market demand for a product based on the statistical
data about past behaviour and empirical relationships
of the demand determinants

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The Determinants of Price Elasticity of
Demand
Availability of substitutes: a commodity with more and
close substitutes tends to have an elastic demand and one
with a few and weak substitutes has an inelastic demand
Nature of the commodity : the demand for necessities
inelastic and the demand for luxuries and comforts is
elastic
Proportion of the income spent : smaller is the
proportion of income spent on a commodity, the smaller
will be the elasticity of demand and vice versa
Recurrence of demand
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The Determinants of Price Elasticity of
Demand
The Number of uses of the commodity : the greater is the
number of uses to which a commodity can be put to, the
greater will be its price elasticity of demand
Time : price elasticity is generally low for the short period as
compared to long period
Postponement of consumption : demand for a commodity
is elastic if its consumptions can be postponed
Price range : demand for a commodity tends to be inelastic
at very high and very low prices, and elastic with in the
moderate range of prices.
Habits of the consumers:
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Demand Forecasting
Demand Forecasting
Expectation about the future course of the
market demand for a product , based on
the statistical data about past behaviour
and empirical relationships of the demand
determinants

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 Demand forecasting
Definition: Demand Forecasting is a systematic
and scientific estimation of future demand for a
product.
There are different methods for Demand
forecasting . They are based on
1. Purpose of forecasting,
2. Data required
3. Data availability
4. Time frame within which the demand is to be
forecasted.
 Why demand forecasting
The knowledge about the future demand for
the product helps in the following areas of
business decision making.
Planning and scheduling production
Acquiring inputs (labour, raw material and
capital)
Making provision for finances
Formulating pricing strategy
Planning advertisement
 Steps in forecasting
Specifying the Objective:  The objective of the demand must be
determined before hand as it will give direction to the whole
research. It may be defined in terms of; long-term or short-term
demand, the whole or only the segment of a market for a firm’s
product, etc.
Determining the Time Perspective: The demand forecast can
either be for a short-period, say for the next 2-3 year or a long
period. For forecasting demand for a short period many
determinants of demand can be assumed to remain constant ,
while in the long run, they may change significantly.
Making a Choice of Method for Demand Forecasting: Once the
objective is set and the time perspective has been specified the
method for performing the forecast is selected as falling under two
categories; survey methods and statistical methods.
 Steps in forecasting
Collection of Data and Data Adjustment: Once the
method is decided upon, the next step is to collect
the required data either primary or secondary or
both.
Estimation and Interpretation of Results: Once the
required data are collected and the demand
forecasting method is finalized, the final step is to
estimate the demand for the predefined years of the
period. Usually, the estimates appear in the form of
equations, and the result is interpreted and
presented in the easy and usable form.
Demand Forecasting
Techniques of Demand Forecasting
Choice of a forecasting technique depends on
objectives, costs, time, nature of data and
complexity of the technique.
SURVEY METHODS
a)Consumer Survey Method
i. Complete Enumeration Method
ii.Sample Survey Method
iii.The End – Use Method
 Opinion Poll Methods

I Expert Opinion Method

ii Delphi Method
Iii Market Studies and Experiments
 STATISTICAL METHOD

1) Trend Projection Methods

2) Barometric Methods
3) Econometrics Method
 Survey methods-
Direct method – Direct approach to customers ; Valid for
short term projects.
1. Complete Enumeration Method – All potential
customers are contacted. Very costly, the causes of demand
may change beyond the scope of questionnaire.
2. Sample survey method – Data is collected from few
sample units out of population on their probable demands
for the forecast period
3. End use method - the list of several users of the product
under forecasting is prepared first, details of their
individual purchasing patterns is collected and then from
such information the complete product demand forecast is
ascertained
 Statistical Methods
 The statistical methods are often used when the forecasting of
demand is to be done for a longer period. They utilize the time-
series (historical) and cross-sectional data to estimate the long-term
demand for a product. Statistical methods are used more often and
are considered superior due to the following reasons:
There is a minimum element of subjectivity in the statistical
methods. They are scientific and depends on the relationship
between the dependent and independent variables. They are more
reliable and the cost involved is minimum.
The statistical methods include:
Trend Projection Methods
Barometric Methods
Econometric Methods
 Trend Projection method
The trend projection method is based on the assumption that
the factors liable for the past trends in the variables to be
projected shall continue to play their role in the future in the
same manner as they did in the past while determining the
variable’s magnitude and direction.
In predicting demand for a product, the trend projection
method is applied to the long time-series data. A long-standing
firm can obtain such data from its departments (such as sales)
and the books of accounts. While the new firms can obtain
data from the old firms operating in the same industry. 
Graphical Method ,Fitting Trend Equation or Least Square
Method and Box-Jenkins Method are the trend projection
methods used.
 Barometric method
This method can nevertheless be used in forecasting
the demand prospects, not necessarily the actual
quantity expected to be demanded.
 Economists use economic indicators as a barometer
to forecast the overall trend in the business activities
in the same way as the weather conditions are
forecasted on the basis of the movement of mercury in
a barometer. 
 Econometric Methods
Regression Method: This method combines the economic theory
with statistical tools of estimation. The economic theory specify the
demand determinants and the nature of the relationship . Under
the regression method,  the nature of demand function is
determined exploring whether it has a single independent variable
or many. if the demand for items like tea and coffee is found to
depend largely on the population of the city, then the demand
functions are said to be single-variable demand functions.
 On the contrary if it is found out that the demand depends on a
number of variables like the price of substitute goods, household
incomes, population, etc. such demand functions are called
as multi-variable demand functions.
Thus, for a single variable demand function, the simple regression
equation is used while for multiple variable functions, a multi-
variable equation is used for estimating the demand for a product.
Limitations of demand forecasting
Internal Limitations
When looking at internal limitations of forecasting, the
obvious one is time. It takes time to make a good
forecast. Most small businesses can’t afford a full time
employee to create and manage the annual forecast.
Another internal limitation may be lack of historical data.
Forecasting starts with the accumulation of past data and
then builds from there. It’s critical that historical records
be maintained in such a way that they can be easily used
as a part of the forecasting process.
Limitations of demand forecasting
External Limitations
The external limitations to forecasting provide the
real challenge in creating a good forecast. You can’t
control the entry or exit of competitors,
competitive promotional activity, factors such as
new technology that affect the natural demand for
your products, dramatic weather events, new laws
or regulations or loss of key existing customers.
One must at least be aware of them and make
reasonable assumptions about some of them and
factor those into the forecast.
SUPPLY
Supply Curve
 The Law of Supply
The law of supply states
6 that there is a positive
Price of soybeans per bushel ($)

5 relationship between
4 price and quantity of a
3 good supplied.
2
This means that supply
1
0
curves typically have a
0 10 20 30 40 50 positive slope.
Thousands of bushels of soybeans
produced per year

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 Determinants of Supply
The cost of producing the good, which in turn
depends on: The price of required inputs -
Raw material, labor, capital, and land.
The technologies that can be used to produce
the product
Number of suppliers
The prices of related products
Future price expectations,
Government Policy (Tax, Subsidies)

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