Orientation

Introduction to economics
What is Economics?

 The term “economics” comes from the Greek word

“oikos” meaning house and ” nomos ” meaning custom or
law.
 Economics is defined as a body of knowledge that
discusses how a society tries to solve the human problems
of unlimited wants and scarce resources.
Managerial economics
Microeconomics
Microeconomics is all about: a. Scarcity } dismal
b. Choices, trade-off } science
There are 2 actors in economics: 1. Consumers
2. Producers
In microeconomics, we will build models about how consumers and
producers behave.
Consumers will try to maximise their utility, subject to budget
constraints
Firms will try to maximise their profits, subject to consumer demand
and input costs.
 Based on this, we will try to answer 3 fundamental
questions: A) What to produce
 B) How to produce
 C) Who gets the produce ( for whom)
 Prices resolve these 3 problems.
 Important distinctions in economics:
 1. Theoretical economics: Process of building models to
explain the world
 Vs
 2. Empirical: Process of testing those models
 2nd Important distinction
 1. Positive: The way things ARE
 2. Normative: The way things SHOULD BE / OUGHT TO BE
Introduction to Economics:
ORIENTATION
 Economics is all about:
1. Economics is all about Choices and decisions
2. Economics is about Scarcity: resources are limited, wants are unlimited, resources have
alternate uses, therefore choices have to be made
3. Economics is about Human actions: Purposeful human behaviour: :
4. Economics is about trade-off: there’s no such a thing as a free lunch
5. So, choices are made on the basis of cost and benefit analysis ( incentives): Opportunity
Cost
6. Utility : subjective benefit
7. Good: (economic good) : something that brings utility to people
8. Economics always uses Marginal analysis to make choices: So MU, MC, MP, MR are
important
Two branches of Economics:
Microeconomics and Macroeconomics
 Microeconomics (micro meaning small) looks at the smaller
picture of the economy and is the study of the behaviour
of smaller units of the economy such as individual
consumer, a seller ,a firm or a product, individual demand,
individual supply, an individual’s income, savings etc.
 Macroeconomics (macro meaning large) is that branch of
economics that deals with the study of aggregates, totals
and averages. We study Aggregate demand, Aggregate
supply, National Income, Aggregate savings and
Investments, expenditure etc.
9. Economics considers productivity/ efficiency: How well we use
scarce resources: maximum output from given specific inputs
10. Means/ resources/ inputs : Land, labour, time, money, natural
resources like oil and natural gas etc
11. Markets in economics: goods market, resource market, capital
market
12. Use of models in economics: a theoretical abstract relationship
between two or more variables
13. The central problem for any economy: What to product, How to
produce, For Whom to produce
14. Branches of Economics: Microeconomics and Macroeconomics
Definitions of Economics

 Adam Smith: “ Political economy, considered as a branch of

science of statesmen or legislator, proposes two distinct objects,
first, to provide a plentiful revenue or subsistence for the
people, or more properly enable them to provide such a
subsistence for themselves, and secondly, to supply the state or
commonwealth with the revenue sufficient for the public
services. It proposes to enrich both the people and the sovereign.
 This is called the “wealth definition”.
Marshal’s definition: Political economy or economics is
the study of man’s actions in the ordinary business of life
: It inquires how he gets his income and how he uses it .
Thus, it is on one side the study of wealth and on the
other and more important side a part of the study of
man”.
 This is called the “welfare definition”.

 Key words: man’s actions, life, income, uses, welfare

 Lionel Robbins definition “ Economics is the science
which studies human behaviour as a relationship
between ends and scarce means which have alternate
uses.”
 This is called the “Scarcity definition”

 Key words: science, ends, scarce means, alternate uses

What is Managerial Economics?

 This subject is about “how the theory learnt in economics can be used
in businesses. How the theories of demand, supply, utiity, can be
applied in real life.”
 Managerial economics is a combination where I use economic tools to
make business decisions. It facilitates business decisions.
 Definition: Managerial economics is the branch of economics which
serves as a link between abstract theory and managerial practice.
Scope of Managerial economics

 1. Theory of demand: transforming raw materials into finished goods. Demand

forecast
 2. Theory of production: After forecasting demand, a business needs to see it’s
production capacity.
 3. Theory of exchange: Also called Price theory. How to price our product, where
do we get profits
 4. Theory of profits: depends on price, demand, competition etc
 5. Theory of capital and investment: Where do we invest, what will be our
returns etc
 6. Environmental issues: Although managerial economics is mostly micro
economics, there are places where we talk of political environment, business
cycles, taxation policies etc
Importance of Managerial economics

 A manager uses managerial economics in:

 1. Decision making
 2. Estimating economic relationships like demand, supply,
cost, profits etc.
 3. Traditional concepts: How to introduce traditional
tools, models, concepts into modern businesses.
 4. Predicting economic quantities: What should be our
quantities, cost, price etc.
Case study

A Small Peek into Big B’s Car Collections: Does Law of

Diminishing Marginal Utility Hold Good?
Abstract

The case probes a fundamental law in economics : The Law of Diminishing

Marginal Utility, by analysing Amitabh Bachchan’s car collection. Indian cine
superstar fondly called Big B, has one of the best collections of cars in India
comprising at least 25 cars. A Rolls Royce Phantom, a Bentley Continental GT, a
Mercedes SL500, a Porsche Cayman S, a Range Rover, a Lexus LX470, a Mercedes
E 240, a BMW X5, a BMW 7 Series, a Mercedes S320 and a Ford Mondeo bedeck
his parking porch. ‘Though wants are unlimited, a particular want is satiable’ is
the banner line of the law of diminishing marginal utility. Whether this law has
failed with Big B shedding no passion in adding to his stock of cars or there is a
failure in proper interpretation of the law is an exciting teaser for the reader.
While the universality of the law is being debated, the case makes a swift side
swing to discuss and deliberate on business implications of the law.
 Big B’s car prices: in INR
• ROLLS ROYCE PHANTOM
3,50,00000

• BENTLEY CONTINENTAL GT
1,65,00000  Mercedes e class 37,93,
• MERCEDES S 350  Lexus lx 470 19,55,
77,84.849  Ford mondeco 14,92,
• BMW 7 SERIES  Mercedes sl 500 13,00,0
73,60,000
 Mini cooper s His 75th birthday car
• PORSCHE CAYMAN
50,00,000
 Bentley arnage r

• RANGE ROVER
39,22,000

• TOYOTA LAND CRUISER

Pedagogical objectives

To understand the relationship between marginal utility and total utility

To analyse the law of diminishing marginal utility and its business implications.
Keywords : Concept of Utility, Marginal Utility, Total Utility, Law of Diminishing
Marginal Utility, Relationship between Marginal Utility and Total Utility,
Consumer Behaviour, Managerial Economics, Microeconomics, Economics for
Business, Business Economics, Economics for Managers, Paul Samuelson
Economics: Art or Science ?

How is it an Art?
1). Art requires skill 1). economics also requires skills: Technical, social, political,
decision making skills
2). Art is practice/performance 2). economics is all about practice . A finance
minister at national level or a manager at corporate level has to perform and show
results
3). Art is perceptive 3). economics is also perceptive. . Everyone’s
parameter of good and bad performance is different.. Since it is all about human
behaviour
4). Art is creative 4). economics is also creative: how a product is made
to how it is sold, how a consumer behaves, for example packaging of products
5). Art requires knowledge 5). economics also requires knowledge.: of domestic
economy, global economy of human behaviour, of statistics, mathematics etc.
How is it a science?

 What is Science?
 Science is a body of organised systemised knowledge. Developed
over a period of time. Establishes cause- effect relationship. It has
the power of prediction. Rules are subject to change and verification
over a period of time. Science is of 2 types--- Pure science and social
science. .
 Economics is not a pure science, it is a social science
 Economics is based on logic: based on logic, it explains relationship
between cause and effect
 Economists make predictions
Conclusion

Economics is both an art and a science

It is a normative and positive science.
Economist P A Samuelson in his “economics”
says “ economics is the oldest of the arts, the
newest of the sciences, indeed the queen of
the social sciences”.
Demand supply analysis

 What is demand?
 Demand is the quantity of a good that consumers are able
and willing to purchase at various prices during a given
period of time
 Demand is defined as the “desire for a commodity, backed
by the ability and willingness to pay for it.’
 Key words: desire, ability, willingness
 Law of demand: ‘other things remaining the same (ceteris
paribus) , higher the price, lower will be the demand and
vice versa’.
Quantity demanded and Demand:

 Quantity demanded represents the exact quantity of a good/service demanded by

consumers at a particular price
 For example, 1 kurta for Rs.1500/-
 Whereas demand is the willingness of a buyer and his ability to pay the price of the good /
service
 For example: 4 kurtas for Rs.500/- each
 3 kurtas for Rs.600/- each
 2 kurtas for Rs.750/- each
 1 kurta for Rs.1000/- each
Demand schedule

 The price quantity relationship is shown arithmetically in the form of a table showing
price and corresponding quantities. This table is called as ‘demand schedule’.
 For example
 price (Rs.) quantity demanded
 5 80 units
 4 100 units
 3 150 units
 2 200 units
 1 240 units
 Characteristics of the law of demand:
 1. inverse relationship
 2. Price: an independent variable
 3. other things remaining the same
 4. reasons underlying the law of demand:
a. income effect
b. substitution effect
 Exceptions to the law of demand:
 1. Veblen goods: goods of conspicuous consumption
 2. Speculative market
 3. Giffen goods
Factors affecting demand
 1. Price of the commodity
 2. Income of the consumer
 3. Prices of related goods : substitutes
and complements
 4. Tastes, preferences, fashion
 5. Festivals, marriages etc
 6. Number of consumers – depends on :
 a. size of population
 B. structure and composition of
population
 C. Transport and Communication

8. Other facilities like Hire purchase, Guarantees,
warranties,
one on one free, discounts etc
9. Money supply
10. Climate, weather conditions
11. Equitable/ inequitable distribution of
incomes
12. Expectations regarding future prices
13. Government policies
14. Business cycles
15. Advertisements – a. Informative Ads
b. Persuasive Ads
Individual and Market demand

 The quantities demanded by an individual at a given price is called

individual demand. The quantity demanded by all the purchasers
together is called Market demand.
 Market demand is the lateral summation of individual demands
 Market demand can be calculated by adding the quantity demanded by
all purchasers. Suppose a commodity has 5 purchasers: a, b, c, d, and
e.
 Market demand will be calculated as:
Elasticity of demand

 There are many factors that affect the demand for a commodity: like
price of the commodity itself, prices of related goods, income of the
consumer, advertising and sales promotion etc.
 In the Law of demand we assume all these factors except the price of
the commodity to remain constant.
 The degree of responsiveness of quantity demanded to changes in these
factors is called it’s elasticity.
Elasticity of demand

 Elasticity of demand is the responsiveness of demand to a change in

factors influencing demand.
 We will be studying 4 kinds of elasticity:
 1. Price elasticity of demand
 2. Income elasticity of demand
 3. Cross elasticity of demand
 4. Promotional elasticity of demand
Market demand
commodity X
 Price per unit a b c d e total (market
dd)
 10 2 3 1 4 6 16
 8 4 5 2 5 7 23
 6 6 7 3 6 8 30
 4 8 9 4 7 9 37
 2 10 11 5 8 10 44
Elasticity of demand

 Methods to calculate elasticity:

 1. Percentage / formula method
 2. Geometric method
 3. TE/TR method
Percentage method

 Percentage change in quantity demanded

 Ep = ________________________________________
 Percentage change in price
Geometric method

 Geometric method to calculate elasticity

 a. when the demand curve is linear
 b. when the demand curve is non- linear
TR/TE method

 Total revenue/ total expenditure method to calculate

elasticity
 Total revenue = price ( or average revenue) x price
 1. if a fall in price leads to a rise in TR or a rise in price
leads to a fall in TR, demand is elastic.
 2. if TR falls with a fall in price and rises with a rise in
price, demand is inelastic
 3. if TR remains unchanged in spite of a rise or fall in
price, demand is unitary elastic
The relationship between demand
and TR can be summarized as:
Change in price
Elasticity less than one elasticity greater than one Unitary elastic
price rises TR falls TR unchanged
TR rises
price falls TR increases TR unchanged
TR falls
Types of price elasticity

1. Perfectly elastic demand

2. Perfectly inelastic demand
3. Unitary elastic demand
4. Relatively elastic demand
5. Relatively inelastic demand
Income elasticity of demand

 income elasticity of demand is defined as the responsiveness

of demand to a change in the income of the consumer.
 Itis the ratio of proportionate or percentage change in
demand to a proportionate or percentage change in income
of the consumer
 Ifthe income of the consumer rises from Rs.500 to Rs.600,
and demand rises from 10 units to 15 units, then the income
elasticity of x is 2.5
Cross elasticity of demand

 The degree of responsiveness in the demand for one

good to a change in the price of another good
( substitute or complement) is called cross elasticity
of demand.
 Cross
elasticity is positive between substitutes and
negative between complements
Promotional elasticity of demand

 Itis the responsiveness of sales to a given change in

advertising and sales promotion expenditure.
 Advertisements can be informative or persuasive.
 The expansion of demand through advertisements
can be measured by the concept of promotional
elasticity of demand.
Importance of the concept of elasticity
in Management
 Elasticity of demand is of great importance in managerial decision making.
 1. In the determination of output level: Whether production will be profitable or not
will depend on the demand for the product. Since demand changes because of change
in prices, the knowledge of elasticity of demand will be helpful in estimating the
output level
 2. In the determination of price: The concept of Elasticity tells us how demand will
respond to a price change
 3. In the price discrimination by a monopolist: A monopolist may charge a higher price
in a market with inelastic demand and lower in a market where demand is elastic
Importance of the concept of
elasticity……..contd
 4. In price determination of FOPs: If a factor of production is relatively important in
the production process, it’s demand will be inelastic and hence it’s price will be
higher.
 5. In demand forecasting: Changing incomes means demand will change. The concept
of income elasticity helps producers to know how much to produce when incomes are
rising. During recession and falling employment and incomes, less will be produced.
 6. In dumping: A firm enters foreign markets to dump it’s products on the basis of the
knowledge of elasticity of demand
 7. In the determination of prices of Joint Products: In case of commodities like cotton and
cotton seeds, Wool and mutton etc, the cost of producing the joint products is not known
separately. So their prices are fixed on the basis of demand elasticity.
 8. In the determination of Government policies: Before imposing statutory price controls,
the government must know the elasticity of demand for that product. Government may
declare as public utilities those products whose demand is inelastic and are in danger of
being controlled by monopolies.
 9. In the determination of Gains from international trade: A country will gain from
international trade if it exports those goods whose demand is inelastic so that it can charge
a higher price and import those whose demand is elastic so that we pay less for our imports
Importance of the concept of
elasticity……..contd……
 10. Importance in Fiscal Policy: The Finance Minister has to take into
account for the product on which she proposes to impose tax if revenue
for the Government is to be increased. If the demand for the
commodity is elastic, a rise in price caused by the tax will reduce
revenue for the government.
 The government can succeed in increasing its revenue only if the
demand for the commodity is inelastic.
Supply analysis

 The supply of a commodity means the amount of that

commodity which producers are able and willing to offer for
sale at a given price.
 Supplyis different from production and stock. At any point of
time, supply may be equal to, less than or more than
production and stock.
 Supply schedule: it is the tabular representation of data on quantity
supplied and the price of the commodity.
 Price quantity supplied
 50 100 units
 55 120 units
 60 150 units
 65 200 units
 70 300 units
Supply curve

 Thisis a graphical / diagrammatic representation of the

supply schedule
 Reserve price: if the price falls too much, the producer will
refuse to sell. This is the reserve price, at this price the
producer is said to have bought his own stock.
 Supply function
Law of supply

 “ Other things remaining the same (Ceteris Paribus), the supply of a commodity goes up as it’s
price increases and vice versa”.
 But what are these ‘other things?’
 Factors affecting / influencing supply
 1. Goals of the firm 9. Agreements among producers
 10. Artificial Shortages
 2. Price of the commodity 11. Govt policies and Taxes
 3. Prices of other commodities
 4. expectations about future prices 12. Political disturbances, War

 5. Prices of FOPs/inputs
 6. Weather
Individual and market supply

 The quantity supplied of a commodity “ x” by an individual

producer/ seller at various prices is called individual supply.
 The quantity supplied of commodity “x” by all producers/
sellers in the market at various prices is called market
supply.
 Itis the lateral summation of the supply by various sellers at
those given prices.
 Market supply schedule
 price (rs) seller a seller b seller c seller d seller e market supply

 100 1000 1200 900 1500 800 5400

 200 2500 1800 1200 3000 1200 9700
 250 3000 2200 1750 4200 2000 13150
 280 3500 2750 2000 4500 2250 15000
 300 4000 3000 2200 5400 2280 17400
Elasticity of supply

 “The degree of responsiveness of supply to a given change in Price”.

 Percentage formula to calculate supply
 Proportionate formula
 Perfectly inelastic supply
 perfectly elastic supply
 Unitary elastic supply
 Relatively elastic supply
 Relatively inelastic supply
 Extension or expansion/contraction in supply and increase/decrease in
supply
 Market equilibrium : it is defined as a condition of rest, of no
disturbances, where demand equals supply at a given price
 a). Shifts in demand : increase and decrease , supply unchanged
 b). Shifts in supply : increase and decrease, demand unchanged
 c) simultaneous shifts in both demand and supply
 1. demand rises, supply falls : sharp rise in price
 2. demand falls, supply rises : sharp fall in price
Equilibrium

Price Demand Supply

10 50 10
20 40 20
25 30 30
40 20 40
50 10 50
The market is in equilibrium when price is Rs.25
Utility analysis

 The satisfaction a person receives from the use of a commodity is called

utility.
 The power of a commodity to give satisfaction is it’s utility.
 Utility is neither satisfaction not usefulness.
 Total utility: the total amount of satisfaction that a person receives from the
consumption of all units of a specific good /service.
 Marginal utility: the addition utility gained from the consumption of one
additional unit of a good /service.
Dr. Marshall’s statement of the law of
diminishing marginal utility
 “The additional benefit which a person derives from a given increase of
his stock of anything diminishes with the growth of the stock that he
has.”
 For example an imaginary consumer consuming rasgullas in this table:
Schedule of TU and MU

‘Number of rasgullas total utility (TU) marginal utility (MU)

1 15 15
2 28 13
3 38 10
4 46 8
5 50 4
6 52 2
7 52 0
8 50 -2
9 45 -5
Production function

 Meaning of production: production is defined as “ the creation of

utilities”.
 Production is any economic activity which is directed towards the
satisfaction of wants of people by converting physical inputs into
physical output.
 Production function: Q = f ( k , l , t…… )
 Where Q = output
 K, l, t are various inputs
 K = capital, l = labour, t = technology
 F = function of
 Utility can be created in the following ways:
 1. Form utility: for example, changing the form of a log of wood into furniture, gold bar into
necklace etc
 2. Place utility: utility can also be created by changing the place to a more convenient
location, for example, the corporation creates place utility by bringing river water into our
taps
 3. Time utility: preservation / storage/ cold storage. Or, a raincoat has time utility in rainy
season, a sweater in cold weather etc
 4. Possession utility: grocery items change hands from seller to user
 5. Service utility: services of doctors, lawyers, teachers also are intangibles which have utility
 6. Knowledge utility: having information creates utility. For example, herbs having medicinal
 properties
PRODUCTION FUNCTION
Types of production function

Short run production function

Long run production function
Types of productivity: measures in
production
 Total product (TP) : it is the total quantity produced by all units of
variable factor and fixed factor.
 Average product: it is the output per unit of variable factor
 TP
 AP = ---------------- TP = AP x variable factor
 variable factor
 MP = it is the change in total product by employing one additional unit
of variable factor

TP, AP, MP

 Fixed factor variable factor TP AP MP

 1 1 20 20 ===
 1 2 50 25 30
 1 3 90 30 40
 1 4 116 29 26

 1 5 118 23.6 02
 1 6 118 19.6 0
Law of variable proportions / law of diminishing
returns / short run production function

 With one variable input ( law of variable proportions) or the

law of diminishing returns
 Statement of the law
 By Prof. Paul Samuelson ” an increase in some varying
inputs relative to other fixed inputs will, in a given state of
technology, make total output increase; but after a point the
extra output resulting from the same additions of extra
inputs is likely to become smaller and smaller”.
 Prof.George J. Stigler :” if the quantity of one
productive service is increased by equal amounts, the
quantities of other productive services remaining
fixed, the resulting increments of the product will
decrease after a certain point”.
 Prof.Boulding :” as we increase the quantity of any
one input which is combined with a fixed quantity of
the other inputs, the marginal physical productivity
of the variable input must eventually decline.”
 Assumptions of the law:
 1. The variable factor is increased unit by unit and all units
are homogeneous , ie exactly identical in quality and
quantity.
 2.The fixed factors are held constant in both quality and
quantity
 3. The state of technology has not changed
 4. Indivisibility of fixed factors
3 HECTATES OF LAND, A WELL, some
implements, some capital
 Number of workers TP (quintals) AP (quintals) MP (quintals)
 1 10 10 10
 2 22 11 12
 3 36 12 14
 4 48 12 12
 5 55 11 7
 6 60 10 5
 7 63 9 3
 8 63 7.8 0
 9 63 7 0

 10 54 5.4 -9
 1. MP will rise till TP is increasing at an increasing rate. After this, TP
will still be increasing , but at a diminishing rate
 2. MP is zero when TP is maximum
 3. when TP actually starts falling, MP will be negative
 4. AP will rise as long as MP is rising. it is MP that pulls up AP. So long
as AP is rising, MP it will be above AP
 5.When MP starts falling, it will cut the AP curve on it’s way down at
the highest point of the AP curve. At this point AP = MP
 6. After this, the AP curve will lie above MP curve because it is fall in
MP that pulls down the AP
Stage I: stage of Increasing returns
Reasons for the increasing returns stage

 In the first stage, the AP, MP and TP increase due to the

following reasons::
 1. The fixed factor is indivisible and every increase in
variable factor leads to better and better utilisation of the
fixed factor. This increase in the efficiency of fixed factors
causes increasing returns,
 2.Due to an increase in employment of the variable factor,
the efficiency of the variable factor also increases due to the
possibility of division of labour and specialisation.
Stage ii : Stage of Diminishing returns
reasons for diminishing returns:

 1. During the first stage, till the optimum output is

reached, the fixed factor is under utilised. AP increases as
long as the fixed factor gets to the point of optimum
utilisation. After this, any more increase in the variable
factor will make the fixed factor inadequate in relation to
the variable factor and the AP will fall.
 2. The two factors are not substitutable. If the variable
factor could substitute for the fixed factor, the fixed factor
would not become inadequate because the variable factor
would stand in for the scarce fixed factor.
Stage III: Stage of Negative returns
Reasons for the negative returns

 1. Due to continuous increase in the variable factor, we

reach the point when units of variable factor become too
much for the fixed factor to cope with. It becomes over
utilised.
 2. This increase in variable factor puts a strain on the fixed
factor and it’s efficiency decreases. Moreover, the variable
factor now has less and less room and space to work with the
this results in the reduction in efficiency of variable factor
also.
The concept of revenue : Total,
Average and Marginal revenue
 The term ‘revenue’ refers to the receipts of the firm from
the sale of certain quantities of a commodity at various
prices.
 Totalrevenue (TR) : is calculated by multiplying the total
output sold by the price at which the product is sold.
 Total revenue = price x output sold
 Total revenue (TR) is the total sale proceeds of a firm by
selling a commodity at a given price.
Average revenue

 Average revenue (AR) is the revenue per unit of the

commodity sold. It is found by dividing the total
revenue by the number of units sold.
 total revenue
 Average revenue (AR) : --------------------------------
= price
 Total sales/ output sold
Marginal revenue (MR)

 Marginal revenue (MR) : is the addition to total revenue by

sale of an additional unit of the product
 Marginal revenue of last( n th) unit sold = total revenue from
sale of n units – total revenue from sale of n – 1 unit
 change in TR
 Or, MR = --------------------------------------
 Change in sales/output sold
Revenue curves in perfect competition

 An individual firm has no control on price fixing. It has to sell the product at given
price, determined by demand and supply. Hence, price will be equal to AR and MR.
 Price supply TR AR MR
 10 1 10 10 ----
 10 2 20 10 10 Price = AR = MR
 10 3 30 10 10
 10 4 40 10 10
 10 5 50 10 10
Revenue curves in imperfect
competition
 Under imperfect competition, a firm can sell more by
reducing price.
 Units sold TR AR MR
 1 50 50 50
 2 90 45 40
 3 120 40 30
 4 140 35 20
 5 150 30 10