Mefa notes from durga prasad navulla

  • 2,984 views
Uploaded on

 

  • Full Name Full Name Comment goes here.
    Are you sure you want to
    Your message goes here
  • sir please provide complete notes.....
    Are you sure you want to
    Your message goes here
  • hi,
    hear i am meenakshi madam wife of venket shesh anand and i want to know abou your mefaa notes from durga prasad navulla.so contact me on my id d.meenakshi10@rediffmail.com thankyou d.meenakshi madam.
    Are you sure you want to
    Your message goes here
No Downloads

Views

Total Views
2,984
On Slideshare
0
From Embeds
0
Number of Embeds
0

Actions

Shares
Downloads
150
Comments
2
Likes
1

Embeds 0

No embeds

Report content

Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

Cancel
    No notes for slide

Transcript

  • 1. MEFA NOTESUNIT-I INTRODUCTION 3. Economics as Science of Scarcity Knowledge of economics is helpful to Here there are two important definitions to bemanagers, engineers etc. it is helpful to engineer considered.in determining several issues such as how much 1. According to Lionel Robbins,quantity is to be supplied issues such as how “Economics is a science which studiesmuch quantity is to be supplied, produced and human behavior as a relationshipwhat should be the price of the product, should between unlimited wants, and scarcethe produce be made internally or bought from resources which have alternative uses”.the outside market, how much quantity is to be 2. According to J.M.Keynes, “Economicsproduced in order to earn certain profit etc. is the study of administration of scare resources and how the level of income Managerial economics provides us a and employment will be determined inbasic insight into seeking solution for several the country”.managerial problems. Economics influences the technical decisions of any industry by using the techniques such as demand analysis, elasticity Introduction to Economics of demand, demand forecasting, break-even analysis, production function, capital budgeting Economics is the science related to the etc.production, distribution and consumption of Kinds of Economics:wealth or the material welfare of mankind,political economy, economic questions, affairs 1. Micro Economicsor aspects. Various economists definedeconomics in different ways. In general, Micro Economics is also called “Theoryeconomics can be defined as a social science of Firm”. Micro economics is that branch ofwhich deals with human behavior, how he uses economics which is concerned with the analysislimited income to satisfy the unlimited wants. of the behavior of the individual units or The definitions of economics can be variables such as individual demand or the pricebroadly classified into three different categories. of the product.1. Economics is Defined as Science of Wealth Micro economics basically deals with Adam smith (the father of economics) individual decision making ad the problem ofdefined economics as a science of wealth. resource allocation. It is concerned withAccording to him “economics is concerned with applications such as Law of Demand, Pricean inquiry into the nature and causes of wealth Theory etc.of nations”.He has given primary importance to wealth and 2. Macro Economicssecondary importance to mankind. Macro economics is that branch of2. Economics as Science of Human Welfare economics which deals with the aggregate behavior of the economy, as a whole it makes a According to Alfred Marshall study of the economic systems in general. E.g.“economics is on one side a study of wealth and National income, Total saving, Totalon the other and more important side a part of Consumption, Unemployment, Economicstudy of man”. Growth rate.He has given primary importance to making andsecondary importance to wealthN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 1
  • 2. MEFA NOTES*Difference between Micro and Macro Definitions:EconomicsS.N Micro Macro “Managerial Economics is the use of economic1. It is study of the It is study of the modes of thought to analyse business behavior of the behavior of the situations”. Mc Nair and Meriam. individual firms or units economy as a whole. “Managerial Economics is the economics2. It is individualistic. It is aggregate. applied in decision-making”. Haynes, Mote and Paul3. It is concerned with the It is concerned behavior of the micro with the behavior “Managerial Economics is the application of variable such as of macro economic theory and methodology to business individual demand, variables such as administration practice” supply. National Income, Brigham and Pappas National Output, Total Savings. “Managerial Economics is a price theory in the service of business executives”4. Its scope is limited. Its scope is vast. Watson.5. It deals with the data of It deals with the Based on the above definitions the common individual firm. data of total view regarding managerial economics is as industry. follows 1. Managerial Economics is concernedManagerial Economics-Meaning with decision making of economics nature. Economics is concerned with the 2. Managerial economics is goal oriented.problem of allocation of scare resources among 3. Managerial Economics facilitatescompeting wants. Those economics principles, forward planning.concepts methods, tools and techniques that can 4. Managerial economics provides linkbe applied practically to solve the problems of between traditional economics andBusiness Management is known as managerial decision science.economics. 5. Managerial Economics directs the utilization of scarce resources in a goal oriented manner. Economics Managerial Economics, Solutions to Principles, Application of Economics business Concepts, Tools and to solve the problems of business management problems/ managers Nature of Managerial Economics: Techniques • Micro Economics in Nature • Normative Economics • Application Oriented • Macro Economics Decision making problems of Business Management • Evaluation of each alternative • AssumptionsTherefore, Managerial Economics is a part ofEconomics and it is concerned with business Micro Economics in Nature:practice for the purpose of facilitating decisionmaking. Micro Economics studies about the individual firm. It studies how an individualN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 2
  • 3. MEFA NOTESfirm can use scarce resource to produce more • The theory of managerial economics isoutput with minimum cost and maximum profit. based mainly on the theory of firmNormative Economics: • Managerial economics is both conceptual and materialistic Managerial Economics tells a business • Managerial economics is concerned withfirm to do certain things which will benefit them managerial decision makingand not to do certain things which leads to • Managerial economics takes the help oflosses. Therefore managerial economics is other sources to make optimum use ofnormative economics because it prescribes scarce resourcesApplication Oriented: • Managerial economics is goal oriented in its approach Managerial Economics tries to solve • Managerial economics is micro-some complicated business problems. Decision economics in character as it concentratedmaking skills can be improved by applying only on the study of the firm and not onsome principles and concepts. the working of the economy.Macro Economics in Nature: Scope of Managerial Economics: Managerial Economics gives an The following topics comes under the scope ofopportunity to evaluate each alternative managerial economics.depending on its cost and profit. There is ascope that the managerial economist can decide • Demand analyse and Forecastingon the best alternative to maximize the profits • Cost Analysisfor the firm. • Production Analysis • Pricing PoliciesEvaluation of each alternative: • Profit Management • Capital management Managerial economics gives anopportunity to evaluate each alternativedepending on its cost and profit. There is a • Demand analyse and Forecasting:scope that the managerial economist can decideon the best alternative to maximize the profits A business firm convert raw materialfor the firm. into finished products and these products are sold in the market, Hence the firm has toAssumptions: estimate and forecast the demand before starting production. A forecast of future Managerial Economics is based on demand is essential. The firm will preparecertain assumptions and the assumptions are not production schedule on the basis of demandvalid universally. Therefore, if there is a change forecast.in assumption, the theory may not hold good. • Cost Analysis: Chief Characteristics of Managerial Economics Every business firm wants to reduce cost. A study of economic costs, and their estimates are • Managerial Economics is the study of useful for management decisions. Estimation of the allocation of the scarce resources cost is essential for decision making. An available to a firm among the activities element of cost uncertainty exists, as all the of that unit to maximize profit. factors determining cost are not always knownN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 3
  • 4. MEFA NOTESor controllable. Cost control is essential for • Product Decisionspricing policies. • Pricing Decisions • Quantity Decision and • Technological Decisions • Production Analysis: • Product Decisions:Production analysis refers to the physical termswhile cost analysis refers to monetary terms. These decision are related to the whatProduction analysis deals with different products the firm will produce and offer for saleproduction functions and their managerial uses. and decision may be related to additions of a product or deleting the existing product. It also • Pricing Policies: includes the style, packing and size of the product. Pricing is an important area of managerialeconomics. Price is the basic thing for the • Pricing Decisions:revenue of a firm, and the success of the pricedecisions taken by it These decisions are related to fixing a price for the products manufactured. If the price is • Profit Management: very high the firm may not be able to sell its products. Even if the price is low, the consumers The primary aim of any firm is to maximize think it is an inferior product.profits. Their exists an uncertainty in theestimation of profits, because of differences in • Quantity Decisions:the costs and revenues, and the effects of itsinternal and external factors. Therefore, profit These decisions are related to how much tomanagement is the difficult area in managerial be manufactured. The production dependseconomics. normally in anticipation of demand. • Capital management: • Technological Decisions: Capital Management implies planning It is concerned with the method to beacquisition, disposition and control of capital. adopted in manufacturing a product. One should see whether a change in technology will benefit Decision Making in Managerial the business firm or not. Economics The managers face a number of Hence, there may be more problems toproblems in day to day management of the firm. be faced while planning for the future. It mayHe has to find the solutions to these problems. relate to production, pricing, capital and raw material. The resources are scarce but they have Decision making is the process of alternative uses.choosing one best alternative from a list ofalternative. A manager has to weigh merits and Decision making is very importantdemerits of each action, He has to select the best because it is related to uncertain. Managerialalternative with the limited resources. The economics understand these decision makingdecisions made must take the business firm in problems and guides us in a purposefulthe right direction. There are different types of direction.decisions to be taken, among them the mostimportant areN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 4
  • 5. MEFA NOTES Importance or Usefulness or Significance or • Managerial Application of Managerial Economics Economics and Operation Research Operation research is an activity carried 1. Managerial economics provides a out by functional specialist within the firm to help number of tools and techniques to build the manager to do his job of solving decision models and with the help of these making problems, while managerial economist is models the managers can handle the real purely an academic subject which seeks to life situations. understand and anal7yse decision making 2. Managerial economics provides most of problems of business. the concepts that are needed for the analysis of business problems. • Managerial 3. it is helpful in making decisions such as Economics and Mathematics (a). What should be the product mix? Mathematics provides us a set of tools (b). Which is the best production which helps in the derivation and exposition of technique? economics analysis. Mathematics is closely linked (c) What should be the level of output to managerial economics. It tries to estimate and and price for the product? produce the relevant economics factors for decision (d). How to make investment decisions? making and forward planning. The branches of 4. The managerial economics helps us to mathematics which are generally used by a understand the economic behavior of managerial economist are geometry, Algebra and individuals calculus. 5. The managerial economics helps us to explain the working of economic system • Managerial economics and Stastics 6. Managerial economics helps to assess the Statistics is widely used by managerial performance of the economy economics. Managerial economics aims at 7. Managerial economics provides a good quantifying the past economic activity to predict its knowledge about cause and effect of future. Probability, correlation, interpolation are various economic phenomena the concepts used by managerial economics to 8. Managerial economics suggest how to solve certain problems. The concept of statistics improve the growth rates in developed helps in decision making. economies • Managerial economics and Accounting Relation with other subjects: Managerial economics is closely related• Managerial Economics and Traditional with accounting which is concerned with financial Economics operations of a business firm. Accounting information is one of the principle sources of data The relationship between managerial used by managerial economist for his decision economics and traditional economics is very much purpose. like the relation of engineering to physics and medicine to biology. Traditional economics • Managerial economics and psychology provide certain concepts, methods and principles Consumer psychology is the basis on which which can be applied to solve the problems of managerial economist acts upon. We always business management. The both deal with the assume that the behavior of the consumer is allocation of scarce resource in an optimum way. always rational, which is reality is not so. A managerial economist must know about Psychology contributes towards understanding the traditional economics in order to understand the behavioral implications, attitudes and motivations principles of managerial economics. of each of the microeconomics variables such as N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 5
  • 6. MEFA NOTESconsumer, supplier, investors, workers or anemployee.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 6
  • 7. MEFA NOTES Functions of Managerial Economist has to obtain statistical data on national income, price level and tax policies The managerial economist has to gather • He should identify new businesseconomics data, analyse all crucial information opportunitiesabout the business environment. He may have to • He should build micro and macromake a continuous assessment of the impact of economic models to solve specificchanging technology. In the Indian context a problemsmanagerial economist is expected to perform the Responsibilities:following functions. 1. Macro-forecasting for demand and • Sales forecasting supply • Industrial market research 2. Production planning at micro, macro • Economic analysis of competing levels. companies 3. Capacity planning and product-mix- determination. • Pricing problems of industry 4. Economic feasibility of new production • Capital projects process • Production programmers 5. Assistance in preparation of overall • Security analysis and forecast development plan • advice on trade and public relations 6. preparation of periodical economic • advice on primary commodities reports • advice on foreign exchange 7. Keeping management information at • Economic analysis on agriculture. various national and international developments on economic matters • Analysis of underdeveloped economies 8. Preparing briefs, speeches, articles and • environmental forecasting papers for top management The important characteristics he needs to have areRole of Managerial Economist: i) Economic intelligenceThe managerial economist plays a very ii) Participating in public debatesimportant role in an organization • The objective of a managerial economist plays a very important role in an organization • The managerial economist must try to maximize profits on their invested capital • Managerial economist must make an accurate forecast as possible, because forecast depends on future which is uncertain. • he should advise the management on domestic and global economic issues • The managerial economist has to maintain contact with data sources. HeN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 7
  • 8. MEFA NOTES DEMAND ANALYSIS In the above table or schedule when the price of the product is Rs.5, its demand is only 1000 units. But when the price has fallen toIntroduction: Rs.1, demand for the product has gone up to Demand is the basis for the starting of 5000 units. This shows that a fall in the priceany business, as the product decision and deals to extension of demand. Similarly whenamount of product to be produced would be we take Rs. 1 price, the demand for the productdecided only on the basis of the demand is 5000 units, when the price started rising up toprevailing in the market i.e. depending on the Rs.5 the demand for the product has fallen tomarket survey and demand forecast. Demand 1000 units. This shows that a rise in price leadsonly decides indirectly the amount of factors of to contraction of demand.production to be employed in the organizationi.e. money, men, material, machinery andmanagement required. Without proper demandanalysis, if production activity is undertaken thebusiness firm may suffer huge losses.Demand: Meaning Demand for a product refers to 1. Desire of an individual for a product 2. Ability to pay for the product 3. Willingness to pay for the product. If there is ability and willingness but no This can be shown with the help of diagram,desire then it is nor a demand. Similarly, DD=Demand Curvewithout willingness if there is desire and ability, On X-axis the quantity of a product demanded isthen also it is not a demand. represented. On Y-axis the price of the product is represented. DD represents the demand curve.Law of demand: It slopes downwards from left to right as price According to law of demand there is an increases, demand is decreasing. As priceinverse relationship or a negative relationship decreases demand curve moves away from thebetween the price of a product and its demand. point of origin.The law may be stated as follows “when theprice falls, demand extends, price rises demand Demand curvefalls, other things, remaining constant. If we show the demand schedule graphically, we get a demand curve. TheExplanation of law of Demand demand curve shows the maximum quantitiesDemand schedule per unit of time that consumers will take at Price in Rs. Quantity Demanded various prices. (units) Assumptions of Law of Demand: 5 1000 4 2000 The assumptions underlying the Law of 3 3000 Demand are: 2 4000 1 5000 • No change in Consumer Income • No change in Consumer Preference Demand schedule is the table showing • No change in the Tastes and Fashionsthe prices per unit of the commodity and the • No change in the Price Related Productamount demanded per period of time. • No change in the population • No change in the Govt. PolicyN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 8
  • 9. MEFA NOTES • No change in Weather Conditions Hence all these assumptions are kept as constant. • No change in Consumer Income If the income of the consumer increases, Demand Function inspite of increase in the price of the goods The demand function for a commodity the demand will increase. Similarly if the describes the relationship between quantities of income decreases, inspite of decrease in the the commodity which consumers demand price the demand will decrease. during a specific period and the factors which influence its demand. Mathematically, demand • No change in Consumer Preference function can be expressed as follows If the consumer have a specific preference of the product or he likes the Dx = ∫(Y , Px , Ps , P , T , E p , N , D, u , a ) c product or he likes the product very much Where He purchases the product if it is costlier also. D = Quantity demanded for the product x Y = Consumer’s income • No change in the Tastes and Fashions Px = Price of good x If fashion of the product is outdated, the Ps = Price of substitute of x demand will decrease even if it is offered at Pc = Price of complements of x a lower price T = Measure of consumer tastes and preferences Ep = Consumer’s expectations above future • No change in the Price Related Product prices. If the price of the related product N = No of customers decreases, demand tends to decrease for the D = Distribution of consumers other similar products also. u = Other determinants of the demand for x a = advertisement • No change in the population ∫ = Unspecified Function If the population goes on increasing the demand tends to decrease even though the Why demand curve slopes downwards: price increases. On the other hand if the The law of demand states that, other population decreases demand tends to things remaining the same, an individual decline even though the price is low consumer will but more units of a commodity at a lower price and less of that commodity at a • No change in the Govt. Policy higher price. Generally, the demand curve The change in the government policies slopes downwards from left to right. Some of and political situation will influence the the reasons for this are demand for the product. • Income effect • A commodity is utilized more when it • No change in Weather Conditions become cheaper In summer season the demand for fans, • Substitution effect air coolers, air-condition is increasing • Multiple use of product considerably irrespective of changes in the price. • Income effect: • No expectation of future price changes. The income of a consumer affects the • No change in the range of foods demand of the product. If the income is fixed available to customers. i.e. there is no change in income, but there is a change in the prices of the products, then it willN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 9
  • 10. MEFA NOTESaffect the demand and the curve slope hand if the income decreases the demand willdownwards. decrease • A commodity is utilized more when it 3. Tastes, Habits and Preferences of the become cheaper: Consumer: If the price of the product falls, the Demand for many goods depends upon the existing buyers purchase more and some new tastes, habits and preference of the consumer. consumers enter the market E.g.: Demand for several goods like ice-cream, chocolates, beverages depends on the taste of • Substitution effect: the individual A fall in the price of a product, while the prices of its substitutes remain unchanged will 4. Relative Price of Substitute Goods and make it attractive to the buyers who will now Complement Goods: purchase more and vice versa. The demand for a product is also affected by the changes in price of the related by • Multiple use of product: the changes in prices of the related goods. Some products can be used for multiple Related goods can be of two typespurpose. A fall in the price of steel, iron etc., 1. Substitutes which can replace each other inwill increase demand considerably. use E.g.: Tea, Coffee and bournvita are substitutes. FACTORS INFLUENCING THE DEMAND 2. Complementary goods are those which areFOR A PRODUCT jointly demanded E.g.: Tea, Sugar and milk are complementary 1. Price of the Product goods. 2. Income of the Consumers 3. Tastes, Habits and Preference of the 5. Consumer Expectation: Consumer A consumer expectation about the future 4. Relative price of Substitute Goods and changes in the price of a given product may also Complement Goods affect its demand. When the consumer expects 5. Consumer Expectation the prices to fall in the future he tends to but less 6. Population and vice versa. 7. Climate and Weather 8. Advertisement effect 6. Population: Increase in population increases demand1. Price of the Product: for necessaries of life. Decrease in population The most important factor affecting will also affect the demand for differentamount demanded is the price of the product. products.The amount of product demanded at a particular 7. Climate and Weather:price is called as price demand. Normally a The climates of areas woolen clothes arelarge quantity is demanded at a lower price but demanded. On a rainy day, ice-cream is notnot at a higher price. Not only the existing price much demanded.but also the expected changes in price will affectdemand. 8. Advertisement Effect: In modern times the consumer2. Income of the Consumer: preference can be changed by advertisement and When consumer’s income increases the sales propaganda. Demand for may products like toothpaste, soaps, washing powder etc., isdemand will increase significantly. On the other partially caused by the advertisement affect.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 10
  • 11. MEFA NOTES In Exhibitions and functions, the social habit, place or situation, force people to purchaseExceptions Or Limitation To the Law goods at higher prices of Demand 1. Giffen Goods/ Inferior Goods Individual Demand Schedule and 2. Veblen Goods Market Demand Schedule 3. Consumer Expectation 4. Consumer Psychological Bias Consider the following table 5. Necessaries Price Goods Demanded by Total 6. Impulse Buying Rs. individual Demand 7. X in Y in Z in in units• Giffen Goods/ Inferior Goods: units units unitsRobert Giffen, British economist observed that 100 10 5 2 17when the price of the product is decreasing the 95 20 10 5 35demand for the product is decreasing. These 90 30 12 10 52Products are called as inferior goods or Giffen 85 40 15 14 69goods. 80 50 20 20 90 Similarly, when the price of the productis increasing the demand is also increasing. In the above table Mr. X is demandingSuch types of products are called superiorgoods. 10 units at Rs. 100 and 50 units at Rs 80, this demand is called individual demand. Individual• Veblen Goods or Prestige Goods demand refers to goods demanded by a single American economist, Veblen explained individual. The table showing at different pricesthat, there are certain goods which are different units were demanded by Mr. X that ispurchased by the consumer not because they called individual demand schedule.really need those goods but they purchase goodsbecause of status symbol i.e., to maintains status Market demand refers to total demandin the society. Prestige goods are those which made by all the individuals in the market. In theconsumers will purchase even though they are above table total demand is 17 units at Rs. 100costlier. and 90 units at Rs. 80. The table representing different prices, different units were demanded• Consumer Expectations: by all the individuals that is called market Whenever the consumer expects a demand schedulefurther fall in the price in future he will notpurchase the products or goods immediately,when price decreases, demand tends to decline. ------Similarly when the consumer expects a furtherincrease in the price for the future he will butthe products immediately• Necessaries: The demand almost remains constantirrespective of the price changes concerned tothese goods as people tend to adjust theirconsumption on other goods as they feel theseare most necessary products.• Impulse buying:N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 11
  • 12. MEFA NOTES Types of Demand E.g. The demand for sugar is loosely tied up 1. Demand for Consumer Goods and with the demand for drinks Producer Goods 2. Durable Goods and Perishable Goods • Industry Demand and Company Demand Demand : 3. Derived Demand and Autonomous Demand Industry is a group of firms producing or 4. Industry Demand and Company Demand manufacturing the same or similar product. 5. Short run Demand and Long run Demand Company is an individual business unit or 6. New demand and Replacement Demand business firm 7. Total Market Demand and Segment When goods are demanded which are produced Market Demand or manufactured by a particular company, that demand is called company’s demand.• Demand for consumer goods and producer goods: E.g. Demand made for Maruti cars produced by When Goods are demanded by consumer for Maruti Udyog Ltd.the direct satisfaction of their wants, they arecalled demand for consumer goods. When goods are demanded which areE.g. Food items, Readymade clothes etc. produced or manufactured by a particular When goods are demanded by producer industry that demand is called industry demand.for production of other goods including E.g. Total demand for cars produced byconsumer goods, they are called demand for automobile industry.producers’ goods. • Short run Demand and Long RunE.g. Machines, tools, Equipment etc. Demand• Durable goods and Perishable goods Short run demand refers to that demand demand which changes immediately due to reaction in Perishable goods are those which can’t price changes and income fluctuation etc.consumed only once, while durable goods arethose goods which can be used more than once Long run demand refers to that demandover a period of time. which does not react immediately due to price change. It will take some time for change in• Derived Demand and Autonomous demand Demand • New Demand and Replacement Demand When the demand for a product is tied to the :purchase of some parent product. Its demand is New demand refers to the demand for theCalled derived demand. new products and it is the addition to the E.g. Demand for cement depends upon existing stock. In replacement demand, the itemdemand for construction industry. is purchased to maintain the asset in good condition. The demand for cars is new demand When goods are demanded and the demand for spare parts is replacementindependently for the direct satisfaction of the demandconsumer wants, it is called autonomousdemand. • Total market Demand and Segment Market demandN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 12
  • 13. MEFA NOTES Take the E.g of the consumption of sugar in (Q2 − Q1 )a given region. The total demand for sugar in Q1the region is the total market demand. The Ep = ( P2 − P1 )demand for sugar from the sweet-making P1industry from this region is the segment marketdemand. UNIT-II ∆Q ELASTICITY OF DEMAND Q = 1 Elasticity of Demand is the measure of the ( ∆P)degree of change in the amount demanded of the P1commodity in response to a given change inprice of the commodity, price of some related ∆Q P1goods or change in consumer income. = × ∆P Q1 There are four important kinds of elasticity Whereof demand. Q1= Quantity demanded before price change 1. Price elasticity of demand Q2= Quantity demanded after price change 2. Income elasticity of demand P1= Price charged before price change 3. Cross elasticity of demand P2= Price changed after price change 4. advertising and promotional elasticity of demand Higher the elasticity of demand, greater will bePrice Elasticity of Demand: the percentage change in quantity demanded every percentage change in price.Meaning: Elastic Demand and Inelastic Demand Price elasticity of demand measures the When a small change in price may bring about aresponsiveness of demand to changes in price. big change in demand then it represents elasticThe price elasticity of demand for a commodity demandis the rate at which quantity bought changes as What ever may be the changes in price ifthe price changes. It is denoted by (Ep) the demand remains more or less constant then it represents inelastic demand. Pr oportionat echange in the quantity demandedEp = Pr oportionate change in price or Types of Price Elastic of demand Change inquantity demanded Types of Price Elastic of demand are generally classified into five categories. Quantity demanded Ep = • Perfect Elastic Change in Pr ice demand Pr ice • Perfect inelastic demand • Unit elasticity demand • Relative/Compara tive Elasticity of demand • Relative/ Comparative Inelasticity of demand Perfect Elasticity of Demand (Ep=∞):N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 13
  • 14. MEFA NOTES As there is no change in the demand and price it It is one in which a small change in price is called as unitary demand.will cause a large change in amount demanded.A small rise in price reduces the demand tozero. A small decrease in price leads to a bigexpansion in demand. The figure shows that the quantityIn the above figure the quantity demanded demanded increases OX0 to OX1, as there is aincreases from OX to OX1 from OX1 to OX2 decrease in price from OP0 to OP1. The amounteven though there is no change in price. The of increase in the quantity demanded is equal toprice is fixed at OP. the amount of fall in the price.Perfect Inelastic Demand(Ep=0): Relative Elastic Demand(E>1): This is one which shows that whateverthe change in price may be the amountdemanded remains same. The demand is said to be relatively elastic when the change in demand is more than the change in price. The figure shows that the quantity demanded increases from OX0 to OX1 as there is a decrease in price from OP 0 to OP1. The amount of the increase in the quantity demanded is greater than the amount of decrease in the price. In the above figure it is shown that thereis no change in the quantity demanded eventhough the price is changing (increase ordecrease). Even though there is an increase in pricefrom OP0 to OP1 to OP2 there is no change indemand. Relative Inelastic Demand(E<1):Unit Elasticity of Demand(Ep=1): In this type of demand a given When the change in demand is less thanpercentage change in price leads to exactly the the change in price, then the demand is said tosame percentage change in amount demanded. be inelastic.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 14
  • 15. MEFA NOTES High income group people are less affected by [rice changes than low income groups people. Demand for high priced and quality goods in inelastic for high income groups whereas the same is elastic for low income people 4. Variety of Use: A commodity having a variety of uses has a comparatively inelastic demand. On the other hand, demand is elastic for a commodity having a limited use In the figure the demand increases fromOX0 to OX1 as there is a decrease in the price 5. Proportion of income spent on the commodityfrom OP0 to OP1. The amount of increase in the If the consumer spends less percentagequantity demanded is lesser than the amount of on a commodity, then demand will be inelasticdecreases in the price. e.g. salt, match box. On the other hand if consumer spends large proportion of his incomeFactors Determine Price elasticity of on a commodity, then the demand will be elasticDemandThe price of elasticity of demand depends on the 6. Durabilityfollowing factors: When a commodity is durable e.g. furniture, toothbrush etc, one is likely to use the 1. Nature of goods commodity for a longer period having high 2. Availability of substitutes price, then higher is its elasticity of demand. 3. Income level 4. Variety of uses 7. Time Period: 5. Proportion of income spent on the commodity 6. Durability of a commodity Demand of a commodity always has a 7. Possibility of postponement reference to a specific period. Generally demand 8. Time period is inelastic during short period and elastic during the long period.1. Nature of goods: Goods may be classified into three Importance of Price Elasticity ofgroups. They are necessaries, comforts and Demandluxuries. The demand for necessaries like salt, The concept of elasticity of demand is of muchfood grains, clothes etc is inelastic like salt, food practical importance. Given the fact that thegrains, clothes etc is inelastic where as demand actions of any enterprise are oriented towardsfor comforts and luxuries like television improving its overall profitability. Here thevehicles etc is elastic concept of elasticity plays crucial role. It measures the proportionate change in sales and2. Availability of Substitutes: hence in profit. Price elasticity of demand is A commodity having a number of highly useful in the following cases.substitutes has relatively elastic demand 1. Price Fixation of a Productwhereas a commodity have less or without 2. Decision Regarding to Price Changessubstitutes is relatively inelastic demand. 3. Price discrimination 4. Taxation Policy3. Income level:N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 15
  • 16. MEFA NOTESIncome Elasticity of Demand The income of consumer too greatlyaffects the demand for a commodity. Given theprice, if the consumers have a higher income,they can buy more products. Thus at higherincomes or increase income levels the demandwill be high and at lower income demand for thecommodity will be lower. When the income of the consumerincreases, the demand for quality productsincreases, while that of poor quality goodsdecreases. Income demand curve called Engelcurve is left to right upward for superiors goodsand downward for inferior goods.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 16
  • 17. MEFA NOTESINCOME DEMAND (ENGEL) SCHEDULE ∆Q Income (Rs.) Demand for Demand for Q ∆Q I = = × Superior goods Inferior goods ∆I Q ∆I 1000 1 6 I 2000 2 5 Where 3000 3 4 Ei = Income elasticity of demand 4000 4 3 ΔQ= Change in quantity demand 5000 5 2 Q = Quantity demanded 6000 6 1 ΔI = Change in incomeAs income of the consumer increases from Rs. I = Income3,000 to 4,000 quantity demanded increases to 3 INCOME ELASTICITY OFto 4 units for superior goods. Where as for DEMAND TYPES:inferior goods demand reduced from 4 to 3 units Income elasticity of demand is classified underpresented in the figure. three heads 1. Zero Income Elasticity of Demand 2. Negative Income Elasticity of Demand 3. Positive Income Elasticity of Demand 1. Zero Income Elasticity of Demand This refers to the situation where a given increase in consumers’ income does not result in any change of the quantity demanded. E.g. Essential goods like salt, milk etc. 2. Negative Income Elasticity of Demand This refers to that situation where given increase2. INCOME ELASTICITY OF in the consumers’ income is followed by anDEMAND actual fall in the quantity demanded for theThe income elasticity is defined as a ratio of commodity. E.g inferior goodspercentage or proportional change in thequantity demanded to the percentage change inincome. It measures the degree ofresponsiveness in quantity demanded due tochange in income. Percentage change in quantity demandEi = Percentage change in incomeN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 17
  • 18. MEFA NOTES3. Positive Income Elasticity of Demand Note: Cross elasticity of demand in caseThis refers to situation where a given increase in of Substitutes is positive and in case ofconsumer’s income is lead to an increase in complements is negative.quantities demanded. Cross Elasticity of demand is useful in the following cases. This may be further classified into Unitary 1. To fix product pricing and changes inincome elasticity of demand (Ei=1), income pricing of the productelasticity of demand greater than unity (Ei>1) 2. To estimate the Effect of Competitors’and income elasticity of demand less than unity Pricing Decisions(Ei<1). The following diagram is explaining it. 4. Advertising or Promotional Elasticity of Demand: Advertising elasticity of demand refers to percentage or proportionate change in sales in response to percentage change in advertisement expenditure. It is denoted by EA % / Pr oportionatechange in Sales EA = % / Pr oportionatechange in advertisement exp enditu ∆S S − S1 EA = ,EA = 2Use of Income elasticity of Demand ∆A A2 − A1 1. For Demand forecasting In the present competitive world 2. For Product line Planning advertising occupied an important place, it 3. Advertisement Planning consists of audio visual activities to increase the demand for a product. Advertising elasticity of3. Cross Elasticity of Demand: demand is a measure to understand how far theCross Elasticity of Demand may be defined as demand for a product will be influenced by“The proportionate change in the quantity advertisement and other promotional activities.demanded of a particular commodity inresponse to a change in the price of another Advertising Elasticity of demand is useful inrelated commodity”. the following cases. Percentage Change inDemand of given good ( A) 1. To know the stage of product in the EC = Percentage Change in Pr ice of Re lated Good ( B ) market 2. To know the effect of advertising in ∆Q A terms of time QA 3. To know the advertising by rivals or EC = ∆PB competitors PB ∆Q A P IMPORTANCE OF ELASTICITY OF EC = × B DEMAND: QA ∆PBWhere, • Useful to theEC= Cross elasticity of demand BusinessmenΔQA= Change in demand of given good • Useful to theQA= Demand of a given good Government and Finance MinisterΔPB=Change in price of related goodPB= Price of a related good • Useful to International TradeN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 18
  • 19. MEFA NOTES• Useful for Planning of Long term forecasting refers to the the business activities forecasts prepared for long period during which• Useful to the consumers the firm’s scale of operations or the production• Useful to Trade unions capacity may be expanded or reduced. DEMAND FORECASTING 5. Short term forecasting: A forecasting is a prediction or Short-term forecasting normally relatedestimation of future situation under given to a period not more than a year. Short termconditions. forecasting relate to the day-to-day information. In the short term forecasting a firm is primarilyDemand Forecasting: concerned with the optimum utilization of its Demand forecasting means expectation existing production capacityabout the future course of the market demandfor product. Demand forecasting is essentially Importance of Demand Forecasting:reasonable judgment of future probabilities ofthe future demand. It cannot be 100% precise. • For planning and Production analysis • Sales ForecastingDemand Estimation: • Control of Business Demand estimation tries to find our • Inventory Controlexpectation present sales level, given the presentstate of demand determinants. • Long term Investment Programmes • Maintain StabilityTypes of Demand Forecasting: • Helpful for Planners and Policy MakersVarious types of demand forecasting are asfollows • For planning and Production analysis: 1. Passive forecasts Demand forecasting is essential before 2. Active forecasts starting any production activity. It is dependent 3. micro forecasting on accurate demand forecasting. 4. Long term Forecasting 5. Short term Forecasting • Sales Forecasting:1. Passive Forecasting: Sales forecasting is dependent on the Here prediction about future is based on demand forecasting. Advertisement pattern of the firm should be based on sales forecasting.the assumption that the firm does not change thecourse of its action. • Control of Business:2. Active Forecasting: The business firm may have to prepare the budget of cost and revenue occurring in future. Forecasting is done assuming that, it will The future accurate estimation of cost andbe changes in the actions by the firm. revenues is based on the demand forecasting.3. Micro Forecasting: • Inventory Control: When individual business firm forecast The business form can have a better controlthe demand for their products, it is known as on raw materials, semi- finished goods, finishedmicro level forecasting. goods, spare parts etc., for future requirements of the firm with the help of demand forecasting.4. Long term forecasting:N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 19
  • 20. MEFA NOTES • Long term Investment Programmes: The methods employed should be able to The growth rate and long term investment produce meaning results quickly. planning of the firm can be estimated with the help of demand forecasting. For planning and • Maintenance Should be Up to Date : Production analysis The forecast should be capable of being maintained on an up-to-date basis • Maintain Stability: Approaches to Forecasting: Production and employment growth rates can be stable through demand forecasting. • Identify and clearly state the objectives of forecasting. The objective may be short- • Helpful for Planners and Policy Makers: term or long-term Demand forecasting can be greatly used by • Select Appropriate method of forecasting planners and policy makers in making optimum allocation of scare resources. • Identify the variables affecting the demand for the product and express them in Requisites of a Good Forecasting Methods: appropriate forms • Gather all relevant date o represent the • Accuracy variable. • Simple and Easy to Compute • It may be made either in terms of physical • Economy units or in terms of rupees of sales volume • Availability • It may be in terms of product group or • Maintenance Should be Up to Date individual products• Accuracy: • It may be annual basis or moth wise or It is necessary to check the accuracy of past week wise on the basis of past records forecast against future performance and of present forecast against past performance.• Simple and Easy to Compute: Management must be able to understand andhave confidence in the methods used forforecasting.• Economy:Costs must be weighted against the benefits of theforecast to the operation of the business.• Availability: N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 20
  • 21. MEFA NOTES Demand Forecasting Methods different opinions on them. This process is repeated again and again unless a I. Intentions of Customer common view point is emerged. 1. Survey Method: IV. Test Market: Under this method the consumers are This method is used for estimating contacted personally to disclose their demand of new products of estimating future purchase plans. This can be done sales potential of existing products in by two ways new geographical areas. In this method a 1. Census method test area is selected which truly represent 2. Sample Method the market. The product is launched in this area exactly in the manner in which• Census method: it is intended to be launched in the Under this method all consumers market. If the product is found successfulare contacted to know their preferences in the test area then the sales are taken asfor the products in future. The interviews a basis for estimating sales in the marketare conducted either orally or through as a whole.questionnaire. With the help of censusmethod the probable demand of all 2. Market Experimentation Method:consumers is summed up. This method involves giving a sum• Sample method: of money to each consumer with which In this method a sample of consumers he is asked to shop around in a simulatedis selected for interview. The sample may market. Consumer behavior is studied bybe random or stratified sampling. This varying prices, quantity, packing,method is easy, less costly and highly advertisement, colour etc.useful. 3. Based on Fast Trends:II. Collective Opinion Method: Under this method opinion of the • Fitting a Trend Linear of Trendsales men taken for demand forecasting. Forecasting Method:The sales men can know the pulse of the Under this method actual dales data isconsumer and they can give correct drawn on a chart and estimating byinformation about the likely demand for observation where the trend line lies.the products. That line can be extended further towards a future period and the correspondingIII. Delphi Technique: sales graph can be read from the graph. Opinions and views are taken fromexperts coming from different • Least Square Methodbackgrounds. Under this method experts This method uses statistical data toare asked the likely demand for a find the trend line which best fits theparticular product. The experts may giveN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 21
  • 22. MEFA NOTESavailable data. The following regressionequation is used S= a. T+b 5. Statistical Method:Where S= Sales • Naïve Method: a, b = Past Data Calculation It is based on the past data of information T = The year for which forecast is available for example Historical required Observation of sales• Time Series Analysis: • Regression Analysis: This method attempts to build This is a statistical technique byseasonal and cyclical variation into the which the demand is forecasted with theestimating equation help of certain independent variables. There are two types of regression S=a+b+c+d analysisWhere a= Trend a. Simple b= Season b. Multiple c= Cycle Simple regression analysis is used a, b, c, d= Constant calculated when the quantity demanded is taken as a from past data. function of a single independent variable. Multiple regression analysis is used to• Moving Average Method: estimate demand as a function of two or This method is based on past sales more independent variables that variesdata and it is used for short term simultaneously.forecasting and it is based on assumptionthat the future is the average of past 6. Judgmental Approach:performance If the management is unable to use any of the above method they have to4. Economic Barometer: make their own judgment in forecasting the demand This method forecasts the futurebased on the occurrence of present These are the demand forecastingevents, first we have to see whether their techniques .exists a relationship between the demandfor a commodity or product and certaineconomic indicator. The aboverelationship can be established throughthe method of least square. E.g. demandfor tractors depends on the farmer’sincome or agricultural income.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 22
  • 23. MEFA NOTES III unit time with a given state of technology,PRODUCTION ANALYSIS managerial ability etc. Production in Economics meanscreation of goods and services which haveexchange value. In other words, it impliescreation of utilities. Production is anorganized activity of transforming input intooutputs to satisfy the demand for thecommodities and services of the company. Inputs refers to the all those thingswhich a firm buts and employs to produce aparticular product. Output means thequantity of goods in the finished formproduced by the firm for selling. Productionanalysis deal with physical production and Production function enables productionsupply side of the market. manager to understand how better he can make use of technology to its greatest potential Definition for Production function: “The production function is the nameDefinition for Production: given to the relationship between the rates ofAccording to the Parkinson: productive services and the rates of output of the product.” “Production is the organized activity -------> Stiglerof transformation resources into finishedproducts in the form of goods and services”. “Production function is that function which defines the maximum amount ofProduction Function: output that can be produced with a given set of inputs”. Production function expresses a -------> Michael R Baye.functional or technical relationship betweenphysical inputs and physical outputs of a Production Function:firm at any particular time period. Theoutput is thus a function of inputs. It can be expressed in an allegoricalProduction is the result of combination of equation:factors of production land, labor, capital andorganization. The factors used for ∫ Q = ( a, b, c, d ...........n)production are called “inputs”. The Whereproduction we get is called “output”. The Q stands for the quantity of outputproduction functions show the maximum a, b, c, d…..n are the various inputs.rates of output that can be obtained fromdifferent combinations of inputs in a given Each form has its own production function depending on the technicalN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 23
  • 24. MEFA NOTESknowledge and managerial ability. An • When inputs are specified in physicalimprovement in the technical knowledge or units, production function helps tomanagerial ability will bring about a new estimate the level of productionproduction function. • With the help of iso-quants, production function explains the Here output is the function of inputs, difference combinations of inputsthe output becomes the dependent variable which will yield the same level ofand inputs are the independent variables. output.Production function has to be expressed in a • Production function indicates theprecise mathematical equation i.e. manner in which the firm can substitute one input for another Y = a + bx without altering the total output It is showing the there is constant • When prices are taken intorelationship between application of input (x) consideration, the productionand the amount of output(Y). function helps to select the least combination of inputs for desired The production function may be fixed outputproduction function are variable production • It considers two types of input-function. In fixed production function each output relationship namelylevel of output requires a uniquecombination of inputs. On the other hand a 1. Law of variable proportion andvariable production proportion production 2. Law of returns to scale.function is one which the same level ofoutput may be produced by two or more • It helps us to under stand the laws ofcombinations of inputs. returns in productionAssumptions: COBB- DOUGLAS • The production function is related to PRODUCTION FUNCTION a particular period of time • There is no change in technology Production function of the linear • The producer is using the best homogenous type is invented by Jnut technique available Wicksell and first tested by C.W. Cobb and • The factors of production are P.H. Douglas in 1928. This famous divisible statistical production function is known as • Production can be fitted to a short run Codd- Dougles production function. or to long run. Originally the function is applied on the • Utilization of inputs at maximum empirical study of the American level of efficiency. manufacturing industry. Cobb-Dougles production function takes the following mathematical form Y =( A K α L1−α )Importance of production function: Where, Y= OutputN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 24
  • 25. MEFA NOTES K= Capital ISO QUANTS L= Labour “Iso” means equal; “quants” means A, α = Positive Constant quantity. It means the quantities throughout a given isoquant are equal. Isoquants areAssumptions: also called isoproduct curves. It shows various combinations of two input factors• It assumes that output is the function such as capital and labour, which yield the of two factors, i.e. capital and labour same level of output.• It is a linear homogenous production The production functions like this function of the first degree when only two inputs are there for• There are constant returns to scale production.• All inputs are homogenous Q =∫( L, K )• There is perfect competition This function has three variables• There is no change in technology Q= output of commodity, L= Labour andCriticism: K=Capital For a given value of Q, there will be• Cobb-Douglas production alternative combinations of L and K. these function is criticized because it shows combinations of L and K will vary with constant returns to scale. But constant variation in Q. Generally both labour and returns to scale are not actuality. Industry capital are necessary for the production of is either subject to increasing returns or commodity; there are substitutes to each dimishing returns. other. Thus, for any given level of output, no• No entrepreneur will like to entrepreneur will need to hirer both labour and capital but he would have an option to increase the inputs in order to have employ any one combination of these constant returns only. His aim will be to factors, out of several possible combinations get increasing returns and not constant returns Q=2 Q=5 Q=9 Q=12 Q=14• This function as applied to K L K L K L K L K L each firm may not give the same result as 1 2 2 2 3 2 4 2 5 20 that of the industry. 0 0 0 0• It based on the assumption that 2 1 3 1 4 1 5 1 6 17 factors of production are substitutable 2 4 3 5 and excludes complementarity of factors. 3 8 4 1 5 1 6 1 7 15 But in the short run non- 0 0 2 complementarity of factors is possible. 4 6 5 7 6 8 7 1 8 13 Therefore, it applies more to the long-run than to the short-run 0 5 4 6 5 7 6 8 8 9 11 6 3 7 4 8 5 9 7 1 10 0N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 25
  • 26. MEFA NOTES In the above table all those substitutes. One input factor can becombinations of labour and capital which substituted by other input factor in ayield the same output. In our example the diminishing marginal rate. If the inputfarmer could employ 1 tractor and 20 labour, factors were perfect substitutes, the2 tractors and 12 labour… 6 tractors 3 isoquants would be a falling straight line.labour to manufacture 2 Quintals of output.If he aims at producing 5 quintals of output, 3. Don’t intersect:the alternative input combinations open to Two isoproducts do not intersect withhim are 2 tractors and 20 labour, 3 tractors each other, it is because, and each of theseand 14 labour and so on. denotes a particular level of output. If the manufacturer wants to operate at higher If we plot these alternative input level of output, he has to switch over tocombinations for a given output and assume another isoquants with higher level of outputa continuous variation in the possible and vice versecombination of labour and capital, we candraw a curve called isoquants for various 4. Do not touch axes:output levels of table are shown in the figure The isoquants touches neither X-axis not Y-axis, as both inputs are required to produce a given product Types of Isoquants Depending upon the degrees of substitutability of inputs, there are four types of Iso-quants. • Linear Isoquants • Input-Output Isoquants Features of Isoquants: • Kinked Isoquants 1. Downwards Slopping • Smooth Isoquants 2. Convex to Origin 3. Do not intersect Explanation of those 4. Do not touch axes • Linear Isoquants:1. Downward sloping: It represents perfect substitutability of Isoquants are downwards sloping curves factors of production.because, if one input increases, the other onereduces. There is no question of increase inboth the inputs to yield a given output. Adegree of substitution is assumed betweenthe factors of production2.Convex to Origin: Isoquants are convex to the origin. It isbecause the input factors are not perfect • Input-output Isoquants:N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 26
  • 27. MEFA NOTESIf the factors of production are strict level of production. If the given level ofcomplementaries and hence show zero production changes, the total cost changessubstitutability, we derive this isoquants and thus the isocost curve moves upwards. And vice versa. In the following figure three downwards sloping straight line cost curves each costing Rs.1.0 lakh, Rs. 1.5 lakh and Rs. 2.0lakh for the output levels of 20,000, 30,000 and 40,000 units. Isocosts farther from the origin, for given input costs, are associated with higher costs. Any change in input prices changes the slope of isocost• Kinked Isoquants: linesIf the factors of production show limitedsubstitutability we find this type of isoquant Marginal Rate of Technical• Smooth Convex Isoquants: SubstitutionThis form assumes continuous The marginal rate of technicalsubstitutability of factors of production substitution refers to the rate at which one input factor is substituted with other to attain a given level of output. In other words, the lesser units of one input must be compensated by increasing amopunt of another input to produce the same level of output. In the following table presents the ratio of MRTS between teh two input factors, say capital and labour. 5 units of decrease in labout are compensated by an increase in 1 unit of capital, resulting in a Iso Costs MRTS of 5:1. Isocosts refers to that cost curve thatrepresents the combination of inputs that Combi inputs Units nations MRTSwill cost the producer the same amount of K Lmoney. In other words, each isocost denotes A 1 20 -a particular level of total cost for a given B 2 15 5:1N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 27
  • 28. MEFA NOTES C 3 11 4:1 D 4 8 3:1 E 5 6 2:1 F 6 5 1:1N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 28
  • 29. MEFA NOTESLeast Cost Combination Of Inputs Graphically we can determine the The isocosts curve indicates the least cost input combination or thealternative combinations of various factors maximum output for given cost, first weof production which can produce a given have to draw iso-quant map and than iso-output. Of these, an entrepreneur would like costs map. Later we have superimpose theto choose the combination of input factors, iso-quants map and the iso-costs map aswhich costs him the least. shown in figure. To explain this how he can determinethe least cost combination for a givenoutput. We need the prices of the factors ofproduction. Let the price of labour (L) beRs.6 per unit and price of capital (K) Rs.9per unit. Assume that any amount of labourand capital can be bought at these respectivefixed prices. Let our farmer wants to produce acertain amount of paddy. Assume that thefarmer has certain cost combination. Thereare two ways to determine the least cost As per the above figure the desiredcombination of input for given output. quantity of output can be produced at a least cost Rs.99 by having 6 units of capital and 7 In the following example there are six units of labour. It is known by the point Ealternative combinations of labour and where the isoquant curve is just tangent tocapital to produce the given production, say the iso-cost curve. At any other point of iso-9 quintals. The cost of each of these quant the total cost is more than Rs.99.combinations will be as follows similarly for a given cost, an entrepreneur can select the best combination of twoCom inputs Units inputs which will give the maximum output Cost by way of selecting that iso-quant curvebinati K L Rs. which is just tangent to a given iso-cost ons 1 3 20 3*9 + 20*6=147 curve. 2 4 13 4*9 + 13*6=105 3 5 10 5*9 + 10*6=105 4 6 8 6*9 + 8*6=102 5 7 6 7*9 + 6 * 6=99 6 8 5 8*9 + 5* 6=102 From the above table we can find thecombination of 5 represents the least cost forproducing the desired production. The leasttotal cost producing various other quantitiescan be determined in a similar way.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 29
  • 30. MEFA NOTES Laws of Returns Labour TP AP MP Stages 0 0 0 0 Stage I 1 10 10 10 Production function shows the 2 22 11 12relationship between the quantity of inputs 3 33 11 11 Stageand the possible output. But the laws of 4 40 10 7 IIproduction deal with the relationship in the 5 45 9 5form of 6 48 8 3 • Law of variable proportion/ Law of 7 48 6.85 0 Stage diminishing returns/ law of returns 8 45 5.62 –3 III • Law of returns to scale TP = Total Production Law of Diminishing Return AP =Average Production (TP ÷Labour ) ∆TP Or Law of Variable MP= Marginal Production ∆Labour Proportion The law of variable proportion Here both Average production andexplains the input- output relation, the marginal production first rise reacheschange in output due to addition of one maximum and then decline. The totalvariable input. This is a short run production increase at increasing rate till thephenomenon. The short run is a period in employment of the 4th worker.which at least one input is fixed. Thus in theshort-run, the increase in production is After that total product increase at apossible only by increasing the variable decreasing rate till 8th worker. Theinputs. Variation is made only in one factors employment of 9th worker will not add anykeeping the other factors fixed, the production and thereafter any addition ofproportion between the fixed factors and the worker will result in decrease in totalvariable factors is varied. Hence the study is product. This is what shown in marginalcalled the law of variable proportion. products. From the above first output is an increasing rate, then increases at decreasing The law also brings diminishing rate and finally decreases.tendency in production is also known as thelaw of diminishing returns. It states that The follwing diagram explains threewhen at least one factor of production is stages of diminishing returns. In first statefixed or factor input is fixed and when all total production increases at a increasingother factors are varied, the total output in rate. The marginal product in this stagethe initial stages will increase at an increase at an increasing rate resulting aincreasing rate, and after reaching certain greater increase in total production. Thelevel of output the total output will increase average product also increases. This stageat declining rate. continuous up to the point where average If variable factor inputs are added product is equal to marginal product. Thefurther to the fixed factor input, the total law of increasing returns is in operation tilloutput may decline. This Law of Returns is this state.also called The Law of Variable proportionsor The Law of Diminishing ReturnsN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 30
  • 31. MEFA NOTES • Homogeneous Variable Factors: The law assumes that all the units of the variables factor are identical and exactly similar to each other. Other wise output may be increase • Atleast One Input is Fixed: The law assumes that at least one factor of production remains constant or fixed. So increase in production can be attempted only with the variable factor Diminishing returns starts from thesecond state onwards. In this stage total • The fixed Factor is indivisible:product increases only at a diminishing rate. The fixed factor remains constant. ItsThe average product also decline. The capacity cannot be divided and used forsecond stage comes to an end where total some other proportionproduct becomes maximum and marginalproduct becomes zero. The marginal Cause For Operation of the Law ofproduction becomes negative in the third Diminishing Returnsstage. So the total product also decline. The • Wrong Combinations of inputsaverage product continues to decline. will give Diminishing returnsAssumptions: • Scarcity of Certain factors like land and capital in the short run will give diminishing marginal productivity of the• The production technology variable factor remains unchanged• Homogeneous Variable Factors • Imperfect substitutes also give• Atleast One Input is Fixed diminishing returns• The fixed Factor is indivisible• The production technology remains unchanged: It is assumed that there is noimprovement in technology. If animproved technology is adopted then theincrease in returns may be more thanproportionate mix.N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 31
  • 32. MEFA NOTES Laws of Returns Causes for Increasing ReturnsProduction function shows the relationshipbetween the quantity of inputs and the • Indivisible factorspossible output. But the laws of production • Scope for greater specializationdeal with the relationship in the form of • Advantage of increasing dimensions • Law of returns to scale • External economies • Law of variable proportion/ Law of 1. Indivisible factors: diminishing returns/ law of returns Some factors of production are available only in a certain minimum size. E. g. Law of Return to Scale Suppose we have installed an electricity generating plant capable of producing one In the long run all the factors of million K.W. power, even though the needsproduction are variable and an increase in of the town is only 5000 K.W. because it idoutput is possible by increasing all the the smallest size available.inputs. Returns to scale implies the change The capacity may not be utilizedin output or returns when all factors are fully. Demand for electricity may bechange simultaneously in same ratio. In this increased. With same plant we can producelaw all the factors of production are changed more. No additional expenditure on plantin the same ratio. and machinery is required. Thus, we get increasing returns where there are There are three laws of returns governing indivisible factors.production function. They are 2. Scope for greater specialization:• Law of When the scale of production is Increasing Returns to Scale increased, there is scope for introduction• Law of greater specialization of labour and equipment. Work can be divided into small Constant Returns to Scale tasks. It increases efficiency of the factors• Law of resulting in increasing returns. Decreasing Returns to Scale 3. Advantages of increasing1. Law of Increasing Returns to dimensions Scale Increased dimensions give rise to This law states that the volume of output certain economies. E.g. the cost ofkeeps on increasing with every increase in constructing a double ducker bus is less thanthe input. Where given increase in factors of that of two single buses. So the cost ofproduction results in a more than operating large and bigger machinery will beproportionate increase in output. In this first less. Thus, the economies of increasedstage of production, the marginal output dimensions reduce costs and give rise to theincreases. It will explain through the law of increasing returns.following 4. External Economies: Pr oportionate Change in Output External economies are those that >1 Pr oportionate Change in Input arise when the industry expands. Transport,N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 32
  • 33. MEFA NOTESbanking, insurance, Research Facilities etc. • There is perfect competitiondevelop when the industry expands. Cost of • The output is measured in physicalproduction is reduced. units• Law of Constant Returns to Scale Increasing returns to scale do not The following table and diagram willcontinue indefinitely. As the firm expands explain about law of returns to scaleproduction more and more, the advantages Factors Total Marginal Stagesof large scale production gradually give C : L Production Productionplace to disadvantages. There is a limit to 1:2 4 4the advantages of size. At certain size of 2:4 10 6 Stageproduction the advantages and 3:6 18 8 Idisadvantages of large scale production 4:8 28 10balance each other and we get constant 5:10 38 10 Stageresult. i.e. 6:12 48 10 IIPr oportionate Change in Output 7:14 56 8 Stage =1 Pr oportionate Change in Input III 8:16 62 6• Law of In the above table 1 acre of land and Decreasing Returns to Scale 2 labour are employed, the total product sis Constant returns to scale are only a 4 units of paddy. When the inputs arepassing phase. If the scale of production is doubled i.e. 2 acre of land and 4 labour areincreased further, diminishing returns will se employed, the output of paddy is more thanin and the costs of production will rise. double i.e. 10 and marginal output goes up Pr oportionate Change in Output <1 from 4 units to 6 units and so on. So in the Pr oportionate Change in Input first stage increasing returns will come.They are • Business may becomes Increasing returns to scale cannot be unmanageable experienced by the firm indefinitely. Firms • Indivisible factors may become slowly enter the phase of constant returns to unmanageable scale. When the input factors are increased • Problems due to supervision control to 5 acres of land and 10 labour then the and coordination will arise. marginal out put remain constant. Doubling To these internal diseconomies are added in all inputs simple results in doubling theexternal diseconomies will give diminishing output. This is the stage of constant returns.returns. A firm cannot enjoy increasingAssumptions: returns indefinitely. Sooner or later they reach the stage of decreasing to scale which • All the factors are variable implies that proportionate increase in all inputs resulting less than proportionate • There are no technological changesN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 33
  • 34. MEFA NOTESincrease in output. This is the third stage or Diagram B shows Constant Returnsthe decreasing returns stage. to scale. The output increases by 100 units. But the distance between the different Every firm experience three phase- Isoquants is sameincreasing returns in the beginning thenconstant returns for a short period and Diagram C shows Diminishingultimately decreasing returns to scale. Returns to scale. The output increases by 100 units. But the distance between the different Isoquants is increasing showing that more factors have to be used than before NP is greater than MN Economies of Scale Production may be carried on a small scale or on a large by a firm. When a firm OX axis shows scale of production. expands its size of production by increasingOY axis Output. As the scale of production all the factors, it secures certain advantagesincreases, up to the point C we get known as economies of production. TheseIncreasing returns. From C to D we get economies of large scale production haveConstant returns. From D onwards we get been classified by Marshall in to two kindsDiminishing Returns. they areLaw of Returns to scale are shownseparately in the following diagrams in Economiesterms of Isoquants Internal External Economies Economies Internal Economies: Internal Economies are those which Diagram A shows increasing Returns are opened to a single factory or a singleto scale. The output increases by 100 units firm independently of the action of otherfrom 100 to 200 and 200 to 300. But the firms. It is based on the size of the firm anddistance between the Isoquants shortens. it is different for different firms.MN is shorter than OM and NP is shorter Causes for internal economiesthan MN. It means that for the given 1. Indivisibilitiesincrease in output the firm has to devote less 2. Specialisation of workersfactors than before. It implies Increasing It may be of following typesReturns • Technical EconomiesN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 34
  • 35. MEFA NOTES • Managerial Economies because it has large assets, properties • Marketing Economies and reputation in the society. • Financial Economies • Risk Bearing Economies: • Risk Bearing Economies A large firm can produce a variety of • Economies of Research products. It can sell the products in different markets both within the country • Economies of Welfare and in foreign countries also if the • Economies of By-products products can be exported. It can purchase the materials from different sources. This • Economies of Labour is called diversification.• Technical Economies: It may be arise to a firm from the Diversification reduces risks. Ifuse of better machines and superior more than one commodity is produced,,techniques of production. As a result, the loss on one product can beproduction increases and the per unit cost compensated by the profit on the otherof production falls. Another technical products. Diversification of productioneconomy lies in the mechanical and marketing increases the ability of theadvantage is using large machines. firm to withstand losses. It will haveBecause the cost of operating large greater stability.machines is less than that of operatinglarge machine. Technical economies also • Economies of Research:be associated when large firm is able to Large firm can establish its ownutilize all its waste materials for the research laboratory and employ traineddevelopment of by-products. research workers. It can thus invent new methods of production, new products • Managerial Economies: etc., which will reduce costs and increase A large firm can appoint specialists to scales.supervise and manage the various • Economies of Welfare:departments. It increases its productive A large firm can provide betterefficiency. working conditions in and out side the factory. Facilities like subsidized • Marketing Economies: canteens, crèches for the infants, A large fir buys material in bulk. recreation rooms, cheap houses,There it can get them at relatively lower educational and medical facilities ten toprices. It can increase its sales by increase the productive efficiency of thesalesmanship, advertisement attractive workers which helps in raisingpacking etc. it can produce quality production and reducing costsproducts. These are also called“Commercial Economies” External Economies: Business firms enjoys a number of • Financial Economies: external economies, which are discussed A large firm can get finance easily belowand even at lower rates of interest • Economies of Concentration • Economies of informationN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 35
  • 36. MEFA NOTES • Economies of Welfare economies depend upon the size of the • Economies of Specilisation industry• Economies of Concentration: When an industry is concentrated in aparticular area, all the member firms reapsome common economies like skilledlabour, improved means of transport andcommunications, banking and financialservices etc. all these factors felicitiestend to lower the unit cost of production. • Economies of Information: Information centre can be set up belarge organizations which can publish ajournal and passes on the information tothe firms regarding the availability ofraw materials, modern machines, exportpossibilities etc. this would help the firmsin raising the productive efficiency • Economies of Welfare: Housing colonies, educationalinstitutions, hospitals, recreation facilitiesetc, can be provided to the workers bythe industry, it would improve efficiencyof the workers and every firm benefitsfrom it • Economies of Specialisation:The firms in the industry can specializein one variety of the product or in onestage of production. Such vertical andlateral specialisation reduces the costs ofproduction of the firms and improvementof quality. Thus internal economies depend uponthe size of the firm and externalN. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 36