1 b module hmts

Economics for Engineers
Syllabus for HMTS3101
For HITK students by
S.K.Sen
Module 1 :
a. Market: Meaning of Market, Types of Market, Perfect Competition, Monopoly, Monopolistic and Oligopoly
market.
b. The basic concept of economics – Needs, Wants, Utility.
c. National Income-GDP, GNP. Demand & Supply, Law of demand, Role of demand and supply in price
determination, Price Elasticity.
d. Inflation: meaning, reasons, etc. (6L)
Module 2 :
a. Business: Types of business, Proprietorship, Partnership, Joint-stock company, and cooperative society – their
characteristics.
b. Banking: role of commercial banks; credit and its importance in industrial functioning.
c. Role of central bank: Reserve Bank of India.
d. International Business or Trade Environment. (4L)
Module 3 :
a. Financial Accounting-Journals. Ledgers, Trial Balance, Profit & Loss Account, Balance Sheet.
b. Financial Statement Analysis (Ratio and Cash Flow analysis). (8L)
c. Cost Accounting- Terminology, Fixed, Variable and Semi-variable costs, Break Even Analysis.
d. Cost Sheet, Budgeting and Variance Analysis.
e. Marginal Cost based decisions. (6L)
Module 4 :
a. Time Value of Money: Present and Future Value, Annuity, Perpetuity.
b. Equity and Debt, Cost of Capital.
c. Capital Budgeting: Methods of project appraisal - average rate of return - payback period - discounted cash
flow method: net present value, benefit cost ratio, internal rate of return.
d. Depreciation and its types, Replacement Analysis, Sensitivity Analysis.

Economics for Engineers
Syllabus for HMTS3101
For HITK students by
S.K.Sen
There will be 2 Internal Tests (One each from Module 1 and Module 2) as per Institute Dairy
Pattern of Qs for Internal tests will be as per HITK template (3 Qs of 10 marks each; no MCQs)
Pattern of Qs for End Sem exam will comprise 5 sections viz. – A, B, C, D and E –
Sec A will have 10 MCQs of 1 mark each (no choice) -
Sec B, C, D and E will have 2 Qs each from the Module 1, 2, 3 and 4 respectively [may have a), b), c) or a), b)] -
Essay type Qs will be avoided
Students are required to answer 5 out of 8 Qs, selecting at least one from each Module
Evaluation : Max marks-100
Internal Test-30
Semester Test-70
Suggested Readings :
1. R. Narayanswami, Financial Accounting- A Managerial Perspective. Prentice-Hall of India Private Limited.
New Delhi
2. Horne, James C Van, Fundamentals of Financial Management. Prentice-Hall of India Private Limited, New
Delhi
3. H. L. Ahuja., Modern Economic Theory. S. Chand. New Delhi.
4. Newman, Donald G., Eschenbach, Ted G., and Lavelle, Jerome P. Engineering Economic Analysis. New York:
Oxford University Press. 2012.
AEIE – Classes will be taken by SKS, AB and KC
ECE-D – Classes will be taken by SKS, AB and JG
10
12x5
= 60

BASIC CONCEPT
of
ECONOMICS
NEEDS, WANTS, UTILITY
For HITK students
by S.K.Sen

For HITK students
by S.K.Sen
Economics is the Social Science that describes the factors
that determine the production, distribution and consumption
of goods and services. It is the study of human efforts to
satisfy unlimited wants with limited resources.
The term economics comes from the Ancient Greek (oikos,
“house”) and (nomos, “custom” or “law”), hence “rules of
the house (hold for good management)”. 'Political
Economy' was the earlier name for the subject, but
economists in the late 19th century suggested “Economics”
as a shorter term for “Economic Science” to establish itself
as a separate discipline outside of Political Science and
other Social Sciences.
Economics focuses on the behaviour and interactions of
economic agents and how economies work. Consistent with
this focus, primary textbooks often distinguish between
Microeconomics and Macroeconomics.

For HITK students
by S.K.Sen
Microeconomics examines the behaviour of basic elements
in the economy, including individual agents and markets,
their interactions, and the outcomes of interactions.
Individual agents may include, for example, households,
firms, buyers, and sellers. Macroeconomics analyzes the
entire economy (meaning aggregated production,
consumption, savings, and investment) and issues
affecting it, including unemployment of resources (labour,
capital, and land), inflation, economic growth, and the
public policies that address these issues (monetary, fiscal,
and other policies).
Other broad distinctions within economics include those
between positive economics, describing “what is”, and
normative economics, advocating “what ought to be”;
between economic theory and applied economics; between

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rational and behavioural economics; and between mainstream
economics (more “orthodox” and dealing with the
“rationality-individualism-equilibrium nexus”) and heterodox
economics (more “radical” and dealing with the “institutions-
history-social structure nexus”). Besides the traditional
concern in production, distribution, and consumption in an
economy, economic analysis may be applied throughout
society, as in business, finance, health care, and government.
Economic analysis may also be applied to such diverse
subjects as crime, education, the family, law, politics,
religion, social institutions, war, science, and the
environment. Education, for example, requires time, effort,
and expenses, plus the foregone income and experience, yet
these losses can be weighted against future benefits education
may bring to the agent or the economy. At the turn of the 21st
century, the expanding domain of economics in the social
sciences has been described as economic imperialism.

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The ultimate goal of economics is to improve the living
conditions of people in their everyday life.
There are a variety of modern definitions of economics.
Some of the differences may reflect evolving views of the
subject or different views among economists. Scottish
philosopher Adam Smith (1776) defined what was then
called political economy as “an inquiry into the nature and
causes of the wealth of nations”, in particular as : a branch
of the science of a statesman or legislator with the twofold
objectives of providing a plentiful revenue or subsistence
for the people ... and to supply the state or commonwealth
with a revenue for the public services.
J. B. Say (1803), distinguishing the subject from its public-
policy uses, defines it as the science of production,
distribution, and consumption of wealth. On the satirical

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side, Thomas Carlyle (1849) coined "the dismal science" as
an epithet for classical economics, in this context,
commonly linked to the pessimistic analysis of Malthus
(1798). John Stuart Mill (1844) defines the subject in a
social context as: The science which traces the laws of such
of the phenomena of society as arise from the combined
operations of mankind for the production of wealth, in so
far as those phenomena are not modified by the pursuit of
any other object.
Alfred Marshall provides a still widely cited definition in
his textbook Principles of Economics (1890) that extends
analysis beyond wealth and from the societal to the
microeconomic level : Economics is a study of man in the
ordinary business of life. It enquires how he gets his income
and how he uses it. Thus, it is on the one side, the study of

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wealth and on the other and more important side, a part of
the study of man.
Lionel Robbins (1932) developed implications of what has
been termed "perhaps the most commonly accepted current
definition of the subject": Economics is a science which
studies human behaviour as a relationship between ends and
scarce means which have alternative uses.
Robbins describes the definition as not classificatory in
"picking out certain kinds of behaviour" but rather
analytical in "focusing attention on a particular aspect of
behaviour, the form imposed by the influence of scarcity."
He affirmed that previous economist have usually centered
their studies on the analysis of wealth: how wealth is
created (production), distributed, and consumed; and how
wealth can grow. But he said that economics can be used to

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study other things, such as war, that are outside its usual
focus. This is because war has as the goal winning it (as a
sought after end), generates both cost and benefits; and,
resources (human life and other costs) are used to attain the
goal. If the war is not winnable or if the expected costs
outweigh the benefits, the deciding actors (assuming they
are rational) may never go to war (a decision) but rather
explore other alternatives. We cannot define economics as
the science that studies wealth, war, crime, education, and
any other field economic analysis can be applied to; but, as
the science that studies a particular common aspect of each
of those subjects (they all use scarce resources to attain a
sought after end).
Microeconomics examines how entities, forming a market
structure, interact within a market to create a market

For HITK students
by S.K.Sen
system. These entities include private and public players
with various classifications, typically operating under
scarcity of tradeable units and government regulation. The
item traded may be a tangible product such as apples or a
service such as repair services, legal counsel, or
entertainment.
In theory, in a free market the aggregates (sum of) of
quantity demanded by buyers and quantity supplied by
sellers will be equal and reach economic equilibrium over
time in reaction to price changes; in practice, various issues
may prevent equilibrium, and any equilibrium reached may
not necessarily be morally equitable. For example, if the
supply of healthcare services is limited by external factors,
the equilibrium price may be unaffordable for many who
desire it but cannot pay for it.

For HITK students
by S.K.Sen
Various market structures exist. In perfectly competitive
markets, no participants are large enough to have the market
power to set the price of a homogeneous product. In other
words, every participant is a “price taker” as no participant
influences the price of a product. In the real world, markets
often experience imperfect competition.
Forms include monopoly (in which there is only one seller
of a good), duopoly (in which there are only two sellers of a
good), oligopoly (in which there are few sellers of a good),
monopolistic competition (in which there are many sellers
producing highly differentiated goods), monopsony (in
which there is only one buyer of a good), and oligopsony
(in which there are few buyers of a good). Unlike perfect
competition, imperfect competition invariably means
market power is unequally distributed. Firms under

For HITK students
by S.K.Sen
imperfect competition have the potential to be "price
makers", which means that, by holding a disproportionately
high share of market power, they can influence the prices of
their products.
Microeconomics studies individual markets by simplifying
the economic system by assuming that activity in the
market being analysed does not affect other markets. This
method of analysis is known as partial-equilibrium analysis
(supply and demand). This method aggregates (the sum of
all activity) in only one market. General-equilibrium theory
studies various markets and their behaviour. It aggregates
(the sum of all activity) across all markets. This method
studies both changes in markets and their interactions
leading towards equilibrium.

For HITK students
by S.K.Sen
In microeconomics, production is the conversion of inputs
into outputs. It is an economic process that uses inputs to
create a commodity or a service for exchange or direct use.
Production is a flow and thus a rate of output per period of
time. Distinctions include such production alternatives as
for consumption (food, haircuts, etc.) vs. investment goods
(new tractors, buildings, roads, etc.), public goods (national
defense, smallpox vaccinations, etc.) or private goods (new
computers, bananas, etc.), and "guns" vs. "butter".
Opportunity cost refers to the economic cost of production :
the value of the next best opportunity foregone. Choices
must be made between desirable yet mutually exclusive
actions. It has been described as expressing “the basic
relationship between scarcity and choice”. For example, if a
baker uses a sack of flour to make pretzels (type of baked bread or

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crisp biscuit) one morning, then the baker cannot use either the
flour or the morning to make bagels (dense bread roll) instead. Part
of the cost of making pretzels is that neither the flour nor
the morning are available any longer, for use in some other
way. The opportunity cost of an activity is an element in
ensuring that scarce resources are used efficiently, such that
the cost is weighed against the value of that activity in
deciding on more or less of it. Opportunity costs are not
restricted to monetary or financial costs but could be
measured by the real cost of output forgone, leisure, or
anything else that provides the alternative benefit (utility).
Inputs used in the production process include such primary
factors of production as labour services, capital (durable
produced goods used in production, such as an existing
factory), and land (including natural resources). Other

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inputs may include intermediate goods used in production
of final goods, such as the steel in a new car.
Economic efficiency describes how well a system generates
desired output with a given set of inputs and available
technology. Efficiency is improved if more output is
generated without changing inputs, or in other words, the
amount of “waste” is reduced. A widely accepted general
standard is Pareto efficiency, which is reached when no
further change can make someone better off without making
someone else worse off.

For HITK students
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Opportunity Cost - The cost of an economic decision. The
classic example is “guns or butter.” What should a nation
produce; butter, a need, or guns, a want? What is the cost
of either decision? If we choose the guns the cost is the
butter. If we choose butter, the cost is the guns. Nations
must always deal with the questions faced by opportunity
cost. It is a matter of choices. Resources are limited thus
we cannot meet every need or want.

For HITK students
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The production-possibility frontier (PPF) is an expository
figure for representing scarcity, cost, and efficiency. In the
simplest case an economy can produce just two goods (say
“guns” and “butter”). The PPF is a table or graph (in
previous slide) showing the different quantity combinations
of the two goods producible with a given technology and
total factor inputs, which limit feasible total output. Each
point on the curve shows potential total output for the
economy, which is the maximum feasible output of one
good, given a feasible output quantity of the other good.
Scarcity is represented in the figure by people being willing
but unable in the aggregate to consume beyond the PPF
(such as at X) and by the negative slope of the curve. If
production of one good increases along the curve,
production of the other good decreases, an inverse

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relationship. This is because increasing output of one good
requires transferring inputs to it from production of the
other good, decreasing the latter.
The slope of the curve at a point on it gives the trade-off
between the two goods. It measures what an additional unit
of one good costs in units forgone of the other good, an
example of a real opportunity cost. Thus, if one more Gun
costs 100 units of butter, the opportunity cost of one Gun is
100 Butter. Along the PPF, scarcity implies that choosing
more of one good in the aggregate entails doing with less
of the other good. Still, in a market economy, movement
along the curve may indicate that the choice of the
increased output is anticipated to be worth the cost to the
agents.

For HITK students
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By construction, each point on the curve shows productive
efficiency in maximizing output for given total inputs. A
point inside the curve (as at A), is feasible but represents
production inefficiency (wasteful use of inputs), in that
output of one or both goods could increase by moving in a
northeast direction to a point on the curve. Examples cited
of such inefficiency include high unemployment during a
business-cycle recession or economic organization of a
country that discourages full use of resources. Being on the
curve might still not fully satisfy allocative efficiency (also
called Pareto efficiency) if it does not produce a mix of
goods that consumers prefer over other points.
Much applied economics in public policy is concerned with
determining how the efficiency of an economy can be
improved. Recognizing the reality of scarcity and then

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figuring out how to organize society for the most efficient
use of resources has been described as the “essence of
economics”, where the subject “makes its unique
contribution.”

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Macroeconomics examines the economy as a whole to
explain broad aggregates and their interactions “top down”,
that is, using a simplified form of general-equilibrium
theory. Such aggregates include national income and
output, the unemployment rate, and price inflation and
subaggregates like total consumption and investment
spending and their components. It also studies effects of
monetary policy and fiscal policy.
Since at least the 1960s, macroeconomics has been
characterized by further integration as to micro-based
modeling of sectors, including rationality of players,
efficient use of market information, and imperfect
competition. This has addressed a long-standing concern
about inconsistent developments of the same subject.

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Macroeconomic analysis also considers factors affecting
the long-term level and growth of national income. Such
factors include capital accumulation, technological change
and labour force growth.

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Wants : Simply the desires. Wants are different from
needs. They are means of expressing a perceived need.
Wants are broader than needs. The idea of want can be
examined from many perspectives. In secular societies
want might be considered similar to the emotional desire,
which can be studied scientifically through the disciplines
of psychology or sociology. Want might also be examined
in economics as a necessary ingredient in sustaining and
perpetuating capitalist societies that are organised around
principles like consumerism. Alternatively want can be
studied in a non-secular, spiritual, moralistic or religious
way, particularly by Buddhism but also Christianity, Islam
and Judaism.
In economics, a want is something that is desired. It is said
that every person has unlimited wants, but limited

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resources (Economics is based on the assumption that only
limited resources are available to us from the infinite
universe). Thus, people cannot have everything they want
and must look for the most affordable alternatives.
Wants are often distinguished from needs. A need is
something that is necessary for survival (such
as food and shelter), whereas a want is simply something
that a person would like to have. Some economists have
rejected this distinction and maintain that all of these are
simply wants, with varying levels of importance. By this
viewpoint, wants and needs can be understood as examples
of the overall concept of demand.
Needs : Needs are based on physiological, personal, or
socio-economic requirements necessary for an individual
to function and live. Food, cloth, shelter and other needs of

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daily life are basic requirements for survival. In recent
years we have seen a perceived shift of certain items from
wants to needs eg. – mobile phones, vehicles, etc. etc.
A need is something that is necessary for an organism to
live a healthy life. Needs are distinguished from wants in
that, in the case of a need, a deficiency causes a clear
adverse outcome: a dysfunction or death.
Needs can be objective and physical, such as the need for
food, or psychological and subjective, such as the need
for self-esteem.
There are also needs of a social or societal nature.
Needs and wants are a matter of interest in, and form a
common substrate for, the fields of Philosophy, Biology,
Psychology, Social Science, Economics and Politics.

For HITK students
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Utility : In economics, utility is a measure of preferences
over some set of goods and services. The concept is an
important underpinning of rational choice theory in
economics and game theory, because it represents
satisfaction experienced by the consumer of a good. A
good is something that satisfies human wants. Since one
cannot directly measure benefit, satisfaction
or happiness from a good or service, economists instead
have devised ways of representing and measuring utility in
terms of economic choices that can be measured.
Economists have attempted to perfect highly abstract
methods of comparing utilities by observing and
calculating economic choices. In the simplest sense,
economists consider utility to be revealed in people's
willingness to pay different amounts for different goods.

For HITK students
by S.K.Sen
Applications : Utility is usually applied by economists in
such constructs as the indifference curve, which plot the
combination of commodities that an individual or a society
would accept to maintain a given level of satisfaction.
Utility and indifference curves are used by economists to
understand the underpinnings of demand curves, which are
half of the supply and demand analysis that is used to
analyze the workings of goods markets.
Individual utility and social utility can be construed as the
value of a utility function and a social welfare
function respectively. When coupled with production or
commodity constraints, under some assumptions these
functions can be used to analyze Pareto efficiency, such as
illustrated by Edgeworth boxes in contract curves. Such
efficiency is a central concept in welfare economics.

For HITK students
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In finance, utility is applied to generate an individual's
price for an asset called the indifference price. Utility
functions are also related to risk measures, with the most
common example being the entropic risk measure.
Scarcity : The fundamental economic problem facing all
societies. Essentially it is how to satisfy unlimited wants
with limited resources. This is the issue that plagues all
government and peoples.
Economic View of Needs and Wants : The economic view
of needs and wants utilizes the fictional concept of the
economic man, who acts rationally to maximize his
potential to consume goods and services that offer him the
highest degree of utility or satisfaction. Our economic
man's quest is limitless. While your needs may eventually

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be satisfied for a while, according to economic theory,
wants never are.
For example, a one-bedroom apartment fulfills your needs
and wants for housing, but once you get married, you want
a townhouse. The want changes to a three-bedroom house
when the first kid comes along. Then you decide you want
a house with a few extra bedrooms, and a pool wouldn't be
bad either, even though the original house fulfills your
need for family housing.
Ethical Considerations : The economic perspective of
needs and wants raises some ethical concerns. One concern
is that consumers are subject to undue persuasion from a
consumer culture that makes it difficult for them to
determine their true needs and wants, rather than

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artificially manufactured needs and wants. A great example
of a manufactured want is the pet rock, which served no
utilitarian purpose.
Another concern is the idea of consumer lock-in, where
our society requires individuals to obtain more and more
income and consumption to meet fundamental needs. For
example, once upon a time, people functioned perfectly
fine without personal automobiles, computers, and cell
phones, but now most people view these items as essential
needs. All these 'needs' add up.
In economics, utility is a measure of preferences over some
set of goods and services. The concept is an important
underpinning of rational choice theory in economics and
game theory, because it represents satisfaction experienced
by the consumer of a good. A good is something that

For HITK students
by S.K.Sen
satisfies human wants. Since one cannot directly measure
benefit, satisfaction or happiness from a good or service,
economists instead have devised ways of representing and
measuring utility in terms of economic choices that can be
measured. Economists have attempted to perfect highly
abstract methods of comparing utilities by observing and
calculating economic choices. In the simplest sense,
economists consider utility to be revealed in people's
willingness to pay different amounts for different goods.
Applications : Utility is usually applied by economists in
such constructs as the indifference curve, which plot the
combination of commodities that an individual or a society
would accept to maintain a given level of satisfaction.
Utility and indifference curves are used by economists to
understand the underpinnings of demand curves, which are

For HITK students
by S.K.Sen
half of the supply and demand analysis that is used to
analyze the workings of goods markets.
Individual utility and social utility can be construed as the
value of a utility function and a social welfare function
respectively. When coupled with production or commodity
constraints, under some assumptions these functions can be
used to analyze Pareto efficiency, such as illustrated by
Edgeworth boxes in contract curves. Such efficiency is a
central concept in welfare economics.
In finance, utility is applied to generate an individual's
price for an asset called the indifference price. Utility
functions are also related to risk measures, with the most
common example being the entropic risk measure.

For HITK students
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Revealed preference : It was recognized that utility could
not be measured or observed directly, so instead
economists devised a way to infer underlying relative
utilities from observed choice. These 'revealed
preferences', as they were named by Paul Samuelson, were
revealed e.g. in people's willingness to pay:
Utility is taken to be correlative to Desire or Want. It has
been already argued that desires cannot be measured
directly, but only indirectly, by the outward phenomena to
which they give rise: and that in those cases with
whichveconomics is chiefly concerned the measure is
found in the price which a person is willing to pay for the
fulfillment or satisfaction of his desire.
Utility functions : There has been some controversy over
the question whether the utility of a commodity can be

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measured or not. At one time, it was assumed that the
consumer was able to say exactly how much utility he got
from the commodity. The economists who made this
assumption belonged to the 'cardinalist school' of
economics. Today utility functions, expressing utility as a
function of the amounts of the various goods consumed,
are treated as either cardinal or ordinal, depending on
whether they are or are not interpreted as providing more
information than simply the rank ordering of preferences
over bundles of goods, such as information on the strength
of preferences.

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Cardinal utility : When cardinal utility is used, the
magnitude of utility differences is treated as an ethically or
behaviourally significant quantity. For example, suppose a
cup of orange juice has utility of 120 utils, a cup of tea has
a utility of 80 utils, and a cup of water has a utility of 40
utils. With cardinal utility, it can be concluded that the cup
of orange juice is better than the cup of tea by exactly the
same amount by which the cup of tea is better than the cup
of water. One cannot conclude, however, that the cup of tea
is two thirds as good as the cup of juice, because this
conclusion would depend not only on magnitudes of utility
differences, but also on the "zero" of utility.
Neoclassical economics has largely retreated from using
cardinal utility functions as the basis of economic
behaviour. A notable exception is in the context of
analyzing choice under conditions of risk.

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Sometimes cardinal utility is used to aggregate utilities
across persons, to create a social welfare function. The
argument against this is that interpersonal comparisons of
utility are meaningless because there is no simple way to
interpret how different people value consumption bundles.
Ordinal utility : When ordinal utilities are used, differences
in utils (values taken on by the utility function) are treated
as ethically or behaviourally meaningless: the utility index
encodes a full behavioural ordering between members of a
choice set, but tells nothing about the related strength of
preferences. In the above example, it would only be
possible to say that juice is preferred to tea to water, but no
more.

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Factors of Production / Resources - These are those elements
that a nation has at its disposal to deal with the issue of
scarcity. How efficiently these are used determine the
measure of success a nation has. They are -
Land - natural resources, etc.
Capital - investment
Labour - the work force; size, education, quality, work ethic.
Entrepreneurs - inventive and risk taking spirit. This is a
rather new addition to a traditional list.
The "Three Basic Economic Questions" - These are the
questions all nations must ask when dealing with scarcity and
effciently allocating their resources.
What to produce?
How to produce?
For whom to produce?

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ADDITIONAL / OPTIONAL

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The supply and demand model describes how prices vary
as a result of a balance between product availability and
demand. The graph depicts an increase (that is, right-shift)
in demand from D1 to D2 along with the consequent
increase in price and quantity required to reach a new
equilibrium point on the supply curve (S).
Prices and quantities have been described as the most
directly observable attributes of goods produced and
exchanged in a market economy. The theory of supply and
demand is an organizing principle for explaining how
prices coordinate the amounts produced and consumed. In
microeconomics, it applies to price and output
determination for a market with perfect competition,
which includes the condition of no buyers or sellers large
enough to have price-setting power.

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For a given market of a commodity, demand is the relation
of the quantity that all buyers would be prepared to
purchase at each unit price of the good. Demand is often
represented by a table or a graph showing price and
quantity demanded (as in the figure). Demand theory
describes individual consumers as rationally choosing the
most preferred quantity of each good, given income,
prices, tastes, etc. A term for this is “constrained utility
maximization” (with income and wealth as the constraints
on demand). Here, utility refers to the hypothesized
relation of each individual consumer for ranking different
commodity bundles as more or less preferred.
The law of demand states that, in general, price and
quantity demanded in a given market are inversely related.
That is, the higher the price of a product, the less of it

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people would be prepared to buy (other things
unchanged). As the price of a commodity falls, consumers
move toward it from relatively more expensive goods (the
substitution effect). In addition, purchasing power from
the price decline increases ability to buy (the income
effect). Other factors can change demand; for example an
increase in income will shift the demand curve for a
normal good outward relative to the origin, as in the
figure. All determinants are predominantly taken as
constant factors of demand and supply.
Supply is the relation between the price of a good and the
quantity available for sale at that price. It may be
represented as a table or graph relating price and quantity
supplied. Producers, for example business firms, are
hypothesized to be profit-maximizers, meaning that they

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attempt to produce and supply the amount of goods that
will bring them the highest profit. Supply is typically
represented as a function relating price and quantity, if
other factors are unchanged.
That is, the higher the price at which the good can be sold,
the more of it producers will supply, as in the figure. The
higher price makes it profitable to increase production.
Just as on the demand side, the position of the supply can
shift, say from a change in the price of a productive input
or a technical improvement. The “Law of Supply” states
that, in general, a rise in price leads to an expansion in
supply and a fall in price leads to a contraction in supply.
Here as well, the determinants of supply, such as price of
substitutes, cost of production, technology applied and
various factors inputs of production are all taken to be

For HITK students
by S.K.Sen
constant for a specific time period of evaluation of supply.
Market equilibrium occurs where quantity supplied equals
quantity demanded, the intersection of the supply and
demand curves in the figure above. At a price below
equilibrium, there is a shortage of quantity supplied
compared to quantity demanded. This is posited to bid the
price up. At a price above equilibrium, there is a surplus
of quantity supplied compared to quantity demanded. This
pushes the price down. The model of supply and demand
predicts that for given supply and demand curves, price
and quantity will stabilize at the price that makes quantity
supplied equal to quantity demanded. Similarly, demand-
and-supply theory predicts a new price-quantity
combination from a shift in demand (as to the figure), or
in supply.

For HITK students
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For a given quantity of a consumer good, the point on the
demand curve indicates the value, or marginal utility, to
consumers for that unit. It measures what the consumer
would be prepared to pay for that unit. The corresponding
point on the supply curve measures marginal cost, the
increase in total cost to the supplier for the corresponding
unit of the good. The price in equilibrium is determined
by supply and demand. In a perfectly competitive market,
supply and demand equate marginal cost and marginal
utility at equilibrium.
On the supply side of the market, some factors of
production are described as (relatively) variable in the
short run, which affects the cost of changing output levels.
Their usage rates can be changed easily, such as electrical
power, raw-material inputs, and over-time and temp work.

For HITK students
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Other inputs are relatively fixed, such as plant and
equipment and key personnel. In the long run, all inputs
may be adjusted by management. These distinctions
translate to differences in the elasticity (responsiveness) of
the supply curve in the short and long runs and
corresponding differences in the price-quantity change
from a shift on the supply or demand side of the market.
Marginalist theory, such as above, describes the
consumers as attempting to reach most-preferred
positions, subject to income and wealth constraints while
producers attempt to maximize profits subject to their own
constraints, including demand for goods produced,
technology, and the price of inputs. For the consumer, that
point comes where marginal utility of a good, net of price,
reaches zero, leaving no net gain from further

For HITK students
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consumption increases. Analogously, the producer
compares marginal revenue (identical to price for the
perfect competitor) against the marginal cost of a good,
with marginal profit the difference. At the point where
marginal profit reaches zero, further increases in
production of the good stop. For movement to market
equilibrium and for changes in equilibrium, price and
quantity also change "at the margin": more-or-less of
something, rather than necessarily all-or-nothing.
Other applications of demand and supply include the
distribution of income among the factors of production,
including labour and capital, through factor markets. In a
competitive labour market for example the quantity of
labour employed and the price of labour (the wage rate)
depends on the demand for labour (from employers for

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production) and supply of labour (from potential workers).
Labour economics examines the interaction of workers and
employers through such markets to explain patterns and
changes of wages and other labour income, labour mobility,
and (un)employment, productivity through human capital, and
related public-policy issues.
Demand-and-supply analysis is used to explain the behaviour
of perfectly competitive markets, but as a standard of
comparison it can be extended to any type of market. It can
also be generalized to explain variables across the economy,
for example, total output (estimated as real GDP) and the
general price level, as studied in macroeconomics. Tracing the
qualitative and quantitative effects of variables that change
supply and demand, whether in the short or long run, is a
standard exercise in applied economics. Economic theory may
also specify conditions such that supply and demand through
the market is an efficient mechanism for allocating resources.

For HITK students
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Economics Basics : Supply and Demand - Supply and
demand is perhaps one of the most fundamental concepts
of economics and it is the backbone of a market economy.
Demand refers to how much (quantity) of a product or
service is desired by buyers. The quantity demanded is the
amount of a product people are willing to buy at a certain
price; the relationship between price and quantity
demanded is known as the demand relationship.
Supply represents how much the market can offer. The
quantity supplied refers to the amount of a certain good
producers are willing to supply when receiving a certain
price. The correlation between price and how much of a
good or service is supplied to the market is known as the
supply relationship. Price, therefore, is a reflection of
supply and demand.

For HITK students
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The relationship between demand and supply underline the
forces behind the allocation of resources. In market
economy theories, demand and supply theory will allocate
resources in the most efficient way possible. How? Let us
take a closer look at the law of demand and the law of
supply.
1. The Law of Demand : The law of demand states that, if
all other factors remain equal, the higher the price of a
good, the less people will demand that good. In other
words, the higher the price, the lower the quantity
demanded. The amount of a good that buyers purchase at a
higher price is less because as the price of a good goes up,
so does the opportunity cost of buying that good. As a
result, people will naturally avoid buying a product that
will force them to forgo the consumption of something

For HITK students
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else they value more. The chart below shows that the curve is a
downward slope.
A, B and C are points on the demand curve. Each point on the curve
reflects a direct correlation between quantity demanded (Q) and
price (P). So, at point A, the quantity demanded will be Q1 and the
price will be P1, and so on. The demand relationship curve illustrates
the negative relationship between price and quantity demanded. The
higher the price of a good the lower the quantity demanded (A), and
the lower the price, the more the good will be in demand (C).

For HITK students
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2. The Law of Supply : Like the law of demand, the law of supply
demonstrates the quantities that will be sold at a certain price. But
unlike the law of demand, the supply relationship shows an upward
slope. This means that the higher the price, the higher the quantity
supplied. Producers supply more at a higher price because selling a
higher quantity at a higher price increases revenue.
A, B and C are points on the
supply curve. Each point on
the curve reflects a direct
correlation between quantity
supplied (Q) and price (P).
At point B, the quantity
supplied will be Q2 and the
price will be P2, and so on.

For HITK students
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Time and Supply : Unlike the demand relationship,
however, the supply relationship is a factor of time. Time is
important to supply because suppliers must, but cannot
always, react quickly to a change in demand or price. So it
is important to try and determine whether a price change
that is caused by demand will be temporary or permanent.
Let's say there's a sudden increase in the demand and price
for umbrellas in an unexpected rainy season; suppliers may
simply accommodate demand by using their production
equipment more intensively. If, however, there is a climate
change, and the population will need umbrellas year-round,
the change in demand and price will be expected to be long
term; suppliers will have to change their equipment and
production facilities in order to meet the long-term levels
of demand.

For HITK students
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3. Supply and Demand Relationship : Now that we know
the laws of supply and demand, let's turn to an example to
show how supply and demand affect price.
Imagine that a special edition CD of your favourite brand is
released for $20. Because the record company's previous
analysis showed that consumers will not demand CDs at a
price higher than $20, only ten CDs were released because
the opportunity cost is too high for suppliers to produce
more. If, however, the ten CDs are demanded by 20 people,
the price will subsequently rise because, according to the
demand relationship, as demand increases, so does the
price. Consequently, the rise in price should prompt more
CDs to be supplied as the supply relationship shows that
the higher the price, the higher the quantity supplied.

For HITK students
by S.K.Sen
If, however, there are 30 CDs produced and demand is still
at 20, the price will not be pushed up because the supply
more than accommodates demand. In fact after the 20
consumers have been satisfied with their CD purchases, the
price of the leftover CDs may drop as CD producers
attempt to sell the remaining ten CDs. The lower price will
then make the CD more available to people who had
previously decided that the opportunity cost of buying the
CD at $20 was too high.
4. Equilibrium : When supply and demand are equal (i.e.
when the supply function and demand function intersect)
the economy is said to be at equilibrium. At this point, the
allocation of goods is at its most efficient because the
amount of goods being supplied is exactly the same as the
amount of goods being demanded. Thus, everyone

For HITK students
by S.K.Sen
(individuals, firms, or countries) is satisfied with the current
economic condition. At the given price, suppliers are selling all the
goods that they have produced and consumers are getting all the
goods that they are demanding.
As you can see on the chart,
equilibrium occurs at the
intersection of the demand and
supply curve, which indicates
no allocative inefficiency. At
this point, the price of the goods
will be P* and the quantity will
be Q*. These figures are
referred to as equilibrium price
and quantity.
In the real market place equilibrium can only ever be reached in
theory, so the prices of goods and services are constantly changing
in relation to fluctuations in demand and supply.

For HITK students
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5. Disequilibrium : Disequilibrium occurs whenever the price or
quantity is not equal to P* or Q*.
i) Excess Supply : If the price is set too high, excess supply will be
created within the economy and there will be allocative
inefficiency.
At price P1 the quantity of
goods that the producers wish
to supply is indicated by Q2.
At P1, however, the quantity
that the consumers want to
consume is at Q1, a quantity
much less than Q2. Because
Q2 is greater than Q1, too
much is being produced
and too little is being consumed. The suppliers are trying to
produce more goods, which they hope to sell to increase profits,
but those consuming the goods will find the product less attractive
and purchase less because the price is too high.

For HITK students
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ii) Excess Demand : Excess demand is created when price is set
below the equilibrium price. Because the price is so low, too many
consumers want the good while producers are not making enough
of it.
In this situation, at price P1, the
quantity of goods demanded by
consumers at this price is Q2.
Conversely, the quantity of goods
that producers are willing to
produce at this price is Q1. Thus,
there are too few goods being
produced to satisfy the wants
(demand) of the consumers.
However, as consumers have to compete with one other to buy the
good at this price, the demand will push the price up, making
suppliers want to supply more and bringing the price closer to its
equilibrium.

For HITK students
by S.K.Sen
6. Shifts vs. Movement : For economics, the "movements"
and "shifts" in relation to the supply and demand curves
represent very different market phenomena:
i) Movements : A movement refers to a change along a
curve. On the demand curve, a movement denotes a
change in both price and quantity demanded from one
point to another on the curve. The movement implies that
the demand relationship remains consistent. Therefore, a
movement along the demand curve will occur when the
price of the good changes and the quantity demanded
changes in accordance to the original demand relationship.
In other words, a movement occurs when a change in the
quantity demanded is caused only by a change in price,
and vice versa.

For HITK students
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Movement along the Demand Curve
Like a movement along the demand curve, a movement along the
supply curve means that the supply relationship remains consistent.
Therefore, a movement along the supply curve will occur when the
price of the good changes and the quantity supplied changes in
accordance to the original supply relationship. In other words, a
movement occurs when a change in quantity supplied is caused
only by a change in price, and vice versa.
Movement along the Supply Curve

For HITK students
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ii) Shifts : A shift in a demand or supply curve occurs when a
good's quantity demanded or supplied changes even though price
remains the same. For instance, if the price for a bottle of beer was
$2 and the quantity of beer demanded increased from Q1 to Q2,
then there would be a
shift in the demand for
beer. Shifts in the demand
curve imply that the
original demand
relationship has changed,
meaning that quantity
demand is affected by a
factor other than price.
A shift in the demand relationship would occur if, for instance,
beer suddenly became the only type of alcohol available for
consumption.

For HITK students
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Conversely, if the price for a bottle of beer was $2 and the quantity
supplied decreased from Q1 to Q2, then there would be a shift in the
supply of beer. Like a shift in the demand curve, a shift in the
supply curve implies that the original supply curve has
changed, meaning that the quantity supplied is effected by a factor
other than price. A shift in the supply curve would occur if, for
instance, a natural disaster caused a mass shortage of hops; beer
manufacturers would be forced to supply less beer for the same
price.

For HITK students
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Elasticity : In economics, the law of demand states that, all
else being equal, as the price of a product increases (↑),
quantity demanded falls (↓); likewise, as the price of a product
decreases (↓), quantity demanded increases (↑). In simple
terms, the law of demand describes an inverse relationship, and
an elasticity, between price and quantity of demand. There is a
negative relationship between the quantity demanded of a good
and its price. The factors held constant in this relationship are
the prices of other goods and the consumer's income. There
are, however, some possible exceptions to the law of demand
(see Giffen goods and Veblen goods).
Mathematical expression : Mathematically, the inverse
relationship may be expressed as a causal relation:
Qx = f(Px), f’ < 0, where Qx is the quantity demanded for good
x, Px is price of the good, f is demand function, f’ is derivative.
Here, Px is casual factor (independent variable) and Qx is
dependent variable.

Graphical depiction : A demand curve is a graphical
depiction that abides by the law of demand. It shows how
the quantity demanded of some product during a specified
period of time will change as the price of that product
changes, holding all other determinants of the quantity
demanded constant. Price is measured on the vertical axis
and quantity demanded on the horizontal axis.
There are two important things to note about the demand
curve :
(i) It is downward sloping indicating that between the
price of a product and the quantity demanded a negative or
inverse relationship exists. In other words, as the price
declines the quantity demanded increases. This is indicated
by a downward movement along the demand curve. An
increase in price decreases the quantity demanded, and an
upward movement along the demand curve occurs. For HITK students
by S.K.Sen

(ii) The movement along a given demand curve due to a
change in price is referred to as "change in quantity
demanded". (i:e demand changes as only the price
changes, and diagrammatically, there is only one demand
curve, with the movement noticeable between points) the
price changes, the quantity demanded changes. The term
"change in demand" refers to a shift of the demand curve
because of factors other than price(in the which case,
prices, incomes of consumers, government policies,
seasons and weather, tastes, reigning fashion, festivals etc
and other non-price factors determine/cause the demand
curve to shift. Diagrammatically, new curves are drawn to
show the shifts, aside from the other curves/readers should
note this important distinction).
For HITK students
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For HITK students
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Exceptions to the law of demand : Generally the amount
demanded of a good increases with a decrease in price of
the good and vice versa. In some cases, however, this may
not be true. There are certain goods which do not follow
this law. These include Veblen goods and Giffen goods.
Further exception and details are given in the sections
below.
Giffen goods : Initially proposed by Sir Robert Giffen,
economists disagree on the existence of Giffen goods in
the market. A Giffen good describes an inferior good that
as the price increases, demand for the product increases.
As an example, during the Irish Potato Famine of the 19th
century, potatoes were considered a Giffen good. Potatoes
were the largest staple in the Irish diet, so as the price rose
it had a large impact on income. People responded by

For HITK students
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cutting out on luxury goods such as meat and vegetables,
and instead bought more potatoes. Therefore, as the price
of potatoes increased, so did the quantity demanded.
Expectation of change in the price of commodity : If an
increase in the price of a commodity causes households to
expect the price of a commodity to increase further, they
may start purchasing a greater amount of the commodity
even at the presently increased price. Similarly, if the
household expects the price of the commodity to decrease,
it may postpone its purchases. Thus, some argue that the
law of demand is violated in such cases. In this case, the
demand curve does not slope down from left to right;
instead it presents a backward slope from the top right to
down left. This curve is known as an exceptional demand
curve.

For HITK students
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Basic or necessary goods : The goods which people need
no matter how high the price is are basic or necessary
goods. Medicines covered by insurance are a good
example. An increase or decrease in the price of such a
good does not affect its quantity demanded.
The law of demand and change in demand : The law of
demand states that, other things remaining same, the
quantity demanded of a good increases when its price falls
and decreases when the price rises. This is represented by
movement along the demand curve, since the product's
price is on the vertical axis.
The demand for goods changes as a consequence of
changes in income, tastes etc. Since these factors are not
on the axes of the demand curve diagram, such a change is
reflected in a shift of the demand curve to a new location.

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A shift of the demand curve is referred to as a change in
demand, in contrast to a movement along a fixed demand
curve, which is referred to as a change in the quantity
demanded.
A demand curve, shown
in red and shifting to the
right, demonstrating the
inverse relationship
between price and
quantity demanded (the
curve slopes downwards
from left to right; higher
prices reduce the
quantity demanded).

For HITK students
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Price elasticity of demand (PED or Ed) is a measure used
in economics to show the responsiveness, or elasticity, of
the quantity demanded of a good or service to a change in
its price, ceteris paribus. More precisely, it gives the
percentage change in quantity demanded in response to a
one percent change in price.
"Price elasticity" is not to be confused with Price elasticity
of supply.
Price elasticities are almost always negative, although
analysts tend to ignore the sign even though this can lead
to ambiguity. Only goods which do not conform to the law
of demand, such as Veblen and Giffen goods, have a
positive PED. In general, the demand for a good is said to
be inelastic (or relatively inelastic) when the PED is less
than one (in absolute value): that is, changes in price have

For HITK students
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a relatively small effect on the quantity of the good
demanded. The demand for a good is said to be elastic (or
relatively elastic) when its PED is greater than one (in
absolute value): that is, changes in price have a relatively
large effect on the quantity of a good demanded.
Revenue is maximized when price is set so that the PED is
exactly one. The PED of a good can also be used to predict
the incidence (or "burden") of a tax on that good. Various
research methods are used to determine price elasticity,
including test markets, analysis of historical sales data and
conjoint analysis.
It is a measure of responsiveness of the quantity of a raw
good or service demanded to changes in its price. The
formula for the coefficient of price elasticity of demand for
a good is : dQ / Q
dP / P
e(p) =

For HITK students
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The above formula usually yields a negative value, due to
the inverse nature of the relationship between price and
quantity demanded, as described by the "law of demand".
For example, if the price increases by 5% and quantity
demanded decreases by 5%, then the elasticity at the initial
price and quantity = − 5% / 5% = −1. The only classes of
goods which have a PED of greater than 0 are Veblen and
Giffen goods. Although the PED is negative for the vast
majority of goods and services, economists often refer to
price elasticity of demand as a positive value (i.e., in
absolute value terms).
This measure of elasticity is sometimes referred to as the
own-price elasticity of demand for a good, i.e., the
elasticity of demand with respect to the good's own price,
in order to distinguish it from the elasticity of demand for

For HITK students
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that good with respect to the change in the price of some
other good, i.e., a complementary or substitute good. The
latter type of elasticity measure is called a cross-price
elasticity of demand.
As the difference between the two prices or quantities
increases, the accuracy of the PED given by the formula
above decreases for a combination of two reasons. First,
the PED for a good is not necessarily constant; as
explained below, PED can vary at different points along
the demand curve, due to its percentage nature. Elasticity
is not the same thing as the slope of the demand curve,
which is dependent on the units used for both price and
quantity. Second, percentage changes are not symmetric;
instead, the percentage change between any two values
depends on which one is chosen as the starting value and

For HITK students
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which as the ending value. For example, if quantity
demanded increases from 10 units to 15 units, the
percentage change is 50%, i.e., (15 − 10) ÷ 10 (converted
to a percentage). But if quantity demanded decreases from
15 units to 10 units, the percentage change is −33.3%, i.e.,
(10 − 15) ÷ 15.
Two alternative elasticity measures avoid or minimise
these shortcomings of the basic elasticity formula: point-
price elasticity and arc elasticity.

For HITK students
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Giffen good : In economics and consumer theory, a Giffen
good is a product that people consume more of as the price
rises and vice versa - violating the law of demand. For any
good, as the price of the good rises, the substitution effect
makes consumers purchase less of it, and more of
substitute goods; for most goods, the income effect (due to
the effective decline in available income due to more being
spent on existing units of this good) reinforces this decline
in demand for the good. But a Giffen good is so strongly
an inferior good (being more in demand at lower income)
that this contrary income effect more than offsets the
substitution effect, and the net effect of the good's price
rise is to increase demand for it.
A Giffen good should not be confused with products
bought as status symbols or for conspicuous consumption

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(Veblen goods). The classic example given by Marshall is
of inferior quality staple foods, whose demand is driven by
poverty that makes their purchasers unable to afford
superior foodstuffs.
They both violate the law of demand (price goes up,
demand goes down and vice-versa).
Veblen goods violate the law of demand because people
actually *prefer* goods to be more expensive as a status
symbol.
Giffen goods (which are also mostly theoretical) violate
the law of demand because when the price of a necessary
good rises (eg. their food staple), they are *forced* to
substitute out even more expensive alternatives in favour
of the staple.

For HITK students
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A giffen good occurs when a rise in price causes higher
demand because the income effect outweighs the
substitution effect. Suppose you have a very low income
and eat two basic food stuffs rice and meat. Meat is a
luxury and is much more expensive than rice.
In economics, Veblen goods are types of material
commodities for which the demand is proportional to its
high price, which is an apparent contradiction of the law of
demand; Veblen goods also are commodities that function
as positional goods. Veblen goods are types of luxury
goods, such as expensive wines, jewelry, fashion-designer
handbags, and luxury cars, which are in demand because
of the high prices asked for them. The high price makes
the goods desirable as symbols of the buyer's high social
status, by way of conspicuous consumption and

For HITK students
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conspicuous leisure; conversely, a decrease of the prices of
Veblen goods would decrease demand for the products.
In an economy, the consumption of Veblen goods is a
function of the Veblen effect (goods desired for being
over-priced) that is named after the American economist
Thorstein Veblen, who first identified conspicuous
consumption as a mode of status-seeking in The Theory of
the Leisure Class (1899).

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