1. Dr. Akhilesh Das Gupta Institute of Technology &
Management
BBA Department
NAME OF THE FACULTY: Ms. Vimla Sharma
SUBJECT CODE: BBA 107
SUBJECT TITLE: Business Economics
TOTAL NO. OF
LECTURES: 60
3. Syllabus Content
• Introduction of business economics , meaning, definition
of economics and its application in Business
• Micro Economics Vs. Macro economics
• Opportunity cost, Marginalism cost, Incremental cost and
time value of Money
• Nudge Theory
4. Meaning
• Economics is a social science that focuses on the
production, distribution, and consumption of goods and
services, and analyzes the choices that individuals,
businesses, governments, and nations make to allocate
resources.
• Assuming humans have unlimited wants within a world of
limited means, economists analyze how resources are
allocated for production, distribution, and consumption.
5. Meaning of Business Economics
• Business economics is a field of applied
economics that studies the financial, organizational,
market-related, and environmental issues faced by
corporations.
• Business economics assesses certain factors impacting
corporations—business organization, management,
expansion, and strategy—using economic theory and
quantitative methods.
6. Definition
Business economics is a ‘special branch of economics that
bridges the gap between abstract economic theory and
managerial practice. Through a process of application of
the principles, concepts and tools of economics to solve the
managerial problems of a business enterprise, business
economists have greatly minimised the problem of
uncertainty arising in business.
7. Nature of Business Economics
1. From the Perspective of Science
It follows a scientific approach and also checks the
validity of all the results thus obtained.
2. From the Perspective of Microeconomics
Business economics focusses more on the analysis and
decision-making abilities of the individual businesses and
therefore utilizes the techniques related to the concept of
microeconomics.
8. 3. Incorporation of Macroeconomic Elements
Although business economics is largely based on the
microeconomy, the nature, and scope of business economics notes
certain concepts of macroeconomics as well.
4. From the Perspective of Art
The concept of art can also be used to discuss the nature and scope
of business economics.
5. Incorporation of Theories of Private Enterprises and Markets
Business economics considers the resource allocation theory
prevalent in the private enterprise economy.
9. 6. Pragmatic Approach
In comparison to the theoretical nature of the microeconomy,
business economics has a pragmatic approach. It is more related
to finding efficient solutions to the problems faced by companies in
the real world.
7. Interdisciplinary Nature of Business Economics
Business economics has an interdisciplinary approach by involving
disciplines from statistics, mathematics, marketing, accounting, etc
.
8. Normative Approach
Normative science includes judgments that have values. It
analyses the circumstance and provides suggestions on the course
of action.
10.
11. ECONOMICS BUSINESS ECONOMICS
Economics is a traditional subject that has prevailed
from a long time.
Business economics is a modern concept and is still
developing.
Economics mainly covers theoretical aspects. Business economics covers practical aspects.
In economics, the problems of individuals and
societies are studied.
In Business economics, the main area of study is the
problems of organizations.
In economics, only economic factors are considered. In business economic, both economic and non-economic
factors are considered.
Both microeconomics and macroeconomics fall
under the scope of economics.
Only microeconomics falls under the scope of business
economics.
Economics has a wider scope and covers the
economic issues of nations.
Business economics is a part of economics and is limited
to the economic problems of organisations
Difference between Economics and Business Economics
12. Difference between Micro and Macro Economics
Micro Economics
1. Micro economics studies
individual economic units.
2. Microeconomics primarily
deals with individual income,
output, price of goods , etc.
3. Micro economics focuses on
overcoming issues concerning
the allocation of resources and
price discrimination.
Macro Economics
1. Macro economics studies a
nation’s economy, as well as
its various aggregates
2. Macro economics is the study
of aggregates such as
national output, income , as
well as general price levels.
3. It focuses on upholding issues
like employment and national
household income.
13. Difference between Micro and Macro Economics
4. Micro economics accounts
for factors like the demand
and supply of a particular
commodity
5. Micro economics offers a
pictures of the goods and
services that are required for
an efficient economy.
6. Micro economics also
focuses on issues arising
due to price variation and
income levels.
7. Micro economics helps to
point out how equilibrium
can be achieved at a small
scale
4. Macro economics accounts
for the aggregate demand and
supply of a nation’s economy.
5. Macro economics helps
ensure optimum utilization of the
resources available to the
country
6. The primary component of
macro economic problems is
income.
7. Macro economics help
determine the equilibrium levels
of employment and income of
the nation.
14. EconomicsApplications and their contribution to
Business
1. Reconciling traditional theoretical concepts of
economics in relation to the actual business
behavior and conditions
2. Estimating economic relationships
3. Predicting relevant economic quantities
4. Using economic quantities in decision-making
and forward planning
5. Understanding significant external forces
15. Concept of Opportunity Cost
• Opportunity cost is commonly defined as the next best
alternative.
• Also, known as the alternative cost, it is the loss of gain
which could have been gained if another alternative was
chosen.
• It can also be explained as the loss of benefit due to a
change in choice.
16. Assumption of the concept of
opportunity cost
• The scarcity of resources.
• The number of possibilities of production is
limited.
• The production of another combination of
goods would have to be forgotten.
17. Opportunity Cost of Decisions
In economics, the opportunity cost of decisions
generally pertains to the opportunity cost
arising due to the decisions of the firm in
production. This decision on the choice of
production occurs due to the scarcity of
resources.
18. Calculation of Opportunity Cost
• Opportunity cost is the extra return on an alternative
available over and above the chosen option.
• Therefore, Opportunity cost = Return from the best
alternative – Return from the already selected option
19. Types of Opportunity Cost
• Explicit Cost
Explicit costs are as the name suggests direct costs that
can be identified clearly. The explicit costs are incurred and
recorded in the books of accounts. These explicit costs
would have to be paid in cash or kind.
• Implicit Cost
Implicit costs are indirect or invisible costs that cannot be
directly or easily traced down. The implicit costs affect the
firm as the loss of its owned resources. Payments are not
usually made as there is no real cost.
20. Time Value of Money
• Time value of money’ is central to the concept of finance.
It recognizes that the value of money is different at
different points of time.
• money can be put to productive use, its value is different
depending upon when it is received or paid.
21. Time Value of Money Formula
The most fundamental formula for the time value of
money takes into account the following:
1. future value of money,
2. present value of money,
the interest rate, the number of compounding periods
per year, and the number of years.
• Based on these variables, the formula for TVM is:
• Present Value= FV*1/(1+r)n
• Keep in mind, though that the TVM formula may
change slightly depending on the situation.
22. Importance
• Easy Valuation
• Businesses must compare the current project cost and
the expected income or money inflow
• Make long-term decisions without converting the project’s
expected income into a present value.
• If money is invested in one project, it must be foregone to
invest in another. It’s known as “Opportunity Cost” in
finance
23. The concept of TVM revolves around the
following three parameters
• Inflation
• Opportunity Cost
• Risk
24. Marginalism
a. It describes both an economical method of analysis
and a theory of value. According to this theory,
individuals make economic decisions "on the
margin." That is, value is determined by how
much additional utility an extra unit of a good or
service provides.
b. The development of marginal theory is commonly
referred to as the Marginalism Revolution and is
seen as the dividing line between classical and
modern economics.
25. Importance
• It is important to recognize, however, that marginal
relations measure only the effect associated with unitary
changes in output or some other important decision
variable.
• Analysing the potential effects on revenues, costs, and
profits
• the study of differences or changes is the key element in
the selection of an optimal course of action.
26. Meaning of Incrementalism
Incremental analysis involves examining the impact of
alternative managerial decisions or courses of action on
revenues, costs, and profit. It focuses on changes or
differences between the available alternatives.
The incremental change is the change resulting from a
given managerial decision.
27. Market forces
• Market forces refer to the forces that determine the prices of
goods and services and the functioning of consumers and
producers in the market. It causes short-term and long-term
fluctuations in the market.
• It explains the increase or decrease in the price in reaction to the
changes in supply and demand and other factors in the market.
It is a naturally occurring phenomenon, given the nation follows
a free market economic system.
28. Market Forces of Supply &
Demand Explained
• Market forces in economics indicate the importance of
understanding the supply and demand concept. These
market forces influence the price of goods and services.
• The market force causes an increase in the price in
reaction to the change in supply and demand.
• Market equilibrium scenario, market forces will be in a
balanced state.
29. Risk-Return and profit
1. Risk
The risk associated with the investments and it may control
by using various applications of economics' There are
certain types of Risk like
a. Market Risk
b. Financial Risk
c. Business Risk
31. There are four market forces
The four major forces that play a key role are:
1. Supply and demand
2. Government intervention
3. Human emotion and consumer buying behavior
4. Technological advancement
32. Nudge Theory
The Nudge Theory is a flexible and modern concept in
behavioural sciences to understand how people think,
make decisions, and behave. The concept helps people
to improve their thinking and decisions, manage all
kinds of changes, and identify and change existing
influences.
33. Behaviour Economics
Behavioural economics studies the biases, tendencies
and heuristics that affect the decisions that people
make to improve, tweak or overhaul traditional
economic theory. It aids in determining whether people
make good or bad choices and whether they could be
helped to make better choices. It can be applied both
before and after a decision is made.
34. It can be applied both before and
after a decision is made.
1. Search heuristics
2. Satisficing
3. Directed cognition
4. Elimination by aspects
5. Mental accounting
6. Anchoring
7. Herd behaviour
8. Framing effects
35. Different Types of Nudges
1. Setting a default option
2. Making certain options easier or harder to select
3. Making certain options more noticeable
4. Creating influence with a crowd
5. Sending a reminder
37. Cardinal Utility approach
The Cardinal Utility approach is propounded by neo-
classical economists, who believe that utility is
measurable, and the customer can express his
satisfaction in cardinal way
38. Assumptions
1. Rationality: It is assumed that the consumers are rational, and
they satisfy their wants in the order of their preference.
2. Limited Resources (Money): The consumer has limited money
to spend on the purchase of goods and services.
3. Maximize Satisfaction: Every consumer aims at maximizing
his/her satisfaction for the amount of money he/she spends on
the goods and services.
4. Utility is cardinally Measurable: It is assumed that the utility is
measurable, and the utility derived from one unit.
5. Diminishing Marginal Utility: This means, with the increased
consumption of a commodity, the utility derived from each
successive unit goes on diminishing.
6. Marginal Utility of Money is Constant: It is assumed that the
marginal utility of money remains constant irrespective of the
level of a consumer’s income.
39. Law of Diminishing Marginal Utility
• The Law of Diminishing Marginal Utility states that the
additional utility gained from an increase in consumption
decreases with each subsequent increase in the level of
consumption. Marginal Utility is the change in total utility
due to a one-unit change in the level of consumption.
• The Law of Diminishing Marginal Utility states the
marginal utility gradually decreases with the level of
consumption, utility being defined as satisfaction or
benefit.
40. Assumptions
• Rationality: It is assumed that the consumers are rational, and they satisfy their
wants in the order of their preference. This means they will purchase those
commodities first which yields the highest utility and then the second highest and so
on.
• Limited Resources (Money): The consumer has limited money to spend on the
purchase of goods and services and thus this makes the consumer buy those
commodities first which is a necessity.
• Maximize Satisfaction: Every consumer aims at maximizing his/her satisfaction for
the amount of money he/she spends on the goods and services.
• Diminishing Marginal Utility: This means, with the increased consumption of a
commodity, the utility derived from each successive unit goes on diminishing. This
law holds true for the theory of consumer behavior.
• Marginal Utility of Money is Constant: It is assumed that the marginal utility of money
remains constant irrespective of the level of a consumer’s income.
41. Law of Diminishing Marginal Utility?
The Law of Diminishing Marginal Utility states that the
additional utility gained from an increase in consumption
decreases with each subsequent increase in the level of
consumption. Marginal Utility is the change in total utility
due to a one-unit change in the level of consumption. The
Law of Diminishing Marginal Utility states the marginal
utility gradually decreases with the level of consumption,
utility being defined as satisfaction or benefit.
42. Total Utility vs. Marginal Utility
Total Utility is an aggregate measure of satisfaction
gained from consumption, whereas Marginal Utility is a
measure of the change in satisfaction gained from
consumption as a result of a change in consumption.
MU(x) = TU(x) – TU(x – 1)
The Marginal Utility gained from the xth unit of
consumption is equal to the difference between the total
utility gained from x units of consumption and the total
utility gained from x–1 units of consumption
43. Law of Equi Marginal Utility
Law of Equi Marginal Utility helps to explain consumer
behaviour in the case of more than one good or service.
There is no limit to human wants, but the income to satisfy
those wants is limited. So, the law of equi marginal utility
explains how a consumer allots their limited income to
various goods and services to attain maximum satisfaction.
44. Assumptions of Law of Equi Marginal
Utility
1. Prices of the products don’t change.
2. The income of the consumer doesn’t change.
3. MU of the money remains constant.
4. The buyer has complete information on the utility they
get from the product or services.
5. The buyer acts rationally to maximize satisfaction.
6. The consumer is able to express or measure utility in
cardinal terms.
7. Products have substitutes, and the consumer has many
wants.
45. Explanation of the Law- Equi-margin utility
The equi-marginal principle is based on the law of
diminishing marginal utility. The equi-marginal principle
states that a consumer will be maximizing his total utility
when he allocates his fixed money income in such a way
that the utility derived from the last unit of money spent on
each good is equal.
This condition for a consumer to maximize utility is
usually written in the following form:
MUX/PX = MUY/PY
So long as MUY/PY is higher than MUX/PX, the consumer
will go on substituting Y for X until the marginal utilities of
both X and Y are equalized.
47. What is Demand…?
In economics, ‘demand’ stands for a consumer’s ability and
desire to purchase a good or service.
Keeping other factors constant, an increase in prices of
goods and services reduces consumer’s demand and vice-
versa. Business spends considerable time and money to
understand this demand definition correctly.
48. Factors affecting demand
1. Tastes and Preferences of The Consumers: With time, the
tastes and preferences of customers change and that can affect
the demand for a particular product.
2. Income: It is one of the significant factors that can affect the
demand both positively and negatively. Income changes the
preferences of individuals, and therefore, affects the need.
3. Change of Price: The demand for a product depends on its
price. If it increases, then its demand goes down and vice-versa.
4. Promotion: Marketing and promotion are vital to the demand
factor. It can change the demand for a product. If a company can
market their product well and influence people, then it may swing
the market share in its favour.
49. Types of Demand
1. Individual and Market demand
2. Autonomous and derived demand
3. Consumer demand
4. Direct demand
5. Joint demand
6. Durable and Non-durable goods demand
7. Seasonal demand
8. Income demand
9. Cross demand
10. Short term and Long term demand
50. Demand Schedule
Demand schedule definition is that it represents a table that
portrays the quantity demand of a product at various price
points. It consists of two columns, the first one lists the
price and the second one displays the aggregate demand.
Below is a format of the demand schedule for reference.
1. Individual demand
Price Quantity
2 50
3 40
4 30
52. Demand Curve
Demand curve definition is that it is a graphical
presentation of the relationship between a product’s price
and its demand in a specific period. Typically, the price of a
product appears on the vertical axis and the demand on the
horizontal axis.
53. Law of Demand
The law of demand expresses a relationship between the
quantity demanded and its price. It may be defined in
Marshall’s words as “the amount demanded increases
with a fall in price, and diminishes with a rise in price”.
Thus it expresses an inverse relation between price and
demand. The law refers to the direction in which quantity
demanded changes with a change in price.
Assumptions of the law:-
• 1. (i) There is no change in the tastes and preferences of
the consumer;
• (ii) The income of the consumer remains constant;
• (iii) There is no change in customs;
54. Assumptions of the law
(iv) The commodity to be used should not confer distinction
on the consumer;
(v) There should not be any substitutes of the commodity;
(vi) There should not be any change in the prices of other
products;
(vii) There should not be any possibility of change in the
price of the product being used;
(viii) There should not be any change in the quality of the
product; and
(ix) The habits of the consumers should remain unchanged.
Given these conditions, the law of demand operates. If
there is change even in one of these conditions, it will stop
operating.
56. Exceptions to the Law of Demand:
In certain cases, the demand curve slopes up from left to
right, i.e., it has a positive slope. Under certain
circumstances, consumers buy more when the price of a
commodity rises, and less when price falls, Many causes
are attributed to an upward sloping demand curve.
(i) War
If shortage is feared in anticipation of war, people may start
buying for building stocks or for hoarding even when the
price rises.
(ii) Depression:
During a depression, the prices of commodities are very
low and the demand for them is also less. This is because
of the lack of purchasing power with consumers.
57. Exceptions to the Law of Demand:
(iii) Giffen Paradox:
If a commodity happens to be a necessity of life like wheat
and its price goes up, consumers are forced to curtail the
consumption of more expensive foods like meat and fish,
and wheat being still the cheapest food they will consume
more of it. The Marshallian example is applicable to
developed economies.
In the case of an underdeveloped economy, with the fall in
the price of an inferior commodity like maize, consumers
will start consuming more of the superior commodity like
wheat. As a result, the demand for maize will fall. This is
what Marshall called the Giffen Paradox which makes the
demand curve to have a positive slope.
58. Movement along the Demand Curve
Movement in the Demand Curve
Movement along the Demand Curve happens because of the change in the price of
commodities. This further affects the quantity Demanded. All other factors remain
unchanged. Under such a scenario, the graph moves along the Y-axis, as the price
is plotted against it. At the same time, the other axis remains constant.
So, in such a scenario, with an increase in price, the Demand decreases, and with
a decrease in price, the Demand increases.
The movement happens in a contraction and expansion format. Consider the
following example.
Contraction of the Curve: For instance, if the price increases from 10to12 for a
commodity, then the supply decreases from 100 to 80. This is called a contraction of
the Demand Curve.
Expansion of the Curve: For instance, if the price decreases from 10to8 for a
commodity, then the supply increases from 100 to 120. This is called an expansion
of the Demand Curve.
59. Shift in the Demand Curve
This happens when there is a change in any other factor apart
from the price. It could be due to the quantity, consumer income,
or several other factors on which the Demand Curve is based.
Under this, even the price can vary. This leads to left or right
Shift in the Demand Curve.
1. The factors leading to a Shift in the Curve are as follows.
2. Increase in Demand quantity of the products due to popularity
3. Increase in the price of a competitive good
4. A rise in the income of consumers
5. Seasonal factors
It leads to a Shift in the Demand Curve, depending on the
factors.
60. Elasticity of Demand
Demand extends or contracts respectively with a fall or rise
in price. This quality of demand by virtue of which it
changes (increases or decreases) when price changes
(decreases or increases) is called Elasticity of Demand.
Types of Elasticity:
1. Price Elasticity- Price Elasticity is the responsiveness of
demand to change in price
2. Income Elasticity - Income elasticity means a change in
demand in response to a change in the consumer’s
income;
3. Cross Elasticity- cross elasticity means a change in the
demand for a commodity owing to change in the price of
another commodity.
61. Degrees of Elasticity of Demand:
Let us now try to understand the different degrees of
elasticity of demand with the help of curves.
(a) Perfect Elasticity of Demand
(b) Perfectly Inelastic Demand
(c) More than Elastic Demand
(d) Less than Elastic Demand
(e) Unitary elastic Demand
62. Income Elasticity of Demand
Income elasticity of demand measures the responsiveness
of demand for a particular good to changes in consumer
income.
Inferior Goods vs. Normal Goods
Depending on the values of the income elasticity of
demand, goods can be broadly categorized as inferior
and normal goods. Normal goods have a positive income
elasticity of demand; as incomes rise, more goods are
demanded at each price level.
Normal goods whose income elasticity of demand is
between zero and one are typically referred to as necessity
goods, which are products and services that consumers will
buy regardless of changes in their income levels. Examples
of necessity goods and services include tobacco products,
haircuts, water, and electricity.
63. Types of Income Elasticity of Demand
There are five types of income elasticity of demand:
1. High: A rise in income comes with bigger increases in
the quantity demanded.
2. Unitary: The rise in income is proportionate to the
increase in the quantity demanded.
3. Low: A jump in income is less than proportionate to the
increase in the quantity demanded.
4. Zero: The quantity bought/demanded is the same even
if income changes
5. Negative: An increase in income comes with a
decrease in the quantity demanded.
64. Cross Elasticity of Demand
It is the ratio of proportionate change in the quantity
demanded of Y to a given proportionate change in the price
of the related commodity X.
It is a measure of relative change in the quantity demanded
of a commodity due to a change in the price of its
substitute/complement. It can be expressed as:
Cross elasticity may be infinite or zero if the slightest
change in the price of X causes a substantial change in the
quantity demanded of Y.
It is always the case with goods which have perfect
substitutes for one another. Cross elasticity is zero, if a
change in the price of one commodity will not affect the
quantity demanded of the other. In the case of goods which
are not related to each other, cross elasticity of demand is
zero.
65. Types of Cross Elasticity of Demand
• 1. Positive:
When goods are substitute of each other then cross
elasticity of demand is positive. In other words, when an
increase in the price of Y leads to an increase in the
demand of X. For instance, with the increase in price of tea,
demand of coffee will increase.
66. Types of Cross Elasticity of Demand
2. Negative:
In case of complementary goods, cross
elasticity of demand is negative. A
proportionate increase in price of one
commodity leads to a proportionate fall in
the demand of another commodity
because both are demanded jointly.
3. Zero:
Cross elasticity of demand is zero when
two goods are not related to each other.
For instance, increase in price of car does
not effect the demand of cloth. Thus,
cross elasticity of demand is zero.
67. Demand Forecasting
Demand forecasting is an amalgamation of two words; the
first one is known as demand, and another one is forecasting.
The meaning of demand is the outside requirements of a
manufactured product or a useful service. In general aspects,
forecasting usually means making an approximation in the
present for an event that would be occurring in the future.
Demand forecasting is a technique that is used for the
estimation of what can be the demand for the upcoming
product or services in the future. It is based upon the real-
time analysis of demand which was there in the past for that
particular product or service in the market present today.
68. Steps of demand forecasting
1. Setting an Objective: The first step involves clearly deciding on
the purpose of the analysis. That is, the manufacturers define their
goals that are achievable through the analysis and compatible with
their needs.
2. Determining the Time Period: In this step, the manufacturer
decides whether the analysis will be carried out for a short or long
duration of time. Many forecasts run for a long duration as they
offer more and consistent data.
3. Selecting a Demand Forecasting Method: In the next step, the
manufacturer decides along with the analysts which method will
give the best results.
4. Collection of Data: In the penultimate step, the data is collected
according to the preconceived attributes for the analysis.
5. Evaluation of Data: In the last step, the collected data is evaluated
to obtain conclusions for the forecast.
6.
69. Methods and techniques Demand
Forecasting
1.) Survey of Buyer’s Choice
When the demand needs to be forecasted in the short run, say a
year, then the most feasible method is to ask the customers
directly that what are they intending to buy in the forthcoming
time period.
2.) Collective Opinion Method
Under this method, the salesperson of a firm predicts the
estimated future sales in their region. The individual estimates
are aggregated to calculate the total estimated future sales.
These estimates are reviewed in the light of factors like future
changes in the selling price, product designs, changes in
competition, advertisement campaigns, the purchasing power of
the consumers, employment opportunities, population, etc.
70. Methods and techniques Demand
Forecasting
3.) Barometric Method
This method is based on the past demands of the product
and tries to project the past into the future. The economic
indicators are used to predict the future trends of
the business. Based on future trends, the demand for the
product is forecasted.
4.) Market Experiment Method
Another one of the methods of demand forecasting is the
market experiment method. Under this method, the
demand is forecasted by conducting market studies and
experiments on consumer behavior under actual but
controlled, market condition
71. Methods and techniques Demand
Forecasting
5) Expert Opinion Method
Usually, market experts have explicit knowledge about the
factors affecting demand. Their opinion can help in demand
forecasting. The Delphi technique, developed by Olaf
Helmer is one such method.
Under this method, experts are given a series of carefully
designed questionnaires and are asked to forecast the
demand. They are also required to give the suitable
reasons. The opinions are shared with the experts to arrive
at a conclusion. This is a fast and cheap technique.
6] Statistical Methods
The statistical method is one of the important methods of
demand forecasting. Statistical methods are scientific,
reliable and free from biases.
72. Advertising Elasticity of demand
Advertising elasticity of demand (AED) measures a
market's sensitivity to increases or decreases in advertising
saturation.
Advertising elasticity measures an advertising campaign's
effectiveness in generating new sales. It is calculated by
dividing the percentage change in the quantity demanded
by the percentage change in advertising expenditures.
A positive advertising elasticity indicates that an increase
in advertising leads to a rise in demand for the advertised
good or services.
74. Concept of Production
Production can be defined as the process of converting the
inputs into outputs. Inputs include land, labour and capital,
whereas output includes finished goods and services.
Organizations engage in production for earning maximum
profit, which is the difference between the cost and
revenue. Therefore, their production decisions depend on
the cost and revenue. The main aim of production is to
produce maximum output with given inputs.
75.
76. Factors of Production
1)Land: Land is utilized to produce income called rent. Land is
available in fixed quantity; thus, does not have a supply price.
This implies that the change in price of land does not affect its
supply. The return for land is called rent.
2)Labour: Labour includes unskilled, semi-skilled and highly
skilled labours. The supply of labour is affected by the change in
its prices. It increases with an increase in wages. The return for
labour is called wages and salary.
3)Capital: Capital is the wealth created by human beings. It is
one of the important factors of production of any kind of goods
and services, as production cannot take place without the
involvement of capital.
4)Enterprise: An enterprise is an organisation that undertakes
commercial purposes or business ventures and focuses on
providing goods and services.
77. Production function
Production function can be defined as a technological
relationship between the physical inputs and physical
output of the organization. Production function is based on
the following assumptions:
1. Production function is related to a specific time period.
2. The state of technology is fixed during this period of
time.
3. The factors of production are divisible into the most
viable units.
4. There are only two factors of production, labour and
capital.
5. Inelastic supply of factors in the short-run period.
78. Production Function in the Short Run
The production function relates the quantity of factor inputs
used by a business to the amount of output that result.
We use three measures of production and productivity:
Total product (total output). In manufacturing industries such as
motor vehicles, it is straightforward to measure how much output
is being produced. In service or knowledge industries, where
output is less “tangible" it is harder to measure productivity.
Average product measures output per-worker-employed or
output-per-unit of capital.
Marginal product is the change in output from increasing the
number of workers used by one person, or by adding one more
machine to the production process in the short run.
79.
80.
81. Law of Diminishing Returns (Law of
Variable Proportions)
Law of Diminishing Returns (Law of Variable Proportions)
• The law of diminishing returns is an important concept of the
economic theory. This law examines the production function
with one variable keeping the other factors constant. It explains
that when more and more units of a variable input are
employed at a given quantity of fixed inputs, the total output
may initially increase at an increasing rate and then at a
constant rate, and then it will eventually increase at diminishing
rates. The main assumptions made under the law of
diminishing returns are as follows:
• 1) The state of technology is given and changed.
• 2)The prices of the inputs are given.
• 3) Labour is the variable input and capital is the constant input.
82. Production in the Long Run
Long run is the period in which the supply of labour and
capital is elastic. It implies that labour and capital are
variable inputs. The long run production function can be
expressed as:
𝑞 = 𝑓(𝐿, 𝐾)
where L= labour, which is variable K=capital, which is
variable
In the long run, inputs-output relations are studied by the
laws of returns to scale. These are long-run laws of
production. The laws of returns to scale functional can be
explained with the help of the isoquant curve.
83. Isoquant Curves
A technical relation that shows how inputs are converted
into output is depicted by an isoquant curve. It shows the
optimum combinations of factor inputs with the help of
prices of factor inputs and their quantities that are used to
produce the same output.
84. Properties of Isoquant
1. Isoquant curves slope downwards: It implies that the slope of
the isoquant curve is negative. This is because when capital (K) is
increased, the quantity of labour (L) is reduced or vice versa, to
keep the same level of output.
2. Isoquant curves are convex to origin: It implies that factor inputs
are not perfect substitutes. This property shows the substitution of
inputs and diminishing marginal rate of technical substitution of
isoquant. The marginal significance of one input (capital) in terms
of another input (labour) diminishes along with the isoquant curve.
3. Isoquant curves cannot intersect each other: An isoquant
implies the different levels of combination producing different levels
of inputs. If the isoquants intersect each other, it would imply that a
single input combination can produce two levels of output, which is
not possible. The law of production would fail to be applicable.
4. The higher the isoquant the higher the output: It implies that the
higher isoquant represents higher output. The upper curve of the
isoquant produces more output than the curve beneath. This is
because the larger combination of input results in a larger output as
compared to the curve that is beneath it.
85. Producer’s Equilibrium
Producer’s equilibrium implies a situation in which a
producer maximises his/her profits. Thus, he /she chooses
the quantity of inputs and output with the main aim of
achieving the maximum profits. Least cost combination is
that combination at which the output derived from a given
level of inputs is maximum or at which the total cost of
producing a given output is minimum.
86. Returns to Scale
Returns to scale implies the behaviour of output when all
the factor inputs are changed in the same proportion given
the same technology.
• The assumptions of returns to scale are as follows:
• 1) The firm is using only two factors of production that are
capital and labour.
• 2) Labor and capital are combined in one fixed proportion.
• 3) Prices of factors do not change.
• 4) State of technology is fixed.
87. There are three aspects of the laws of
returns
1. Increasing Returns to Scale
It is a situation in which output increase by a
greater proportion than increase in factor
inputs. For example, to produce a particular
product, if the quantity of inputs is doubled and
the increase in output is more than double, it is
said to be an increasing return to scale.
• 2. Constant Returns to Scale
A constant return to scale implies the situation
in which an increase in output is equal to the
increase in factor inputs. For example, in the
case of constant returns to scale, when the
inputs are doubled, the output is also doubled.
88. Diminishing returns to scale
Diminishing returns to scale refers to a situation in which
output increases in lesser proportion than increase in factor
inputs. For example, when capital and labour are doubled,
but the output generated is less than double, the returns to
scale would be termed as diminishing returns to scale.
89. Concept of Cost
The concept of cost is a key concept in Economics. It refers
to the amount of payment made to acquire any goods and
services. In a simpler way, the concept of cost is a financial
valuation of resources, materials, risks, time and utilities
consumed to purchase goods and services. From an
economist's point of view, the cost of manufacturing any
goods and services is often said to be the concept of
opportunity cost.
90. Types of Cost
The concept of cost can be effortlessly comprehended by
classifying the costs. The process of grouping costs is
based on similarities or common characteristics. A well-
defined classification of costs is certainly essential to
mention the costs of cost centers. The different types of
cost concepts are:
1. Outlay costs and Opportunity costs
2. Accounting costs and Economic costs
3. Direct/Traceable costs and Indirect/Untraceable costs
4. Incremental costs and Sunk costs
5. Private costs and social costs
6. Fixed costs and Variable costs
91. Short run cost
The Short-run Cost is the cost which has short-term
implications in the production process, i.e. these are used
over a short range of output. These are the cost incurred
once and cannot be used again and again, such as
payment of wages, cost of raw materials, etc.
• In the short-run period, factors, such as land and
machinery, remain the same.
• On the other hand, factors, such as labor and capital, vary
with time. In the short run, the expansion is done by hiring
more labor and increasing capital. The existing size of the
plant or building cannot be increased in case of the short
run.
92. Short Run cost and its Types
Following are the cost concepts that are
taken into consideration in the short
run:
(i.) Total Fixed Costs
Refer to the costs that remain fixed in the
short period. These costs do not change
with the change in the level of output.
(ii.) Total Variable Costs
• Refer to costs that change with the
change in the level of production. For
example, costs incurred on purchasing
raw material, hiring labor, and using
electricity.
93. Short Run cost and its Types
(iii) Total Cost (TC):
Involves the sum of TFC and TVC.
It can be calculated as follows:
Total Cost = TFC + TVC
TC also changes with the changes in the
level of output as there is a change in
TVC
(iv) Average Fixed Costs (AFC):
Refers to the per unit fixed costs of
production. In other words, AFC implies
fixed cost of production divided by the
quantity of output produced.
94. Short Run cost and its Types
(v) Average Variable Costs (AVC):
Refer to the per unit variable cost of
production. It implies organization’s
variable costs divided by the quantity of
output produced.
It is calculated as:
AVC = TVC/ Output
(vi) Average Cost (AC):
Refer to the total costs of production
per unit of output.
AC is calculated as:
AC = TC/ Output
95. Short Run cost and its Types
(vii) Marginal Cost:
Refer to the addition to the total cost
for producing an additional unit of
the product.
Marginal cost is calculated as:
MC = TCn = TCn-1
MC curve is also a U-shaped curve
as marginal cost initially decreases
as output increases and afterwards,
rises as output increases. This is
because TC increases at decreasing
rate and then increases at increasing
rate.
96. Long run cost function
The long-run cost curve is also referred to as the marginal
cost of the plant. It compares the total cost of a plant with
its output size. It is the slope of the long-run cost curve. If
the long-run cost curve is plotted on the x-axis and the size
of the plant on the y-axis, the slope will show the long-run
cost of the plant.
In the long-run cost curve, we see that for every increase in
the output size, the long-run cost of the plant increases. It
follows that the long-run cost curve for a plant is in fact the
average cost of the plant and the rate of return.
97. Mentioned below are some factors of the
long-run cost curve
1.) Long-run Total Cost
The Long-run Total Cost (LTC) is the minimum cost by which a
given level of output can be determined. This long-run total cost,
least cost possible in producing various output with variable
inputs. It represents the smallest amount of multiple measures of
production. It is seen that LTC is either less or similar to short-
run total cost but can never be more than it.
2. Long-run Average Cost
Long-run Average Cost (LAC) is the total cost divided by any
level of output. It is ideally derived by long-run average price
from short-run average cost curve. In the short-run turn, a firm or
plant remains fixed, and the curve corresponds to a respective
plant. Here the long average cost curve is termed as planning or
envelope curve due to its function in preparing plans for
enlarging production at a minimum cost.
98. 3. Long-run Marginal Cost Curve
In Long run Marginal Cost (LMC), the added cost of
production and the unit of a product becomes a variable.
This cost can be derived from short-run marginal cost.
The long-run cost curve is a vast chapter with diagrams
and explanations on determining variables. These graphs
and curves make a significant part of a firm's production
and sale.
•
99. Economies and Diseconomies of Scale
Economies of scale refer to these reduced costs per unit
arising due to an increase in the total output.
Diseconomies of scale, on the other hand, occur when the
output increases to such a great extent that the cost per
unit starts increasing.
100. Internal and External Economies
When a firm opts for large-scale production, the economies
arising out of it are grouped into two categories:
• Internal economies – economies of production that the
firm accrues when it increases the output leading to a
drop in the cost of production. These arise due to
endogenous factors like entrepreneurial efficiency, talents
of the management team, type of machinery, etc.
These economies arise within the firm and help the firm
only.
• External economies – these are the benefits that each
member firm of the industry accrues due to the expansion
of the entire industry.
101. Internal Diseconomies and Economies
of Scale
• While studying returns to scale, we observed that they
increase during the initial stages, remain constant for a
while, and then start decreasing. The reason is simple –
initially, the firm enjoys internal economies of scale and
after a certain limit, it suffers from internal diseconomies
of scale.
103. Concept of Market Structure
A market is a place where parties can gather to facilitate
the exchange of goods and services. The parties involved
are usually buyers and sellers. The market may be physical
like a retail outlet, where people meet face-to-face, or
virtual like an online market, where there is no direct
physical contact between buyers and sellers.
104. Characteristics of Market
1. One commodity
In practical life, a market is understood as a place where
commodities are bought and sold at retail or wholesale
price.
2. Area
In economics, market does not refer only to a fixed
location. It refers to the whole area or region of operation of
demand and supply.
3. Buyers and Sellers:
To create a market for a commodity what we need is only a
group of potential sellers and potential buyers. They must
be present in the market of course at different places.
105. These all types of market having
different kind of practices to mechanism
the Price
There are two major types of market,
Monopoly is the separate market
Its is the important part for the price and
out-put decision
Types of Market
Imperfect Competition
Monopolistic
Competition Oligopoly Market
Perfect Market
Perfect
Competition
Market
Types of Market
106. Perfect competition market
Perfect competition is a type of market structure where all
companies or firms are selling the same product, and because of
having no control over their product prices, they tend to be price
takers. In this market, consumers have full or perfect knowledge
about the product that is on sale.
1. They know what firm charges what price for a specific
product. There is a perfect mobility in terms of resources
including labor, and there are no barriers to entry and exit
involved for such firms.
2. Perfect competition refers to a particular type of market
model that involves a huge number of buyers and sellers
having perfect or complete information of homogenous
products.
3. Perfect competition and monopoly are completely in contrast
to each other.
4. Real markets prevail beyond the boundaries of perfect
competition market, and hence are referred to as imperfect.
107. Characteristics of perfect competition
market
1. A Large Number of Buyers and Sellers
2. An Identical or a Homogeneous Product
3. No Individual Control Over the Market Supply and
Price
4. No Buyers’ Preferences
5. Perfect Knowledge
6. Perfect Mobility of Factors
7. Free Entry and Free Exit of Firms
8. Absence of Transport Cost and a Close Contact
between Buyers and Sellers
108. Firm and industry equilibrium
Conditions of Equilibrium of the Firm and Industry:
A firm is in equilibrium when it has no tendency to change its
level of output. It needs neither expansion nor contraction. It
wants to earn maximum profits in by equating its marginal cost
with its marginal revenue, i.e. MC = MR.
Diagrammatically, the conditions of equilibrium of the firm
are:
(1) The MC curve must equal the MR curve. This is the first
order and necessary condition. But this is not a sufficient
condition which may be fulfilled yet the firm may not be in
equilibrium.
109. Diagrammatically, the conditions of
equilibrium of the firm are:
(2) The MC curve must cut the MR curve from below and after the point of
equilibrium it must be above the MR. This is the second order condition.’
Under conditions of perfect competition, the MR curve of a firm coincides with
the AR curve. The MR curve is horizontal to the X- axis. Therefore, the firm is
in equilibrium when MC=MR=AR (Price).
110. Conditions
The second condition implies the equality of MC and MR.
Under a perfectly competitive industry these two conditions
must be satisfied at the point of equilibrium, i.e.
MC = MR … (1)
AC = AR … (2)
AR = MR
MC = AC = AR
111. Short-Run Equilibrium of the Firm and
Industry
A firm is in equilibrium in the short-run when it has no
tendency to expand or contract its output and wants to earn
maximum profit or to incur minimum losses.
The short-run is a period of time in which the firm can vary
its output by changing the variable factors of production.
The number of firms in the industry is fixed because neither
the existing firms can leave nor new firms can enter it.
112. Assumptions
1. All firms use homogeneous factors of production.
2. Firms are of different efficiency.
3. Cost curves of firms vary from each other.
4. All firms sell their products at the same price determined
by demand and supply of the industry so that the price of
each firm, P (Price) = AR = MR.
5. Firms produce and sell different quantities.
The short-run equilibrium of the firm can be explained with
the help of marginal analysis and total cost- total revenue
analysis.
113. Monopoly Market
1. Single supplier
A monopolistic market is regulated by a single supplier. Hence,
the market demand for a product or service is the demand for
the product or service provided by the firm.
2. Barriers to entry and exit
Government licenses, patents, and copyrights, resource
ownership, decreasing total average costs, and significant
startup costs are some of the barriers to entry in a monopolistic
market.
3. Profit maximizer
In a monopolistic market, the company maximizes profits. It can
set prices higher than they would’ve been in a competitive
market and earn higher profits. Due to the absence of
competition, the prices set by the monopoly will be the market
price.
114. Monopoly market
4. Unique product
In a monopolistic market, the product or service provided
by the company is unique. There are no close substitutes
available in the market.
5. Price discrimination
A company that is operating in a monopolistic market can
change the price and quantity of the product or service.
Price discrimination occurs when the company sells the
same product to different buyers at different prices.
115. A Firm’s Short-Run Equilibrium in
Monopoly
Like in perfect competition, there are three possibilities for
a firm’s Equilibrium in Monopoly. These are:
1. The firm earns normal profits – If the average cost = the
average revenue
2. It earns super-normal profits – If the average cost < the
average revenue
3. It incurs losses – If the average cost >
the average revenue
116. Normal Profits
A firm earns normal profits when the average cost
of production is equal to the average revenue for the
corresponding output.
117. Super-normal Profits
A firm earns super-normal profits when the
average cost of production is less than the
average revenue for the corresponding
output.
Losses
A firm earns losses when the
average cost of production is
higher than the average
revenue for the
corresponding output.
118. Price Discrimination
Price discrimination refers to a pricing strategy that charges
consumers different pri
Advantages of Price Discrimination
Advantages of this pricing strategy can be viewed from the
perspective of both the firm and the consumer:
• Profit maximization: The firm is able to turn consumer surplus
into producer surplus. In a first-degree price discrimination
strategy, all consumer surplus is turned into producer surplus. It
also ties into survivability, as smaller firms are able to better
survive if they are able to offer different prices in times of
greater and lower demand.
• Economies of scale: By charging different prices, sales
volume is likely to increase. As a result, firms can benefit from
increasing their production towards capacity and
utilizing economies of scale.
119. Different Types of Price Discrimination
1. First Degree Price Discrimination
Also known as perfect price discrimination, first-degree price
discrimination involves charging consumers the maximum price
that they are willing to pay for a good or service. Here, consumer
surplus is entirely captured by the firm.
2. Second Degree Price Discrimination
Second-degree price discrimination involves charging
consumers a different price for the amount or quantity
consumed.
3. Third Degree Price Discrimination
Also known as group price discrimination, third-degree price
discrimination involves charging different prices depending on a
particular market segment or consumer group. It is commonly
seen in the entertainment industry.
120. Monopolistic competition market
1. A Large number of sellers and buyers: There are a
large number of buyers in the market. All buyers have
their unique preferences. These buyers are divided into
selling companies based on their preferences.
2. Different prices of products: For example, a leather
jacket made by the PUMA brand can cost up to $400,
while a good locally produced leather jacket can cost
less than $50. Therefore, in monopolistic competition,
the same product can have different prices.
3.
121. Monopolistic competition market
3. Seller control over the Price of the Product, but not
over the Market: A seller has control over the price of the
products produced by his company. For example, the PUMA
brand sells its jackets at high prices for its brand name.
4. Product Variation: Product variation is an essential feature
of monopolistic competition. For example, different tea brands
like Tata Tea, Society Tea, and Brooke Bond Taj Mahal Tea
sell tea at different prices by promoting different
characteristics of the tea.
5. Freedom of Entry and Exit: Take the example of a coffee
shop in a shopping mall. People enjoy coffee as long as it
provides services to people. But, if one day for some reason
the owner of the coffee shop wants to close the business.
122. Short Run equilibrium
Monopolistic competition has a downward sloping demand
curve. Thus, just as for a pure monopoly, its marginal
revenue will always be less than the market price, because
it can only increase demand by lowering prices, but by
doing so, it must lower the prices of all units of its product.
Hence, monopolistically competitive firms maximize profits
or minimize losses by producing that quantity where
marginal revenue = marginal cost, both over the short run
and the long run.
123. Long Run Equilibrium of Monopolistic
Competition:
In the long run, a firm in a monopolistic competitive market
will product the amount of goods where the long run
marginal cost (LRMC) curve intersects marginal revenue
(MR). The price will be set where the quantity produced
falls on the average revenue (AR) curve. The result is that
in the long-term the firm will break even.
124. Product Differentiation
The product differentiation process may be as simple as
redesigning of packaging to introducing a brand new
functional feature in a product. The different factors through
which the process is implemented include:
1. Price differentiation
Products in the market are differentiated solely on the price
factor. This establishes a price hierarchy for a particular
product from lower to higher costs.
2. Non-price differentiation
Products, in this case, are differentiated by form, shape,
feature, function, color, customization, durability, quality,
services, etc.
125. Types of Product Differentiation
1. Vertical Differentiation
Vertical differentiation focuses on differentiation in a
product based on quality. In any market, a quality hierarchy
exists for a particular type of product that ranks products of
one kind from a position of low quality to the highest quality
product.
2. Horizontal Differentiation
Horizontal differentiation is when products are differentiated
according to a specific feature. The differentiation can be
about colors, packaging, shapes, flavors, etc.
126. Oligopoly Market
An oligopoly is a market structure with a small number of
firms, none of which can keep the others from having
significant influence. The concentration ratio measures the
market share of the largest firms.
Oligopolist do not compete with each other. Instead, they
collaborate on various fronts, such as economies of scale,
market demand, and product differentiation. Also, they
rely on free-market forces to earn higher profits than a
competitive market.
127. Types of Oligopoly
1. Pure or Perfect Oligopoly: If the firms in an oligopoly market
manufacture homogeneous products, then it is known as a pure
or perfect oligopoly. Even though it is rare to find oligopoly firms
with homogeneous products, industries like steel, cement,
aluminum, etc., come under pure oligopoly.
2. Imperfect or Differentiated Oligopoly: If the firms in an
oligopoly market manufacture differentiated products, then it is
known as an imperfect or differentiated oligopoly. For
example, talcum powders are produced by different firms and
have differentiated characteristics, yet all the talcum powders are
close substitutes for each other.
3. Collusive Oligopoly: Collusive Oligopoly, also known
as Cooperative Oligopoly, is a market where different firms
cooperate with each other to determine the output or price, or
both price and output of products.
4. Non-Collusive Oligopoly: If the firms in an oligopoly market
compete with each other, then it is known as a Non-Collusive
Oligopoly.
128. Features of Oligopoly
1. Few Firms
2. Non-Price Competition
3. Interdependence
4. Barriers to Entry of Firms
5. Role of Selling Costs
6. Nature of the Product
7. Group Behaviour
8. Intermediate Demand Curve
129. Collusive Oligopoly Model: Price
Leadership Model
Collusive oligopoly is a form of the market, in which there
are few firms in the market and all of them decide to avoid
competition through a formal agreement.
They collude to form a cartel, and fix for themselves an
output quota and a market price. Sometimes a leading firm
in the market is accepted by the cartel as a price leader.
Members of the cartel accept the price as fixed by the price
leader.
130. Features of oligopoly are as below:
(i) Few Firms: A few firms, but large in size, dominate the
market for a commodity. Each firm commands a significant
share of the market and can impact market price of the
product through its independent price-output policy.
(ii) Barriers to the Entry of Firms: There are various barriers
to the entry of new firms. These barriers are almost similar
to those under monopoly. Patenting is the most important
form of entry-barrier. Entry of the new firms is extremely
difficult, if not impossible.
131. Non-Collusive Oligopoly: Sweezy’s
Kinked Demand Curve Model
One of the important features of oligopoly market is price
rigidity. And to explain the price rigidity in this market,
conventional demand curve is not used. The idea of using
a non-conventional demand curve to represent non-
collusive oligopoly was best explained by Paul Sweezy in
1939. Sweezy uses kinked demand curve to describe price
rigidity in oligopoly market structure.
The kink in the demand curve stems from the asymmetric
behavioural pattern of sellers. If a seller increases the price
of his product, the rival sellers will not follow him so that the
first seller loses a considerable amount of sales.
132. Sweezy’s Kinked Demand Curve Model
The MR curve has two segments :
At output less than OQ the MR curve (i.e.,
dA) will correspond to DE portion of AR
curve, and, for output larger than OQ, the
MR curve (i.e., BMR) will correspond to the
demand curve ED. Thus, discontinuity in
MR curve occurs between points A and B.
In other words, between these two points,
MR curve is vertical.
Equilibrium is achieved when MC curve
passes through the discontinuous portion
of the MR curve. Thus the equilibrium
output is OQ, to be sold at a price OP.
