All about economics basic

1. Supply
• Indicates the quantities of a good or service that the
seller is willing and able to provide at a price, at a given
point of time, other things remaining the same.
• Supply of a product X (Sx) depends upon:
– Price of the product (Px)
– Cost of production (C)
– State of technology (T)
– Government policy regarding taxes and subsidies (G)
– Other factors like number of firms (N)
• Hence the supply function is given as:
Sx = (Px, C, T, G, N)

2. Law of Supply
 Law of Supply states that other things remaining the same, the
higher the price of a commodity the greater is the quantity supplied.
 Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the
incentive to supply.
 Supply bears a positive relation to the price of the commodity.
Point on
Supply
Curve
Price
(Rs. Per
cup)
Supply (‘000
cups per
month)
a 15 10
b 20 20
c 25 30
d 30 45
e 35 60
Supply Schedule
c
e
d
Supply Curve
10 20 30 40 50 60
20
15
35
30
25
Quantity of Coffee
0
b
a

3. Change in Supply
 Shift in the supply curve from
• S0 to S1
 More is supplied at each
• price (Q1>Q0)
 Increase in supply caused by:
S2
S1
S0
Price
Quantity
O
 Improvements in the
technology
 Fall in the price of inputs
 Shift in the supply curve from
S0 to S2
 Less is supplied at each
price (Q2<Q0)
 Decrease in supply caused by:
 A rise in the price of inputs
 Change in government
policy (VAT)
Q2
P
Q0 Q1

4. Market Equilibrium
D
 Equilibrium occurs at the price where the quantity demanded and
the quantity supplied are equal to each other.
 At point E demand is equal to supply hence 25 is equilibrium price
Price
S
Quantity
O
25
E
30
Price
(Rs)
Supply
(‘000 cups/
month)
Demand
(‘000 cups/
month)
15 10 50
20 15 40
25 30 30
30 45 15
35 70 10

5. Let’s Analyze
Imagine that there is a drought in the nation. Discuss the
possible implications of drought on the demand and
supply of food grains in the nation.

6. Let’s Analyze
Suggest the impact of a liberal monetary policy on supply
of the goods in an economy.

7. Market Equilibrium
Quantity
O
30
Price
(Rs)
Supply
(‘000 cups/
month)
Demand
(‘000 cups/
month)
15 10 50
20 15 40
25 30 30
30 45 15
35 70 10
 For prices below the equilibrium, Quantity demanded exceeds
quantity supplied (D>S)
– Price pulled upward
 For prices above the equilibrium, Quantity demanded is less than
quantity supplied (D<S)
– Price pulled downward.
 At point E demand is equal to supply hence 25 is equilibrium price.
Price
S
30
E
25
20
D

8. Changes in Market
Equilibrium
(Shifts in Supply Curve)
E2
S2
S2
E
D1
D1
S1
S1
Price
Quantity
O
E0
P0
P
P2
Q0 Q Q2
S0
S0

9. Q1
E1
D2
Q*
E2
Changes in Market Equilibrium
(Shifts in Demand Curve)
D0
D1
D0
D1
S1
S1
Price
D2
Quantity
O
E
P1
P
P*
Q

10. Change in Both Demand
and Supply
P2
Q2
E2
S2
D1
D1
Quantity
Price
O
S1
S2
S1
D2
D2
Q1
P1 E1
D2
D2
E0

11. Elasticity of Demand
• Mathematically, it is the percentage change in
quantity demanded of a commodity to a percentage
change in any of the (independent) variables that
determine demand for the commodity.
• Four major types of elasticity:
– Price elasticity,
– Income elasticity,
– Cross elasticity
– Advertising (or promotional) elasticity.

12. Price Elasticity of Demand
•Price elasticity of demand means the sensitivity of
quantity demanded of a commodity to a given
change in its own price.

13. Slope of demand curve is used to display
price elasticity of demand
Perfectly elastic demand
• ep=∞ (in absolute terms).
• Horizontal demand curve
• Unlimited quantities of the commodity can
be sold at the prevailing price
• A negligible increase in price would result
in zero quantity demanded
• Perfectly inelastic demand
• The other extreme of the elasticity range
• ep=0 (in absolute terms)
• Vertical demand curve
• Quantity demanded of a commodity
remains the same, irrespective of any
change in the price
• Such goods are termed neutral.
Degrees of Price
Elasticity
Price
Quantity
O
P D
Q1
Q2
Price
Quantity
O
P1
P2
D
Q1

14. Degrees of Price
Elasticity
Highly elastic demand
• Proportionate change in quantity
demanded is more than a given change
in price
• ep >1 (in absolute terms)
• Demand curve is flatter
Unitary elastic demand
• Proportionate change in price brings
about an equal proportionate change in
quantity demanded
p
• e =1 (in absolute terms).
• Demand curves are shaped like a
rectangular hyperbola, asymptotic to the
axes
Relatively inelastic demand
• Proportionate change in quantity
demanded is less than a proportionate
change in price
p
• e <1 (in absolute terms)
• Demand curve is steep
Price
O
D
D
Q2 Quantity
Q1
P1
P2
Quantity
Price D
O
D
P1
Q1 Q2
P2
Price
Quantity
O
P1
P2
Q1 Q2
D
D
Contd.

15. • Nature of commodity
• Availability and proximity of substitutes
• Alternative uses of the commodity
• Proportion of income spent on the commodity
• Time
• Durability of the commodity
• Items of addiction
Determinants of Price Elasticity
of Demand

16. Income Elasticity of Demand
(ey)
• ey measures the degree of responsiveness of demand
for a good to a given change in income, ceteris paribus.
• Degrees:
– Positive income elasticity
• Demand rises as income rises and vice versa
• Normal good
– Negative income elasticity
• Demand falls as income rises and vice versa
• Inferior good
Proportionate change in income of consumer
=
Proportionate change in quantity demanded of commodity X
ey

17. Cross Elasticity of
Demand
• ec measures the responsiveness of demand of
one good to changes in the price of a related
good
• Degrees
– Negative Cross Elasticity
• Complementary goods
– Positive Cross Elasticity
• Substitute goods
Proportionate change in price of commodity Y
=
Proportionate change in quantity demanded of commodity X
ec

18. • Degrees
– Zero Cross Elasticity

19. Promotional Elasticity of
Demand
• Advertising (or promotional) elasticity of demand (ea) measures the
effect of incurring an “expenditure” on advertising, vis-à-vis an
increase in demand, ceteris paribus.
• Some goods (like consumer goods) are more responsive to
advertising than others (like heavy capital equipments).
• Degrees
– ea>1
• Firm should go for heavy expenditure on advertisement.
– ea <1
• Firm should not spend too much on advertisement
Proportionate change in advertising expenditure
=
Proportionate changein quantity demanded (or sales) of commodity X
ea

20. Importance of Elasticity
• Determination of price
• Basis of price discrimination
• Determination of rewards of factors of production
• Government policies of taxation

21. Thank You