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MANAGERIAL ECONOMICS 10. Entrepreneur

Often considered as the fourth factor of
2. Management production, he or she is the one who combines or
It deals with principles which help in organizes the other factors of production by
decision making under uncertainty and improve introducing both new products and new ways of
effectiveness of organization. making old products. (When it is not distinguished
as a fourth factor, entrepreneurship is included
3. Economics under labor.)
It provides a set of propositions for optimum
allocation of scarce resources to achieve the 11. Commodities
desired objectives. These are the things that are produced by
the factors of production.
4. Managerial Economics
It deals with the integration of economic Types of Commodities
theory with business practice for the purpose of
facilitating decision making and forward planning 13. Goods
by management. These are those commodities that are
tangible (e.g., food grains, cars, shoes, etc.).
5. Scope of Managerial Economics
14. Services
a. Demand analysis and forecasting These are those commodities that are
b. Production function intangible (e.g., transportation, haircut, internet,
c. Cost analysis etc.).
d. Inventory management ***
e. Advertising
f. Price system 15. Gross National Product
g. Resource allocation It refers to the total output of all
h. Capital budgeting commodities in one country over some period,
usually taken as a year.
Factors of Production
16. Economic Problem
7. Land
It consists of all those free gifts of nature, a. Human needs and wants are unlimited
such as land, forests, minerals, etc., commonly and vary in their intensity.
called natural resources. b. Means or resources are relatively limited
and they have alternative uses.
8. Labor c. But if these means are used to satisfy
It refers to all human resources, mental and one want, the same means cannot be
physical, both inherited and acquired. used to satisfy another want.

9. Capital 17. Seven Questions Faced by All Economies

It includes all those man-made aids to
further production, such as tools, machinery, plant
and equipment, including everything man-made
which is not consumed for its own sake but is used
in the process of making other goods and services.
***
a. What commodities are being produced
and in what quantities?
b. By what methods are these commodities
produced?
c. How is society’s output of goods and
services divided among its members?

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d. How efficient is the society’s production
and distribution?
e. Are the country’s resources being fully
utilized, or are some of them lying idle?
f. Is the purchasing power of money and
savings constant, or is it being eroded
because of inflation?
g. Is the economy’s capacity to produce
goods and services growing from year to
year or is it remaining static?
18. Firm
a. It is defined as an independently
administered business unit.
b. It is a center of control where the
decisions about what to produce and
how to produce are taken.
c. It is a business unit which hires
productive resources for the purpose of
producing goods and services.
19. Competitive Industry
It is characterized by the following:
a. Large number of firms;
b. Homogeneous product; and
c. Freedom of entry and exit.
20. Plant
It is a technical unit of a given capacity of
output (e.g., sugar plant). Unlike a firm, it is not
considered as an economic unit. It is not involved in
deciding about the quality and quantity of product
to be produced, the market to which it should be
sold, and the suppliers from which the raw materials
should be purchased.
21. Types of Business Organizations
a. Sole proprietorship
b. Partnership
c. Corporation
22. Private Sector
It is owned by private individuals, families or
groups of individuals. It is characterized by private
ownership in the means of production, economic
freedoms and profit motive.
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23. Public Sector
It includes public or state enterprises like
railways. It is owned and controlled by the State.
24. Cooperative Sector
It is considered as part of the private sector
but is characterized for its non-capitalist nature
(e.g., cooperative credit societies, consumers’
cooperative societies, etc.).
25. Joint Sector
It refers to organizations or enterprises that
are jointly owned by the public and private sectors,
but day-to-day management is usually left to the
private sector.
26. Accounting Profit
It is the surplus of revenue over and above
all paid-out costs, including manufacturing and
overhead expenses.
Accounting profit = Total revenue – (Wages
+ Rent + Interest + Cost of materials + Other explicit
costs)
27. Economic Profit or Pure Profit
It is a return from the sale of an output over
and above the costs of all inputs used and any
opportunity costs.
Economic profit = Total revenue – (Explicit
costs + Implicit costs)
28. Opportunity Cost
It is defined as the income foregone, which
is the income a businessman could expect from the
second best alternative use of his resources.
29. Gross Profit
It is the residual portion when cost of
production is deducted from the total sales
proceeds.
30. Net Profit
It is the residual portion when the following
payments are made out of gross profit:
a. Remuneration for the factors of
production contributed by the
entrepreneur himself (e.g., rent, cost of
materials, etc.);
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b. Depreciation and maintenance charges;
c. Monopoly profits; and
d. Chance profits.
31. Monopoly Profits
These are profits earned by a producer not
because of the business skill or ability of the
entrepreneur, but because he is a monopolist in the
field.
32. Chance Profits
These are profits earned by an entrepreneur
just by chance (e.g., because of an outbreak of war).
33. Profit Expectation Criteria
a. The rate of profit should be sufficient to
attract share capital if felt necessary;
b. The rate of profit should be comparable
to that in similar companies;
c. The profit rate should be comparable to
the profit rates in the past; and
d. The profits should be large enough to
allow for a plough-back for business
expansion.
34. Demand
It is the quantity of a good that consumers
are willing and able to purchase at various prices
during a given period of time.
36. Factors Influencing Individual Demand
a. Price of the Product – The higher the
price, the lower the quantity demanded.
b. Income – The higher the income of
individuals, the more goods are
demanded.
c. Tastes and habits
d. Relative prices of substitute goods –
The higher the price of the substitute
good A, the more demand is generated
for substitute good B.
e. Relative prices of complementary goods
– The higher the price of complementary
good A, the less demand is generated for
complementary good B.
f. Consumer’s expectations – An
expectation for future increase in price
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of a certain good increases the its
current demand.
g. Advertisement effect
37. Substitute Products
These are products that a consumer
perceives as similar or comparable, so the having
more of one good causes the consumer to desire
less of the other good (e.g., tea and coffee).
38. Complementary Products
These are goods needed to be used in
combination in order to satisfy a given want (e.g.,
car and petrol).
39. Factors Influencing Market Demand
a. Price of the product
b. Distribution of income and wealth in the
community
c. Community’s common habits and scale
of preferences
d. General standards of living and
spending habits of the people
e. Number of buyers in the market and the
growth of population
f. Age structure and sex ratio of the
population
g. Future expectations
h. Level of taxation and tax structure
i. Inventions and innovations
j. Fashions
k. Climate or weather conditions
l. Customs
m. Advertisement and sales propaganda
40. Demand Schedule
It is a tabular statement that narrates how
much amount of a commodity is demanded by an
individual or a group of individuals in the market at
alternative prices, per unit of time.
41. Demand Curve
It is a downward sloping curve (from left to
right) serving as a graphical presentation (quantity
demanded for the x-axis and price per unit for the
y-axis) of a demand curve. It has a negative slope
representing an inverse relationship between price
and demand.
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42. Law of Demand on the contrary, they may purchase more for the
Other things being equal (ceteris paribus), purpose of hoarding (e.g., stocks traded in the stock
the higher the price of a commodity, the smaller is exchange market).
the quantity demanded and the lower the price, the
larger is the quantity demanded. 48. Consumers’ Psychological Bias or Illusion
Some sophisticated consumers do not buy
43. Assumptions Underlying the Law of Demand when there is a stock clearance sale at reduced
prices, thinking that the goods may be of bad
a. No change in consumer’s income quality.
b. No change in consumer’s preferences
c. No change in fashion 49. Expansion/Extension and Contraction of
d. No change in the prices of related goods Demand
e. No expectations of future price changes These terms refer to the changes in the
or shortages quantity demanded within the same demand curve
f. No change in size, age-composition and (i.e., because of an increase or decrease in price
sex ratio of the population alone).
g. No change in the range of goods
available to the consumers (no invention a. Expansion or extension – increase in
or innovation) quantity demanded due to price
h. No change in the distribution of income decrease.
and wealth of the community b. Contract – decrease in quantity
i. No change in government policy demanded due to price increase.
j. No change in weather conditions
50. Increase and Decrease in Demand
Exceptions to the Law on Demand These terms refer to changes in demand due
to causes other than price. These changes result in
45. Giffen Goods the shifting of the demand curve.
In the case of these certain inferior goods,
when the price falls, quite often less quantity will be a. Increase in demand – shift of the
purchased than before because of the negative demand curve to the right.
income effect and people’s increasing preference b. Decrease in demand – shift of the
for a superior commodity with the rise in their real demand curve to the left.
income (e.g., cheap potatoes, cheap bread, pucca
rice, etc.). 51. Reasons for Increase or Decrease in Demand
Factor Relationship with
46. Articles of Snob Appeal Demand
These are certain commodities that are Change in income Direct – as the income
demanded just because they happen to be of consumers increase,
expensive or prestige goods. These are generally demand for the product
ostentatious articles, and purchased only by rich increases
people for using them as ‘status symbols.’ Thus, Change in the pattern Varies depending on
when prices of such articles rise, their demand also of income distribution the product
rises (e.g., diamonds, Rolls Royce cars, Johney Change in tastes, Varies depending on
Walker Scotch Whiskey, etc.). habits and preferences the product
Change in fashion and Varies depending on
47. Speculation customs the product
When people are convinced that the price of Change in the supply of Inverse – as the supply
a particular commodity will still rise further, they will the substitutes of substitutes increase,
not contract their demand with the given price rise;

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the demand for main
product may decrease
Change in the prices of Direct – as the prices of
substitutes substitutes increase,
the demand for main
product increases
Change in the supply of Direct – as the supply
complementary goods of complementary
goods increase, the
demand for main
product increases
Change in the prices of Inverse – as the prices
complementary goods of complementary
goods increase, the
demand for main
product decreases
Change in population Direct – as the
population increase,
the demand increases
Advertisement and Varies depending on
publicity persuasion the product
52. Elasticity
It refers to the extent of variation in one item
in response to changes in a related factor.
53. Price Elasticity of Demand
It refers to the degree of responsiveness of
demand for a commodity to a given change in its
price.
54. Formula for Price Elasticity of Demand
a. Price elasticity of demand = Percentage
change in quantity demanded /
Percentage change in price
b. Percentage change in quantity
demanded = Net change in quantity
demanded / Original quantity demanded
c. Percentage change in price = Net change
in price / Original price
Types of Price Elasticity of Demand
56. Perfectly Elastic Demand (e = ∞)
This is the case when the demand is infinite
at the given price (horizontal demand curve). With a
slight rise in the price of the commodity, the
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consumers stop buying it (e.g., demand for the
product of a firm in a perfectly competitive market).
57. Perfectly Inelastic Demand (e = 0)
This is the case when the demand for a
commodity shows no response at all to a change in
price (vertical demand cure). Commodities of
absolute necessity seem to have this type of
elasticity (e.g., salt).
58. Relatively Elastic Demand (e > 1)
This is the case when the proportion of
change in the quantity demanded is greater than
that of price. The numerical value of this type of
elasticity lies between one (1) and infinity. It is
represented by a gradually sloping (flatter) demand
curve.
59. Relatively Inelastic Demand (e < 1)
This is the case when the proportion of
change in the quantity demanded is less than that
of price. The numerical value of this type of
elasticity lies between zero (0) and one (1). It is
represented by a rapidly sloping (steeper) demand
curve.
60. Unitary Elastic Demand (e = 1)
This is the case when the proportion of
change in demand is exactly the same as the
change in price. The numerical value of this type of
elasticity is exactly 1. It is represented by a
rectangular hyperbola asymptotic to the two axes.
***
61. Factors Influencing Price Elasticity of Demand
a. Nature of commodity – Luxury and
comfort goods are relatively elastic and
necessary goods are relatively inelastic.
b. Availability of a substitute – Where there
exists a close substitute in the relevant
price range, demand will tend to be
elastic.
c. Number of uses – Single-use goods will
have generally elastic demand as
compared to multi-use goods (e.g.,
electricity).
d. Consumers’ income – The larger the
income of a consumer, his demand for
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overall commodities tends to be
relatively inelastic (e.g., the demand
pattern of a millionaire is rarely affected
even by significant price changes).
e. Being a luxury item – A small change in
price of luxury items will have an
insignificant effect on their demand
(inelastic).
f. Being sold in bulk – Things sold in bulk
(e.g., potatoes, onions, etc.) tend to have
price inelastic demand.
g. Proportion of expenditure – Items that
constitute a smaller amount of
expenditure in a consumer’s family
budget tend to have a relatively inelastic
demand (e.g., cinema tickets).
h. Durability of the commodity – In the
short run, demand for durable goods
tends to be inelastic (e.g., furniture,
motor cycles, T.V. sets, etc.).
i. Influence of habit and customs –
Articles which have a demand on
account of conventions, customs or
habit tend to have less elasticity (e.g.,
cigarettes to a smoker, alcohol to an
alcoholic, wedding dress, etc.).
j. Time – In the short period, demand will
be less elastic, while in the long period, it
becomes more elastic.
k. Recurrence of demand – Commodities
purchased more often (e.g., cassettes,
compact disks, etc.) have a more price
elastic demand than that of
commodities purchased only once (e.g.,
T.V. sets).
l. Possibility of postponement – When the
demand for a product is postponable
(e.g., jewelry), it will tend to be price-
elastic than those goods which are
urgently or immediately required (e.g.,
life-saving drugs).
62. Income Elasticity of Demand
It refers to the degree of responsiveness of
demand for a commodity to a given change in the
income of the consumers.
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63. Formula for Income Elasticity of Demand
a. Income elasticity of demand =
Proportionate change in quantity
demanded / Proportionate change in
consumers’ income
b. Proportionate change in quantity
demanded = Change in quantity
demanded / Original quantity
demanded
c. Proportionate change in consumers’
income = Change in consumers’ income
/ Original consumers’ income
Types of Income Elasticity of Demand
65. Negative Income Elasticity (ey < 0)
This is the case when the demand for a
product decreases as income increases and
conversely where demand for a product increases
as there is fall in income, the elasticity of demand is
negative (e.g., demand for inferior goods).
66. Zero Income Elasticity (ey = 0)
This is the case when a change in income
has no effect upon the quantity demanded of a
product (e.g., demand for salt).
67. Unit Income Elasticity (ey = 1)
This is the case when the demand for the
product increases in the same proportion in which
income increases. It is considered to be a dividing
line between necessaries and comforts. In other
words, the income elasticity of demand for
necessaries will be less than unity; while the income
elasticity of demand for comforts will be more than
unity.
68. Low Income Elasticity (ey >0, ey < 1)
This is the case when the income elasticity
of demand for a product is positive but less than
one (1). It suggests that the commodity concerned
must be a necessary. This is because as income
increases the percentage of income spent on
necessaries goes on diminishing (e.g., salt).
69. High Income Elasticity (ey > 1)
This is the case for products which satisfy
the consumers’ comforts and luxuries. In other
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words, the income elasticity of demand for articles
of comforts and luxuries is greater than unity (e.g.,
precious stones).
70. Cross Elasticity of Demand
It refers to the responsiveness of demand
for a commodity to a given change in the price of a
related commodity – substitute or complementary
product.
71. Formula for Cross Elasticity of Demand
a. Cross elasticity of demand = Percentage
change in quantity demanded of product
“X” / Percentage change in the price of
product “Y”
b. Percentage change in quantity
demanded of product “X” = Change in
quantity demanded of product “X” /
Original quantity demanded of product
“X”
c. Percentage change in the price of
product “Y” = Change in price of product
“Y” / Original price of product “Y”
72. Cross Elasticity of Demand for Substitute
Commodities
A positive cross elasticity of demand
between two products asserts that these are
substitute commodities. An increase in the price of
product “Y” leads to the increase in the demand of
product “X” (e.g., Playstation and Xbox).
73. Cross Elasticity of Demand for Complementary
Commodities
A negative cross elasticity of demand
between two products asserts that these are
complementary commodities. An increase in the
price of product “Y” not only leads to the decrease
in the demand of product “Y” but also results in the
decrease in the demand of product “X” (e.g., refills
and ball-point pens).
74. Forecast
It is a guess or anticipation or a prediction
about any event which is likely to happen in the
future. It is made either through experience or
through statistical methods.
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75. Demand Forecast
It refers to the prediction of future demand
for a firm’s product or products.
76. Purpose of Demand Forecasting
a. Fulfillment of objective of the plans
b. Preparation of a budget
c. Stabilization of employment and
production
d. Expansion of firms
Time Period of Demand Forecasts
78. Short-Period Forecasts
a. Period – one (1) year
b. Basis – judgment of experienced staff of
the firm.
c. Sales promotion policies of the firm or
the tax policies of the government rarely
change.
d. Importance – for deciding the
production policy, price policy, credit
policy and marketing and distribution of
the firm’s product.
79. Long-Period Forecasts
a. Period – five (5) to ten (10) years
b. Basis – scientific analysis and
statistical methods
c. Importance – for deciding about
whether a new factory is to be
established, a new product can be
introduced, or capital needs are to be
raised.
80. Very-Long Period Forecasts
a. Period – over ten (10) years
b. Basis – secular factors like growth of the
population, development of the
economy, the political situation in the
country, and the changes in the
international trade; and sociological
factors like age of marriage, changes in
traditions.
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81. Levels of Forecasts
a. Firm – forecasts for the sales of its
products.
b. Industry – prepared by the trade
association and are based on statistical
data and market survey.
c. Nation – based on indices such as
national income and national
expenditure.
82. General Forecast
It gives a total picture of the demand for all
the products of a firm or demand from all the
markets of the firm’s product.
83. Specific Forecasts
a. Product-specific forecasts – give the
forecasts of each of the products
produced by the firm.
b. Area-specific forecasts – give the
forecasts of each of the markets where
the firm markets its product.
84. Established Products
These are goods which are already
established in the market; information about these
goods is available: present demand, number of
substitutes, level of competition and markets.
85. New Products
These are those which are yet to be
introduced in the market; information about these
products is not known.
86. Demand Forecasting for Capital and Consumer
Goods
a. The demand for capital goods is derived
from the demand for the product
produced by them (highly fluctuating).
b. The demand for consumer goods
depends on the income of the
consumers as well as their price.
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87. Demand Forecasting for Durable Goods and
Perishable Goods
a. The demand for durable goods can be
postponed. Thus, if prices of these
goods increase, then the demand falls,
because people will postpone their
consumption of these goods (e.g.,
washing machines, refrigerators, etc.).
b. The demand for perishable goods
depends on the current incomes and
current demand (e.g., vegetables and
fruits).
Methods of Forecasting Demand for Established
Goods
89. Interview and Survey Approach
This forecasting method is used to
anticipate the expected sales of a commodity by
collecting information regarding the expected
expenditures of consumers. It is usually used for
short-period forecasts.
90. Projection Approach
This forecasting method projects past
experience into the future with the help of statistical
methods. In essence, past data is collected, a trend
is observed, then a functional relationship
(correlation) is established between the variables.
Once a relationship is established, it is possible to
project this into the future.
Methods of Forecasting Demand for New Products
92. Evolutionary Method
The forecast is based on the information
about the already established goods from the
concerned product evolved (e.g., colored T.V.’s
demand based on black and white T.V.’s demand).
93. Substitution Method
Since most new goods are substitutes of
already established goods, in this method, the
forecast can be based on the information about the
substitute (established) of the concerned product
(new).
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94. Opinion-Polling Method
The expected consumers/buyers are
directly contacted and their opinion about the new
product is gathered.
***
95. Index Number
It is a statistical device for measuring
differences in the magnitude of a group of related
variables over two different situations (e.g., two
different periods or two different places).
96. Price Index
It is a normalized average of price relatives
for a given class of goods or services in a given
region, during a given interval of time. It is a statistic
designed to help to compare how these price
relatives, taken as a whole, differ between time
periods or geographical locations.
97. Wholesale Price Index Numbers
It is an index that measures and tracks the
changes in the price of goods in the stages before
the retail level – that is, goods that are sold in bulk
and traded between entities or businesses instead
of consumers.
98. Retail Price Index
It is a measure of inflation which considers the
changes in the retail prices of a basket of goods and
services.
99. Consumer Price Index
It measures the weighted average prices of
the basket of goods and services consumed by
households.
100. Quantity Index
It expresses the relative average of the
volume of production in different sectors of an
industry. Thus, it permits comparison of the volume
of goods produce or distributed or consumed (e.g.,
industrial production index, agricultural production
index, etc.).
101. Production Function
It is the name given to the relationship
between the rates of input of productive resources
and the rate of output of a product.
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102. Aspects of the Production Function
a. The maximum quantity of output that
can be produced from any chosen
quantities of various inputs; and
b. The maximum quantities of various
input that are required to yield a given
quantity of output.
103. Total Physical Product
It is the total quantity of output produced in
physical units by a firm during a period of time.
104. Marginal Product
It is the change in total product caused as a
result of one additional unit of variable factor
employed in combination with fixed factors.
105. Formula for Marginal Product
Marginal product or MP = Change in total
product or TP / Change in variable factor units
106. Average Product
It is the total product that a firm produces in
a given time perioded divided by the quantity of a
variable factor that is used to produce it.
107. Formula for Average Product
Average product or AP = TP / Variable factor
units
Time Spans for Decision-Making for a Firm
109. Short Run
It is a period of time during which at least
one of the firm’s input cannot be varied.
110. Long Run
It is the period of time long enough to make
all the changes that a firm wants to make within
limits of existing or present production function
(i.e., everything else changes except level of
technology).
111. Very Long Run
It is the period of time long enough that the
whole new technology can be introduced and
production function itself is changed.
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112. Law of Diminishing Returns / Law of Variable
Proportion / Law of Returns
An increase in some inputs relative to other
fixed inputs will, in a given state of technology,
cause output to increase; but after a point the extra
output resulting from the same conditions of extra
inputs will become less and less.
Stages of the Law of Diminishing Returns
114. Stage 1 – Increasing Returns
In the beginning, the quantity of fixed factor
(e.g., machinery) is abundant relative to the quantity
of the variable factor (e.g., worker). As more and
more units of variable factors are added to constant
quantity of fixed factor then fixed gets more
intensively and effectively utilized and production
increases at a rapid rate.
115. Stage 2 – Diminishing Returns
The peculiar feature of this stage is that the
marginal product falls through out the stage and
finally touches to zero.
116. Stage 3 – Negative Returns
In this stage, marginal product falls below
“X” axis i.e., negative because total product starts
falling.
Exceptions to the Law of Diminishing Returns
118. New Methods of Cultivation
This law assumes no change in the
technique of production. Scientific rotation of crops,
better quality seeds, modern implements, fertilizers,
and better irrigation facilities, however are the
changes which take place in agriculture. The
marginal product under these conditions, will in fact
increase.
119. New Soil
When new land (soil) is brought under
cultivation, the marginal product will increase for a
time; thus the law of diminishing returns does not
operate in the beginning.
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Laws of Returns to Scale
121. Law of Increasing Returns to Scale
If the increase in all factors leads to more
than proportionate increase in output, returns to
scale are said to be increasing. Thus, if all factors
are doubled, the output increases by more than
double, then the returns to scale are increasing.
122. Law of Constant Returns to Scale
If we increase all factors of production (i.e.,
scale) in a given proportion and the output
increases in the same proportion, returns to scale
are said to be constant.
123. Law of Diminishing or Decreasing Returns to
Scale
If the increase in all factors leads to a less
than proportionate increase in output, returns to
scale are decreasing.
***
124. Diseconomies of Scale (Small-Scale
Production)
Any firm which is newly established
operates on a small scale in the initial stages. The
following are the implications of production on a
small scale:
a. A lot of time and resources are wasted in
erecting the factory thereby increasing
the total expenditure for the first year of
operations.
b. The workers appointed in the factory
take some time to adjust themselves to
the techniques of production. Till this
adjustment is made, there is lot of
wastage of raw materials and power.
c. In the initial stages, production is on a
small scale because the product is not
yet known in the market. The firm is not
sure whether the entire production
would be sold.
125. Economies of Scale
It is a proportionate saving in costs gained
by an increased level of production.
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Classification of Economies of Scale
127. Internal Economies
These are those advantages of large-scale
production which accrue to a firm on account of its
superior techniques and management.
126. External Economies
These occur if in a particular region, many
firms with superior technique and management are
concentrated and provide some common service
bringing several benefits for all the firms.
Classification of Internal Economies
128. Technical Economies
A firm that produces goods on a large scale
can install improved and up-to-date machinery,
thereby reducing the cost of production. It is also
possible in a big firm to avail the benefits of
specialization and division of labor resulting to
superior quality of goods produced.
129. Commercial Economies
A firm that produces on a large scale is
required to buy raw materials on a large scale. Bulk
buying enables a firm to procure the materials at a
lower cost through its strong bargaining power. It
can secure favorable credit terms from the
suppliers. It can also negotiate with transport
operators and secure concessional freight rates for
transportation of raw materials and finished
products.
130. Managerial Economies
A firm producing on a large scale can afford
to hire the services of experts in various fields such
as purchases, production, marketing and finance.
131. Financial Economies
A firm producing on a large scale can avail
the benefits of cheaper finance. A firm which has
acquired reputation and a high credit-rating can
raise new capital quickly, easily and on much
favorable terms.
132. Risk and Uncertainty
A firm which produces on a large scale can
earn large profits. It can build up huge reserves out
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of undistributed profits. Capacity of such a firm to
sustain losses is, therefore, big.
***
Diseconomies of Large-Scale Production
134; Internal Diseconomies
As a firm expands beyond a certain limit, it
becomes unmanageable and unwieldy.
a. The top executive may find it impossible
to look into evenly the broad functioning
of various departments.
b. Delegation of responsibilities and
decentralization of very large number of
works cannot be stretched too far.
c. A very large number of workers may
cause factions and groupism amongst
them.
135. External Diseconomies
a. Expansion of industry result to
overcrowding of industrial units in a
locality.
b. The competition among firms to secure
raw materials and other resources for
itself causes their prices to rise.
c. With the increase demand for resources,
additional resources which become
available are naturally of a lower quality
compared to those already employed
(e.g., best workers are selected first and
as more and more workers are required,
a firm has to appoint whosoever are
available rather than who are suited for
the work).
***
136. Supply
It means the quantities of goods which are
offered for sale at particular prices during a given
period of time. Thus, it may also be defined as the
amount of the commodity which the sellers (or
producers) are able and willing to offer for sale at a
particular price, during a certain period of time.
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137. Determinants of Supply
a. Price
b. Natural conditions (e.g., climatic
conditions like rainfall, temperature, etc.)
c. State of technology
d. Transport conditions
e. Prices and availability of factors of
production
f. Government’s policy
g. Cost of production
h. Prices of other products (e.g., effect of
change in price of wheat to the supply of
rice)
138. Law of Supply
Other things remaining unchanged (ceteris
paribus), the supply of a commodity expands with a
rise in its price and contracts with a fall in its price.
139. Exceptions to the Law of Supply
a. Supply of labor – It is observed that as
wages increase, a worker might work for
a lesser number of hours than before to
allow for more time for leisure.
b. Supply of savings – As the rate of
interest rises, the volume of investment
required to reach a specified earning
objective declines.
140. Expansion and Contraction in Supply
a. Expansion – It is the rise in the quantity
supplied in response to a rise in price.
b. Contraction – It is the fall in the quantity
supplied in response to a fall in price.
141. Increase and Decrease in Supply
These are the rise or fall in supply
forthcoming in the market due to causes other than
a change in price.
142. Causes of Change in Supply
a. Cost of production
b. Natural factors
c. Change in techniques of production
d. Policies of the Government
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e. Development of transportation
f. Business combines (i.e., reduction of
supply by entering into agreement
among producers with a view to raising
prices in the market)
143. Elasticity of Supply
It is defined as the ratio of the percentage
change or proportionate change in quantity
supplied to the percentage or proportionate change
in price.
144. Formula for Elasticity of Supply
a. es = Percentage change in quantity
supplied / Percentage change in price
b. Percentage change in quantity supplied
= Change in quantity supplied / Original
quantity supplied
c. Percentage change in price = Change in
price / Original price
Types of Elasticity of Supply
146. Perfectly Inelastic Supply (es = 0)
This is the case when a given quantity of a
commodity can be supplied whatever might be the
price. It is represented by a straight line parallel to
the Y-axis (e.g., supply of exclusive items like the
painting of Mona Lisa).
147. Relatively Inelastic Supply (es < 1)
This is the case when the change in supply
is relatively less when compared to the change in
price. It is represented by a relatively steeper supply
curve.
148. Relatively Elastic Supply (es > 1)
This is the case when the change in supply
is relatively more when compared to the change in
price. It is represented by a gradually sloping
(flatter) supply curve.
149. Unitary Elastic Supply (es = 1)
This is the case when the change in price
and supply of the commodity are proportionately
equal to each other.
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150. Perfectly Elastic Supply 153. Market
This is the case when the supply becomes It is a place or platform where buyers and
zero (0) with even a slight fall in the price and sellers meet each other to effect a business
becomes infinite with a slight rise in price. This is transaction.
indicative of the fact that the suppliers of such a
commodity are willing to supply any quantity of the 154. Classification of Markets Based on the Nature
commodity at a higher price. It is represented by a of Competition
straight line parallel to the X-axis.
Market
151. Factors Determining Elasticity of Supply

a. Nature of commodity Perfect Imperfect

• Tend to be inelastic – antiques, old
wines, old stamps, old and original
handwritten manuscripts, etc.
• Tend to be elastic – cloth and other
factory made goods of daily
consumption.
b. Level of technology
• Tend to be inelastic – cloth produced
only on handloom technology
• Tend to be elastic – cloth processed
using modern automatic spinning
and weaving machines
c. Time element
• Tend to be inelastic – shorter time-
span
• Tend to be elastic – longer time-
span
d. Scale of production
• Tend to be inelastic – small-scale
production
• Tend to be elastic – large-scale
production
e. Natural factors
• Tend to be inelastic – agricultural
goods vulnerable to natural factors
152. Factor Mobility
It refers to the ability to move factors of
production—labor, capital, or land—out of one
production process into another. It may involve the
movement of factors between firms within an
industry, as when one steel plant closes but sells its
production equipment to another steel firm. It also
allows for a more elastic supply of a commodity.
Competition Competition
Pure Monopoly
Perfect Duopoly
Oligopoly
Monopolistic
Competition
Monopsony
155. Pure Competition
a. Large Number of Buyers and Sellers –
Even if a buyer increases or reduces his
demand, it does not make any significant
effect on the total demand in the market.
The same goes with the seller’s side.
Every seller and buyer under this type of
market is a price-taker and not a price-
maker.
b. Homogeneous Products – The products
sold by different sellers under pure
competition are homogeneous (i.e.,
exactly alike in quality). Since every
buyer is buying the standard variety, he
does not bother to know as to which
particular manufacturer produced the

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product (e.g., rice classified under
different standard grades).
c. Free entry and free exit of firms – An
entrepreneur who has the necessary
capital and skill can start any business
of his choice. Similarly, an existing
producer is free to close down his
business if he chooses. Since there are
no hindrances to the entry of new firms
and exit of existing firms, the number of
total firms under this type of market
always remains large.
156. Perfect Competition
a. Large number of buyers and sellers
b. Homogeneous products
c. Free entry and free exit of firms
d. Perfect knowledge – all the buyers and
sellers under this type of market have
perfect knowledge of market condition
(e.g., total quantity supplied and sold on
a particular day or during a week).
e. No discrimination –The seller must
deliver the goods so long as every buyer,
visiting his shop, is willing to pay the
required price. Similarly, a buyer has no
reason to discriminate between sellers
so long as every seller is charging the
same price.
f. No cost of transportation – It is
assumed that the cost of transportation
does not exist for carrying goods from
one place to another.
g. Mobility of factors of production –
Various factors of production are
assumed to be perfectly mobile from one
place to another and from one
occupation to another.
h. Automatic price mechanism – The price
of a product is determined by the
interaction of total demand and total
supply in the market. Since there are
many sellers and many buyers, no
individual seller or a buyer can fix or
influence the price (see nos. 165-168).
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157. Monopoly
This is an extreme type of market where
there is only one producer resulting to the absence
of any competition.
Types of Monopolies
159. Pure and Perfect Monopoly
For this type of monopoly to exist, the
following conditions must be satisfied:
a. One firm producing in the market; and
b. The commodity produced should have
no substitute.
160. Impure or Simple Monopoly
a. Single producer – There is only one
producer in this type of market.
b. No close substitutes – To avoid any
possibility of competition in the market
there should be no close substitutes for
the product of the monopolist (i.e., the
cross-elasticity of demand for the
monopolist’s product is low).
c. Barriers to entry of firms – There are
barriers (either natural or artificial) that
restrict new firms from entering the
market.
d. Price and supply control – There is only
one seller who controls the entire supply
in the market enabling him to also fix the
price of his product (price-maker).
***
161. Monopolistic Competition
a. Fairly large number of firms – The
number of sellers operating under this
type of competition (20-25 sellers) is
larger than under oligopoly but less than
under perfect competition.
b. Product differentiation – Every seller
tries to distinguish his product from the
products manufactured by others. He
claims that his Research and
Development Department has developed
a new product after considerable
research (hence being associated with
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monopoly). As a matter of fact, however,
the product so introduced in the market
is not new. The same old product is sold
under a different trade name, style,
design and color (e.g., burgers).
c. Selling costs – Every producer under this
type of market spends huge amounts on
publicity. He follows all the media of
advertising such as press, radio,
television, etc. Every effort is made to
keep the product before the eyes of the
consumers, throughout the year. He has
to spend huge amounts on publicity
because he cannot afford to lag behind
in the race.
d. Multiplicity of prices – Similar products
which are differentiated by brand names
and advertisements are sold at different
prices Every producer enjoys the
freedom to price his own product within
certain limits.
e. Price war – A seller may reduce the price
of his product to attract new customers
and extinguish rivals from the market.
Naturally, other producers are required
to reduce their prices in order to retain
their customers. This trend becomes
harmful to all the sellers since it reduces
the profits of all of them.
f. Gift articles – Instead of reducing the
price, sellers hand over small gift articles
to the buyers who buy the product. This
enables a producer to achieve a
substantial increase in sales within a
short time.
162. Monopsony
a. There are many sellers but only one
buyer.
b. The buyer is influential and determines
the price of the product. He may exploit
the sellers by offering a very low price.
c. It is the opposite form of monopoly.
163. Oligopoly
a. Small number of producers – Because of
their small number, each firm has a large
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share of market supply. The action of
one firm result in a reaction of other
firms in the market. The firms are
mutually dependent on each other.
b. Products may either be homogenous or
differentiated
• Homogenous – e.g., production of
coal, copper, etc.
• Differentiated – e.g., production of
automobiles, computers, etc.
c. Restrictions to entry – These
restrictions are generally financial or
technological in nature. Entry is not
impossible under this type of market but
it is difficult.
d. Price control – The firms are mutually
dependent. For instance, if one firm
reduces the price of its product, other
firms will follow.
164. Duopoly
It is a type of oligopoly where two firms have
dominant or exclusive control over a market. All
characteristics of oligopoly are the same as this
type of market except for the number of
participating sellers.
165. Equilibrium
A system is in this state when there is no
tendency for change.
166. Equilibrium Price
It is the market price where the quantity of
goods supplied is equal to the quantity of goods
demanded. This is the point at which the demand
and supply curves in the market intersect.
177. Surplus
If the price of the commodity is above the
equilibrium price, there would be a surplus or
excess supply in the market. This is because the
quantity supplied is more than the quantity
demanded. The sellers will not be able sell as much
as they want, so they will tend to offer buyers a
lower price. Therefore, the price will tend to move
downwards towards the equilibrium price.
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178. Shortage
If the price of the commodity is below the
equilibrium price, there would be a shortage or
excess demand in the market. This is because the
quantity demanded is more than the quantity
supplied. The buyers will not be able to buy all they
want to buy, so they will tend to offer sellers a higher
price. Therefore, the price will tend to move upwards
towards the equilibrium price.
179. Business or Trade Cycle
It refers to the wave like fluctuations in the
aggregate economic activity, particularly in
employment, output and income.
Phases of Business Cycles
181. Expansion
During this phase, the economy experiences
relatively rapid growth, interest rates tend to be low,
production increases, and inflationary pressures
build.
182. Peak
It is reached when growth hits its maximum
rate. It typically creates some imbalances in the
economy that needs to be corrected.
183. Contraction
The correction of imbalances occurs
through this period when growth slows,
employment falls, and prices stagnate.
184. Trough
It is reached when the economy hits a low
point and growth begins to recover.
***
185. Inflation
It occurs when the general level of prices
and costs is rising.
186. Demand-Pull Inflation
It occurs when consumer demand outpaces
the available supply of many types of consumer
goods forcing an overall increase in the cost of
living.
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187. Causes of Demand-Pull Inflation
a. A growing economy – When consumers
feel confident, they spend more and take
on more debt. This leads to a steady
increase in demand, which means higher
prices.
b. Asset inflation – A sudden rise in exports
forces an undervaluation of the
currencies involved.
c. Government spending – When the
government spends more freely, prices
go up.
d. Inflation expectations – Companies may
increase their prices in expectation of
inflation in the near future.
e. More money in the system – An
expansion of the money supply with too
few goods to buy makes prices increase.
188. Cost-Push Inflation
It occurs when overall prices increase due to
increases in the cost of wages and raw materials.
Higher costs of production can decrease aggregate
supply in the economy. Since the demand for goods
hasn’t changed, the price increases from
production are passed onto consumers.
189. Causes of Cost-Push Inflation
a. Monopoly – Companies that achieve a
monopoly over an industry can create
cost-push inflation. A monopoly reduces
supply to meet its profit goal.
b. Wage inflation – Wage inflation occurs
when workers have enough leverage to
force through wage increases.
Companies then pass higher costs
through to consumers.
c. Natural disasters – These events,
including the depletion of natural
resources, cause inflation by disrupting
and limiting supply.
d. Government regulation and taxation –
These rules can reduce supplies of many
products.
e. Exchange rates – Any country that
allows the value of its currency to fall will
experience higher import prices. The
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foreign supplier does not want the value
of its product to drop along with that of
the currency. If demand is inelastic, it
can raise the price and keep its profit
margin intact.

190. GDP or Gross Domestic Product

It is a measure of national output produced
in a particular country.

191. GNP or Gross National Product

It is the GDP plus net property income from
abroad (which includes dividends, interest and
profit).

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