Micro Economics - Unit 1,2 - NEP - Notes

BBA 1 year Micro Economics-Major I
Syllabus
Unit-1 Introduction to economics, Definitions of economics, Nature and Scope of Economics, Significance
and Evolution of Micro Economics, Functions of Managerial Economics.
Unit-2 Concept of Law of Demand, Law of Supply, Concept of Market Equilibrium, Elasticity of Demand,
Demand Determinants.
Unit-3 Utility Analysis, Marginal Concept of Utility, and Indifference Curve Analysis: Assumptions,
Properties of Indifference curve, Theory of Consumer Surplus.
Unit-4 Elements of Cost, Factors of Production, Theory of Rent, Theory of Interest, Theories of Profit.
Unit-5 National Income: Estimates and Analysis (GNP, NNP, GDP, HDI), Methods of Measurement of
National Income, Types of Market Structure, Perfect v/s Imperfect Market, Trade Cycles.
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Introduction
Unit-1
Micro Economics-I
Economics is a social science that deals with human wants and their satisfaction. People have
unlimited wants. But the resources to satisfy these wants are limited. They are always
engaged in work to secure the things they need for the satisfaction of their wants. The farmer
in the field, the worker in the factory, the clerk in the office, and the teacher in the school
are all at work. The basic question that arises here is: Why different people undertake
these activities? The answer is that they are working to earn income with which they satisfy
their wants.
People have multiple wants to satisfy. They have to satisfy their want for food, cloth, shelter,
education, health, etc. Thus human wants are unlimited. In a sense they are insatiable. When
one want is satisfied another want takes its place and so on in an endless succession. By doing
some work or activity people earn money. This money is used to satisfy their wants. Thus our
activities have two common aspects; first, we are all engaged in earning our living, and
secondly, these earnings enable us to satisfy our want for different goods and services. This
action of earning and spending is called economic activity.
Prof. Seligman says ― “the starting point of all economic activity is the existence of human
wants”. Wants give rise to efforts and efforts secure satisfaction. The things which directly
satisfy human wants are called consumption goods. A few consumption goods like air,
sunshine, etc. are abundant. They are available at free cost. But most of goods are scarce.
They are available only by paying a price. And, therefore, they are called economic goods.
They do not exist in sufficient quantity to satisfy all wants.
People everywhere are engaged in some kind of economic activity for satisfaction of their
wants. “Wants, efforts, satisfaction” said Bastitat ― “constitute the circle of economics”.
The subject matter of economics is generally divided into four parts. They are Production,
Consumption, Exchange and Distribution. Production means producing things or creation or
addition of utilities to the goods and services to make them capable of satisfying various
wants Consumption deals with human wants and their satisfaction. Exchange refers to transfer
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of goods and services through the medium of money and various credit instruments. Finally,
distribution refers to the sharing of income from production by four factors of production
namely, land, labour, capital and organization. Here, we study how wage, rent, interest and
profit are determined.
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DEFINITIONS OF ECONOMICS
Several economists have defined economics taking different aspects into account. The word ‘Economics’
was derived from two Greek words, oikos (a house) and nemein (to manage) which would mean ‘managing
an household’ using the limited funds available, in the most satisfactory manner possible.
i) Wealth Definition
Adam smith (1723 - 1790), in his book “An Inquiry into Nature and Causes of Wealth of Nations” (1776)
defined economics as the science of wealth. He explained how a nation’s wealth is created. He considered
that the individual in the society wants to promote only his own gain and in this, he is led by an “invisible
hand” to promote the interests of the society though he has no real intention to promote the society’s
interests.
Criticism:
Smith defined economics only in terms of wealth and not in terms of human welfare. Ruskin and Carlyle
condemned economics as a ‘dismal science’, as it taught selfishness which was against ethics. However,
now, wealth is considered only to be a mean to end, the end being the human welfare. Hence, wealth
definition was rejected and the emphasis was shifted from ‘wealth’ to ‘welfare’.
ii) Welfare Definition
Alfred Marshall (1842 - 1924) wrote a book “Principles of Economics” (1890) in which he defined “Political
Economy” or Economics is a study of mankind in the ordinary business of life; it examines that part of
individual and social action which is most closely connected with the attainment and with the use of the
material requisites of well being”. The important features of Marshall’s definition are as follows:
a) According to Marshall, economics is a study of mankind in the ordinary business of life, i.e., economic
aspect of human life.
b) Economics studies both individual and social actions aimed at promoting economic welfare of people.
c) Marshall makes a distinction between two types of things, viz. material things and immaterial things.
Material things are those that can be seen, felt and touched, (E.g.) book, rice etc. Immaterial things are those
that cannot be seen, felt and touched. (E.g.) skill in the operation of a thrasher, a tractor etc., cultivation of
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hybrid cotton variety and so on. In his definition, Marshall considered only the material things that are
capable of promoting welfare of people.
Criticism:
a) Marshall considered only material things. But immaterial things, such as the services of a doctor, a teacher
and so on, also promote welfare of the people.
b) Marshall makes a distinction between (i) those things that are capable of promoting welfare of people and
(ii) those things that are not capable of promoting welfare of people. But anything, (E.g.) liquor, that is not
capable of promoting welfare but commands a price, comes under the purview of economics.
c) Marshall’s definition is based on the concept of welfare. But there is no clear-cut definition of welfare.
The meaning of welfare varies from person to person, country to country and one period to another.
However, generally, welfare means happiness or comfortable living conditions of an individual or group of
people. The welfare of an individual or nation is dependent not only on the stock of wealth possessed but also
on political, social and cultural activities of the nation.
iii) Welfare Definition
Lionel Robbins published a book “An Essay on the Nature and Significance of Economic Science” in 1932.
According to him, “economics is a science which studies human behaviour as a relationship between ends
and scarce means which have alternative uses”. The major features of Robbins’ definition are as follows:
a) Ends refer to human wants. Human beings have unlimited number of wants.
b) Resources or means, on the other hand, are limited or scarce in supply. There is scarcity of a commodity,
if its demand is greater than its supply. In other words, the scarcity of a commodity is to be considered only
in relation to its demand.
c) The scarce means are capable of having alternative uses. Hence, anyone will choose the resource that will
satisfy his particular want. Thus, economics, according to Robbins, is a science of choice.
Criticism:
a) Robbins does not make any distinction between goods conducive to human welfare and goods that are not
conducive to human welfare. In the production of rice and alcoholic drink, scarce resources are used. But the
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production of rice promotes human welfare while production of alcoholic drinks is not conducive to human
welfare. However, Robbins concludes that economics is neutral between ends.
b) In economics, we not only study the micro economic aspects like how resources are allocated and how
price is determined, but we also study the macroeconomic aspect like how national income is generated. But,
Robbins has reduced economics merely to theory of resource allocation.
c) Robbins definition does not cover the theory of economic growth and development.
iv) Growth Definition
Prof. Paul Samuelson defined economics as “the study of how men and society choose, with or without the
use of money, to employ scarce productive resources which could have alternative uses, to produce various
commodities over time, and distribute them for consumption, now and in the future among various people
and groups of society”.
The major implications of this definition are as follows:
a) Samuelson has made his definition dynamic by including the element of time in it. Therefore, it covers the
theory of economic growth.
b) Samuelson stressed the problem of scarcity of means in relation to unlimited ends. Not only the means are
scarce, but they could also be put to alternative uses.
c) The definition covers various aspects like production, distribution and consumption.
Of all the definitions discussed above, the ‘growth’ definition stated by Samuelson appears to be the most
satisfactory. However, in modern economics, the subject matter of economics is divided into main parts, viz.,
i) Micro Economics and ii) Macro Economics.
Economics is, therefore, rightly considered as the study of allocation of scarce resources (in relation to
unlimited ends) and of determinants of income, output, employment and economic growth.
The Central Economic Problem
Economic problem arises because of scarcity of resources in relation to demand for them.
Prof. Lionel Robbins of London School of Economics has defined economics as “a science which studies
human behavior as a relationship between ends and scarce means which have alternative uses”.
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Accordingly, he has given the following reasons for emergence of economic problems;
1. Human wants (or ends) are unlimited
Man is a bundle of wants. There is no end to human wants. As one want is satisfied, many others crop
up and this goes on endlessly. Again one particular want cannot be satisfied for all times to come e.g.
want for food. After fulfilling it at a particular time, it crops up again and again. Thus wants are not
only unlimited but recurring in nature also. In this sense they are insatiable. Wants differ in urgency
or intensity. Some wants are more important while others are less important. This enables a man to
arrange his wants in order of preference and make a choice among different wants.
2. Resources (means) to satisfy wants are limited (scarce)
Goods and services are produces by an economy with its resources namely-land, labour, capital and
enterprise. Unfortunately, such resources are limited in relation to its demand. Due to scarcity of
resources, we cannot produce all the goods and services that the various sections of the society need.
If more resources are employed for the production of one commodity, fewer resources are left for
production of other goods. Consequently, some wants will have to go unsatisfied. Therefore an
economy has to decide how to make best possible use of its limited resources.
3. Resources have alternative uses
The resources of an economy are not only scarce but also have alternative uses and therefore choice
has to be made in their use. For example, a plot of land can be used to produce wheat or for
construction of a factory or for a school building. If the plot is used for the cultivation of wheat, it
cannot be used for other purposes. In other words, production of one commodity has to be sacrificed
for production of other. Thus, the economy constantly faced with choosing better alternative uses to
which its resources should be put.
In short, the problem of making a choice among alternative uses of resources is called the basic or central
problem of an economy. Such problems are common to all economies. The central problems relate to
different aspects of resources are cited below;
I. The problem of allocation of resources:
a) What to produce
b) How to produce
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c) For whom to produce
II. The problem of utilization of resources:
(a) Problem of efficiency in production and distribution

(b) Problem of full employment of resources
(c) The problem of growth of resources
The problem of allocation of resources
An economy has to allocate its scarce resources in such a way that serves the best needs of the society. This
problem is in fact the problem of ‗what, how and for whom to produce?
(1) What to produce and in what quantities?
Since human wants are unlimited and the resources of the economy to satisfy them are limited the economy
cannot produce all goods and services required by the people. More of one
good or service produced means less of other goods. Therefore every society must exactly choose which
goods and services are to be produced and in what quantities. For instance, the economy has to decide
whether the resources are to be allocated for the production of consumer goods or capital goods, or necessary
goods or luxurious goods or civil goods or military goods. After deciding which goods should be produced
society has to decide the quantity of each good has to be produces.
(2) How to produce?
This problem refers to the choice of technique of production. It means that which combination of resources
or factors to be used for the production of goods and services. There are two types of techniques of
production. ie. the capital intensive technique of production and labour intensive techniques of production.
More labour and less capital or relatively less labour and more capital can be used for production. Similarly,
small scale or large scale production can be used. The guiding principle here is that only those techniques
should be employed which cause the least possible cost to produce each unit of a commodity or service.
(3) For whom to produce?
This problem refers who will consume the goods and services produces. A few rich and many poor or vice-
versa?. The goods and services produced for the people who can purchase them. And the purchasing power
of the people depends on how the produced goods and services are distributed among the people who are
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helped to produce them. i.e., how is the product distributed among the four factors of production-land,
labour, capital and enterprise.
SCOPE OF ECONOMICS
Scope means province or field of study. In discussing the scope of economics, we have to indicate whether it
is a science or an art and a positive science or a normative science. It also covers the subject matter of
economics.
i) Economics - A Science and an Art
a) Economics is a science: Science is a systematized body of knowledge that traces the relationship between
cause and effect. Another attribute of science is that its phenomena should be amenable to measurement.
Applying these characteristics, we find that economics is a branch of knowledge where the various facts
relevant to it have been systematically collected, classified and analyzed. Economics investigates the
possibility of deducing generalizations as regards the economic motives of human beings. The motives of
individuals and business firms can be very easily measured in terms of money. Thus, economics is a science.
Economics - A Social Science: In order to understand the social aspect of economics, we should bear in
mind that labourers are working on materials drawn from all over the world and producing commodities to be
sold all over the world in order to exchange goods from all parts of the world to satisfy their wants. There is,
thus, a close inter-dependence of millions of people living in distant lands unknown to one another. In this
way, the process of satisfying wants is not only an individual process, but also a social process. In
economics, one has, thus, to study social behaviour i.e., behaviour of men in-groups.
b) Economics is also an art. An art is a system of rules for the attainment of a given end. A science teaches
us to know; an art teaches us to do. Applying this definition, we find that economics offers us practical
guidance in the solution of economic problems. Science and art are complementary to each other and
economics is both a science and an art.
ii) Positive and Normative Economics
Economics is both positive and normative science.
a) Positive science: It only describes what it is and normative science prescribes what it ought to be. Positive
science does not indicate what is good or what is bad to the society. It will simply provide results of
economic analysis of a problem.
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b) Normative science: It makes distinction between good and bad. It prescribes what should be done to
promote human welfare. A positive statement is based on facts. A normative statement involves ethical
values. For example, “12 per cent of the labour force in India was unemployed last year” is a positive
statement, which could is verified by scientific measurement. “Twelve per cent unemployment is too high” is
normative statement comparing the fact of 12 per cent unemployment with a standard of what is
unreasonable. It also suggests how it can be rectified. Therefore, economics is a positive as well as normative
science.
iii) Subject Matter of Economics
Economics can be studied through a) traditional approach and (b) modern approach.
a) Traditional Approach: Economics is studied under five major divisions namely consumption,
production, exchange, distribution and public finance.
1. Consumption: The satisfaction of human wants through the use of goods and services is called
consumption.
2. Production: Goods that satisfy human wants are viewed as “bundles of utility”. Hence production would
mean creation of utility or producing (or creating) things for satisfying human wants. For production, the
resources like land, labour, capital and organization are needed.
3. Exchange: Goods are produced not only for self-consumption, but also for sales. They are sold to buyers
in markets. The process of buying and selling constitutes exchange.
4. Distribution: The production of any agricultural commodity requires four factors, viz., land, labour,
capital and organization. These four factors of production are to be rewarded for their services rendered in
the process of production. The land owner gets rent, the labourer earns wage, the capitalist is given with
interest and the entrepreneur is rewarded with profit. The process of determining rent, wage, interest and
profit is called distribution.
5. Public finance: It studies how the government gets money and how it spends it. Thus, in public finance,
we study about public revenue and public expenditure.
b) Modern Approach
The study of economics is divided into: i) Microeconomics and ii) Macroeconomics.
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1. Microeconomics analyses the economic behaviour of any particular decision making unit such as a
household or a firm. Microeconomics studies the flow of economic resources or factors of production from
the households or resource owners to business firms and flow of goods and services from business firms to
households. It studies the behaviour of individual decision making unit with regard to fixation of price and
output and its reactions to the changes in demand and supply conditions. Hence, microeconomics is also
called price theory.
2. Macroeconomics studies the behaviour of the economic system as a whole or all the decision-making
units put together. Macroeconomics deals with the behaviour of aggregates like total employment, gross
national product (GNP), national income, general price level, etc. So, macroeconomics is also known as
income theory.
Macro Economics
The word ‘macro’ is derived from the Greek word ‘makros’ which means ‘large’. Therefore macro
economics is the study of economy in its totality or as a whole.
It is concerned with the study of national income and not individual income, national saving and not
individual saving, aggregate consumption expenditure and not individual consumption expenditure, total
production and not production of individual firm, price level and not individual price etc.
In short it deals with the economy as a whole. The problem of full employment, aggregate consumption,
aggregate investment, total savings, general level of prices and variations in them are all the subject matter of
macro economics.
Scope of Macro - Economics
Theory of Theory of Theory of Growth

National Income Employment Theory of Money
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LIMITATIONS
1. It regards aggregates as homogenous without caring about their internal composition and structure.
2. Aggregate variables which form the economic system may not be of much significance
3. An indiscriminate and uncritical use of macroeconomics in analysing the problems of real world can
often be misleading.
4. The measurement of macroeconomic concepts involves a number of statistical and conceptual
difficulties.
Definitions of Macro Economics
1) According to culberton’s-“Macro economic theory of income employment price and money.”

2) Accordingly to K.E. Boulding –“Macro economics deals not with individuals quantities as such but with
aggregate income but with national income, not with individuals price but with price levels, not with
individuals output but with national output.”
3) According to Edward Shapiro –Macro economics attempts to answer the truly ‘big’ question of
economic life – full employment or unemployment, capacity or under capacity production.
Nature of Macro Economics

1) Macro economics studies the concept of national income and its different elements and the method of
measurement.
2) It studies problems relating to employment and unemployment. It studies different factors determining the
level of employment.
3) Determination of general price level is also studied under macro economics. Problems relating to inflation
and deflation are an important component of macro economics.
4) Change in demand and supply of money have an important impact on the level of employment.
Macroeconomics studies function of money & theories relating to it.
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5) Problems relating to economic growth is another important component of macro economics like plans for
overall increase in national income, output, employment are framed so the economic development of
economy as a whole.
6) It also studies issues relating to international trade, export, import exchange rate and balance of payments
are the principal issue in this context.
Importance of Macro Economics

1) Macro economics is helpful for getting us an idea of the functioning of an economic system it is very
essential for a proper and adequate knowledge of behavior pattern of the aggregative variable, as the
description of a large and complex economic system.
2) It says about the study of national income and social accounts. It is the study of national income which
enables us to know that three fourth of the world is living in object poverty without proper national difficult
to formulate proper economic policies.
3) Macroeconomic approaches are of almost importance to analyze and understand the effect of inflation and
deflation different sections of society are affected differently as a result of charges in the value of money.
4) Economic fluctuation is a characteristics features of the capitalist form of economy. The economic booms
and depression in the level of income and employment follow one another in cyclical fashion.
5) The study of macro economics is essential for the proper understanding of Micro economics. No micro
economics law could be framed without a prior study of the aggregate.
Limitations of Macroeconomics
1) Individual unit is ignored: While studying macroeconomics, individual unit is ignored, one cannot think
of increasing national saving at the expense of individual welfare.
2) It overlooks individual differences: Macro analysis overlooks individual differences for e.g.: overall
prices in the economy may b stable but price of petrol is increasing day by day. This puts a burden on
common man.
3) Too much stress on macro analysis: Too much stress on macro analysis is also one of the limitations of
macro economics. For e.g. An economy may be growing due to yearly over year rise in GDP but if the
wealth is concentrated in the hands of few rich people. From developmental point of view this is not an ideal
condition.
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Micro Economics
The term ‘micro’ is derived from the Greek word ‘mikros’ which means ‘small’. Therefore micro economics
studies the economic behavior of individual units of an economy and not an economy as a whole. It concerns
itself with the detailed study of individual decision-makers like a household, a firm or individual consumers
and producers. How a consumer maximizes his satisfaction with his limited income or how a firm maximizes
its profits or how the wage of a worker is determined are all instances of micro analytical approach.
According to Prof. Boulding ― “Micro economics is the study of particular firms, particular households,
individual prices, particular households, individual prices, wage incomes, individual industries, particular
commodities”.
Micro economic analysis is also known as “microscopic analysis”. Since the subject matter of micro
economics deals with the determination of factor prices and product prices micro economics is called as
‘price theory’.
Scope of Micro - Econimics
Theory of Theory of Theory of Economics

Demand Production Distribution of Welfare
It’s theoretical and practical importance as under:
1. To understand the working of economy

2. To provide tools for economic policies
3. Helpful in efficient employment of resources
4. Help to business executive
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5. Helpful in understanding the problems of taxation

6. Helpful in International Trade
7. To examine the conditions of economic welfare
8. The basis for prediction
9. Construction and use of models
Limitations
1. Based on unrealistic assumption of full employment in the economy

2. Based on the assumption of Laissez-Fare which is no longer practised.
3. Microeconomics is concerned with the study of parts and neglects the whole thus it presents an
imprecise picture of the economy.
4. Microeconomics is not only inadequate but also misleading in analysing several economic problems.
The following comparison further clarifies the distinction.
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ROLE OF ECONOMICS AND DECISION MAKING
Q.1 What do you mean by decision making?

Well decision making is not something which is related to managers only or which is related to corporate
world, but it is something which is related to everybody’s life. Whether a person is working or non working,
irrespective of his/her field decision making is important to everyone. You need to make decision
irrespective of the work you are doing. As a student also you have to take so many decisions. Suppose at a
particular point of time you want to go for a movie, and at the same point of you want to go for shopping
then what you will do. You can’t do two things at the same point of time. You have to decide what to first
and what to do next. Therefore decision making can be called as choosing the right option from the given
one. To decide is to choose. Whether to do this or to do that is what decision making. Meaning of decision
making:
Decision making is the most important function of business managers. Decision making is the central
objective of Managerial Economics. Decision making may be defined as the process of selecting the suitable
action from among several alternative courses of action. The problem of decision making arises whenever a
number of alternatives are available. Such as : What should be the price of the product? What should be the
size of the plant to be installed? How many workers should be employed? What kind of training should be
imparted to them? What is the optimal level of inventories of finished products, raw material, spare parts,
etc.? Therefore we can say that the problem of decision making arises due to the scarcity of resources. We
have unlimited wants and the means to satisfy those wants are limited,with the satisfaction of one want,
another arises, and here arises the problem of decision making. While performing his function manager has
to take a lot of decisions in conformity with the goal of the firm. Most of the decisions are taken under the
condition of uncertainty, and involves risks. The main reasons behind uncertainty and risks are uncertain
behavior of the market forces which are as follows: The demand and supply Changing business environment
Government policies External influence on the domestic market Social and political changes Economic
problem: Meaning of Economic problem: To know the meaning of the term economic problem we have to
put together the four characteristics i.e. Human wants are unlimited. Human wants vary in their intensity. The
means or resources are relatively limited. There are alternative uses of the limited resources. Therefore
economic problem can be called as the problem related to the unlimited wants with limited resources.
Problem arises due to this unlimited wants only. Resources used to satisfy one want cannot be used to satisfy
the other want – it means that every man begins to face the problem of economizing his means. The problem
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of economy is how to use the relatively limited resources with alternative uses in the face of unlimited wants.
Every try to use his/her limited resources with alternative uses so that he gets the maximum satisfaction out
of his limited resources. Everyone tries to satisfy those wants which are most urgent or intense and then those
wants slightly less urgent and so on thus sacrificing the satisfaction of those wants which lower on the scale
of preference for which he may not have resources. This is known as the problem of economy--- how to
make the maximum use of limited resources.
The sources of Economic problem:

Resource sand scarcity: This is the main source of the economic problem. we have limited resources and the
means to satisfy those resources are very limited. Here the resources of the society consists not only of the
free gifts of the nature such as land, forests and minerals, but also of human capacity both mental and
physical and of all sorts of man-made aids to further production, such as tools, machinery, building etc.
These resources can be divided into three main groups:
1. All those free gifts of nature, such as land, forests, minerals, etc. are commonly called as natural resources
and known to economists as LAND.
2. All human resources, mental and physical, both inherited and acquired, which economists call LABOUR.
3. All those man-made aids to further production, such as tools, machinery, plants and equipments, including
everything man-made which is not consumed for its own sake but is used in the process of making other
goods and services, and which is known to economists as CAPITAL.
Economics help us in economizing our means. It helps us in understanding the problem and making the right
decision so that its helpful for the organization for its further planning. Managerial economic is concerned
with decision making at the firm level.
Decision making problems faced by business firms:

• To identify the alternative courses of action of achieving given objectives.
• To select the course of action that achieves the objectives in the economically most efficient way.
• To implement the selected course of action in a right way to achieve the business objectives. The prime
function of management is Decision making and forward planning. Forward planning goes hand in hand with
decision making. Forward planning means establishing plans for the future.
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What is Managerial Economics?

Managerial economics is a stream of management studies that emphasizes primarily solving business problems
and decision-making by applying the theories and principles of microeconomics and macroeconomics. It is a
specialized stream dealing with an organization’s internal issues by using various economic theories. Economics
is an indispensable part of any business. All the business assumptions, forecasting, and investments are derived
from this single concept. This is managerial economics meaning in a nutshell.
All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze
the business environment. The scope of managerial economics is a continual process, as it is a developing
science. Demand analysis and forecasting, profit management, and capital management are also considered under
the scope of managerial economics.
Managerial Economics
Demand Analysis and Forecasting
Demand analysis and forecasting involves huge amount of decision-making! Demand estimation is an integral
part of decision making, an assessment of future sales helps in strengthening the market position and maximizing
profit. In managerial economics, demand analysis and forecasting holds a very important place.
Profit Management
Success of a firm depends on its primary measure and that is profit. Firms are operated to earn long term profit
which is generally the reward for risk taking. Appropriate planning and measuring profit is the most important
and challenging area of managerial economics.
Capital Management
Capital management involves planning and controlling of expenses. There are many problems related to capital
investments which involve considerable amount of time and labor. Cost of capital and rate of return are important
factors of capital management.
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Unit 2
Unit-2
Demand & Supply Analysis
Economics-I
MEANING OF DEMAND
Demand constitute three things as (i) desire for a commodity (ii) willingness to buy “The demand for anything at a given
price is the amount of it which will be bought per unit of time at the that price.” According to Hansen, “By demand, we
mean the quantity of a commodity that will be purchased at a particular price and not merely the desire of a thing.”
CLASSIFICATION OF DEMAND The main classification types of demand are as under:
1. Price Demand: Price demand refers to the various quantities of commodity which the consumer will buy per unit of
time at a certain prices (other things remaining the same). The quantity demanded changes with the change in price. The
quantity demanded increases with a fall in price and the quantity demanded falls with an increase in price. In other words,
we can say that quantity demanded and price has a negative correlation as
DA= f (PA)
Where DA = Demand for commodity A
f = Function
PA = Price of the commodity A.
P↑ D↑
P↓ D↓
2. Income Demand: Being ceterus-paribus, the income demand indicates the relationship between income and demand of
the consumer. The income demand shows how much quantity a consumer will buy at different levels of his income.
Generally, there is positive relationship between income and demand of the consumer i.e. DA = f (YA)
Where DA = Demand for commodity A YA = Income of the consumer A. P↑ D↑ P↓ D↓ The above function shows as
the income of the consumer increases demand also increases and when income falls demand also decreases. 3. Cross
Demand: Cross demand refers to the relationship between quantity demanded of good ‘A’ and price to related good ‘B’
other things being equal. In simple words, from cross demand we mean the change in the quantity demanded of a
commodity without any change in its price but due to the change in the price of related goods i.e. B commodity. The related
goods can either be substitute goods or complementary goods. The demand curve in the case of substitute goods or
complementary goods. The demand curve in the case of substitute will be of upward sloping while the demand curve in
complementary goods will be of downward slop.
Demand is the quantity of a good or service that consumers are willing and able to buy at a given price in a given time
period
Each of us has an individual demand for particular goods and services and our demand at each price reflects the value that
we place on a product, linked usually to the enjoyment or usefulness that we expect from consuming it. Economists give
this a term - utility
Effective Demand
 Demand is different to desire! Effective demand is when a desire to buy a product is backed up by an ability to
pay for it
Latent Demand
 Latent demand exists when there is willingness to buy among people for a good or service, but where consumers
lack the purchasing power to be able to afford the product.
Dr.Payal Jain 19
Derived Demand
The demand for a product X might be connected to the demand for a related product Y – giving rise to the idea of a derived
demand. For example, demand for steel is strongly linked to the demand for new vehicles and other manufactured
products, so that when an economy goes into a recession, so we expect the demand for steel to decline likewise.
Steel is a cyclical industry which means that market demand for steel is affected by changes in the economic cycle and
also by fluctuations in the exchange rate.
Zinc is a good example of a product with a strong derived demand. It has a wide-range of end users such as galvanised
zinc used in cars and new buildings, die-casting used in door furniture and toys, brass and bronze used in taps and pipes.
And also rolled zinc (used in roofing, guttering and batteries) and in chemicals used in making tyres and zinc cream.
Transport as a Derived Demand

The demand for transport is the number of journeys consumers or firms are willing and able to purchase at various prices in
a given time period. Transport is rarely demanded for its own sake, the journey, but for what the journey enables e.g.
commuting, taking a holiday or distribution. When an economy is growing, there is an increase in derived demand for
commuting, business logistics and transport for holiday purposes.
The Law of Demand

There is an inverse relationship between the price of a good and demand.
1. As prices fall, we see an expansion of demand.
2. If price rises, there will be a contraction of demand.
Ceteris paribus assumption

Many factors affect demand. When drawing a demand curve, economists assume all factors are held constant except one
– the price of the product itself. Ceteris paribus allows us to isolate the effect of one variable on another variable
The Demand Curve

A demand curve shows the relationship between the price of an item and the quantity demanded over a period of time.
There are two reasons why more is demanded as price falls:
1. The Income Effect: There is an income effect when the price of a good falls because the consumer can maintain the
same consumption for less expenditure. Provided that the good is normal, some of the resulting increase in real income is
used to buy more of this product.
2. The Substitution Effect: There is a substitution effect when the price of a good falls because the product is now
relatively cheaper than an alternative item and some consumers switch their spending from the alternative good or service.
The Law of Demand

 As price falls, a person switches away from rival products towards the product
 As price falls, a person's willingness and ability to buy the product increases
 As price falls, a person's opportunity cost of purchasing the product falls
Dr.Payal Jain 20
Note: Many demand curves are drawn as straight lines to make the diagrams easier to interpret
The chart below shows average season ticket prices for English Premier League clubs. What factors affect the willingness
and ability to pay for a season ticket? Why is there such a large difference in prices?
What is Demand
The quantity of product that the consumers are willing to buy at a given price over a given period of time is called demand
for that product. Thus demand is:
1. The desire for possession, and

2. The willingness (and ability) to pay for
What is Law of Demand
It is clear that demand is always at a price. The price and quality demanded have an inverse relationship. Thus increase in
price of a product will decrease its demand and vice versa. It is called law of demand and it assumes all other factors to be
constant except price. Let us consider the following example:
1. Px 12 10 8 6 4 2

2. Qx 10 20 30 40 50 60
Law of Demand Graph
Plotting the above law of demand graphically
Illustration of Law of Demand Graph

We have the curve dd which given us various price-quantity combinations demanded by the consumers. The demand curve
is a negatively slopped curve moving from left to right, showing the inverse relationship.
The increase or decrease in demand due to price changes is referred to as the extension or contraction of demand. The
factor held constant, does not increase or decrease the demand along the original demand curve but they shift the whole
demand curve towards right or left.
Factors Influencing Demand

Following are the factors influencing Demand for a product:
1. Price of the commodity itself (charges or expected charges)

2. Tastes and preferences of the consumers
3. Incomes of the consumers
Dr.Payal Jain 21
4. Price of the related goods, substitutes or complementary.

5. No of consumers in the market.
Reasons for Downward Sloping Demand Curve
When price fall the quantity demanded of a commodity rises and when price rise quantity of a commodity falls, other thing
remaining the same.
There are two factors of downward sloping demand curve due to which quantity demanded increase when price falls.
1. Income Effect
When the price of a commodity falls, the consumer can by more quantity of the commodity with his given income. As a
result, price of a commodity, consumer’s real price or purchasing power increase. This increase in real income induces the
consumer to buy more of that commodity. This is called income effect of the changes in price of the commodity.
2. Substitution Effect
The other reason why the quantity of a commodity rises as its prices falls is the substitute effect. When the price of a
commodity falls it becomes cheaper than other commodities. This induces the consumer to substitute the commodity whose
price is fallen for other commodities, which relatively becomes dearer.
Market Demand Curve

Horizontally summing up of all the individual demand curves gives us market demand curve.
Limitations of Law of Demand

When the prices of normal goods rises, the demand for them decrease, there are few cases where the law cannot operated.
Following are the limitations of law of demand.
1. Prestige Goods
There are certain commodities like sports car or diamond, which are the sign of distinction and honor in any society. If the
price of these goods increases the demand for them may be increase instead of falling.
2. Price Expectations
Expect a further increase in the price of a specific commodity they will go to buy more and more in spite of rising in price.
In this case the violation of law is temporary.
3. Ignorance of the Consumer

If the consumer is ignorant about the rise in price of goods, he may buy more of the commodity at higher price.
4. Giffen Goods
If the prices of basic goods like (sugar, wheat etc) on which the poor spend a large part of their income declining the poor
increase the demand for superior goods. When the price of giffen goods fall it demand will also falls. There is a positive
price effect in the case of giffen goods.
MARGINAL UTILITY ANALYSIS

Utility is a measure of the satisfaction that we get from purchasing and consuming a good or service
 Total utility: The total satisfaction from a given level of consumption
 Marginal utility: The change in satisfaction from consuming an extra unit
Standard economic theory believes in the idea of diminishing returns i.e. the marginal utility of extra units declines as more
is consumed
Marginal utility and willingness to pay
Marginal utility is the change in total satisfaction from consuming an extra unit of a good or service
Dr.Payal Jain 22
 Beyond a certain point, marginal utility may start to fall (diminish)

 In our example, this happens with the 4th unit where MU falls to 12
 The 8th unit carries zero marginal utility i.e. total utility stays the same
 If marginal utility is falling, then consumers will only be prepared to pay a lower price
 This helps to explain the downward sloping demand curve
Total Utility Marginal Utility

Quantity Consumed
(TU) (MU)
1 10 10
2 24 14
3 40 16
4 52 12
5 61 9
6 68 7
7 72 4
8 72 0
The law of demand states that the demand is inversely related to price other things remaining constant (ceteris paribus). It
means if price raises demand contracts or decreases and if price diminishes demand expands or increases. The law of
demand operates only if factors determining demand other than prices are constant. It means prices of complementary
goods, substitutes, income, taste of consumer, population, advertisement etc should be constant.
Law of demand can be explained with the help of demand schedule and demand curve as following
Price( in Rs) Demand(per week)

10 400
15 300
20 200
Let the initial price Rs 10 per kg and demand be 400 kg per week. If the prices raise to Rs 15 the consumer s reduce their
demand. In above table demand is at 300 kg/week when price is Rs 15. If the price further raises to Rs 20 the demand
further decreases to 200kg/week. It shows that demand changes inversely to the change in price when other things remain
constant. If we represent the table in figure then we obtain a downwardly sloped demand curve as shown below

In the above figure the demand curve is downwardly sloped. It shows that demand decreases with rise in price and
increases with fall in price.
Assumptions
Dr.Payal Jain 23
1. Price of related goods is constant

2. Income and taste of consumers are constant
3. Size of population is constant
4. There is no change in taxes and advertisement, money supply and government expenditure.
Limitation/ exception of law of demand

1. Goods of prestige: Demand for goods of prestige like gold, demand may not decrease even there is rise in price. They
are purchased and consumed because of their heavy prices.
2. Goods of hobbies: The law of demand does not hold in case of goods of hobbies like collection, ticket collection, and
collection of historical and archaeological materials and so on. The things are collected even paying more and more
amount
3. Goods of addiction: in case of goods and addiction like alcohol, tobacco, drugs etc the demand does not decrease even
there is increase in price. Instead of operation of law of demand consumers purchase more units even if there is rise in
price.
4. Giffen goods: Demand for giffen goods increase even there is rise in price and vice versa. The law of demand isn’t
applicable to them. The goods which are both basic and inferior are geffen goods.
5. Goods of tradition: The goods consumed according to tradition, culture and religion have demand usually not inversely
related to price. For example, during dashain the Nepalese people purchase more goods to celebrate the festival even if
prices are increased.
6. Future expected price: If the consumers expect fall in price in near future, they do not purchase more right now even if
there is fall in price currently and vice versa.
7. Future availability: If the consumers have fear of shortage of commodity in near future, they purchase more and keep
the stock even if price has been higher. But if they expect greater availability of goods in the near future, they purchase
less quantity even price has been decreased.
8. Change in taste and preference: If the consumers have the fear of the goods out of fashion in near future, they demand
less even if prices are decreased.
9. Irrationality: Law of demand does not operate in case of irrational consumers. The unscrupulous consumers spend the
money not according to satisfaction from the goods.

Why does demand law operate?
Why does demand curve slopes downward?
Why does demand vary inversely with price?
1. Diminishing marginal utility: According to Gossen, of a consumer goes on consuming more units of same commodity
without time gap, marginal utility diminishes. It means 2nd unit gives less utility or satisfaction than 1st unit, 3rd gives
less than 2nd and so on. Therefore, the consumer demands more only if prices are reduced.
2. Real income effect: if price falls real income increases even if the money is constant. Therefore, consumers demand
more. If the price rises, real income falls even if money income is constant. Therefore, consumers demand less.
3. Substitution effect: if a commodity becomes cheaper the commodity is substituted for other substituting goods. If the
commodity becomes expensive, it is substituted by other substitutes.
4. No. of uses: If the price falls, the commodity is used for least important purposes too. That’s why demand increases. If
price rises, the commodity is used only for important purposes. That’s why demand decreases.
5. No. of consumers: If price falls, the consumers who were unable to purchase the commodity because of high price, will
also be able to consume the commodity. That’s why demand increases and vice versa.
Types of Demand
1. Price demand: Demand primarily dependent upon price is called price demand. This demand is sensitive or
responsive to the change in price. In case of normal goods, demand increases with fall in price and vice versa. But in
case of giffen goods demand increases even there is rise in price.
Dr.Payal Jain 24
1. Cross demand: Demand primarily dependent upon prices of related goods is called cross demand. The complementary
goods and substitutes are called related goods. In case of complementary goods like pen and ink demand for good is
inversely related to the prices of other goods but the case in substituting goods are just opposite. Demand for substituting
goods is directly related to prices.
2. Income demand: Demand primarily dependent upon income is called income demand. This demand is sensitive or
responsive to the change in income. In case of normal goods, demand increases with rise in income and vice versa. But
in case of giffen goods demand decreases when there is increase income.
3. Direct demand: Demand for goods and services made by final consumers to satisfy their wants or needs is called direct
demand. For example guest of hotels make the demand for food.
4. Derived demand: Demand for goods and services made according to direct demand is called derived demand. For
example demand made by hotels for vegetable, groceries is called derived demand.
5. Joint demand: Demand made for two or more goods and services to satisfy single need or want is called joint demand.
For example, tea sugar are demand together to satisfy a single need. The complementary goods are jointly demanded
Dr.Payal Jain 25
6. Composite demand: Demand for a single commodity made in order to use for different purposes is called composite
demand. In this case, commodity is one but the number of uses is multiple. For example, the electricity is used for
lighting, heating, transportation for the use of different electrical device.
Factors determining the elasticity of Demand:

1. Degree of necessity:
If goods are very essential then such goods’ demand is inelastic. If they are not very necessary for human life then
demand for goods is elastic.
2. Proportion of customers income spending on the commodity:
If people spend small amount form the income upon a commodity then demand of such commodity is inelastic but if
they spend huge part of their income for the commodity then its demand is elastic.
3. Existence of substitute good:
If there is available of close substitute goods then in this case demand is elastic but if there is no close substitute of
commodity then demand is elastic.
4. Habit:
If goods are related to the taste and preference then demand of such goods is inelastic and vice-versa.
5. Several use of commodity:
If goods are of multipurpose then its demand is elastic but if it is use for single purpose its demand is inelastic.
6. Postponement:
If consumers can post pond the need of goods then its demand is elastic but if they can’t be post-pond then its demand is
inelastic.
7. Range of Price:
If the commodities are of low price range and high price, demand for these goods is inelastic but if they are of middle
price range then its demand is elastic.
8. Time Period:
If time period is shorter, there is no chance to change choice then demand for those goods is inelastic but is time period
is long then demand is elastic.
9. Income level:
The commodity which is purchased by low and high level income earner then demand is inelastic but in the case of
middle income earner demand is elastic.
DETERMINANTS OF DEMAND
1) Price of the commodity 2) Price of substitutes and complementary goods. 3) Consumers’ income. 4) Consumer’s taste
and preference. 5) Consumers’ expectations of future prices 6) Demonstration effect. 7) Consumer-credit facility 8)
Population of the country Distribution of national income
DEMAND SCHEDULE
Demand schedule refers to the response of amount demanded to change in price of a commodity. It summarizes the
information on prices and quantity demanded. It is of two types. 1. Individual Demand Schedule 2. Market Demand
Schedule
1. Individual Demand Schedule:

Considering other things being equal individual demand schedule refers to the quantities of the commodities demanded by
the consumer at various prices. Individual demand curve refers to the quantity demanded by the consumer at different
levels of prices
2. Market Demand Schedule

The market demand is the summation of collection demand of all persons of a homogeneous commodity. Basically, the
market demand schedule-depicts the functional relationship between prices and quantity demanded. If we are interested to
know the demand schedule for a year, we will add the demand for all the months of that particular year. In this way, we
Dr.Payal Jain 26
may conclude that market demand schedule is a lateral summation of the quantities purchased by all individuals at different
prices in a particular period of time.
Elasticity of Demand and its Types

Elasticity is a concept in economics that talks about the effect of change in one economic variable on the other.

Elasticity of Demand, on the other hand, specifically measures the effect of change in an economic variable on the
quantity demanded of a product. There are several factors that affect the quantity demanded for a product such as
the income levels of people, price of the product, price of other products in the segment, and various others.
Elasticity of Demand, or Demand Elasticity, is the measure of change in quantity demanded of a product in response
to a change in any of the market variables, like price, income etc. It measures the shift in demand when other
economic factors change.

In other words, the elasticity of demand is the percentage change in quantity demanded divided by the percentage
change in another economic variable.

The demand for a commodity is affected by different economic variables:

1. Price of the commodity
2. Price of related commodities
3. Income level of consumers
3 Types of Elasticity of Demand

On the basis of different factors affecting the quantity demanded for a product, elasticity of demand is categorized
into mainly three categories: Price Elasticity of Demand (PED), Cross Elasticity of Demand (XED), and Income
Elasticity of Demand (YED).

1. Price Elasticity of Demand (PED)

Any change in the price of a commodity, whether it’s a decrease or increase, affects the quantity demanded for a
product. For example, when there is a rise in the prices of ceiling fans, the quantity demanded goes down.

This measure of responsiveness of quantity demanded when there is a change in price is termed as the Price
Elasticity of Demand (PED).

The mathematical formula given to calculate the Price Elasticity of Demand is:

Dr.Payal Jain 27
PED = % Change in Quantity Demanded % / Change in Price

The result obtained from this formula determines the intensity of the effect of price change on the quantity
demanded for a commodity.

2. Income Elasticity of Demand (YED)

The income levels of consumers play an important role in the quantity demanded for a product. This can be understood by
looking at the difference in goods sold in the rural markets versus the goods sold in metro cities.

The Income Elasticity of Demand, also represented by YED, refers to the sensitivity of quantity demanded for a certain
good to a change in real income (the income earned by an individual after accounting for inflation) of the consumers who
buy this good, keeping all other things constant.
The formula given to calculate the Income Elasticity of Demand is given as:

YED = % Change in Quantity Demanded% / Change in Income

The result obtained from this formula helps to determine whether a good is a necessity good or a luxury good.

3. Cross Elasticity of Demand (XED)

In a market where there is an oligopoly, multiple players compete. Thus, the quantity demanded for a product does
not only depend on itself but rather, there is an effect even when prices of other goods change.

Cross Elasticity of Demand, also represented as XED, is an economic concept that measures the sensitiveness of
quantity demanded of one good (X) when there is a change in the price of another good (Y), and that’s why it is also
referred to as Cross-Price Elasticity of Demand.

The formula given to calculate the Cross Elasticity of Demand is given as:

XED = (% Change in Quantity Demanded for one good (X)%) / (Change in Price of another Good (Y))

The result obtained for a substitute good would always come out to be positive as whenever there is a rise in the
price of a good, the demand for its substitute rises. Whereas, the result will be negative for a complementary good.

These three types of Elasticity of Demand measure the sensitivity of quantity demanded to a change in the price of
the good, income of consumers buying the good, and the price of another good.
Dr.Payal Jain 28
5 other types of Elasticity of Demand

The effect of change in economic variables is not always the same on the quantity demanded for a product.

The demand for a product can be elastic, inelastic, or unitary, depending on the rate of change in the demand with respect to
the change in the price of a product.

On the basis of the amount of fluctuation shown in the quantity demanded of a good, it is termed as ‘elastic’, ‘inelastic’,
and ‘unitary’.

 An elastic demand is one that shows a larger fluctuation in the quantity demanded of a product, in response to
even a little change in another economic variable. For example, if there is a hike of $0.5 in the price of a cup of
coffee, there are very high chances of a steep decline in the quantity demanded.

 An inelastic demand is one that shows a very little fluctuation in the quantity demanded with respect to a change
in another economic variable. An example of this can be petrol or diesel.

 Unitary elasticity is one in which the fluctuation in one variable and quantity demanded is equal.

We can further classify these elastic and inelastic types of demand into five categories.
1. Perfectly Elastic Demand

When there is a sharp rise or fall due to a change in the price of the commodity, it is said to be perfectly elastic demand.

In perfectly elastic demand, even a small rise in price can result in a fall in demand of the good to zero, whereas a small
decline in the price can increase the demand to infinity.

However, perfectly elastic demand is a total theoretical concept and doesn’t find a real application, unless the market is
perfectly competitive and the product is homogenous.

The degree of elasticity of demand helps to define the slope and shape of the demand curve. Therefore, we can determine
the elasticity of demand by looking at the slope of the demand curve.

A Flatter curve will represent a higher elastic demand. Thus, the slope of the demand curve for a perfectly elastic demand is
horizontal.

Dr.Payal Jain 29

2. Perfectly Inelastic Demand

A perfectly inelastic demand is the one in which there is no change measured against a price change.

Like perfectly elastic demand, the concept of perfectly inelastic is also a theoretical concept and doesn’t find a practical
application. However, the demand for necessity goods can be the closest example of perfectly inelastic demand.

The numerical value obtained from the PED formula comes out as zero for a perfectly inelastic demand.

The demand curve for a perfectly inelastic demand is a vertical line i.e. the slope of the curve is zero.

3. Relatively Elastic Demand

Relatively elastic demand refers to the demand when the proportionate change in the demand is greater than the
proportionate change in the price of the good. The numerical value of relatively elastic demand ranges between one to
infinity.

In relatively elastic demand, if the price of a good increases by 25% then the demand for the product will necessarily fall by
more than 25%.

Unlike the aforementioned types of demand, relatively elastic demand has a practical application as many goods respond in
the same manner when there is a price change.

The demand curve of relatively elastic demand is gradually sloping.
4. Relatively Inelastic Demand

In a relatively inelastic demand, the proportionate change in the quantity demanded for a product is always less than
the proportionate change in the price.

For example, if the price of a good goes down by 10%, the proportionate change in its demand will not go beyond
Dr.Payal Jain 30
9.9..%, if it reaches 10% then it would be called unitary elastic demand.

The numerical value of relatively inelastic demand always comes out as less than 1 and the demand curve is rapidly
sloping for such type of demand.
5. Unitary Elastic Demand

When the proportionate change in the quantity demanded for a product is equal to the proportionate change in the price of
the commodity, it is said to be unitary elastic demand.

The numerical value for unitary elastic demand is equal to 1. The demand curve for unitary elastic demand is represented as
a rectangular hyperbola.
Dr.Payal Jain 31

Micro Economics - Unit 1,2 - NEP - Notes

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BBA 1 year Micro Economics-Major I

ii) Welfare Definition

iii) Welfare Definition

iv) Growth Definition

The major implications of this definition are as follows:

The Central Economic Problem

1. Human wants (or ends) are unlimited

2. Resources (means) to satisfy wants are limited (scarce)

3. Resources have alternative uses

I. The problem of allocation of resources:

c) For whom to produce

II. The problem of utilization of resources:

(a) Problem of efficiency in production and distribution

The problem of allocation of resources

(1) What to produce and in what quantities?

(2) How to produce?

(3) For whom to produce?

i) Economics - A Science and an Art

ii) Positive and Normative Economics

Economics is both positive and normative science.

iii) Subject Matter of Economics

The study of economics is divided into: i) Microeconomics and ii) Macroeconomics.

Scope of Macro - Economics

Theory of Theory of Theory of Growth

Definitions of Macro Economics

1) According to culberton’s-“Macro economic theory of income employment price and money.”

Nature of Macro Economics

Importance of Macro Economics

Scope of Micro - Econimics

Theory of Theory of Theory of Economics

It’s theoretical and practical importance as under:

1. To understand the working of economy

5. Helpful in understanding the problems of taxation

1. Based on unrealistic assumption of full employment in the economy

The following comparison further clarifies the distinction.

ROLE OF ECONOMICS AND DECISION MAKING

Q.1 What do you mean by decision making?

The sources of Economic problem:

Decision making problems faced by business firms:

What is Managerial Economics?

Transport as a Derived Demand

The Law of Demand

Ceteris paribus assumption

The Demand Curve

The Law of Demand

1. The desire for possession, and

1. Px 12 10 8 6 4 2

Illustration of Law of Demand Graph

Factors Influencing Demand

1. Price of the commodity itself (charges or expected charges)

4. Price of the related goods, substitutes or complementary.

Market Demand Curve

Limitations of Law of Demand

3. Ignorance of the Consumer

MARGINAL UTILITY ANALYSIS

Marginal utility and willingness to pay

 Beyond a certain point, marginal utility may start to fall (diminish)

Total Utility Marginal Utility

Price( in Rs) Demand(per week)

1. Price of related goods is constant

Limitation/ exception of law of demand

Factors determining the elasticity of Demand: