Business Economics

Answer 1.

INTRODUCTION

Elasticity of demand: Elasticity of demand refers to how sensitive demand for a good is

compared to changes in other economic factors, such as price or income. The elasticity of
demand helps companies predict changes in demand based on a number of different factors,
including changes in price and the market entry of competitive goods. The elasticity of demand
for a given good or service is calculated by dividing the percentage change in quantity demanded
by the percentage change in price. In short Elastic demand is one in which the change in quantity
demanded due to a change in price is large

Revenue: Revenue is the income generated from normal business operations and includes
discounts and deductions for returned merchandise. It is the top line or gross income figure from
which costs are subtracted to determine net income.
 

CONCEPT AND APPLICATION

Total Revenue: Total revenue is the amount of money that a company earns by selling its goods
and/or services during a period of time. It is the total income of an organization. We can
calculate total revenue by multiplication of quantity and price of the given commodity. Take, for
example, a leather craftsman who sells boots for $100 per pair. If he regularly sells 50 pairs per
month, his total revenue is $5,000 ($100 x 50 = $5,000)

Total Revenue=Quantity × Price

Average Revenue: The revenue generated per unit of output sold is called average revenue. This
revenue refers to the price of the product selling. It helps to determine the brand profit. It is
calculated by dividing the organization's total revenue by the number of units sold by the
organization. For example, if a firm sells 50 products and the total revenue is 1000, the average
revenue will be 20(1000/50). Hence we can say average revenue is the profit of a firm per unit
product.

Average Revenue = Total Revenue / Quantity sold

Marginal Revenue: The change in total revenue per unit product is called marginal revenue. It
is an additional income per commodity. It is obtained by subtracting the total revenue of the
commodity's required quantity by the total revenue of the preceding quantity of the commodity. 

Marginal Revenue=TR n−TR n−1

Here, n is the number of units sold, and TR is the commodity's total revenue.

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Price elasticity of demand: Price elasticity of demand is a measurement of the change in
consumption of a product in relation to a change in its price. We can calculate the price elasticity
of demand by dividing the percentage change in demand of the commodity by the percentage
change in the commodity price. 

Percentage change ∈demand

Price elasticity of demand ( E d ) =
Percentage change∈ price

Let us calculate the total revenue, marginal revenue, and price elasticity with different prices and
quantities of a commodity.

PRICE QUANTITY TOTAL MARGINAL PRICE

 REVENUE REVENUE ELASTICITY

6 0 0 - -

5 100 500 500 -11

4 200 800 300 -3

3 300 900 100 -1.4

2 400 800 -100 -0.7143

1 500 500 -300 -0.333

0 600 0 -500 -0.09

Working:

For Price = 5 and Quantity = 100 units

Total Revenue = Q x P

= 100 x 5

= 500

Marginal Revenue = total revenue at 100 units – total revenue at 0 units of the commodity

= 500 – 0

= 500

Price elasticity = 0.5/-0.0455

= -11

We always ignore the negative sign and consider the absolute value only. Here, the price
elasticity of demand is more than one, which means that the commodity has elastic demand.
Similarly, we can calculate the total revenue, marginal revenue, and price elasticity of the good
at different prices and quantities. 

Relationship between AR and MR.

The relationship between average revenue and marginal revenue is the same as between any
other average and marginal values. When average revenue falls marginal revenue is less than the
average revenue. When average revenue remains the same, marginal revenue is equal to average
revenue.
The concepts of MR and AR both together constitute a powerful analytical tool in economic
analysis. Average revenue is the price per unit of output.

CONCLUSION
Price elasticity of demand measures the change in percentage of demand caused by a percent
change in price. If the elasticity is between 0-1, demand is said to be inelastic (little change).
Greater than 1, demand is said to be elastic.
The AR and MR of the table show average revenue and marginal revenue with increase in a
commodity's output but later the average revenue keeps falling and remains positive, also the
marginal revenue after some time starts to become negative.

Answer 2.
INTRODUCTION
Demand forecasting: Demand forecasting is the process of making estimations about future
customer demand over a defined period, using historical data and other information. Proper
demand forecasting gives businesses valuable information about their potential in their current
market and other markets, so that managers can make informed decisions about pricing, business
growth strategies, and market potential. Without demand forecasting, businesses risk making
poor decisions about their products and target markets – and ill-informed decisions can have far-
reaching negative effects on inventory holding costs, customer satisfaction, supply chain
management, and profitability

CONCEPT AND APPLICATION

To understand lets discuss the qualitative and quantitative methods of demand forecasting. 

QUALITATIVE METHODS: Qualitative forecasting techniques are used when there isn’t a lot
of data available to work with, such as for a relatively new business or when a product is
introduced to the market. In this instance, other information such as expert opinions, market
research, and comparative analyses are used to form quantitative estimates about demand.
Different qualitative techniques of forecasting demand are as follows:

 The Delphi Method: This is a group technique in which a panel of experts is questioned

individually about their perceptions of future events. The experts do not meet as a group, in
order to reduce the possibility that consensus is reached because of dominant personality
factors. Instead, the forecasts and accompanying arguments are summarized by an outside
party and returned to the experts along with further questions. This continues until a
consensus is reached.

 The market research method: Market research is the process of testing the popularity of a
service or individual item by gauging the reactions of prospective customers. This allows
businesses to determine their target markets and seek ideas and responses from consumers
to fine-tune their products. Businesses can either perform market research internally or hire
 an agency that specializes in collecting this information. The study can be conducted via
consumer surveys, product testing, or focus groups, in which participants are typically
compensated with product samples or a small stipend for their time. They can also design
polls for prospective consumers in order to help the business gain better insight into where
they stand and whether they hold a future in the chosen market in the presence of strong
competitors.

 Panel consensus technique: The panel consensus method, is by bringing the internal

members or experts from all level in the company together, and have an open discussion
about a product or activity, any people is allowed to give their own opinions, and the
meeting will end when a consensus is reached.

QUANTITATIVE METHODS: Qualitative forecast often contain huge amount of subjective

judgements, as there are lots of personal opinions and other human factors, accurate and
reliability are always the big concerns. Whereas Quantitative methods are more objective and
‘scientific’. It always involve the historical data, and by using the mathematical models to
process those information to found out the patterns embed in the data.
The different kinds of quantitative methods are as follows:

 Time series forecasting: Time series methods are attempts to predict the future patterns by
using historical data which over a period time. Time series is a sequence of time-based data
points collected at specific intervals of a given phenomenon that undergoes changes over
time. It is indexed according to time. The four variations to time series are (1) Seasonal
variations (2) Trend variations (3) Cyclical variations, and (4) Random variations.
 Smoothing techniques: Smoothing techniques are used to eliminate a random variation
from the historical demand. This helps in identifying demand patterns and demand levels
that can be used to estimate future demand. The most common methods used in smoothing
techniques of demand forecasting are simple moving average method and weighted moving
average method.
1. Simple moving average method: This method calculates the mean of average
prices over a period of time and plot these mean prices on a graph which acts as a
 scale. For example, a five-day simple moving average is the sum of values of all
five days divided by five.
2. Weighted moving average method: weighted moving average method uses a
predefined number of time periods to calculate the average, all of which have the
same importance. For example, in a four-month moving average, each month
represents 25% of the moving average.
 Barometric methods: Barometric methods are used to speculate the future trends based
on current developments. This methods are also referred to as the leading indicators
approach to demand forecasting. Many economists use barometric methods to forecast
trends in business activities. The basic approach followed in barometric methods of
demand analysis is to prepare an index of relevant economic indicators and forecast
future trends based on the movements shown in the index.
 Econometric methods: Econometric methods make use of statistical tools combined
with economic theories to assess various economic variables (for example, price change,
income level of consumers, changes in economic policies, and so on) for forecasting
demand. The forecasts made using econometric methods are much more reliable than any
other demand forecasting method. An econometric model for demand forecasting could
be single equation regression analysis or a system of simultaneous equations.
 Regression analysis: The regression analysis method for demand forecasting measures
the relationship between two variables. Using regression analysis a relationship is
established between the dependent (quantity demanded) and independent variable
(income of the consumer, price of related goods, advertisements, etc.).

CONCLUSION
The quantitative and qualitative methods of demand forecasting show us that demand forecasting
is the judgment of the market's future of an organization with some scientific backgrounds.
Hence, demand forecasting helps an organization speculate the future demand of the
organization's commodity to perform the production and change different strategies accordingly.

Answer 3a.

INTRODUCTION
Elasticity of supply: The price of elasticity of supply is a measure of the degree of
responsiveness of the quantity supplied to the change in the price of a given commodity. It is an
important parameter in determining how the supply of particular product is affected by
fluctuations in its market price. It also gives an idea about the profit that can be made by selling
that product at its different price.

% change∈supply of a commodity
Price elasticity of supply=
percentage change ∈ price of a commodity

CONCEPT AND APPLICATION

In price elasticity of supply, the negative sign is ignored, and the only absolute value is
considered. The value of price elasticity of supply lies between 0 and infinity. Here, 0 is
perfectly inelastic supply, and infinite is perfectly elastic supply.

Let us calculate the price of the given commodity.

Q = 200 units

Q` = 250 units

P = Rs 8 per unit

P` =?

Es = 2

Q −Q
Percentage change in quantity supplied of the commodity = × 100
Q

250−200
= ×100
200

50
= ×100
200

= 25%
 P −P
Percentage change in price of the commodity = × 100
P

P −8
= ×100
8

% change∈supply of a commodity
Price elasticity of supply=
percentage change ∈ price of a commodity

25 %
2=
P −8
×100
8

P −8
2( ×100) = 25%
8

P −8
×100 = 25%
4

(P` - 8) * 25 = 25

P` - 8 = 1

P` = 9

Hence, the price at which the organization is supplying 250 units is Rs 9 per unit. 

CONCLUSION
The firm needs to take some actions to improve the organization's ability to respond quickly and
effectively to the changes in the market conditions as that high price elasticity of supply is
desirable. These actions may include creating space capacity, use of latest technology,
maintaining sufficient stocks, developing better storage facilities and distribution systems,
providing better training for the workers, locating the production near the market for easy
transportation, and allowing inward immigration of labour for the labour shortage. 
3. b. Calculate the elasticity of supply if a 15 %increase in the price of soya bean oil
increases its supply from 300 to 345 units (5 Marks)

Answer 3b.

INTRODUCTION

Elasticity of supply: The price of elasticity of supply is a measure of the degree of

responsiveness of the quantity supplied to the change in the price of a given commodity. It is an
important parameter in determining how the supply of particular product is affected by
fluctuations in its market price. It also gives an idea about the profit that can be made by selling
that product at its different price.

% change∈quantity supplied of a commodity

Elasticity of supply=
% change∈ factors affecting supply of commodity

CONCEPT AND APPLICATION

Price elasticity of supply: Price elasticity of supply is the percentage change in quantity
supplied of a product because of percentage change in price of the product.

percentage change ∈supply of a commodity

Price elasticity of supply=
percentage change ∈ price of a commodity

Let us calculate the price elasticity of supply for the soya bean oil. The following figures are
given in the question.

Q = 300 units

Q` = 345 units

Percentage increase in price of soya bean oil = 15%

Es =?
 Q −Q
Percentage change in quantity supplied of the commodity = × 100
Q

345−300
= ×100
300

45
= ×100
300

= 15%

P −P
Percentage change in price of the commodity = × 100
P

= 15%

% change∈supply of a commodity
Price elasticity of supply=
percentage change ∈ price of a commodity

15 %
=
15 %

=1

Es = 1

If a product has a price elasticity of supply of more than 1, then the product is elastic and If a
product has a price elasticity of supply equal to 1, then the product is unit elastic when it is more
then 1, it means a slight change in the commodity price will change the commodity's supply with
a more significant proportion. Also, when equal to 1 it means the percentage change in price and
percentage change in the commodity supply are the same. But if a product has a price elasticity
of supply between 0 and 1, the product is inelastic. It means that the percentage change in the
commodity supply is smaller than the percentage change in that commodity price.

CONCLUSION
For the given commodity, i.e., soya bean oil, supply elasticity is equal to 1 which means that
soya bean oil has a unit elastic supply. Hence, the percentage change in the price of soya bean oil
is the same as the percentage change in soya bean oil supply.