Business Economics (PGEMP)

Session 01: Introduction

Dr. Monika Gupta

Assistant Professor
Economics Area

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GSK Article discussion

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 GSK Article

A B C D
Demand & Supply Production & Cost Market structure External envt.
Margins Distribution network
Sales Cost efficiencies Government regulation
Growth Cost reduction New segments Taxes
Customer behaviour Profit and loss Market share
Restructuring Merger
Value added growth Leaders /Monopoly
Short Run/Long Run power – Pricing power

A, B, C – Microeconomics/
Business Economics
D- Macroenvironment
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 Introduction

• Evolution of the Economics Adam Smith – The Father of Economics

1776 – Wealth of Nations

• Definition of the Economics Economics is a science which studies human

behaviour as a relationship between ends
and scarce means which have alternative
• Objective of a firm or a consumer uses.
• Maximize profit
• Maximize Utility

• Micro Vs Macroeconomics

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 Some Basic Economic Concepts

• The role of assumptions and Ceteris Paribus

• Ceteris paribus (other things remaining constant) is a Latin phrase that means all
variables other than the ones being studied are assumed to be constant. Literally,
ceteris paribus means “other things being equal.”

• Laissez-faire ("let (it/them) do")

• An economic environment in which transactions between private parties are free
from government restrictions, tariffs, and subsidies, with only enough regulations to
protect property rights.

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Exercise

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 SOUTH WEST LEATHER DESIGNS

South West leather Designs specializes OUTPUT PRICE TOTAL COST

in the production of fashionable leather
belts for women. Its original designs are 0 40 40000
sometimes imitated by rival leather 1000 35 42000
goods manufacturers, but the South 2000 32.5 43500
West logo is a registered trademark that
affords the company some protection 3000 28 45500
from outright counterfeiting of its 4000 25 48500
products. It therefore enjoys some
monopoly power. 5000 21.5 52500
The given table presents the demand 6000 18.92 57500
and cost conditions faced by the firm. 7000 17 63750
How many belts do you think should 8000 15.35 73750
be manufactured?
9000 14 86250

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 TOTAL PROFITABILI
OUTPUT PRICE TR PROFIT
COST TY (P/S)

0 40 40000
1000 35 42000 35000 -7000 -20
2000 32.5 43500 65000 21500 33.08
3000 28 45500 84000 38500 45.83
4000 25 48500 100000 51500 51.5
5000 21.5 52500 107500 55000 51.16
6000 18.92 57500 113520 56020 49.35
7000 17 63750 119000 55250 46.43
8000 15.35 73750 122800 49050 39.94
9000 14 86250 126000 39750 31.55

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The target output/production can
be decided on the basis of anyone TOTAL PROFITABILI
OUTPUT PRICE TR PROFIT
of the following depending on the COST TY (P/S)
firm’s objective–
0 40 40000
*Maximum Profit
1000 35 42000 35000 -7000 -20
*Profitability
*market expansion or high sales 2000 32.5 43500 65000 21500 33.08
*Incremental change in the cost 3000 28 45500 84000 38500 45.83
and revenue i.e. Marginal cost and
4000 25 48500 100000 51500 51.5
marginal revenue
5000 21.5 52500 107500 55000 51.16
6000 18.92 57500 113520 56020 49.35
Selection of anyone of the above
7000 17 63750 119000 55250 46.43
will also have some opportunity
cost 8000 15.35 73750 122800 49050 39.94
9000 14 86250 126000 39750 31.55

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 What is Opportunity costs

• Opportunity Costs – the implicit value of a resource in its best alternative

use or the opportunity foregone.
• Examples
• A player attends baseball training to be a better player instead of taking
a vacation. The opportunity cost was the vacation.
• Jill decides to drive to work instead of taking the bus. It takes her 90
minutes to get there and the bus ride would have been 40, so her
opportunity cost is the extra time she is devoting when not taking the
bus.
• When the government spends $15 billion on interest for the national
debt, the opportunity cost is the program the money might have been
spent on, like education or healthcare.

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• Decision maker has to see how the revenue and cost is behaving

• Incremental /Marginal changes are important

• Incremental change in the revenue is due to the change is demand of the

product since TR = P*Q
• It all depends on the utility…

• Lets see the role of Utility in consumer demand

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 Chocolate example

Chocolate Expression Marginal Total Utility Price

Utility
1 Very excited 5 5 4
2 Happy 4 9 4
3 Ok 2 11 4
4 Not good 0 11 4
5 BAD -2 9

A consumer will chose the commodities till MB>=MC means

MU>=P

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 The Basis of Choice: Marginal Utility

• Marginal means “incremental”, additional or extra.

• The marginal utility of product i is the rate of-change of total utility as the
quantity of product i consumed changes by one unit; i.e.
• The additional satisfaction gained by the consumption or use of one more
unit of something.
U
MU i =
 xi

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THE BASIS OF CHOICE: UTILITY

Total Utility and Marginal Utility of

Trips to the Club Per
Week
TRIPS TOTAL MARGINAL
TO CLUB UTILITY UTILITY
1 12 12
2 22 10
3 28 6
4 32 4
5 34 2
6 34 0

FIGURE 6.5 Graphs of Frank’s Total and

Marginal Utility

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Consumer Surplus

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 Consumer Surplus

• The difference between the maximum amount a person is willing to pay

(depending upon the utility) for a good and its current market price.

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 Producer Surplus

• The difference between the amount a producer of a good receives and the
minimum amount the producer is willing to accept for the good

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 Annexure

• Any expectations and (unbiased ☺) suggestions ….you may write at

monika.gupta@spjimr.org

• Keywords – Microeconomics, Macroeconomics, Opportunity Costs, Production,

cost, profitability , Marginal Utility, Consumer surplus

• Readings - Chapter 1 & 2 from prescribed text book Principles of Economics by

Mankiw.
• Sources of Material/Current news on Economics in general
• Different Economics related Newspaper such as Business Standard, Economic
Times, Financial Times, Bloomberg and Livemint

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 Plan for the Next Session

• Topics - Demand analysis and factors affecting demandReadings

• Chapter 4: ‘The Market Forces of Supply and Demand’

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 Acknowledgements

• All slides in this presentation have been prepared by the instructor herself.
Assistance is taken form various sources.

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• Thank you!

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 Business Economics (PGEMP)

Session 02: Demand analysis and Elasticity of Demand

Dr. Monika Gupta

Assistant Professor
Economics Area

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• Your research demand has given you the following demand function
• Q=90 – 3p

• Analyse the same

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 The Basis of Choice: Utility

• Diminishing marginal utility and downward-sloping demand

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 What is Demand?

• Desire to pay
• Ability to pay
• Willingness to pay

Demand is the quantity of goods or services that consumers are able and
willing to buy at a given price at a particular time

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 The Demand Curve
Price of Ice-
Cream Cone

$3.00

2.50

2.00 relationship between price and demand

1.50

1.00

0.50

Quantity of
Ice-Cream
Cones
0 1 2 3 4 5 6 7 8 9 10 11 12
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 What is Market Demand Curve

• Market demand refers to the sum of all individual demands for a particular
good or service.
• Graphically, individual demand curves are summed horizontally to obtain
the market demand curve.

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• What are the factors you need to consider to analyse the demand?
• What are the factors which affect your supply?

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 The Demand Function

• A general equation representing the demand curve

Qxd = f(Px , PY , Y, T, O)

• Qxd = quantity demand of good X.

• Px = price of good X.
• PY = price of a related good Y.
• Substitute good.
• Complement good.
• Y = income.
• T = Tastes of the consumer
• O = any other variable affecting demand.

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 Determinants of Demand and Shift in demand
curve
• The price of a product (“own price”)
• Prices of related good products (“cross price”)
• Prices of substitutes - When a fall in the price of one good reduces the demand for another good, the
two goods are called substitutes.
• Prices of complements - When a fall in the price of one good increases the demand for another good,
the two goods are called complements
• Examples: Fish and Chicken, Rice and Wheat, Pen and Ink, Sugar and Milk
• Consumer’s income and / or wealth - Normal good and Inferior good
• Advertising and consumer’s tastes
• Population
• Other individual specific, socioeconomic, cultural and environmental factors
• For example - Place of residence, Weather / Climate, Religious or cultural practices, Influence of other
consumers, (“Neighbor’s envy, owner’s pride”)

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 Market Supply Curve

• Ceteris paribus, the amount of a product that firms are willing to offer for sale at
a given price is called the quantity supplied.
• The supply curve shows the amount of a good that will be produced at alternative
prices.
• Law of Supply
• The supply curve is upward sloping.
• Shift in Supply curve
• An improvement in technology
• For agricultural commodities, more favorable weather conditions
• Input prices
• Government regulations and Taxes (Excise tax and Ad valorem tax)
• Substitutes in production

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 Equilibrium of Supply and Demand
Price of Ice-
Cream Cone
Supply
$3.00

2.50 Equilibrium
The curves intersect at
2.00 equilibrium, or market-
clearing price.
1.50 Quantity demanded
equals quantity
1.00 supplied at P=$2.

0.50 Demand

0 1 2 3 4 5 6 7 8 9 10 11 12 Quantity of Ice-
Cream Cones
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 The Market Mechanism and Equilibrium

• The market mechanism is the tendency in a free market for price to change
until the market clears
• Markets clear when quantity demanded equals quantity supplied at the
prevailing price
• Market clearing price – price at which markets clear
• The Price (P) that Balances supply and demand or in Equilibrium
• QxS = Qxd
• No shortage or surplus

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 A graphical exercise

Question. Show in a diagram the effect (shift) on the demand curve, the
supply curve, the equilibrium price, and the equilibrium quantity of each of
the following events.

a) The market for newspapers in your town

Case 1: The salaries of journalists go up.
Case 2: There is a big news event in your town, which is reported in the
newspaper.

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 Solution

Case 1: Journalists are an input in the production of newspapers; an increase in

their salaries will cause newspaper publishers to reduce the quantity supplied at
any given price. This represents a leftward shift of the supply curve from S1 to S2
and results in a rise in the equilibrium price and a fall in the equilibrium quantity as
the equilibrium changes from E1 to E2.

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 Solution

Case 2: Townspeople will wish to purchase more newspapers at any given price.
This represents a rightward shift of the demand curve from D1 to D2 and leads to a
rise in both the equilibrium price and quantity as the equilibrium changes from E1
to E2.

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Elasticity of Demand

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 Business Perspective
Examples involving Price and Income
• By what percentage will your sales decrease if you raise your price 5.0 per cent?
• Your competitor has initiated a price war by a 10.0 per cent price-cut. How will the
demand for your product be affected?

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 Elasticity of demand

What is Elasticity?
• The responsiveness or flexibility with respect to change in other
variable
• Percentage change in one variable with respect to percentage
change in another variable

• What is Elasticity of demand?

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 A Taxonomy of Elasticity

Elasticity

Elasticity of Demand Elasticity of Supply

Price elasticity of Cross Price Elasticity Income Elasticity of

Demand of Demand Demand

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 Price (Own) Elasticity of Demand

• A measure of responsiveness or proportional change in quantity demand

with respect to propositional change in price
Percentage change in quatity demanded
Price elasticity of demand = −
Percentage change in price

• Elasticity is a pure number and is unit free!

• Price elasticity is negative

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 How to calculate elasticity?

• If the price of an ice cream cone increases from $2.00 to $2.20 and the
amount you buy falls from 10 to 8 cones then your elasticity of demand
would be calculated as:

(8 − 10) Also known as

 100
10 − 20 percent Point elasticity
= = −2
(2.20 − 2.00) – measured at
100 10 percent a point
2.00

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 Different types of Price Elasticity of Demand

• Perfectly inelastic demand (0) – vertical

• Unit Elasticity (1)
• High Elasticity of demand (>1) - The flatter the demand curve
• Less elasticity of Demand (<1) - The steeper the demand curve
• Perfectly elastic demand (∞)– horizontal

Note that elasticity of a curve, like slope or curvature, could vary

from point to point.

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 Perfectly Inelastic Demand- Elasticity equals 0

Price Demand
Example??

1. An $5
increase
in price... 4

100 Quantity
2. ...leaves the quantity demanded unchanged.
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 Inelastic Demand- Elasticity is less than 1

Price
Example??

1. A 25% $5
increase
in price... 4

Demand

90 100 Quantity
2. ...leads to a 10% decrease in quantity.
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 Unit Elastic or Iso Elastic Demand-
Elasticity equals 1
Price
Example??

1. A 25% $5
increase
in price... 4

Demand

75 100 Quantity
2. ...leads to a 25% decrease in quantity.
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 Elastic Demand- Elasticity is greater than 1
Price
Example??

1. A 25% $5
increase
in price... 4

Demand

50 100 Quantity
2. ...leads to a 50% decrease in quantity.
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 Perfectly Elastic Demand- Elasticity equals
infinity
Price
1. At any price Example??
above $4, quantity
demanded is zero.

$4 Demand

2. At exactly $4,
consumers will
buy any quantity.

3. At a price below $4, Quantity

quantity demanded is infinite.
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 A Taxonomy of Elasticity

Elasticity

Elasticity of Demand Elasticity of Supply

Price elasticity of Cross Price Elasticity Income Elasticity of

Demand of Demand Demand

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 Cross-Price Elasticity of Demand
• Proportional change in quantity demand with respect to proportional
change in related good QX / QX QX PY
E XY = = 
PY / PY PY QX
• Substitutes - Two goods for which an increase in the price of one leads to
an increase in the quantity demanded of the other. Ex: Tea/Coffee,
Rice/Wheat, Chicken/Mutton
• Complements -Two goods for which an increase in the price of one leads to
a decrease in the quantity demanded of the other Ex: Milk/Sugar,
Rice/Vegetables, Car/Petrol
Substitutes Complements
E XY  0 E XY  0
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 Income Elasticity of Demand

• Definition of Income Elasticity: proportional change in quantity demand

with respect to propositional change in income
Q / Q Q I
EI = = 
I / I I Q
• Point to Remember: Income elasticities could be both positive and
negative, depending up on the nature of the commodity.

Normal Good Inferior Good

EI  0 EI  0

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 Income Change, Price change and consumer
behaviour
• Normal Goods
• Inferior Goods
• Giffen Goods

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 Elasticity of Supply

• The price elasticity of supply measures the relationship between change in

quantity supplied and a change in price and
• Defined as the percentage change in quantity supplied divided by the
percentage change in price.
• Depends on the flexibility of sellers to change the amount of the good they
produce

• Sign: Positive.

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 Elasticity of Supply

• Determinants of the Price Elasticity of Supply

• Flexibility of sellers: goods that are somewhat fixed in supply (beachfront
property) have inelastic supplies.
• Time horizon: supply is usually more inelastic in the short run than in the long
run.
• Time to produce, Storage capacity, etc.
• How costs respond to output changes?

• Elastic supply
• Quantity supplied responds substantially to changes in the price
• Inelastic supply
• Quantity supplied responds only slightly to changes in the price
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 Relationship between Price Elasticity, TR and MR

• If Ed is elastic (Ed > 1), a rise in price ______total revenue

• If Ed is elastic (Ed > 1), a rise in price lowers total revenue

• If Ed is inelastic (Ed < 1), a rise in price _____total revenue

• If Ed is inelastic (Ed < 1), a rise in price increases total revenue

• If Ed is unit elastic (Ed = 1), a rise in price leaves total revenue_________.

• If Ed is unit elastic (Ed = 1), a rise in price leaves total revenue unchanged.

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 Exercise

Amazon.com, the online bookseller, wants to increase its total revenue. One
strategy is to offer a 10% discount on every book it sells. Amazon.com knows that
its customers can be divided into two distinct groups according to their likely
responses to the discount. The accompanying table shows how the two groups
respond to the discount.

Cases Group A (sales per Group B (sales per

week) week)
Volume of sales before the 10% discount 1.55 million 1.50 million

Volume of sales after the 10% discount 1.65 million 1.70 million

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 Exercise

A) How the discount will affect total revenue from each group.

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• Suppose Amazon.com knows which group each customer belongs to when
he logs on and can choose whether or not to offer the 10% discount. If
Amazon.com wants to increase its total revenue, should discounts be
offered to group A or to group B, to neither group, or to both groups?

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 Solution - A

• the percent change in the quantity demanded by group A is

• Since the change in price is 10%, the price elasticity of demand for group A is

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 Solution – B and C

• For group A, since the price elasticity of demand is 0.625 (demand is

inelastic), total revenue will decrease as a result of the discount. For group
B, since the price elasticity of demand is 1.25 (demand is elastic), total
revenue will increase as a result of the discount.
• If Amazon.com wants to increase total revenue, it should definitely not
offer the discount to group A and it should definitely offer the discount to
group B.

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 Annexure

• Keywords – Law of Demand, Demand Curve and Supply Curve, Slope and Shift in the
supply and demand curve, Market Equilibrium, Determinants of demand , Elasticities of
Demand, Price, Income and Cross Price Elasticity of Demand, Relationship between
Revenue and elasticity

• Readings - Chapter 4,5 , 6,7 from the prescribed text book.

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 Plan for the Next Session

• Topics
• Production Decisions of a firm, Short run Production Function, Law of
Diminishing Returns, Economies and Diseconomies of scale, Cost concepts
and application

• Readings – Chapter 13

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 Acknowledgements

• All slides in this presentation have been prepared by the instructor herself.
Assistance is taken from the text book. Any omission of references is
unintentional. I acknowledge the assistance of my guide Prof. Sanjay K.
Singh.

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• Thank you!

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