MODULE 1

What is ECONOMICS?
❑ What is ECONOMICS?
• Economics is a social science.
• Its basic function is to study how people-individual,
households, firms and nations maximize their gains
from their limited resources and opportunities.
• Which studies human behaviour in relation to
optimizing allocation of available resources to
achieve the given ends.
• Economics is the study of how economic agents or
societies choose to use scarce productive resources
that have alternative uses to satisfy wants which are
unlimited and of varying degrees of importance.
❑ Two views about the subject matter of
ECONOMICS:
• The Traditional View
• The Modern View
The Traditional View: Consumption, Production,
Exchange and Distribution
Consumption: relates to the study of the consumer, the nature of
human wants, their satisfaction and the nature of demand.
Production: the factor inputs are converted into outputs. Land,
labour, capital and organization are the four agents of production.
Exchange: refers to transactions between producers and
consumers. It examines the price and output decisions under
various market conditions.
Distribution: studies the respective shares, i.e. rent, wages,
interest and profit that go to the four agents of production.
• The Modern View: Price Theory, Income and
Employment Theory and Growth Theory
The price theory, income and employment theory and
growth theory are better known as microeconomics and
macroeconomics respectively.
Microeconomics is concerned with the determination of
price, which is a function of demand and supply. The
four aspects of the traditional view are covered in
microeconomics.
Macroeconomics is concerned with the economic
system as a whole. It analyses the total income,
expenditure, employment and growth of the entire
economy.
❑Fundamental Problems of an Economy:
What to Produce?
How to Produce?
For Whom to Produce?
❑ Economics can be classified as Positive or
Normative
POSITIVE ECONOMICS
1. Positive Economics describes what
is, i.e. observed economic
phenomenon.
2. Positive Economics is descriptive
in nature.
3. It deals with actual or realistic
situations. These are fundamental
statements and describe what
was, what is and what would be.
These statements can be tested,
proven or disproven and do not
involve personal value judgments.
4. Example:
Higher interest rates will reduce
house prices.
Does a currency devaluation fuel
inflation?
NORMATIVE ECONOMICS
1. Normative Economics prescribes
what ought to be, i.e. it
distinguishes the ideal from the
actual.
2. Normative Economics is
perspective in nature.
3. It examines the real economic
events from moral and ethical
angles and judges whether certain
economic events are desirable or
undesirable.
4. Example:
The government should increase
taxes on tobacco products in order to
reduce smoking.
Higher education should be free for
all students.
What is MANAGERIAL ECONOMICS?
Some Definitions:
• "Managerial Economics is concerned with the
application of economic concepts and economic
analysis to the problems of formulating rational
decision making.” -----Mansfield
• “Managerial Economics is the integration of
economic theory with business practice for the
purpose of facilitating decision making and
forward planning by management.” -----Spencer
and Seigelman
• “Managerial Economics is concerned with the
application of economic principles. and
methodologies to the decision-making process
within the firm or organization. It seeks to
establish rules and principles to facilitate the
attainment of the desired economic goals of
management”-----Douglas
• “Managerial economics applies the principles
and methods of economics to analyse problems
faced by management of a business, or other types
of organizations and to help find solutions that
advance the best interests of such organization.”
-----Davis and Chang
❑ What is MANAGERIAL ECONOMICS?
• Managerial economics is the study of economic
theories, logic and tools of economic analysis that are
used in the process of business decision making.
• Economic theories and techniques of economic
analysis are applied to analyse business problems,
evaluate business options and opportunities with a
view to arriving at an appropriate business decision.
• Managerial economics is the discipline that deals with
the application of economic concepts, theories and
methodologies to the practical problems of
businesses/ firms in order to formulate rational
managerial decisions for solving those problems.
❑ Nature of MANAGERIAL ECONOMICS:
• Microeconomic in nature
• It is pragmatic
• Managerial Economics describes, what is the observed
economic phenomenon (positive economics) and
prescribes what ought to be (normative economics).
• It is based on strong economic concepts (conceptual in
nature)
• Analyses the problems of the firms in the perspective
of the economy as a whole (utilizes some theories of
macroeconomics)
• It helps to find optimal solution to the business
problems (problem solving in nature)
❑ Scope of MANAGERIAL ECONOMICS:
• Estimation of product demand
• Analysis of product demand
• Planning of production schedule
• Deciding the input combination
• Estimation of cost of product
• Analysis of cost of product
• Achieving economies of scale
• Determination of price of product
• Analysis of price of product
• Analysis of market structures
• Profit estimation and planning
• Planning and control of capital expenditure
❑ The Circular Flow of Economic Activity:

Two sector Economy

Three sector Economy
Four sector Economy
❑ Nature of the Firm:
• A firm is an association of individuals who have
organized themselves for the purpose of turning
inputs into output.
• The firm organizes the factors of production to
produce goods and services to fulfill the needs of the
households.
• Each firm lays down its own objectives which is
fundamental to the existence of a firm.
❑ Objective of the Firm:
❑ Two Condition for Profit Maximization:
❑ What is DEMAND?
• Demand may be defined as the quantity of goods and
services desired by an individual, backed by the
ability and willingness to pay.
• “Demand” is thus defined as that want, need or desire
which is backed by willingness and ability to buy a
particular commodity, in a given period of time.
• Demand is effective desire, as it is backed by
willingness to pay and ability to pay. Moreover
effective demand will always be attributed with a
price and a particular point of time.
• The term ‘demand’ for a commodity (i.e., quantity
demanded) always has a reference to ‘a price’, ‘a
period of time’ and ‘a place’.
❑ Determinants of Demand:
i. Price of the commodity X (Px )
ii. Consumer’s income (Y)
iii. Price of related (substitute or complementary)
commodity (Po )
iv. Consumer’s taste and preferences (T)
v. Advertising (A)
vi. Future expectations (Ef )
vii. Population and economic growth (N)
viii.Credit facilities/discount by sellers
ix. Multiplicity of use of goods
x. Distribution of National Income
Dx = f(Px , Y, Po, T, A, Ef , N)
• Individual Demand: The quantity of a commodity
which an individual is willing to buy at a particular
price during a specific time period, given his money
income, his taste and prices of other commodities
(particular substitutes and complements), is called
‘individual’s demand for a commodity’.
• Market Demand: The market demand for a
commodity is the sum of individual demands by all the
consumers (or buyers) of the commodity, over a period
and at a given price, other factors remaining the same.
• Firm Demand: The quantity of a firm’s product that
can be disposed of at a given price over a time period
connotes the demand for the firm’s product.
• Industry Demand: The aggregate demand for the
product of all the firms of an industry is known as the
demand for industry’s product.
• Durable Goods Demand: Durable goods are those that
can be used more than once, over a period of time. Ex-
car, readymade shirts, machines, tools, etc.
• Non-durable Goods Demand: Goods that can be used
only once and their total utility is exhausted in a single
use. Ex- coal, oil, bread, jam, etc.
• Short-term Demand: Demand for goods that are
demanded over a short period. Ex- crackers on the
occasion of Diwali, goods of seasonal use, etc.
• Long-term Demand: Demand which exists over a long
period. Ex- demand for consumer and producer goods,
durable and non durable goods, etc.
• Direct Demand: Demand for goods that are directly
used for consumption by the ultimate consumer is
known as direct demand. Ex- bread, tea, readymade
shirts, scooters, houses, etc.
• Indirect Demand: Demand for goods that are not used
by consumers directly. They are used by producers for
producing other goods. Ex- raw materials, machines,
coal, limestone, etc.
• Derived Demand: When a product derives its usage
from the use of some primary product, its demand is
known as derived demand. Ex- tyres (for vehicles),
cement (for construction), etc.
• Autonomous Demand: The demand for a product that
can be independently used. Ex- demand for food, milk,
vegetables, food, shelter, cloth etc.
• Joint Demand: It is the combined demand of two or
more interlinked goods. Thus, it refers to the purchasing
of one good at the same time as purchasing another good.
Ex- printer and ink, ink cartridges and printer, razor and
razor blades
• Composite Demand: the situation when a particular type
of goods is used to produce more than one type of
product. In the case of composite demand, if demand for
one product that uses the commodity rises, the supply of
other products using the commodity will fall. Ex- demand
for sugar for ice-cream, supply of sugar for the others
• Competitive Demand: Competitive Demand means you
can derive equal satisfaction from either product. Ex-
substitutes like jam and marmalade
❑ Law of Demand:
• The law of demand states that other things remaining
constant (ceteris paribus), when the price of a
commodity rises, the demand for that commodity falls
and when the price of a commodity falls, the demand
for that commodity rises,.
• As the law states, there is an inverse relationship
between the price and quantity demanded.
• The law holds under the condition that “other things
remain constant (ceteris paribus)”.
• The factors remain constant only in the short run. So
that, the LoD holds only in the short run.
• Marshall explain the law as “The amount demanded
increases with a fall in price and diminishes with a
rise in price”.
❑ Factors Behind the Law of Demand:
• Law of Diminishing Marginal Utility
• Price Effect
• Substitution Effect
• Income Effect
• New Consumers
• Several Uses
• Psychological Effects
❑ Exceptions to the Law of Demand:
• Expectations regarding future prices/ Price change
expectations
• Status Goods
• Giffen Goods
• Income change of the family
• Veblen goods or Snob Appeal
• Luxury items
• Essential or necessary products and services
• Insignificant portion of income spent
• Goods with no substitutes
• Consumers negligence
• Demonstration Effect
• Changes in taste, preferences, and fashionable products
• Trading in stock exchanges
❑ What is SUPPLY?
• Supply refers to the quantities of a good or service
that the seller is willing and able to provide at a price,
at a given point of time, other things remaining the
same.
• Supply means the willingness of the firms to sell a
particular commodity.
• The law of supply indicates only the direction of
change in quantity supplied in response to a change in
price.
❑ Determinants of Supply:
i. Price of the commodity X (Px )
ii. Cost of Production (wages, interest, rent and prices of
raw materials) (C)
iii. State of Technology (T)
iv. Government policy regarding taxes and subsidies (G)
v. Number of Producers (or firms) (N)
vi. The number of firms producing and selling the
commodity
vii. Price of related goods produced
viii. Future expectations regarding prices

Sx = f(Px , C, T, G, N)
❑ Law of Supply:
• The law of supply states that other things remaining
constant (ceteris paribus), when the price of a
commodity rises, the quantity supplied of it in the
market increases, and when the price of a commodity
falls, its quantity demanded decreases.
• As the law states, there is an direct relationship
between the price and quantity supplied.
• The law holds under the condition that “other things
remain constant (ceteris paribus)”.
❑ Elasticity of Demand:
• The concept of elasticity of demand therefore refers to
the degree of responsiveness of quantity demanded of a
good to a change in its price, consumer’s income and
prices of related goods.
• Elasticity of demand helps in measuring the magnitude
of responsiveness of quantity demanded of a good to
change in its price.
• According to Alfred Marshall: “Elasticity of demand
may be defined as the percentage change in quantity
demanded to the percentage change in price.”
• According to A.K. Cairncross: “The elasticity of
demand for a commodity is the rate at quantity bought
changes as the price changes.”
❑ Degrees of Price Elasticity:
• Perfectly Elastic Demand : ep =
• Perfectly Inelastic Demand : ep =0
• Highly Elastic Demand: ep >1
• Relatively Inelastic Demand: ep <1
• Unitary Elastic Demand: ep =1
❑ Types of Elasticity of Demand:
 𝜟𝒒𝒙
𝑿 𝟏𝟎𝟎 𝜟𝒒𝒙 𝜟𝒑𝒚 𝜟𝒒𝒙 𝒑𝒚
𝒒𝒙
𝑬𝑪 = 𝜟𝒑𝒚 = 𝒒𝒙
÷ 𝒑𝒚
= 𝜟𝒑 𝑿 𝒒𝒙
𝑝
𝒑𝒚 y
𝑿 𝟏𝟎𝟎 𝒚
❑ Measurement of Price Elasticity:

𝜟𝑬𝒙𝒑
𝑬𝒅 = 𝟏 −
𝑿𝜟𝑷
(ΔExp=change in Expenditure, X= Initial Demand, ΔP=Change in price)
 𝜟𝑸 𝑷
= (−) 𝜟𝑷 𝑿
𝑸
❑ Importance of Elasticity of Demand:
1. Determination of Price
2. Basis of Price Discrimination
3. Useful for Business
4. Helpful to Finance Minister
5. Fixation of Wages
6. In the Sphere of International Trade
7. Paradox of Poverty
8. Effect on Employment
9. Incidence of Taxation
10. Determination of Price of Public Utilities
11. Determination of Rewards of Factor of Production
12. Government Policies of Taxation
❑ Demand Forecasting: