Mefa notes from durga prasad navulla

MEFA NOTES
UNIT-I
INTRODUCTION 3. Economics as Science of Scarcity

Knowledge of economics is helpful to Here there are two important definitions to be
managers, engineers etc. it is helpful to engineer considered.
in determining several issues such as how much 1. According to Lionel Robbins,
quantity is to be supplied issues such as how “Economics is a science which studies
much quantity is to be supplied, produced and human behavior as a relationship
what should be the price of the product, should between unlimited wants, and scarce
the produce be made internally or bought from resources which have alternative uses”.
the outside market, how much quantity is to be 2. According to J.M.Keynes, “Economics
produced in order to earn certain profit etc. is the study of administration of scare
resources and how the level of income
Managerial economics provides us a and employment will be determined in
basic insight into seeking solution for several the country”.
managerial problems. Economics influences the technical
decisions of any industry by using the
techniques such as demand analysis, elasticity
Introduction to Economics of demand, demand forecasting, break-even
analysis, production function, capital budgeting
Economics is the science related to the etc.
production, distribution and consumption of Kinds of Economics:
wealth or the material welfare of mankind,
political economy, economic questions, affairs 1. Micro Economics
or aspects. Various economists defined
economics in different ways. In general, Micro Economics is also called “Theory
economics can be defined as a social science of Firm”. Micro economics is that branch of
which deals with human behavior, how he uses economics which is concerned with the analysis
limited income to satisfy the unlimited wants. of the behavior of the individual units or
The definitions of economics can be variables such as individual demand or the price
broadly classified into three different categories. of the product.
1. Economics is Defined as Science of Wealth
Micro economics basically deals with
Adam smith (the father of economics) individual decision making ad the problem of
defined economics as a science of wealth. resource allocation. It is concerned with
According to him “economics is concerned with applications such as Law of Demand, Price
an inquiry into the nature and causes of wealth Theory etc.
of nations”.
He has given primary importance to wealth and 2. Macro Economics
secondary importance to mankind.
Macro economics is that branch of
2. Economics as Science of Human Welfare economics which deals with the aggregate
behavior of the economy, as a whole it makes a
According to Alfred Marshall study of the economic systems in general. E.g.
“economics is on one side a study of wealth and National income, Total saving, Total
on the other and more important side a part of Consumption, Unemployment, Economic
study of man”. Growth rate.
He has given primary importance to making and
secondary importance to wealth
N. DURGA CHAITANYA PRASAD M.Com, M.B.A. (SITE) 1

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*Difference between Micro and Macro Definitions:
Economics
S.N Micro Macro “Managerial Economics is the use of economic
1. It is study of the It is study of the modes of thought to analyse business
behavior of the behavior of the situations”. Mc Nair and Meriam.
individual firms or units economy as a
whole. “Managerial Economics is the economics
2. It is individualistic. It is aggregate. applied in decision-making”.
Haynes, Mote and Paul
3. It is concerned with the It is concerned
behavior of the micro with the behavior “Managerial Economics is the application of
variable such as of macro economic theory and methodology to business
individual demand, variables such as administration practice”
supply. National Income, Brigham and Pappas
National Output,
Total Savings. “Managerial Economics is a price theory in the
service of business executives”
4. Its scope is limited. Its scope is vast. Watson.

5. It deals with the data of It deals with the Based on the above definitions the common
individual firm. data of total view regarding managerial economics is as
industry. follows
1. Managerial Economics is concerned
Managerial Economics-Meaning with decision making of economics
nature.
Economics is concerned with the 2. Managerial economics is goal oriented.
problem of allocation of scare resources among 3. Managerial Economics facilitates
competing wants. Those economics principles, forward planning.
concepts methods, tools and techniques that can 4. Managerial economics provides link
be applied practically to solve the problems of between traditional economics and
Business Management is known as managerial decision science.
economics. 5. Managerial Economics directs the
utilization of scarce resources in a goal
oriented manner.
Economics Managerial Economics, Solutions to
Principles, Application of Economics business
Concepts,
Tools and
to solve the problems of
business management
problems/
managers
Nature of Managerial Economics:
Techniques • Micro Economics in Nature
• Normative Economics
• Application Oriented
• Macro Economics
Decision making problems of Business
Management • Evaluation of each alternative
• Assumptions
Therefore, Managerial Economics is a part of
Economics and it is concerned with business Micro Economics in Nature:
practice for the purpose of facilitating decision
making. Micro Economics studies about the
individual firm. It studies how an individual


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firm can use scarce resource to produce more • The theory of managerial economics is
output with minimum cost and maximum profit. based mainly on the theory of firm
Normative Economics: • Managerial economics is both
conceptual and materialistic
Managerial Economics tells a business • Managerial economics is concerned with
firm to do certain things which will benefit them managerial decision making
and not to do certain things which leads to
• Managerial economics takes the help of
losses. Therefore managerial economics is
other sources to make optimum use of
normative economics because it prescribes
scarce resources
Application Oriented: • Managerial economics is goal oriented
in its approach
Managerial Economics tries to solve • Managerial economics is micro-
some complicated business problems. Decision economics in character as it concentrated
making skills can be improved by applying only on the study of the firm and not on
some principles and concepts. the working of the economy.

Macro Economics in Nature: Scope of Managerial Economics:

Managerial Economics gives an The following topics comes under the scope of
opportunity to evaluate each alternative managerial economics.
depending on its cost and profit. There is a
scope that the managerial economist can decide • Demand analyse and Forecasting
on the best alternative to maximize the profits • Cost Analysis
for the firm. • Production Analysis
• Pricing Policies
Evaluation of each alternative: • Profit Management
• Capital management
Managerial economics gives an
opportunity to evaluate each alternative
depending on its cost and profit. There is a • Demand analyse and Forecasting:
scope that the managerial economist can decide
on the best alternative to maximize the profits A business firm convert raw material
for the firm. into finished products and these products are
sold in the market, Hence the firm has to
Assumptions: estimate and forecast the demand before
starting production. A forecast of future
Managerial Economics is based on demand is essential. The firm will prepare
certain assumptions and the assumptions are not production schedule on the basis of demand
valid universally. Therefore, if there is a change forecast.
in assumption, the theory may not hold good.
• Cost Analysis:
Chief Characteristics of Managerial
Economics Every business firm wants to reduce cost. A
study of economic costs, and their estimates are
• Managerial Economics is the study of
useful for management decisions. Estimation of
the allocation of the scarce resources cost is essential for decision making. An
available to a firm among the activities element of cost uncertainty exists, as all the
of that unit to maximize profit. factors determining cost are not always known

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or controllable. Cost control is essential for • Product Decisions
pricing policies. • Pricing Decisions
• Quantity Decision and
• Technological Decisions
• Production Analysis:
• Product Decisions:
Production analysis refers to the physical terms
while cost analysis refers to monetary terms.
These decision are related to the what
Production analysis deals with different
products the firm will produce and offer for sale
production functions and their managerial uses.
and decision may be related to additions of a
product or deleting the existing product. It also
• Pricing Policies:
includes the style, packing and size of the
product.
Pricing is an important area of managerial
economics. Price is the basic thing for the
• Pricing Decisions:
revenue of a firm, and the success of the price
decisions taken by it
These decisions are related to fixing a price
for the products manufactured. If the price is
• Profit Management:
very high the firm may not be able to sell its
products. Even if the price is low, the consumers
The primary aim of any firm is to maximize think it is an inferior product.
profits. Their exists an uncertainty in the
estimation of profits, because of differences in
• Quantity Decisions:
the costs and revenues, and the effects of its
internal and external factors. Therefore, profit
These decisions are related to how much to
management is the difficult area in managerial
be manufactured. The production depends
economics.
normally in anticipation of demand.
• Capital management:
• Technological Decisions:
Capital Management implies planning
It is concerned with the method to be
acquisition, disposition and control of capital.
adopted in manufacturing a product. One should
see whether a change in technology will benefit
Decision Making in Managerial the business firm or not.
Economics
The managers face a number of Hence, there may be more problems to
problems in day to day management of the firm. be faced while planning for the future. It may
He has to find the solutions to these problems. relate to production, pricing, capital and raw
material. The resources are scarce but they have
Decision making is the process of alternative uses.
choosing one best alternative from a list of
alternative. A manager has to weigh merits and Decision making is very important
demerits of each action, He has to select the best because it is related to uncertain. Managerial
alternative with the limited resources. The economics understand these decision making
decisions made must take the business firm in problems and guides us in a purposeful
the right direction. There are different types of direction.
decisions to be taken, among them the most
important are

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Importance or Usefulness or Significance or • Managerial
Application of Managerial Economics Economics and Operation Research
Operation research is an activity carried
1. Managerial economics provides a out by functional specialist within the firm to help
number of tools and techniques to build the manager to do his job of solving decision
models and with the help of these making problems, while managerial economist is
models the managers can handle the real purely an academic subject which seeks to
life situations. understand and anal7yse decision making
2. Managerial economics provides most of problems of business.
the concepts that are needed for the
analysis of business problems. • Managerial
3. it is helpful in making decisions such as Economics and Mathematics
(a). What should be the product mix? Mathematics provides us a set of tools
(b). Which is the best production which helps in the derivation and exposition of
technique? economics analysis. Mathematics is closely linked
(c) What should be the level of output to managerial economics. It tries to estimate and
and price for the product? produce the relevant economics factors for decision
(d). How to make investment decisions? making and forward planning. The branches of
4. The managerial economics helps us to mathematics which are generally used by a
understand the economic behavior of managerial economist are geometry, Algebra and
individuals calculus.
5. The managerial economics helps us to
explain the working of economic system • Managerial economics and Stastics
6. Managerial economics helps to assess the Statistics is widely used by managerial
performance of the economy economics. Managerial economics aims at
7. Managerial economics provides a good quantifying the past economic activity to predict its
knowledge about cause and effect of future. Probability, correlation, interpolation are
various economic phenomena the concepts used by managerial economics to
8. Managerial economics suggest how to solve certain problems. The concept of statistics
improve the growth rates in developed helps in decision making.
economies
• Managerial economics and Accounting
Relation with other subjects:
Managerial economics is closely related
• Managerial Economics and Traditional with accounting which is concerned with financial
Economics operations of a business firm. Accounting
information is one of the principle sources of data
The relationship between managerial used by managerial economist for his decision
economics and traditional economics is very much purpose.
like the relation of engineering to physics and
medicine to biology. Traditional economics • Managerial economics and psychology
provide certain concepts, methods and principles Consumer psychology is the basis on which
which can be applied to solve the problems of managerial economist acts upon. We always
business management. The both deal with the assume that the behavior of the consumer is
allocation of scarce resource in an optimum way. always rational, which is reality is not so.
A managerial economist must know about Psychology contributes towards understanding the
traditional economics in order to understand the behavioral implications, attitudes and motivations
principles of managerial economics. of each of the microeconomics variables such as


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consumer, supplier, investors, workers or an
employee.


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Functions of Managerial Economist has to obtain statistical data on national
income, price level and tax policies
The managerial economist has to gather • He should identify new business
economics data, analyse all crucial information opportunities
about the business environment. He may have to • He should build micro and macro
make a continuous assessment of the impact of economic models to solve specific
changing technology. In the Indian context a problems
managerial economist is expected to perform the Responsibilities:
following functions.
1. Macro-forecasting for demand and • Sales forecasting
supply • Industrial market research
2. Production planning at micro, macro
• Economic analysis of competing
levels.
companies
3. Capacity planning and product-mix-
determination. • Pricing problems of industry
4. Economic feasibility of new production • Capital projects
process • Production programmers
5. Assistance in preparation of overall • Security analysis and forecast
development plan • advice on trade and public relations
6. preparation of periodical economic • advice on primary commodities
reports • advice on foreign exchange
7. Keeping management information at
• Economic analysis on agriculture.
various national and international
developments on economic matters • Analysis of underdeveloped economies
8. Preparing briefs, speeches, articles and • environmental forecasting
papers for top management
The important characteristics he needs
to have are
Role of Managerial Economist:
i) Economic intelligence
The managerial economist plays a very ii) Participating in public debates
important role in an organization

• The objective of a managerial economist
plays a very important role in an
organization
• The managerial economist must try to
maximize profits on their invested
capital
• Managerial economist must make an
accurate forecast as possible, because
forecast depends on future which is
uncertain.
• he should advise the management on
domestic and global economic issues
• The managerial economist has to
maintain contact with data sources. He


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DEMAND ANALYSIS In the above table or schedule when the
price of the product is Rs.5, its demand is only
1000 units. But when the price has fallen to
Introduction:
Rs.1, demand for the product has gone up to
Demand is the basis for the starting of
5000 units. This shows that a fall in the price
any business, as the product decision and
deals to extension of demand. Similarly when
amount of product to be produced would be
we take Rs. 1 price, the demand for the product
decided only on the basis of the demand
is 5000 units, when the price started rising up to
prevailing in the market i.e. depending on the
Rs.5 the demand for the product has fallen to
market survey and demand forecast. Demand
1000 units. This shows that a rise in price leads
only decides indirectly the amount of factors of
to contraction of demand.
production to be employed in the organization
i.e. money, men, material, machinery and
management required. Without proper demand
analysis, if production activity is undertaken the
business firm may suffer huge losses.

Demand: Meaning
Demand for a product refers to
1. Desire of an individual for a product
2. Ability to pay for the product
3. Willingness to pay for the product.
If there is ability and willingness but no This can be shown with the help of diagram,
desire then it is nor a demand. Similarly, DD=Demand Curve
without willingness if there is desire and ability, On X-axis the quantity of a product demanded is
then also it is not a demand. represented. On Y-axis the price of the product
is represented. DD represents the demand curve.
Law of demand: It slopes downwards from left to right as price
According to law of demand there is an increases, demand is decreasing. As price
inverse relationship or a negative relationship decreases demand curve moves away from the
between the price of a product and its demand. point of origin.
The law may be stated as follows “when the
price falls, demand extends, price rises demand Demand curve
falls, other things, remaining constant. If we show the demand schedule
graphically, we get a demand curve. The
Explanation of law of Demand demand curve shows the maximum quantities
Demand schedule per unit of time that consumers will take at
Price in Rs. Quantity Demanded various prices.
(units)
Assumptions of Law of Demand:
5 1000
4 2000
The assumptions underlying the Law of
3 3000
Demand are:
2 4000
1 5000 • No change in Consumer Income
• No change in Consumer Preference
Demand schedule is the table showing • No change in the Tastes and Fashions
the prices per unit of the commodity and the • No change in the Price Related Product
amount demanded per period of time. • No change in the population
• No change in the Govt. Policy


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• No change in Weather Conditions Hence all these assumptions are kept as
constant.
• No change in Consumer Income
If the income of the consumer increases, Demand Function
inspite of increase in the price of the goods The demand function for a commodity
the demand will increase. Similarly if the describes the relationship between quantities of
income decreases, inspite of decrease in the the commodity which consumers demand
price the demand will decrease. during a specific period and the factors which
influence its demand. Mathematically, demand
• No change in Consumer Preference function can be expressed as follows
If the consumer have a specific
preference of the product or he likes the Dx = ∫(Y , Px , Ps , P , T , E p , N , D, u , a )
c

product or he likes the product very much Where
He purchases the product if it is costlier
also. D = Quantity demanded for the product x
Y = Consumer’s income
• No change in the Tastes and Fashions Px = Price of good x
If fashion of the product is outdated, the Ps = Price of substitute of x
demand will decrease even if it is offered at Pc = Price of complements of x
a lower price T = Measure of consumer tastes and preferences
Ep = Consumer’s expectations above future
• No change in the Price Related Product prices.
If the price of the related product N = No of customers
decreases, demand tends to decrease for the D = Distribution of consumers
other similar products also. u = Other determinants of the demand for x
a = advertisement
• No change in the population ∫ = Unspecified Function
If the population goes on increasing the
demand tends to decrease even though the Why demand curve slopes downwards:
price increases. On the other hand if the The law of demand states that, other
population decreases demand tends to things remaining the same, an individual
decline even though the price is low consumer will but more units of a commodity at
a lower price and less of that commodity at a
• No change in the Govt. Policy higher price. Generally, the demand curve
The change in the government policies slopes downwards from left to right. Some of
and political situation will influence the the reasons for this are
demand for the product. • Income effect
• A commodity is utilized more when it
• No change in Weather Conditions become cheaper
In summer season the demand for fans, • Substitution effect
air coolers, air-condition is increasing • Multiple use of product
considerably irrespective of changes in
the price. • Income effect:

• No expectation of future price changes. The income of a consumer affects the
• No change in the range of foods demand of the product. If the income is fixed
available to customers. i.e. there is no change in income, but there is a
change in the prices of the products, then it will

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affect the demand and the curve slope hand if the income decreases the demand will
downwards. decrease

• A commodity is utilized more when it 3. Tastes, Habits and Preferences of the
become cheaper: Consumer:
If the price of the product falls, the Demand for many goods depends upon the
existing buyers purchase more and some new tastes, habits and preference of the consumer.
consumers enter the market E.g.: Demand for several goods like ice-cream,
chocolates, beverages depends on the taste of
• Substitution effect: the individual
A fall in the price of a product, while the
prices of its substitutes remain unchanged will 4. Relative Price of Substitute Goods and
make it attractive to the buyers who will now Complement Goods:
purchase more and vice versa. The demand for a product is also
affected by the changes in price of the related by
• Multiple use of product: the changes in prices of the related goods.
Some products can be used for multiple Related goods can be of two types
purpose. A fall in the price of steel, iron etc., 1. Substitutes which can replace each other in
will increase demand considerably. use
E.g.: Tea, Coffee and bournvita are substitutes.
FACTORS INFLUENCING THE DEMAND 2. Complementary goods are those which are
FOR A PRODUCT jointly demanded
E.g.: Tea, Sugar and milk are complementary
1. Price of the Product goods.
2. Income of the Consumers
3. Tastes, Habits and Preference of the 5. Consumer Expectation:
Consumer A consumer expectation about the future
4. Relative price of Substitute Goods and changes in the price of a given product may also
Complement Goods affect its demand. When the consumer expects
5. Consumer Expectation the prices to fall in the future he tends to but less
6. Population and vice versa.
7. Climate and Weather
8. Advertisement effect 6. Population:
Increase in population increases demand
1. Price of the Product: for necessaries of life. Decrease in population
The most important factor affecting will also affect the demand for different
amount demanded is the price of the product. products.
The amount of product demanded at a particular
7. Climate and Weather:
price is called as price demand. Normally a
The climates of areas woolen clothes are
large quantity is demanded at a lower price but demanded. On a rainy day, ice-cream is not
not at a higher price. Not only the existing price much demanded.
but also the expected changes in price will affect
demand. 8. Advertisement Effect:
In modern times the consumer
2. Income of the Consumer: preference can be changed by advertisement and
When consumer’s income increases the sales propaganda. Demand for may products
like toothpaste, soaps, washing powder etc., is
demand will increase significantly. On the other
partially caused by the advertisement affect.

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In Exhibitions and functions, the social habit,
place or situation, force people to purchase
Exceptions Or Limitation To the Law goods at higher prices
of Demand
1. Giffen Goods/ Inferior Goods Individual Demand Schedule and
2. Veblen Goods Market Demand Schedule
3. Consumer Expectation
4. Consumer Psychological Bias Consider the following table
5. Necessaries Price Goods Demanded by Total
6. Impulse Buying Rs. individual Demand
7. X in Y in Z in in units
• Giffen Goods/ Inferior Goods: units units units
Robert Giffen, British economist observed that 100 10 5 2 17
when the price of the product is decreasing the 95 20 10 5 35
demand for the product is decreasing. These 90 30 12 10 52
Products are called as inferior goods or Giffen 85 40 15 14 69
goods. 80 50 20 20 90
Similarly, when the price of the product
is increasing the demand is also increasing.
In the above table Mr. X is demanding
Such types of products are called superior
goods. 10 units at Rs. 100 and 50 units at Rs 80, this
demand is called individual demand. Individual
• Veblen Goods or Prestige Goods demand refers to goods demanded by a single
American economist, Veblen explained individual. The table showing at different prices
that, there are certain goods which are different units were demanded by Mr. X that is
purchased by the consumer not because they called individual demand schedule.
really need those goods but they purchase goods
because of status symbol i.e., to maintains status Market demand refers to total demand
in the society. Prestige goods are those which made by all the individuals in the market. In the
consumers will purchase even though they are above table total demand is 17 units at Rs. 100
costlier. and 90 units at Rs. 80. The table representing
different prices, different units were demanded
• Consumer Expectations: by all the individuals that is called market
Whenever the consumer expects a demand schedule
further fall in the price in future he will not
purchase the products or goods immediately,
when price decreases, demand tends to decline. ------
Similarly when the consumer expects a further
increase in the price for the future he will but
the products immediately

• Necessaries:
The demand almost remains constant
irrespective of the price changes concerned to
these goods as people tend to adjust their
consumption on other goods as they feel these
are most necessary products.

• Impulse buying:


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Types of Demand E.g. The demand for sugar is loosely tied up
1. Demand for Consumer Goods and with the demand for drinks
Producer Goods
2. Durable Goods and Perishable Goods • Industry Demand and Company Demand
Demand :
3. Derived Demand and Autonomous
Demand Industry is a group of firms producing or
4. Industry Demand and Company Demand manufacturing the same or similar product.
5. Short run Demand and Long run
Demand Company is an individual business unit or
6. New demand and Replacement Demand business firm
7. Total Market Demand and Segment When goods are demanded which are produced
Market Demand or manufactured by a particular company, that
demand is called company’s demand.
• Demand for consumer goods and
producer goods: E.g. Demand made for Maruti cars produced by
When Goods are demanded by consumer for Maruti Udyog Ltd.
the direct satisfaction of their wants, they are
called demand for consumer goods. When goods are demanded which are
E.g. Food items, Readymade clothes etc. produced or manufactured by a particular
When goods are demanded by producer industry that demand is called industry demand.
for production of other goods including E.g. Total demand for cars produced by
consumer goods, they are called demand for automobile industry.
producers’ goods.
• Short run Demand and Long Run
E.g. Machines, tools, Equipment etc. Demand

• Durable goods and Perishable goods Short run demand refers to that demand
demand which changes immediately due to reaction in
Perishable goods are those which can’t price changes and income fluctuation etc.
consumed only once, while durable goods are
those goods which can be used more than once Long run demand refers to that demand
over a period of time. which does not react immediately due to price
change. It will take some time for change in
• Derived Demand and Autonomous demand
Demand
• New Demand and Replacement Demand
When the demand for a product is tied to the :
purchase of some parent product. Its demand is New demand refers to the demand for the
Called derived demand. new products and it is the addition to the
E.g. Demand for cement depends upon existing stock. In replacement demand, the item
demand for construction industry. is purchased to maintain the asset in good
condition. The demand for cars is new demand
When goods are demanded and the demand for spare parts is replacement
independently for the direct satisfaction of the demand
consumer wants, it is called autonomous
demand. • Total market Demand and Segment
Market demand


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Take the E.g of the consumption of sugar in (Q2 − Q1 )
a given region. The total demand for sugar in Q1
the region is the total market demand. The Ep =
( P2 − P1 )
demand for sugar from the sweet-making
P1
industry from this region is the segment market
demand.
UNIT-II ∆Q
ELASTICITY OF DEMAND Q
= 1
Elasticity of Demand is the measure of the ( ∆P)
degree of change in the amount demanded of the P1
commodity in response to a given change in
price of the commodity, price of some related ∆Q P1
goods or change in consumer income. = ×
∆P Q1
There are four important kinds of elasticity Where
of demand. Q1= Quantity demanded before price change
1. Price elasticity of demand Q2= Quantity demanded after price change
2. Income elasticity of demand P1= Price charged before price change
3. Cross elasticity of demand P2= Price changed after price change
4. advertising and promotional elasticity of
demand Higher the elasticity of demand, greater will be
Price Elasticity of Demand: the percentage change in quantity demanded
every percentage change in price.
Meaning: Elastic Demand and Inelastic Demand
Price elasticity of demand measures the When a small change in price may bring about a
responsiveness of demand to changes in price. big change in demand then it represents elastic
The price elasticity of demand for a commodity demand
is the rate at which quantity bought changes as What ever may be the changes in price if
the price changes. It is denoted by (Ep) the demand remains more or less constant then
it represents inelastic demand.
Pr oportionat echange in the quantity demanded
Ep =
Pr oportionate change in price
or
Types of Price Elastic of demand
Change inquantity demanded Types of Price Elastic of demand are
generally classified into five categories.
Quantity demanded
Ep = • Perfect Elastic
Change in Pr ice
demand
Pr ice
• Perfect inelastic
demand
• Unit elasticity
demand
• Relative/Compara
tive Elasticity of demand
• Relative/
Comparative Inelasticity of demand

Perfect Elasticity of Demand (Ep=∞):


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As there is no change in the demand and price it
It is one in which a small change in price is called as unitary demand.
will cause a large change in amount demanded.
A small rise in price reduces the demand to
zero. A small decrease in price leads to a big
expansion in demand.

The figure shows that the quantity
In the above figure the quantity demanded demanded increases OX0 to OX1, as there is a
increases from OX to OX1 from OX1 to OX2 decrease in price from OP0 to OP1. The amount
even though there is no change in price. The of increase in the quantity demanded is equal to
price is fixed at OP. the amount of fall in the price.
Perfect Inelastic Demand(Ep=0): Relative Elastic Demand(E>1):
This is one which shows that whatever
the change in price may be the amount
demanded remains same. The demand is said to be relatively
elastic when the change in demand is more than
the change in price. The figure shows that the
quantity demanded increases from OX0 to OX1
as there is a decrease in price from OP 0 to OP1.
The amount of the increase in the quantity
demanded is greater than the amount of
decrease in the price.

In the above figure it is shown that there
is no change in the quantity demanded even
though the price is changing (increase or
decrease).
Even though there is an increase in price
from OP0 to OP1 to OP2 there is no change in
demand.
Relative Inelastic Demand(E<1):
Unit Elasticity of Demand(Ep=1):
In this type of demand a given When the change in demand is less than
percentage change in price leads to exactly the the change in price, then the demand is said to
same percentage change in amount demanded. be inelastic.


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High income group people are less
affected by [rice changes than low income
groups people. Demand for high priced and
quality goods in inelastic for high income
groups whereas the same is elastic for low
income people

4. Variety of Use:

A commodity having a variety of uses
has a comparatively inelastic demand. On the
other hand, demand is elastic for a commodity
having a limited use
In the figure the demand increases from
OX0 to OX1 as there is a decrease in the price 5. Proportion of income spent on the commodity
from OP0 to OP1. The amount of increase in the If the consumer spends less percentage
quantity demanded is lesser than the amount of on a commodity, then demand will be inelastic
decreases in the price. e.g. salt, match box. On the other hand if
consumer spends large proportion of his income
Factors Determine Price elasticity of on a commodity, then the demand will be elastic
Demand
The price of elasticity of demand depends on the 6. Durability
following factors: When a commodity is durable e.g.
furniture, toothbrush etc, one is likely to use the
1. Nature of goods commodity for a longer period having high
2. Availability of substitutes price, then higher is its elasticity of demand.
3. Income level
4. Variety of uses 7. Time Period:
5. Proportion of income spent on the
commodity
6. Durability of a commodity Demand of a commodity always has a
7. Possibility of postponement reference to a specific period. Generally demand
8. Time period is inelastic during short period and elastic
during the long period.
1. Nature of goods:
Goods may be classified into three Importance of Price Elasticity of
groups. They are necessaries, comforts and Demand
luxuries. The demand for necessaries like salt, The concept of elasticity of demand is of much
food grains, clothes etc is inelastic like salt, food practical importance. Given the fact that the
grains, clothes etc is inelastic where as demand actions of any enterprise are oriented towards
for comforts and luxuries like television improving its overall profitability. Here the
vehicles etc is elastic concept of elasticity plays crucial role. It
measures the proportionate change in sales and
2. Availability of Substitutes: hence in profit. Price elasticity of demand is
A commodity having a number of highly useful in the following cases.
substitutes has relatively elastic demand 1. Price Fixation of a Product
whereas a commodity have less or without 2. Decision Regarding to Price Changes
substitutes is relatively inelastic demand. 3. Price discrimination
4. Taxation Policy
3. Income level:

MEFA NOTES
Income Elasticity of Demand

The income of consumer too greatly
affects the demand for a commodity. Given the
price, if the consumers have a higher income,
they can buy more products. Thus at higher
incomes or increase income levels the demand
will be high and at lower income demand for the
commodity will be lower.

When the income of the consumer
increases, the demand for quality products
increases, while that of poor quality goods
decreases. Income demand curve called Engel
curve is left to right upward for superiors goods
and downward for inferior goods.


MEFA NOTES
INCOME DEMAND (ENGEL) SCHEDULE ∆Q
Income (Rs.) Demand for Demand for Q ∆Q I
= = ×
Superior goods Inferior goods ∆I Q ∆I
1000 1 6 I
2000 2 5 Where
3000 3 4 Ei = Income elasticity of demand
4000 4 3 ΔQ= Change in quantity demand
5000 5 2 Q = Quantity demanded
6000 6 1 ΔI = Change in income
As income of the consumer increases from Rs. I = Income
3,000 to 4,000 quantity demanded increases to 3 INCOME ELASTICITY OF
to 4 units for superior goods. Where as for DEMAND TYPES:
inferior goods demand reduced from 4 to 3 units
Income elasticity of demand is classified under
presented in the figure.
three heads
1. Zero Income Elasticity of Demand
2. Negative Income Elasticity of Demand
3. Positive Income Elasticity of Demand

1. Zero Income Elasticity of Demand
This refers to the situation where a given
increase in consumers’ income does not result in
any change of the quantity demanded.
E.g. Essential goods like salt, milk etc.

2. Negative Income Elasticity of Demand
This refers to that situation where given increase
2. INCOME ELASTICITY OF in the consumers’ income is followed by an
DEMAND actual fall in the quantity demanded for the
The income elasticity is defined as a ratio of commodity. E.g inferior goods
percentage or proportional change in the
quantity demanded to the percentage change in
income. It measures the degree of
responsiveness in quantity demanded due to
change in income.

Percentage change in quantity demand
Ei =
Percentage change in income


MEFA NOTES
3. Positive Income Elasticity of Demand Note: Cross elasticity of demand in case
This refers to situation where a given increase in of Substitutes is positive and in case of
consumer’s income is lead to an increase in complements is negative.
quantities demanded. Cross Elasticity of demand is useful in the
following cases.
This may be further classified into Unitary 1. To fix product pricing and changes in
income elasticity of demand (Ei=1), income pricing of the product
elasticity of demand greater than unity (Ei>1) 2. To estimate the Effect of Competitors’
and income elasticity of demand less than unity Pricing Decisions
(Ei<1). The following diagram is explaining it. 4. Advertising or Promotional
Elasticity of Demand:

Advertising elasticity of demand refers
to percentage or proportionate change in sales in
response to percentage change in advertisement
expenditure. It is denoted by EA
% / Pr oportionatechange in Sales
EA =
% / Pr oportionatechange in advertisement exp enditu
∆S S − S1
EA = ,EA = 2
Use of Income elasticity of Demand ∆A A2 − A1
1. For Demand forecasting In the present competitive world
2. For Product line Planning advertising occupied an important place, it
3. Advertisement Planning consists of audio visual activities to increase the
demand for a product. Advertising elasticity of
3. Cross Elasticity of Demand: demand is a measure to understand how far the
Cross Elasticity of Demand may be defined as demand for a product will be influenced by
“The proportionate change in the quantity advertisement and other promotional activities.
demanded of a particular commodity in
response to a change in the price of another Advertising Elasticity of demand is useful in
related commodity”. the following cases.
Percentage Change inDemand of given good ( A) 1. To know the stage of product in the
EC =
Percentage Change in Pr ice of Re lated Good ( B ) market
2. To know the effect of advertising in
∆Q A
terms of time
QA 3. To know the advertising by rivals or
EC =
∆PB competitors
PB
∆Q A P IMPORTANCE OF ELASTICITY OF
EC = × B DEMAND:
QA ∆PB
Where, • Useful to the
EC= Cross elasticity of demand Businessmen
ΔQA= Change in demand of given good
• Useful to the
QA= Demand of a given good
Government and Finance Minister
ΔPB=Change in price of related good
PB= Price of a related good • Useful to International
Trade


MEFA NOTES
• Useful for Planning of Long term forecasting refers to the
the business activities forecasts prepared for long period during which
• Useful to the consumers the firm’s scale of operations or the production
• Useful to Trade unions capacity may be expanded or reduced.

DEMAND FORECASTING 5. Short term forecasting:
A forecasting is a prediction or Short-term forecasting normally related
estimation of future situation under given to a period not more than a year. Short term
conditions. forecasting relate to the day-to-day information.
In the short term forecasting a firm is primarily
Demand Forecasting: concerned with the optimum utilization of its
Demand forecasting means expectation existing production capacity
about the future course of the market demand
for product. Demand forecasting is essentially Importance of Demand Forecasting:
reasonable judgment of future probabilities of
the future demand. It cannot be 100% precise. • For planning and Production analysis
• Sales Forecasting
Demand Estimation: • Control of Business
Demand estimation tries to find our
• Inventory Control
expectation present sales level, given the present
state of demand determinants. • Long term Investment Programmes
• Maintain Stability
Types of Demand Forecasting: • Helpful for Planners and Policy Makers
Various types of demand forecasting are as
follows • For planning and Production analysis:
1. Passive forecasts Demand forecasting is essential before
2. Active forecasts starting any production activity. It is dependent
3. micro forecasting on accurate demand forecasting.
4. Long term Forecasting
5. Short term Forecasting • Sales Forecasting:
1. Passive Forecasting: Sales forecasting is dependent on the
Here prediction about future is based on demand forecasting. Advertisement pattern of
the firm should be based on sales forecasting.
the assumption that the firm does not change the
course of its action.
• Control of Business:
2. Active Forecasting: The business firm may have to prepare the
budget of cost and revenue occurring in future.
Forecasting is done assuming that, it will
The future accurate estimation of cost and
be changes in the actions by the firm. revenues is based on the demand forecasting.

3. Micro Forecasting: • Inventory Control:
When individual business firm forecast The business form can have a better control
the demand for their products, it is known as on raw materials, semi- finished goods, finished
micro level forecasting. goods, spare parts etc., for future requirements
of the firm with the help of demand forecasting.
4. Long term forecasting:

MEFA NOTES
• Long term Investment Programmes: The methods employed should be able to
The growth rate and long term investment produce meaning results quickly.
planning of the firm can be estimated with the
help of demand forecasting. For planning and • Maintenance Should be Up to Date :
Production analysis The forecast should be capable of being
maintained on an up-to-date basis
• Maintain Stability:
Approaches to Forecasting:
Production and employment growth rates
can be stable through demand forecasting. • Identify and clearly state the objectives of
forecasting. The objective may be short-
• Helpful for Planners and Policy Makers:
term or long-term
Demand forecasting can be greatly used by
• Select Appropriate method of forecasting
planners and policy makers in making optimum
allocation of scare resources. • Identify the variables affecting the demand
for the product and express them in
Requisites of a Good Forecasting Methods: appropriate forms
• Gather all relevant date o represent the
• Accuracy
variable.
• Simple and Easy to Compute
• It may be made either in terms of physical
• Economy
units or in terms of rupees of sales volume
• Availability
• It may be in terms of product group or
• Maintenance Should be Up to Date
individual products
• Accuracy: • It may be annual basis or moth wise or
It is necessary to check the accuracy of past week wise on the basis of past records
forecast against future performance and of
present forecast against past performance.

• Simple and Easy to Compute:
Management must be able to understand and
have confidence in the methods used for
forecasting.

• Economy:
Costs must be weighted against the benefits of the
forecast to the operation of the business.

• Availability:


MEFA NOTES
Demand Forecasting Methods different opinions on them. This process
is repeated again and again unless a
I. Intentions of Customer common view point is emerged.
1. Survey Method:
IV. Test Market:
Under this method the consumers are This method is used for estimating
contacted personally to disclose their demand of new products of estimating
future purchase plans. This can be done sales potential of existing products in
by two ways new geographical areas. In this method a
1. Census method test area is selected which truly represent
2. Sample Method the market. The product is launched in
this area exactly in the manner in which
• Census method: it is intended to be launched in the
Under this method all consumers market. If the product is found successful
are contacted to know their preferences in the test area then the sales are taken as
for the products in future. The interviews a basis for estimating sales in the market
are conducted either orally or through as a whole.
questionnaire. With the help of census
method the probable demand of all 2. Market Experimentation Method:
consumers is summed up.
This method involves giving a sum
• Sample method: of money to each consumer with which
In this method a sample of consumers he is asked to shop around in a simulated
is selected for interview. The sample may market. Consumer behavior is studied by
be random or stratified sampling. This varying prices, quantity, packing,
method is easy, less costly and highly advertisement, colour etc.
useful.
3. Based on Fast Trends:
II. Collective Opinion Method:
Under this method opinion of the • Fitting a Trend Linear of Trend
sales men taken for demand forecasting. Forecasting Method:
The sales men can know the pulse of the Under this method actual dales data is
consumer and they can give correct drawn on a chart and estimating by
information about the likely demand for observation where the trend line lies.
the products. That line can be extended further towards
a future period and the corresponding
III. Delphi Technique: sales graph can be read from the graph.
Opinions and views are taken from
experts coming from different • Least Square Method
backgrounds. Under this method experts This method uses statistical data to
are asked the likely demand for a find the trend line which best fits the
particular product. The experts may give

MEFA NOTES
available data. The following regression
equation is used
S= a. T+b 5. Statistical Method:
Where
S= Sales • Naïve Method:
a, b = Past Data Calculation It is based on the past data of information
T = The year for which forecast is available for example Historical
required Observation of sales

• Time Series Analysis: • Regression Analysis:
This method attempts to build This is a statistical technique by
seasonal and cyclical variation into the which the demand is forecasted with the
estimating equation help of certain independent variables.
There are two types of regression
S=a+b+c+d analysis
Where
a= Trend a. Simple
b= Season b. Multiple
c= Cycle Simple regression analysis is used
a, b, c, d= Constant calculated when the quantity demanded is taken as a
from past data. function of a single independent variable.
Multiple regression analysis is used to
• Moving Average Method: estimate demand as a function of two or
This method is based on past sales more independent variables that varies
data and it is used for short term simultaneously.
forecasting and it is based on assumption
that the future is the average of past 6. Judgmental Approach:
performance If the management is unable to use
any of the above method they have to
4. Economic Barometer: make their own judgment in forecasting
the demand
This method forecasts the future
based on the occurrence of present These are the demand forecasting
events, first we have to see whether their techniques .
exists a relationship between the demand
for a commodity or product and certain
economic indicator. The above
relationship can be established through
the method of least square. E.g. demand
for tractors depends on the farmer’s
income or agricultural income.


MEFA NOTES
III unit time with a given state of technology,
PRODUCTION ANALYSIS managerial ability etc.
Production in Economics means
creation of goods and services which have
exchange value. In other words, it implies
creation of utilities. Production is an
organized activity of transforming input into
outputs to satisfy the demand for the
commodities and services of the company.

Inputs refers to the all those things
which a firm buts and employs to produce a
particular product. Output means the
quantity of goods in the finished form
produced by the firm for selling. Production
analysis deal with physical production and Production function enables production
supply side of the market. manager to understand how better he can
make use of technology to its greatest
potential

Definition for Production function:
“The production function is the name
Definition for Production: given to the relationship between the rates of
According to the Parkinson: productive services and the rates of output
of the product.”
“Production is the organized activity -------> Stigler
of transformation resources into finished
products in the form of goods and services”. “Production function is that function
which defines the maximum amount of
Production Function: output that can be produced with a given set
of inputs”.
Production function expresses a -------> Michael R Baye.
functional or technical relationship between
physical inputs and physical outputs of a Production Function:
firm at any particular time period. The
output is thus a function of inputs. It can be expressed in an allegorical
Production is the result of combination of equation:
factors of production land, labor, capital and
organization. The factors used for ∫
Q = ( a, b, c, d ...........n)

production are called “inputs”. The Where
production we get is called “output”. The Q stands for the quantity of output
production functions show the maximum a, b, c, d…..n are the various inputs.
rates of output that can be obtained from
different combinations of inputs in a given Each form has its own production
function depending on the technical

MEFA NOTES
knowledge and managerial ability. An • When inputs are specified in physical
improvement in the technical knowledge or units, production function helps to
managerial ability will bring about a new estimate the level of production
production function. • With the help of iso-quants,
production function explains the
Here output is the function of inputs, difference combinations of inputs
the output becomes the dependent variable which will yield the same level of
and inputs are the independent variables. output.
Production function has to be expressed in a • Production function indicates the
precise mathematical equation i.e. manner in which the firm can
substitute one input for another
Y = a + bx
without altering the total output
It is showing the there is constant • When prices are taken into
relationship between application of input (x) consideration, the production
and the amount of output(Y). function helps to select the least
combination of inputs for desired
The production function may be fixed output
production function are variable production • It considers two types of input-
function. In fixed production function each output relationship namely
level of output requires a unique
combination of inputs. On the other hand a 1. Law of variable proportion and
variable production proportion production 2. Law of returns to scale.
function is one which the same level of
output may be produced by two or more • It helps us to under stand the laws of
combinations of inputs. returns in production

Assumptions: COBB- DOUGLAS
• The production function is related to PRODUCTION FUNCTION
a particular period of time
• There is no change in technology Production function of the linear
• The producer is using the best homogenous type is invented by Jnut
technique available Wicksell and first tested by C.W. Cobb and
• The factors of production are P.H. Douglas in 1928. This famous
divisible statistical production function is known as
• Production can be fitted to a short run Codd- Dougles production function.
or to long run. Originally the function is applied on the
• Utilization of inputs at maximum empirical study of the American
level of efficiency. manufacturing industry. Cobb-Dougles
production function takes the following
mathematical form
Y =( A K α L1−α )

Importance of production function:
Where,
Y= Output

MEFA NOTES
K= Capital ISO QUANTS
L= Labour
“Iso” means equal; “quants” means
A, α = Positive Constant
quantity. It means the quantities throughout
a given isoquant are equal. Isoquants are
Assumptions: also called isoproduct curves. It shows
various combinations of two input factors
• It assumes that output is the function
such as capital and labour, which yield the
of two factors, i.e. capital and labour same level of output.
• It is a linear homogenous production The production functions like this
function of the first degree when only two inputs are there for
• There are constant returns to scale production.
• All inputs are homogenous Q =∫( L, K )
• There is perfect competition This function has three variables
• There is no change in technology Q= output of commodity,
L= Labour and
Criticism: K=Capital
For a given value of Q, there will be
• Cobb-Douglas production alternative combinations of L and K. these
function is criticized because it shows combinations of L and K will vary with
constant returns to scale. But constant variation in Q. Generally both labour and
returns to scale are not actuality. Industry capital are necessary for the production of
is either subject to increasing returns or commodity; there are substitutes to each
dimishing returns. other. Thus, for any given level of output, no
• No entrepreneur will like to entrepreneur will need to hirer both labour
and capital but he would have an option to
increase the inputs in order to have
employ any one combination of these
constant returns only. His aim will be to
factors, out of several possible combinations
get increasing returns and not constant
returns
Q=2 Q=5 Q=9 Q=12 Q=14
• This function as applied to K L K L K L K L K L
each firm may not give the same result as 1 2 2 2 3 2 4 2 5 20
that of the industry. 0 0 0 0
• It based on the assumption that
2 1 3 1 4 1 5 1 6 17
factors of production are substitutable 2 4 3 5
and excludes complementarity of factors. 3 8 4 1 5 1 6 1 7 15
But in the short run non- 0 0 2
complementarity of factors is possible. 4 6 5 7 6 8 7 1 8 13
Therefore, it applies more to the long-run
than to the short-run 0
5 4 6 5 7 6 8 8 9 11
6 3 7 4 8 5 9 7 1 10
0

MEFA NOTES
In the above table all those substitutes. One input factor can be
combinations of labour and capital which substituted by other input factor in a
yield the same output. In our example the diminishing marginal rate. If the input
farmer could employ 1 tractor and 20 labour, factors were perfect substitutes, the
2 tractors and 12 labour… 6 tractors 3 isoquants would be a falling straight line.
labour to manufacture 2 Quintals of output.
If he aims at producing 5 quintals of output, 3. Don’t intersect:
the alternative input combinations open to Two isoproducts do not intersect with
him are 2 tractors and 20 labour, 3 tractors each other, it is because, and each of these
and 14 labour and so on. denotes a particular level of output. If the
manufacturer wants to operate at higher
If we plot these alternative input level of output, he has to switch over to
combinations for a given output and assume another isoquants with higher level of output
a continuous variation in the possible and vice verse
combination of labour and capital, we can
draw a curve called isoquants for various 4. Do not touch axes:
output levels of table are shown in the figure The isoquants touches neither X-axis
not Y-axis, as both inputs are required to
produce a given product

Types of Isoquants
Depending upon the degrees of
substitutability of inputs, there are four types
of Iso-quants.

• Linear Isoquants
• Input-Output Isoquants
Features of Isoquants:
• Kinked Isoquants
1. Downwards Slopping • Smooth Isoquants
2. Convex to Origin
3. Do not intersect Explanation of those
4. Do not touch axes
• Linear Isoquants:
1. Downward sloping: It represents perfect substitutability of
Isoquants are downwards sloping curves factors of production.
because, if one input increases, the other one
reduces. There is no question of increase in
both the inputs to yield a given output. A
degree of substitution is assumed between
the factors of production

2.Convex to Origin:
Isoquants are convex to the origin. It is
because the input factors are not perfect • Input-output Isoquants:


MEFA NOTES
If the factors of production are strict level of production. If the given level of
complementaries and hence show zero production changes, the total cost changes
substitutability, we derive this isoquants and thus the isocost curve moves upwards.
And vice versa.

In the following figure three
downwards sloping straight line cost curves
each costing Rs.1.0 lakh, Rs. 1.5 lakh and
Rs. 2.0lakh for the output levels of 20,000,
30,000 and 40,000 units. Isocosts farther
from the origin, for given input costs, are
associated with higher costs. Any change in
input prices changes the slope of isocost
• Kinked Isoquants: lines
If the factors of production show limited
substitutability we find this type of isoquant

Marginal Rate of Technical
• Smooth Convex Isoquants: Substitution
This form assumes continuous The marginal rate of technical
substitutability of factors of production substitution refers to the rate at which one
input factor is substituted with other to attain
a given level of output. In other words, the
lesser units of one input must be
compensated by increasing amopunt of
another input to produce the same level of
output. In the following table presents the
ratio of MRTS between teh two input
factors, say capital and labour. 5 units of
decrease in labout are compensated by an
increase in 1 unit of capital, resulting in a
Iso Costs MRTS of 5:1.
Isocosts refers to that cost curve that
represents the combination of inputs that Combi inputs Units
nations MRTS
will cost the producer the same amount of K L
money. In other words, each isocost denotes A 1 20 -
a particular level of total cost for a given B 2 15 5:1


MEFA NOTES
C 3 11 4:1
D 4 8 3:1
E 5 6 2:1
F 6 5 1:1


MEFA NOTES
Least Cost Combination Of Inputs
Graphically we can determine the
The isocosts curve indicates the least cost input combination or the
alternative combinations of various factors maximum output for given cost, first we
of production which can produce a given have to draw iso-quant map and than iso-
output. Of these, an entrepreneur would like costs map. Later we have superimpose the
to choose the combination of input factors, iso-quants map and the iso-costs map as
which costs him the least. shown in figure.

To explain this how he can determine
the least cost combination for a given
output. We need the prices of the factors of
production. Let the price of labour (L) be
Rs.6 per unit and price of capital (K) Rs.9
per unit. Assume that any amount of labour
and capital can be bought at these respective
fixed prices.

Let our farmer wants to produce a
certain amount of paddy. Assume that the
farmer has certain cost combination. There
are two ways to determine the least cost As per the above figure the desired
combination of input for given output. quantity of output can be produced at a least
cost Rs.99 by having 6 units of capital and 7
In the following example there are six units of labour. It is known by the point E
alternative combinations of labour and where the isoquant curve is just tangent to
capital to produce the given production, say the iso-cost curve. At any other point of iso-
9 quintals. The cost of each of these quant the total cost is more than Rs.99.
combinations will be as follows similarly for a given cost, an entrepreneur
can select the best combination of two
Com inputs Units inputs which will give the maximum output
Cost by way of selecting that iso-quant curve
binati
K L Rs. which is just tangent to a given iso-cost
ons
1 3 20 3*9 + 20*6=147 curve.
2 4 13 4*9 + 13*6=105
3 5 10 5*9 + 10*6=105
4 6 8 6*9 + 8*6=102
5 7 6 7*9 + 6 * 6=99
6 8 5 8*9 + 5* 6=102

From the above table we can find the
combination of 5 represents the least cost for
producing the desired production. The least
total cost producing various other quantities
can be determined in a similar way.

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