Social science studies human behaviour as a relationship between unlimited wants & scarce means/resources having alternative uses

----Lionel Robbins

Micro & Macro Economics

Mikros means small--- that branch of economics

which studies particular firm, household,individual prices,wages ,particular commodities Macro means large-----

 Economics is a study of mankind in the ordinary

business of life-----Alfred Marshall It teaches the art of rational decision making which is core of business Managerial eco is a separate discipline by itself, having its own selection of economic principles & methods Knowledge of fundamentals of economics & economic theories is useful in business.

Meaning of Business Economics

B.E is concerned with the application of economic

concepts and economics to the problems of formulating rational decision making------ Mansfield B.E is integration of economic theory with business practice for the purpose of decision making & forward planning-----Spencer & Siegelman

M.E

Traditional eco & Tools & techniques of decision sciences

Business Management

 M.E relates to overlapping area of economics along with

tools of decision sciences such as maths,eco, statistics,accounts and econometrics as applied to business mgt problems. Primarily analysing economic aspect of business problem & decision making

Elements of Business Economics

Demand

Supply
Price

Cost

Market

Elements of Business Economics

Product

Capital budgeting

Nature of B.E

Basically micro in nature ---level of firm Uses macro economics----Pragmatic----does not deal with abstract theories It is concerned with only those aspects of economics which can be applied in practice Basically Normative Economics not positive economics That is, it studies things as they should be/ought to be It is essentially prescriptive in nature rather than descriptive in nature.In economic theory laws are formulated while in B.E we apply laws in policy planning at the level of firm Identifies problem & provides soln Choosing the best soln consistent with firms objectives

 Positive eco explains eco phenomena as----What is, what

was, & what will be? Normative eco prescribes what it ought to be Marshall ,Pigou normative eco Eco suggest policy measures to politicians M.E===Pure/positive sci with applied/normative sci. It is positive when it is restricted to statements about cause & effects & to functional ralations of economic variables. It is normative when it involves norms & standards,mixing them with cause-effect analysis.

 Micro MIKROS SMALL- individual eco

unit/variables Particular eco qty like prices,wages,income etc & their determination How individual consumers & producers behave & interact. Macro-MAKROS-AGGREGATE- study of economic system as a whole

Scope of B.E
Micro economics deals with small individual units of economy such as consumer, producer etc. Choice of business,size of business,technology,price,market,investment, theory of demand,nature of product etc.

 Analysis of market structure & pricing theory

Macro-economics applied to business environment

includes Type of economic system of particular country Trends in production,income ,saving ,prices etc. Political environment Trends in labour Industrial policy,monetary policy

Scope of B.E
Demand Analysis & Forecasting
Cost & Production analysis Pricing practices & policies

Profit mgt
Capital Budgeting Competition Firm

Application of B.E
Predicting economic quantities
Estimating economic relationship Understanding external forces

Implementation of business policies

Concept of Profit & Wealth Maximisation

Profit excess of income over all expenses
Profit helps in predicting behaviour of firms as well as

price & output under different markets. 2 profit maximising conditions MR=MC MC must be rising & MR must be decreasing/MC intersects MR from below

Demand Analysis & Elasticity of Demand

Demand is Number of units of a particular goods or

service the customers are willing & able to purchase during a given set of conditions.

qty

price

time

Place

 Demand means effective desire for a commodity

backed by ability & willingness to pay for it. The amt the buyers are willing to purchase at a given price & over a given period of time.

 Price of Commodity of demand Determinants Income of the consumer Price of substitute good Price of complementary good Special influences like climate

Price expectations
Demonstration effect Consumer taste,fashion etc.

 Basic objective of demand theory is to identify &

analyse the basic determinants of customer needs & wants.

Individual demand is demand for particular good at different prices by single consumer Market demand is total demand by all individuals at particular price or different prices

Demand Schedule

Demand Curve

Types of Demand
Direct & Derived

Joint Demand

Composite

Types of Demand
Consumer Goods & Producer Goods

Competitive/Substitute

Firm & Company

Law of Demand
Other things remaining the same, demand for a

commodity will increase when its price falls & vice versa Alfred Marshall There is inverse or negative relationship between price & quantity demanded. Demand curve normally slopes downwards.

Assumptions of law of demand

Other things like income, taste, habit, fashion,climatic

conditions etc is assumed to remain the same. Normal good not Giffen goood Good not a Veblen good Rational human being

Why Demand curve slopes downward? Income

Effect Number of Customers Substitution Effect

Different Uses

Diminishing Marginal Utility

Exceptions to Law of Demand Demand curve may shift upwards

Veblen Goods Giffen Goods Information asymmetry Inflation

Speculation

Bandwagon effect

Elasticity of Demand due to a change in its price.

Income
Price
Elasticity of demand

Degree of responsiveness of demand for a commodity

Cross

 Foundations of Managerial Economics by BN Ghosh

Anes Student Edition

 Ratio ofElasticity relative change in demand and price . Price of demand

It is the extent of response of demand for a commodity

to a given change in price ,other determinants remaining the same. Types o f price elasticity of demand

Income Elasticity of Demand

Proportionate change in qty demanded due to change

in income Types Unitary, Relatively Elastic, Relatively Inelastic, Zero income elasticity Negative income elasticity

Cross Elasticity of Demand due to a given change in the price of some related
commodity. subsitutes

Degree of responsiveness of demand for a commodity

A positive cross elasticity shows that the two products are

A negative cross elasticity shows that the two products are

complementary

Measurement of Elasticity of 1) Percentage method Demand

Percentage change in Qty demanded/Percentage change in price

2)Point Method Lower segment of the demand curve/Upper segment of the demand curve

3) Total Expenditure Method Pg306 net com

Utility Analysis of Demand The theory of consumer behaviour or the demand

theory explains decision making behaviour of the consumer in demanding a particular commodity .There are two major approaches regarding the measurement of utility 1)Cardinal utility theory/Neoclassical Demand Analysis - Alfred Marshall 2)Ordinal utility theory/Indifference curveEdgeworth,Pareto,, J. R. Hicks & R.G.D Allen

Production
Transformation of input into output
Rate of output per unit of time The technological physical relationship between

inputs & outputs is called as production function Functional relationship under given technology between physical rates of input & output of a firm per unit of time.

 Flow concept Physical term State of technology &inputs

Short run & long run production function/Time

Element

Laws of production

Law of variable proportions/Law of diminshing marginal returns

One factor is variable & other factors are fixed British economist Malthus,Ricardo,Mill It was refined by Neo classical economist Marshall

--

-- Benham Originally exp with reference to agri but applicable to mining ,fishing etc. Law of variable proportions is modern version of LDMR

 It is assumed that only one factor is variable while

others are constant. As the amount of variable factor increases, other things remaining the same, output or returns to the factor will increase more than proportionate to increase in input ,then it will increase in same proportion and finally output will increase less than proportionate. Assumptions-------- It is based upon the fact that all factors of production cannot be substituted for one another.

 Total Product, Average product & Marginal Product Pg 237 of mithani Law is explained with MARGINAL PRODUCT PRODUCTION SCHEDULE GRAPH INCREASING RETURNS---machinery may require

minimum number of workers for full & Efficient operation. So,when number of workers is increased machine is properly.------Indivisibility of fixed factors

 DIMINISHING RETURNS------ When fixed factors are

overutilised there are internal problems/diseconomies & marginal product falls. MP falls becoz given qty of fixed factors are combined with larger & larger amount of variable factors.--------imperfect substitutability of factors.
NEGATIVE RETURNS----- When input of variable

factor is much more than fixed factors. Eg excessive use of chemical fert. on farms Overstaffing in store

 Adjustment among different factors can be brought about

Law of Returns to Scale/Long run in the long run. All factors become variable.

Size of plant can be enhanced.

As a firm in the long run increases the quantities of all

factors employed, other thing being equal,output may rise initially at rapid rate than the rate of increase in inputs, then output may increase in same proportion as input & finally output may increase less than proportionately.

Assumptions
Technique of prod remains same
All units of factor are homogeneous Returns are measured in physical terms

Three stages
Law of increasing returns
Law of constant returns Law of diminishing returns

There are increasing returns to scale when a given percentage increase in input will lead to greater relative percentage increase in resultant output. Internal economies of scale----------------etc with the expansion of size of firm.

Utility Analysis of Demand

The theory of consumer behaviour or the demand

theory explains decision making behaviour of the consumer in demanding a particular commodity .There are two major approaches regarding the measurement of utility. 1)Cardinal utility theory/Neoclassical Demand Analysis - Alfred Marshall 2)Ordinal utility theory/Indifference curveEdgeworth,Pareto,, J. R. Hicks & R.G.D Allen

Law of Diminishing Marginal Utility& Law of Demand/Cardinal

Utility is the level of satisfaction derived by the consumer from purchase of commodity.
Marginal utility is the addition to the total utility as a

result of consuming additional unit of a commodity.

A consumer tries to equalise Mux=Px so that satisfaction is maximum. It implies that by increasing the stock of a commodity its MU is diminished. Hence a consumer would buy more when the price falls.

Marginal Utility
Slices of Pizza

0 1

2
3

Total Utility Utility 0 utils 50 utils 90 utils utils 110 utils utils 115 utils utils

Marginal
X 50 utils 40 20 5

Graph

Law of Equi-marginal Utility

The Law of Equi-Marginal Utility is an extension to the

law of diminishing marginal utility. The principle of equi-marginal utility explains the behaviour of a consumer in distributing his limited income among various goods and services. This law explains how a consumer allocates his money income between various goods so as to obtain maximum satisfaction.

 A consumer will be at equilibrium when Mux/Px=Muy/Py

Law of Equi-marginal Utility

That is MU & Price are equalised while purchasing various commodities.

If Px falls equilibrium will be disturbed.Therefore to

achieve equilibrium, consumer will have to reduce his MUx & increase MUy till some extent. Therefore he purchases more of x and less of y. That is he substitutes commodity x for y when price of x falls.--- Substitution effect----psychological attitude.

 Income Effect---changes in real income of the consumer

due to changes in price of the commodity. When price of the commodity falls the purchasing power of money increases i.e ,consumer can buy same amount of commodity with less money or he can buy more with same money. Income effect may be positive, negative or zero. Income effect is positive (when commodity has relatively a higher MU) when more of the commodity is purchased whose price has fallen. Income effect is negative when the quantity purchased is less than before with a fall in the price of a given commodity. Zero when ----when income is spent on some other commodity

 Assumptions of Marshallian Utility Analysis Cardinal Utility Independent Utility Additive Utility Constant MU of money DMU Rationality

Indifference Curve Technique

Ordinal measurement implies comparison & ranking of

satisfaction enjoyed by the consumer without quantification .

Utility is seen as level of satisfaction rather than amount of

satisfaction. People are not interested in any one commodity at a time .

People are interested in number of commodities & satisfaction

resulting from their combinations. People can compare the level of satisfaction given by one particular combination of goods with that of another combinations.
Level of satisfaction is a function of increasing stock of

goods.A larger stock of goods apparently gives higher level of satisfaction than that of a smaller stock of goods.

A consumer conceptually arranges goods & their combinations in the order of their significance or level of satisfaction

Scale of Preference

Scale of Preference
Combination between pen / pencil Level of satisfaction Ranking order based on preference

12 /12
10 /9 5/5

Indifference Schedule
It is list of alternative combinations in the stock of two

goods which gives equal satisfaction to the consumer.

All combinations in the set of goods gives him equal

/same satisfaction. The consumer may come across some combinations which give the same level of satisfaction to him, so he prefers them equally. He is said to be indifferent to such combination.

Indifference schedule
Combination Pen X a 1 b 2 Pencil Y
12 8

MRS
-----4/1

c d

3 4

6
5

-2/1
-1/1

Indifference schedule

Indifference Curve

Indifference Curve
It is graphical representation of indifference schedule

It is the locus of points representing different

combinations of two goods (say x & y) which give equal satisfaction to the consumer. Different points on IC curve shows different combinations of two goods ( total stock same),but all combinations are of equal significance to him. Therefore he is indifferent to them. One IC shows one level of satisfaction.

Indifference Map
A group/set of IC is called an indifference map. It represents scale of preference of a consumer

regarding different combinations of the given two goods. It is pictograph of consumers choice & scale of preference. Higher IC shows higher level of satisfaction & lower IC shows lower level of satisfaction. Each IC shows a different level of satisfaction.

Assumptions
A consumer is interested in buying two goods in

combination. Rank his preference Non-satiation Rational Ordinal measurement of utility

Convex MRS Negatively sloped

properties

Never Intersect

Marginal Rate of Substitution

The amount of y that must be given up to get one more unit of x inorder to maintain same level of

satisfaction (same IC)

Downward slope of IC measures MRS.

Budget line
Income

Budget Constraint
Prices of two goods x

&y

The Consumer Equilibrium

Consumer equilibrium is achieved when, given his budget

constraint ,the consumer reaches the highest possible point on the indifference curve. Price line is tangent to the indifference curve. Indifference curve is convex to origin MRSxy is diminishing At point e consumer is in equilibrium.

Income Effect
Assume taste,preference ,prices of two goods to remain the

same, If income of the consumer changes the effect it will have on his buying pattern is called income effect. If income of the consumer increases his budget line will shift upwards to the right parallel to the original budget line.
Substitution effect ----- Uses of IC -------SUBSIDY & RATIONING

Indifference of Return

Iso quant

Iso cost

Producers Equilibrium

Production Function through

Isoquants/ Isoproduct Curves

In the long run, as all factors are variable the firm has a

wider choice of using different factors. Factors can be substituted to some extent so that level of output can be maintained at a particular level. Eg.10 units of output X can be produced as follows 2L +9 k 3l + 6k 4L +4k

Isoquants/ Isoproduct Curves This is similar to the concept of indifference curve. Isoquant shows different combinations of two factors which produce same/given quantity of output An isoquant shows different combinations of factors producing same output. Therefore the producer will be indifferent as regards choice between two factor combinations.

Production Function through

Isoquant schedule/Curve
Combination of Labour & Capital Units of Labour Units of Capital Output

A
B

1
2

15
11

200
200

C
D

3
4

8
6

200
200

Isoquant map
It shows set of isoquants/isoproducts

A higher isoquant shows a higher level of output &

a lower isoquant shows a lower level of output.

Marginal rate of technical substitution of any two

factors say labour & capital, is the number of units of capital which can be replaced by one of labour, the output remaining the same.
Isocost line shows various combinations of two

factors which a producer can purchase with a given outlay/expenditure.

Desired output

Least possible Cost Producers Equilibrium

Producers Equilibrium
Equal product/Isoquant curves shows various

possibilities of combining two factors A rational firm is interested in least cost combination of factors Compare a production map with cost line/Cost constraint Cost line is determined by factor prices Assume some fund/Money & factor prices Point of tangency between isoquant & cost line is producers equilibrium

Cost of production--Types
It is the aggregate of price paid for the factors of

production used in producing the commodity

Money

Fixed/Supplementary

Real

Implicit

Variable/Prime

Opportunity/Alter native

Economic

Marginal & Average

Private Cost
The cost incurred by the firm in producing a commodity or service

Social Cost
Total cost which includes direct & indirect cost that the society has to pay for the output of the commodity

 Nominal cost is the money cost of production i.e the

expenditure incurred on producing the product.

Real cost pain & scarifice by labourAdam Smith
Physical quantities of various factors used in producing a

commodity.
Opportunity cost /Social cost of production is the next

best alternative use of the factor which is sacrificed.For eg. Opportunity cost of producing one unit of commodity x is the amount of commodity y that must be sacrificed inorder to use resources to produce x rather than y.

 Explicit/Accounting costs are direct contactual monetary

payments incurred through market transactions.It is out of pocket expenses incurred to buy/hire resources required for production.

Implicit cost are the opportunity cost of the use of factors

which a firm does not buy or hire but already owns It is the cost of the factors owned by entrepreneur himself.
Economic cost= Explicit cost + Implicit cost

TP(Q) TFC O 1 2 3 4 5 6 7 8 100

TVC 0 25 40 50 60 80 110 150 300

TC 100 125 140 150

AFC ----100 50 33.3 25 20 16.3 14.2 12.5

AVC --------25 20 16.6 15 16 18.3 21.4 37.5

AC ------125 70 50 40 36 35 35.7 50

MC ----25 15 10 10 20 30 40 150

Traditional Theory of cost

Short Run Cost
TFC/TVC/TC AFC/AVC/AC/MC

Relationship between AC & MC

Refer Business Economics by DM Mithani

Long Run Average Cost

Can change all factors of production LAC curve is regarded as the long run planning

curve/envelope curve.
LAC is drawn by joining minimum points of SAC curves.

It is drawn on the basis of three possible plant sizes

LAC curve is U-shaped. It implies that when a firm

adopts a larger scale of output, its long run average cost in the beginning decreasing (economies of scale), then reaches minimum & finally starts rising(diseconomies of scale).

 It shows law of increasing returns to scale. A rational entrepreneur will select the optimum scale

of plant.
The optimal scale of plant is that plant at which a

SAC is tangent to LAC, & BOTH CURVES HAVE MINIMUM POINTS.

Revenue Concepts
Total Revenue is the total sales receipt. It depends on

two factors-price of the product & quantity of the product sold. Average Revenue is revenue obtained per unit of output sold. TR/Q It is price of the product.Price is always per unit. Marginal re venue is the addition made to the total revenue by selling one more unit of product.

Perfect Competition
Characteristics of perfect competition:

There are many sellers. The products sold by the firms in the industry are identical. Entry into and exit from the market are easy, and there are many potential entrants. Buyers (consumers) and sellers (firms) have perfect information. Price Taker A firm in a perfectly competitive market is said to be a price taker because the price of the product is determined by market supply and demand, and the individual firm can do nothing to change that price. Both buyers and sellers are price takers. Aprice taker is a firm or individual who takes the market price as given. In most markets, households are price takers they accept the price offered in stores.

There are no barriers to entry Barriers to entry are social, political, or economic impediments that prevent other firms from entering the market. Barriers sometimes take the form of patents granted to produce a certain good. Technology may prevent some firms from entering the market. Social forces such as bankers only lending to certain people may create barriers. The firms' products are identical. This requirement means that each firm's output is indistinguishable from any competitor's product. There is complete information/Perfect Knowledge Firms and consumers know all there is to know about the market prices, products, and available technology. Any technological breakthrough would be instantly known to all in the market.
There is difference between Firm and the Industry The demand curves facing the firm is different from the industry demand curve. A perfectly competitive firms demand schedule is perfectly elastic even though the demand curve for the market is downward sloping.

Revenue schedule
Quantity 1 2 3 Price/Average Revenue 250 250 250 Total Revenue 250 500 750 ----250 250 Marginal Revenue

Market Price $10 8 Market supply Price $10 8

Firm

6
4 2 0 Market demand

6
4 2 0 10

Individual firm demand

1,000

3,000 Quantity

20

30

Quantity

Two conditions for Equilibrium

MC=MR
MC curve should intersect MR curve from below & not

from above

Monopoly
Qty 1 2 3 4 price 25 24 23 22 TR 25 48 69 88 MR --23 21 19

Monopolistic Competition
Qty 1 2 3 4 price 25 23 22 21 TR 25 46 66 84 MR ---

Oligopoly
Competition among few---Fellned Workable Competition----Clark

Quasi monopoly----Samuelson
Interdependence--------any change in price,output,quality of

product or advertising expenditure by any firm is likely to evoke retaliation from others

Elements/Features of Oligopoly
Few ( large )sellers dominate the market
Each seller has sizeable influence on the market Consider action & reaction of rivals

Mutual interdependence
Not able to visualise consequences of its policy Demand curves keeps shifting Strong barriers High cross elasticity Homogeneous or differentiated product

Collusive Oilgopoly
Collusion reduces the degree of competition between

the firms & helps them act monopolistically in their effort of profit maximisation. Collusion reduces uncertainty surrounding the market since cartel members are not suppose to act independently & in the manner which will harm interest of members. Cartels are the perfect form of collusion. Collusion through price leadership is an imperfect form of collusion between oligopoly firms.

 Price leadership is an informal position of a firm an

oligopolistic setting to lead other firms in pricing.(partial oligopoly) Sometimes price leadership is barometric.i.e one of the firms not necessary dominant one, takes lead in announcing change in price,paricularly when such a change is due ,but not affected due to uncertainty in market.

Sweezys Model

Cournot Model
Assumptions

Two independent firms selling homogenous product

Both operate with zero cost & face downward sloping

linear demand curve Each firm expects no reaction from other firm in response to a change in its own behaviour. Though in practice each firm does change its own output, but no firm learns from past experience or mistake & continues to believe that the rival will not react.

Price Discrimination
The act of selling the output of the same product at

different prices in different markets or to different buyers. Discriminating monopoly FORMS DEGREES INGREDIENTS/CONDITIONS ESSENTIAL Price discrimination is categorized into three types: First degree price discrimination - charging what ever the market will bear, Second degree price discrimination - quantity discounts Third degree price discrimination - separate markets and customer groups.

First degree
This first type of product pricing is based on the sellers

ability to determine exactly how much each and every customer is willing to pay for a good. Different consumers have different preferences and levels of purchasing power and thus the amount they would be willing to pay for a good often exceeds a single competitive price. This difference between what a consumer is willing to pay and the price actually paid is known, of course, as consumers surplus. Thus a firm engaging in first degree price discrimination is attempting to extract all the consumers surplus from its customers as profits

Second Degree
In this case the seller charges a higher per-unit price

for fewer units sold and a lower per-unit price for larger quantities purchased. In this case the seller is attempting to extract some of the consumer's surplus Common examples of second degree price discrimination include quantity discounts for energy use; the variations in price for different sizes of boxed cereal, packaged paper products;

Third Degree
Third Degree Price Discrimination

The last type of price discrimination exists where the firm is able to segment its customers into two or more separate markets Each market defined by unique demand characteristics. Some of these markets might be less price sensitive (price inelastic) relative to other markets where quantity demanded is more sensitive to price changes (price elastic). Examples of third degree price discrimination include: business vs. tourist airfares, business vs. residential telephone service, and senior discounts.

Degrees of price discrimination

Pigou First degree Monopolist charges different prices to different buyers

for each different unit of same product The price charged for each product & each buyer depends on MU the buyer estimates & what max price he is willing to pay The entire consumer surplus of buyer is converted into producers profits.

Second Degree Price Discrimination

The monopolist sells blocks of output at different prices Max. possible price is charged for some given minimum

block of output purchased by the buyer & then additional blocks are sold at successively lower prices. Monopolist captures a part of consumers surplus Public Utilities

Third degree price discrimination

The firm divides its total output into many sub-

markets It sets different prices for its product in each market in relation to the demand elasticities. Different prices are charged in different market,but in each market buyers are treated equally.